Define each of the following terms: b. Current asset usage policies: relaxed policy, restricted policy, and moderate policy
Define each of the following terms:
Relaxed policy for current asset usage is the one wherein the corporation carries substantial amounts of cash, marketable securities and inventories. Moreover, a liberal credit policy is adopted which results in higher receivables. As a larger amount is invested in the current assets, the return on total investment is relatively low. However, there is a reduction in risk element. This is because the company has sufficient liquidity to doge the contingencies.
A company might decide to have a very low investment in cash, marketable securities and inventories. The credit policy adopted might be stringent, thereby restricting the quantum of receivables. Such a policy of asset investment is referred to as a restricted policy. While budgeting the current asset investment, the contingencies are not considered. Thus, the actual figures should not deviate from the budgeted ones. This policy is adopted to lower the interest costs, as lower amounts of current assets require less funding. Moreover, such a lower investment increases the return on total assets.
A combination of relaxed policy and restricted policy is termed as moderate policy for asset investment. The risk element is lower than a restricted policy and higher than a relaxed policy. The profitability also lies between the one offered by the other two policies. This policy ensures a smooth operation of working capital cycle with a moderate profit.
Relaxed policy - It is a type of current asset policy which calls for higher discounts, longer credit period, and lower credit standards resulting in a high level of receivables and sales.
Restricted policy - It is a type of current asset policy which calls for smaller discounts, shorter credit period, and more restrictive credit standards resulting in the lower level of receivables and sales.
Moderate policy - It is a type of current asset policy which lies between relaxed policy and restricted policy.