TYPES OF CAPITAL: FIXED AND CIRCULATED /WORKING CAPITAL

The appetite of organisations for capital is insatiable. Understanding the nature of capital and its effective allocation is essential to an organisation’s success. When challenged with the prime motive of profit maximisation, most business people look dumb founded, saying, “it has always been that way”. However, business as we know today is only 200 years old. Today’s capitalism was conceived by a small handful of 18th century enlightenment philosophers inspired by Newtonian mechanism. Their idea of capital was solely material capital – measured in money. However, the challenge is to decide which division, project, or acquisition gets scarce capital (Gary, 2000). This challenge varies with the type of capital.

Capital according to Francis (1995) is that which confers wealth, profit, advantage, or power. This implies that no business can carry on for long without knowing what capital it has (fixed or working) at its disposal, and using them efficiently. Sound capital, is a reflection of organisational strength, and is invariably evaluated by potential investors, creditors and other stakeholders. In this unit, therefore, we shall lay emphasis on the types of capital – fixed and circulated or working.

OBJECTIVES

At the end of this unit, you should be able to:
define fixed and working capital
discuss the management of fixed capital
explain the classification of working capital
discuss factors affecting working capital requirements
distinguish between fixed capital and working capital.

 Management of Fixed Capital

It is said that fixed assets constitute fixed capital. They include land, plant, and machinery (often called permanent assets). Fixed assets are not convertible into cash within one year. They fall within the area of fixed capital and capital budgeting.

Fixed capital management is concerned with the problem that arises in an attempt to manage the fixed assets.

Objectives of Fixed Capital Management

• The goal of fixed capital management is to manage the firms fixed assets in such a way that a satisfactory level of fixed capital is maintained. The fixed capital should be sufficient to ensure margin of safety for the firm. 
• Each of the fixed assets must be managed efficiently to avoid over capitalisation/under capitalisation. 
• Each of the long-term sources of finance must be continuously managed to ensure that they are obtained and used in the best possible manner since lot of cost is involved in their acquisition. 

SELF-ASSESSMENT EXERCISE 1

• Identify the objectives of fixed capital management. 

Meaning and Classification of Working Capital

Working capital represents that part of the capital, which is invested in current assets such as stock of raw materials and finished goods, bills receivable, accounts receivable and for meeting current expenses like wages, salaries, rent etc. (Jain 1999).

There are two concepts of working capital: “gross” and “net”. The term “gross” is also referred to as working capital, this means the total current assets”. The term “net working capital” can be defined as:

• The difference between current assets and current liabilities; Position of a firm’s current assets, which is financed with long-term funds. 

Sufficient working capital is needed for the management of a business. No businessperson can be successful if it has no sufficient supply of working/circulated capital. Funds needed for operating needs differ from time to time in every business but some amount is needed to carry out business efficiently. In view of that, working capital could be classified into two as follows:

Permanent or Fixed/ Working Capital

As the word depicts, fixed/working capital is that part of capital, which is permanently locked up in the circulation of current assets and in keeping it moving. Every manufacturing concern has to maintain stock of raw materials, work-in-progress, finished products, loose tools and equipment. It (manufacturing) requires money for the payment of wages and salaries throughout the year. Permanent or fixed working capital can be sub-divided into the following classes:

• Regular working capital; and 
• Reserve margin or cushion working capital. 

Variable Working Capital

The variable working capital changes with the volume of business. It may be sub-divided into 

• seasonal and
• special working capital. 

In some businesses, such as sugarcane, operations are seasonal; therefore, working capital requirements change greatly during the year. The capital required to meet the seasonal needs of the industry is termed seasonal working capital. While special working capital is that variable capital which is needed to finance special operations such as the inauguration of extensive marketing campaigns, experiments with products or with methods of distribution, carrying out special jobs and similar other operations that are outside the usual business of buying, fabricating and setting.