Capital is the lifeblood of any business, and its importance in economics and finance is also undeniable.
Therefore, it can be easily said that capital is a broader term that has different implications and meanings when used in different settings.
However, in most cases, capital refers to the financial capital required to run business operations.
But we know that it’s not the only definition of capital.
In reality, capital is a web of different concepts in different fields of studies that include tangible as well as intangible capital.
However, whatever type or definition of capital is concerned, it relates to any business entity’s economic or financial aspects.
In this article, we are going to discuss everything about capital. We will define capital and discuss its type, importance in business, and types of capital in any business with examples. So let’s get into it.
What Is Capital?
How do we define capital without division of its meanings for different fields of study?
Well, we can generically define capital as,
Capital is anything that brings value or benefit to its owners.
If we focus on the business capital,
It will be fuel to keep any business running.
And if we go by the book, capital can be defined as,
“Capital encompasses all financial resources any business entity uses to continue its operation and acquire other resources(tangible and intangible). In other words, capital is the money used to generate more money by selling products/services to customers.”
Another definition of capital says,
“Capital is a vital source of financing in all types of businesses no matter what. The purpose of capital is to fund the resources required to run any business.”
There is yet another perspective to define the meaning of capital that states,
Capital includes all non-human assets owned by a business entity, individual, or economy to generate income.
However, this concept is more focused on distinguishing human capital from other types of capital.
One last definition of capital to quote is:
Capital refers to the capital assets, long-term and short-term, necessary to run the day-to-day operations of a business entity.
Sources Of Capital
We are not going to talk about the capital structure of any company and how capital structure relates to business value and operations.
However, briefly discussing the sources of capital is important to comprehend the concept of capital.
The most common sources of capital for any business entity are as follows:
Tangible assets represent all the assets having a physical existence and are required to generate income for the business entity.
For instance, machinery and plant are tangible assets necessary for the production process that, in turn, has an important place in the money conversion cycle of the business entity.
Financial assets of a business entity represent cash, investment stocks & securities, bank balance, cash equivalents, etc. The financial assets also include the assets that can be easily converted into cash.
Any business entity’s human capital is critical for any supply chain’s overall success. Human resources represent all the workers, whether at top management or lower management, which contribute to producing and selling goods/services of a business entity.
The perceived value of brand recognition represents a company’s brand capital or intangible asset.
Types of Capital
As we earlier mentioned, capital is not a concept limited to finance or business only. Economics has its own definition of capital, and finance has its own.
Similarly, capital has been categorized into different sub-categories, each representing a type of capital. We are going to list all types of capital you will ever hear about.
1. Economic Capital
Economic capital represents the money or financial resources a company needs to run the business and ensure its stability and existence.
Any firm’s economic capital is required to overcome any risks, be it legal, credit, market, or operational risk.
2. Human Capital
Human capital is the most critical and important resource for any business entity. It represents the collection of resources that humans or groups of humans possess that can be beneficial in generating revenues.
Human capital is analyzed based on the unique sets of abilities and characteristics they possess. The most popular parameters of human capital are education, knowledge, creativity, physical health, strength, training, decision making, life experience, etc.
3. Intellectual Capital
As we already talked about the intangible assets of a business entity, intellectual capital represents that class of capital.
Intellectual capital for any business entity represents the expertise, knowledge, competency, and information that helps increase wealth and fulfill customer requirements.
4. Natural Capital
The natural resources occurring on Earth are the natural capital. Natural capital also includes environmental goods necessary for human survival like food, oxygen, water, and minerals.
Plants, soil, and animals are also accounted for as natural capital.
5. Financial Capital
Financial capital, also called investment capital, represents a business entity or individual’s financial/economic resources.
Financial capital is necessary for acquiring the resources that help generate revenue in the future. Sources of financial capital are equity, debt, partnerships, stocks, etc.
6. Constructed/Manufactured Capital
Human-made systems, infrastructure, processes, objects, etc., represent the constructed or manufactured capital.
The constructed capital is necessary for converting materials into products. It includes technology, transportation, buildings, energy, tools, communication devices, etc.
7. Other Types
There are other types of capital as well that include social capital, cultural capital, and experiential capital.
Experiential capital can be sourced by learning new skills, buildings something, traveling, exploring new ideas, etc. Cultural capital includes education, clothing, histories, stories, behavior & mannerism, etc.
What Is Business Capital And Its Importance
Now we will discuss the business capital and its importance for any business entity. Business capital is required to continue the production of goods/services for profit generation.
Business entities need the capital to create value for the business as well as the customers.
Capital is allocated to different business areas that play an important role in value generation.
The importance of capital is often analyzed collectively with the capital structure of any business entity.
The capital structure represents capital division based on equity and debt funding. Business capital is also important as it helps economists, accountants, and investors understand the business entity’s health.
Types of Business Capital
Here are the most popular types of business capital that you must know:
1. Working Capital
The working capital of any business entity represents the liquid assets available to meet the company’s day-to-day expenses.
In other words, working capital is the amount of cash on hand that a company can use for operational continuity. The following formula calculates the working capital:
Working Capital = Current Assets – Current Liabilities
Account receivables + Inventory – Account Payables also represent the working capital of any entity. Working capital is also referred to be the measure of short-term liquidity.
It tells whether the company is eligible to meet the current obligations with available funds.
If current liabilities are more than current assets, it means that if the need arises, the company will be out of funds to meet the short-term obligations.
2. Debt Capital
The debt capital of a business entity represents the funds borrowed from creditors, banks, and financial institutions.
Debt capital is a primary source of funding for any business entity and is also one of the major blocks of a firm’s capital structure. Debt can be long-term or short-term, depending on the needs and size of the business entity.
3. Equity Capital
Equity capital represents the funding acquired by the company from non-debt sources. IPOs, stock issues, profit reinvestment, etc., are different sources of equity capital for a running business.
Equity is the owner funding; it can be public equity for companies and private equity for private companies or partnerships.
Equity, like debt, is also one of the building blocks of an entity’s capital structure. The equity capital of any business is represented as Share Capital in the financial statements.
4. Trading Capital
Any business entity’s longevity and sustained growth depend on the capital available to operate the business irrespective of the circumstances.
Trading capital is a type of business capital that is specifically used for brokerage firms and financial institutions. It represents the money allotted to an individual or firm to buy and sell various securities.
Money Vs. Capital
In the end, we will explain the difference between money and capital.
Money and capital are two distinct concepts that the readers often intermingle. Therefore, it is important to differentiate between the two.
In essence, capital is also money. But when we talk about economics and finance, money represents financial capital/assets like cash that a business owns for meeting the obligations, funding day-to-day operations, and generating profit.
At the same time, capital refers to the business’s financial interests and investments(in the form of cash or non-cash).