Capital
Capital is a broad term for anything that gives its owner value or advantage, like a factory and its equipment, intellectual property like patents, or a company's or person's financial assets. Even though money itself can be called capital, the word is usually used to describe money used to make things or invest.
In general, money is essential for the day-to-day operations of a business. The finance professionals in an organization keep a tab on the capital requirements. The job is to ensure the availability of capital for the needs of the company. The capital is mostly of three types, equity capital, debt capital and working capital. In the financial industry, the fourth type of capital is relevant. It is called trading capital.
Different kinds of capital
Here are the top four types of capital organizations focus on in more depth.
Debt Capital
A company can get money by taking out loans. This is debt capital, which can come from either the public or the private sector. Most of the time, this means borrowing money from the various lending institutions like the banks or NBFCs or selling bonds for already up and running businesses. Small businesses with few resources can get cash from their relatives or online lenders. Small businesses might also approach online crowdfunding sources to get capital.
Just like people, corporations need a credit history if they want to get debt capital. Debt capital must be paid back regularly with interest. Interest rates vary depending on the money borrowed and the borrower's credit history.
Individuals see debt as a burden, but if used efficiently, it can enhance the return on equity, as long as the debt amount is manageable. It's the only way for most businesses to get a lump sum that's big enough to pay for a big investment in the future. But companies and possible investors need to keep an eye on the debt ratios like the debt coverage ratio or the interest coverage ratio.
Bonds are common for businesses to borrow money, especially when interest rates are low and borrowing is cheaper. Moody's Analytics says that the number of corporate bonds issued by U.S. companies rose by 70% from 2019 to 2020.
Equity Capital
Equity capital comes in many different forms. Usually, the equity is the risk capital which is invested to generate higher returns than debt. As the equity has a higher risk, the investors look for higher returns.
Most of the time, all forms of equity will be set up as shares of the company's stock. Private equity comes from a small group of investors, while public equity comes from selling shares of a company on a stock exchange.
When an individual investor buys a stock, that person gives equity capital to a company. When a business makes its first public offering, it makes the biggest splash for getting equity capital (IPO). In 2021, IPOs of some new companies like Zomato, Paytm, Nykaa, etc were launched.
Working Capital
Working capital is the cash that a business has on hand to meet its daily needs. The following two calculations are used to figure it out:
- Current assets minus current debts
- Receivables plus inventories minus payables
- Working capital shows how liquid a company is in the short term. In particular, it shows how well a company can pay its debts, accounts payable, and other obligations that are due within a year.
Working capital is the difference between what you own right now and what you owe. If a business has more debts than assets, it may run out of working capital.
Working capital management should be performed efficiently, else the company might face short term cash flow problems. Thus, the companies should ensure some surplus short term funds to face emergencies.
Trading Capital
Any business needs a lot of money to run and make money. The balance sheet is an important part of figuring out how much money a company has.The word "trading capital" is used by industry experts involved in several deals.
Investors can try a number of trade optimization strategies to increase their trading capital. These strategies try to make the best use of money by figuring out the best amount to invest in each trade. Traders, in particular, need to figure out how much money they will need for their investment strategies to be successful.
Capital vs Money
At its core, capital is money. But capital is often looked at in terms of how it is used now and how it will be used in the future to reach financial and business goals.
Most of the time, you have to pay for capital. This is the interest cost that must be paid to pay back debt capital. This is the cost of giving money back to shareholders from equity capital. Capital is used to shape the growth and development of a company as a whole.
What does capital mean in the finance domain?
To a finance professional, capital usually signifies assets which can be liquidated to get cash or cash equivalents. In other words, it is money that you have on hand that you can use for short-term or long-term requirements. In the big picture, capital is all the money currently in circulation and being traded for immediate needs or long-term wants.
What is an organization's capital?
A company's capital is the money it has on hand to run day-to-day operations and grow in the future. One source of capital for the business is the money it makes.
The value of a company's capital would include everything it owns and all of its money. The capital should also account for the liabilities, and the liabilities should be subtracted from the assets. But an accountant who is in charge of the company's daily budget would only count the cash on hand as capital.
What Does Capital look like on the balance sheet?
Capital can be any financial asset that is used. The money made from its current activities is shown as capital on a company's balance sheet. Some examples are the money in a bank account, the money from selling stock shares, and the money from selling bonds.
Disclaimer: This content is authored by an external agency. The views expressed here are that of the respective authors/ entities and do not represent the views of Economic Times (ET). ET does not guarantee, vouch for or endorse any of its contents nor is responsible for them in any manner whatsoever. Please take all steps necessary to ascertain that any information and content provided is correct, updated and verified. ET hereby disclaims any and all warranties, express or implied, relating to the report and any content therein.
