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 and sales.

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 capital include:

• Direct materials
• Production supplies
• Commissions
• 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:

• Spontaneous sources
1. Trade credit
2. Outstanding expenses
• Commercial papers
• Inter Corporate Deposits
• Invoice financing
• Banks/NBFCs
• Various short-term provisions
• Accounts receivable
• Advances received from customers
• Fixed deposits of 1 year or less

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 short-term basis.

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 certain seasons.
• 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 more.

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 capital.

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.