Working capital policies are strategic financial approaches that govern a company's management of short-term assets and liabilities. These policies play a crucial role in a business's financial stability, growth, and risk management, guiding decisions about how to balance its financial resources. The most commonly followed working capital policies are:
1. Aggressive policy
As the name suggests, this policy is a high-risk one and is mainly followed by companies looking for brisk growth. Owing to the risk factors, returns are also higher. To follow this, a business must minimise its current assets or the debt it is owed. Here, there are no debtors as payments are collected in time and are eventually invested in businesses. Creditors’ payments are delayed to the maximum. Doing so may provide possibilities to sell out company assets to clear debts.
2. Conservative policy
Businesses with a low-risk appetite are inclined towards such a policy. Credit limits are pre-set to a specific amount in this policy, and these enterprises refrain from doing business on credit. Generally, a conservative working capital policy is followed to keep the company assets and liabilities in sync with each other, with the assets valuing on the higher side in case of sudden difficulties.
3. Matching policy
This is a hybrid between a working capital management policy and a working capital financing policy. Businesses generally follow this policy when they want to maintain minimal working capital by utilising funds elsewhere. Here, the current assets of the balance sheet are matched with the current liabilities and less cash is kept in hand. This enables the rest of the finance to expand the business, increase production, and more.
Comparison of working capital financing policies
Working capital financing policies are critical for a company's financial health. They determine the balance between short-term assets and liabilities. Three common policies are aggressive, conservative, and matching, each with distinct characteristics and implications.
|High short-term debt, low cash
|Low short-term debt, high cash
|Moderate short-term debt, cash
|High risk due to debt reliance
|Low risk with ample liquidity
|Balanced risk-reward strategy
|Potential for higher returns
|Lower returns due to less debt
|Moderate returns, lower risk
|Limited due to high debt
|Enhanced due to cash reserves
|Higher interest expenses
|Lower interest expenses
|Moderate interest expenses
|Weak liquidity management
|Strong liquidity management
|Balanced liquidity approach
|Risk-averse, stable businesses
|Balanced approach for most
The choice among these policies depends on a company's risk tolerance, growth objectives, and industry dynamics. Companies often adjust their working capital financing policies to adapt to changing financial circumstances and market conditions.
Benefits of working capital policy
A well-structured working capital financing policy offers several benefits to businesses. Firstly, it ensures the availability of sufficient liquidity to cover day-to-day operations, reducing the risk of insolvency. Secondly, it helps optimise the use of assets by aligning short-term liabilities with short-term assets, improving operational efficiency. Additionally, a balanced policy can enhance a company's creditworthiness, making it easier to secure loans or credit when needed. Moreover, it provides the flexibility to adapt to changing market conditions, supporting growth and innovation. Overall, a strategic working capital financing policy is a vital tool for maintaining financial stability, growth, and resilience in a dynamic business environment.
Which working capital policy is right for you?
Choosing the right working capital policy hinges on your business's unique circumstances and objectives. If you prioritise stability and safety, a conservative policy with ample cash reserves is suitable. It safeguards against unforeseen challenges but may limit potential returns. For those seeking aggressive growth and willing to accept higher risk, an aggressive policy with increased short-term debt can fuel expansion but comes with greater financial risk.
A matching policy strikes a balance, offering moderate risk and flexibility. Analyse your risk tolerance, industry dynamics, and financial goals to make an informed choice. Furthermore, be prepared to adapt your policy as your business evolves and market conditions change.
As per your enterprise’s working capital financing policy, select a working capital loan and meet short or long-term expenses with ease.