Download - ITFT Working capital management approaches
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WORKING CAPITAL MANAGEMENT- APPROACHES
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Working Capital Financing Mix
Approaches to Financing Mix
The Hedging or Matching Approach
The Conservative Approach
The Aggressive Approach
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The Hedging Approach Hedging approach refers to a process of matching
maturities of debt with the maturities of financial need . In this approach maturity of source of fund should match the nature of asset to be financed
This approach is also known as matching approach.
The hedging approach suggests that the permanent working capital requirement should be financed with fund from long term sources while the temporary working capital requirement should be financed with short term funds.
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Hedging approach to asset financing
Fixed Assets
Permanent Current Assets
Total Assets
Fluctuating Current Assets
Time
Short-termDebt
Long-termDebt +EquityCapital
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Conservative Approach This approach suggested that the entire
estimated investments in current asset should be finance from long term source and short term should be use only for emergency requirement
Distinct features of this approach • Liquidity is greater• Risk is minimized• The cost of financing is relatively more as
interest has to be paid even on seasonal requirement for the entire period
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Conservative approach to asset financing
Fixed Assets
Permanent Current Assets
Total Assets
Fluctuating Current Assets
Time
Short-termDebt
Long-termDebt +Equity capital
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Trade off between Hedging and Conservative Approaches• The hedging approaches implies low cost , high
profit and high risk while the conservative approach leads to high cost , low profit , low risk Both the approaches are the two extreme and neither of them serve the purpose of efficient working capital management
• A trade off between the two will then be an acceptable approach , One way of determining the trade off is by finding the AVG of maximum and minimum requirement of current asset or working capital
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Aggressive Approach
• The aggressive approach suggests that the entire estimated requirement of current asset should be financed from short-term sources and even a part of fixed asset investment be financed from short - term sources
This approach make the finance mix • More Risky• Less costly • More Profitable
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Aggressive approach to asset financing
Fixed Assets
Permanent Current Assets
Total Assets
Fluctuating Current Assets
Time
Short-termDebt
Long-termDebt +Equity capital
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