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Is it true that if Long-term Finance is invested in Working Capital then it is said to be Conservative Policy. And if Short-term Finance is invested in Working Capital then it is said to be Aggressive Policy?
(Since Non-Current Assets should always be financed by Long-term Finance so any extra finance needed in NCA could be financed from Short-term Finance? Same with the Current Assets should always be financed by Short-term Finance so any extra finance needed in CA could be financed from Long-term Finance?)
Is it correct that we don’t have to calculate any ratios rather we interpret the increase in Long-term Finance with the increase in Non-Current Assets [AND] increase in Short-term Finance with the increase in Current Assets to know which Policy company has adopted?
But this is the case if we’re given two SOFP’s to interpret the increase or decrease (from one period to the another) BUT in case we’re given one SOFP then how do we identify the policy adopted by company such as in question called APX Co (BPP kit Dec 2009) where we’re asked to analyze & discuss working capital financing policy? Could you please explain that?
What you have written is correct.
In APX, although you are not given two SOFP’s you are given the SOFP for the year just finished and you are given information about forecasts for next year.
You can see from the SOFP how much of the working capital was financed last year from short-term and from long-term finance. From the forecast ratios for next year you are able to comment on how it is changing. You do not not need any specific ratios although you can see suggestions in the printed answer. (And appreciate that when this was asked in the actual exam, only 2 of the 6 marks for part (c) were for actually commenting on the policy of this particular company. The rest of the marks were for explaining what the different policies are.)
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Thanks for the Answer 🙂 Can you please correct few other statements of mine below?
1) Whenever we are asked about Working Capital Financing & Investment Policies in exam we will be given two SOFP’s of the same company so that we can see how much of the working capital was financed from Short-term & from Long-term Finance. Just like in the case of APX Co we are given one SOFP with Forecast SOFP [that makes them two SOFP’s] so that we can identify Working Capital Finance from one period to the another?
2) [In Gorwa Co question] Company’s Short-term Finance is raised by $4375 which has been invested in Working Capital which is increased by $4600 so where does the company raise extra money for Working Capital of $225?
Did they raise $225 from Long-term Finance which is increased by 1107 so the money left for the company to invest in Non-Current Assets $882 which is also indicated by the increase in NCA?
3) So we can say that Gorwa Company has used Short-term Finance to be largely invested in Working Capital of amount $4600 [which was largely financed by Short-term Finance BUT the other small amount of $225 is invested from Long-term Finance?]
And it has used Long-term Finance to be largely invested in Non-current Assets of amount $882 BUT the other small amount of $225 goes to be invested in Working Capital.
4) Is there any ratio that can tell whether how much Long-term Finance is invested in Non-current Assets & how much in Working Capital?
I have used this ratio to identify that (882/1107) = 79.6% of Non-current Assets are financed through Long-term Finance AND (225/1107) = 20.4% of Working Capital is financed through Long-term Finance.
Whilst, I have used this ratio to identify that (225/4375) = 5.1% of Working Capital is financed through Long-term Finance AND the rest (4375/4375) = 100% of Working Capital is financed through Short-term Finance?
[Please advise me whether I have used these ratios correctly & did I say everything above right?]
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