Question

Differentiate between fixed capital and working capital.

Hint:

Fixed capital is used for long-term investments in assets, while working capital ensures a business has enough liquidity to meet its short-term operational needs.

Answer 1

Fixed capital and working capital are two types of capital used in business operations. Both are essential for the functioning and growth of a business, but they serve different purposes. Below is a detailed differentiation between fixed capital and working capital: Step 1: Definition of Fixed Capital.
Fixed capital refers to the long-term investments made by a business in assets that are used for more than one year. These assets are not intended for resale but are essential for the production process. Examples of fixed capital include machinery, buildings, land, and equipment. Fixed capital is used to generate revenue over a long period and is a permanent investment in the business.
Step 2: Definition of Working Capital.
Working capital refers to the short-term capital required by a business to fund its day-to-day operations. It is the difference between a company's current assets (such as cash, accounts receivable, and inventory) and its current liabilities (such as accounts payable). Working capital ensures that a business has enough liquidity to meet its short-term obligations and operate smoothly.
Step 3: Time Horizon.
- Fixed Capital: The time horizon for fixed capital is long-term, as it is invested in assets that will be used for many years. - Working Capital: Working capital is short-term, usually needed to fund operations over a cycle (such as monthly or quarterly).
Step 4: Liquidity.
- Fixed Capital: Fixed capital is less liquid as it involves long-term investments in physical assets. These assets cannot be easily converted into cash. - Working Capital: Working capital is more liquid because it involves current assets that can be quickly converted into cash if needed.
Step 5: Role in Business.
- Fixed Capital: Fixed capital is used to acquire the necessary infrastructure for the production of goods or services. It plays a key role in long-term growth and expansion. - Working Capital: Working capital is used to cover the short-term financial needs of the business, such as paying salaries, purchasing raw materials, and managing operational expenses.
Step 6: Investment Nature.
- Fixed Capital: Investment in fixed capital is typically high and involves purchasing assets that are used for long-term production. - Working Capital: Investment in working capital is relatively smaller and is focused on the everyday functioning of the business.