Explain Role or Importance of Fixed Capital

Explain Role or Importance of Fixed Capital

Following diagram briefly explain the main role or importance of fixed capital.

The main role or importance of fixed capital is listed in following eight points:

1. Fixed capital is required to buy fixed assets for the company.
2. It is needed to meet various promotionl expenses of a company.
3. It aids a company to modernise by easing the process of purchasing modern machines and implementation of latest technologies.
4. It is necessary to replace out of date and scrapped assets.
5. It helps in expansion and diversification of a company.
6. It also helps in automation of a company.
7. It is essential if a company decides to widen its scope of activities.
8. It increases the capital requirements of a company.

Now let's discuss above points highlighting role or importance of fixed capital.

1. Establishment of company

Every company needs fixed capital to initiate its business activities. No company either big or small can be established without making investments in form of a fixed capital.

Maximum amount of fixed capital is required during the foundation stage of a company. At this inception level, fixed capital is mainly used to meet the preliminary expenses of a company.

Fixed Capital is needed to buy fixed assets required for the smooth functioning of the company in a long run.

The company needs fixed capital to make a purchase of various fixed-assets like land and building, plant and machinery, furniture and fixtures, etc.

2. Promotion of company

Once a company is established, its promotion takes place. The promoters of a company execute the promotional activities.

The promoters need fixed capital to pay their promotion expenses.

Generally, the promotional expenses cover cost incurred on the:

• Preparation of project reports,
• Payment of preliminary (establishment) expenses,
• Legal and other professional fees,
• Issuance of a company's prospectus to the investors.

3. Modernisation of company

Modernisation is an innovative approach used to enhance the traditional (existing) functioning of any system or process.

Modernisation is necessary to enhance efficiency and increase productivity of business. It shall be implemented as and when new research and development takes place.

To introduce modernisation, the company has to acquire new machineries and technologies. It needs fixed capital to purchase modern machines and implement latest technologies.

4. Replacement of obsolete assets

In a course of time, company has to replace old and outdated assets such as plant and machinery, furniture and fixtures, etc.

Such replacement of fixed assets is necessary to increase the efficiency and productivity of the company.

The company needs sufficient fixed capital to replace the old, outdated or obsolete assets.

5. Expansion and diversification

The meaning of expansion and diversification of a company:

1. Expansion means growth of business activities in the same sector of an economy.
2. Diversification implies growth of business activities in more than one sector of economy.

Generally, most companies undergo expansion and diversification.

To expand and diversify its business activities, a company needs finance in the form of fixed capital.

6. Automation of company

Automation is a process of reducing dependency on manual labour and/or minimizing regular human interventions by installing self-operating (programmed or automatic) machines.

If a labour-intensive company decides to automate its routine production activities, then it must first procure self-operating machines. Company needs a lot of fixed capital to make a purchase and install automatic-machines.

7. Widen the scope of activities

Generally, the main focus of most companies is on their manufacturing and trading activities. Companies also need to pay proper attention on their distribution network to increase the sale of their goods and services.

So, if any such company widens its scope of activities, then it will need more fixed capital.

8. To increase capital requirements

Company requires fixed capital to increase its capital requirements to sustain and face regular competition in a long run.

The primary and major sources of fixed capital requirements of a company can be satisfied from:

1. Public – by issuing shares, and
2. Banks – by applying for the loans.