Category Archives: THEORY OF WORKING CAPITAL MANAGEMENT

Interpretation

Interpretation From the summary of results in Table, it can be seen clearly that the hedging approach is the most risky while the conservative approach is the least risky. The trade stands midway; less risky than the hedging approach but more risky than the conservation approach. The measure of risk is the level of NWC. From the point of view of profit (reflected in the level of total cost of financing plan) a s

Comparison of the Trade off Plan

Comparison of the Trade off Plan With the Hedging and Conservative Approaches For a comparison of the three approaches to determine an appropriate financing mix, the summary of the results of these approaches on profitability and risk is given in Table. TABLE Comparison of Trade off Plan Comparison of the Trade off Plan With the Hedging and Conservative Approaches The minimum level would be zero in each case.

A Trade off Between the Hedging and Conservative Approaches

A Trade off Between the Hedging and Conservative Approaches It has been shown that the hedging approach is associated with high profits as well as high risk, while the conservative approach provides low profits and low risk. Obviously, neither approach by itself would serve the purpose of efficient working capital management. A trade off between these two extremes would give an acceptable financing strategy. The

Risk Considerations

Risk Considerations The two approaches can also be contrasted on the basis of the risk involved. Hedging Approach The hedging approach is more risky in comparison to the conservative approach. There are two reasons for this. First, there is, as already observed, no NWC with the hedging approach because no long term funds are used to finance short term seasonal needs, that is, current assets are just equal to cur

Comparison of Hedging Approach with Conservative Approach

Comparison of Hedging Approach with Conservative Approach A comparison of the approaches can be made on the basis of (i) cost considerations, and (ii) risk considerations. Cost Considerations The cost of these financing plans has a bearing on the profitability enterprise. We assume that the cost of short term funds and long term funds, as in the Section dealing with profitability risk trade off, is 3 per cent and

Conservative Approach

Conservative Approach This approach suggests that the estimated requirement of total funds should be met from long term sources, the use of short term funds should be restricted to only emergency situations or there is an unexpected outflow of funds. In the case of the Hypothetical Ltd. The requirements including the entire Rs 9,000 needed in October, will be financed by sources. The short term funds will be use

DETERMINING FINANCING MIX

DETERMINING FINANCING MIX Apart from the profitability risk trade off, another important ingredient of the theory of working capital management is determining the financing mix. One of the most important decisions, in other words, involved in the management of working capital is how current assets will be financed. There are, broadly speaking, two sources from which funds can be raised for current asset financi

Combined Effect of Changes in Current Assets

Combined Effect of Changes in Current Assets and Current Liabilities on Profitability Risk Trade off The combined effects of changes in current assets and current liabilities can be measured by considering them simultaneously. We have shown in the preceding sections the effects of a decrease in the current assets total assets ratio and the effects of an increase in the current liabilities total assets ratio. The

Effect of an Increase In the Ratio

Effect of an Increase In the Ratio One effect of an increase in the ratio of current liabilities total assets would be that profitability will increase. The reason for the increased profitability lies in the fact that current liabilities, which are a short term source of finance, will increase whereas the long term sources of finance will be reduced. As short term sources of firm are less expensive than long run s

Effect of the level of Current Assets on the Profitability Risk Trade off

Effect of the level of Current Assets on the Profitability Risk Trade off The effect of the level of current assets on profitability risk and trade off can be shown, using the ratio of current assets to total assets. This ratio indicates the percentage of total assets that are in the form of current assets. A change in the ratio will reflect a change in the amount of current assets. It may either increase or de