Financial capital (also simply known as capital or equity in finance, accounting and economics) is any economic resource measured in terms of money used by entrepreneurs and businesses to buy what they need to make their products or to provide their services to the sector of the economy upon which their operation is based, e.g., retail, corporate, investment banking, etc. In other words, financial capital is internal retained earnings generated by the entity or funds provided by lenders (and investors) to businesses in order to purchase real capital equipment or services for producing new goods and/or services.
In contrast, real capital (or economic capital) comprises physical goods that assist in the production of other goods and services, e.g. shovels for gravediggers, sewing machines for tailors, or machinery and tooling for factories.
IFRS concepts of capital maintenance
Financial capital generally refers to saved-up financial wealth, especially that used in order to start or maintain a business. A financial concept of capital is adopted by most entities in preparing their financial reports. Under a financial concept of capital, such as invested money or invested purchasing power, capital is synonymous with the net assets or equity of the entity. Under a physical concept of capital, such as operating capability, capital is regarded as the productive capacity of the entity based on, for example, units of output per day.
Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power. Accordingly, there are three concepts of capital maintenance in terms of International Financial Reporting Standards (IFRS):
Physical capital maintenance; Financial capital maintenance in nominal monetary units; and Financial capital maintenance in units of constant purchasing power.
Financial capital is provided by lenders for a price: interest. Also see time value of money for a more detailed description of how financial capital may be analyzed. Furthermore, financial capital, is any liquid medium or mechanism that represents wealth, or other styles of capital. It is, however, usually purchasing power in the form of money available for the production or purchasing of goods, etcetera. Capital can also be obtained by producing more than what is immediately required and saving the surplus.
Financial capital can also be in the form of purchasable items such as computers or books that can contribute directly or indirectly to obtaining various other types of capital. Financial capital has been subcategorized by some academics as economic or "productive capital" necessary for operations, signaling capital which signals a company's financial strength to shareholders, and regulatory capital which fulfills capital requirements.
Sources of capital
Long term – usually above 7 years
Share Capital
Mortgage loan
Retained Profit
Venture capital
Debenture
Project finance
Medium term – usually between 2 and 7 years
Term Loans
Revenue-based financing
Leasing
Hire Purchase
Short term – usually under 2 years
Bank Overdraft
Trade credit
Deferred Expenses
Factoring
Capital market
Long-term funds are bought and sold: Shares Debenture Long-term loans, often with a mortgage bond as security Reserve funds Euro Bonds
Money market
Financial institutions can use short-term savings to lend out in the form of short-term loans: Commercial paper Credit on open account Bank overdraft Short-term loans Bills of exchange Factoring of debtors
Differences between shares and debentures
Shareholders are effectively owners; debenture-holders are creditors. Shareholders may vote at AGMs (Annual General Meetings, alternatively Annual Shareholder Meetings) and be elected as directors; debenture-holders may not vote at AGMs or be elected as directors. Shareholders receive profit in the form of dividends; debenture-holders receive a fixed rate of interest. If there is no profit, the shareholder does not receive a dividend; interest is paid to debenture-holders regardless of whether or not a profit has been made. In case of dissolution the firm's debenture holders are paid first, before shareholders.
Types of capital
Fixed capital
Fixed capital is money firms use to purchase assets that will remain permanently in the business and help it make a profit. Factors determining fixed capital requirements: Nature of business Size of business Stage of development Capital invested by the owners location of that area