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Working capital refers to the funds required for meeting the day-to-day operational expenses of a business. It is essential for maintaining smooth production, purchasing raw materials, paying wages, meeting administrative expenses, and ensuring uninterrupted business operations. The determination of an appropriate level of working capital is one of the most important financial decisions because both excessive and inadequate working capital adversely affect profitability and liquidity. Different approaches have been developed to determine the amount of working capital that a business should maintain. The three broad approaches are the conservative approach, the aggressive approach, and the moderate or hedging approach. The conservative approach emphasizes maintaining a relatively high level of working capital. Under this approach, a firm finances not only its permanent working capital but also a part or the whole of its temporary working capital through long-term sources such as equity, retained earnings, long-term loans, or debentures. Temporary working capital refers to the additional working capital required during seasonal or cyclical increases in business activity, while permanent working capital is the minimum amount continuously required for regular operations. The main objective of the conservative approach is to minimize the risk of liquidity problems. Since long-term funds are generally stable and readily available, the firm is less likely to face ________ _____ ____ ________ _________.
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