WORKING CAPITAL POLICIES essay sample

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WORKING CAPITAL POLICIES

CONSERVATIVE WORKING

CAPITAL POLICY

This policy enables a company to maintain higher working capital and a higher level of current assets. The working capital is financed by long-term finance sources which eliminates the risk associated with short term finances (Efinancemanagement.com).

ADVANTAGES

The level of current assets and working capital is high. Any abnormalities in production, sales or delays in procurement are absorbed by the higher levels of inventory. The company is able to achieve higher customer satisfaction levels and the company operations run smoothly.The higher levels of accounts receivables attracts more customers which increases sales and in turn higher profit levels.The higher levels of working capital and cash enables the company to avoid the insolvency risks associated with changes in interest rates and the need to refinance using short term sources of finance.DISADVANTAGEThe employment of long term financing is likely to be affected by higher interest rates. The long term funds cannot be paid off in short term and they may remain unutilized. The idle funds are subjected to opportunity costs.There are higher carrying costs which are brought about by the high level of debtors and inventory. This has a direct impact on profitability. This type of working capital management is inefficient.

AGGRESSIVE WORKING CAPITAL POLICY

Short term finances are used to finance the temporary and permanent working capital. The levels of inventory, bank balances and accounts receivables are sufficient and there is no cushion for uncertainty (Efinancemanagement.com).

ADVANTAGE

There are low interest rates because the short term finances are put to maximum use. There are no idle funds since the loans can be repaid in the off seasons. This type of working capital management can be referred to as the most efficient if the operating cycle works smoothly. Holding and carrying costs are lower due to the low levels of inventory. The profitability levels are affected directly and positively. The company enjoys higher profitability.

DISADVANTAGE

There are high levels of insolvency risks involved because the permanent assets are also financed by the short term funds. There is need for repeated refinancing so as to maintain the permanent assets. The finances may not always run smoothly and in case the firm is unable to finance the permanent assets, it is forced to sell them. There is also risks of liquidation if the firm is unable to realize the sold assets on time. The firm is not cushioned against unexpected shocks and therefore may not be able to meet requirements of sudden large contracts of sales. The firm therefore loses many huge profitable opportunities. Cases of equipment breakdowns and lack of raw materials would adversely affect the operating cycle of the business.

HEDGING WORKING CAPITAL POLICY

Short term finances are achieved using short term debts while long term finances are met with long term debts. Each asset is compensated by a debt instrument with almost equal maturity. This policy is also referred to as maturity matching policy (Efinancemanagement.com).

ADVANTAGE

Interest costs are optimized as funds remain on the balance sheet until they are required and repaid as soon as they are …

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