Definitions

Fixed capital

Fixed capital

Fixed capital is a concept in economics and accounting, first theoretically analysed in some depth by the economist David Ricardo. It refers to any kind of real or physical capital (fixed asset) that is not used up in the production of a product and is contrasted with circulating capital such as raw materials, operating expenses and the like. Fixed capital is that portion of the total capital which is invested in fixed assets (such as land, buildings, vehicles and equipment) which stay in the business almost permanently.

Refining the distinction between fixed and circulating capital in Das Kapital, Karl Marx emphasizes that it is really purely relative, i.e. refers only to the comparative rotation speeds (turnover time) of different types of capital assets. Fixed capital also "circulates", except that the circulation time is much longer, because a fixed asset may be held for 5, 10 or 20 years before it has yielded its value and is discarded for its salvage value.

In national accounts, fixed capital is conventionally defined as the stock of tangible, durable fixed assets owned or used by resident enterprises for more than one year. This includes plant, machinery, vehicles & equipment, the value of land improvements, and buildings. Land itself is not included in fixed capital even though it is a fixed asset, because it is not a product (a reproducible good). But the value of land improvements is included.

Attempts have been made to estimate the value of the stock of fixed capital for the whole economy using direct enterprise surveys of "book value", administrative business records, tax assessments, and data on gross fixed capital formation, price inflation and depreciation schedules. A pioneer in this area was the economist Simon Kuznets.

Using the so-called "perpetual inventory method", one starts off from a benchmark asset figure, and adds on the net additions to fixed assets year by year, while deducting annual depreciation, all data being adjusted for price inflation using a capital expenditure price index. In this way, one obtains a time series of annual fixed capital stocks.

However, it is widely acknowledged that it is extremely difficult to obtain any accurate measurement of the value of fixed capital, especially because even the owner himself or herself may not know what assets are currently "worth". Some valuations for fixed assets may refer to historic cost (acquisition cost) or book value, others to current replacement cost, current sale value in the market, or scrap value. The depreciation write-off permitted for tax purposes may also diverge from so-called "economic depreciation" or "real" depreciation rates. Economic depreciation rates are calculated on the basis of the observed average market prices that depreciated assets at different ages actually sell for. Sometimes statisticians try to estimate the average "service lives" of fixed assets as a basis for calculating depreciation and scrap values.

A business executive who invests in or accumulates fixed capital is tying up money in a fixed asset, hoping to make a future profit. Thus, such an investment usually implies a risk. Sometimes depreciation write-offs are also viewed partly as a compensation for this risk.

Sources of fixed capital

An owner can obtain fixed capital from the aptly-named capital market, where loans are given on a long-term basis. It can also come from reserve funds, the selling of shares and the issuing of debentures.

Factors which influence fixed-capital requirements

The nature of the undertaking

The nature of the business certainly plays a role in determining fixed capital requirements. A florist, for example, needs less fixed capital than a vehicle-assembly factory.

The size of the undertaking

A general rule applies: the bigger the business, the higher the need for fixed capital.

The stage of development of the undertaking

The requirement of capital for a new undertaking is usually greater than that needed for an established business that has reached optimum size.

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See also

de: fixes Kapital

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