There are a variety of indicators, including capital, that businesses can use to decide if a company is healthy and well-managed. Capital is a fundamental element of a balance sheet that gives corporate leaders and financial analysts insight into a company’s management. Understanding what capital is and how it operates can help individuals who are in a financial role, a leadership position or interested in starting their own company

In this article, we define what capital in business is, review different type of capital, explore how it functions and discuss how businesses use and manage it.

What is capital?

Capital refers to the assets and money companies require to fund their standard operations and generate revenue. Capital allows businesses to cover payroll expenses and produce their products or services. Products and services provide profit, which businesses then can use as new capital and continue to increase revenue.

Although capital includes money, it can also describe other elements of a business, such as machinery or brand name association. Money is a financial instrument organizations can use to buy or sell assets that become capital and increase a company’s value. Instead, capital includes different things that you can use to generate revenue.

Types of capital

Here are some of the main types of capital that businesses can use:

• Financial capital: Financial capital comprises all types of funding that companies use to create wealth. Examples of financial capital include investments, equity and debt, and these elements can help a company generate revenue.

 

• Human capital: Human capital includes skills and intellectual capital that individuals possess. Intellectual capital is the intelligence of people working for the company, including their ability to solve problems and create strategies, while skills and talents also allow the people working for a company to operate the business and develop strategies for increasing revenue.

 

• Natural capital: Natural capital includes animals, wind, water, solar light and crops that businesses can use to increase production and generate revenue. Companies may or may not own the natural resources that allow them to operate.

• Working capital: Working capital consists of the liquid assets a company can use to operate and fulfill its daily duties by measuring a company’s ability to cover its short-term obligations, meaning those due within one year. Companies can calculate it by subtracting current liabilities from current assets or subtracting accounts payable from accounts receivable and inventory.

 

• Trading capital: Trading capital is the amount of money a company or individual dedicates to buying and selling securities. There’s usually a legal minimum for how much money a company needs to have in its account as trading capital before making transactions, as this can help prevent businesses from losing money.

 

• Specialty capital: Specialty capital is a means companies can use to create capital and grow and it allows companies to have more time to focus on generating revenue while the bank pays off the company’s bills. For example, supply chain financing consists of giving invoice payments to the bank with the agreement to pay the bank later.

Understanding business capital

Business capital is essential to run a company and finance its assets. You can find a list of capital assets on a company’s balance sheet, either on the long-term or current portion. Those assets may include equipment, cash or production facilities. Companies have capital structures that include different types of capital, and the way they manage it influences their return on investment and growth.

Companies can use capital to purchase the equipment and tools they require to create their products or to buy manufacturing plants and offices that can help generate revenue. Managers use capital to increase the company’s profit potential or to create future wealth. They typically decide how they plan to finance their working capital and how to invest what they gained.

How does business capital work?

Business capital can be vital to a company’s operations. It represents the funding that allows a company to buy the assets necessary to function and stay competitive. Adequate funding is one aspect of a business that financial analysts study to assess how efficient it is and how well it may generate a return for its investors. A business manager’s goal is to keep the operations efficiently running and generate the highest potential returns for investors. Analysts and managers use financial ratios to measure a company’s performance. Here are some examples of ways businesses can use capital:

Return on invested capital or ROI

ROI tells you how well a company uses its capital money to generate returns by considering income versus debt and equity. Here’s the formula you can use to calculate ROI:

ROI = (Net income – Dividend) / (Debt + Equity)

Return on equity or ROE

ROE tells you how well the company reinvests financing from equity to grow the business. It also shows how the company generates shareholder value. Here’s the formula for calculating ROE:

ROE = Net income / Shareholders’ equity

Return on assets or ROA

ROA, or return on assets, tells you how well the company uses its assets to generate revenues. Here’s the formula you can use to calculate ROA:

ROA = Average total assets / Net income

Equity capital vs. debt capital

Equity and debt are financial capital you can use to fund a company because they bring cash to the business, allowing it to buy assets that generate revenue. Companies report both equity and debt in their balance sheet, although the terms are distinctly different. Debt is a loan, line of credit or credit card you need to repay in the future and its repayment conditions are usually strict.

Equity is an ownership share in a company that business owners sell in exchange for cash. Investors who buy an equity share receive money corresponding to the company’s residual value when the owner sells it. Equity doesn’t relate to interest expense, and you don’t have to repay it in the future. An example of equity capital is venture capital, such as when a business owner sells company stocks to investors and receives cash to fund the business operations. The investor expects their stock value to increase later as the business grows.

How do businesses use capital?

Most businesses use capital as a way to grow. Capital helps a company grow by providing the assets it needs to generate more revenue. A company that expands physically, adds new technologies or relocates might need additional cash to purchase new facilities or hire new personnel. To bring that cash into the company, managers can use debt or equity capital and borrow money or ask investors to inject cash into the business. Growing a business also requires strategic investments in areas that foster expansion.

For example, if a company that sells products invests in new retail buildings, it needs to cover the marketing expenses that can bring customers to these new places and generate more revenue. The money companies borrow to achieve their growth plans is growth capital. Here are some ways that businesses can use capital for growth:

• Purchasing equipment: A company might need to increase its production to grow. To do so, it might have to buy new machinery.

• Hiring new employees: As the company increases its production, it might require additional employees to use the latest equipment and meet the newly created demand.

• Entering a new market: A company can grow by providing services in a new geographic location or opening a new branch in a new area.

• Acquiring a company: A company can grow by buying another company and incorporating its business.

Companies manage their business capital by keeping it well-balanced and ensuring there’s always enough capital liquidity at every stage of their business’s growth. They may use key ratios that measure the balance between assets and liabilities or show cash flow. Companies can also invest their cash to get interest returns. Companies grow their capital constantly as their business grows. When a business grows, it usually requires more capital because leaders need to invest in more personnel, marketing or new product development. To raise a company’s capital, executives can partner with investors who might have the expertise and additional cash to help the business. They may also contract loans or other types of credit.