Permanent and temporary working capital, and their importance

Classification by time. On the basis of time, working capital is classified as permanent (fixed) working capital and temporary (variable) working capital.

Permanent (fixed) working capital. It is the minimum amount of current assets needed all the time to use the fixed facilities effectively and to keep current assets circulating: from cash to inventories, from inventories to receivables and from receivables back to cash. This minimum level never falls to zero while the business runs, and it grows as the business grows. It is further divided into regular working capital (needed for that circulation) and reserve working capital (an amount over the regular need, kept for contingencies such as strikes, rising prices or depression).

Temporary (variable) working capital. It is the extra working capital needed over and above the permanent level to meet seasonal demands and special exigencies. It is divided into seasonal working capital (for seasonal needs) and special working capital (for special exigencies, such as an extensive marketing campaign or research). It rises and falls with the level of activity.

Importance. Working capital is the lifeblood of a business, and adequate working capital brings:

1. Solvency, through an uninterrupted flow of production;
2. Goodwill, because payments are made promptly;
3. Easy loans from banks on favourable terms, given a good credit standing;
4. Cash discounts on purchases, which reduce cost;
5. Regular supply of raw materials and continuous production;
6. Regular payment of salaries and wages, which raises employees' morale and efficiency.