Capital refers to money a company uses to finance growth. Capital may take the form of economic assets including cash, as well as equity and debt raised for operational purposes. The method a company uses to raise capital is called its capital structure. Businesses deal with four different types of capital in varying proportions. Debt and equity capital are raised by selling securities. The other two types of capital, working and trading capital, are usually funded by a company's cash flows. Working capital is any liquid assets a company uses to finance day to day operations and short term debts, primarily cash and accounts receivable. It is calculated on a regular basis by subtracting current liabilities from current assets (CurrAssets - CurrLiabilities) or by subtracting accounts payable from the sum of accounts receivable and inventory ((AccRec + Inv) - AccPay). Trading capital is an amount of money allocated to buying and selling tradable securities. Firms that do a significant amount of trading may have a fund of trading capital set aside to finance the buying and selling of marketable securities. Capital can also refer to capital assets, which are financially significant assets with a longer lifespan than one year that is intended to be used to generate profit through use rather than being sold. The most common capital asset a company has is PP&E, or plants, property, and equipment. Raising any type of capital comes at a cost. Buying new equipment requires spending cash, issuing debt necessitates interest payments, selling stock dilutes the value of stockholder shares, and so on. In order for capital to successfully create wealth, it has to be deployed in a way that generates a greater return than the cost. Many companies use a combination of methods to raise capital and finance operations. The way that a company organizes this is called its capital structure. Depending on the industry, certain methods of raising capital may be more or less common. Big conglomerates that earn a consistently large income, such as General Electric, usually take on significant debts to pay for expansion. However, because these companies earn such a large income, they can pay the debt back easily. For smaller companies, such as start-ups, taking on debt is much riskier, and so equity financing is more common. Companies may also change their capital structure in response to a change in a business context. For example, a small company that primarily relies on equity financing that is then acquired by a conglomerate might be switched to heavier debt financing by the new owners.
The cost of this form of capital depends on the cost of the interest payments, which in turn are dependent largely on the credit quality of the borrower.
When investors buy company stocks they often come with voting rights, meaning investors have a say as to where the capital they invest goes.Other Types of Capital
1. Working Capital
2. Current Assets
3. Trading Capital
What Does Capital Mean in Finance?
Investor Pro Tip
Capital FAQs
Capital refers to money a company uses to finance growth, and may take the form of economic assets including cash, as well as equity and debt raised for operational purposes.
The four types of capital include debt capital, equity capital, working capital and trading capital.
Companies raise debt capital by selling bonds and raise equity capital by selling additional shares of stock.
Capital can also refer to capital assets, which are financially significant assets with a longer lifespan than one year that are intended to be used to generate profit through use rather than being sold.
The most common capital asset a company has is PP&E, or plants, property, and equipment.
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.
To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.
