How is working capital different from fixed capital?

There are several key differences between working capital and fixed capital. Most importantly, these two forms of capital serve very different strategic objectives. The former is a source of short-term financing for day-to-day operations, while the latter represents investments in physical capital, such as property and equipment.

Working capital is generally thought of as a measure of a firm’s ability to meet its obligations occurring over the next year. The term is commonly defined as the difference between current assets and current liabilities. In practice, variations on how working capital is calculated typically include the treatment of short-term debt and cash equivalents. Fixed capital refers to long-term assets including machinery and property used in the course of production.

With these definitions in mind, there are several key differences between working capital and fixed capital. The first is liquidity. Working capital assets must be easily convertible into cash, while fixed capital is typically expensive and has a particular functional use making it relatively illiquid.

A second differentiating factor is strategic scope. Working capital is comprised of short-term assets and liabilities used in a firm’s day-to-day operations. Fixed capital investments are more integral to a firm's business plan because they are typically expensive and have a long useful life.

Finally, there is a separate budgeting process for working capital and fixed capital. Working capital budgeting is based on short-term financial projections, usually a year or less. Fixed capital budgeting is based on long-term planning decisions involving the firm’s strategic objectives; multiyear cash flow outlook; and investment criteria, such as benchmarks for return on invested capital and payback period.