Page 225 - DMGT405_FINANCIAL%20MANAGEMENT

Unit 10: Working Capital Management

Conservative Approach Notes

Under this approach, a firm finances its permanent assets and also a part of temporary current
assets with long-term financing and is less risky so far as insolvency is concerned, however the
funds may be invested in such investments which fetch small returns to build up liquidity.

Aggressive Approach

The firm uses mere short-term financing than is warranted. In this approach, the firm finances a
part of its permanent current assets with short-term financing. This is more risky, but may add
to the return on assets.

Task How do changes in the ratio of current liabilities to total assets affect profitability
and risk?

Self Assessment

Fill in the blanks:
9. A ………………current asset policy tends to reduce risk.

10. The …………..component depends on how conservative or aggressive is the current asset
policy of the firm.

10.6 Financing of Working Capital

Following are the different short-term and long-term sources of finance available for working
capital:
1. Long-term sources: For example, Share capital (equity and preference), Retained earnings,
and debentures/bonds of different types, loans from bank and financial institutions, venture
capital financing.
2. Short-term sources:
(a) Bank credit: cash credit, bills finance, overdraft facility, working capital demand
loan, commercial paper.
(b) Transaction credit: trade allowed by creditors, outstanding labour and other expenses.
Some of the short-term sources of finance are given below as a reference:
(a) Trade credit: It represents credit granted by suppliers of goods, etc., as an incident of
sale. The usual duration of such credit is 15 to 90 days. It can be in the form of an “open
account” or “bills payable.” Trade credit is preferred as a source of finance because it
is without any explicit cost and till a business as a going concern keeps on rotating.
(b) Advance from customers: Manufacturers and contractors engaged in producing and
constructing costly goods involving considerable length of manufacturing or
constructions usually demand advance mainly from their customers at the time of
accepting the orders for executing the contracts or supplying the goods.
(c) Bank advances: Banks receive deposits from public for different periods at varying
rates of interest. These funds are invested and lent in such a manner that when
required they may be called back. Lending results in firm revenues out of which
costs such as interest on deposits, administrative costs are met and a reasonable
profit is made.

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