After the determination of the level of current assets, the company has to ascertain how the financing of current assets will be carried out and what should be the ideal amount of investment in current assets. The focus is on the ideal blend of short term debt and long term capital that should be applied for backing its current assets.
For a firm which has a stable growth, the entire amount of assets and therefore the working capital requirements vary with the passage of time. In order to simplify matters, the assets are categorized into two types, such as current assets and fixed assets.
Fixed assets are anticipated to increase at a fixed rate that indicates the consistent growth rate in sales. Current assets are also assumed to demonstrate the similar type of growth rate in the long term, nevertheless, they represent significant variation close to the line of trend simply due to cyclical patterns or seasonal patterns in purchases and sales.
Investment in current assets can be categorized into two segments:
Investment in permanent current assets: This denotes what is the requirement of a firm yet at the lowest point of its sales cycle.
Investment in temporary current assets: This indicates a variable constituent that changes according to the seasonal variations.
A company applies a number of strategies for funding its working capital requirements. There are three important strategies among them and they are as follows:
Strategy 1: Here financing for the long term is utilized to satisfy requirements of fixed assets and prime necessities of working capital. In case the requirement of working capital is lower than the highest requirement, the excess is put into liquid assets, for example tradeable securities and cash.
Strategy 2: Financing in the long term is utilized to satisfy requirements for permanent working capital, necessities of fixed assets, as well as a component part of varying requirements of working capital. At the time of seasonal upturn, financing for short term is utilized. At the time of seasonal downturn, the excess is put into liquid assets.
Strategy 3: Financing for the long term is applied to satisfy the necessities of fixed assets and requirements of permanent working capital. Financing for the short term is utilized for satisfying variable requirements of working capital. This indicates towards the Matching Principle.
The policy of current asset investment states that increased degree of current assets leads to lower anticipated return and lower risk, if every other factor stays constant.
Last Updated on : 27th June 2013