Variable Working Capital
Temporary or variable working capital (VWC) refers to the
portion of the total capital required over and above the fixed
working capital to meet seasonal needs and contingencies. This
extra working capital is needed to support changing production
Unlike the salary earnings of an employee, businesses do not
earn an equal amount of money every month throughout the year.
Instead, they get occasional opportunities to earn substantial
money and, thus, have to make the most of such chances. Thus,
all firms have temporary liquidity requirements and need enough
variable working capital to fulfil them.
The KredX platform provides collateral-free working capital
solutions in the form of invoice discounting. This helps unlock
money tied up in unpaid invoices providing businesses easy and
instant access to funds to address short-term liabilities.
How Is Variable Working Capital Determined?
There is no standard academic formula to calculate temporary
working capital. However, if you know the value of permanent
working capital, the VRC could be calculated as:
Variable Working Capital Formula = Net Working Capital (NWC) –
Permanent Working Capital (PWC)
Note that NWC is calculated as the difference between a
company’s current assets (cash, inventories of raw materials,
finished goods, account receivables) and current liabilities
(accounts payable, taxes).
Business owners should plot the value of VWC every day as it
fluctuates frequently. Factors such as seasonal demand of
specific products and occurrence of special events affect the
variable capital. Usually, stable businesses have smaller
fluctuations, whereas the bigger and growing ones have larger
swings in working capital demands.
Some examples of variable costs that affect variable working
- Direct materials
- Production supplies
- Credit card fees
- Staff wages
- Freight charges
Sources Of Financing Variable Working Capital:
Many sources of financing VWC arise in the normal course of
business operations. They can use the following sources of
financing for temporary requirements of working capital:
Inter Corporate Deposits
Various short-term provisions
Advances received from customers
Fixed deposits of 1 year or less
- Trade credit
- Outstanding expenses
For immediate and instant access to VWC, businesses need access
to spontaneous sources of working capital. These unsecured funds
do not come with any explicit costs attached, and their amount
varies with the level of sales.
For instance, trade credit is an arrangement for spontaneous
finances where a company buys goods or services without paying
for them immediately. This reduces the need for the capital
investment required to operate a business when managed properly.
On the other hand, outstanding expenses are those that remain
unpaid at the end of the accounting period. Such expenses are
payable but are not paid immediately and can be used on a
Types Of Variable Working Capital:
VWC can be classified into the following types based on the
reasons for the fluctuation of the net working capital.
Seasonal Variable Working Capital
Many businesses have fluctuating working capital demands based
on seasons. For example, during the peak sales period, they
require additional and immediate financial assistance due to
high customer demands.
On the other hand, during the off-season, working capital
demands drop considerably. Therefore, these businesses opt for
seasonal working capital to deal with surging demands in
Special Variable Working Capital
Businesses use this type of working capital to meet special
and unexpected financial needs. They set aside or make
arrangements for these additional funds to deal with sudden
fluctuations in working capital needs.
The special working capital can be used for risk management
(fires, floods, famine, changes in government policy),
financing marketing campaigns, launching new products and
Comparing Permanent And Temporary Working Capital:
Permanent or fixed working capital consists of the minimum
current assets a business requires to keep its operations
afloat. The size of such capital depends on production scale and
growth. Businesses use only long-term financing sources to
fulfil fixed working capital demands.
Temporary or variable working capital is the additional capital
required by a business to meet sudden and unexpected changes in
sales and production. Businesses use this type of funds to meet
short-term cash flow requirements. Seasonal demands and certain
unique circumstances affect the need for this type of working
The primary reason to compare these two types of working capital
is to make suitable decisions related to financing working
capital demands. Fixed working capital is usually the cheaper
option but cannot be redeemed easily, while variable working
capital is more expensive but has time flexibility. This means
you can use them when needed and repay the loan amount when the
purpose is served.
Accordingly, businesses should pick a source of financing to
account for their variable working capital needs and streamline
operating activities with ease. For instance, with KredX’s
invoice discounting, you can get seamless access to
collateral-free financing using unpaid invoices.
Variable working capital is usually used to meet
sudden and unexpected working capital demands of a
business. For example, increase in orders or cost
of raw materials.
The following are some of the factors that affect
working capital demands:
- Production cycle
- Business cycle
- Available raw materials
- Size of business
- Nature of business
- Credit policy
- Earning capacity
- Taxation policies
In this type of working capital, the fund
requirements remain constant for a while but then
increases with an increase in sales and time.