Every company needs working capital to finance everyday operations. Therefore, it is the backbone of a firm irrespective of its size and nature. One may calculate a company’s working capital by subtracting its current liabilities from current assets. A shortage of capital can significantly impact a company’s productivity, resources and growth potential.
Picking the right working capital policy for efficient management ensures the business owner gets the most out of their efforts. Let’s look at the types of working capital policies, their benefits, and other crucial information.
A working capital policy refers to a company's rules and guidelines to manage its working capital efficiently. The primary focus is to maintain a balance between the business's assets and liabilities, ensuring financial stability and operational efficiency. With the right working capital financing policy, a company owner can provide enough liquidity to meet everyday operations and minimise the cost of cash holding and short-term assets.
A company can get working capital financing in many ways, including the following:
Also Read: Working Capital Management - Meaning, and How It Works
Working capital policy is a strategic financial approach to managing a company's short-term assets and liabilities. It plays a crucial role in establishing a company's growth, stability, and risk management and guiding decisions about finance resources. The most common working capital policies in financial management include the following:
As its name suggests, a conservative working capital policy is safe and effective. It primarily focuses on reserving current assets to clear current liabilities and handling emergencies arising during the business lifecycle.
While the policy provides ample funds to tackle various situations, the company has a smaller amount to re-invest in the business.
So, evaluating the company’s growth plan before choosing this working capital policy is essential.
Also Read: Top 9 Factors Affecting the Working Capital
This type of working capital policy is best suited for businesses in a secure position. It works by reserving some current assets and establishing creditors’ terms that allow repayment later and debt collection immediately.
Achieving these parameters efficiently helps maintain minimal working capital and supports business growth.
However, it is a high-risk policy that requires weighing the substantial gains against the company’s risk appetite.
A well-established business feels more comfortable with the idea of taking risks. In such situations, opting for a matching policy is appropriate.
Such companies have enough assets to pay their current liabilities, and they have a lean working capital. This policy is ideal for companies gathering momentum and breaking into a new expansion phase.
It provides a bigger amount to re-invest into the business by holding back the working capital.
Also Read: Gross Working Capital Vs. Net Working Capital: Definition, Formula, Example
While a working capital financial policy is crucial for a company’s finances, below are each policy’s distinct implications and characteristics:
Parameter | Conservative | Aggressive | Matching |
Profitability | Lower returns | Higher returns | Moderate returns |
Risk Level | Low risk | High risk | Balanced risk reward |
Approach | High cash, low short-term debt | Low cash, high short-term debt | Moderate cash, moderate short-term debt |
Interest Rate | Low-interest rate | High-interest rate | Moderate interest rate |
Flexibility | High flexibility | Limited flexibility | Moderate flexibility |
Liquidity | Strong liquidity | Weak liquidity | Balanced liquidity |
Suitability | Stable businesses due to average risk | Growth-oriented businesses due to risk tolerance | Balanced suitability for most businesses |
Also Read: Know The Difference Between Term Loan And Working Capital Loan
Choosing the best working capital policy offers multi-faceted benefits to a company.
Overall, an appropriate working capital financing policy is vital to maintain growth, financial stability and residence in the business environment.
Also Read: Working Capital Cycle: Meaning, Calculation & More
The best working capital policy for a business is one tailored to the company’s industry, growth plans, risk tolerance, and business size. Therefore, the final choice depends on a company's unique objectives and circumstances. Companies prioritising safety and stability must opt for a conservative working capital policy with sufficient cash reserves. It protects against unpredictable events but limits potential returns. Conversely, those seeking aggressive growth and are comfortable taking risks must opt for an aggressive policy. It provides a higher short-term debt to fuel business expansion but with a greater financial risk. A matching policy strikes a perfect balance between risk and flexibility.
A company owner must choose their final working capital policy after analysing their risk tolerance, financial goals, and industry dynamics.
Also Read: Working Capital Demand Loan (WCDL) - Definition & Meaning
A company can unlock its hidden potential, optimise operations, and support sustainable growth by implementing the right working capital policy. However, remember that it is a continuous journey that needs constant monitoring, adaptability, and utilisation of the available financial resources. So, let business thrive and take control of its finances with a working capital loan from Hero FinCorp.
Also Read: Working Capital Turnover Ratio: Definition, Advantages, And Formula Calculation
1. How do you determine the appropriate level of working capital for a company?
You may calculate a company's working capital by subtracting its current liabilities from its assets.
2. What factors influence the working capital requirements of a business?
Business size, financing requirements, operational needs, and growth goals are some factors influencing a business’s working capital requirements.
3. What are the key components of a working capital policy?
Accounts payable, accounts receivable, inventory, cash balance, business size, debt management, and gross working capital are the major components of an effective working capital financing policy.
4. How often should a company review and adjust its working capital policies?
Ideally, a company should update its policy annually, supplemented with a monthly or quarterly review.
5. What role do industry trends play in shaping working capital strategies?
Industry trends are pivotal in shaping a company’s liquidity, financial ability, and streamlining operations.