January 26, 2022

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Variable Working Capital Meaning and Key Explanations

Variable Working Capital Meaning and Key Explanations
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Working capital can be variable or permanent. Other names for it are fluctuating or temporary working capital. This type of WC is required to meet demands during seasonal periods.

Definition of variable working capital

Variable working capital is the WC that is required by a business to meet increased seasonal demand for the business product. It can also be defined as the additional working capital needed to meet changing production and sales activities of a business.

Key Explanations of Variable Working Capital

Fluctuating capital is needed when there are changes in production or sales activities. Machines may go bad and require extra cash for maintenance more than what was budgeted for the month. Therefore, an additional WC is required to meet this need. Furthermore, a customer may demand more of the company’s products than it does request. To meet this need, the company will need more WC funds.

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It tells the business about fluctuations in the working capital, when they are likely to occur, and how to plan for it. If carefully observed, there are seasonal fluctuations and other special events that may cause fluctuations.

During seasonal periods the company faces more demands. And may not have extra products to meet the required demand. What will the firm do? Buy or make more of the products. To meet the demand for more of the business product or service, there is the need for additional working capital financing. This implies that the business owner must plan its working capital during the seasonal period.

Another thing that causes temporary working capital is when a customer/client requests special orders. Or request for orders more than it normally does. This situation may arise within days. And the business may lack funds to meet the urgent demand.

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How to Fund Variable Working Capital

One way to fund variable working capital is to have savings or investment the business can fall back on when there are special orders. These savings can be invested in mutual funds and treasury bills. The business will earn interest from this investment and can withdraw its fund anytime to meet seasonal demands and special orders.

Another way to deal with these variations is by borrowing loans for working capital. Variable working capital requires short-term loans. Why? Since the variation doesn’t occur daily, a short-term loan is the best option. Also, short-term loans are easier to acquire from banks, family, or friends. This working capital loans will take few days to acquire. Bank overdraft is an example.

Conclusion

Variable working capital, which is also called fluctuating or temporary WC is that extra obligation that must be funded to meet customers/clients’ demands. This can be funded using short-term borrowing or by investing surplus cash now to meet seasonal and special demands in the future.

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