Capital is a key ingredient for every business. Without capital, no business can run and exist in the market. It is like fuel to any type of business that is utmost required by them to function and run their daily operations in smooth manner. Capital is needed to procure fixed assets that enables business to complete their services efficiently. There are basically two types of capital necessarily required by every business organization: Fixed capital and Working capital. The main difference in between these two is that fixed capital is used for procuring fixed assets for business such as plant and machinery, land, buildings, machinery, transportation, etc., whereas working capital is one used for covering the daily operations such as meeting payroll, paying bills, payments to vendor etc. A right combination of both these types of capital is needed by business enterprises to succeed in their goals and objectives.
Let understand these both capital types in more detail as below: –
Contents
What is Fixed Capital?
Fixed capital refers to funds used by business for procurement of fixed assets. It is long-term investment supporting the business in long run. In layman’s terms, the fixed capital is money invested in physical assets such as office space, land and building, transportation, machinery and many more. These are long-term assets that stays permanently in business or for atleast more than one accounting period. Physical assets are treated as prerequisite for every business organization as they support the business expansion and improvement of their services.
Fixed capital is a key for every business success as it facilitate companies to improve their productivity, grow their business size and enhance service quality. Some of the prominent sources of fixed capital are issue of equity, preference shares, term loans, lease financing, issue of debentures, private placement of shares, etc. Overall, this capital carries feature of being permanent in nature and can be withdrawn only when business closes down due to some reason. Therefore, it can be said that it is the capital having long-lasting existence.
What is Working Capital?
Working capital denotes the money required by business for running its day-to-day activities. It is capital injected into the current assets of business. Working capital is an indicator of company’s efficiency and financial health. It is approximate fund required to run business and represents value coming after subtraction of current liabilities from current assets. The formula for working capital is- Working Capital = Current Assets – Current Liabilities.
Current represents those assets of company that can be liquefied within one year and current liabilities are outstanding payments that company needs to make in coming financial year. Inventories, debtors, cash in hand, etc. are few examples of current assets, whereas creditors, short-term loans, tax provisions and bank overdraft are few examples of current liabilities. Working capital is a significant part of operation capital in business organizations. The biggest advantage of this capital is that it provides companies better flexibility that ultimately assist in satisfying their clients. Business expansion and investments in goods and services are also some of pros of working capital.
Differences between Fixed capital and Working capital
Now there are certain differences in between fixed capital and working capital. So, lets discuss about them.
| Basis | Fixed Capital | Working Capital |
| Meaning | Fixed capital refers to capital where investment is made by shareholders in physical assets. | On other hand, working capital means the capital used by company for funding its day-to-day operations. |
| Nature of Term | Fixed capital is permanent by nature and comprises of long-term assets like machinery, equipments, property, etc. | Working capital is temporary in nature that is used for paying off short-term obligations such as bills, bonds, stocks, etc. |
| Types of Assets comprised | Fixed capital is composed of durable goods that are permanent, i.e., life of the goods exceeds one accounting period. | Working capital comprises of short-term assets and liabilities. |
| How liquid is it | Fixed capital is less liquid and cannot be liquidated into cash immediately. The assets are sold off at the time of company’s liquidation. | Working capital is highly liquid and can be converted into cash immediately as and when needed. |
| Acquiring type of assets | Fixed capital is used for buying of non-current assets such as land, property, machinery, plant and fixtures, etc. | Working capital is utilized for short-term financing. |
| Accounting Period | It provides benefits for more than one accounting period. | It provides benefits for less than one accounting period. |
| Objectives Served | The fixed capital serves strategic objectives of firm. | Whereas, working capital serves the operational objectives. |
| Risk Factor | Risk factor is higher in the fixed capital. | There is lessor risk in working capital. |
| Sources | The sources of fixed capital are selling shares, debentures, bonds, long term loans, etc. | Working capital can be funded with trade credit, short term loans, deposits, etc. |
| Objective of Investment | Investors put their money into fixed capital with the hope of making profit in future. | Whereas, money is invested by investors in working capital for getting immediate return. |
Conclusion
Fixed capital and Working capital are imperative for every business organization to start and operate their activities smoothly. Seeing all the arguments above, it is quite clear that total capital also referred to as fixed capital and working capital, are not intrinsically at odds with each other. They both functions in tandem as working capital is needed for using the fixed assets of company, otherwise there is no point in having machinery and equipments, if raw materials are not used for good’s production.
Furthermore, it is incorrect to imply that one is more crucial than the other.
Starting of business is not possible without fixed capital and in the same manner, operating it in the absence of working capital is not possible. Therefore, a special attention needs to be taken while doing investment in these two in the business.