A company is in the process of finalising its financial strategy for the upcoming year, with a particular focus on balancing profitability and…

CA Intermediate · Financial Management and Strategic Management · MTP · May 2026
A company is in the process of finalising its financial strategy for the upcoming year, with a particular focus on balancing profitability and liquidity through its working capital policies. The management anticipates that the level of investment in current assets – especially inventories and receivables (book debts) will have a direct impact on sales volume and, consequently, on Earnings Before Interest and Tax (EBIT). For the next financial year, the company has projected its investment in fixed assets at 2.60 crore, while current liabilities are expected to stand at 2.34 crore. With these baseline estimates in place, the company must decide how aggressively or conservatively it should invest in current assets. The Financial Controller has been tasked with evaluating alternative working capital policies. Each policy represents a different level of investment in current assets, which in turn affects sales potential, operating efficiency, risk exposure, and profitability. A higher investment in inventories and receivables may support increased sales and improved customer service but could also lead to higher carrying costs and risk of obsolescence or bad debts. On the other hand, a more conservative approach may reduce costs and risks but could constrain sales growth and customer satisfaction. In this context, the Financial Controller is analysing various scenarios of working capital investment (expressed in ₹ crore), comparing their impact on sales, EBIT, and overall financial performance. The objective is to identify an optimal policy that strikes a balance between risk and return while ensuring adequate liquidity for smooth business operations. Working capital policy Investment in current assets Estimated sales EBIT Conservative 4.50 12.30 1.23 Moderate 3.90 11.50 1.15 Aggressive 2.60 10.00 1.00 After evaluating the working capital policy, the financial controller has advised the adoption of the moderate working capital policy. The company is now examining the use of long-term and short-term borrowings for financing its assets. The company will use - 2.50 crore of the equity funds. The corporate tax rate is 35 per cent. The company is considering the following debt alternatives: Financing Policy Short-term debt Long-term debt Conservative 0.54 1.12 Moderate 1.00 0.66 Aggressive 1.50 0.16 Interest rate-Average (%) 12 16 Required: (1) Working capital investment for each policy. (a) Net working capital position, (b) Rate of return, and (c) Current ratio (2) Financing for each policy. (a) Net working capital position, (b) Rate of return on shareholder equity, and (c) Current ratio

Suggested Answer and Working Notes:

Statement showing Working Capital for each policy (1) Statement showing working capital investment under each policy Particulars Working capital policy Conservative Moderate Aggressive (A) Current assets 4.50 3.90 2.60 (B) Fixed assets 2.60 2.60 2.60 (C) Total assets (A) + (B) 7.10 6.50 5.20 (D) Current liabilities 2.34 2.34 2.34 (E) Net worth (C) – (D) 4.76 4.16 2.86 (F) Estimated sales 12.30 11.50 10.00 (G) EBIT 1.23 1.15 1.00 (i) Net working capital position (A) – (D) 2.16 1.56 0.26 (ii) Rate of return (G)/(C) (in per cent) 17.3 17.7 19.2 (iii) Current ratio (A)/(D) 1.92 1.67 1.11 (2) Statement showing effect of financing under alternative financing policy (₹ in crores) Particulars Financing policy Conservative Moderate Aggressive (A) Current assets 3.90 3.90 3.90 (B) Fixed assets 2.60 2.60 2.60 (C) Total assets (A) + (B) 6.50 6.50 6.50 (D) Current liabilities 2.34 2.34 2.34 (E) Short-term debt 0.54 1.00 1.50 (F) Long-term debt 1.12 0.66 0.16 (G) Equity capital 2.50 2.50 2.50 Total liabilities (D) + (E) + (F) + (G) 6.50 6.50 6.50 Estimated sales 11.50 11.50 11.50 (H) EBIT 1.15 1.15 1.15 (I) Less: Interest on short-term debt [12% of (E)] (0.06) (0.12) (0.18) (J) Interest on long-term debt [16% of (F)] (0.18) (0.11) (0.03) (K) EBT [(H) – (I) – (J)] 0.91 0.92 0.94 (L) Less: Taxes @ 35% (0.32) (0.32) (0.33) (M) EAT [(K) – (L)] 0.59 0.60 0.61 (a) Net working capital [(A) – (D) – (E)] 1.02 0.56 0.06 (b) Rate of return on equity funds [(M)/(G)%] 23.6% 24% 24.4% (c) Current ratio [(A)/(D) + (E)] 1.35 1.17 1.02

Topics: Part-A: Financial Management

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