Distinguish between permanent working capital and temporary working capital.

Even though each component of the current accounts (each dollar of cash, each account receivable, each item of inventory, each account payable, etc.) turns over several times each year, the overall balance of these accounts never goes to zero. Permanent working capital is the base level of these accounts: the dollar amount of current assets and current liabilities required at all times by a company. Temporary working capital is the remainder: the additional balances of working capital that comes and goes with the business cycle, the time of year (seasonality), or simply day-to-day events. The distinction is important to financial managers because the techniques used to analyze and manage permanent and temporary working capital differ; it is important to recognize the difference so the correct financial managing tools can be applied. Specifically, permanent working capital is analyzed in much the same way as capital budgeting decisions by applying time value of money analysis to a forecast of long-term changes to cash flows. This is the subject of this chapter. Temporary working capital, is analyzed using the tools of financial risk management.

1 Comment on "Distinguish between permanent working capital and temporary working capital."

  1. can u give examples?

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