Question

A company's Net Operating Working capital rises and falls seasonally and with business cycles.

How much NOWC to carry and how to finance it is a company's continuous balancing act?

What are the types of NOWC financing policies, and how do they affect a company?

Answer 1

In this situation company should determine the minimum net operating working capital that is almost every time required in the business irrespective of seasonal and cyclical fluctuations and this amount of permanent net operating capital should be financed from long term source of financing and rest fluctuating requirement of working capital should be financed from short term sources as per the requirement of timing, this will help to the organization to maintain a balance in net operating working capital either their would be excess nor the shortage of working capital and balance would be maintained in financial charges for funds used in working capital financing.

Three approaches are used for working capital financing

(1) aggressive approach - Under this approach a all the fluctuating working capital and a portion of permanent working capital is financed from short term sources of financing. This is a riskier approach in which a shortage of funds may hamper the production process

(2) Moderate approach- Under this approach all permanent working capital and a portion of temporary or seasonal working capital if financed from long term sources are financed and rest of seasonal working capital is financed from short term approach, under this approach a balance is maintained between the short term and long term requirement of working capital

(3) conservative approach- in this all the working capital requirement, permanent or seasonal are financed from long term sources and there is no use of short term financing. this is a costly approach and cost a lot to the organization