Capital and Types of Capital
Capital is a business term used for financial assets such as funds available in deposit accounts and investments used for products such as manufacturing equipment. Buildings used for manufacturing goods and to keep them safe are also classified as Capital.
Capital also refers to any investment made by the owner into its business. In companies’ case, the amount paid or contributed by shareholders in exchange for shares of a company’s stock is classified as Capital.
All businesses need capital to purchase assets and maintain operations. Capital can be raised through equity or debt financing. Generally, businesses focus on three types of business capital, which are listed as follows:
- Equity capital
- Debt capital; and
- Working capital
Business capital is one of the integral elements of running a business and financing capital intensive assets.
Capital assets of a business could be found on its statement of financial position either under the head of current assets or non-current assets. Common examples of capital assets include manufacturing equipment, cash, and cash equivalents, marketable securities as well as storage and production facilities.
Understanding Capital in Detail
Financial capital is an integral component of running a business as well as helping an economy to grow. Businesses have capital structures that include both equity and debt capital. How businesses finance their working capital (capital needed for running a business on daily basis) and invest the capital, raised through issuing debt or equity, is critical for growth as well as return on investment.
Capital is usually cash or liquid assets held for expenditure purposes. In economics, the term capital could be expanded to include a business entity’s capital assets. Generally, capital is a measurement of wealth and also a resource that is used for increasing wealth through direct investments and capital investments in projects.
Capital is used for providing facilities for the production of goods or a platform for making services available to the public for the sole purpose of generating profit. Businesses invest capital in expanding business operations as well as in projects that promise attractive returns mainly to generate more profit which would ultimately result in more wealth and resources for the businesses to carry out their core business activities.
Businesses require a significant amount of capital to run operations and generate profitable returns. Analysis of an entity’s statement of financial position is central to the assessment and review of its business capital. A company’s statement of financial position or balance sheet is classified into three main heads which are as follows:
- Liabilities; and
A company’s statement of financial provides a good basis for the metric analysis of its capital structure. Equity financing provides a business entity with the capital in the form of cash that is reported under the head of equity on the face of its balance sheet with an expectation of return for the shareholders. Debt financing provides an entity with capital usually in the form of cash that must be repaid over a period of time through making scheduled liability payments. Capital raised through debt financing typically comes with relatively lower interest rates together with stringent provisions for repayment. Some of the key metrics for analyzing an entity’s business capital include debt to capital ratio, debt to equity ratio, the weighted average cost of capital, and return on investment/ equity.
Types of Capital
Typically, there are four main types of capital which we will discuss in detail:
A corporation can acquire debt capital through obtaining loans or issuing debt instruments such as bonds. This type of capital can be obtained through government as well as private sources. Some of the sources of debt capital include family, friends, online lenders, financial institutions, insurance companies, credit cards, and federal loan programs.
Entities aspiring to raise capital through debt financing must have an active credit history to do so. Capital raised through debt financing usually requires repayment of principal amount together with interest on a regular basis. Interest usually varies depending on the type and amount of the capital obtained as well as the borrower’s credit credentials.
There are a number of sources through which capital can be raised through equity financing. Usually, distinctions are made between public equity, private equity, and real estate equity. Public and private equity is usually structured in the form of shares. Capital through public equity is raised when a company listed on a public stock exchange issues shares to the general public. Private equity is usually raised by issuing shares to selected individuals or corporations.
Working capital includes a business entity’s most liquid assets that are available for meeting daily expenditures. Working capital for an entity can be calculated using the following two formulas:
- Working Capital = Accounts Receivable + Inventory – Accounts Payable
- Working Capital = Current Assets – Current Liabilities
Working capital basically measures an entity’s short term liquidity. In other words, it is a measure of an entity’s ability to cover all its obligations that are expected to be due within a year.
Trading capital may be held by firms or individuals that place a large number of trades on a daily basis. Trading capital basically refers to the amount of money allocated for buying and selling various securities.
Investors may try to add to their trading capital by employing different methods of trade optimization. These methods are used for making the best of the available capital by determining the ideal percentage of funds to invest with each trade. In order to be successful, it is important for investors to determine the optimal cash reserves needed for their investing strategies.