Capital allows a business to operate. It is an essential part of any business operation and can generally be categorized into two types: fixed and working capital. Fixed and working capital are both vital to a small business. Fixed capital includes the assets or investments needed to start and maintain a business, like property or equipment. Working capital is the cash or other liquid assets that a business uses to cover daily operations, like meeting payroll and paying bills.
While both fixed and working capital are necessary for running a successful business, they are two distinct types of capital. It’s important to understand the differences between the two and know the assets your business has in both types of capital. Here we’ll outline the key differences between fixed and working capital.
What Is Fixed Capital?
- Fixed capital includes property, facilities, equipment and tools that your business uses on an ongoing basis. Entrepreneur lists some additional examples of long-term assets. These are assets often needed to start and operate a business.
- These assets, such as vehicles, real estate, commercial ovens and construction equipment, are not easily liquidated (or turned to cash) but they may be resold and reused at any time. The amount of fixed capital a business requires varies by business and industry.
- Fixed-capital investments are usually depreciated on the company’s accounting statements over a long period of time, but can sometimes be deducted all at once with the Section 179 deduction.
- Fixed capital supports the business indirectly and serves over a long period of time.
What Is Working Capital?
- Working capital is the difference between a company’s current assets (what you have) and liabilities (what you owe). To calculate your working capital ratio, you divide your current assets from your current liabilities. A score that falls between 1.5 and 2 is considered sufficiently healthy for a business.
- This figure measures how efficiently you’re operating, your company’s liquidity, and its short-term financial health.
- Working capital allows a business to expand. Without working capital, it’s difficult for a company to grow, pay off debts and become (or remain) profitable.
- Working capital directly supports the business by providing the funds used for daily operational expenses. It serves the business in the short-term, but is crucial to keep operations like payroll and supplies running smoothly.
- While fixed capital is strategic, working capital is operational for a business. It can be converted into cash assets immediately.
Your company’s fixed capital or assets can help ensure its long-term health, as it needs these assets and investments to continue operating and serving customers. Your company’s working capital, on the other hand, ensures its short-term health; if you have cash or other liquid assets on hand, you can restock inventory, pay your employees on time, pay taxes and meet any other frequent obligations. Knowing the fixed and working capital for your business gives you great insight into how healthy financially your business is, and any areas you need to be aware of before making financial decisions. It helps you understand opportunities to streamline or grow your business, as well as gives potential investors or lenders insight into your business.
Working capital is often an area a business needs support in, which is why they turn to short-term loans to cover business expenses or help growth. When small business owners come up short on working capital, they often turn to working capital loans to fill the gaps.
Originally published November 13, 2019. Updated on September 28, 2023.
