What is permanent working capital?
Permanent working capital refers to the minimum amount of capital that a business must maintain to support its ongoing operations. This type of working capital is essential for ensuring that a company can continue its day-to-day activities without interruption. Unlike temporary working capital, which fluctuates with seasonal or cyclical changes, permanent working capital remains relatively stable. It covers the core operational expenses and ensures that the business can meet its short-term obligations while investing in assets necessary for growth. Managing permanent working capital effectively is crucial for maintaining liquidity and supporting business growth. Businesses need to balance their working capital to avoid liquidity issues and ensure smooth operations.
Types of permanent working capital
Permanent working capital can be classified into several types based on its nature and usage:
- Fixed working capital: This type represents the portion of working capital invested in assets that are essential for daily operations, such as inventory and receivables. It remains constant to support uninterrupted business activities.
- Reserve working capital: This is the additional capital set aside to handle unforeseen expenses or emergencies. It provides a cushion to manage unexpected fluctuations in business operations.
- Regular working capital: This refers to the routine working capital required to maintain daily operational activities. It includes funds needed for ongoing production and service delivery.
Understanding these types helps businesses manage their finances more effectively and ensure they have adequate resources for operational needs and growth.
How to Calculate Permanent Working Capital?
Looking to calculate permanent working capital? There is no official formula, but do not worry.
Here is how to find it:
- Determine your company’s net working capital every day
- List these daily values and find the smallest number in the list for the month. This is your fixed working capital for that month
- Do this for each month to track annual changes
Remember, this number will change as your business and its assets and liabilities grow. If your capital falls below this fixed value, it could be a concern.
How do you calculate working capital?
Calculating working capital involves assessing the company's ability to meet its short-term liabilities with its short-term assets. It provides insight into the company’s operational efficiency and liquidity.
1. Assess net working capital
To assess net working capital, subtract current liabilities from current assets. This calculation reveals whether a business has sufficient short-term assets to cover its short-term liabilities, indicating financial health and operational efficiency.
2. Break it down
Breaking down the calculation involves evaluating individual components such as cash, accounts receivable, and inventory for assets, and accounts payable and short-term debt for liabilities. This detailed analysis helps in understanding specific areas that impact overall working capital.
3. Add up fixed costs
Adding up fixed costs involves including regular operating expenses like rent, salaries, and utilities in the calculation. These fixed costs are crucial for determining the total working capital needed to cover ongoing operational expenses.
4. Be prepared for the future
Being prepared for the future means factoring in potential changes in business conditions, such as fluctuations in sales or unexpected expenses. Maintaining an adequate working capital buffer helps in managing these future uncertainties and sustaining business operations effectively.
Difference between permanent and temporary working capital
Basis |
Permanent working capital |
Temporary working capital |
Meaning |
Permanent working capital is the level of current assets that need to be kept for the firm to run smoothly, no matter the business activity |
Temporary working capital is the extra working capital needed for seasonal or temporary demands, over and above the permanent working capital |
Also known as |
Fixed or hardcore working capital |
Fluctuating or variable working capital |
Period |
Long term |
Short term |
Used for |
Fixed and essential needs |
Temporary or seasonal needs |
Nature |
Permanent working capital stays stable |
Temporary working capital changes, sometimes increasing and sometimes decreasing |
Fund |
Regular funds needed for daily operations |
Temporary funds needed only for seasonal tasks |
Need at times |
Permanent working capital serves as a reserve for uncertain situations like lockdowns, strikes, or economic downturns |
Temporary working capital is for special needs like advertising a product |
How to improve permanent working capital?
Improving permanent working capital involves strategic management of resources and finances:
- Optimise inventory management: Efficient inventory control reduces excess stock and frees up capital. Implementing just-in-time inventory systems can help maintain optimal levels.
- Enhance receivables collection: Accelerating accounts receivable collection improves cash flow. Implementing stricter credit policies and offering discounts for early payments can be effective.
- Manage operating expenses: Reducing unnecessary operating expenses ensures that more capital is available for productive use. Regularly reviewing and controlling these expenses helps in maintaining a healthy working capital balance.
- Review and adjust financing strategies: Consider refinancing options or negotiating better terms with suppliers to improve cash flow and working capital.
In conclusion, effective management of permanent working capital is vital for maintaining operational stability and supporting business growth. By optimising inventory, enhancing receivables collection, managing operating expenses, and reviewing financing strategies, businesses can improve their working capital position. For substantial financial adjustments or expansions, considering Bajaj Finserv Business Loan might be beneficial to meet long-term capital needs and foster growth.
