Concept of Fixed and Working Capital

For running a business, we need capital. Other factors of production depend on the availability of capital. Capital is not only cash but also liquid assets. Two significant types of capital required for running a business are fixed capital and working capital. Fixed capital is capital invested in fixed assets, whereas working capital is capital invested in recurring expenses. Types of working capital are based on the concept-gross working capital and net working capital; based on the time, we have permanent and temporary working capital. These types help us to understand the function of working capital.

Fixed Capital

To understand fixed capital, you need to understand fixed assets. Fixed assets are assets that are to be used for the long term. These assets do not turn into cash quickly, but they can be resold and reused. Thus, in simpler terms, when a business spends money or liquid assets on goods and services, which give long-term benefits like buildings or machinery, it is called fixed capital.

Working capital 

When capital in the form of cash or liquid asset is used to pay off recurring expenses, it is called working capital. Recurring expenses are expenses that repeat themselves quickly. Working capital is crucial in business expansion as the short-term operations, and expenses like salary, service bills, and business debts are not paid off.

Working Capital = Current Assets – Current Liabilities

Current assets indicate the assets that can be easily converted into cash in a short period. In business, a few examples of existing assets are cash, prepaid expenses, inventory, and marketable securities.

In contrast, current liabilities are responsibilities of the business that need to be paid off, usually by using existing assets in a short period. In business, current liabilities are accounts payable, the current portion of long-term debt, unearned revenues, etc.

Example

This example will make your concept of fixed capital and working capital clearer. 

You own a garment factory. First, you will need land or a building. The building is a fixed asset as it is a one-time investment; you do not need to pay for the same building again for a very long term. Capital invested in this building is huge, but it will give you benefits in the long term. The money or liquid assets spent for buying this building is your fixed asset. 

Now you need electricity to power this building. To obtain electricity, you need to pay for it in short periods. Therefore, your working capital is the amount of money or liquid assets spent on paying electricity bills monthly. Similarly, the money or liquid assets spent on buying machinery for making garments is the fixed capital, and the salaries paid to the labourers who operate this machine are working capital.

Types of Working Capital

The working capital is further divided into two types based on a concept: gross working capital and net working capital. Two types based on time are permanent working capital and temporary working capital. 

Based on concept 

• Gross Working Capital- It is the aggregate, meaning the total number of funds invested in the company’s current assets. 
• Net Working Capital- The current assets exceed the current liabilities in a business. The amount by which the current assets exceed is called net working capital. The net working capital is shown in the equation of working capital. Hence, the sum of all current assets such as cash, inventory, accounts receivable minus current liabilities such as accounts payable will give you the net working capital of a company.

Based on time

• Permanent Working Capital- It is also called fixed working capital. Part of the working capital is permanently used to pay off current assets without interrupting the business. It is the minimum amount of current assets needed to keep the business going—for example, the minimum cash required to function operational activity in a company.
• Temporary Working Capital- It is also called variable or fluctuating working capital. When the working capital is invested for a temporary period in the business, it is called temporary working capital. As the size and assets of the business change, this temporary working capital changes. 

Conclusion 

The concept of fixed capital and working capital is a crucial part of a business as it helps understand the function of capital for running a business. Fixed capital is linked with long-term financial health, whereas working capital is linked with short-term financial health. The working capital types help us understand how and where the working capital is utilised. Appropriate and optimum use of working capital can help expand and develop the business.