Page 246 - DMGT207_MANAGEMENT_OF_FINANCES

Unit 10: Working Capital Management

Aggressive Approach Notes

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:
1. 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.
2. 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.
3. 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.

4. Loans: In a loan account, the entire advance is disbursed at one time either in cash or by
transfers to the current account of the borrower.

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