Principle of working capital management policy
The following are the 4 principles of working capital management policy:
1) Principle of equity position: as per this principle every investment in the current assets should contribute to the net worth of the firm. The position of current assets can be well judged by the two ratios; current assets to total asset and current asset to total sales.
2) Principle of cost of capital: different sources of working capital finance have different cost of capital. Generally there is –ve relationship between the risk and cost of capital, which means more the risk less will be the cost and less the risk more will be the cost. So there should be balance between the two.
3) Principle of maturity of payment: as per this principle the firm should make an every effort regarding the maturity of payment. In case the period to pay back the liabilities is short than it becomes difficult for the firm to meet it obligations in time.
4) Principle of risk variation: there is direct relationship between risk and profitability.
If the firm makes large investment in current asset→ increase liquidity→ reduce risk→ decrease the opportunity for gain for the firm.
If the firm makes less investment in current asset→ decrease liquidity→ increase risk→ increase the opportunity for gain for the firm.
The firm may have conservative management policy which means to minimize the risk or
aggressive management policy which means to maximize the risk or moderate management policy which means the balance between the risk and profit.