Fixed and Working Capital

Every company needs funds to finance its assets and activities. These assets are of two kinds: fixed assets and current assets. The money invested in them is called fixed capital and working capital respectively. The decision about how much to invest in each, and how to manage that investment, is a core part of financial management.

Fixed Capital: Meaning and Management

Fixed assets are those that remain in the business for more than one year — usually much longer. Examples include plant and machinery, furniture and fixtures, land and building, and vehicles. The investment in these assets is typically very large, and once made, the decision is almost impossible to reverse without incurring a huge loss. Such decisions are called capital budgeting decisions or investment decisions.

Fixed capital refers to the total investment in these long-term assets. Managing fixed capital means deciding how to allocate the firm's capital among different projects or assets that will affect the business for many years. These decisions influence the long-term growth, profitability, and risk of the firm.

Because fixed assets last for more than one year, they must be financed through long-term sources of capital: equity shares, preference shares, debentures, long-term loans, and retained earnings. A fixed asset should never be financed through short-term sources.

Investment in fixed assets includes expenditure on:

• Acquisition (buying new assets)
• Expansion (increasing capacity)
• Modernisation (updating technology)
• Replacement (replacing old assets)

Examples of such decisions include purchasing land and building, buying plant and machinery, launching a new product line, or investing in advanced production techniques. Even major expenditures like a large advertising campaign or a research and development programme — if they have long-term implications — are treated as capital budgeting decisions.

Why Fixed Capital Management is Important

1. Long-term growth: The funds invested in long-term assets yield returns in the future, directly affecting the business's future prospects.
2. Large amount of funds involved: A substantial portion of the firm's capital gets blocked in long-term projects. These investments are planned only after detailed analysis, including where to procure funds and at what rate of interest.
3. Risk involved: Because the amounts are huge and affect the firm's returns over the long term, fixed capital decisions influence the overall business risk complexion of the firm.
4. Irreversible decisions: Once taken, these decisions cannot be reversed without heavy losses. Abandoning a project after heavy investment is very costly. Every detail must be carefully evaluated before committing.

Factors Affecting the Requirement of Fixed Capital

1. Nature of Business: A trading concern needs lower investment in fixed assets than a manufacturing organisation, because it does not need to buy plant and machinery.
2. Scale of Operations: A larger organisation operating at a higher scale needs bigger plants, more space, etc., and therefore requires higher investment in fixed assets.
3. Choice of Technique: A capital-intensive organisation (which relies more on machines than manual labour) requires higher fixed capital. A labour-intensive organisation requires less.
4. Technology Upgradation: In industries where assets become obsolete quickly (e.g., computers), replacements are due faster, requiring higher investment in fixed assets.
5. Growth Prospects: If a company expects higher growth, it may create higher capacity in advance to meet anticipated demand, which requires larger fixed capital.
6. Diversification: When a firm diversifies into new lines of business (e.g., a textile company starting a cement plant), its fixed capital requirements increase. …