Defensive strategy
From CEOpedia | Management online
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 |
Examples of Defensive strategy
- Negotiating better payment terms: Negotiating better payment terms with vendors, creditors and other suppliers is an important defensive strategy. This can help the business to conserve cash and improve its financial situation in times of need.
- Establishing a cash reserve: Establishing a cash reserve is an effective defensive strategy as it allows the business to weather any economic downturn. By setting aside a portion of revenues, the business can fund operations in the event of a cash crunch.
- Increasing debt repayment: Increasing debt repayment is another defensive strategy. By paying off debts as quickly as possible, the business can improve its cash flow and reduce its risk of being unable to meet its financial obligations.
- Leveraging assets: Leveraging assets is a great defensive strategy that can help the business generate additional cash flow. By leveraging assets such as equipment, land or inventory, the business can generate additional funds to cover short-term needs.
- Investing in short-term assets: Investing in short-term assets is another defensive strategy. By investing in assets such as stocks and bonds, the business can generate additional funds to cover short-term needs.
- Optimizing working capital: Optimizing working capital is another defensive strategy. By increasing the efficiency of the use of working capital and reducing the amount of capital needed to fund operations, the business can improve its cash position.
Advantages of Defensive strategy
- Defensive strategy helps to secure liquidity in the short term, ensuring the company's financial credibility.
- This strategy allows a company to maintain its market position and adapt to existing market conditions.
- This strategy also enables the company to acquire short-term capital, making full use of the self-financing option.
- Defensive strategy allows the company to secure its main needs in terms of net working capital.
- By using internal sources of financing, a company can reduce its reliance on external financing sources, thus reducing its costs.
- This strategy helps a company to minimize risk and maximize short-term profits.
Limitations of Defensive strategy
- Defensive strategy limits a company's ability to take advantage of new opportunities presented by the market. Since the main goal of this strategy is to maintain the current market position, the company is less likely to invest in new ventures which could potentially yield higher returns.
- The defensive strategy also limits the amount of capital available for investment activities, as the company tends to rely on short-term sources of financing. This could reduce the potential to generate higher revenues from investments in the long-term.
- The defensive strategy also limits the amount of flexibility a company has when faced with changing market conditions. Since the strategy focuses on maintaining the current market position, the company is less inclined to adapt to changing needs and respond quickly to new opportunities.
- The defensive strategy also limits the potential for innovation and growth, as the focus is on maintaining the current market position. The company is less likely to invest in new technologies or explore new markets.
- Diversification of sources of finance: This involves using a variety of sources for financing operations, such as issuing debt, using bank loans, issuing stock, and using trade credit.
- Financial Leverage: This involves using debt and equity to finance operations, thus increasing the amount of capital available with the same amount of equity.
- Retain Earnings: This involves using profits from operations to finance operations.
- Cost Cutting: This involves reducing operational costs to increase profits and free up cash flow.
In conclusion, defensive strategy is a conservative approach to financing operations, utilizing a variety of sources of finance such as debt, equity, trade credit and retained earnings. The aim is to ensure liquidity in short periods, eliminate current threats, maintain financial credibility and maximize profits. Cost cutting is also a key element of this strategy, as it helps to increase profits and free up cash flow.
| Defensive strategy — recommended articles |
| Appropriation of retained earnings — Assets funding strategy — Capital gearing — Capital restructuring — Funding Operations — Free Reserves — Reserve capital — Capital rationing — Capital buffer |
References
- Fornell, C., & Wernerfelt, B. (1987). Defensive marketing strategy by customer complaint management: a theoretical analysis. Journal of Marketing research, 24(4), 337-346.
- Hauser, J. R., & Shugan, S. M. (2008). Defensive marketing strategies. Marketing Science, 27(1), 88-110.
- Ginsberg, J. M., & Bloom, P. N. (2004). Choosing the right green marketing strategy. MIT Sloan management review, 46(1), 79-84.
