Figure 192

Carrying Costs and Shortage Costs

Short-term financial policy: the optimal investment in current assets Dollars

Total cost of holding current assets

Total cost of holding current assets

Carrying costs

Carrying costs

Shortage costs Amount of current assets (CA)

CA* represents the optimal amount of current assets. Holding this amount minimizes total costs.

Carrying costs increase with the level of investment in current assets. They include the costs of maintaining economic value and opportunity costs. Shortage costs decrease with increases in the level of investment in current assets. They include trading costs and the costs related to being short of the current asset (for example, being short of cash). The firm's policy can be characterized as flexible or restrictive.

A. Flexible policy

Dollars

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