Conservative Approach - Financing Current Assets
An exact similar of asset life along with the life of the funds required to finance the asset may not be possible. A firm that follows the conservative approach depends more on long-term funds for financing needs. Consequently, the firm, finances its permanent assets and a part of its temporary assets along with long-term funds.
It should be notice that short-term funds are cheaper than long-term funds. Several sources of short-term funds like accruals are cost-free. Still, short-term funds must be repaid during the year and so they are highly risky. Through this in mind, we can seem the risk-return trade off of the three approaches:
- The conservative approach is a low return-low risk approach. This is since the approach uses more of long-term funds such are now more expensive than short-term funds. These funds conversely, are not to be repaid during the year and are hence less risky.
- The aggressive approach on another hand is a highly risky approach. Conversely it is a high return approach also for this reason is that it relies more on short-term funds which are less costly although riskier.
- The matching approach is in between the life of the funds financing the assets and since it matches the life of the asset.