Permanent Working Capital
Permanent Working Capital

Permanent Working Capital

Working capital is the amount of capital required by a company to meet its day-to-day expenses. The management of working capital is an indicator of the short-term financial position and is crucial for a company’s operational efficiency. In the small businesses space, careful planning and understanding the linkages between finances and operations are crucial to grow sustainably. The effectiveness of this management can be measured from the profit earned per conversion cycle verses the finance cost incurred during the same time. Simple ratio analysis will help to gauge this effect quantitatively.

Permanent working capital is that part of working capital which is continuously invested in a company’s current assets to support seamless operations. It is the lowest amount of liquidity required for a business to run profitably all year long. This includes, for example, the investments required to maintain sufficient financial reserves or a minimum raw material inventory. The quantity of permanent working capital needed depends on the size and growth plans of the business.

Difference between Permanent and Temporary Working Capital


Basis


Permanent Working Capital


Temporary Working Capital



Nature

This is the core amount of current assets a business needs for continuous operations, serving as the financial baseline

This is additional capital required to address short-term fluctuations such as seasonal peaks or unexpected demands



Stability

It is mostly consistent, indicating the company’s continuous need to keep operations running smoothly

It varies significantly over time due to external factors like sales cycles, seasonal trends, and production requirements



Duration

This is a perpetual requirement, necessary throughout the year to uphold regular business activities, independent of external business cycles

This is needed occasionally, in periods of heightened business activity, to manage short-term spikes in demand or supply needs



Calculation

Typically, not quantified with a precise formula but assessed through qualitative analysis of the company’s ongoing operational demands and historical data

Calculated by determining the difference between total current assets needed at peak times and permanent working capital



Financing

Funded through long-term financing options such as equity or long-term debts to ensure stability and lower financing costs

Generally financed through short-term means like commercial paper, short-term loans, or revolving credit facilities, due to its transient nature

How can working capital loans help in better working capital management

A working capital loan is designed to address temporary deficiencies in a company’s working capital through external financing. These loans serve various purposes, including strategic business positioning.

For instance, a sudden surge in product demand due to unexpected events might create a profitable opportunity for a company. If the company’s existing working capital is insufficient to meet this increased production need, it might obtain a loan to purchase extra raw materials and expand its inventory.

Additionally, business owners might use working capital loans to capitalize on supplier discounts for bulk purchases. Such strategic buying can be crucial for maintaining the company’s financial health and improving profit margins.

It’s important to note that working capital loans are typically not suitable for acquiring long-term assets or investments, as other financing options.

Invoice discounting

Invoice discounting can enhance your working capital in a several ways. Firstly, it converts your accounts receivable into immediate cash, allowing quicker access to funds for operational expenses like paying suppliers, salaries, and taxes, or for seizing new business opportunities. Secondly, it reduces your dependence on external financing such as overdrafts, loans, or trade credits, which can lower your interest expenses, improve your debt-to-equity ratio, and boost your creditworthiness. Lastly, it shortens the working capital cycle by accelerating the cash inflow from issued invoices. This efficiency in cash flow enables better inventory management, decreases the cash conversion cycle, and ultimately enhances your profitability.

Tips to improve working capital

  1. Speeding up Operating Cycles: A faster operating cycle, or a speedier conversion of sales into cash, is one way to improve cash flow. Requiring upfront payments, tightening credit conditions, and enhancing sales forecasting are some strategies to reduce non-payment risks and increase working capital.

  2. Avoid Financing Fixed Assets with Working Capital: Working capital should not be used to finance fixed assets like buildings and equipment; instead, long-term loans or leases should be used. Because of the substantial expenditures involved, using working capital for such assets can put a pressure on financial stability and negatively impact creditworthiness.

  3. Check Industry reputation of New Customers: While dealing with new customers, you should do a thorough due diligence for the customers specifically targeting their payments. It will help you to develop business and also improve your pricing tactics for managing the cost of credit period.

  4. Utilize Trade Receivables Insurance: This kind of insurance shields companies against late payments, improving net working capital and opening the door to more favorable credit terms. Banks frequently choose insured receivables as secured collateral since they provide better terms for borrowing.

  5. Reducing Unnecessary Expenses: Reducing unnecessary costs can increase liquidity and free up resources. This could entail optimizing supply chain agreements or haggling with vendors for discounts.

  6. Decreasing Bad Debt: Sales of higher-margin products, improved credit management, and just-in-time logistics inventory optimization are all necessary to reduce bad debt. This boosts competitive standing in addition to improving working capital.

  7. Find Additional Bank Finance: Maintaining a strong relationship with banks, through transparent communication about business operations and financial strategies, can facilitate access to better financing options to support working capital needs.

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About Red Fort Capital

Red Fort Capital is dedicated to empowering Indian MSMEs (Micro, Small, and Medium Enterprises) on their path to business growth through customized business loans. We understand that securing a business loan in India can pose significant challenges, particularly when factors like a less-than-ideal credit score, a relatively short business history, unclear financial records, or variable cash flow come into play.
As a respected Non-Banking Financial Company (NBFC), we take pride in offering a diverse range of secured business loans, spanning from 1 to 10 Crores. What sets us apart is our remarkable ability to disburse funds fast, in just 7 days. Our financial solutions are meticulously designed to cater to a spectrum of needs, including working capital requirements, equipment and machinery purchases, invoice/bill discounting, and last-mile financing, among others.

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