Circulating Capital: What It Is, How It Works, and Example

What Is Circulating Capital?

Any resource used to fund a company’s day-to-day operations is part of its circulating capital. These resources can be cash, raw materials, goods-in-process, finished goods, and accounts receivable (AR). It’s called circulating capital because it runs through the business in a continuous cycle. A healthy level of circulating capital means a company can pay its short-term debt and improve its operations. You can calculate a company’s circulating capital by subtracting its current liabilities from its current assets—both of which are found on the balance sheet. Circulating capital can be impacted by different factors, including seasonality, business size, and industry.

How Circulating Capital Works

Circulating capital needs are influenced by a company’s industry, whether it operates in a capital-intensive sector or not (e.g., utilities versus professional services), the degree of seasonality a business exhibits, its size, where it is in its lifecycle (mature versus startup), and by a host of internal factors such as its production cycle, financial management, credit policies and creditworthiness. Understanding a company’s circulating capital level, both overall and each of its constituents, will enable you to assess its health and solvency, analyze operational efficiency, review trends over time and compare it to others in its industry.

High inventory levels relative to its peers could mean a company is having difficulty selling its products while high receivable levels could indicate an inability to collect payments from customers. While absolute levels are important so is the trend as well as the reason behind it. For example, a company could be building inventory in anticipation of a seasonal jump in demand. Alternatively, a high level of cash might seem to be positive; but it could actually indicate the company isn’t managing its capital efficiently.

Circulating Capital vs. Fixed Capital 

Circulating capital references the amount of resources in current and short-term assets, also known as the capital a company has available to fund the goods and services it produces. Fixed capital, on the other hand, refers to funds that are tied up in long-term assets rather than being consumed in the production process. Fixed capital is also known as non-permanent capital. 

Fixed capital is the money invested for longer than one production cycle (typically one year). Circulating capital typically includes current assets, while fixed capital can include fixed and long-term assets. 

Economist Karl Marx theorized that fixed capital is also circulating, the circulation cycle is just longer. Meanwhile, there is a distinction between circulating capital and variable capital. Circulating capital includes inputs as well as wages and labor, meanwhile, variable capital is considered only wages.   

Circulating Capital vs. Working Capital

While the two terms are often used interchangeably, they are different. Working capital is calculated as current assets less current liabilities. Meanwhile, circulating capital is mostly current assets. Working capital is a measure of liquidity. 

Example of Circulating Capital

A company’s buildings, warehouses, and machinery are fixed capital. Intangible assets such as patents, brand names, and other intellectual property are also forms of fixed assets. Unlike circulating assets that are used in day-to-day business operations, very little of a company’s fixed assets can be directly attributable to its profit generation. Learning how to analyze circulating capital will give you a better understanding of how much capital a business has available to fund its short-term (one year) activities and generate profits.