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Working Capital Approaches

The document outlines three working capital strategies: Hedging (Matching), Conservative, and Aggressive. The Hedging strategy balances risk and profitability by matching asset and debt maturities, while the Conservative strategy minimizes risk with low profitability by using long-term financing for both fixed and some temporary assets. The Aggressive strategy focuses on maximizing profitability with high risk, financing fixed assets and part of permanent working capital with long-term funds, while relying on short-term funds for temporary working capital.

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16 views3 pages

Working Capital Approaches

The document outlines three working capital strategies: Hedging (Matching), Conservative, and Aggressive. The Hedging strategy balances risk and profitability by matching asset and debt maturities, while the Conservative strategy minimizes risk with low profitability by using long-term financing for both fixed and some temporary assets. The Aggressive strategy focuses on maximizing profitability with high risk, financing fixed assets and part of permanent working capital with long-term funds, while relying on short-term funds for temporary working capital.

Uploaded by

puteriraudhah7
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TYPES OF WORKING CAPITAL STRATEGIES/

APPROACHES

These three working capital approaches are best explained with the help of the following
graph and equations.

First, we need to understand the graph properly.

i) Hedging (Matching) strategy


ii) Conservative strategy
iii) Aggressive strategy.

Hedging (Maturity Matching) Strategy


This is a meticulous strategy of financing the working capital with moderate risk and
profitability.
In this strategy, each of the assets would be financed by a debt instrument of almost the
same maturity.
It means if the asset is maturing after 30 days, the payment of the debt which has financed
it will also have its due date of payment after almost 30 days.
Hedging strategy works on the cardinal principle of financing i.e. utilizing long-term
sources for financing long-term assets i.e. fixed assets and a part of permanent working
capital and temporary working capital are financed by short-term sources of finance.
Long Term Funds will Finance >> FA + PWC
Short Term Funds will Finance >> TWC

Conservative Strategy
As the name suggests, it is a conservative strategy of financing the working capital with
low risk and low profitability.
In this strategy, apart from the fixed assets and permanent current assets, a part of
temporary working capital is also financed by long-term financing sources.
It has the lowest liquidity risk at the cost of higher interest outlay. Here, funds are applied
as below and can be clearly seen in the above diagram.
Long Term Funds will Finance >> FA + PWC + Part of TWC
Short Term Funds will Finance >> Remaining Part of TWC
Aggressive Strategy
This strategy is the most aggressive strategy out of all the three.
The complete focus of the strategy is in profitability.
It is a high-risk high profitability strategy.
In this strategy, the dearer funds i.e. long term funds are utilized only to finance fixed
assets and a part of the permanent working capital.
Complete temporary working capital and a part of permanent working capital also are
financed by the short-term funds.
It saves the interest cost at the cost of high risk. Here, funds are applied as below and
can be clearly seen in the above diagram.
Long Term Funds will Finance >> FA + Part of PWC
Short Term Funds will Finance >> Remaining Part of PWC + TWC

Conclusion
These three strategies are plotted on a number line with one side as ‘risk’ and the other
side as ‘profitability’. Conservative strategy is on the side of lower profitability and lower
risk. On the contrary, an aggressive strategy is on the side of higher profitability and higher
risk.

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