What is Fixed Capital?
Fixed capital, or fixed assets or capital assets, refers to a company’s long-term assets, such as land, buildings, or equipment that is used in producing goods or services.
- Fixed capital describes a company’s investment in long-term assets – relatively permanent – land, buildings, or major equipment.
- The concept of fixed capital is contrasted with circulating capital, which describes money that is invested in short-term assets that are used up or turned over in sales within a short time frame.
- For accounting purposes, fixed capital assets are usually defined as assets that are not intended to be used up or exhausted within one accounting period or one year.
Understanding Fixed Capital
The capital invested in such long-term operating assets is considered “fixed” because, unlike other assets (e.g., inventory of goods), the assets are not likely to be sold and converted into cash at any time in the foreseeable future. Also, such types of assets are not used up by a business in producing goods.
Fixed capital may also be referred to as real capital or physical capital, as it is invested in what is commonly termed “real” or “physical” assets. The value of such assets is commonly depreciated, as shown on a company’s financial statements, over several years.
Fixed capital assets usually constitute a major investment for a company and, therefore, may only be made possible by the company taking on debt in the form of loans or bond issues or through the issuance of equity shares.
A company’s fixed capital stands in contrast to what is termed “circulating capital.” Circulating capital is capital that is needed and used to continually reinvest in replenishing assets that are used up in a company’s ordinary course of business, such as raw materials used in the production of goods, wages, and other business expenses.
Fixed Capital and Circulating Capital
The concepts of fixed capital and circulating capital were originally put forward by economist David Ricardo and have since gained broad acceptance in business and accounting.
Fixed capital may refer either to relatively permanent assets that a business may purchase and own, such as an office building or manufacturing equipment, or to the same kind of assets even if they are only leased. Again, what “fixes” the capital is that it is committed to assets that are not quickly used up in the business’ ordinary operations and typically held for a very long time.
Some economists exclude land from the category of fixed capital. However, economists who draw such a distinction include any value-adding improvements to owned land in the calculation of fixed capital.
Other economists have pointed out that fixed capital only differs from circulating capital in terms of time. Like circulating capital invested in assets such as inventory, most fixed capital assets also must eventually be replaced.
However, fixed assets are usually only sold or replaced after many years. Another distinction between fixed capital assets and circulating capital assets is that fixed assets are typically a much more illiquid investment.
A company may quickly and easily sell its inventory of goods. However, disposing of an asset such as a large parcel of land may take quite some time, especially if it aims to secure a very favorable profit from the sale.
In accounting practices, fixed capital are assets that are not projected to be used up within a typical accounting period, such as a company’s fiscal year. The term is also commonly used to describe the value of intangible assets such as copyrights, patents, or goodwill.
Fixed capital is sometimes contrasted with variable capital – a term that is virtually synonymous with circulating capital – the level of which continually fluctuates.
For example, the amount of money that a company spends on wages for employees will likely expand or contract from year to year, based on its operational needs. In contrast, the money invested in purchasing an office building is the same regardless of the number of employees working in the building.
Incremental Fixed Capital
An additional concept that is related to fixed capital is that of incremental fixed capital. It refers to additional capital that is used in the maintenance of long-term fixed assets.
For example, money spent on performing annual maintenance operations on major pieces of manufacturing equipment may be considered incremental fixed capital.
CFI is the official provider of the Certified Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.
In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful: