Working Capital part 1– Current Asset Investment Strategy
Tuesday, 23 March 2010 21:15
Managing Current Asset Investment with CNF Exchange
CNF Exchange specializes in helping companies manage cash flow difficulties and manage their current asset investment strategies more effectively. Typically, companies balance a number of factors when deciding on their level of investment in current assets. These factors include return on investment in the short and long term, amount of inventory on hand and flexibility to manage unexpected large orders and increased market demand. Higher degrees of investment in current assets can lead to short-term cash shortfalls if sales do not justify increased inventory. Companies should consider their current asset investment strategy in terms of both short term and long term investment; current asset levels should be maintained at a level that considers increased consumer demand against the possibility of cash flow difficulties if that demand does not materialize. CNF Exchange can help companies assess their current asset investment strategy and provide financing alternatives to maintain liquidity even during short-term downturns in the economic marketplace.
When trying to determine the best level of working capital financing, a company can focus on their Current Asset Investment Strategy. There is a risk/return trade-off when considering this strategy for developing a working capital management framework. The current asset strategy of a company is an important consideration for Lenders that are relying on current assets as collateral for short-term lending.
Working capital is generally defined as current assets. Current assets consist of accounts such as cash, marketable securities, accounts receivable, and inventory. Net working capital is defined as total current assets minus total current liabilities, where current liabilities are represented by accounts payable, notes payable and accrued liabilities.
There are two current asset investment strategies- restrictive and relaxed:
1. Restrictive Current Asset Investment Strategy
When using a restrictive current asset investment strategy a company will maintain a low level of current assets relative to sales. Accounts Receivables (A/R) are kept low and inventory is managed as tightly as possible. This strategy may have a negative impact on sales as shorter A/R terms are less flexible and a smaller selection of inventory is held to meet consumer demand. However, this restrictive strategy can sometimes be the most profitable as fewer funds are invested in current assets leading to a larger return on investment, as long as the savings from tighter A/R terms and inventory exceeds lost sales.
2. Relaxed Current Asset Investment Strategy
Contrary to the restrictive strategy, a relaxed current asset investment strategy leads to a company maintaining a higher level of current assets relative to sales. Using this strategy, the company will keep a higher level of A/R and inventory. Given the larger investment in current assets the company may have a relatively lower return on investment. However, this strategy may lead to a larger current ratio (current assets/current liabilities), increase liquidity, and lower the risk of lost sales due to the extension of A/R terms and less inventory depletion with the increased inventory.
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