Fixed capital means the portion of the capital, which is meant for meeting the permanent or long-term needs of the business. In other words fixed capital is required for the acquisition of those assets that are to be used over a long period. So, Fixed capital is an alternative term for fixed assets.
Fixed capital is required for acquisition of the following assets:
- Tangible assets such as land, buildings, plant and machinery, furniture and fittings, etc.
- Intangible assets such as goodwill, patents, copyrights, promotion, cost, etc.
It should be noted that the fixed assets couldn’t be withdrawn from the business without disturbing the normal working of the undertaking. It is, therefore, necessary that sufficient funds are raised for acquisition of fixed assets. These funds are required not only while establishing a new enterprise but also for expanding, diversifying and maintaining intact the existing enterprise.
Assessment of Fixed Capital Requirements
The assessment of fixed capital requirements is done by preparing a list of the fixed assets needed by the business. Having compiled a list of the fixed assets required for the business, it will not be difficult to ascertain the total funds required for purchase of fixed assets. The price of land can be found out from the property agents, the information regarding the estimated cost of construction of building can be obtained from the building contractors, the suppliers of machines can be asked to give quotations for the plant and equipment to be installed. Similarly, the amounts to be paid for patents, trade marks, goodwill etc. can also be ascertained.
Factors Determining the Amount of Fixed Capital
The amount of fixed capital requirements of a business depends basically on the following factors:
- Nature of the business: The nature of the business to a great extent determines the amount of fixed capital required by the business. For example, public utility concerns like electricity supply companies, water supply companies or railway companies would require heavy investment in fixed assets; on the other hand, a trading concern would require relatively much less investment in fixed assets.
- Size of the business: Size of the business has also its impact on the fixed capital requirements of the business. It can generally be said that larger the size of the business, the heavier would be the investment in fixed capital.
- Types of products: A company manufacturing simple consumer articles like soap, oil etc., will require a smaller amount of fixed capital as compared to a company manufacturing complicated industrial goods such a heavy machinery, automobiles, etc.
- Diversity of production lines: More fixed capital will be required in case of companies which have diversity of production lines as compared to companies which do not have much of diversification. For example, a company producing ancillary products or by-products together with main products will require greater amount of fixed capital as compared to companies which manufacture only main products.
- Method of production: A company manufacturing each part of a finished product by itself requires a greater amount of fixed capital as compared to a company which gets the parts manufactured from outside and merely assembles them in its own factory.
- Method of acquisition of fixed assets: A company which purchases fixed assets against immediate cash payment or ownership basis requires a greater amount for fixed capital as compared to a company which acquires , fixed assets on hire-purchase system or lease system.
Management of Fixed Capital
Management of fixed capital is concerned with the raising of required fixed capital at minimum cost and its effective utilization. The following principles should be observed in order to have an efficient management of fixed capital:
- Generally only such fixed assets should be purchased which are likely to increase the earning capacity of the business.
- Wherever feasible, fixed assets should be purchased on rental or hire purchase system. This would result in releasing pressure on bulk funds.
- Obsolete or outmoded fixed assets should not be bought even though they may be available at lower prices.
- There should not be any idle capacity. This would increase the overhead burden. In other words, new fixed assets should be bought only when there is already full utilization of the existing fixed assets.
- Fixed assets should be maintained properly. Periodical inspection, overhaul and scheduled repairs would considerably increase the working life of the assets.
- Proper depreciation should be provided out of profits to enable timely replacement of the fixed assets.
- Investment in fixed assets should have a proper relationship with sales and profits. Fixed assets turnover ratios for different years can be found out to determine whether investment in fixed assets has been judicious or not.
- The requirements of fixed capital should be met out of long-term, funds such as share capital, debentures, loans from financial institutions, etc.