Investment in current assets

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The level of investment in current assets

This varies from company to company, depending on the following:

1) Length of working capital cycle

  • The working capital cycle or operating cycle is the period of time between when a company settles its accounts payable and when it receives cash from its accounts receivable.

  • As the operating period lengthens, the amount of finance needed increases. 

    Companies with comparatively longer operating cycles than others in the same industry sector, will therefore require comparatively higher levels of investment in current assets.

2) Terms of trade

  • These determine the period of credit extended to customers, any discounts offered for early settlement or bulk purchases, and any penalties for late payment.

  • A company whose terms of trade are more generous than another company in the same industry sector will therefore need a comparatively higher investment in current assets.

3) Policy on level of investment in current assets

  • Even within the same industry sector, companies will have different policies regarding the level of investment in current assets, depending on their attitude to risk.

  • A company with a comparatively conservative approach to the level of investment in current assets would maintain higher levels of inventory, offer more generous credit terms and have higher levels of cash in reserve than a company with a comparatively aggressive approach.

  • While the more aggressive approach would be more profitable because of the lower level of investment in current assets, it would also be more risky, for example in terms of running out of inventory in periods of fluctuating demand or of failing to have the particular goods required by a customer

4) Industry in which organisation operates

  • Some industries, such as aircraft construction, will have long operating cycles due to the length of time needed to manufacture finished goods and so will have comparatively higher levels of investment in current assets than industries such as supermarket chains, where goods are bought in for resale with minimal additional processing and where many goods have short shelf-lives.

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