Capital is, in general, any sort of valuable goods that can be used to gain profit and serves as a basis of wealth. Capital provides effective functioning of every member of the economic system including individuals, families, businesses and institutions, because it is used as the main vehicle of their financial activities.
Capital in a broad sense might include different types of things and objects, it might be financial assets like bank deposits, stocks or bonds, or an intellectual property that could be turned into profit like copyrights or trademarks, or means of production like factories and equipment. In a narrower sense, capital means money that allows businesses to pay for their everyday needs and ensure their future growth and income.
Cash being used to work the business is a thing most often paralleled with the idea of capital, so, generally speaking, money equals capital, and from the financial perspective it is often considered as a tool for investing and managing current objectives.
Use of capital
As the main function of capital is to provide further development and a growing income, companies and individuals use their capital to pay their current production expenses and dealings, as well as invest it any way they think might bring profit. Typically, capital is being put into use by paying off labor wages, property bills, and production costs.
Capital is used not only for providing a company's economic and trading activity, but also as a way to measure its worth and wealth. Specialists and government organizations (for instance, in the US such organization is the Bureau of Economic Analysis) prepare reports on individuals’ and businesses’ capitals and use the information to analyze it, find out inner correlations and consistent patterns and use it for future planning.
Structure of business capital
Company owners also have to control and evaluate their capital, these processes are crucial for the company productivity and success. Balance sheets are typically used for such activities, where the biggest part of capital analysis is reviewed. The capital structure of a business is reflected in a balance sheet, where different forms of capital are presented by separated groups (equity, assets, liabilities and so on). Debt liabilities in a form of cash asset that a company has to pay back over time are presented as debt financing in the balance sheet, while the income from the stock shares operations is reported as equity financing. Other important aspects for analysis include such relations as debt to equity ratio, debt to capital ratio, return on capital, and also a rate of weighted average cost of capital.
Sources and types of capital
When talking about capital, it’s necessary to understand what kind of economic unit is meant. Individuals and small businesses operate their capitals a bit differently than large corporations, companies and governments, though the main principle of capital being the core of their functioning is still the same in any case.
In the business world, regardless of type and size of a company, there are several types of capital that are important to distinguish:
- working capital;
- equity capital;
- debt capital.
It’s essential to study each type of capital to signify their differences and importance for analytics.
Working capital is the most important one for a short time period, especially for current business operations, since it is the liquid assets of a company that might be spent on current liability payments and exercising everyday economic activities. So, in general, working capital is just an amount of current assets with the subtraction of current liabilities plus receivable accounts and the inventory subtracting payable accounts. In other words, a company needs to have a positive working capital to remain successful, which means that current assets should prevail over current liabilities.
Equity capital is another type of capital that represents an amount of money received from those who hold a company's shares of stock. Many business owners use their own assets to start a company and don’t sell shares immediately, but others choose to involve investors to get equity in exchange for control of some sort in a company. It results in the different forms equity capital might be represented by, like public equity (when the company shares might be bought on an exchange), private equity (when the shares are distributed in a stable group of investors) or real estate equity, to be precise.
Debt capital is one more critically important type of capital, because loans and debts are heavily integrated into all sorts of business and often make up a huge part of a company's capital, since in many cases borrowing is the only way for a business to obtain a needed sum of money to get started. Different ways to acquire capital through debt exist in the business world, though there are some tendencies showing that larger companies prefer to borrow from banks. Another popular method of obtaining capital for corporations is to issue bonds, which might be especially convenient when the rates are low. Small businesses usually apply for a loan through government programs or credit companies, sometimes attracting friends and family for financial support.
There is one more type of capital which is critically important for financial institutions, that is called trading capital. It represents an amount of money allowable for operations with the assets on an exchange.
These are the main types of capital distinguished by source and possible use, and it’s also worth mentioning that in most cases these types are not strictly divided, overlapping in some aspects.