## Working Capital Policies: Risk-Return Trade-off
### The Two Aims of WC Management
Working capital management has two competing objectives:
1. Profitability — earn higher returns
2. Solvency (Liquidity) — avoid cash shortages and stock-outs
### Conservative Policy
- Maintains high levels of current assets (cash, inventory, receivables).
- Lower risk of insolvency — minimal chance of cash shortage or stock-out.
- Lower return — large idle assets earn little.
- A liquid firm has less risk but pays a cost: idle resources sacrifice profit.
### Aggressive Policy
- Maintains low levels of current assets.
- Higher return — assets are deployed more productively.
- Higher risk — greater chance of stock-outs, cash shortages, lost customers.
### The Trade-off
> To achieve higher profitability, the firm may have to sacrifice solvency by maintaining a relatively low level of current assets.
### Visual Summary
| Policy | Current Assets | Return | Risk |
|---|---|---|---|
| Conservative | High | Low | Low |
| Aggressive | Low | High | High |
| Moderate | Balanced | Medium | Medium |
### Key Insight
There is no free lunch: liquidity has a cost, and profitability has a risk. The optimal policy depends on the firm's risk appetite and industry.