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The requirement for working capital fluctuates according the level of inventory, production, debtors and creditors etc. The working capital needs are not uniform during the year because of the seasonality of the product being manufactured and business cycles. Separately from this, the working capital requirement would also base upon the demand of the product and demand-supply condition of the raw material. Relationship of all these variables would find out the requirement for working capital at any time.
Under situations where the working capital requirement is decreased, it results in excess cash. Such excess cash may be required while the demand picks up. The firms might hold this surplus cash as buffer to meet unpredictable financial requirements. As this excess cash doesn't earn any return the firms may invest such cash balance in marketable securities and another investment avenue.
Because this excess cash balance is obtainable only for a short period of time, this should be invested in liquid securities and highly safe. The three fundamental features: safety, marketability and maturity must be kept in mind whereas making investment decisions regarding temporary excess cash. Now safety implies that the default risk that is: payment of interest and principal amount on maturity must be minimized. As the prices of long-term securities are more sensitive to interest rate modifications as compared to short-term securities the firms must invest in securities of short-term maturity. Marketability termed as convenience, transaction and speed cost along with that security or an investment can be converted in cash.
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