TYPES OF WORKING CAPITAL NEEDS

  Important aspect of working capital management is to analyze the total working capital needs of the firm in order to find out the permanent and temporary working capital.  It has already been discussed that the working capital is required because of existence of operating cycle.  Moreover, the lengthier the operating cycle, greater would be the need for working capital.  The operating cycle is a continuous process and therefore, the working capital is needed constantly and regularly.  However, the magnitude and quantum of working capital required will not be same all the times, rather it will fluctuate.

The need for current assets tends to shift over time.  Some of these changes reflect permanent changes in the firm as is the case when the inventory and receivables increase as the firm grows and the sales becomes higher and higher.  Other changes are seasonal as is the case with increased inventory required for a particular festival season.  Still others are random, reflecting the uncertainty associated with growth in sales due to firm specific or general economic factors.  The working capital need therefore, can be bifurcated into permanent working capital and temporary working capital as follows:

1.    Permanent Working Capital:  There is always a minimum level of working capital which is continuously required by a firm in order to maintain its activities.  Every firm must have a minimum of cash, stock and other current assets in order to meet its business requirements irrespective of the level of operations.  Even during slack season, every firm maintains some current assets.  This minimum level of current assets which must be maintained by any firm all the times is known as permanent working capital for that firm.  This amount of working capital is constantly and regularly required in the same way as fixed assets are required.  So, it may also be called fixed working capital.

2.    Temporary Working Capital:  Over and above the permanent working capital, the firm may also require additional working capital in order to meet the requirements arising out of fluctuations in sales volume.  This extra working capital needed to support the increased volume of sales is known as temporary of fluctuating working capital.  For example, in case of spurt in sales, more stock must be maintained in order to meet the demand.  This additional inventory may become excess when the normal sales level reappears after some time.

It may be noted that both the permanent working capital and temporary working capital are necessary for every firm and the financial manage must make a distinction between the two.  The permanent working capital, once decided and arranged may not require regular attention or management as such.  But care must be taken of the temporary working capital.  The firm must be able to arrange additional working capital immediately whenever need arises.  The temporary working capital is needed to meet the temporary liquidity requirements only.

The permanent working capital may either be constant over a period of time or may be increasing over a period of time.  Further, that the permanent working capital is constant or increasing regularly while the temporary working capital is fluctuating from time to time.  The bifurcation of total working capital into permanent and temporary components is relevant for the working capital policy decisions relating to financing of working capital needs.  A financial manager has to decide about the financing of permanent and temporary working capital from different sources.  Moreover, he is to arrange funds for investment in temporary working capital needs without loss of time.  He is in fact, required to manage the total working capital needs in such a way as to keep available sufficient working capital to the firm as and when required.
 

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