1. Aggressive policy
As the name suggests, this policy is a high-risk one and is mainly followed by companies looking for brisk growth. Owing to the risk factors, returns are also higher. To follow this, a business must minimise its current assets or the debt it is owed. Here, there are no debtors as payments are collected in time and are eventually invested in businesses. Creditors’ payments are delayed to the maximum. Doing so may provide possibilities to sell out company assets to clear debts.
2. Conservative policy
Businesses with a low-risk appetite are inclined towards such a policy. Credit limits are pre-set to a specific amount in this policy, and these enterprises refrain from doing business on credit. Generally, a conservative working capital policy is followed to keep the company assets and liabilities in sync with each other, with the assets valuing on the higher side in case of sudden difficulties.
3. Matching policy
This is a hybrid between aworking capital management policyand a working capital financing policy. Businesses generally follow this policy when they want to maintain minimal working capital by utilising funds elsewhere. Here, the current assets of the balance sheet are matched with the current liabilities and less cash is kept in hand. This enables the rest of the finance to expand the business, increase production, and more.
Comparison of working capital financing policies
Working capital financing policies are critical for a company's financial health. They determine the balance between short-term assets and liabilities. Three common policies are aggressive, conservative, and matching, each with distinct characteristics and implications.
| Criteria | Aggressive policy | Conservative policy | Matching policy |
| Approach | High short-term debt, low cash | Low short-term debt, high cash | Moderate short-term debt, cash |
| Risk Level | High risk due to debt reliance | Low risk with ample liquidity | Balanced risk-reward strategy |
| Profitability | Potential for higher returns | Lower returns due to less debt | Moderate returns, lower risk |
| Flexibility | Limited due to high debt | Enhanced due to cash reserves | Moderate flexibility |
| Interest costs | Higher interest expenses | Lower interest expenses | Moderate interest expenses |
| Liquidity management | Weak liquidity management | Strong liquidity management | Balanced liquidity approach |
| Suitability | Risk-tolerant, growth-oriented | Risk-averse, stable businesses | Balanced approach for most |
The choice among these policies depends on a company's risk tolerance, growth objectives, and industry dynamics. Companies often adjust their working capital financing policies to adapt to changing financial circ*mstances and market conditions.
Benefits of working capital policy
A well-structured working capital financing policy offers several benefits to businesses. Firstly, it ensures the availability of sufficient liquidity to cover day-to-day operations, reducing the risk of insolvency. Secondly, it helps optimise the use of assets by aligning short-term liabilities with short-term assets, improving operational efficiency. Additionally, a balanced policy can enhance a company's creditworthiness, making it easier to secure loans or credit when needed. Moreover, it provides the flexibility to adapt to changing market conditions, supporting growth and innovation. Overall, a strategic working capital financing policy is a vital tool for maintaining financial stability, growth, and resilience in a dynamic business environment.
Which working capital policy is right for you?
Choosing the right working capital policy hinges on your business's unique circ*mstances and objectives. If you prioritise stability and safety, a conservative policy with ample cash reserves is suitable. It safeguards against unforeseen challenges but may limit potential returns. For those seeking aggressive growth and willing to accept higher risk, an aggressive policy with increased short-term debt can fuel expansion but comes with greater financial risk.
A matching policy strikes a balance, offering moderate risk and flexibility. Analyse your risk tolerance, industry dynamics, and financial goals to make an informed choice. Furthermore, be prepared to adapt your policy as your business evolves and market conditions change.
As per your enterprise’s working capital financing policy, select aworking capital loanand meet short or long-term expenses with ease.
FAQs
Three common policies are aggressive, conservative, and matching, each with distinct characteristics and implications. The choice among these policies depends on a company's risk tolerance, growth objectives, and industry dynamics.
What is the meaning of working capital explain with its types? ›
Regular working capital is the amount of funds businesses require to fund its day to day operations. For example, cash needed for making payment of wages, raw materials, salaries comes under regular working capital. Reserve Margin Working Capital.
What is working capital funding policy? ›
Working capital financing or working capital policy is defined as the funds that a business needs to finance its daily operations and cover its short-term expenses such as salaries, rent, inventory purchases, and other expenses.
What are the benefits of working capital financing? ›
It ensures a company can meet its short-term obligations, such as paying suppliers and employees, without financial strain. Adequate working capital allows businesses to manage operations smoothly, invest in growth opportunities, and handle unexpected expenses.
What are the 4 main components of working capital? ›
A well-run firm manages its short-term debt and current and future operational expenses through its management of working capital, the components of which are inventories, accounts receivable, accounts payable, and cash.
What are three examples of working capital? ›
Regular working capital: This is the least amount of capital required to meet current working expenses under normal conditions. Some examples of this capital include salary and wage payments, materials and supplies, and overhead costs.
How do you explain working capital? ›
Working capital is a financial metric that is the difference between a company's curent assets and current liabilities. As a financial metric, working capital helps plan for future needs and ensure the company has enough cash and cash equivalents meet short-term obligations, such as unpaid taxes and short-term debt.
What is another name for working capital? ›
Working capital is also known as Net Working Capital (NWC). This is derived by comparing the current assets with the current liabilities on the balance sheet.
What does the working capital stand for answer? ›
Working capital indicates the liquidity levels of businesses for managing day-to-day expenses and covers inventory, cash, accounts payable, accounts receivable and short-term debt. It is an indicator of the short-term financial position of an organisation and is also a measure of its overall efficiency.
How do you calculate working capital policy? ›
Working capital = current assets – current liabilities. Net working capital = current assets (minus cash) - current liabilities (minus debt).
Working capital requirement is the amount of funds or financing needed now to grow and finance ongoing costs. Capital is a more permanent measure of your assets versus liabilities. It includes equity and long-term debt financing, savings, and owned property.
What is the principle of working capital policy? ›
This principle states that the working capital should be so raised from different sources that the firm is able to repay them on maturity out of its inflows of funds. Otherwise the firm would fail to repay on maturity and ultimately, it would find itself into liquidation though it is earning huge profits.
What is working capital financing in simple words? ›
Working Capital Financing is when a business borrows money to cover day-to-day operations and payroll rather than purchasing equipment or investment. Working capital financing is common for businesses with an inconsistent cash flow.
What are the risks of working capital financing? ›
Poor working capital management can increase financial risk by relying too much on debt, paying high interest rates, or facing default or bankruptcy. For example, if a business has too many payables, it may face liquidity problems, late payment penalties, or legal actions.
What is the difference between conservative and aggressive working capital policy? ›
Aggressive and conservative levels of working capital sit at opposite ends of the spectrum. An aggressive policy means spending as much as possible to churn out products, move inventory and deliver services. With a conservative approach, money is being saved, and your business is buffered, somewhat, against risk.
What are the four types of working capital required by a business concern? ›
It is of two types: Initial and Regular working capital. Variable Working Capital: It is the difference between networking capital and permanent working capital. The amount of temporary' working capital depends upon the extent of extra demand in season. It is of two types: seasonal and special working capital.
What are the types of capital fixed and working capital? ›
Fixed capital is defined as the assets or investments needed to establish and operate a business, such as property or equipment. Usually, working capital refers to cash or other liquid assets that an organisation uses to finance day-to-day operations such as payroll and bill payments.
What are the three main working capital strategies differ primarily in? ›
Question: The three main working capital strategies, namely aggressive, conservative, and moderate, differ primarily in the: relative amounts of short-term debt used.
