Working capital is a crucial parameter in an organization’s operational competency. Based on the organization and its necessity, there can be different working capital types under 2 views, namely, operating cycle and balance sheet view. Prudent management of different working capital types renders adequate business growth and daily mandatory operational funds for various needs.
Besides this, the policy the organization adopts to fund its working capital holds utmost importance. While inept policy for long term keeps the organization’s fund underutilized, its overall growth may be hampered or at worse witness massive losses. Likewise, an aggressive policy adoption for a substantial time-period may result in maximum fund utilization and higher growth, the company in times of financial emergencies holds the risk of witnessing monetary mismatches. However, this risk can be met by availing a working capital loan.
Thus, it is essential to have a clear understanding about different working capital funding strategies or policies to generate optimal results. Working capital policies, in general, include determining the finance sources. Also, it determines allocation of these funds towards current liabilities and assets. Broadly, there are 3 major working capital strategies that can assist optimize working capital financing for a company, namely, conservative, hedging, and aggressive according to the risk levels involved.
- Conservative policy
A company takes up this policy just when it needs to minimize its risk to the extent possible. As per this policy, management regulates all its credit limits rigorously to make sure that there’s low risk. Moreover, current assets here are always over par against current liabilities to keep adequate availability of funds. Businesses majorly use long-term business financing options to fund fluctuating current and fixed assets. Use of the short-term sources are kept to the lowest level possible for low risk. Undertaking conservative working capital policy, results in underutilization of the funds, which cuts down your business returns and compromises growth.
- Aggressive policy
As the name suggests, aggressive strategy means involvement of maximum risk, which is known to bring huge potential to attain higher growth. When observing this policy, organizations make sure their current assets like debtors’ value are minimized through timely payments or minimal credit sales. At the same time, management even considers delaying the creditors payment to the extent possible.
Companies aiming to avail accelerated growth can choose this policy. However, as it comes with massive risk, strong corporate acumen and adroit handling of funds are crucial. If not done right, the need for a working capital loan may come up.
- Hedging policy
Also called matching policy, opting for this strategy ensures the right sync between the company’s current assets and short-term liabilities. In other terms, this financing policy aims at striking a balance between the 2 extreme strategies, in terms of growth and risk potential. Companies employing this policy use the long-term fund sources to invest in the fixed assets and opt for the short-term financing options to meet current asset funding.
Conclusion
For zeroing on a specific funding policy and financing options, you must account for parameters like liquidity, profitability and working capital requirement. Ideally, a combination of policies must be used for working capital management, which solely depends upon your risk appetite.
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