Fixed and working capital, although both necessary for the survival of any business, are used in very diverse ways. While fixed capital ties up into long-term assets, from which one can start the production business and expand further, on the other hand, managing day-to-day operating requirements and ensuring liquidity is where working capital is involved. Understanding these two kinds of capital enables a business to make more strategic financial decisions, and to balance long-term investments by keeping short-term financial health. Discuss, what is fixed and working capital, their functions, and the main differences between the two.
What is Fixed Capital?
Fixed capital is money spent on fixed assets that contribute to the production process of a company for a long period of time. Such investments do not aim at sales but are used in the organization continuously for the generation of operations and revenues.
Characteristics of Fixed Capital
Fixed capital has some characteristic features which distinguish it from other capitals:
- Long-Term Use: Fixed capital funds assets that have a longer life of more than a year; therefore, the investment is long-term to the business.
- Tied with non-current assets: This class of assets comprises tangible elements like land, machinery, and buildings and intangible assets like patents and trademarks.
- Low liquidity: It is difficult to convert fixed assets into cash quickly and without much loss of value.
Types of Fixed Capital
Fixed capital investment can be categorized into different asset types:
- Tangible Fixed Assets: These are physical assets essential for the company’s operations, like factories, equipment, and office buildings.
- Intangible Fixed Assets: Non-physical assets like trademarks, patents, and goodwill fall into this category, offering long-term competitive advantages.
- Strategic Investments: Some companies may use fixed capital to invest in other firms or subsidiaries for strategic growth purposes.
How Fixed Capital Works in a Business
Fixed capital investments form a very important basis of setting up a company and ensuring it grows. For instance, in a manufacturing business, one will need machines and a facility to make products. These are long-term assets funded by fixed capital that will generate revenues over time. Current assets are not sold very often but are used to provide the core activities for the company, providing consistency and stability in the output.
The concept of fixed capital is part of any finance curriculum from which courses for ACCA course and CMA programs teach the concept of how a student would invest in long-term assets, capital budgeting, and management of fixed assets. The students learn the following topics by the eligibility criteria of the ACCA as well as the ACCA syllabus of asset management strategy in accountancy and finance.
What is Working Capital?
Working capital is the amount of money a business needs to finance its short-term costs. It is just the difference between a company’s current assets and current liabilities. A firm needs it to carry on normal business operations on a daily basis. A company should be able to liquidate its assets at short notice, meet all of its short-term obligations, and pay for those surprise costs that come up suddenly in any business.
Characteristics of Working Capital
There are specific features that differentiate working capital from fixed capital.
- Short-Term Orientation: Funding works with short-term needs with such frequency of recharging for it because its assets, as well as liabilities, change hand-to-hand for an organization from day to day.
- Involves Current Assets and Liabilities: It is made up of liquid assets such as cash, inventory, and accounts receivable, and encompasses obligations like accounts payable and short-term loans.
- Supports operational needs: Working capital allows a business to buy inventories, pay wages, and other recurrent costs in order to keep the operations running.
Types of Working Capital
Working capital can also be divided into various subheads to analyze cash flow
- Gross Working Capital: Gross Working Capital incorporates the entire current assets a firm owns, which can be quickly used to generate cash.
- Net Working Capital: This is the difference between current assets and current liabilities and, therefore, available funds for operations.
- Permanent vs. Temporary: Permanent working capital is the amount of capital required to carry out normal business operations, while temporary working capital is the amount of working capital needed to satisfy the seasonal or fluctuating needs of the business.
How Working Capital Works in a Business
Working capital is a source of financial cushion that ensures businesses are able to face their expenses and remain stable. For example, a retailer uses working capital to acquire inventory it sells to clients. The cash from selling replenishes the working capital, allowing the store to restock its products as well as pay its suppliers. A positive working capital means that a company will be in a position to meet its obligations while negative working capital may indicate cash flow problems.
In programs like ACCA courses and CMA, working capital management is really a significant area in which students learn about liquidity management, inventory management, and credit policy core skills required in finance and accounting roles.
Fixed Capital vs Working Capital
The purpose, type of assets, sources of funding, and level of liquidity differ significantly between fixed and working capital. Good business financial management requires an understanding of these differences.
Purpose & Timeframe
- Fixed Capital: These capitals are intended for more extended periods because they involve assets whose benefits are extracted over a time frame of more than one year. Their application is mainly in finance infrastructure, technology, and all the equipment that maintains any business.
- Working Capital: It is directly concerned with short-term requirements and thus ensures the smooth running of daily operations, covering expenses on inventory, wages, and utility bills. It keeps cycling with every transaction in the business.
Nature of Assets
- Fixed Capital: Tied to non-current assets that have lasting value such as machinery, buildings, or land. These are vital assets for the business and will not be sold in normal circumstances.
- Working Capital: Refers to the current assets of a business, including cash, accounts receivable, and inventory, used daily in its operations, where such assets are used and replaced on a constant basis.
Liquidity
- Fixed Capital: This capital is related to assets that have low liquidity. Such capital cannot easily be converted into cash without a substantial time investment or value loss.
- Working Capital: Consists of highly liquid assets, therefore, it makes funds available to a business in readiness for operational demands and any unforeseen expenses.
Sources of Finance
- Fixed Capital: Fixed capital is sourced from long-term fund sources, such as equity financing, long-term loans, and bond issues.
- Working Capital: Funded from short-term credit sources mainly and includes trade credit, a short-term bank loan, cash flow from operations, small business cash advances, or any other source.
Role in Business Operations
- Fixed Capital: The fixed capital gives the business structural assets required for any production and expansion or strategic growth.
- Working Capital: All the costs involved for production, payroll, as well as a supply chain are covered to ensure that working capital does not stop daily running operations.
| Comparison Aspect | Fixed Capital | Working Capital |
| Purpose | Long-term asset investment | Short-term operational funding |
| Asset Type | Non-current assets (machinery, property) | Current assets (cash, inventory) |
| Liquidity | Low liquidity | High liquidity |
| Sources of Finance | Equity, bonds, long-term loans | Trade credit, short-term loans |
| Operational Impact | Structural support for growth | Financial stability for daily operations |
Examples of Fixed & Working Capital
- Fixed Capital Example: A manufacturing firm buys some machinery to produce a good, that the firm intends to use for several years.
- Working Capital Example: A grocery store is constantly purchasing inventory, so its inventory turnover is relatively quick; products are sold quickly.
Conclusion
In summary, both of these are vital for a successful business, but they offer different services. Fixed capital funds long-term assets associated with the production and growing process of a business entity. Working capital ensures liquidity for meeting the short-term liabilities of a business. The prudent management of both types contributes to a company’s stable financial state and resilience to various disturbances. Further, management of fixed and working capital is something that every commerce student and professional requires for their programs like the CA, CFA, ACCA course, or CMA. Firms need to have a balance between fixed and working capital as it would determine sustainable growth in operation and efficiency, on which long-term success would be built.
