Working Capital Policies/Approach

June 1st, 2008 Comments off
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For a firm, it can exercise a few options/policies when considering the risk return aspect when managing its working capital.

The following describe the different policies:

 

 

(1) MATCHING OR HEDGING APPROACH/POLICY

 

  • This approach or policy is a moderate policy that matches assets and liabilities to maturities.
  • Basically, a firm uses long term sources to finance fixed assets and permanent current assets and short term financing to finance temporary current assets

 

  • Simple illustration:

 

  • A fixed asset/equipment which is expected to provide cash flow for 8 years should be financed by say 8 years long-term debts
  • Assuming a firm needs to have additional inventories for 2 months, it will then sought short term 2 months bank credit to match it.

 

 

(2) CONSERVATIVE APPROACH/POLICY

 

  • Conservative because the firm prefers to have more cash on hands
  • Fixed and part of current assets are financed by long-term or permanent funds
  • As permanent or long-term sources are more expensive, this leads to “lower risk lower return”
  • Having excess cash at off-peak period hence the need to invest the idle or excess cash to earn returns.

(3) AGGRESSIVE APROACH/POLICY

  • The firm want to take high risk where short term funds are used to a very high degree to finance current and even fixed assets

 

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Financial Accounting

 
 

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