Capital is the key to a successful and fully-functional business. Without capital, a business can’t function. Neither, for that matter, can any organisation, whether it’s a charity, household or even a national economy.
But what exactly do we mean when we talk about capital?
Many people use the term ‘capital’ interchangeably with either ‘money’ or ‘cash’. But while cash is certainly a type of capital, the definition of capital extends beyond money.
Indeed, capital can refer to any asset owned by your company that has a monetary value, from inventory to machinery and plant, or even your property. Typically, however, capital refers to liquid assets that a company holds in order to meet its expenditures. Businesses use capital in order to pay for the costs incurred in delivering their products and services. Hence, when you order new equipment or upgrade your software, this is known as a capital investment.
The greater an organisation’s capital, the greater its value is considered to be.
Examples of capital
A company’s capital usually falls into one of several categories. Although there is some overlap, these are the most common examples of capital within an organisation.
Equity capital is acquired whenever an investor buys shares in a company. Equity capital is divided into public and private equity. Public equity is acquired when investors trade on the stock exchange while private equity capital comes from private investors.
Debt capital is capital that the company acquires by taking on debts. These may include start-up loans, bridging finance, credit cards and other forms of business debt.
Working capital refers to the funds and liquid assets available to cover the company’s operational expenses. These may include:
- rent or mortgage payments
- pension contributions
- capital investments like machinery, plant or software
- loan or company credit card repayments
- outsourced functions like HR, payroll or marketing
The relationship between capital and cash flow
The relationship between capital and cash flow is extremely important for businesses. Cash flow management needs to ensure that the company has working capital ready to meet its financial obligations.
Working capital and cash flow are terms that are often used interchangeably.
However, while working capital provides a snapshot of your company’s finances, cash flow refers to how much cash the business is able to generate within a given time period.
Frequently asked questions about capital
What are capital assets?
Capital assets are the assets held by a company that help make up its net worth. This not only means the cash at its disposal but its property, vehicles, machinery, investments, IPs and anything else of monetary value.
What is the difference between fixed and liquid capital assets?
Fixed capital assets help the company to generate cash. However, they are not consumed, sold or disposed of quickly in order to make money. Machinery, plant and vehicles are all examples of fixed assets.
Liquid assets, however, move through the company more quickly and freely. These include stocks, bonds, accounts receivable and, of course, cash.
What are the sources of capital?
Businesses have three main sources of capital. These are:
- Working capital – the necessary capital to facilitate business operations and meet obligations in a timely manner
- Debt capital – capital obtained by taking on business loans, credit cards and other debts
- Equity capital – this is obtained by issuing bonds and shares either privately or over the stock market.