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CA Intermediate · Financial Management and Strategic Management · Introduction to Working Capital Management

Compared with a conservative working capital financing policy, an aggressive policy, in which part of permanent current assets is financed by short-term borrowings, generally results in:

An aggressive policy gives lower net working capital, higher liquidity risk and higher expected profitability. Cheaper short-term funds finance even permanent current assets, which saves interest cost, but they must be refinanced repeatedly, so the firm is more exposed to liquidity problems than under a conservative policy.

  1. ALower net working capital, higher liquidity risk and higher expected profitabilityCorrect
  2. BHigher net working capital, lower liquidity risk and higher expected profitability
  3. CHigher net working capital, higher liquidity risk and lower expected profitability
  4. DLower net working capital, lower liquidity risk and lower expected profitability

Explanation

Short-term funds are cheaper but must be renewed often, so using them for permanent needs raises the risk of a liquidity crunch. Since less long-term finance is tied up in current assets, net working capital is lower. The cost saving raises expected profit. The second option describes no real policy trade-off, and the third and fourth describe the conservative trade-offs wrongly mixed.

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