Know how to determine fixed capital of the business?

Everybody says that investment or fixed capital budgeting decisions are very crucial for every business. It is very important to properly analyse the fixed capital requirements. No one tells us how to decide the fixed capital of the company or what are the factors that determine the fixed capital requirement.  But before discussing about the factors affecting fixed capital, we should know what is fixed capital.

Fixed asset refers to those assets which remain in the business organisation for more than a year. For example-  plant and machinery, furniture and fixtures, land and buildings, vehicles, launching a new product line, investing in advanced techniques of production, advertising campaigns, research and development programs, etc.

WHY ARE FIXED CAPITAL DECISIONS CRUCIAL?

Long term growth of the company

The fixed capital decisions affect the long-term growth of the business. These are the funds invested in long term assets which will earn returns for the company in the future.

Large amount of money  involved

The fixed capital decisions are very crucial as they involve a very big portion of a company's fund. It is very important for these investments to earn returns for the company as a very big amount is being blocked in the long-term project.

Risk involved

Fixed capital involves a large amount of funds. Therefore, decisions regarding fixed capital are very risky for the company. If a single decision went wrong, it will destroy the company as well as its reputation.

Fixed capital decisions are not reversible

The decisions of fixed capital cannot be reversed without encouraging large amounts of losses. Cancelling a project without heavy funds is difficult. Therefore, the decisions should be analysed properly with its financial pros and cons.

What are the factors that affect fixed capital decisions?

Nature of business

The nature of business truly affects its fixed capital  requirements.  For example- A trading company needs less investment in fixed assets but a manufacturing company needs a huge amount of investment in plant and machinery, etc.

Size of operations

It is very simple to understand that if the operations of the business are at a lower scale, it will require a very less amount of fixed capital. But, if the business operates in a very big size it requires more space, bigger plant, etc.

Choice of technique of production

If the business organisation adopts labour intensive technique of production , the requirement of fixed capital will be less. And if the company adopts capital intensive technique of production, it will require a heavy amount of investment in fixed capital.

Advanced and upgraded technology

There are some industries in which the assets become obsolete sooner. Thus, the replacement of these assets are faster and it increases the investment in fixed assets.

Diversification

If any business organisation wants to diversify its operations for its growth, the fixed capital requirement will increase.

 Available financing alternatives

There are many financing alternatives available to the business organisation. If the company chooses a financing alternative like leasing, then the business organisation needs less fixed capital as compared to other financing alternative like purchasing the asset.

Growth prospects

If any company has higher growth prospectus then it will require higher investment in fixed assets.  And, if the company has low growth prospects, then it will require less investment in fixed capital.