Fixed and working capital

 

Fixed and working capitalWhat Is Fixed Capital?

Fixed capital is that portion of the total capital of the company which is invested in tangible fixed assets such as land and building, plant and machinery, furniture, etc as well as in intangible fixed assets such as goodwill, patents, copyrights, etc that stay in the business permanently or at least for more than one accounting year.

What Is Working Capital?

Working capital is that portion of the total capital of the company which is required for conducting the day-to-day operations of business. It is required on a continuous basis in business. 
 Working capital can be gross working capital or net working capital.
Gross working capital means all the current assets of the company such as cash, debtors, inventories, etc and net working capital means all the currents assets of the company minus all the current liabilities of the company such as creditors, short-term loans, etc.
Gross working capital = all current assets
Net working capital = all current assets – all current liabilities
 Working capital could be positive or negative. If the currents assets exceed the current liabilities, it is called as positive working capital and if the current liabilities exceed the current assets, it is called as negative working capital or working capital deficit.
 Working capital is also called as circulating capital.

Difference Between Fixed Capital And Working Capital:-

Fixed Capital Working Capital
Fixed capital is long-term in nature. Fixed capital investment stays in the business for a long period of time i.e. many years. Working capital is short-term in nature. Working capital investment stays in the business for a short period of time i.e. for a year.
Fixed capital is not required continuously in business. It is required mostly when a company wants to make a big investment such as purchase of some fixed asset or expansion of business. Working capital is required continuously to conduct day-to-day operations of business such as purchase of raw materials, paying salaries, etc.
Fixed capital investments have low liquidity. For e.g. an fixed asset cannot be sold easily to get cash. For that a certain asset disposal procedure has to be followed. Working capital has high liquidity. For e.g. A company can convert its current assets such as debtors into cash relatively easily.
The main sources of fixed capital are shares, debentures and long-term loans which are repayable after many years. The main sources of working capital are profits retained by the company, fixed deposits, trade creditors, short-term loans, shares and debentures.
The amount of fixed capital required is more than working capital. The amount of working capital required is less than fixed capital.

Operating Cycle:-

Operating cycle is an important measure of the working capital management and operating efficiency of the company. Operating cycle is the average amount of time a company takes to turn the cash used to purchase inventory of raw materials into cash again by its eventual sale as finished products. Operating cycle starts when the company spends money to purchase stock of raw materials and ends when the company receives money from the customers who buy the finished products made from those raw materials. Operating cycle is also called as cash conversion cycle.

 The company purchases raw materials from the suppliers on credit or cash. If they are purchased on credit, the suppliers are termed as creditors and the company pays them some time after the purchase of raw materials from them as per the credit terms given by them. The raw materials so purchased are kept in the storeroom for some time. Then the raw materials lie in the factory as work-in-progress till the process of converting them into finished products takes place. After the raw materials are turned into finished products, they are kept in the godown till the time they are sold. Then the finished products are finally sold to the customers on credit or cash. If they are sold on credit, the customers are termed as debtors and they pay the company some time after the sale of goods to them as per the credit terms given to them. This whole process is called as operating cycle of the company.

 Operating cycle is generally measured in days, and shorter the operating cycle, the better. Shorter operating cycle ensures liquidity and reduces the need of financing. Shorter operating cycle ensures that the cash does not get tied up in the operations of the business and can also be utilized for other activities of the company.

 operating cycle is made up of three elements – days inventory outstanding, days sales outstanding and days payables outstanding. The formula for calculating operating cycle is :-
Operating cycle = days inventory outstanding + days sales outstanding – days payables outstanding.

operating cycle

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