Working capital management: investment and financing policies
Lecture for Corporate Finance
Mgr. Tetiana Konieva, Ph.D
Corporate Finance
FIU/BAFIK

Outline of the lecture
•Working capital
•Net working capital
•Working capital investment policies
•Working capital investment policy of Xiaomi
•Sources of long-term financing
•Sources for short-term financing
•Working capital financing policies
•Working capital financing policy of Xiaomi
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Working capital & Net working capital:
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•Working capital = Current assets, that expected to be realized in the normal operating cycle or
within 12 months after the reporting period; held primary for the purpose of trading; cash and cash
equivalents
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•Permanent Working capital – amount of current assets at the lowest point of the operating cycle
(inventories, accounts receivable, cash, short-term financial investments)
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•Temporary Working capital – those current assets (inventories, accounts receivable, cash,
short-term financial investments), that fluctuating during the operating cycle because seasonality,
peculiarities of the production process …..
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•Net working capital = Current assets – Current liabilities
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Or
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•Net working capital = Equity + Long-term financing – Fixed assets

Working capital investment policies:
The investment policy is about how many resources invests the company into the current assets
(inventories, accounts receivable, cash, financial investments) in order to provide the targeted
sales.

Relaxed working capital investment policies:
•Relaxed Policy: the estimation of current assets for achieving the targeted revenue is prepared
after carefully considering uncertain events such as seasonal fluctuations, a sudden change in the
level of activities or sales, etc. After the reasonable estimates, a cushion to avoid unforeseen
circumstances is left to prevent the maximum possible risk. The diagram represents the point Rx
which uses the highest level of current assets for achieving the same level of sales.
•Companies with relaxed working capital policies assume the advantage of almost no risk or low
risk. This policy guarantees the entrepreneur of the smooth functioning of the operating cycle. We
know that earnings are more important than higher earnings. On the other hand, there is a
disadvantage of lower return on investment because higher investment in the current assets attracts
higher interest costs, reducing profitability.
•Profit  = Incomes – Costs  (including interest costs)
•Return on investments  (assets or current assets or equity or …) = Profit  \ investments

Restricted working capital investment policies:
•Restricted Policy – the estimation of current assets for achieving targeted revenue is done very
aggressively without considering any contingencies and provisions for any unforeseen event. After
deciding, these policies are forcefully implemented in the organization without tolerating any
deviations. In the diagram, point R represents the restricted policy that attains the same revenues
level with the lowest current assets.
•Adopting this policy would benefit the lower working capital requirement due to the lower level of
current assets. This saves the interest cost to the company, which produces higher profitability,
i.e., higher return on investment (ROI). On the other hand, there is a disadvantage in the form of
high risk due to a very aggressive policy.
•Profit  = Incomes – Costs  (including interest costs)
•Return on investments  (assets or current assets or equity or …) = Profit   \ investments

Moderate working capital investment policies:
•Moderate Policy
•The moderate policy balances the two policies, i.e., restricted and relaxed. It assumes the
characteristics of both policies. To strike a balance, moderate policy assumes the risk to be lower
than restricted and higher than conservative. In the profitability front also, it lies between the
two.

Working capital investment policies:
Policy
Relaxed
Moderate
Restricted
Sales
1000
1000
1000
Current assets
500
400
300
Ratio of current assets outstanding = sales \ current assets
1000\500 = 2 times per year current assets transfer into the revenue (sales)
2.5 times per year current assets transfer into the revenue (sales)
3.33 times per year current assets transfer into the revenue (sales)

Working capital investment policy of Xiaomi:



Sources of long-term financing:
•Depreciation funds
•(Financial) Leasing
•Long-term bank credit
•Issued bonds
•Equity (issued shares)

Sources for short-term financing:
•Net working capital = Equity + Long-term debts – Fixed assets or
Net working capital = Current assets – Current liabilities
•Trade payable
•Other accounts payable
•Consignment
•Factoring
•Sort-term bank credit
•Other current liabilities

Working capital financing policies:
Working capital financing policy - is about what type of capital and how many of it we attracted in
order to finance company’s assets.
•Conservative Strategy:
Long Term Funds will Finance >>
Fixed Assets + Permanent Working capital + Part of Temporary Working capital
Short Term Funds will Finance >>
Remaining Part of Temporary Working capital
•Hedging (Maturity Matching) Strategy:
Long Term Funds will Finance >>
Fixed Assets + Permanent Working capital
Short Term Funds will Finance >>
Temporary Working capital
•Aggressive Strategy:
Long Term Funds will Finance >>
Fixed Assets + Part of Permanent Working capital
Short Term Funds will Finance >>
Remaining Part of Permanent Working capital
 + Temporary Working capital
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Working capital = Current assets

Conservative financing policies:
Long Term Funds will Finance >> Fixed Assets FA + Permanent Working capital PWC + Part of Temporary
Working capital TWC
Short Term Funds will Finance >> Remaining Part of Temporary Working capital
Net working capital = Current assets – current liabilities = 400+200 – 90 = 510 or
Net working capital = Equity + Long term debts - Fixed Assets = 700+310 – 500 = 510
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Temporary Working capital TWC = 200

Short Term Funds (current liabilities: short-term bank credit, account payable) = 90
Long Term Funds = 1010 =  Equity 700 +
Long term debts 310
Permanent Working capital PWC = 400
Fixed Assets FA = 500

Moderate financing policies:
Long Term Funds will Finance >>  Fixed Assets + Permanent Working capital
Short Term Funds will Finance >> Temporary Working capital
Net working capital = Current assets – current liabilities = 400+200 – 200 = 400 or
Net working capital = Equity + Long term debts - Fixed Assets = 700+ 200 – 500 = 400
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 Temporary Working capital TWC = 200
Short Term Funds (current liabilities: short-term bank credit, account payable) = 200
Permanent Working capital PWC = 400
Long Term Funds = 900 =  Equity 700 +
Long term debts 200
Fixed Assets FA = 500

Aggressive financing policies:
Long Term Funds will Finance >> Fixed Assets + Part (small or even 0) of Permanent Working capital
Short Term Funds will Finance >> Remaining Part of Permanent Working capital  + Temporary Working
capital
Net working capital = Current assets – current liabilities = 400+200 – 500 = 100 or
Net working capital = Equity + Long term debts - Fixed Assets = 400 +200 – 500 = 100
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Temporary Working capital TWC = 200
Short Term Funds (current liabilities: short-term bank credit, account payable) = 500


Permanent Working capital PWC = 400
Long Term Funds = 600 =  Equity 400 +
Long term debts 200
Fixed Assets FA = 500

Working capital financing policies:
Factors
Conservative
Aggressive
Hedging
Liquidity = Current assets \ Current liabilities
Liquidity is high because of the heavy usage of long-term funds. It can take advantage of sudden
opportunities.
Current ratio = (400+200)\90 = 6.7
Liquidity is low due to greater dependability on short-term funds, even for a part of long-term
assets. It does not keep idle funds and therefore saves interest costs on them. Current ratio = 1.2
Liquidity is balanced, i.e., neither high nor low. It attempts to strike a balance between
liquidity and the cost of idle funds.
Current ratio = 3
Profitability
Under normal circumstances, profitability is less in this strategy because of too much idle and
costly funds. Higher rates and a bigger magnitude of interest costs reduce the profitability.
Higher profitability is obtained since the interest cost is minimized in this approach.
Because of cut to cut management, a balance is achieved between interest cost and loss of
profitability. Moderate profitability is maintained here. It is greater than conservative and
lesser than aggressive
Risk
There is a very low risk of bankruptcy as this approach maintains a higher level of liquidity in
the business.
There is a high risk of bankruptcy due to maintaining an extremely tight liquidity position.
The risk is balanced here. The firm will bow down to bankruptcy only in an extremely bad situation
Asset Utilization
Too high level of current assets makes its utilization ratio low.
Similarly, too low a level of current assets makes the utilization ratio high.
Moderate
Net Working Capital =
Current assets – Current liabilities
There is a requirement for more working capital to execute the conservatism. Higher working capital
avoids all risks. NWC = 510
Very low working capital is maintained. Low working capital increases risk but saves the interest
cost. NWC = 100
Moderate working capital is maintained to stay somewhere between conservative and aggressive
strategies
NWC = 400

Working capital financing policy of Xiaomi
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