2.1 The Division of Stock
When a man's labor results in his own meager subsistence, he seldom considers the prospect of deriving any revenue from his production. Some stock may be accumulated, enough for a few days or a few weeks, or for the non-productive winter season, but with the intention of consumption rather than trade.
But when a man's labor is capable of generating sufficient stock to maintain him for a longer period of time, or when the stock he creates cannot feasibly be preserved until he will need to consume it (e.g., perishable goods), two courses of action are possible: he may restrict his production to only as much as he needs, or he may seek to trade his excess stock for other goods, generally those that improve his quality of living by the luxury or convenience of having them.
(EN: My sense is that the two are rather closely related - in that a person who can produce more than he needs to consume has time, rather than goods, to dispose of. He may spend this time at leisure or nonproductive pursuits, or he may spend it making more of his principal good to trade with others, or he may spend his time on other labors to produce other goods. This seems a more accurate method of division.)
Productive Use of Capital
An individual who chooses to spend time in excess of that required to obtain the goods he needs on additional production will find himself with an accumulation of capital - either in the form of goods that can be traded or with money (in a society where goods are traded for such), and has a choice to hoard his excess or employ it to yield a profit. In the latter instance, two options are available to him:
First, capital may be used in the manufacture or exchange of goods. The merchant, for example, seeks to obtain goods only to sell them again, as he derives no benefit from goods in inventory. Second, it may be used to make improvements to land, machines, or other things with the goal of making them more effective in producing goods (or capable of producing goods of higher quality or value) in future.
(EN: Smith seems to overlook investment in the modern sense - the use of capital to enable others to produce, for the sake of gaining either a share of their profits, or earning interest on loaned sums.)
Capital Investment in Production
In virtually all endeavors, some amount of capital must necessarily be invested in the tools of the trade. The amount varies according to profession: the farmer may need but a shovel and scythe to ply his trade, whereas the blacksmith must invest in a furnace, forge, and anvil.
Where an individual means to be a master of a shop, he will also need to make capital investment in the materials and tools of his workers, as well as to pay their wages in advance of having capital goods to sell.
Types of Stock
The general stock of any society or nation is the aggregated stock of all its members, and is considered in terms of three portions:
The first portion is that which is reserved for consumption and affords no revenue or profit. This includes the food, homes, clothing, furniture, and personal effects of its citizens. Such things are material goods, but function as mere possessions rather than capital in the productive sense, though in some instances a specific artifact that might be considered a possession to one might be employed as capital by another (a house that is rented is the capital of the landlord).
The significance of personal property is that it is the basis of all demand for goods in a society. While some goods are created as the inputs to production rather than immediately consumable, they are in demand only because they will ultimately lead to the production of a good that will become personal property, and that will generally be consumed and need to be replenished.
The second portion is said to be "circulating capital," which creates revenue by changing hands. This would include money (in the sense of commodity money); finished goods intended for sale; and raw materials intended to be converted into finished goods.
Circulating capital is depleted by use - an item, once sold, is no longer in inventory to be sold again, and more often than not the item is sold to an individual who consumes it, requiring it to be replaced from another source rather than repurchased from the buyer.
The third portion is the capital that is considered to be "fixed," it is used to generate a profit, but does not change possession. This capital would include the tools and machinery used in production; buildings such as workshops, warehouses, farms, and stores; land used for farming or other productive use; and the training and education that contribute to the productive capability of individuals. (EN: The last seems a bit tenuous, as is not a tangible asset, though I would agree that it adds "value" to a person.)
It's noted that fixed capital must be supported by circulating capital. A machine or tool does not create revenue unless and until some salable good is produced by using it. Fixed assets that are idle are merely possessions.
Also, a fixed asset will depreciate in value by virtue of use - tools and equipment break down, a mine or a forest becomes depleted, and a workshop may become dilapidated. To some degree, undertaking maintenance will prolong the lifespan of fixed assets, but most are eventually rendered unfit for further use, merely by using them.
Employment of Stock
Generally speaking, every man "of common understanding" will seek to employ whatever stock he has at his disposal in a manner that best benefits himself. He may seek to use it for present consumption if he would gain better enjoyment (value) than by holding it in reserve for other uses, and will seek to employ it in the most profitable manner if his object is to generate greater value in future than he currently has. To do otherwise defies logic and common sense.
However, the productive use of capital depends on a general sense of security. In countries where men fear that their possessions will be taken from them, by force or deceit, by government or by others, then the tendency is to conceal a greater part of their stock. Stock that is thus hidden can be reserved for future use, but it is not put to productive use, as productive use would require it to be exposed to the perception of those that might wish to seize it.
(EN: Smith speaks of the direct seizure of assets by force, but the same principle remains true of taxation - though arguably, taxation is ultimately seizure of assets by force if the individual refuses to "voluntarily" hand them over.)
Calculation of Profit
Previously, it was considered that the cost of any commodities may be regarded as a combination of three components - the wages of labor, the profits of stock, and the rent of land - in varying degrees. This can be considered in the context of a specific product, or aggregated to consider all products in a given economy.
This is a difference between producer and laborer. To the wage-laborer, the whole of his wages constitutes income, but those whose income results from the production and sale of goods must deduct from revenue received (gross rent) all expenses undertaken to arrive at the true profit (net rent). The latter, not the former, should be considered in determining the income and the impact of the producer.
It has also been suggested that the intention of fixed capital is to increase the productive powers of laborer. Acquiring more land, making improvements to land, or acquiring better equipment results in the ability of the same amount of effort to result in an increased amount of product, or an increased value of product by virtue of its quality. The same can be said of the quantity and quality of materials that are the input to production: more clothing can be made of more cloth, more valuable clothing can be made of more valuable cloth.
Because fixed capital remains in the possession of the producer, its maintenance is often excluded from the net revenue of the producer. But because circulating capital directly and immediately is transferred to the buyer in the act of sale, the producer must regularly replenish his stock, and that expense can be deducted from his net profit. However, the machinery and equipment of trade require a certain expense to obtain or create, then an ongoing cost to maintain and repair, which might rightly be considered to be an expense of production that decreases profit rather than an incidental cost paid out of profit.