Capital is the money needed to produce goods and services. In plain terms, it is money. All businesses must have capital in order to purchase assets such as land, buildings, machinery, raw materials and maintain their operations. Business capital comes in two main forms: debt and equity. Debt refers to loans and other types of credit that must be repaid in the future, usually with interest. Equity, on the other hand, generally does not involve a direct obligation to repay the funds. Instead, equity investors receive an ownership position in the company which usually takes the form of stock, and thus the term “stock equity.”
One of the factors of capital is the factor of production, debt capital; the cost is the interest rate that the company must pay in order to borrow funds. For equity capital, the cost is the returns that must be paid to investors in the form of dividends and capital gains. Since the amount of capital available is often limited, it is allocated among various businesses on the basis of price. Companies with the most profitable investment opportunities are willing and able to pay the most for capital, so they tend to attract it away from unproductive companies or from those whose products are not in demand.
The amount of business capital reported on a company’s financial statements is based on the total amount of funds in the equity account. When the company is first established, all the funds invested in the start-up are allocated to owner or shareholder’s equity. As more money is invested, this value increases. At the end of every year, the total net profit or loss is allocated to this account, either increasing or decreasing the value of the company.
A company can also increase their capital by selling shares of stock in the company. Each stock purchase increases the cash available to the business while providing a small ownership share. The more shares that are owned by one particular institution or person, the greater influence they have over operations.
Once the funds are received, business capital can be used to purchase new equipment, pay for space, hire staff or met any other operational needs. It is important to note that all investors require a return on their investment in cash payment terms.
Some organisations that are profitable on paper are forced to stop trading due to their failure to meet short-term debts. In order for organisations to remain in business it is very important that an organisation successfully manages its working capital. An organisation working capital is used to pay short-term obligations that include accounts payable and buying inventory. If an organisation working capital gets low, then the company is at risk running out of cash. An organisation can be profitable businesses but they can run into trouble if they lose the ability to meet their short-term obligations.
Types of Capital
- Fixed capital – Fixed capital consists those elements that a business uses over a long term. These elements stay in the business permanently and are essential for the business to operate smoothly. Examples are land, buildings, machinery and resources.
- Working capital – working capital is also sometimes called operating capital. This covers short term needs and can vary according to productivity and output. These often monthly expenses. Examples are wages, salaries, water, electricity, telephones, raw material and packaging.
- Own capital – own capital is money provided by owners of the business and could come from savings or from the sale of an asset or an investor who want a share in the business. Examples are personnel capital or venture capital.
- Borrowed capital – Borrowed capital is money that is borrowed from a financial or investment institution or person. The money has to be repaid with interest. The institution as no ownership in the business. Examples are bank loans and overdraft.