Definition
Fixed capital is the part of a firm's resources that yields a return while remaining in the owner's possession — tools, machinery, buildings, improvements to land, and the acquired skills of workers. Circulating capital is the part that yields a return precisely by changing hands — raw materials, work in progress, finished goods, and the wages of workmen.
Smith introduces the distinction in Book II to clarify what is being saved and invested in different kinds of business. The two categories work together but obey different rhythms: fixed capital is consumed slowly; circulating capital is consumed and renewed within every production cycle.
Why it matters
How it works
In Smith's framing, a manufacturer's spinning machine is fixed capital — its value transfers slowly to the cloth produced over years. The cotton and the wages paid this week are circulating capital — they vanish into the finished product, which is then sold, and the proceeds buy next week's cotton and wages. The two flows are continuous and interdependent. Stopping either one halts production.
The ratio between fixed and circulating capital varies sharply across industries. Heavy manufacturing is fixed-capital intensive; trading and retail are circulating-capital intensive. Agriculture sits somewhere between, with land improvements as fixed capital and seed, livestock, and wages as circulating. Smith uses these contrasts to explain why different sectors employ different numbers of workers per pound of invested capital — and why credit instruments are especially valuable to circulating-capital businesses that need to bridge the gap between expenditure and sale.
The accounting categories survive almost unchanged in the modern firm. Fixed assets (plant, equipment, intangibles) versus working capital (inventory, receivables, payables) is the same distinction in modern language. The same imbalance Smith warned about — fixed capital expanded faster than circulating capital can support — still routinely sinks otherwise viable businesses today.