Questions to expert:

EXPERT ONE:
How important is working capital with regards to making financing decisions? How will the working capital affect financing
decision?
The level of current assets is a key factor in a companys liquidity position. A company must have or be able to generate enough cash to
meet its short-term needs if it is to continue in business. Therefore, working capital management is a key factor in the companys longterm success: without the oil of working capital, the engine of non-current assets will not function. The greater the extent to which
current assets exceed current liabilities, the more solvent or liquid a company is likely to be, depending on the nature of its current
assets.
Because working capital management is so important, a company will need to formulate clear policies concerning the various
components of working capital. Key policy areas relate to the level of investment in working capital for a given level of operations and
the extent to which working capital is financed from short-term funds such as a bank overdraft. A company should have working capital
policies on the management of inventory, trade receivables, cash and short-term investments in order to minimise the possibility of
managers making decisions which are not in the best interests of the company. Examples of such suboptimal decisions are giving credit
to customers who are unlikely to pay and ordering unnecessary inventories of raw materials. Sensible working capital policies will
reflect corporate decisions on: the total investment needed in current assets, i.e. the overall level of investment; the amount of
investment needed in each type of current asset, i.e. the mix of current assets; and the way in which current assets are to be financed.
Working capital policies need to consider the nature of the companys business since different businesses will have different working
capital requirements. A manufacturing company will need to invest heavily in spare parts and components and might be owed large
amounts of money by its customers. A food retailer will have large inventories of goods for resale but will have very few trade
receivables. The manufacturing company clearly has a need for a carefully thought out policy on receivables management, whereas the
food retailer may not grant any credit at all. Working capital policies will also need to reflect the credit policies of a companys close
competitors, since it would be foolish to lose business because of an unfavourable comparison of terms of trade. Any expected
fluctuations in the supply of or demand for goods and services, for example due to seasonal variations in business, must also be
considered, as must the impact of a companys manufacturing period on its current assets.
How does Working capital affects both the liquidity and profitability of a business?
Short term Investment decisions are concerned with the decisions about the level of cash, inventory and debtors etc. (working capital)
Efficient cash management, Inventory management and receivable management are essential ingredients of sound working capital
management.
The working capital should be neither more or less than required. Both the situations are harmful. If the amount of working capital is
more than required, it will no doubt increase the liquidity but decrease the profitability. Similarly if there is a shortage of working capital,
it will face the problem of meeting day to day requirements.
Thus optimum amount of current assets and current liabilities should be determined so that the profitability of the business remains
intact and there is no fall in the liquidity.
EXPERT TWO:
How will we know or how can we determine the level of current assets that should be carried? (ALTERNATIVE CURRENT
ASSET INVESTMENT POLICIES)
An aggressive policy with regard to the level of investment in working capital means that a company chooses to operate with lower
levels of inventory, trade receivables and cash for a given level of activity or sales. An aggressive policy will increase profitability since
less cash will be tied up in current assets, but it will also increase risk since the possibility of cash shortages or running out of inventory
is increased. A conservative and more flexible working capital policy for a given level of turnover would be associated with maintaining a
larger cash balance, perhaps even investing in short-term securities, offering more generous credit terms to customers and holding
higher levels of inventory. Such a policy will give rise to a lower risk of financial problems or inventory problems, but at the expense of
reducing profitability. A moderate policy would tread a middle path between the aggressive and conservative approaches. All three
approaches are shown in Figure 3.1. It should be noted that the working capital policies of a company can be characterised as
aggressive, moderate or conservative only by comparing them with the working capital policies of similar companies. There are no
absolute benchmarks of what may be regarded as aggressive or otherwise, but these characterisations are useful for analysing the
ways in which individual companies approach the operational problem of working capital management.
How is working capital calculated?
How will we finance the working capital? (ALTERNATIVE CURRENT ASSET FINANCING POLICIES)
EXPERT THREE:
What are the benefits of having an adequate working capital?

PROBLEM of the company

Good morning, I want to develop an asset financing plan for my company. Currently I have P500,000 current assets of which 15% are
permanent and P700,000 in fixed assets. The current long-term rate is 11% and the current short-term rate is 8.5%. (TAX rate 40%).
Now, I am confused as to which financing plan to pursue whether to apply the conservative with 80% of assets financed by long-term
sources or apply the aggressive with only 60% of assets financed by long-term sources? Which plan can you recommend and what are
the risks associated with each plan?

QUESTIONS FROM NETIZENS TO EXPERTS:

Facebook:
1. How can we avoid problems of shortage and surplus of funds?
Financial Planning is required to avoid shortage or surplus of finance. Importance of financial planning is:
a) By planning utilization of finance, it reduces waste , duplication of efforts and gaps in the planning.
b) It helps in coordinating the various business activities such as sales, purchases, production, finance etc.
c) It is a technique of control. It helps in setting up standard and compare with the actual performance. The deviations, if any are then
analysed. Causes found out and corrective measures are taken.
(d)It helps in avoiding shocks and surprises as proper provision regarding Shortage or surplus is made in advance by anticipating future
receipts and Payments.
2. Is there an exact financing pattern to be applied? How will we know that we chose the appropriate financing pattern?
3. What if I have an excessive working capital, is okay? (answer is disadvantages)