Fixed capital
Encyclopedia
Fixed capital is a concept in economics
and accounting, first theoretically analysed in some depth by the economist David Ricardo
. It refers to any kind of real or physical capital
(fixed asset) that is not used up in the production of a product and is contrasted with circulating capital
such as raw materials, operating expenses and the like. Fixed capital is that portion of the total capital that is invested in fixed assets (such as land, buildings, vehicles and equipment) that stay in the business almost permanently, or at the very least, for more than one accounting period. Fixed assets can be purchased by a business, in which case the business owns them, but also leased, hired or rented, if that is cheaper or more convenient, or if owning the fixed assets is practically impossible.
Refining the classical distinction between fixed and circulating capital in Das Kapital
, Karl Marx
emphasizes that it is really purely relative, i.e. refers only to the comparative rotation speeds (turnover time) of different types of capital assets. Fixed capital also "circulates", except that the circulation time is much longer, because a fixed asset may be held for 5, 10 or 20 years before it has yielded its value and is discarded for its salvage value. A fixed asset may also be resold and re-used, which often happens with vehicles and planes.
In national accounts
, fixed capital is conventionally defined as the stock of tangible, durable fixed assets owned or used by resident enterprises for more than one year. This includes plant, machinery, vehicles & equipment, installations & physical infrastructures, the value of land improvements, and buildings. The European system of national and regional accounts (ESA95) explicitly includes produced intangible assets (e.g. mineral exploitation, computer software, copyright protected entertainment, literary and artistics originals) within the definition of fixed assets. Land itself is not included in fixed capital even though it is a fixed asset, because it is not a product (a reproducible good). But the value of land improvements is included.
", administrative business records, tax assessments, and data on gross fixed capital formation
, price inflation
and depreciation
schedules. A pioneer in this area was the economist Simon Kuznets
.
Using the so-called "perpetual inventory method", one starts off from a benchmark asset figure, and adds on the net additions to fixed assets year by year, while deducting annual depreciation, all data being adjusted for price inflation using a capital expenditure
price index
. In this way, one obtains a time series
of annual fixed capital stocks.
However, it is widely acknowledged that it is extremely difficult to obtain any accurate measurement
of the value of fixed capital, especially because even the owner himself or herself may not know what the assets are currently "worth". What they are worth may become apparent only at the point where they are definitely sold for a price. Some valuations for fixed assets may refer to historic cost (acquisition cost) or book value, others to current replacement cost, current sale value in the market, or scrap value. The depreciation
write-off permitted for tax purposes may also diverge from so-called "economic depreciation" or "real" depreciation rates. Economic depreciation rates are calculated on the basis of the observed average market prices that depreciated assets at different ages actually sell for. Sometimes statisticians try to estimate the average "service lives" of fixed assets as a basis for calculating depreciation and scrap values, based on the observed length of time that fixed assets are actually held and used by their owners.
or renting
a fixed asset (such as a vehicle) rather than buying it is preferred by enterprises because the cost of using it is lowered thereby, and the real owner may be able to obtain special tax advantages.
, where loans are given on a long-term basis. Funding can also come from reserve funds, the selling of shares, and the issuing of debentures, bonds
or other promissory notes.
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
and accounting, first theoretically analysed in some depth by the economist David Ricardo
David Ricardo
David Ricardo was an English political economist, often credited with systematising economics, and was one of the most influential of the classical economists, along with Thomas Malthus, Adam Smith, and John Stuart Mill. He was also a member of Parliament, businessman, financier and speculator,...
. It refers to any kind of real or physical capital
Physical capital
In economics, physical capital or just 'capital' refers to any already-manufactured asset that is applied in production, such as machinery, buildings, or vehicles. In economic theory, physical capital is one of the three primary factors of production, also known as inputs in the production function...
(fixed asset) that is not used up in the production of a product and is contrasted with circulating capital
Circulating capital
Circulating capital refers to physical capital and operating expenses, i.e., short-lived items that are used in production and used up in the process of creating other goods or services. This is roughly equal to Intermediate consumption. It includes raw materials, intermediate goods, inventories,...
such as raw materials, operating expenses and the like. Fixed capital is that portion of the total capital that is invested in fixed assets (such as land, buildings, vehicles and equipment) that stay in the business almost permanently, or at the very least, for more than one accounting period. Fixed assets can be purchased by a business, in which case the business owns them, but also leased, hired or rented, if that is cheaper or more convenient, or if owning the fixed assets is practically impossible.
Refining the classical distinction between fixed and circulating capital in Das Kapital
Das Kapital
Das Kapital, Kritik der politischen Ökonomie , by Karl Marx, is a critical analysis of capitalism as political economy, meant to reveal the economic laws of the capitalist mode of production, and how it was the precursor of the socialist mode of production.- Themes :In Capital: Critique of...
, Karl Marx
Karl Marx
Karl Heinrich Marx was a German philosopher, economist, sociologist, historian, journalist, and revolutionary socialist. His ideas played a significant role in the development of social science and the socialist political movement...
emphasizes that it is really purely relative, i.e. refers only to the comparative rotation speeds (turnover time) of different types of capital assets. Fixed capital also "circulates", except that the circulation time is much longer, because a fixed asset may be held for 5, 10 or 20 years before it has yielded its value and is discarded for its salvage value. A fixed asset may also be resold and re-used, which often happens with vehicles and planes.
In national accounts
National accounts
National accounts or national account systems are the implementation of complete and consistent accounting techniques for measuring the economic activity of a nation. These include detailed underlying measures that rely on double-entry accounting...
, fixed capital is conventionally defined as the stock of tangible, durable fixed assets owned or used by resident enterprises for more than one year. This includes plant, machinery, vehicles & equipment, installations & physical infrastructures, the value of land improvements, and buildings. The European system of national and regional accounts (ESA95) explicitly includes produced intangible assets (e.g. mineral exploitation, computer software, copyright protected entertainment, literary and artistics originals) within the definition of fixed assets. Land itself is not included in fixed capital even though it is a fixed asset, because it is not a product (a reproducible good). But the value of land improvements is included.
Estimating the value of fixed capital
Attempts have been made to estimate the value of the stock of fixed capital for the whole economy using direct enterprise surveys of "book valueBook value
In accounting, book value or carrying value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or Impairment costs made against the asset. Traditionally, a company's book value...
", administrative business records, tax assessments, and data on gross fixed capital formation
Gross fixed capital formation
Gross fixed capital formation is a macroeconomic concept used in official national accounts such as the UNSNA, NIPAs and the European System of Accounts . The concept dates back to the NBER studies of Simon Kuznets of capital formation in the 1930s, and standard measures for it were adopted in the...
, price inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
and depreciation
Depreciation
Depreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....
schedules. A pioneer in this area was the economist Simon Kuznets
Simon Kuznets
Simon Smith Kuznets was a Russian American economist at the Wharton School of the University of Pennsylvania who won the 1971 Nobel Memorial Prize in Economic Sciences "for his empirically founded interpretation of economic growth which has led to new and deepened insight into the economic and...
.
Using the so-called "perpetual inventory method", one starts off from a benchmark asset figure, and adds on the net additions to fixed assets year by year, while deducting annual depreciation, all data being adjusted for price inflation using a capital expenditure
Capital expenditure
Capital expenditures are expenditures creating future benefits. A capital expenditure is incurred when a business spends money either to buy fixed assets or to add to the value of an existing fixed asset with a useful life extending beyond the taxable year...
price index
Price index
A price index is a normalized average of prices for a given class of goods or services in a given region, during a given interval of time...
. In this way, one obtains a time series
Time series
In statistics, signal processing, econometrics and mathematical finance, a time series is a sequence of data points, measured typically at successive times spaced at uniform time intervals. Examples of time series are the daily closing value of the Dow Jones index or the annual flow volume of the...
of annual fixed capital stocks.
However, it is widely acknowledged that it is extremely difficult to obtain any accurate measurement
Measurement
Measurement is the process or the result of determining the ratio of a physical quantity, such as a length, time, temperature etc., to a unit of measurement, such as the metre, second or degree Celsius...
of the value of fixed capital, especially because even the owner himself or herself may not know what the assets are currently "worth". What they are worth may become apparent only at the point where they are definitely sold for a price. Some valuations for fixed assets may refer to historic cost (acquisition cost) or book value, others to current replacement cost, current sale value in the market, or scrap value. The depreciation
Depreciation
Depreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....
write-off permitted for tax purposes may also diverge from so-called "economic depreciation" or "real" depreciation rates. Economic depreciation rates are calculated on the basis of the observed average market prices that depreciated assets at different ages actually sell for. Sometimes statisticians try to estimate the average "service lives" of fixed assets as a basis for calculating depreciation and scrap values, based on the observed length of time that fixed assets are actually held and used by their owners.
Investment risk of fixed capital
A business executive who invests in or accumulates fixed capital is tying up money in a fixed asset, hoping to make a future profit. Thus, such an investment usually implies a risk. Sometimes depreciation write-offs are also viewed partly as a compensation for this risk. Often leasingLeasing
Leasing is a process by which a firm can obtain the use of a certain fixed assets for which it must pay a series of contractual, periodic, tax deductible payments....
or renting
Renting
Renting is an agreement where a payment is made for the temporary use of a good, service or property owned by another. A gross lease is when the tenant pays a flat rental amount and the landlord pays for all property charges regularly incurred by the ownership from landowners...
a fixed asset (such as a vehicle) rather than buying it is preferred by enterprises because the cost of using it is lowered thereby, and the real owner may be able to obtain special tax advantages.
Sources of funding for fixed capital investment
An owner can obtain funding for purchase of fixed capital assets from the aptly named capital marketCapital market
A capital market is a market for securities , where business enterprises and governments can raise long-term funds. It is defined as a market in which money is provided for periods longer than a year, as the raising of short-term funds takes place on other markets...
, where loans are given on a long-term basis. Funding can also come from reserve funds, the selling of shares, and the issuing of debentures, bonds
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
or other promissory notes.
Factors which influence fixed-capital requirements
- The nature of the undertaking: the nature of the business certainly plays a role in determining fixed capital requirements. A florist, for example, needs less fixed capital than a vehicle-assembly factory.
- The size of the undertaking: a general rule applies: the bigger the business, the higher the need for fixed capital.
- The stage of development of the undertaking: the requirement of capital for a new undertaking is usually greater than that needed for an established business that has reached optimum size.
See also
- CapitalCapital (economics)In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
- Fixed investmentFixed investmentFixed investment in economics refers to investment in fixed capital, i.e., tangible capital goods , or to the replacement of depreciated capital goods which have been scrapped....
- Gross fixed capital formationGross fixed capital formationGross fixed capital formation is a macroeconomic concept used in official national accounts such as the UNSNA, NIPAs and the European System of Accounts . The concept dates back to the NBER studies of Simon Kuznets of capital formation in the 1930s, and standard measures for it were adopted in the...
- Organic composition of capitalOrganic composition of capitalThe organic composition of capital is a concept created by Karl Marx in his critique of political economy and used in Marxian economics as a theoretical alternative to neo-classical concepts of factors of production, production functions, capital productivity and capital-output ratios. Marx first...
- Capital accumulationCapital accumulationThe accumulation of capital refers to the gathering or amassing of objects of value; the increase in wealth through concentration; or the creation of wealth. Capital is money or a financial asset invested for the purpose of making more money...
- Capital formationCapital formationCapital formation is a concept used in macroeconomics, national accounts and financial economics. Occasionally it is also used in corporate accounts. It can be defined in three ways:...
- Consumption of fixed capitalConsumption of fixed capitalConsumption of fixed capital is a term used in business accounts, tax assessments and national accounts for depreciation of fixed assets...