DEFINITION
Financial Capital is money and credit or other sources of funding used to build wealth.
The Key Takeaways
- Financial capital includes money, credit and other types of funding to build wealth and prosperity for individuals and businesses.
- Financial capital is used by businesses to purchase more equipment, materials or buildings that they can use to produce goods or to provide services.
- In the world of business, there are three main types of capital: debt, equity and specialty capital.
- The largest capital markets in the world help finance 65% of America’s economic activities.
Financial Capital Definitions and Examples
Investments in financial capital are how businesses invest their money. Capital is used to purchase more equipment, materials, or buildings that are then used to produce goods or to provide services. Capital assets include cash, investments and other financial instruments. These assets appear on the balance sheets.
Managers cannot use this money to increase their salaries, dividends or prices. The money must be used to grow the company’s profits and increase future gains.
How does financial capital work?
In the world of business, there are three types of capital:
- Debt
- You can also find out more about Equity
- Specialty
The funding sources are different, but they can all help an enterprise grow.
Debt Capital
First, there is debt. The companies receive capital that they repay with interest. Initially, entrepreneurs will borrow money from their family or credit cards. After establishing a good track record, entrepreneurs can apply for bank loan as well as federal government assistance through the Small Business Administration.
When a company reaches a certain size, it can raise funds by selling bonds to investors.
Debt has the advantage that owners do not have to share in profits. The downside is that the owners must pay back the loan, even if it fails.
Note:
Interest costs are a downside to borrowing money.
Equity Capital
The second capital type is equity. This involves the firm receiving cash now from investors in exchange for an eventual share of profits.
2 Most entrepreneurs invest their own money to start a venture, in the hope of receiving 100% of their investment back later. They invest in the business instead of spending cash flow if the company is successful.
Angel investors, venture capitalists or partners are other ways to obtain equity. In exchange for cash, the firm will have to give up some of its control. These investors become part-owners of the company.
When a company is really big and successful, they can raise more capital by issuing shares. This is known as an initial public offering. Any investor can buy the stock of a company. Stocks are sometimes called equity.
3. Specialty Capital
Specialty capital is the third type. It is often a way to buy time in order to increase revenue, such as by delaying bills.
Supply chain financing is a popular type of specialty capital. It’s similar to a business payday loan. The bank lends the company minus the fee the amount of the invoice. The banks receive payment when the invoice has been paid.
Note:
Vendor financing allows suppliers to accept payment delays for goods and services. Also known as “trade credit” As collateral, a vendor may ask for shares of the company.
Investing in the stock exchange can help finance managers of companies create additional capital.
Capital Structure
Capital Structure is the way a company creates and manages capital. The majority of public companies combine debt (via bonds) with equity (via various types of stocks).
This formula is used by many analysts to determine the strength of a company. This formula is known as the Debt-to-Equity Ratio. A ratio of more than 50% indicates that a company has more debt. Analysts believe that they are highly leveraged, and therefore riskier.
Working capital is another component of capital structure. Working capital is the amount of cash needed to operate the business. The formula to calculate a company’s current assets is current liabilities minus current assets.
Note:
A ratio of 2:1 indicates that the company has sufficient liquidity to meet current needs. 5 An increase in the ratio means that the company isn’t using its money to build future profit.
Capital Markets
U.S. companies can innovate and grow with ease because they have easy access to capital. America has one of the largest capital markets in the world. These markets fund 65% the nation’s economic activities.
Investors can gain current information on every aspect of a company they may invest in by using the transparency of the U.S. Stock Market.
The U.S. market for fixed income bonds is 1.9x larger than that of the European Union, the second largest market. Investment banks that service this market guarantee the success of bonds by underwriting them.
Financial Capital vs. capital in economics
Capital in economics includes durable goods like machinery, equipment, tools, and more. These products are used to make other products.
The three other factors of production include:
- Raw materials are natural resources
- Entrepreneurship is the pursuit of profit through innovation
- Employees are referred to as labor
Human capital is the skill and ability of individuals. Social capital is a network’s value.
These components of the supply are used in a market-based economy where laws of demand and supply direct production.
Financial capital is sometimes called the fifth production factor. This is not entirely accurate. Financial capital is what makes production possible, by providing income for the producers.
