Working capital management is the management of the net of current assets and current liabilities with the objective of reaching the right balance between profitability and liquidity. The aim of managing inventory (stock), trade receivables (debtors), cash, trade payables (creditors), is to obtain the right balance of all the current assets and current liabilities at any given time so that the achieve the objectives of working capital management in the form of profitability and liquidity. Working capital management is made up of so many parts, such as the management of inventory, management of trade receivables, management of cash, management of trade payables, financing of working capital. To discuss the different approaches to financing working capital, it is important to identify that ordinarily, company may use short-term sources of finance to finance its short-term activities, such as working capital activities and long-term source of finance for its capital investments in non-current assets. The choice of which source of finance a company uses to finance its working capital and other activities depend on several factors such as: availability of fund, the length of time such funds may be required for, the purpose for which the funds is required, the size of the company, the rate of interest but for the discussion of the financing of the working capital, the two main factors that needs to be considered are the risk of the finance used and the cost of finance; either by financing working capital using short or long-term source of finance. The risk and cost factors are inversely related, in that if a company goes for a low risk source of finance, it is related to a high cost source of finance and vice versa.
Assuming a normal yield curve (the term structure of interest rate) where the interest rate curve is upward sloping, a short-term loan will be cheaper than a long-term source of finance. This means that...