Capital is the wealth, financial assets and resources a business or individual holds for investment or production. In finance and accounting, capital refers to money used to fund business operations.
What does capital mean in accounting?
In pure accounting terms, capital represents the value of the investment in the business by the owner or owners. It’s a central part of running a business from day to day and financing future growth.
But in a broader sense, the word ‘capital’ can describe anything that confers value or benefit to its owners, including intellectual property, natural resources, financial assets, and plenty more.
Capital is, in most cases, the lifeblood of a business because it sets the foundation for acquiring equipment, hiring employees and funding everyday operations.
Why is capital important for a business?
Capital is integral to how most businesses operate and grow. Small businesses especially rely on capital to invest in other assets and finance daily activities. Without the financial resources that capital provides, businesses will struggle to survive.
Companies use their capital to pay for the ongoing production of goods and services to generate profit. Investing capital in production processes can result in higher production levels, which generate more profit and supercharge economic growth.
Getting capital is vital for improving employee productivity and meeting market demand. Companies have to manage how they invest their capital to achieve a return on investment.
Anything held for business purposes that creates value is considered capital.
What are the four types of capital?
Most accountants categorise capital into four main types, all based on the source and function. Your business capital structure defines the mix of debt capital, equity capital, and working capital for daily expenditures.
1. Debt capital
Debt capital refers to gaining capital assets through borrowing. A business can acquire capital by taking out a loan from a bank (or another financial institution), and the borrowed money is debt capital.
Issuing bonds to raise capital is another example. On your balance sheet, debt capital has a corresponding debt liability. Debt financing requires regular repayment with interest, so you’ll need an active credit history to obtain it.
2. Equity capital
Equity capital serves as a revenue-raising activity through the sale of shares and stocks of the business. Equity financing can come in several forms, including private equity capital and public equity capital.
Private equity capital is raised through a closed group of potential investors. Public equity, on the other hand, is raised by listing a company’s shares on a stock exchange.
Equity capital can come in various forms, but both build the owner’s equity in the business.
3. Working capital
Working capital is the money or liquid capital assets needed for a business’s daily operations. It’s a company’s liquid capital assets available for fulfilling daily obligations.
Working capital is calculated by subtracting current liabilities from current assets. Positive working capital means the business can meet its immediate debts and is a measure of short-term liquidity.
A company that has more liabilities than assets could soon run short of working capital, so tracking it closely is a must for to managing cash flow.
4. Trading capital
Trading capital is the amount of money allocated to an individual or firm for buying and selling securities. A common feature in trading markets, it involves investments and securities across multiple exchanges.
What are capital assets?
They are long-held assets a business uses to generate profit. They are usually long-term investments and not intended for resale as part of regular business operations.
Capital assets can appear on either the current or long-term portion of the balance sheet. Capital is cash or liquid assets held or obtained for expenditures, and some examples of capital assets include:
- Intellectual property and other intangible assets.
- Machinery, equipment, vehicles, etc.
- Storage facilities and building expansions.
- Cash, cash equivalents and bank account balances held as liquid capital assets.
Authorised capital is the maximum amount of share capital a company is legally allowed to issue under its articles of association. It sets the ceiling for raising equity.
Paid-up capital is the actual amount of money received by the company from shareholders in exchange for shares. Retained earnings are profits reinvested back into the business instead of being paid out as dividends.
What other forms of capital are there?
Beyond financial capital, businesses rely on several forms of capital, which include human capital, social capital, natural capital, and others.
Natural capital is the valuable stocks of natural resources and ecosystems that provide benefits to society – think forests, fisheries, natural gas. Traditional accounting tends to undervalue natural, human and social capital.
Modern frameworks like integrated reporting promote a holistic view that encompasses financial, manufactured, human, intellectual, social, and natural capital, providing a fuller picture of a company’s assets and long-term value than the balance sheet alone.
How is capital shown on the balance sheet?
A company’s balance sheet gives metric analysis of a capital structure, split among assets, liabilities, and equity.
Capital structures vary across the financial industry and financial institutions. With careful planning, a business balances debt and equity to fund building expansions, enter new markets and meet capital needs.
Ultimately, whether you’re managing personal finance or business capital, capital is the foundation of growth. Make sure you use accounting software to track your capital investment, financial assets and net worth, and to keep your balance sheet in good shape as your business grows.
