Temporary Working Capital and Permanent Working Capital
Working Capital or net working capital is the measurement of company current assets and current liabilities. It measures the company’s liquidity reflect by using the current asset pay for current liabilities. It also reflects the company’s operational efficiency and short-term financial health.
Permanent Working Capital
Permanent Working Capital is the minimum level of working capital required by the business in order to operate. The company usually starts with minimum working capital and it needs to maintain this level to continue operation. It expects to be consistent from one year to another. It is also known as fixed working capital.
Permanent working capital is not always fixed, it can be changed over time depending on the level of business activities. It requires more working capital when company expands its operation over time. So the fixed working capital is not fixed as its name suggests.
What is the Level of Permanent Working Capital?
There is no exact amount of permanent working capital for every business. Each company needs to figure it out by themselves. It is the total of current asset less current liabilities which allow the company to operate without any difficulties.
Company has to define the minimum cash level that they can use to pay supplier, payroll, and other expenses without difficulty. It also requires maintaining a minimum level of inventory to ensure enough goods for sale. Accounts receivable balance will depend on the sale volume and nature of business.
Therefore the minimum level of working capital will be the result of current asset and liability which arrive from the total of all components. Different businesses require different levels of cash, inventory, receivables, and payable, so it leads to various levels of working capital.
Type of Permanent Working Capital
Permanent working capital is classified into reserve working capital and regular working capital.
Regular Working Capital
It is the minimum level of working capital that require in one business from one to another business cycle. It is the requirement to operate the business.
Reserve Working Capital
It is the permanent working of capital that exceeds the minimum requirement (regular working capital). The company may require to maintain permanent working capital more than the business requirement. It can happen during the union strike, recession, or other unexpected events.
Temporary Working Capital
Temporary working capital is the working capital that exceeds the permanent level.
It is hard to maintain the working capital at the permanent level, so businesses usually keep it higher than the minimum level. The amount of working capital that exceeds the permanent level is considered as the temporary working capital.
Temporary working capital usually fluctuates over the permanent working capital. It is not fixed at any rate. The current assets balance may increase or decrease due to various reasons. Inventory balance will increase before the peak seasons as the company needs to increase the stock and ready for peak season. For manufacturing, the inventory balance will decrease if the buyer decreases the order amount. The cash amount also changes base on the management decision over long-term investment. It will decrease after the company making a new investment.
Type of Temporary Working Capital
Temporary working capital is classified into seasonal and special working capital.
- Seasonal Working Capital: It is the change of working capital due to seasonal change. The company increases stock in the peak season and decreases in the low season.
- Special Working Capital: It is the working capital that changes due to special purchases such as regulation requirements.