Some Aspects Of Shortterm Financial Policy

The short-term financial policy that a firm adopts will be reflected in at least two ways:

1. The size of the firm's investment in current assets. This is usually measured relative to the firm's level of total operating revenues. A flexible, or accommodative, short-term financial policy would maintain a relatively high ratio of current assets to sales. A restrictive short-term financial policy would entail a low ratio of current assets to sales.5

2. The financing of current assets. This is measured as the proportion of short-term debt (that is, current liabilities) and long-term debt used to finance current assets. A restrictive short-term financial policy means a high proportion of short-term debt relative to long-term financing, and a flexible policy means less short-term debt and more long-term debt.

If we take these two areas together, we see that a firm with a flexible policy would have a relatively large investment in current assets, and it would finance this investment with relatively less in short-term debt. The net effect of a flexible policy is thus a relatively high level of net working capital. Put another way, with a flexible policy, the firm maintains a higher overall level of liquidity.

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