In any enterprise, the need for constant funding is always present. It is important for an enterprise to raise money by any means possible. One of the best ways to do this is to increase the amount of manufacturing and working capital that it has. The amount of capital that a manufacturing firm needs depends on the nature of the products that it manufactures and makes. Some manufacturing firms produce simple products that require only raw materials and labor to produce, while other manufacturing firms, such as those that produce sophisticated products, require a significant amount of capital in order to start-up and expand.
Fixed capital refers to fixed assets. Examples of fixed assets are inventory, machinery, buildings, fixed assets located on a plant site, and other fixed assets that cannot be replaced. Fixed capital funds generally are used to expand a firm’s operations or to buy new equipment. A company can use these funds to finance the purchase of new inventory or to reduce fixed costs. A firm’s fixed assets, however, cannot be replaced, so a company must depend on its sources of revenue to finance these purchases. Fixed capital funds are usually held by the firm until the value of the firm’s stock increases above a predetermined level.
Variable capital is a type of capital that can fluctuate with the direction of a firm’s stock price. This category of capital is commonly referred to as working capital. In most businesses, working capital represents the difference between total assets and total liabilities – the difference between net worth per outstanding asset. Firms usually capitalize their working capital by issuing debentures. However, some firms use their working capital in ways that do not involve the issuance of debentures.
In a growing economy, there are many firms that use retained earnings as the source of their working capital. To earn retained earnings, firms must reinvest the earnings that have been previously retained. Many firms that have retained earnings to reinvest these earnings either by purchasing existing products or by expanding their production facilities. A manufacturing unit that has retained earnings is referred to as a fixed rate savings plant. A variable rate savings plant, on the other hand, is referred to as a variable rate facility.
Cash flow describes the movement of money from operations. A firm establishes its cash flow during the start up phase of its operations. During this time, the company does not require large amounts of working capital. A company only requires small sums of cash during its start up period and these cash amounts can increase as operations grow.
There are two types of working capital: tangible and intangible. Tangible working capital is associated with the property, plant, equipment, and supplies that create and support the operations of a business. Intangible assets include accounts receivable, inventory, and loans. The cost of producing the tangible assets and the cost of financing them are included in the cost of goods sold.
In contrast, intangible working capital is the cost of executing the customer orders and the cost of providing goods and services to customers using credit or other methods of payment. Examples of intangible assets are accounts receivable, inventory, accounts payable, accounts owed, and patents. The cost of producing these intangible assets is known as the cost of good sold and the cost of financing them is known as the cost of goods bought. A fixed rate loan is one of the most common forms of working capital.
Manufacturing and working capital comprise approximately eighty percent of total assets of any business. A company needs the remaining balance to finance growth and make investments. Working Capital Management (W CM) is an aid for managers who aim at meeting the short term and long term cash flow requirements of the business. W CM aids in decision making concerning the use of funds from the various working capital sources.