Short Term Financial Policies

1229 WordsFeb 28, 20115 Pages
PTMBA I / Trim III (A. Y. 2010-11) Div. C. Assets of Short Term Financial Policy Flexible Short Term Financial Policy Maintainance of high ratio of current assets to sales. This would include:- ❖ Keeping large cash & bank balances ❖ Making substantial investment in inventories. ❖ Liberal Credit Term meaning high level of debtors. Restrictive Short Term Financial Policy. This would include:- ❖ Low cash balances / no investment in marketable securities ❖ Small inventory level ❖ No credit on Sales & hence receivables at minimum Thus, flexible short-term financial policies are costly in that they require higher cash outflows to finance cash and marketable securities, inventory, and accounts…show more content…
In other words, the optimal policy is a flexible one. Thls is illustrated in the middle graph. If carrying costs are high or shortage costs are low, the optimal policy is a restrictive one. That is, the optimal policy calls for modest current assets. This is illustrated in the bottom graph. Alternative Financing Policies for Current Assets In an ideal economy, short term assets can always be financed with short term debt, and long term assets can be financed with long term debt & equity. In this economy, net working capital is always zero. Imagine the simple case of a grain elevator operator. Grain elevator operators buy crops after harvest, store them, and sell them during the year. They have high inventories of grain after the harvest and end with low inventories just before the next harvest. Bank Loans with maturities of less than one year are used to finance the purchase of grain. These loans are paid with the proceeds from the sale of grain. Current assets cannot be expected to drop to zero in the real world because a long-term rising level of sales will result in some permanent investment in current assets. A growing firm can be thought of as having a permanent requirement for both current assets and long term assets. This total asset requirement will exhibit balances over time reflecting 1) A secular growth trend 2) A seasonal variation around

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