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Types of Working Capital
Types of Working Capital
Working capital refers to the funds that a company needs to cover its day-to-day
operational expenses and maintain its current assets. Permanent working capital
is the minimum level of current assets that a company must maintain to support
its ongoing business operations, taking into account its production capacity or
relevant sales range. It ensures that the company has enough funds to cover its
short-term liabilities, meet customer demands, and continue its operations
smoothly.
TEMPORARY WORKING CAPITAL
Temporary working capital is the surplus or excess working capital that a
company maintains beyond its permanent working capital requirement. It
represents the additional funds available to the company to meet short-term
needs or unexpected fluctuations in business activities. For example, during peak
seasons or periods of high demand, a company may require additional working
capital to finance increased production, maintain higher inventory levels, or
extend credit to customers. This additional working capital, over and above the
permanent working capital, is considered temporary working capital.
These needs may arise due to factors like increased production or a higher
demand for products. According to the policy, these short-term working capital
needs should be financed using short-term sources of financing, such as short-
term loans, trade credit, or lines of credit. Short-term financing options are
suitable for covering temporary needs because they offer flexibility and can be
easily adjusted based on changing business conditions.
This aggressive approach allows the company to free up capital and allocate it to
other purposes, such as investments, expansion, or paying off other debt.
However, it also introduces higher risk to the company's financial stability. Short-
term financing needs to be repaid within a shorter timeframe, which can put
pressure on the company's cash flow if not managed properly.
The aggressive working capital financing policy requires careful monitoring and
management of the company's cash flow, as well as a solid understanding of its
ability to generate funds in the short term to meet repayment obligations.
However, financing temporary working capital with long-term sources can also
have potential drawbacks. It ties up long-term funds for short-term needs, which
may limit the company's flexibility in making long-term investments or
addressing other financial obligations. It is crucial for the company to carefully
assess its cash flow and ensure that it can comfortably service the long-term
financing used for temporary working capital.