What Is Capital?
Capital is a broad term that can describe anything that confers value or
benefit to its owners, such as a factory and its machinery, intellectual property
like patents, or the financial assets of a business or an individual.
While money itself may be construed as capital, capital is more often
associated with cash that is being put to work for productive or investment
purposes. In general, capital is a critical component of running a business
from day to day and financing its future growth.
Business capital may derive from the operations of the business or be raised
from debt or equity financing. Common sources of capital include:
Personal savings
Friends and family
Angel investors
Venture capitalists (VC)
Corporations
Federal, state, or local governments
Private loans
Work or business operations
Going public with an IPO
How Capital Is Used
Capital is used by companies to pay for the ongoing production of goods and
services to create profit. Companies use their capital to invest in all kinds of
things to create value. Labor and building expansions are two common areas
of capital allocation. By investing capital, a business or individual seeks to
earn a higher return than the capital's costs.
Business Capital Structure
A company’s balance sheet provides for metric analysis of a capital structure,
which is split among assets, liabilities, and equity. The mix defines the
structure.
Debt financing represents a cash capital asset that must be repaid over time
through scheduled liabilities. Equity financing, meaning the sale of stock
shares, provides cash capital that is also reported in the equity portion of the
balance sheet. Debt capital typically comes with lower rates of return and
strict provisions for repayment.
Some of the key metrics for analyzing business capital are weighted average
cost of capital, debt to equity, debt to capital, and return on equity.
Types of Capital
Below are the top four types of capital that businesses focus on in more detail
Debt Capital
A business can acquire capital by borrowing. This is debt capital, and it can
be obtained through private or government sources. For established
companies, this most often means borrowing from banks and other financial
institutions or issuing bonds. For small businesses starting on a shoestring,
sources of capital may include friends and family, online lenders, credit card
companies, and federal loan programs.
Equity Capital
Equity capital can come in several forms. Typically, distinctions are made
between private equity, public equity, and real estate equity.
Private and public equity will usually be structured in the form of shares of
stock in the company. The only distinction here is that public equity is raised
by listing the company's shares on a stock exchange while private equity is
raised among a closed group of investors.
Working Capital
A company's working capital is its liquid capital assets available for fulfilling
daily obligations. It is calculated through the following two assessments:
Current Assets – Current Liabilities
Accounts Receivable + Inventory – Accounts Payable
Working capital measures a company's short-term liquidity. More specifically,
it represents its ability to cover its debts, accounts payable, and other
obligations that are due within one year.
Trading Capital
Any business needs a substantial amount of capital to operate and create
profitable returns. Balance sheet analysis is central to the review and
assessment of business capital.
Trading capital is a term used by brokerages and other financial institutions
that place a large number of trades daily. Trading capital is the amount of
money allotted to an individual or a firm to buy and sell various securities.
What Does Capital Mean in Economics?
To an economist, capital usually means liquid assets. In other words, it's cash in hand that is
available for spending, whether on day-to-day necessities or long-term projects. On a global
scale, capital is all of the money that is currently in circulation, being exchanged for day-to-day
necessities or longer-term wants.
What Is the Capital in a Business?
The capital of a business is the money it has available to fund its day-to-day operations and to
bankroll its expansion for the future. The proceeds of its business are one source of capital.
Capital assets are generally a broader term. The capital assets of an individual or a business may
include real estate, cars, investments (long or short-term), and other valuable possessions. A
business may also have capital assets including expensive machinery, inventory, warehouse
space, office equipment, and patents held by the company.
Many capital assets are illiquid—that is, they can't be readily turned into cash to meet immediate
needs.
A company that totaled up its capital value would include every item owned by the business as
well as all of its financial assets (minus its liabilities). But an accountant handling the day-to-day
budget of the company would consider only its cash on hand as its capital.
What Are Examples of Capital?
Any financial asset that is being used may be capital. The contents of a bank account, the
proceeds of a sale of stock shares, or the proceeds of a bond issue all are examples. The proceeds
of a business's current operations go onto its balance sheet as capital.
What Are the 3 Sources of Capital?
Most businesses distinguish between working capital, equity capital, and debt capital, although
they overlap.
Working capital is the money needed to meet the day-to-day operation of the business
and pay its obligations promptly.
Equity capital is raised by issuing shares in the company, publicly or privately, and is
used to fund the expansion of the business.
Debt capital is borrowed money. On the balance sheet, the amount borrowed appears as a
capital asset while the amount owed appears as a liability.
Why is capital necessary for production?
Capital is an important factor of production because it's what allows labor and
land to be purchased. Steady streams of capital are often required in order to
keep a business going.
What is capital as a factor of production?
As a factor of production, capital refers to the purchase of goods made with money
in production. For example, a tractor purchased for farming is capital. Along the same
lines, desks and chairs used in an office are also capital.
Negative Working Capital is when a business' current liabilities exceed its
current income and assets. A temporarily Negative Working Capital typically occurs
when a business makes a large purchase, such as investing in more stock, new
products, or equipment.Aug
