What are the Types of Working Capital Policies?

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. 

What is the Working Capital Policy?

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.

Ways to Get Working Capital Financing

A company can get working capital financing in many ways, including the following:

• Business Loan: Lending institutions like Hero FinCorp offer different types of Business Loans to create a working capital financial policy, including working capital loans, term loans, asset-based loans, and lines of credit.
• Trade Credit: This is when a supplier allows a business to purchase goods and services on trade credit and pay later. It provides short-term working capital finance to a company.
• Invoice Financing: The option allows a business to borrow funds against an outstanding invoice. The funding providers like Hero FinCorp pay a percentage of the invoice amount and collect the total amount from the client on the due date.
• Crowdfunding: Companies may use crowdfunding platforms to raise funds from people interested in their business.
• Factoring: It involves selling accounts receivable at a discount and receiving immediate cash in exchange. It helps businesses facing cash flow issues.

Also Read: Working Capital Management - Meaning, and How It Works

What Are The Different Types of Working Capital Policies?

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: 

Conservative Policy

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 

Aggressive Policy

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.

Matching Policy

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

Comparison of Working Capital Financing Policies

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

Benefits of Working Capital Financing Policy

Choosing the best working capital policy offers multi-faceted benefits to a company. 

1. It ensures sufficient liquidity in the business to cover everyday operations while reducing the insolvency risk. 
2. It optimises asset usage by aligning them with short-term liabilities, efficiently improving operational efficiency.
3. A balanced policy enhances a business’s creditworthiness, making credit and loans more accessible when a working capital requirement arises.
4. It offers flexibility to adjust to the changing market conditions and supports innovation and growth.

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 

Which Working Capital Policy is Right for You?

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

Conclusion

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

Frequently Asked Questions

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.