Everything about Financial Capital
To under financial capital, it’s very important to know what Capital is exactly. Capital can be described as something which provides value or benefits to the owner. Capital is frequently associated with cash; it can be used for producing or investment purposes. Capital is an essential part of any type of business whether it is a small business or any big billion dollars company. Capital is used to support the goods and services of the business to invite profits to the company.
When an individual or company invests capital, they seek higher returns than the invested capital. It’s is used to increase the worth of the broad range of categories, such as, social, financial, physical, and intellectual. According to an economist; capital is an asset that is used to buy tools, equipment, and gadgets that bring and increase work productivity in the business.
As it’s is mentioned above capital is mostly associated with cash but money and capital are not the same. Capital is a very wide term that involves every aspect of business that brings profit to the company. Whereas, money is used to complete the sell or buy of the assets to increase the value of the business.
There are usually four types of capital, Financial, Economic, Natural, and Human. Here financial capital is well explained below.
Financial Capital Definition & their examples
Financial capital meaning, the capital invested in the productivity tools or equipment by the Lenders to enable the business to produce goods and services, and the income or profits generated through it are called financial capital. Financial capital can be in any form that generates wealth in the company such as, money, credits, or assets.
For example, a sewing machine is brought for the fabric or clothing business. Here capital invested in the sewing machines and the return or profit the company has received from the investment is called financial capital.
Another example, wood cutting tools brought for manufacturing furniture, where capital is invested in wood cutting tool and returns company will get from will be called financial capital.
This type of capital cannot be used for personal benefits such as giving raises to employees or buying another car, etc. It should be only used where the invested money becomes bigger and brings profit to the company.
Type of Financial (Business) capital
There are three types of financial capital Debt Capital, Equity Capital, and Specialty Capital.
- Debt capital is raised from the loans or bonds and should be paid back with interest.
- Equity capital is raised from selling shares of the company.
- Speciality capital is additional cash raised by company operations.
Let’s read about all the types of financial capital in detail:
Debt Capital
It’s the first type of financial capital where the fund is raised from bonds or loans. Initially, people borrow money from relatives, acquaintances, or credit cards. And once they set up a good track record of credit score then they go for the loans from banks or small businesses basically from the market.
Once the company become well established and big they had to repay the borrowed money with interest.
There are both pros and cons to debt capital.
- Pros: Company can take or borrow money without sharing any kind of profit or ownership.
- Cons: If any loss happens to the company in meantime still borrowed money had to be paid to the creditor with interest. The company can’t escape from it.
Equity Capital
It’s the safest way to generate capital. Inequity capital, the fund is generated by sharing ownership authority with the investors. Investors are partners or we can call them partial owners of the business.
Since in the equity capital, ownership rights are shared, the investors share profits and loss also with it. That’s why Investor agrees only to invest if there is the potential of growth in the business.
Most small startups and baby entrepreneurs go for equity capital.
Inequity capital, no interest needs to be paid, unlike debt capital.
An individual or company go for equity capital when there is not an adequate amount of fund is available. The investor can be an individual or multiple people. The major source of equity capital is family members, relatives, friends, venture capitalists, and angel investors.
Just like debt capital, equity capital also has pros and cons:
- Pros: Company is not bound to repay the investors if the business anyhow fails.
- Cons: Company will be sharing ownership to the investors and profit of the company along with it.
Speciality Capital
Speciality capital is the third type of financial capital. In this type of capital, entrepreneurs or owners of the company ask for time to grow revenue by delaying invoices.
For example, in the furniture manufacturing business, the company can buy goods and technical tools to manufacture furniture and ask the provider of the goods to lend some time to grow revenue. This method is called vendor financing.
There is another method where private banks or other corporations lend funds to the owner to clear their invoice. Once the owner gets a paycheck or generated his revenue through selling goods or services now it’s time to repay the bank with interest or fees or both. This is the most expensive way of capital production.
Another way through which a company’s owner or finance manager can generate financial capital for the business is by buying stocks (or investing in the stock market).
Capital Structure
Capital structure refers to how a corporation raises and manages its capital. Usually, companies use both debt (through bank loans) and equity (by sharing stocks of the company) to meet the capital requirements of the company.
The common formula which is used to find out the capital health of the company is the debt to equity ratio. The company that has more debt than equity is riskier than the company that has more equity than debt.
Capital Market
One of the biggest reasons behind the success of America’s economic growth is easy access to capital. As I said before capital no matter what type, is one of the most important aspects of a successful business.
Transparency in the American stock market helps investors to read every aspect of any company and take a wise decisions while buying stocks.
