Fixed Capital vs Working Capital: What’s the Difference?

Understanding capital is crucial for the stability and growth of your business. Two kinds of capital that small business owners encounter are fixed capital and working capital. They’re vital for your company’s financial well-being — but the distinction between them isn’t always clear.

Let’s explore the key differences between these two types of capital and a few strategies to manage them effectively.

What’s the Difference Between Fixed Capital and Working Capital?

Fixed capital refers to long-term assets like real estate and equipment. These types of assets are a fundamental part of your business. Investing in fixed capital can help pave the way for future growth and success.

Working capital, on the other hand, includes more liquid assets such as cash and accounts receivable. It’s important for maintaining the day-to-day operations of your business. It ensures a smooth cash flow and the flexibility needed to meet your financial obligations.

What Is Fixed Capital?

In general, fixed capital represents tangible assets that are essential to the long-term operation of your business. These long-term assets may not directly generate income, but without them, your business would not be able to provide goods or services. Fixed capital is often captured as a line item on your balance sheet under “plant, property, and equipment” (PP&E).

Fixed capital investments often require careful planning. You should consider your business needs and how you plan to grow. Investing in upgraded technology, new equipment or more space can help you take your business to the next level.

Examples of fixed assets include:

• Real estate.
• Equipment and machinery.
• Company vehicles.
• Technology.
• Office furniture.

What Is Working Capital?

Essentially, working capital is the difference between your company’s current assets and current liabilities. (“Current” = one year or one accounting period.) It’s a measure of your company’s liquidity, financial health and operational efficiency. It consists of short-term assets that can be used to cover day-to-day business operations, expenses and short-term debts.

Working capital is important because it helps ensure your business has enough to meet its financial obligations. It can help maintain smooth operations and allows you to invest in new opportunities when they come up.

How to Calculate Working Capital

Calculating your net working capital is fairly simple. You simply need to subtract your current liabilities from your current assets. Keep in mind there are other working capital formulas you may want to consider, such as your working capital ratio or your working capital requirement.

Net Working Capital = Current Assets – Current liabilities

Examples of current assets can include:

• Cash or cash equivalents.
• Accounts receivable.
• Raw materials.
• Inventory.

Examples of current liabilities can include:

• Accounts payable.
• Wages.
• Income taxes.
• Short-term loans.

Fixed Capital vs Working Capital

How Do Fixed Capital and Working Capital Impact a Company’s Financial Health?

Fixed capital. Fixed capital plays an important part in your company’s financial health and it’s often critical to your operation. Investments in these capital assets can enhance efficiency and productivity, but they can also come with a hefty price tag. You’ll want to be sure to have an effective strategy in place to help find the balance between long-term growth and short-term liquidity.

Working capital. Adequate working capital is essential to current operations and future growth. A positive working capital ratio can show financial stability, which can be attractive to lenders and investors. Insufficient working capital can put a strain on your cash flow, affecting your ability to pay suppliers, wages and other operational expenses. Carefully managing and monitoring your current assets and liabilities can help you maintain a healthy cash flow and boost profitability.

How to Manage Fixed Capital and Working Capital

Budget. A budget can serve as your financial blueprint, enabling you to forecast revenues, plan expenditures and allocate resources effectively. Setting financial goals for your business can help you cut back on spending and optimize your investments. It can also help you make informed decisions and adjustments when unexpected expenses pop up.

Monitor your cash flow and other financial statements. Many small businesses are concerned about cash flow. Monitoring your business’s cash flow and financial statements provides a real-time snapshot of your business’s financial health. It can help ensure that you have sufficient liquidity and be prepared for cash flow gaps.

Consider an accountant. When making strategic financial decisions for your business, you may want to consider seeking professional advice. They can help you make the right business moves and help your company succeed.