Matching Working Capital Policy

Matching Working Capital Policy:

if the matching working capital policy takes a balanced approach. It uses both long-term financing as well as short-term financing. The policy attempts to identify permanent and fluctuating current assets. Long-term financing is used for the permanent current assets and short-term financing is used for the fluctuating portion of current assets. Fluctuations are normally caused by seasonal difference in sales but can also be caused by temporary shortages in needed assets(warmah.com).

By implementing a balanced approach Lawrence sports will be taking a middle ground in the total cost to finance operations. This balance may reduce shareholder equity due to the higher cost of long-term financing but can be partially offset by using short-term liquid investments such as T-bills. The the trade-off in shareholder value will be preferable to the risk of default the company faced under our current working capital policy

Simple and straightforward, this working capital policy works in an arrangement where the current assets of the business are used perfectly to match the current liabilities. It is a medium risk proposition and requires a good amount of attention. For example, if the creditor is due to be paid 8 months from today, the company will ensure that there is cash to pay the creditor 8 months hence. Today the company may or may not keep the cash on hand.

Sounds risky? Yes. Then why would companies opt for this working capital policy? Because, by keeping as little cash, as they can, unemployed and sitting in the banks. They can reinvest it in purchasing more goods, more machinery, which will increase production and, should the sales go according to plan, so will the profit. Hence keeping low levels of working capital means that you can employ your funds more productively elsewhere.

Reference:

Emery, D. R., Finnerty, J. D., & Stowe, J. D. (2007). Corporate Financial Management (3rd ed.). Upper Saddle River, NJ: Pearson Prentice Hall.

http://warmah.com/articles/financing_working_capital.html

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