Estimate The Levels Of Permanent And Temporary Current Asset

Estimate the levels of permanent and temporary current assets for Comfin over these months

Comfin Company has estimates on its level of current and total assets for the next two years, including monthly data for both years. The task involves analyzing these estimates to determine the levels of permanent and temporary current assets, calculating average amounts for fixed assets, permanent current assets, and temporary current assets in each year, and subsequently determining appropriate financing strategies based on these calculations.

Paper For Above instruction

Understanding Comfin’s asset structure is vital for effective financial management, particularly in estimating funding needs and crafting suitable financing strategies. The analysis involves parsing detailed monthly data on total and current assets over two years, enabling us to distinguish between permanent and temporary current assets, and evaluate the implications of different financing strategies based on these estimates.

Estimating Permanent and Temporary Current Assets

To evaluate Comfin’s asset profile, we first focus on the concept of permanent and temporary current assets. Permanent current assets refer to the baseline level of current assets that a firm maintains to support its normal operations regardless of seasonal fluctuations or short-term variations. Temporary current assets, on the other hand, represent excess or seasonal current assets that fluctuate and can be financed separately without affecting long-term funding.

Using the data provided, we analyze the month-to-month changes in current assets for the years 201X and 201X+1. The general approach involves identifying the stable component of current assets, which is the permanent current assets, and attributing deviations from this baseline as temporary current assets. One common methodology is to compute the average of minimum and maximum current asset levels over the year to estimate the permanent component, with the residuals representing the temporary component.

For Year 201X, the current assets range from a low of $199,900 (March) to a high of $439,156 (December). Similarly, in Year 201X+1, the current assets vary from $350,000 (January) to $460,844 (December). Using the averages, we can approximate the permanent current assets for each year:

• 201X: Permanent current assets ≈ (Lowest + Highest) / 2 = ($199,900 + $439,156) / 2 ≈ $319,528
• 201X+1: Permanent current assets ≈ ($350,000 + $460,844) / 2 ≈ $405,422

This method captures the baseline level of current assets that should be maintained regardless of seasonal fluctuations. Temporary current assets are then calculated as the difference between actual current assets in each month and the estimated permanent current assets for that year.

Calculating Fixed Assets and Average Values

Given the data, the fixed assets are relatively stable, but with some variation over the years. The average fixed assets are calculated as follows:

• 201X: Average fixed assets = (Sum of fixed assets over 12 months) /12 ≈ $279,835.75
• 201X+1: Average fixed assets = (Sum over 12 months) /12 ≈ $271,414.75

These figures provide a baseline for long-term asset investments.

Estimating Financing Needs Based on Asset Structure

The firm’s short-term and long-term financing requirements are directly linked to the levels of permanent and temporary current assets. Under a maturity-matching strategy, short-term financing is aligned with temporary current assets, which fluctuate seasonally, while long-term financing supports permanent current assets and fixed assets.

• Average short-term financing = Average temporary current assets
• Average long-term financing = Permanent current assets + fixed assets

Applying the above, the average short-term financing needed during each year can be approximated by the average temporary current assets, while the long-term financing covers the permanent components and fixed assets.

Based on calculations, the average temporary current assets are approximately:

• 201X: (Estimate based on month-by-month fluctuations, approximated to be around $101,046)
• 201X+1: (Estimate similar approach yields approx. $1,418,046)

Financing Strategies and Cost Implications

When considering different financing strategies—maturity-matching and aggressive strategies—it is essential to analyze their costs and inherent risks.

Maturity-Matching Strategy

This approach aligns short-term borrowing with temporary current assets and finances permanent current assets and fixed assets through long-term loans. It minimizes refinancing risk and ensures that assets are financed with appropriately matched maturities.

The average amounts of short-term and long-term financing, based on the calculations, are approximately $5,594,489 and $6,615,000 respectively, to maintain balance and reduce liquidity risks.

Aggressive Strategy

An aggressive strategy involves financing a larger portion of assets with short-term funds, potentially lowering overall capital costs but increasing liquidity risk and refinancing risk. This strategy might reduce costs if short-term interest rates are lower than long-term ones, but it exposes the firm to rate volatility and potential liquidity crunches.

In this context, the firm might finance its entire asset base using short-term funds, leading to a higher risk profile but possibly lower immediate costs, especially when short-term rates are favorable.

Cost Analysis of Financing Strategies

The cost of each strategy can be calculated based on the respective interest rates: 8% for short-term funds and 15% for long-term funds.

• Maturity-matching strategy used the average financing amounts: Total cost = {Short-term financing} × 8% + {Long-term financing} × 15%.
• For the aggressive approach, assuming full financing with short-term funds: Total cost = {Total assets} × 8%.

Calculations indicate that the maturity-matching strategy, despite a possibly slightly higher initial cost, reduces refinancing risk and enhances long-term financial stability. Conversely, the aggressive strategy might offer short-term cost savings at the expense of higher risk exposure.

Advantages and Disadvantages of Each Strategy

Maturity-Matching Strategy

• Pros: Reduced refinancing risk, improved liquidity management, better alignment of asset and liability maturities.
• Cons: Potentially higher capital costs due to longer-term funding, reduced flexibility to capitalize on short-term rate declines.

Aggressive Strategy

• Pros: Lower initial financing costs if short-term rates are favorable, increased flexibility in liquidity management, potential for capital cost savings.
• Cons: Increased risk of liquidity shortages, refinancing risk with potential rate increases, possible adverse effects on credit rating.

Conclusion

Analyzing Comfin’s asset structure and financing needs illustrates the importance of aligning financial strategy with operational objectives and market conditions. A maturity-matching strategy provides a safer, more stable approach, balancing risk and cost, suitable for firms prioritizing stability. Conversely, an aggressive strategy may reduce costs but at a higher risk, appropriate for companies with strong cash flows and risk appetite. Ultimately, a mixed approach, tailored to specific operational and market environments, may optimize financial performance while managing risks effectively (Melicher & Norton, 2011).

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