HOW CAN OPERATING CYCLE BE REDUCED

1. Production Management. There should be proper production planning and coordination at all levels of activity.
2. Purchasing Management. The purchasing manager should ensure the availability of the right type, quantity and
quality of materials/merchandise obtained at the right price, time and place through proper logistics
management.
3. Marketing Management. The marketing people should strive to continually develop effective advertisement,
sales promotion activities, effective salesmanship and appropriate distribution channels.
4. Credit and Collections Policies. Sound credit and collection policies will enable the finance manager to minimize
investment in working capital particularly on inventory and receivables.
5. External Environment. The financial manager should be aware and sensitive to fluctuations in demand, entrants
of new competitors, government fiscal and monetary policies, price fluctuations, etc. to be able to anticipate
and minimize any adverse impact of the changes to the company.

ALTERNATIVE POLICIES AS TO THE SIZE OF INVESTMENT IN CURRENT ASSETS

1. Relaxed Current Asset Investment Policy. Marginal carrying costs of current assets will increase while marginal
shortage costs will decrease.
2. Restricted Current Asset Investment Policy. Marginal carrying costs of current assets will decrease while
marginal shortage costs will increase.
3. Moderate Current Asset Investment Policy. This is a policy that is between the relaxed and restricted policies.
This policy dictates that the firm will have just enough current assets so that the marginal carrying costs and
marginal shortage costs are equal, thereby minimizing total cost.

COSTS RELEVANT TO INVESTMENT IN CURRENT ASSETS

Carrying costs are the cost associated with having current assets. Generally consist of (a) opportunity costs associated
with having capital tied up in current assets instead of more productive fixed assets and (b) explicit costs which are costs
necessary to maintain the value of the current assets.
Shortage costs are the costs associated with not having current assets and can include (a) opportunity costs and (b)
explicit transaction fees paid to replenish the particular type of current asset.

RELAXED POLICY RESTRICTED POLICY MODERATE POLICY

Current asset holdings are:
Highest Low Optimized
Most appropriate when carrying costs relative to storage costs
are:
Carrying costs increase and shortage costs
Low High decrease with the level of investment in current
assets.

ALTERNATIVE STRATEGIES IN FINANCING WORKING CAPITAL

1. Long-Term/Permanent Assets. These consist equipment, long-term investments and the portion of a firm's
current of property, plant and assets that remain unchanged over the year.
2. Fluctuating or Seasonal Assets. These are current assets that vary over the year due to seasonal or cyclical
needs.

FACTORS TO BE CONSIDERED WHEN CHOOSING A FINANCING POLICY

1. Maturity Hedging. Most firms finance inventories with short-term bank loans and long-lived assets with long-
term financing. This type of maturity mismatching would necessitate frequent refinancing and is inherently risky
because short-term interest rates are more volatile than longer-term rates.
2. Cash Reserves. The flexible financing policy implies surplus cash and a little short-term borrowing. This policy
reduces the probability that a firm will experience financial distress.
3. Relative Interest Rates. Short-term interest rates are usually lower than long-term rates. This implies that it is,
on the average, more costly to rely on long-term borrowing as compared to short-term borrowing.
4. Availability and Costs of Alternative Financing. Firms with easy and sustained access to alternative sources will
want to shift toward more restricted policy.
5. Impact on Future Sales. A more restricted short-term financial policy probably could reduce future sales to level
that would be achieved under flexible policy.