Factors Determining the Requirements of Fixed Capital

Fixed capital is the fund which is required for the purchase of those assets that are to be used over and over for a long period. Such assets are land, machinery, building, payment rights, copy rights and other overhead expenses. These expenses are born regardless of the number of units produced. Fixed capital is, thus, the funds which are required not only for the purchase of fixed assets but also non-current assets at the start of business.

Mode of acquiring of fixed assets

If a business purchases fixed assets from the market, it requires more capital than a business which acquires them on lease basis.

Nature of business

Nature of business determines the amount of fixed capital. Huge fixed investment is required in public enterprises such as railways, electricity, sewerage system etc. Manufacturing concerns also need sizable amount of fixed capital trading and financial firms need less fixed capital. They require more working capital to invest in current assets.

Non-current assets

Investments in non-current assets, like goodwill, patent, copy right; long-term investments etc are a part of fixed capital and influence the fixed capital of a business.  

Number of activities

If an enterprise undertakes more than one activity, say manufacturing, marketing, insurance etc it requires larger investment in fixed assets.

Size of business

Capital required by a business depends upon its size. Generally, the larger the size of business, the greater is the need of fixed capital and vice versa.

Type of business

If an industry is capital intensive, like iron and steel industry, a large amount of fixed capital is required in them. In labor intensive industries, lesser amount of fixed capital is needed.

Technique of production

If an industry requires automatic machines and uses modern techniques of production, it calls for larger investment in fixed assets.

Sources of raising fixed capital

There are two sources of raising fixed capital by a company such as borrowed capital and owned capital. In order to finance fixed capital, a company depends on long-term types of finance. It makes use of both the sources owned as well as borrowed. Owned capital is raised by issue of shares and ploughing back of profits. Borrowed capital is raised by issuing debentures, public deposits and loans from industrial and financial institutions. A company cannot make mistake of financing fixed assets out of short-term sources of finance as the funds invested in fixed assets are permanently sunk into the business and are not convertible into cash at a short notice. The sources of fixed capital, both owned and borrowed are now discussed in brief.

Debentures (Borrowed capital)

A company may raise long-term finance through public borrowing. These loans are raised by issue of debentures. A debenture is an instrument issued by a company to acknowledge the loan taken under the company’s seal. A debenture holder is the creditor of the company. The company pays fixed rate of interest on debentures. After the commencement of companies ordinance, a company is not allowed to issue debentures.

Loans from industrial and financial institutions (Borrowed capital)

Another significant source of raising long-term finance is from the financial institutions like the IDBP, PICIC, NIT, BEL, certificates etc. The loans are obtained both in local and foreign currency for the purchase of machinery equipment etc.

Owned capital

An enlisted company can now raise owned capital by issuing of more than one kind and classes of share capital. The capital mopped up through the sale of shares is a part of the capital of a company. It belongs to the company for all intents and purposes. Such capital has a claim on dividend in case of profit but no right to receive interest. It is, therefore, in no way burden on the resources of a company.

Ploughing back of profits (Owned capital)

Ploughing back of profits is the process of retaining profits year after year and their utilization in the business for the development of the business. The technique of reinvestment of profits or ploughing back of profits is employed for making the company self dependent for finances. This method is also employed for expansion of business, redemption of loans and debentures etc.