Q.Distinguish between permanent working capital and temporary working capital.

Working capital is classified on the basis of time into permanent and temporary working capital, according to whether it is always required or needed only from time to time.

Permanent working capital never falls to zero for a going concern and behaves like a long-term investment, while temporary working capital rises and falls with the level of business activity.

On the basis of time, working capital is classified into permanent (fixed) and temporary (variable) working capital.

Permanent working capital is the minimum amount a firm must keep invested in current assets at all times to carry on its operations, even at the lowest point of activity — a minimum stock on the shelves and a minimum cash in hand. Because for a going concern this minimum never falls to zero, it behaves like a long-term investment and is best financed from long-term sources. It is sub-divided into regular working capital (to keep the operating cycle moving) and reserve working capital (a contingency cushion).

Temporary working capital is the extra amount needed over and above the permanent level to meet seasonal and special needs — for example, extra stock and cash before a festival or peak season. It rises and falls with the level of activity, and is best financed from short-term sources. It is sub-divided into seasonal working capital and special working capital (for a one-off event such as a large single order).

The practical importance of the distinction is that it tells a firm which kind of finance to match to which part of its working capital — a permanent need should not be funded by a short-term loan that must soon be repaid, nor should long-term funds be locked into a purely seasonal requirement.

Students sometimes reverse the financing rule — permanent working capital should be financed from long-term sources and temporary from short-term sources, not the other way round. Another slip is forgetting the sub-types (regular/reserve and seasonal/special), which strengthen the answer.