Current assets formation tactics and strategy of funding
Tactical management solutions current assets related to optimizing the value of current assets and consist in choosing policies inventory management, cash management, accounts receivable.
There are two tactics choice value of current assets, depending on their relationship with the volume of sales:
- Limiting tactics;
- A flexible approach.
When using tactics supported limiting the amount of current assets at the lowest possible level, that company does not create additional reserves, maintains strict discipline of payments to suppliers. This tactic reduces maintenance costs of current assets, minimizes the risk of loss of the use of working capital. But in this model, the company has limited opportunities to increase revenue through expansion of their business, can not respond quickly to changing market conditions. This increases the risk associated with the formation of working capital.
As for liquidity, if the company has a small amount of current liabilities as soon as possible and try to reduce excess inventory and uncollectible receivables, this policy can support the required level of liquidity. But large amounts of current commitments and limited amounts of current assets liquidity of the company will be low.
Flexible tactics is to provide a high level of correlation between current assets and sales, the company is increasing following balance sheet which provide the opportunity to increase production with appropriate changes in market conditions and allow to stimulate sales by offering deferred payments. These items include: cash, securities, insurance and reserve stocks. As a result of liquidity of the company (if the formation of the majority of its working capital on a long term basis) increases. However, this policy is expensive and management of current assets should be based on the choice between the costs associated with the increase in current assets and benefits from an increase in current assets.
Strategies for financing current assets assigned to depend on them based on the principle of variable funding. This permanent part of current assets is determined at the level of the minimum requirements of current assets in the period. The variable part - the difference between the actual and the minimum requirement for circulating assets.
That portion of current assets financed by equity and long-term debt, called net working (working) capital.
Net working capital = current assets - current liabilities.
The higher net working capital, the lower the liquidity risk.
Depending on the choice of manager of financial sources covering the variable part of current assets, are four strategies of financing current assets:
1. The ideal strategy - current assets financed by current liabilities.
From the perspective of liquidity, this model is the most risky, because in case of simultaneous presentation of the creditors of all obligations the company will be forced to sell some of its assets.
2. Aggressive strategy is to finance long term fixed assets and permanent part of current assets.
The risk associated with an aggressive strategy, high. This strategy can afford only company that has no problems with the renewal of short-term loans or obtaining loans from commercial suppliers.
3. Conservative strategy is to finance nearly all the assets at the expense of long-term sources.
Typically, conservative strategy applied in the initial stages of the company provided sufficient quantities of capital owners and the availability of long-term loans for investment financing.
4. The compromise strategy is to finance fixed assets, permanent part of current assets and approximately half of the variable current assets by long-term sources. Another part of current assets financed by short-term.
The model is the most realistic, but in certain periods of the company can have extra current assets, which reduces their profitability.
Thus, the results of this example, we can conclude that in terms of optimizing profitability and risk strategy is the optimal compromise funding. This strategy combines the best rate of return and average risk, provides a sufficiently high level of financial stability and solvency.
However, based on the priority objectives of financial and economic activities at various stages of its development, the best strategy may be other funding. Generally, when selecting financing strategy needs to find the desired relationship between the level of profitability using its own capital and risk reduction of financial viability, estimated the value of its net working capital.