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Working capital management – Cash and funding strategies

Strategies for funding working capital

In the same way as for long-term investments, a firm must make a
decision about what source of finance is best used for the funding of
working capital requirements.

Current assets are made up of two elements:

 permanent – the proportion of current assets that are effectively ‘fixed, e.g.
buffer inventory levels, minimum receivables and minimum cash balances.

 fluctuating – the proportion of current assets that changes, e.g. inventory above
the buffer level, receivables above the minimum level.

The choice of funding working capital is either from:

 short-term sources – cheaper due to lower risk for investor, but more risky as
may not be renewed.

 long-term sources – more expensive than short-term but less risky.

The strategy adopted depends on management’s attitude to risk

 aggressive – finance most current assets, including permanent ones, with short-
term finance. Risky but cheaper (more profitable).

 conservative – finance most current assets, including a portion of fluctuating
ones, with long-term finance. Safer but more expensive.

 matching – fluctuating current assets financed with short-term sources,
permanent current assets financed by long-term sources.

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