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 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 business’s operations or be raised from debt or equity financing. When budgeting, businesses of all kinds typically focus on working capital, equity capital, and debt capital. A business in the financial industry identifies trading capital as a fourth component.
The concept of capital has several different meanings. It is useful to differentiate between five kinds of capital: financial, natural, produced, human, and social. All are stocks that can produce flows of economically desirable outputs.
Types of Capital
Below are the top four types of capital that businesses focus on in more detail
A business can acquire capital by borrowing. The debt capital can be obtained through private or government sources. Most often means borrowing from banks and other financial institutions or issuing bonds for established companies. For small businesses starting on a shoestring, sources of capital may include friends and family, online lenders, credit card companies, and federal loan programs.
Like individuals, businesses must have an active credit history to obtain debt capital. Debt capital requires regular repayment with interest. The interest rates vary depending on the type of capital obtained and the borrower’s credit history.
Individuals rightly see debt as a burden, but businesses see it as an opportunity, at least if the debt doesn’t get out of hand. It is the only way most businesses can obtain a large enough lump sum to pay for a major investment in the future. But both businesses and their potential investors need to keep an eye on the debt to capital ratio to avoid getting in too deep.
Issuing bonds is a favorite way for corporations to raise debt capital, especially when prevailing interest rates are low, making it cheaper to borrow. In 2020, for example, corporate bond issuance by U.S. companies soared 70% year over year, according to Moody’s Analytics.2 Average corporate bond yields had then hit a multi-year low of about 2.3%.
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.
When an individual investor buys shares of stock, they provide equity capital to a company. The biggest splashes in raising equity capital come, of course, when a company launches an initial public offering (IPO). In 2020, new issues appeared from young companies, including Palantir, DoorDash, and Airbnb.
A company’s working capital is its liquid capital assets to fulfill 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.
Note that working capital is defined as current assets minus its current liabilities. A company with more liabilities than assets could soon run short of working capital.
Any business needs substantial 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 many trades daily. Trading capital is the amount of Money allotted to an individual or a firm to buy and sell various securities.
Investors may attempt to add to their trading capital by employing various trade optimization methods. These methods attempt to make the best use of capital by determining the ideal percentage of funds to invest with each trade.
In particular, to be successful, traders need to determine the optimal cash reserves required for their investing strategies.
A big brokerage firm like Charles Schwab or Fidelity Investments will allocate considerable trading capital to professionals who trade stocks and other assets for it.
Capital vs. Money
At its core, capital is Money. However, for financial and business purposes, capital is typically viewed from the perspective of current operations and investments in the future.
Capital usually comes with a cost. For debt capital, this is the cost of interest required in repayment. For equity capital, this is the cost of distributions made to shareholders. Overall, capital is deployed to help shape a company’s development and growth.
What Is Corporate Capital?
Corporate capital is the mix of assets or resources a company can draw on in financing its business.
Corporate capital results from debt and equity financing. In deciding on and managing its capital structure, a company’s management has important decisions on the relative proportions of debt and equity to maintain.
- Corporate capital includes any assets a company may use to finance its operations, which may be derived through debt or equity sources.
- Capital structure is the particular mix of debt and equity that make up a company’s corporate capital.
- How a company manages its corporate capital can reveal a lot about the quality of its management, financial health, and operational efficiency.
Understanding Corporate Capital
A corporation has several options for sourcing capital.1 Equity capital is one comprehensive source with multiple components. Common shares and preferred shares issued by the company and additional paid-in capital are part of a company’s equity capital. These types of equity allow outside investors the opportunity to take partial ownership of the company. Retained earnings, accumulated profits that have been reinvested in the business instead of paid out to shareholders, are another form of equity.
Debt capital is Money borrowed from another entity that is due to be paid back later, typically with additional interest. Borrowings include fixed income securities such as loans, bonds, and notes payable. A company’s capital structure might also include hybrid securities such as convertible notes.