Differences Between Fixed Capital and Working Capital

In business and corporate finance, capital is the money that a company has available to fund its day-to-day operations and future growth. It can be primarily divided into two types – fixed and working capital. This article explores these two main variants of capital in detail. However, before diving deep into the difference between working capital and fixed capital, we need to understand the concept of capital.

An economist’s definition of capital does not simply imply money. Capital refers to the primary assets a business venture uses to ensure smooth production. 

Apart from their presence on the balance sheet, capital includes cash, cash equivalents, securities, infrastructure and establishment costs, etc. To understand the difference between fixed and working capital, you must know that capital adds value to the organisation. 

Capital can also mean different financial assets and investments in machinery, transportation and technology that add value to the company. Overall, imagine capital as an instrument that adds wealth or financial strength to a business without itself being a part of the production. The fixed capital vs. working capital tussle can now be explained with ease.

Investments meant for long-term assets of an organisation come under fixed capital. Fixed capital is used to purchase assets that stay with the business. Thus, plants, equipment and purchase of property fall under this category.

Situation: Imagine that you are willing to invest in an enterprise that produces goods or services to meet customer demands. The initial investment required for facilitating the basic framework of your production process is huge. 

This investment aids in creating long-term belongings during its primary stage. Thus, you may use that capital for purchasing basic machinery, equipment, purchasing working space, and any other investment that is utilised for more than one accounting cycle. 

Now, in a short-run production function, at least one of the production factors is variable. Your initial investment for setting up a business is, therefore, your fixed capital. Fixed capital facilitates long-term investments and is not liquid, contrary to its variable counterpart.

Capital utilised for acquiring current assets is the working capital. In the light of fixed capital and working capital difference, the latter is more liquid, and they have very specific functions like acquiring labour, etc.

Working capital is an operation-oriented instrument that measures the economic stability of a firm. In other words, they represent the difference between current assets and liabilities. Current assets include liquid resources like cash and inventories, while current liabilities represent those outstanding amounts like short-term loans, bank overdrafts, etc. 

Situation: Imagine that your organisation is finally ready to begin production. However, before you proceed, you will require certain important components like labour and credit, etc. Irrespective of your production, you will need labour to keep your production process running.

The operating capital is an essential business instrument since it determines your operating efficacy. In times of distress, for example, you can tweak the amount of capital spent on these resources. An organisation with sufficient working capital can think about business expansion and reinvesting in raw materials.