Fixed and working capital differ when it comes to their usage in a business. One serves the long-term requirements of the business, while the other serves short-term requirements. To efficiently manage your business’ cash flow and overall financial health, it’s critical that you understand the difference between the two. Consider the following four, key differences between fixed and working capital.
- Meaning
Fixed capital refers to the investment made in the long-term assets of a business. This capital is part of the business’ total capital that is not used for production. Rather, it is kept in the business for more than one accounting year. Overall, fixed capital investments are essential to a firm’s business plan; they are usually expensive and have a long, useful life.
Working capital consists of a business’ short-term assets and liabilities. This capital is used in the business’ day-to-day operations, and is assessed by investors to determine the financial health and liquidity of the establishment. The state of a business’ working capital determines whether it has enough short-term assets to cover short-term debts.
- Uses
Fixed capital is used to purchase non-current assets for the business (e.g. plant and machinery, land and building, furniture and fixtures, vehicles, patents, goodwill, trademark, copyright, etc.). The need of fixed capital will obviously vary depending on the nature of the business.
Working capital is used for short-term financing. The current assets that make up working capital include assets that can be converted into cash within one year: inventory, cash, notes receivable, accounts receivable, etc. The current liabilities include liabilities which are due for payment within one year: creditors, short term loans, bank overdraft, etc.
- Liquidity
Fixed capital is very illiquid, while working capital is highly liquid. As stated above, working capital can be easily converted into cash, while fixed capital is expensive and has a specific use (making it relatively illiquid).
- Purpose
Fixed capital has a strategic objective. Fixed capital budgeting is based on long-term planning decisions of the business and includes a multiyear cash-flow outlook. Working capital, on the other hand, has an operational objective. It is used to fuel day-to-day operations, and is based on short-term financial objectives.
Insufficient working capital can have a dangerous outcome for your business. If your business is struggling with cash-flow, consider what securing additional working capital can do for your small business. Even a business considered “high-risk” by traditional lenders can secure the working capital it needs to cover expenses and grow. Consider what First American Merchant’s flexible working capital solutions can offer your business.