Aggressive Approach Working Capital

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A working capital policy is called an aggressive policy if the firm decides to finance a part of the permanent working capital by short term sources.  So, the short term financing under aggressive policy is more than the short term financing under the hedging approach.  The aggressive policy seeks to minimize excess liquidity while meeting the short term requirements.  The firm may accept even greater risk of insolvency in order to save cost of long term financing and thus in order to earn greater return. 

Neither the hedging approach nor the conservative approach can be used by any firm in the strict sense.  Therefore, the financial manager should try to have a trade-off between the hedging and conservative approach.  Though, the trade-off between risk and profitability depends largely on the financial manager’s attitude towards risk, yet while doing so he must take care of the following factors:

a)    Flexibility of the Mix:  The financing mix of the working capital must be flexible enough.  If the working capital needs are expected to be arising for a short period only then short-term sources should be used so that whenever the funds are released, they can be refunded.  In such a situation, if the firm opts for long term sources, then the firm may not be able to refund even it if desires to refund and the pre-payment penalties may be prohibitory.

b)    Cost of Financing: The financial manager should also take into account the respective cost of financing from short term sources and long term sources.  It is worth nothing that it is not the rate of interest which is material, but the total cost of financing over a period of say one year, is relevant.  For example, a firm has opportunity of raising funds by the issue of 14% debentures (7 years) or by taking a working capital term loan @ 18%.  In this case, the rate of interest on long term source (i.e., 14% on 7 years debentures) is lower but it does not mean that the firm should go only for long term sources.  The financial manager should also find out the annual cost of financing.  In case of debenture issue, interest for full year would be payable while in case of short term bank loan, interest at the rate of 18% would be payable only for the period for which the bank loan facility is availed.  It is quite likely that the total interest payable on bank loan in a year may be much lower than the annual cost of interest on debenture.  Similarly, the financial manager should also find out the total cost of financing under both the hedging and conservative approach and accordingly the decision regarding financing mix may be taken.

c)    Risk Attached with Financing Mix:  It is already noted that the short term financing is more risky.  If the firm opts for short term sources to finance the current assets, then it may have to renew the borrowing at the end of each maturity.  Moreover, the total cost of financing may fluctuate from one period to another depending upon the short term interest rates.  But in case of long term financing, there is no risk regarding the cost of financing and renewals.
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