working capital finance. financing current assets- policies short term current assets financed by...
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WORKING CAPITAL FINANCE
Financing Current Assets- Policies
• Short termCurrent Assets financed by only short term financial sources(period < 1year) like CP’s, Bill discounting, etc..• Long termNet Current Assets or permanent current assets or working capital financed by long term sources (period> 5years) like Equity Share Capital, Preference Share Capital, Debentures, Long term loans, etc.• Spontaneous FinancingRefers to Automatic sources of short term funds arising in the Normal course of business like trade credit, outstanding expenses, etc.
APPROACHES FOR FINANCING CURRENT ASSETS
• Matching or Hedging
• Conservative
• Aggressive
Matching or Hedging
• Expected life of an asset is matched with the source of finance period with which an asset is financed.
• Fixed assets & permanent current assets should be financed by long term funds and temporary current assets should be financed by short term funds.
Conservative
• Firm depends more on long term funds for financing needs.
• Firm finances its regular or permanent current assets & a part of temporary current assets with long term sources of funds.
• Where the firm do not require funds temporary current assets , the idle funds can be invested in marketable securities so that the firm conserves LIQUIDITY.
Aggressive
• Firm finances part of regular or permanent current assets with short term sources of funds.
RISK RETURN TRADE OFF IN MANAGING A FIRM’S NET WORKING CAPITAL
Firm Profitability Firm Liquidity
Investing in additional marketable securities & inventories
LOWER HIGHER
Increasing the use of short term versus long term sources of financing
HIGHER LOWER