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Hello Sir! I am having another problem with working capital [I have seen all your lectures on working capital But unfortunately I still can’t prove in question whether the company is using short-term or long-term financing & whether the company should change its policy or not]
I am aware Working capital financing policies can be classified into conservative, moderate & aggressive approaches [ thanks to ur lectures 🙂 ] and I know these approaches so u don’t have to mention them.
BUT how can I see whether the company is using short-term financing or long-term financing with the help of ratios [just mention the name of ratio it will help enough]
Lastly, please confirm me this is what I read somewhere which is really important for me to grasp [“Both Working Capital Investment & Financing Policies use the terms Conservative, Moderate & Aggressive”]
It is not a question of looking at ratios, but of examining the SOFP.
If there is an overdraft, then that amount will be be being financed by short-term finance. If there is no overdraft then all of the amount will be being financed by long-term finance.
Your last statement is correct 🙂
I understood your last response Sir. But I want to be correct in these 3 statements whether these are true or not?
1) It can also be said that in a conservative policy approach, the working capital (current assets – current liabilities) will be higher because there will be more current assets because of long-term investment in the non-current assets, but lesser current liabilities because we used long-term liabilities to finance our current assets
However, aggressive approach will be where working capital is lower because we have used short-term financing policy to finance its current assets. So, current assets will be lower, but higher current liabilities since we have used short-term liabilities such as Bank Overdraft or Short-term loans etc
2) In other words if there is a higher Current ratio (current assets / current liabilities) will indicate that the company has used long-term policy to finance its current assets. Therefore, it is a conservative policy that company has adopted.
BUT if we have a lower Current ratio then it clearly indicate that company is utilizing short-term policy to finance in its current assets. Therefore, it is aggressive policy that is adopted by company.
3) Is it true that we can use CURRENT RATIO [without any other ratio] to identify whether the company has used conservative or aggressive approach?
Thanks for your time though 🙂
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