WC Funding Policies

NotesVideoQuizObjective Test

Working Capital Funding

Even companies in the same industry will have different levels of inventory and receivables, due to their differing policies.

An aggressive policy uses lower levels of inventory and trade receivables than a conservative policy, and so will lead to a shorter cash operating cycle.

A conservative policy on the level of investment in working capital, in contrast, with higher levels of inventory and trade receivables, will lead to a longer cash operating cycle.

The higher cost of the longer cash operating cycle will lead to a decrease in profitability while also decreasing risk, for example the risk of running out of inventory.

Matching funding policy

  1. Use long-term finance

    For both permanent current assets and non-current assets

  2. Use short-term finance

    to cover the short-term changes in current assets represented by fluctuating current assets

Conservative funding policy

  • This will use a higher proportion of long-term finance than a matching policy, thereby financing some of the fluctuating current assets from a long-term source.

  • This will be less risky and less profitable than a matching policy, and will give rise to occasional short-term cash surpluses.

Aggressive funding policy

  • This will use a lower proportion of long-term finance than a matching policy, financing some of the permanent current assets from a short-term source such as an overdraft. 

    This will be more risky and more profitable than a matching policy

Management attitudes to risk, previous funding decisions and organisation size

  • Management attitudes to risk will determine whether there is a preference for a conservative, an aggressive or a matching approach. 

    Previous funding decisions will determine the current position being considered in policy formulation.

  • The size of the organisation will influence its ability to access different sources of finance. 

    A small company, for example, may be forced to adopt an aggressive working capital funding policy because it is unable to raise additional long-term finance, whether equity of debt.

NotesVideoQuizObjective Test