Defensive strategy

Defensive strategy
See also

Defensive strategy is one of the three strategies for financing operations. In literature, it is often referred to as a conservative, conservative, gentle, passive, pessimistic and survival strategy. The main objective of this strategy is to secure liquidity in short periods, eliminate current threats, maintain financial credibility and maximize profit in short periods. By adopting this strategy, the company strives to maintain its market position and adapt to existing barriers on the market, strives to operate within the existing structure. The defensive strategy is also aimed at acquiring short-term capital, fully using the self-financing option and securing the main needs in terms of net working capital. The company uses internal sources of financing for its operations.

Main characteristics

The defensive strategy of asset financing has the following characteristics :

  • the financial risk is limited to zero,
  • there is a slight risk of losing the company's payment liquidity,
  • it refers to the breakdown of current assets into two parts: fixed and variable and is based on the assumption that fixed capital is to finance fixed assets and the fixed part of current assets. This means that a fixed part of total assets should be covered with fixed capital,
  • maximizing the share of fixed capital in financing current assets strengthens the paying balance of the company and its financial stability,
  • there is a positive level of net working capital,
  • increasing the net working capital requirement financed by the enterprise from its own resources means that the enterprise incurs other costs,
  • increasing the demand for working capital, which is financed from long-term loans, increases the cost of capital, because long-term loans have a higher interest rate on short-term loans,
  • significant involvement of fixed capital decreases the rate of profitability of equity,
  • the enterprise maintains a high level of financial liquidity, which results in lowering the rate of return and the increase in the cost of capital,
  • it facilitates the use of financial leverage and tax shield to a limited extent,
  • in an advantage relationship - the risk creates a strategy with low risk and small benefits.

Other strategies

In addition to the defensive strategy, we also distinguish :

  • Aggressive strategy - it allows you to take full advantage of the opportunities created by the financial market. It allows you to maximize profit in the long run and a higher risk level. Funds for financing operations are acquired primarily on the capital market. This strategy is risky and assessed negatively by the majority of creditors, because in the case of a reduction in cash proceeds or as a result of difficulties in obtaining a bank loan, as well as an increase in the interest rate on the loan, the enterprise may lose its ability to pay its liabilities in a timely manner. In the literature, it can also be called dynamic, active, development, offensive and risky strategy.
  • moderate strategy - this is an indirect strategy between conservative and aggressive. Fixed assets should be covered with fixed or own capital. In this strategy, the net working capital is nil or slightly positive. It is safe in terms of maintaining current financial liquidity, but in the case of this strategy, the company should have flexible opportunities to raise short-term capital. It absorbs the average financial costs and causes the risk related to loan indebtedness. The strategy assumes a moderate use of financial leverage, a tax shield and brings moderate return on equity. The moderate strategy is also defined as a balanced, flexible and harmonious strategy.

Comparative analysis of the characteristics of the asset financing strategy

Evaluation criteria Defensive strategy Aggressive strategy Moderate strategy
Degree of financing current assets with net working capital higher (net working capital adopts a positive level) smaller (net working capital is assumed to be negative) average (net current capital adopts zero or low positive)
Degree of financing of current assets with a fixed capital higher (a fixed part of current assets is financed with a fixed capital) smaller (a part of fixed assets should be financed with fixed assets, current assets should be financed with short-term foreign capital) average (current assets should be financed by short-term foreign capital)
Degree of financing current assets with short-term capital smaller (sources short-term cover current assets) higher (short-term financing sources cover total current assets and partly fixed assets) average (short-term financing sources cover a fixed and variable part of current assets over the minimum level of security)
Costs of financing higher (long-term capital is high interest) lower (short-term loans are low-interest) average
The risk of financial debt lower higher average
The use of financial leverage and tax shields lower higher average
Profitability of capital lower higher average
The financial liquidity higher lower average

References