What is Fixed Capital?
Fixed capital includes the assets and capital investments - such as property, plant, and equipment (PP&E) - that are needed to start up and conduct business, even at a minimal stage. These assets are considered fixed in that they are not consumed or destroyed during the actual production of a good or service but have a reusable value. Fixed-capital investments are typically depreciated on the company's accounting statements over a long period of time - up to 20 years or more. Fixed capital can be contrasted with variable capital, the cost and level of which change over time and with the scale of a company's output. For instance, machinery used in production would be considered fixed capital, while human labor would be a component of variable capital.
The concept of fixed capital was first introduced in the 18th century by the political economist David Ricardo. For Ricardo, fixed capital referred to any kind of real or physical asset that was consumed in the production of a product. This was opposed to Ricardo's idea of circulating capital, such as raw materials, operating expenses and labor. In Marxian economics, fixed capital is closely related to the concept of constant capital.
- Fixed capital includes the assets and capital investments - such as property, plant, and equipment.
- The amount of fixed capital needed to set up a business is quite variable, especially from industry to industry.
- Fixed capital is subject to the accounting practice of depreciation.
Explaining Fixed Capital
Serving as the mechanism upon which production activities take place, fixed capital includes tangible items, such as equipment and facilities, which are needed for business operations. Fixed capital does not include materials used in the actual composition of the good being produced. Investments in fixed capital include the addition of new tools and equipment, as well as real estate needed to create and house the goods being produced. A fixed asset may be resold and reused at any time before its useful life is over, which often happens with vehicles and airplanes.
Fixed Capital Requirements
The amount of fixed capital needed to set up a business is quite variable, especially from industry to industry. Some lines of business require high fixed-capital investment. Common examples include industrial manufacturers, telecommunications providers and oil exploration firms. Service-based industries, such as accounting firms, may have more limited fixed capital. This can include office buildings, computers and networking devices, and other standard office equipment.
While production businesses often have easier access to the inventory necessary to create the good being produced, the procurement of fixed capital can be lengthy. It may take a business a significant amount of time to generate the funds necessary for larger purchases, such as new production facilities, or external financing may be required. This can increase the risk of financial losses associated with low production if a company experiences an equipment failure and does not have redundancy built into the fixed capital assets.
Actual Depreciation Rates
Fixed capital investments typically don't depreciate in the even way that is shown on income statements. Some devalue quite quickly, while others have nearly infinite usable lives. For example, a new vehicle loses significant value when it is officially transferred from the dealership to the new owner. In contrast, company-owned buildings may depreciate at a much lower rate.
The depreciation method allows investors to see a rough estimate of how much value fixed-capital investments are contributing to the current performance of the company.
Liquidity of Fixed Capital Assets
While fixed capital often maintains a level of value, these assets are not considered very liquid in nature. This can be due to the limited market for certain items, such as manufacturing equipment, or the high price involved, as with real estate. Additionally, the time commitment required to sell fixed capital assets is often lengthy.
Fixed Capital in Classical Political Economy
Fixed capital was developed in classical political economy by David Ricardo and used throughout the years by thinkers such as Karl Marx. Fixed capital is the portion of total capital outlay of a business invested in physical assets such as land, factories, vehicles and machinery that stay in the business almost permanently, or, more technically, for more than one accounting period. Fixed assets can be purchased and owned by a business, or else they can also be structured as a long-term lease. On the other side of the capital equation is that which circulates, or which is consumed by a company in the process of production. This includes raw materials, labor, operating expenses, etc. Marx emphasized that the distinction between fixed and circulating capital is relative, since it refers to the comparative turnover times of various types of physical capital assets. Fixed capital also "circulates," except that the turnover time is far longer, because a fixed asset may be held for several years or decades before it has yielded its value and is discarded for its salvage value.
Marx considered labor to be the prime component of so-called variable capital.