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Chapter 7
Policies regarding working capital
management
3.1 Aggressive vs conservative
Aggressive approach – low levels of working capital – low current assets, high
current liabilities – high profitability but high risk
Conservative approach – high levels of working capital – high current assets, low
current liabilities – lower profitability but lower risk
3.2 Over-capitalisation and working capital
Excessive current assets and low current liabilities mean that the business is over-
capitalised. There has been an over investment by the business in current assets.
Profitability will suffer as a result.
3.3 Overtrading
Healthy trading growth typically leads to:
increased profitability and
the need to increase investment in non-current assets and working capital.
If the business does not have access to sufficient capital to fund the
increase it is said to be “over trading”. This can cause serious trouble
for the business if it is unable to pay its business payables.
Indicators of overtrading are:
A rapid increase in revenue
A rapid increase in the volume of current assets
Most of the increase in assets being financed by credit
A dramatic drop in the liquidity ratios (see next section)
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