At a casual glance, working capital policies are similar to working capital strategies. Yet, there are certain differences between the two, a prime one being the approach. While the capital policies are moderate and restricted, working capital strategies incidentally are quite aggressive and even conservative. An understanding of this simple distinguishing character helps, especially considering the two are interrelated and dependent on each other.
A very crucial aspect of working capital is its net sales, known as the working capital turnover ratio. Like any business and the capital involved in them, capital policies can be distinguished depending on the risk, liquidity, and profitability involved in them. Majorly, they are of three types.
1. Restricted capital policies:
Having a lower working capital requirement, this is a policy that is convenient under most circumstances. The assessment and estimation of current assets aimed at achieving targeted revenue are done very aggressively in this process. A downside of such policies is that no fall-back options or contingencies are planned in it. The restricted policies are implemented in the organizations extremely aggressively with no deviation from its norms and regulations.
These capital policies are extremely popular considering that they generate similar revenue like the other policies, despite involving the lowest current assets. The lower working capital requirement leads to a lower cost of interest and in turn higher returns on investment (ROI) for the company. Being one of the most risk involved policies on working capital, this is also known as an aggressive working capital policy.
2. Relaxed capital policies:
Revenue generation involves many variables like seasonal changes, events or festivals, the unexpected change in activities, etc. Quite opposite to the restricted policies, relaxed capital policies focus primarily on these variable factors; a detailed projection of target revenue being prepared on the basis of current assets that are constantly prone to change. Contingencies and buffers of sorts are put in place in the estimation as a safety precaution.
The involvement of variables and relevant contingencies make this policy go high in terms of current assets, though the revenue generated is quite similar to that of a restricted policy despite the involvement of much higher value current assets. This policy has the immense upside of having low risk and thereby smooth functioning of a company is assured. Inversely to restricted policies, the relaxed ones lead to higher costs on interest and thereby leading to a lesser return on investments. A relaxed policy is often called conservative working capital policy, owing to its nature.
3. Moderate capital policies:
While the two capital policies above were extremes, a moderate policy for working capital is one which has aspects from both. As a result, in terms of risk involved it lies between the two; just as its working capital turnover ratio lies in between that of the two too. A moderate policy is advantageous since it assures mediocre profit along with a reasonable guarantee on smooth business operations and working capital, and a businessman needs a clear guide to working capital loans in case of shortfalls.
This policy takes into account all the variables as well as non-variable factors and attempts to draw a course of action involving both. Target revenue is estimated accordingly, with mediocre risk lying on current assets and working capital.
Policies on working capital can be structured over many factors, the above being a general assessment of the risks and profitability. Singular components of networking capital like accounts receivable, accounts payable, cash, inventory, etc. can be used to devise policies.
There are many policies and schemes which help manage working capital to help keep the business agile. Conventionally, a high cash level usually encourages investment in liquid assets, at least for the short term. Similarly, a policy on accounts receivable states of payment terms, credit period and limit, etc; while one on inventory policy would involve matters of minimizing assets and its likes.
The basic layout of policies on working capital revolves around capital assets, variable and otherwise; risk involved, and profit generation. These risks involved as well as the factors that are taken into policymaking vary greatly, their general method of handling differentiating the types of policies.
In the case of working capital deficits, it is vital to refer to immediate financial assistance and avoid hampering organizational output and operations. Business loans offered by numerous leading lenders can provide the necessary finances to help meet such monetary deficits.
Working capital is the lifeblood of any business operations, irrespective of its size. Accurate and pre-emptive management is vital to ensure profit margins and growth.