Fixed Capital Method vs. Fluctuating Capital Method

Fixed Capital Method

Fixed Capital Method refers to the method of capitalization used in the case of companies that require a fixed amount of capital for their operations, such as manufacturing or construction firms. In this method, the capital required for the business is determined based on the cost of fixed assets such as land, buildings, machinery, etc. This capital is considered as fixed and does not change over time.

Advantages of Fixed Capital Method:

- Easy to calculate as it is based on the fixed assets of the company.
- Provides a stable base for the company's operations.
- Helps in obtaining long-term financing as it gives a clear idea of the capital required.

Disadvantages of Fixed Capital Method:

- Does not take into account the fluctuating nature of the business.
- May lead to overcapitalization or undercapitalization, which can affect the company's performance.

Fluctuating Capital Method

Fluctuating Capital Method refers to the method of capitalization used in the case of companies that require a fluctuating amount of capital for their operations, such as service-based firms. In this method, the capital required for the business is determined based on the working capital requirements, such as inventory, accounts receivables, and accounts payables. This capital is considered as fluctuating and changes over time.

Advantages of Fluctuating Capital Method:

- Takes into account the fluctuating nature of the business.
- Helps in avoiding overcapitalization or undercapitalization.
- Provides a more accurate picture of the company's capital requirements.

Disadvantages of Fluctuating Capital Method:

- Difficult to calculate as it is based on the working capital requirements of the company.
- May be less attractive to long-term financing sources as it may appear less stable.

Conclusion

Both Fixed Capital Method and Fluctuating Capital Method have their advantages and disadvantages, and the method chosen depends on the nature of the business. While Fixed Capital Method provides stability, Fluctuating Capital Method provides flexibility. It is essential to choose the right method to ensure the smooth functioning and success of the business.