Question

Answer the following question.
You are the finance manager of a newly established company. The Directors have asked you to determine the amount of fixed capital requirements for the company. Explain any five factors that you will consider while determining the fixed capital requirement for the company.

Answer the following question.
You are the Finance Manager of a newly established manufacturing company. Explain any six factors that you will consider while determining the fixed capital requirements of the company.

Answer 1

The requirement of fixed capital depends upon various factors which are explained below :

1. Nature of Business: The type of business Co. is involved in is the first factor which helps in deciding the requirement of fixed capital. A manufacturing company needs more fixed capital as compared to a trading company, as a trading company does not need a plant, machinery, etc.

2. Scale of Operation: The companies which are operating at large scale require more fixed capital as they need more machinery and other assets whereas small scale enterprises need less amount of fixed capital.

3. The technique of Production: Companies using capital-intensive techniques require more fixed capital whereas companies using labor-intensive techniques require less capital because capital-intensive techniques make use of plant and machinery and the company needs more fixed capital to buy plant and machinery.

4. Technology Up-gradation: Industries in which technology up-gradation is fast need more amount of fixed capital as when new technology is invented old machines become obsolete and they need to buy new plant and machinery whereas companies when technological up-gradation is slow they require less fixed capital as they can manage with old machines.

5. Growth Prospects: Companies which are expanding and have higher growth plan require more fixed capital as to expand, they need to expand their production capacity and need more plant and machinery so more fixed capital is required. 

Answer 2

The Finance Manager of a manufacturing company considers the following points while determining the fixed capital requirements of the company

1. Type of business:
The amount of fixed capital required by a company depends, to a large extent, on the type of business that it deals in. Organisations that deal in services or trading (having a small operating cycle) require less fixed capital. In contrast, a manufacturing firm involving a large operating cycle would require a large amount of fixed capital.
Service or trading organisations → Small fixed capital requirement
Manufacturing organisations → Large fixed capital requirement

2. Scale of operations:
Higher scale of operations implies that a larger amount needs to be invested in plants, land, building, etc., and thereby it requires large fixed capital and vice versa.
High scale of operation → Large fixed capital requirement
Small scale of operation → Small fixed capital requirement

3. Alternative techniques of production:
An organisation can opt for either capital-intensive techniques or labour-intensive techniques of production. Organisations that follow capital-intensive techniques require higher investment in plants and machineries. Therefore, they require a larger amount of fixed capital. In contrast, organisations that follow labour-intensive techniques require lower amount of fixed capital.
Capital-intensive techniques → Large fixed capital requirement
Labour-intensive techniques → Small fixed capital requirement

4. Growth prospects:
Higher growth and expansion of a company is associated with higher production, more sales, more inputs, etc. This requires a higher level of machinery and equipment. Thus, organisations with high growth prospects require a higher amount of fixed capital and vice versa.
High growth prospects→ Large fixed capital requirement
Low growth prospects→ Low fixed capital requirement

5. Regular up-gradation of technology:
Organisations having machinery or equipment that are prone to becoming obsolete frequently require higher investment in fixed capital. This is because regular replacement of obsolete equipment requires a large investment in fixed capital.
6. Available alternatives for financing:
One of the alternatives for financing can be obtaining the assets on lease. If leasing facilities are easily available in the financial market, then it is more feasible for the company to obtain the assets on lease rather than purchasing it. In this way, the need to invest a huge sum in fixed assets considerably reduces, which in turn reduces the fixed capital requirements.
Easy availability of leasing facility → Low fixed capital requirement
Difficulty in obtaining assets on lease → High fixed capital requirement

7. Possibility of collaboration:
At times, business organisations undergo collaboration with each other and jointly establish certain facilities. In such cases, an individual organisation’s requirement for fixed capital reduces.