In the conservative policy for financing working capital the difference between temporary and permanent current assets is overlooked and all assets are financed using long term capital. In the conservative policy the increase in current assets cannot be covered by short term financing and is supported by long term funding.
When there is any decrease in the level of current assets the excess funds are utilized by investing in short term marketable securities. The conservative policy of working capital reduces the firm’s risk regarding liquidity and eradicates the risk from the changing level of interest rates and unavailability of short term financing. This policy is less profitable than other policies in that it has a higher financing cost, as the long term financing sources such as long term debt or equity have higher costs. This marginal cost cannot be covered by the earnings from short term marketable securities (Rao, 1989).
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