9.7 Working capital financing policies: Aggressive, conservative and matching financing policy

Working capital financing policies refer to the strategies and approaches a company adopts to finance its short-term operational needs. Three common working capital financing policies are:

Aggressive Financing Policy: Under an aggressive financing policy, a company relies more on short-term financing to meet its working capital requirements. The key characteristics of an aggressive financing policy include:

Higher reliance on short-term debt: The company uses short-term loans, lines of credit, and trade credit to fund its working capital needs.
Lower cash reserves: The company keeps minimal cash reserves, preferring to invest available funds in more productive assets.
Greater risk tolerance: The company is willing to take on higher levels of debt and leverage to finance its operations.
Potential benefits: Aggressive financing policy can result in lower financing costs, improved return on equity, and higher profitability.

Conservative Financing Policy: Under a conservative financing policy, a company adopts a more cautious approach and relies on long-term financing sources to fund its working capital needs. The key characteristics of a conservative financing policy include:

Reliance on long-term debt: The company secures long-term loans and financing arrangements to support its working capital requirements.
Higher cash reserves: The company maintains significant cash reserves to meet unexpected expenses and ensure financial stability.
Lower risk tolerance: The company prioritizes stability and minimizes the risk of short-term liquidity issues.
Potential benefits: Conservative financing policy provides financial stability, reduces the risk of default, and enhances the company’s ability to withstand economic downturns or adverse market conditions.

Matching Financing Policy: A matching financing policy aims to align the maturity and cash flow patterns of assets and liabilities. The key characteristics of a matching financing policy include:

Financing with similar maturity: The company matches the maturity of its short-term assets (such as receivables and inventory) with the maturity of its short-term liabilities (such as short-term loans and lines of credit).
Minimizing interest rate and refinancing risk: By aligning the cash inflows and outflows, the company reduces the risk associated with interest rate fluctuations and the need for frequent refinancing.
Potential benefits: Matching financing policy helps ensure a better match between cash inflows and outflows, reducing the risk of cash flow imbalances and optimizing liquidity management.