Q. Process of financing working capital?
Working capital policies on the process of financing working capital can be characterised as moderate, conservative and aggressive. A conservative funding policy would involve financing working capital needs predominantly from long-term sources of finance. If current assets are examined into permanent and fluctuating current assets a conservative policy would use long-term finance for permanent current assets and some of the fluctuating current assets.
Such a policy would raise the amount of lower-risk finance used by the company at the expense of increased interest payments and lower profitability. Velm plc is obviously not pursuing a conservative financing policy since long-term debt only accounts for 2·75% (40/1450) of non-cash current assets. Somewhat it seems to be following an aggressive financing policy characterised by short-term finance being used for all of fluctuating current assets and most of the permanent current assets as well. Such a policy will reduce interest costs and increase profitability but at the expense of an increase in the amount of higher-risk finance used by the company.
Between these two boundaries in policy terms lies a moderate or matching approach where short-term finance is used for fluctuating current assets and long-term finance is used for permanent current assets. This is an appearance of the matching principle which holds that the maturity of the finance should match the maturity of the assets.