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Types of Working Capital – Permanent Working Capital, Temporary Working Capital

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Working capital is the RAM of your business that keeps your operational system running faster and smoother. As much as working capital does for your business, it also contains different types, which can be useful during various stages of your business activities.

Working Capital types

Different Types of Working Capital:

1. Operational Capital – Operational Capital has been split into permanent working-capital and temporary working-capital. Which is based on the operating cycle as well as a balance sheet.

  • Permanent Working Capital:- Permanent working capital is also known as Fixed Working Capital or Hard Core Working Capital. It means the base capital/investment money required at all times to continue business activities. Permanent working-capital refers to the base investment amount in all types of current resources, provided for carrying out business activities at all times. The valuation of all current assets increases and decreases over time. However, minimum running assets are required at all times to run business activities efficiently.

    • Seasonal Variable Working Capital:- This working capital refers to the working-capital that the business requires every year during the season. Businesses that work in the production or manufacture of products or provide all services that have seasonal demand have to maintain seasonal working-capital. It can be considered as reserve working capital but only to adapt to sudden changes in the market and seasonal fluctuations.

Seasonal working-capital is considered as its temporary increase in working capital. This only applies to businesses that have weather effects, For example, manufacturers of raincoats and umbrellas for which the relevant weather is monsoon, woolen clothes for which the relevant weather is winter, etc.

    • Special Variable Working Capital:- Many special programs can also be undertaken for business development. The event can be advertising campaigns, advertising strategy, system development work, marketing research strategy, setting up the latest business, expanding markets, and many more. Unique working capital is the fact that a sudden simultaneous increase in short-term working-capital is due to a special occasion. 

    • Temporary Working Capital:- It is also known as fluctuating or variable working-capital. After understanding permanent working-capital it is very easy to understand the term temporary working-capital. There is a close relationship between the level of production and sales of temporary working-capital. There is no uniform production & sales throughout the year. If a large order is received for production and a large amount of debt is sold, then a greater amount of temporary working-capital is required. At the same time, if production is done in anticipation of demand in the near future, you need a temporary working-capital.

      • Regular Working-Capital:- This type of working-capital is the minimum working capital that a business defines as the capital required for the day-to-day operations of its business. We need businesses to maintain a reasonable level of regular working-capital for stable operations. It is normally required in the normal course of business to ensure the smooth flow of the working-capital cycle. Examples include payment of salaries and wages and overhead expenses for processing raw materials, etc.

      • Reserve Margin Working-Capital:- It is also known as the cushion working-capital. It is a type of fund that is held above the business working-capital. Traders use such funds as a contingency for unforeseen market conditions or opportunities. It refers to the short-term financial arrangements made by your business units to meet uncertainties. A firm is always operating with the expectation of certain risks that may ever be controllable or uncontrollable. Reserve working-capital can be used to meet uncontrollable risks in the world and to sustain its business.

  • 2. Gross Working-Capital:- The balance sheet is popularly known as gross working capital for reporting the firm’s current assets. Current assets are short-term assets that can be easily converted into cash within a year of the deadline. Gross working-capital is the total assets of the company. These assets are basically those that we can convert into cash within a year. Assets include cash, receivables, marketable securities such as stocks, short-term investments, etc.

3. Net Working-Capital:- Net working capital is the most commonly used capital among companies. There are two ways to get networking capital which are explained to you here. The first way is, you can only find net working-capital by finding the difference in current assets on current liabilities from the business sheet. The second way is that networking capital is a subset of current assets that are informally financed by long-term assets. Networking capital is the most important type of working capital for management decisions on working-capital financing.

4. Negative Working-Capital:- Negative working-capital means that, sometimes, the value of current assets is less than current liabilities, which shows you negative working-capital. When that type of situation arises, it indicates that your business is going to face a financial crisis very soon. A proper plan for its management should be a proper plan for managing its financial crisis.

5. Positive Working-Capital:- It means a type of working-capital where current assets exceed current liabilities. Current liabilities mean payments within one year within the standard course of business or possibly less than current assets payable from the revenue income of this business.

# Difference between Permanent and Temporary working capital

BasisPermanent Working CapitalTemporary Working Capital
MeaningPermanent working capital refers to the level of current assets that have to be maintained and are important for the firm to run its business regardless of the level of business operations.Temporary working capital refers to the working capital which is over & above the permanent working capital. It is necessary to meet seasonal needs and temporary needs.
Also known asFixed or Hard Core Working CapitalFluctuating or variable working-capital
PeriodFor Long termFor Short term
UsedUsed for fixed assets.Used for temporary or seasonal needs.
NaturePermanent working capital is stable Temporary working capital fluctuates i.e. sometimes increasing and sometimes decreasing.
FundNeed to keep regular funds for day to day workTemporary fund for seasonal works only
Needed at timesPermanent working capital will always be the reserve capital for uncertain situations like lockout, strike, or depression.Temporary working capital will be only for special needs like advertising of a product etc.

What is Working Capital Management? Importance, Components, and Benefits

Working capital management plays a very important role in the success of any business venture. More and more companies that are running into losses or struggling financially will be profitable and liquid. The working capital management system helps you determine whether productive capital can be held for productive uses. Many finance professionals & business experts often ignore the importance of this management. It is an effective management technology tool that has the potential to guarantee long-term success.

# What is Working Capital Management?

Working capital management is a business tool that helps companies to make effective use of their current executives. It helps companies maintain a sufficient amount of flow to meet lower targets. By managing an executive effectively, companies may be at risk of being free otherwise stuck on their balance sheets. As a result, they may be able to reduce the need for external lending, expand their businesses, merge or acquire funds, or invest in R&D. It forms part of the total capital of the company. This capital is required by all businesses to meet their short-term requirements and is an important part of current assets.

# How is Working Capital Calculated?

The working capital formula is: Working capital = Current Assets – Current Liabilities.

The working capital formula tells us that short-term liquid assets have been repaid after short-term liabilities. It is a measure of the short-term liquidity of a company and is important for financial analysis, financial modeling, and cash flow management.

# What is Effective Working Capital Management?

Effective working capital management encompasses many aspects of short-term finance such as: maintaining adequate levels of cash, converting short-term asset (i.e., receivable and inventory) accounts into cash, and approving outgoing payments control to vendors, employees, and others. To do this successfully, companies invest short-term funds in working capital portfolios of short-dated, highly liquid securities, or they may issue loans or finance as lines of bank financing by issuing commercial paper or other money market instruments. In simple words, efficient working capital management means ensuring sufficient liquidity in the business to be able to meet short-term expenses and debts.

# Working Capital Management Solutions

Most companies are using a wide range of multiple solutions to support effective working capital management for themselves & their products. Such as:

  • Electronic invoicing:- Presenting electronic invoices in managing current funds can help companies a lot in achieving working capital gains. By streamlining invoicing, you can reduce the risk of errors in your company, automate manual processes, and you can easily ensure that your customers receive the invoice as soon as possible so that they can pay soon. Methods of submitting electronic invoices can enable companies to automatically initiate purchase orders in invoices or to present high volumes of invoices using system-to-system integration.
  • Cash flow forecasting:- By predicting future cash flows – such as payments and receivables – companies can plan for any subsequent cash gaps and make better use of any surpluses. With this, you can more accurately predict your future cash flow, which will give you better insight into even more working capital management decisions.
  • Dynamic discounting:- It is a solution that you can use to provide initial payment to buyers & suppliers. But this time there is no external fund, as the program is funded by the buyer through an early payment discount. Like supply chain finance, it also enables suppliers to reduce their days’ sales outstanding (DSOs). Or, it allows buyers to get an attractive risk-free return on their surplus cash.
  • Supply chain finance:- For buyers, supply chain finance also is known as reverse factoring. It is a way for suppliers to offer prompt payment through one or more third-party funds. Suppliers can improve their DSO by paying early at a lower cost of money while buyers can conserve their working capital by paying according to agreed payment terms.
  • Flexible funding:- Working capital providers who offer flexible funding. They can allow buyers to move fundamentally between supply chain finance and the dynamic discount model, meaning that companies can adapt to their changing working capital requirements to support their suppliers.

# Importance of Working Capital Management

Working capital management requires sufficient cash flow to perform its daily tasks. Such as making payments, purchasing raw materials, or managing unexpected expenses. The working capital business plays an important role in meeting all these requirements and also serves as a report card for the financial management of the company. Proper working capital management facilitates the business to operate smoothly and improve its earnings.

This includes proper management of inventory, accounts receivable, and accounts payable so that sufficient cash is available regularly operations, this is an accounting strategy that not only helps businesses meet and enhance their financial obligations. It also helps identify areas of the business that need height to maintain profitability and liquidity.

# Advantages of Working Capital Management

  • It is helpful in attracting new customers, refreshing the brand, increasing online presence, creating marketing capital for event sponsorship, direct marketing campaigns, and more.
  • It helps prevent payment delays and manages cash flow for significant operating expenses such as payroll, keeping utility current, payments of leases or mortgages, and more.
  • It is useful to purchase additional inventory needed to fill future orders, restock your inventory, buy new products, etc., and expand the business infrastructure.
  • Useful in advance payment when you want to take advantage of wholesale pricing for the update tool.
  • Ideal for seasonal businesses to restore inventory in the off-season, hire temporary employees, promote accurate marketing, cover expenses such as rent, insurance, taxes, salaries, and more.
  • Especially useful to meet unexpected and unforeseen expenses.

# Disadvantages of Working Capital Management

  • Additional working capital with the company does not earn any interest for the company.
  • There is a possibility of overspending or purchasing unnecessary things for the business.
  • Companies use working capital to finance long-term projects.
  • This strategy only takes into account monetary factors.
  • The working capital management policy is that it is not situational in nature.

# Components of Working Capital Management

  • Inventory Management:-  Inventory is goods that are bought by a company for the purpose of selling in the market and making a profit. The turnover of our inventory determines how successful our business is. Inventory is basically purchased from raw materials, WIP products, and manufactured goods or suppliers. Where the company buys an excessive stock and places a heavy burden on finance. Similarly, if the inventory is not available on time, it is a loss of sales. Therefore, inventory management involves the control of stock that is purchased for sale in the normal course of business. Read more about Inventory Management. 
  • Accounts Receivable:- Account receivable is the amount received by customers in the normal course of business due to credit sales by the company. You will find accounts receivable on the company’s balance sheet under current assets. The important point is that they are classified as assets but in real terms, they are not available for use until they are realized in a more liquid form. It is an important component of working capital management and must be managed efficiently to improve the financial health of the company’s operations. Read more about Account Receivable.
  • Accounts Payable:- Once you have established your current accounts receivable, it is payable to view your accounts. Accounts payable is practically the opposite of your accounts receivable. Accounts payable are the obligations of the company to pay its debts to its creditors and suppliers. Liabilities payable come under the head of current liabilities and are one of the major components of working capital management. Accounts payable can be managed through negotiations with creditors to extend the due period. Read more about Account Payable.
  • Cash and Cash Equivalents:- These are the most important current assets that are managed under working capital management. Being the most liquid form of assets, we must manage it effectively and efficiently to maintain the financial stability of the company, meet unexpected expenses and handle regular operating expenses on time. Apart from this, managing cash properly also helps in maintaining the rating of the company and protecting the company from insolvency.

# Types of Working Capital Management Ratios

Working capital management uses these ratios to measure the liquidity of an organization.

  • Current Ratio:- The current ratio, which we also call the working capital ratio. It measures the availability of sufficient resources to meet its short-term obligations. In other ways, it states readily available cash to meet your daily obligations. The formula for calculating the current ratio is: Working Capital Ratio = Current Assets / Current Liabilities
  • Inventory turnover Ratio:- Inventory is a huge working capital and that’s why businesses need to measure how well inventions are used. The inventory turnover ratio measures how many times a company has sold and changed inventory over a given period of time. The formula to measure inventory turnover ratio is: Inventory turnover ratio = Sales / closing stock
  • Collection Ratio: – The collection ratio indicates the turnover receivable in days. This tells you the entire average time taken by your customer to pay. This ratio helps you identify customers who have a poor payment record. The formula for calculating the collection ratio is: Collection ratio = Receivable / Total sales x 365 days.

Do MSMEs get working capital loans in India? All about WCL

As it is clear from the name itself that it is a loan for working capital. Capital in the business is the money to fund its day-to-day operations whether it’s a wholesaler, distributor, retailer, or any MSMEs. Therefore MSMEs can get working capital loans for many reasons like when they need funds during times of reduced business activities. The main purpose of working capital loans is to meet short-term needs. We told you earlier in the article what is working capital management? From there you can understand its importance, components, and benefits. In this article, we will explain how to get a working capital loan for your business in India? Its features, types, benefits, eligibility criteria, and more.

# What is a Working Capital Loan?

A working capital loan is a type of short-term loan given by a bank or alternative lender to finance the daily operations of your company. These loans are a great way to focus more on your business growth and generate capital. These loans are intended to provide working capital for short-term capital expenditures, such as wages, rent, debt service payments, or finance activities, such as sales and marketing or research and development. The fact is that these loans are especially for small and medium enterprises to increase their working capital needs and meet all their daily operating expenses.

# Features of Working Capital Loan

Interest RateDepends on several factors such as your net income, collateral, location, business stability, existing monthly obligations, and more & varies from bank to bank. Generally range between 17% -27% interest rate
Loan AmountDepends on business requirements
Age CriteriaMinimum 25 years and Maximum 65 years 
Repayment Tenure12– 84 months (in some cases 12-36 months)
CollateralDepends on a bank or alternative lender
Processing FeeUp to 3% – 6.5%of the loan amount
Loan offered toEntrepreneur, Pvt. and Public limited companies, Partnership Firms, Sole Proprietorships, MSMEs and Self-Employed Professionals, manufacturing, or trading
Business TenureMinimum 3 years in business with profit

# Why should you take a Working Capital Loan?

One of the primary features of working capital loans is that it is accepted only based on existing orders or outstanding invoices. This facility ensures that a person cannot borrow more than required and that the value of the loan can be repaid quickly. Here are some other benefits associated with working capital loans:

  • Working capital loans have a flexible repayment period and interest rate, which allows businesses to deal with uncertainties judiciously.
  • Lenders do not impose any restrictions on the usage of working capital loans, they expect the loan to be used to increase revenue and maintain daily operations.
  • Working capital loans are generally fast and easy to secure, allowing business owners to efficiently meet any immediate financial need.
  • Working capital loans do not require you to offer assets as collateral. However, in some cases that involve high risk, you may need to provide some guarantee.

# Types of Working Capital Loans

Working capital loans offered by banks or alternative lenders are given in various ways, which provide flexibility to the borrower. These are some of the popular methods of financing working capital in India.

  1. Trade Credit:- It is the most popular source of working capital finance in India. This type of loan offers you a working capital loan by a potential or current supplier of the business. Credit plays an important role in this. Suppliers offer trade credits when you place bulk orders with them. However, this loan is granted only when the supplier thoroughly evaluates your credit, profit, and credit history.
  2. Bank Overdraft:- Bank overdrafts are also called cash credits. An overdraft is a facility where the financial institution offers credit when the balance in your bank account is zero. Mostly this facility is obtained by most businesses including; The purchaser avails a specific amount to use it for operational payments. Here interest rates and line of credit depend on a firm’s relationship with the lending authority. In addition, businesses have to pay interest only on the amount that is used by them, rather than the entire amount. This is the most cost-effective solution as the borrower keeps accumulating the amount to save interest costs.
  3. Accounts Receivables:- Accounts receivable financing is also a type of working capital loan for businesses. You can always use your confirmed sales order or receivable account to apply for this working capital loan. Especially if your company lacks funds to fulfill the sales order. However, such loans are secured only if your company has a reputed history and proven track record of paying the loan on time.
  4. Short-Term Loan:- A short-term loan comes with a fixed payback period and an interest rate. It is not a line of credit but a full debt. It is necessary to repay the loan with interest on time. The tenure is determined by the lending institution or bank. This is a secured loan. However, depending on the credibility of your credit history and relationship with the lender, you can secure this loan without any collateral.

# Uses of Working Capital Loan

1. For Inventory and Equipment purchases

In today’s times, equipment and inventory are expensive and the business owner’s use of existing cash reserves to buy it can create a serious cash crisis. So many business owners take out working capital loans for big-ticket purchases such as equipment and stocking inventory.

2. For Business Expansion

In most businesses there comes a time when they receive a lot of orders and service requests. Business owners have to increase their operations to meet the increasing demands of customers. At this time you can easily accomplish your goal by using the working capital loan. Working capital loans can be used to expand an office/factory, open a new location, add support infrastructure, etc.

3. To appoint new employees and train employees

As your business expands, you will need to hire new employees. In addition to training new employees, you have to continuously train existing employees to keep them updated on the latest trends and ways of working. Working capital loans can be used to meet all these requirements of your business.

4. To Handle Emergency Problems

Running a business is very complex. You never know when and what problems will arise such as equipment failure, natural disasters, sick workers, vehicle breakdowns, etc. Since lenders distribute the working capital loan immediately, the money can be used to cover and solve any unexpected problems in your business.

5. For Miscellaneous Business Expenses

Running a business is cost-intensive. There are many expenses for its management, such as new software updates, client meetings, utility bills, etc. Regardless of the type of business expense, a working capital loan can help you to meet all cost crises.

# Eligibility for a Working Capital Loan

Working capital loan criteria vary from lender to lender. However, some basic requirements to be eligible for a working capital loan are listed below.

  • The minimum age requirement of the applicant is 25 years and the maximum is 65 years
  • Companies must have a turnover of at least 10 lakh. Other than this Business Vintage, Annual Turnover, and work experience to be defined by the lender
  • The enterprise must have a minimum annual income (ITR) of Rs. 2 lakhs every year
  • Good CIBIL score and repayment history
  • No previous loan default with any financial institution
  • Individuals can apply if they have an experience of at least 2 years in the current business and total business experience of at least 5 years

# Documents Required

Here are the standard documents you need to submit for a working capital loan. To know this, see the list below.

  • Duly filled application form with passport-sized photographs
  • Self-written business plan
  • PAN card or a copy of valid identity proof of applicant (Individual, Firm & company) & co-applicants is mandatory (KYC documents as identity proof include Passport, Aadhar card, Voter’s ID card, Driving License, PAN Card, and Utility Bills)
  • Any of the address proof from Ration card, voter ID card, driving license, or Passport
  • Last 3 years income tax return with computation of income, profit and loss account and balance sheet of the last 2 years
  • Last 1 year’s bank statement
  • Proof of business continuation include Sales Tax Certificate, ITR, Establishment or Trade license
  • Certificates of business registration, including; business registration proof, GST registration, partnership deed, rental agreement, company PAN card, etc.
  • Any other document required by the lender
  • Loan statement with sanction letters in the last one year (of other banks as well)

# Some Banks and Websites that can help you Get Working Capital Loans in India

There are several public and private banks and websites in India that offer working capital loans to their customers:

Banks:

  • HDFC Bank
  • ICICI Bank
  • Axis Bank
  • State Bank of India
  • Indian Overseas Bank
  • Bank of Baroda

Websites:

  • Paisa Bazaar
  • Biz2credit
  • Bajaj Finserv
  • Capital Float
  • IIFL finance
  • Loan meet
  • Capital first
  • Lender club
  • Namaste credit
  • Instakash
  • Lendingkart, etc.

# Drawbacks of Working Capital Loans

Here are some drawbacks of Working Capital loans.

  • In working capital loans, interest rates are comparatively higher for other forms of debt financing to compensate for the lender’s higher risk.
  • For small businesses without a track record of cash flow, a working capital loan can be linked to the business owner’s personal credit, and any defaults or missed payment will harm the person’s credit score.
  • High interest may be prohibitive to finance large-scale organizational efforts.

Frequently Asked Questions(FAQs)

# Are all working capital loans unsecured?

No! Some banks will require an asset as security to obtain a working capital loan. For example, some banks may accept residential, commercial, and industrial assets as collateral. You can also deposit shares, stocks, gold, and book data.

# What is the difference between working capital and term loan?

Working capital loans are short-term with a repayment period of a few months. Term loans can be short, medium, or long-term. Their duration is usually between one to ten years, but some term loans can extend up to 30 years.

# When to get a working capital loan?

The main reason for getting a working capital loan is to meet the short-term financial requirements of a business. Here are some situations where a working capital loan comes in handy:

  • The peak season to meet inventory demands
  • To meet operating expenses during the slow season
  • Additional capital in case of emergency
  • To maintain steady cash flow for cyclical businesses
  • To capitalize on available opportunities

# How does a working capital loan work?

Sometimes, a company may not have enough finances to manage its daily expenses. This may be due to a decline in business activity, fluctuations in the sales cycle, or unstable cash flows. To handle current assets and liabilities, a company may consider working capital debt. Now, there are various types under this type of loan:

  • Term loan
  • Bank guarantee
  • Bill discount
  • Letter of credit (lc)
  • Line of credit
  • Cash Credit / Overdraft
  • Packing credit
  • Post shipment finance

Depending on the needs of the business, the company may choose one of these types to meet its needs.

Conclusion:

It was all about different types of working capital. We need to balance this with various working-capital methods, techniques, ideas, and strategies. This will definitely help you to effectively manage any type of working capital that each and every single business may need from time to time. We hope this information will help you to understand the types of Working-Capital Management. You can read more about working capital management & learn hoe to MSMEs get working capital loans in India. 


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