Reviewed by Sep 30, 2020| Updated on
Physical capital refers to assets, such as building, machinery, and vehicles, which are owned and employed by an organisation. Physical capital constitutes one of the factors of production other than land and labour. The assets constitute fixed capital means that they are not consumed in the process of production.
There are three important factors of production, namely, land, labour, and physical capital. Land or property includes factories, manufacturing facilities, or warehouses. It also includes natural resources, such as ores extracted from mines in the case of the steel industry.
Labour refers to the human resources employed by an organisation, including skilled and unskilled workers. The third component is physical capital constituting of assets employed by an organisation.
Examples of physical capital include tools and assets that facilitate a production process. In the automotive industry, the welding equipment that joins the various parts of a car is part of physical capital. Other assets which are used include computers and printers, which indirectly contribute to the production process.
Companies have to invest in physical capital early on, even before they secure their first order. A manufacturing company has to invest in the land, build a factory, purchase plant and machinery, and build assembling lines for the purpose of making the initial batch of goods.
Physical capital requires a huge investment. Hence, industries which are established with extensive investments may have entry barriers. A new company will not be able to enter the industry unless it is capable of investing extensively in physical capital—for example, the telecom industry in India requires huge investment in telecom towers.
Physical capital is generally illiquid. The manufacturing facility cannot be broken up and sold. Certain facilities are designed for specific products only. A sale, if any, has to be made of the entire undertaking. Physical capital is depreciable. An organisation can charge depreciation on the assets.
Physical capital is part of the overall organisation. It contributes to the profits as an asset of the organisation. It derives its value from the valuation of the organisation as a whole. Any changes to the organisation, such as a merger with another company or a demerger of the undertaking, affects the value of the physical capital.