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General growth in fixed assets and permanent current assets

Total asset requirement

General growth in fixed assets and permanent current assets

Total asset requirement

Time long-term debt and equity. Net working capital—current assets minus current liabilities—is always zero. Figure 19.3 displays a "sawtooth" pattern that we will see again when we get to our discussion on cash management in the next chapter. For now, we need to discuss some alternative policies for financing current assets under less idealized conditions.

Different Policies for Financing Current Assets In the real world, it is not likely that current assets will ever drop to zero. For example, a long-term rising level of sales will result in some permanent investment in current assets. Moreover, the firm's investments in long-term assets may show a great deal of variation.

A growing firm can be thought of as having a total asset requirement consisting of the current assets and long-term assets needed to run the business efficiently. The total asset requirement may exhibit change over time for many reasons, including (1) a general growth trend, (2) seasonal variation around the trend, and (3) unpredictable day-today and month-to-month fluctuations. This fluctuation is depicted in Figure 19.4. (We have not tried to show the unpredictable day-to-day and month-to-month variations in the total asset requirement.)

The peaks and valleys in Figure 19.4 represent the firm's total asset needs through time. For example, for a lawn and garden supply firm, the peaks might represent inventory buildups prior to the spring selling season. The valleys would come about because of lower off-season inventories. There are two strategies such a firm might consider to meet its cyclical needs. First, the firm could keep a relatively large pool of marketable securities. As the need for inventory and other current assets began to rise, the firm would sell off marketable securities and use the cash to purchase whatever was needed. Once the inventory was sold and inventory holdings began to decline, the firm would reinvest in marketable securities. This approach is the flexible policy illustrated in Figure 19.5 as Policy F. Notice that the firm essentially uses a pool of marketable securities as a buffer against changing current asset needs.

At the other extreme, the firm could keep relatively little in marketable securities. As the need for inventory and other assets began to rise, the firm would simply borrow the needed cash on a short-term basis. The firm would repay the loans as the need for assets

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

VII. Short-Term Financial Planning and Management

19. Short-Term Finance and Planning

© The McGraw-Hill Companies, 2002

CHAPTER 19 Short-Term Finance and Planning

Alternative Asset Financing Policies

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