Working capital is necessary for holding some convertible assets like stock of materials and finished goods, bills receivables, accounts receivables and cash. Through the use of these assets the operation or the working of the business is carried on. These assets rotate around the business activities in a circular way and are fed again and again but in a circular flow. There is a definite cycle about which these assets move. For example, materials are processed or transformed into finished goods which are sold to the customers on credit for creating bills receivables or accounts receivables, and such bills or accounts receivables are liquidated into cash that can again be utilised in purchasing materials for production purposes. But working capital does not represent the amount invested in these assets. The group name of these assets is current assets. Corresponding to these assets, there is a group of current liabilities comprised of bills payables, accounts payables, expenses payable etc. Working capital is the excess of current assets over current liabilities.
The amount required for current assets should not be confused with the working capital. Some writers have used the term circulating capital or revolving capital for it. This is because the working capital is invested, recovered, and reinvested repeatedly during the life time of the concern. In other words, it keeps on revolving or circulating from cash to current assets and back. Apparently, it would appear that working capital requirements can be met with short term funds but this is not so. Some of its part is permanent in nature and so we must make a distinction between temporary and permanent or regular working capital requirements.
At the time of the commencement of business, permanent investment is needed not only in fixed assets but also in current assets to make production feasible and this part of initial working capital is permanently blocked in the enterprise. Amount of working capital needed over and above this level is temporary working capital. With the passage of time, size of the temporary and permanent working capital changes.