Working capital is the primary component when it comes to a business’s operational competency and growth potential. Managing it efficiently not only ensures that short-term requirements are met adequately but also sets the stage for achieving long-term objectives more efficiently. So, when running a business, it is essential to both understand the concept of working capital & its types as well as learn of ways to manage it effectively.
Working capital is the difference between a company’s assets and liabilities. Hence, with adequate working capital, you can meet all short-term expenses and liabilities in your business efficiently. You can address financial emergencies with greater ease when there’s sufficient working capital.
Based on periodicity, any business usually requires two primary types of working capital to finance its operations –
Permanent working capital also known as fixed working capital, this type of working capital is constant throughout business operations. Also known as fixed working capital, companies need to maintain such an amount to meet its basic financial requirements, like paying rent & salaries, repaying creditors, et al. The amount, thereby, to maintain in your company depends on its size and scale of operations.
While permanent working capital is a broader term, its classification provides a more nuanced understanding of it.
There are certain expenses in your business that you cannot do without. For instance, in case of a manufacturing business, there’s a constant monetary need to fund the processing of raw materials. The minimum amount required to finance expenses of that kind is called regular working capital.
Sudden financial obligations may arise due to unprecedented circumstances in any business. That may include natural calamities, changes in government policies, etc. Reserve margin working capital is for this purpose.
However, not always does reserve margin working capital suffice, such as unprecedented financial needs. In that case, you might look for alternative financing options, such as invoice discounting service from KredX.
Also known as variable working capital, it is the excess amount a business needs over and above its permanent counterpart. It is related to the volume of production in a business. Since sales and production fluctuate throughout a year, working capital requirements may also vary. It can be classified into two types.
Production and sales largely depend on the season. In specific seasons, a company might note much higher sales compared to the rest of the year. For instance, if you own a clothing business, there will be massive demand during the festive seasons. Seasonal working capital is the amount required to fund that kind of demand.
Since in such seasons, there’s a massive cash outflow in the form of purchasing raw materials, paying distributors, etc. several businesses opt for financing services like invoice discounting, bank loans, etc.
It is the amount of capital a business needs to mitigate exceptional financial obligations, like a sudden demand for PPE kits. It can also include launching a sudden marketing campaign because of moves by competitors.
These are the different types of working capital that you may need in your company. Understanding “what is working capital” in depth can facilitate better management of the same.
The primary factors that determine the amount of working capital you will need in your business are –