What Is Capital in Business: Types, Sources, and Role

In the world of business, few words carry as much weight as capital. The more capital a company has, the stronger its position and the more appealing it becomes to investors.

But what is capital in business?

While most associate this broad term with cash, it’s not limited to that. 

In the following sections, we explain what capital means for business, what the different types of capital are, how they’re used, and more. 

What Is Capital in Business?

Capital refers to the cash and financial assets a business uses to fund its day-to-day operations, meet obligations, enable growth, and invest in long-term projects. It can be found on the current or long-term portion of a company’s balance sheet. 

Capital includes a variety of assets, like cash, cash equivalents, and marketable securities. It also consists of things like equipment for manufacturing, production facilities, storage space, and more. 

Generally, capital can be held by both individuals and businesses as part of their net worth. However, in this article, we’ll be exploring this term entirely from the perspective of a company’s assets. 

Needless to say, any type of business organisation requires capital to function, from small businesses to large corporations. 

Types of Capital in Business

In business, capital can be seen in many different forms. There are six main types of capital:

• Working capital;
• Debt capital;
• Equity capital;
• Human capital;
• Trading capital.

Here’s what you need to know about each one. 

Working Capital

All capital that’s available to cover a company’s short-term liquidity needs is categorised as working capital. 

It can be calculated by subtracting current liabilities from current assets, where current liabilities are the accounts payable and other obligations, while current assets are accounts receivable, cash, and liquid assets. 

In essence, this type of capital can measure a company’s short-term liquidity and demonstrates its ability to cover obligations like paying suppliers and employees, repaying debt, and more. 

Debt Capital

Debt capital represents any funds raised via borrowing from private or government sources, like banks, financial institutions, and online lenders. 

In most cases, established companies rely on banks and similar financial institutions to raise debt capital. On the other hand, smaller businesses with limited resources usually depend on help from friends and family, credit card companies, or federal loan programs. 

Just like in the case of individual debt, businesses need to have a good credit history to obtain debt capital and must make a repayment at the agreed interest rates. These repayments are considered long-term liabilities and are recorded in the company’s balance sheet. 

Although raising debt capital is a strategic way to secure future growth and make significant investments, it’s key that companies closely monitor their debt-to-capital ratio in order to avoid risks. 

Equity Capital

Meanwhile, equity capital is capital raised by selling ownership shares in the business and can be private equity, public equity, or real estate equity.

Private equity represents all investments from private investors, venture capitalists, and angel investors. In other words, this is the equity that is collected among a closed investors’ group. This type of equity capital is among the most popular ones for startup capital. 

Public equity capital, on the other hand, is when capital is raised from the stock exchange via an Initial Public Offering (IPO). As you can imagine, this is a rather costly way to raise capital and is more suited for established businesses.

Finally, real estate equity capital is raised when a lender grants a company the right to operate within their property in exchange for shares of the business.

Unlike with debt capital, there are no repayment obligations with equity capital. However, the drawback is that ownership is severely diluted. 

Physical Capital

Businesses can also have physical capital – tangible assets that help produce goods or services that will later be sold to customers.

Physical capital consists of things like equipment, machinery, real estate, raw materials, and manufacturing equipment. Storage facilities and infrastructure also fall under this category. 

All of the above-mentioned assets affect the company’s profitability as they allow the business to create and distribute products and services on the market. 

Human Capital

Let’s not forget about human capital – an intangible but equally important asset. 

Human capital represents the value of employees’ skills, knowledge, and expertise that contribute to the business’s success.

Although often neglected, human capital is incredibly important for business growth. For instance, investing in training, development, and intellectual property can make dramatic improvements in performance.

Trading Capital

Lastly, trading capital is used by companies in the financial industry to buy and sell securities, such as capital investments, bonds, and stock. It’s the term that brokerages and financial institutions use to make numerous trades daily.

For example, think of Fidelity Investments, J.P. Morgan, and other brokerage giants. These companies regularly make trades using trading capital. 

The Importance of Capital in Business

In short, capital is what ensures a business is able to stay in operation. 

In that sense, it’s important for the following reasons:

• Funding operations and growth – Capital enables businesses to cover expenses related to inventory, salaries, and daily operations. It also creates opportunities for market expansion, economic growth, and investments in long-term projects.
  
• Supporting cash flow – Capital isn’t just about raising funds or securing investors – it’s also about managing cash flow effectively. Businesses often rely on a merchant account to accept card payments from customers. This plays a crucial role in turning sales into liquid capital that can be reinvested into operations or growth.
  
• Managing risks and liabilities – Capital provides a buffer to deal with financial obligations and unexpected challenges, like market downturns or other unforeseen situations.
  
• Attracting potential investors – When deciding whether a company is an attractive investment, investors take into account key ratios like capital. Effective capital management signals financial stability and future prospects to lenders. 

Considering the importance of capital in business, it’s safe to say that a company is simply not able to function and operate without access to capital. 

Sources of Capital for Businesses

Luckily, companies can raise capital from several different sources, some of which we covered in the previous sections. 

One of the most popular options is via debt financing or borrowing from banks, financial institutions, or issuing bonds. This opportunity is suitable for those in need of both short- and long-term funding.

Alternatively, businesses can rely on equity financing or selling ownership shares to investors, including venture capitalists or via an IPO. Internal financing is also an option, where retained profits and reinvested earnings help fund growth operations. 

Lastly, companies can sometimes take advantage of government and private programs, like grants, subsidies, and loans, designed to support businesses. 

Key Capital-Related Concepts

Now that we’ve covered the basics of capital in business, let’s take a look at some of the core capital-related concepts that business owners and leaders must be familiar with. 

Capital Structure

A company’s capital structure represents the debt capital and equity capital a business uses to fund its activities. This is incredibly important as it demonstrates how the company is currently positioned and how financially stable it is.

The capital structure is, therefore, a key component that investors and future prospects analyse when determining how appealing a company is. The balance sheet is the main document that offers information about the business’s capital structure and is the first place potential investors will look. 

Thanks to the capital structure of a business, investors can also explore key ratios, like debt to equity, debt to capital, weighted average cost of capital, return on equity, and others. 

Capital Gains and Losses

Capital gains and losses are two other vital components when discussing capital in business.

When a company sells capital assets with the aim of collecting more money than they’ve initially paid, it’s making capital gains. A range of assets can be used for this purpose, including bonds, real estate, stocks, and more.

When the business holds assets for more than a year and then sells them, it’s making long-term capital gains. If sales are made sooner than 12 months after acquisition or manufacturing, it’s making short-term capital gains.

On the other hand, when a company sells assets for less than their purchase price, they’re accumulating capital losses. 

These two concepts are important as they impact taxes. For example, when a business’s capital losses exceed its capital gains, there are no capital gains tax obligations. 

Liquid Capital and Cash Equivalents

Above, we touched upon liquid capital assets and cash equivalents. 

In a nutshell, liquid capital is the easily accessible cash or assets that can quickly convert into cash. Think of things like savings and short-term investments.

Naturally, this element is crucial for businesses as it helps support emergency situations and unforeseen needs that may arise as a result of sudden changes, economic turbulence, and more. 

How To Manage Capital Effectively

In business, managing capital effectively is at the forefront of success, profitability, and growth. 

To improve capital management, it’s highly recommended to consistently monitor cash flow. Make sure you’re regularly assessing accounts payable and accounts receivable in order to keep track of liquidity. Where possible, rely on cash flow tools to spot any financial gaps and ensure undisturbed, smooth operations. 

In addition, explore every avenue to raise capital strategically. Make accurate evaluations on when to raise extra capital and ensure you’re aware of the most suitable types of options for your business. Don’t forget that bringing external funds into the company can sometimes go hand in hand with risks and challenges that you must be prepared for. 

Finally, reinvest capital into activities that will help you expand operations, like acquiring modern technology or even enhancing human capital. Most importantly, set aside capital to build buffers for unplanned expenses or market disturbances. 

The Role of Capital in Business Success

From an economic perspective, capital is a necessity for any unit, whether it’s an individual, a small startup, an established corporation, or an entire economy. It’s the foundation of any organisation, enabling smooth day-to-day operations, growth, and long-term financial stability. 

By understanding capital in business in detail, you can put in place different practices that will help you manage your capital better, resulting in fruitful gains across all company levels. 

Frequently Asked Questions

Is capital the same as money?

Although capital can be money (as it includes physical and non-physical assets), the two terms aren’t always the same. For financial and business purposes, capital represents assets used for current operations and future investments. Money, on the other hand, is used to purchase or sell goods and services. It’s therefore used for immediate actions rather than long-term growth.

Where does capital fit in economics?

From an economic perspective, capital simply means liquid assets. In other words, it represents cash available for spending or the money in circulation in the economy.

How is capital used in business?

Capital can be used in different ways in business. For example, it’s often relied upon for growing economically, running business operations, funding long-term investments, attracting investors, and more.