Introduction
A self-liquidating loan is a short—or intermediate-term credit paid back with the proceeds from the purchases of the assets it was used to acquire. The expiration and schedule of payments are arranged to correspond with when income from the assets is anticipated (Keown et al., 2019). These loans are meant to finance investments yielding fast and consistent cash flow.
Application of the Concepts and Principles to the Cases
Case of Applewood Homes
Applewood Homes is deciding whether to borrow $5 million short or long-term to expand its care facilities, which will last 10 years.
Application of Self-Liquidating Debt
The principle of self-liquidating debt cannot be applied to the case of Applewood Homes to borrow $5 million to invest in expanding the organization’s care facilities. The estimated time these facilities will work is ten years. The company works with senior housing complexes, and the revenue from these additional care facilities will not be fast. Even though the credit for these assets improves the quality of care the company provides to its clients, it might not be the optimal credit choice for them (Reuten, 2019).
A self-liquidating loan is similar to a revenue bond with a sinking fund characteristic. Revenue bonds are backed by designated funding sources, like tolls on a highway, while a sinking fund sets aside funds specifically for debt repayment. As the researchers state, purchasing depreciable assets like machinery, office supplies, or fixed assets like real estate does not make financial sense (Keown et al., 2019). In this case, improved care facilities are the long-term investment into the depreciable asset.
Case of XYZ Chemicals
XYZ Chemicals requires $2 million to buy inventory to support its increasing sales, with no expectation of future reduction in inventory needs.
Application of Self-Liquidating Loan
The self-liquidating loan is the credit XYZ Chemicals requires in the discussed situation. As the company needs $2 million to buy inventory necessary for the increasing sales volumes, this sum will be repaid soon. In addition, the company’s leaders do not think the sales will be lower in the future, meaning the organization will develop and expand. These loans typically target projects or assets that create cash flow since they are simple to repay by selling the capital acquired and keeping the proceeds as profit in the interim (Keown et al., 2019). This description corresponds to the characteristics of the self-liquidating loan.
Case of HomeBake
HomeBake anticipates needing an extra $5 million from November to January to fund its seasonal inventory and receivables expansion.
Application of Self-Liquidating Loan
HomeBake’s case is also optimal for taking a self-liquidating loan. According to the description of their business situation, the organization will need an additional $5 million on a seasonal basis to increase the number of receivables and inventories. It is possible to make parallels with a self-liquidating loan a retail company can use to buy excess inventory before the holiday shopping season (Harker & Horton, 2022). The loan would subsequently be repaid using the proceeds from selling that merchandise. A similar pattern is applied to HomeBake, which will experience a rise in profit from November to January.
Conclusion
Therefore, self-liquidating loans are paid back with the cash flow that the assets produce, which is used to finance purchases. A self-liquidating loan is typically taken out to cover a short-term requirement for more cash-generating purchases. Seasonal enterprises most frequently utilize these loans and have a high volume of sales in a short amount of time. Self-liquidating loans often have a short payback scope since they finance transient gains in asset values.
References
Keown, A. J., Martin, J. D., & Petty, J. W. (2019). Foundations of finance. Pearson.
Reuten, G. (2019). The unity of the capitalist economy and state: A systematic-dialectical exposition of the capitalist system. Brill.
Harker, C., & Horton, A. (2022). Financing prosperity by dealing with debt. UCL Press.