When asked what capital is, several business people will say capital is the money used to start a business. As true as that is, it goes further than that, especially when it relates to business. So, what is capital in business?
This discussion will enlighten you on the more advanced meaning of capital and its relation in business.
So, keep reading to find out more.
What Is Capital? – What Is Capital in Business
Capital is commonly seen to be only money because of money’s ability to make investments and productive results effectively.
However, money isn’t the only thing that is capital.
Capital, in its simplest terms, is anything that generates or increases its owner’s value.
It can be intellectual property, financial assets, machinery, or an individual.
As long as you are using something to generate value, it is capital.
Types of Capital – What Is Capital in Business
Capital comes in different types, and they include
Financial Capital
These are anything that has monetary value or relation.
This means that they serve as forms of money and financial funding in generating wealth.
They include;
- Debt
- Investments
- Working capital
- Equity
Human Capital – What Is Capital In Business
This has to do with the value of people’s skills and experience.
They are intangible qualities and assets that can’t be on financial books and sheets but generate and increase productivity and, therefore, profitability.
Some examples are:
- Intellect
- Skills/Talents
- Physical
Natural Capital
Natural capitals are the world’s natural asset and raw materials.
They can be useful in generating values of different sorts.
Some examples are:
- Animals
- Ecologies
- Vegetation
- Commodities
Capital In Business – What Is Capital In Business
In the business context, capital refers to all the assets a business uses to establish, operate, sustain, and grow a business.
Capital in business includes both intangible and tangible assets.
They are grouped under the following three aspects:
Financial Business Capital
The following are under financial business capital:
Debt Capital – What Is Capital in Business
These are capital, usually money you get from borrowing from a government or private sources.
Debt capital is often expected to be paid back with interest.
Established businesses often borrow from firms or banks or issue bonds.
However, with small businesses, their sources are mostly their family and friends, credit card organisations, federal loans, and online lenders.
Any business intending to raise capital this way needs to have a good credit history, especially when its source is an organisation, firm, or institution.
Interest rates differ based on the business’s credit history and the amount or kind of capital acquired.
Debit capital is a sure way to get a large sum of money to use for business operations and investments.
So, several businesses opt for this.
Advantages of Debt Financing– What Is Capital in Business
When you use debt capital in your business, it is debt financing.
You can either decide to use this form of financing alone or with other forms.
However, before you do that, you need to know the pros and cons and weigh them before concluding.
The following are some of the pros of debt financing:
Maintaining Business Ownership
If you want no external power or say in your business, opting for debt capital or financing is the best.
This is because when you borrow from any source, such as a bank, lending firm, and so on, your business ownership won’t be on the line.
The only requirement will be to pay back at an agreed time with the agreed interest.
While owing the funds you borrow, the sources you borrow from will not dictate your business’s daily operation.
Tax Deduction – What Is Capital in Business
Tax is something you should consider when considering using debt financing or not in your business.
This is because, in several cases, a business loan’s payments, interest, and principal are categorised as business expenses.
Hence, the interest payments and principal can be deducted when it comes to your business taxes income.
Cons of Debt Financing – What Is Capital in Business
The major disadvantage of debt financing is the repayment.
Repaying borrowed funds is stress-free when there’s a consistent cash inflow into the business.
However, if there are slow or no sales, it can become problematic to pay back debts.
No two businesses make the same sales each month.
Most businesses have times when their sales peak is higher than others.
Nonetheless, lenders usually demand payment for every debt financing in monthly instalments.
Hence, it can be challenging for some businesses to keep up, resulting in late payments.
In worst cases, it can cause harm to a business owner’s credit rating and increase interest rates.
It is even worse if a business fails and goes into bankruptcy, as debt lenders will demand their repayment before business equity investors.
So, it is best not to go for debt financing when you aren’t sure of paying back at the right time.
Equity Capital
This is any fund investors pay into businesses in exchange for preferred or common stock.
Equity capital often serves as the main funding for businesses.
When investments are made, the funds are often at risk because the investors won’t be repaid until all creditors are settled if the business undergoes corporate bankruptcy.
Additionally, the investors don’t get an interest attached to their investment.
Regardless, most of them are willing to invest in companies to own a stake.
Therefore, businesses utilise this to fund their operation and generate revenue.
When a business opts for equity capital for financing, it is referred to as equity financing.
Pros of Equity Financing – What Is Capital in Business
Like everything in business, you need to weigh the pros and cons of using equity capital to finance your business.
Below are some of the pros of equity financing:
Alternative Sources of Funding
Debt financing is not often for all businesses.
Hence, equity financing serves as an alternative source of funding.
Startups that don’t qualify for bank loans or government grants can obtain funding from venture capitalists, crowdfunding, or angel investors.
With equity financing, the business will not face the risk of paying back the shareholders.
Investors often focus on future investment returns.
As a result, it often gives the business the opportunity to grow and reinvest revenues into the business instead of focusing on paying back a loan and interest.
Access to Other Benefits – What Is Capital in Business
Businesses that opt for equity financing often enjoy other benefits from their investors.
Most investors are interested in the growth of the businesses they invest in.
Hence, they get involved in the business operations and personally contribute to its growth.
They provide the business with management expertise, advice, business contacts, and other forms of capital i.e. natural resources or personnel.
Smart business owners utilise all these benefits to grow their businesses successfully.
Cons of Equity Financing – What Is Capital in Business
As there are good benefits to equity financing, there are also downsides.
So, before you opt for equity capital to finance your business, ensure that you weigh the following cons with the pros.
Loss of Complete Ownership
When you opt for equity capital, you need to understand that you will be giving up a share of the ownership of your business.
Automatically, you will also be diluting the control you have in the business.
If your business becomes successful and profitable in the long run, the investors will be given a percentage of the profits.
Several venture capitals require between 30-50% equity stakes, especially if a startup doesn’t have a firm financial background.
So, if you aren’t willing to dilute your corporate power in your company, this option is likely not for you.
No Tax Deductions
With equity financing, a business has no tax protection.
Shareholders receive dividends from the business’s profits.
These dividends are not tax-deductible expenses.
Therefore, it is included in the equity financing cost.
Investors bear risks when they fund businesses, so they expect higher returns.
So, businesses that opt for equity financing will have to pay more than if they had opted for debt financing.
Trading Capital – What Is Capital in Business
Trading capital has to do with the substantial amount of money a business has available to sell and buy securities such as bonds and stocks from the financial market.
It is the amount of money you need to trade in business.
Hence, it should be the first thing you consider when your business is ready to start investing.
These are some sources you can raise capital for trading:
Friends and Family – What Is Capital in Business
The quickest and most convenient source to get capital for trading is by meeting your friends and family.
You shouldn’t compel or manipulate them.
Instead, convince and explain to them your desire and readiness to trade.
Before you go to them, you need to have a trading strategy with a maximum probability of returns and minimum risks.
With that, you can easily explain things to them and offer them a reasonable return share.
Deal With Brokers
Another source for raising trading capital is making a deal with the broker you intend to trade securities with.
This deal will be a partnership.
You and the broker will define the terms and agree on the returns.
Also, you need to set up a trading strategy before meeting a broker.
This will show the broker that you are reliable to trade with.
Proprietary Capital – What Is Capital in Business
Some proprietary trading firms provide funds to businesses and individuals who want to trade.
However, they don’t fund every business or individual that comes to them because of the risks of trading.
Before they can agree to fund a business or individuals, they must be presented with an excellent trading strategy with outstanding performance metrics.
When you can present them with such, they will be willing to fund you but will take control of your strategy.
In exchange, you will get a share of the returns.
General Public
You can raise capital for trading from the general public, i.e., social media platforms.
However, you will need to market your trading strategy and gain the public’s trust.
You will need people who can guarantee your authenticity, such as your country ID and licenses, to gain their trust.
Working Capital
This is a company’s available liquid monetary assets for performing daily tasks and obligations.
It measures companies’ ability to pay their debts and other tasks and obligations within a year.
There are two ways to calculate working capital, they are:
- Accounts Receivable + Inventory – Account Payable
- Current Assets – Current Liabilities
Any business with fewer assets than liabilities will shortly run out of working capital.
Working capital is very important because if you run out of it, you risk running out of business.
So, to ensure this doesn’t happen, you can work to increase and strengthen your operating capital by doing the following:
Don’t Fund Fixed Assets with Your Working Capital
Working capital is business cash.
Without enough cash, the business cannot perform its daily activities, affecting its overall performance.
Therefore, it is wise to use working capital only to perform those daily activities.
Don’t use your working capital to fund fixed assets.
Fixed assets are usually expensive and will only deplete a business’ working capital if used to finance them.
So, use a lease or long-term loan instead of funding your business fixed assets with its working capital.
Make Personal Investments – What Is Capital in Business
You can increase your working capital by making personal investments in your business.
However, you will need to check the cost and returns on every investment you make.
If personal losses are outweighed by the payoff your business gets, and you can easily bear the personal losses, then this strategy will be viable for you.
Minimise Bad Debts – What Is Capital in Business
Bad debts can happen in business that extends their trade credit.
The more bad debts you have in your business, the more your working capital decreases.
So, to increase your working capital, you need to minimise the bad debts in your business.
You can increase margins for all your products and services, collect payment faster, and improve your credit management process.
Human Business Capitals – What Is Capital in Business
Businesses use human capital to perform services and create products that generate revenues.
However, companies can own human capital like other assets.
This means a person can decide to leave a company at any time.
Financial capital is used to acquire human capital.
This is one reason companies give more interest to financial capital than others.
The commonly used human capitals in businesses include:
Intellect
This refers to people’s intelligence that can be utilised to operate a company successfully.
Intellectual abilities such as problem-solving, creative thinking, and forming strategies come in handy in achieving business goals business.
Often, companies try to train and give their employees opportunities to develop intellectual qualities because of what they will gain from it.
Skills/ Talents – What Is Capital in Business
A person’s talents and skills are used almost in similar ways as intelligence for business operation and generation of revenues.
However, unlike intelligence, skills are not limited to a person’s mental capacity.
In other words, a person might not be mentally skilful but could be physically or socially skilful.
A socially skilful person can help promote a business to external parties, connect better with customers, and network with investors.
This can all work for the betterment of the company they work for.
So, companies are often willing to train and provide opportunities for their employees to improve or develop their skills.
Natural Business Capitals
Several businesses use natural resources to create products and generate income.
Production or manufacturing companies regularly use natural resources like solar, animals, plants, wind, and crops to increase their value.
Companies do not own all-natural assets.
However, they own any natural asset that they acquire.
For example, if a company should purchase land and grow plants or crops they use for production on that land, the company automatically owns the land, plants, and crops.
Capital Gains versus Losses – What Is Capital in Business
When you invest in your business, you aim to produce revenue and use that revenue to grow your business.
Capital is what you invest in your business, and it can either increase or decrease based on the success of your goal.
Capital Gain – What Is Capital in Business
This is when your capital increases in value.
For example, you purchased equipment worth $2000, and with this equipment and other raw materials worth $100, you made products and sold them for $50,000.
To calculate your gain, you will add the machine cost ($2000) to the price of the raw materials $100 which will be ($2,100).
After that, you will subtract that $2,100 from the selling price of the product, $500,000.
This will show your gain to be $47,900.
Therefore, your capital has increased in value.
Capital Losses
Sometimes investment doesn’t turn out well, and people experience capital losses.
Capital losses are when your capital decreases in value.
Using the earlier example but with a slight change.
The total cost of producing a product is $2,100, including the cost of equipment and raw materials, and you place the product for $1,500.
To calculate if you are at a loss, subtract the product’s actual price of $1,500 from the cost of production of $2,100.
Unfortunately, this will be a capital loss as you would lose $600 with no interest.
To avoid a capital loss with your investment, you must make the appropriate analysis and calculation before investing.
Conclusion on What Is Capital in Business
Capital in business includes financial, human, and natural capital.
However, in business, financial capital is considered the most important as it acquires human and natural capital.
Hopefully, you understand what each type of capital would mean for your startup business.
