What Is Capital?
Let me explain capital directly: it's a broad term for anything that gives value or benefit to its owners, like a factory with its machinery, patents as intellectual property, or the financial assets held by a business or person.
You might think of money as capital, but it's more about cash put to work for production or investments. Capital is essential for running a business daily and funding its growth.
Businesses get capital from their operations or by raising it through debt or equity financing. When budgeting, they usually look at three types: working capital, equity capital, and debt capital. If you're in finance, trading capital is a fourth one.
Key Takeaways
- A business's capital is the money available for daily operations and future growth.
- The main types are working capital, debt, equity, and trading capital, with trading used by brokerages.
- Debt capital shows up as a liability on the balance sheet.
- A company's capital structure is the mix of these types used to fund the business.
- Economists use capital to evaluate resource efficiency in families, businesses, or economies.
Understanding Capital
From an economist's view, capital is crucial for any unit, be it a family, small business, large corporation, or whole economy. You'll find capital assets on the balance sheet, either current or long-term, including cash, equivalents, marketable securities, equipment, facilities, and storage.
In the broadest sense, capital measures wealth and helps increase it. You hold capital as part of your net worth, and companies structure it with debt, equity, and working capital for expenses.
Capital is typically cash or liquid assets for spending. Broader still, it includes all assets with value like equipment, real estate, and inventory. For budgeting, though, it's about cash flow.
Capital measures wealth and provides resources for growth via investments. How you finance working capital and invest obtained capital matters for prosperity.
How Capital Is Used
Companies use capital to fund ongoing production of goods and services for profit. They invest in things like labor and building expansions to create value, aiming for returns higher than costs.
At national and global levels, economists track capital through metrics like personal income, consumption, and GDP reports to see its impact on growth.
Business and financial capital are viewed through capital structure. In the U.S., banks must hold minimum capital for risk, per regulations. Private companies assess their own thresholds and needs via balance sheet analysis.
Business Capital Structure
A company's balance sheet shows capital structure split among assets, liabilities, and equity. Debt financing is cash that must be repaid, while equity from stock sales is reported in equity.
Debt often has lower returns but strict repayment terms. Key metrics include weighted average cost of capital, debt to equity, debt to capital, and return on equity.
Types of Capital
Businesses focus on these top four types.
Debt Capital
Businesses borrow for capital, from banks, bonds, or for small ones, friends, online lenders, or federal programs. You need credit history, and it requires interest repayment, varying by type and history.
Debt is an opportunity if managed, providing lumps for investments, but watch the debt to capital ratio to avoid trouble. Corporations often issue bonds when rates are low, like in 2020 when issuance soared.
Equity Capital
This comes as private equity, public equity, or real estate equity, usually as stock shares. Public is on exchanges, private among select investors. Buying shares provides equity capital, with big events like IPOs.
Working Capital
This is liquid assets for daily obligations, calculated as current assets minus liabilities, or receivables plus inventory minus payables. It shows short-term liquidity for covering debts due within a year. More liabilities than assets mean trouble ahead.
Trading Capital
Businesses need capital to operate profitably, reviewed via balance sheets. Trading capital is money for daily trades in finance firms. Investors optimize it by determining ideal investment percentages. Big firms allocate it to traders.
Capital vs. Money
Capital is money at core, but in business, it's for operations and future investments, with costs like interest for debt or distributions for equity, shaping growth.
The Bottom Line
Capital means different things by context. On balance sheets, it's money for immediate use, as working, equity, or debt capital. Brokerages have trading capital. Economists see it as circulating cash in economies.
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