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Flexible policy (F) Compromise policy (C) Restrictive policy (R)

General growth in fixed assets and permanent current assets

With a compromise policy, the firm keeps a reserve of liquidity that it uses to initially finance seasonal variations in current asset needs. Short-term borrowing is used when the reserve is exhausted.

Flexible policy (F) Compromise policy (C) Restrictive policy (R)

General growth in fixed assets and permanent current assets

With a compromise policy, the firm keeps a reserve of liquidity that it uses to initially finance seasonal variations in current asset needs. Short-term borrowing is used when the reserve is exhausted.

The two policies, F and R, we depict in Figure 19.5 are, of course, extreme cases. With F, the firm never does any short-term borrowing, and with R, the firm never has a cash reserve (an investment in marketable securities). Figure 19.6 illustrates these two policies along with a compromise, Policy C.

With this compromise approach, the firm borrows in the short term to cover peak financing needs, but it maintains a cash reserve in the form of marketable securities during slow periods. As current assets build up, the firm draws down this reserve before doing any short-term borrowing. This allows for some run-up in current assets before the firm has to resort to short-term borrowing.

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