Fixed and Variable working capital

Fixed capital requirements: In order to start the business, funds are required to purchase fixed assets like land and building, plant and machinery, and furniture and fixtures. This is known as fixed capital requirements of the enterprise. The funds required in fixed assets remain invested in the business for a long period of time.

Different business units need a varying amount of fixed capital depending on various factors such as the nature of the business, etc. A trading concern, for example, may require a small amount of fixed capital as compared to a manufacturing concern. Likewise, the need for fixed capital investment would be greater for a large enterprise, as compared to that of a small enterprise.

Fixed capital involves allocation of firm’s capital to long-term assets or projects. Managing fixed capital is related to the investment decision and it is also called Capital Budgeting. The capital budgeting decision affects the growth and profitability of the company.

Factors Affecting Requirement of Fixed Capital:

• Nature of Business
• Scale of Operation
• Technique of Production
• Technology Up-gradation
• Growth Prospects
• Availability of Finance and Leasing Facility
• Level of Collaboration/Joint Ventures

Variable working capital

Temporary or Variable Working Capital:

It represents the additional current assets required at different times during the operating year to meet additional inventory, extra cash, etc.

It can be said that Permanent working capital represents minimum amount of the current assets required throughout the year for normal production whereas Temporary working capital is the addi­tional capital required at different time of the year to finance the fluctuations in production due to seasonal change. A firm having constant annual production will also have constant Permanent work­ing capital and only Variable working capital changes due to change in production caused by seasonal changes. (See Figure 7.1.)

Similarly, a growth firm is the firm having unutilized capacity, however, production and operation continues to grow naturally. As its volume of production rises with the passage of time so also does the quantum of the Permanent working capital. (See Figure 7.2.)

Types of working Capital

(a) Gross Working Capital:

Gross working capital refers to the amount of funds invested in vari­ous components of current assets. It consists of raw materials, work in progress, debtors, finished goods, etc.

(b) Net Working Capital:

The excess of current assets over current liabilities is known as Net working capital. The principal objective here is to learn the composition and magnitude of current assets required to meet current liabilities.

(c) Positive Working Capital:

This refers to the surplus of current assets over current liabilities.

(d) Negative Working Capital:

Negative working capital refers to the excess of current liabilities over current assets.

(e) Permanent Working Capital:

The minimum amount of working capital which even required dur­ing the dullest season of the year is known as Permanent working capital.