What is Circulating Capital
Circulating capital can consist of cash, operating expenses, raw materials, inventory in process, finished goods inventory and accounts receivable. The opposite of constant (fixed) capital, circulating capital is, by definition, a company's non-permanent capital. It refers to the resources a company draws on to produce its goods and services, including paying salaries and other operating expenses such as rent and utilities. Circulating capital is frequently referred to as working capital or alternatively, revolving capital.
BREAKING DOWN Circulating Capital
In contrast to fixed capital, circulating capital references the number of resources in current and short-term assets, a company has available to fund the goods and services it produces. Fixed capital, on the other hand, refers to funds that are tied up in long-term assets rather than being consumed in the production process.
For example, a company’s buildings, warehouses and machinery are fixed capital. Intangible assets such as patents, brand names and other intellectual property are also forms of fixed assets. Unlike circulating assets which are used in day-to-day business operations, very little of a company’s fixed assets can be directly attributable to its profit generation. Learning how to analyze circulating capital will give you a better understanding of how much capital a business has available to fund its short-term (one year) activities and generate profits.
The Importance of Circulating Capital
Circulating capital needs are influenced by a company’s industry, whether it operates in a capital-intensive sector or not (e.g., utilities versus professional services), the degree of seasonality a business exhibits, its size, where it is in its lifecycle (mature versus startup) and by a host of internal factors such as its production cycle, financial management, credit policies and creditworthiness. Understanding a company’s circulating capital level, both overall and each of its constituents, will enable you to assess its health and solvency, analyze operational efficiency, review trends over time and compare it to others in its industry.
For example, high inventory levels relative to its peers could mean a company is having difficulty selling its products while high receivables levels could indicate an inability to collect payments from customers. While absolute levels are important so is the trend as well as the reason behind it. For example, a company could be building inventory in anticipation of a seasonal jump in demand. Alternatively, a high level of cash might seem to be positive; but it could actually indicate the company isn’t managing its capital efficiently.