Question

Describe various types of working capital.

Answer 1

1. Permanent Working Capital: It represents the minimum working capital that a business must always maintain to carry out its basic operations. This amount remains continuously tied up in current assets and is therefore financed through long-term sources. There are two types of permanent working capital:
   1. Initial Working Capital: Initial working capital is a portion of permanent working capital that is required when a business is first set up. This amount is essential to begin business activities. At the start, the business typically does not receive credit from suppliers, so all operational expenses must be paid in cash. The necessary funds for these initial expenses usually come from the owners' personal contributions.
   2. Regular Working Capital: It refers to the portion of permanent working capital that is essential for the smooth and ongoing functioning of the business. It represents the surplus of current assets over current liabilities and includes sufficient cash to meet immediate obligations, maintain adequate inventory, and ensure enough finished goods are available for timely delivery to customers.
2. Temporary or Variable Working Capital: This is the portion of working capital required over and above the permanent working capital. It is needed to meet the seasonal and special requirements of the business. Since it fluctuates based on business needs, it is also called variable working capital. The amount of temporary working capital depends on the level of extra demand during the season or unexpected situations. Usually, it is sourced from short-term financing options. Temporary working capital is divided into two types:
   1. Seasonal Working Capital: Seasonal working capital refers to the additional funds required during specific periods of high demand. Businesses that deal in seasonal products, like woollen garments, fans, or umbrellas, typically need more working capital during peak seasons. As Gerstenberg states, “Besides their initial and regular working capital, most businesses need extra current assets at certain times to meet seasonal demand.” When the busy season starts, companies must invest additional funds to buy raw materials and pay extra workers. For instance, sugarcane, wheat, and cotton must be purchased in large quantities during their respective harvest seasons.
   2. Special Working Capital: This type of working capital refers to additional funds kept aside to handle unexpected situations or contingencies that may arise in a business. It is wise for a company to maintain a reserve of working capital as a safeguard during emergencies. Businesses should allocate extra funds to manage unforeseen events such as:
      1. Special activities to handle a sudden surge in demand.
      2. Periods of unusually low activity or economic slowdown, which result in the accumulation of inventory.
      3. Unforeseen events like strikes, lockouts, or natural disasters such as earthquakes, floods, or fires.