Capital (Business) - Explained
What is Capital?
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Table of ContentsWhat is Capital?How is Capital Used?Types of CapitalAdditional Paid-In CapitalCapital vs. Money
What is Capital?
Capital as a financial term as a wide range of meaning. It can mean the financial strength of an individual or business, money used to start a business, money invested for profits or a factor for producing goods and services. However, in this context, capital refers to financial value, assets and tangible factors involved in production of goods and services. It describes assets that are essential for business performance and production of goods. Capital includes financial value such as funds, equipment, machinery, facilities (storage or production facilities) that an organization needs in order to start a business.
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How is Capital Used?
Money is different from capital, although many people confuse money with capital. The major distinguishing factor is that money is used for purchase of goods at secure services (usually for immediate needs) while capital is used to generate more wealth, through production of goods and services, or through investment. Capital refers to elements responsible for the creation of ongoing goods and continuous services. Capital comprises of other factors aside from funds or financial value in terms of money. While money is strictly about a physical currency or denomination, capital is beyond that. Capital includes equipment, facilities, softwares, automobiles, buildings and other tangible factors. Capital can be used in production of goods and services and also to create wealth. Products of capital, whether goods or services, must be ongoing, that is, they must continually be offered to generate wealth for a business. The ability to create value and render an ongoing service is a must-have quality for capital. Capital can be transferred from one business to another in exchange for fund. Businesses use capital in starting off their business, to create value and provide ongoing goods and services. Aside from financial values which are funds held in deposit accounts, tangible assets also make up a capital. However, tangible assets such as machines and equipments can depreciate in value. However, this depreciation does not pose any threat to the business as it is useful for tax deductions.
Types of Capital
There are different types of capital and each has distinctive qualities. The major types of capital are;
- Debt Capital: This is a form of capital acquired through borrowing. Financial institutions such as banks, insurance companies, private sources and public sources offer debt capital to businesses. Debt capital must be paid back.
- Equity capital: The type of capital is derived from sales of stock or investment.
- Trading Capital: Traders and business owners use trading capital to create a cash reserve that will be useful for future investments. Trade capital refers to the amount a company allots to buying and selling of securities.
- Working Capital: This capital reflects the financial health of a business. A working capital is the value that serves as the difference between a company's current assets and its current liabilities. Working capital is also used in determining the financial strength or insolvency of a business.
Additional Paid-In Capital
Additional Paid-In Capital is the value of share capital over or above its stated par value (face value). It is applicable to common shares and preferred shares. Oftentimes additional paid-in capital occurs when an issuing company offers a new share at an amount which can be reduced when a company repurchases its shares. When investors or businesses buy directly from the issuing company, the amount paid is often additional paid-in capital.
Capital vs. Money
Although, people often use capital and money as interchangeable terms, both do not have exact meanings. While money is used in purchase of goods and services, capital is used as a wide term. Capital refers to any factor of a company; tangible assets such as equipment, facilities, machinery, among others and financial value in terms of funds that are responsible for the operations and growth of the company. Businesses or individuals render services and goods in exchange for money but capital is the combination of factors used in the production of goods and services. Also, while money serve immediate purposes, capital can be used to generate income or used for investment purposes.