If you run or work at a business, you’ve probably heard people talk about things like “capital” or “raising capital.” But what does it all actually mean? Capital in business refers to the money that a business has access to. It’s a pretty broad term that can cover a lot of different sources of finances.
We’ll break down the major types of capital in business so you can get a handle on what they are and how they work. We’ll keep it conversational and easy to follow along. Ready? Let’s dive in!
Working Capital: The Fuel for Day-to-Day Operations
First up is working capital. This refers to the money businesses use to pay for regular operating expenses. Things like inventory, payroll, utilities, rent, etc. Working capital is crucial for funding daily operations and keeping the lights on.
Most businesses get their working capital from revenue coming in from sales and services. But sometimes, extra capital is needed to bridge a gap. For example, to buy inventory before new sales come in. Short term loans or lines of credit are ways to access additional working capital.
The goal is to have enough working capital to cover expenses during slow periods. Companies track metrics like the current ratio to evaluate their working capital health.
The higher the current ratio, the more working capital is available to cover short-term obligations.
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Share Capital: Funds from Issuing Shares
Next up is share capital. This refers to funds that companies raise by issuing shares of stock in their business. Share capital is generated when a company initially sells shares through an IPO (Initial Public Offering), or sells new shares after going public.
The money received from investors buying shares goes into the business in exchange for partial ownership. Shareholders then may receive profits in the form of dividends. Companies may issue different classes of shares like common stock or preferred stock.
Share capital doesn’t need to be repaid like debt financing. However, shareholders expect returns on their investment. Issuing stock shares is one way for companies to raise large amounts of capital, especially for growth and expansion.
Capital Employed: Invested Funds to Support Operations
Moving on, capital employed refers to the total amount of capital invested in a business to support operations. This includes both shareholder equity from share capital, and debt capital from loans and other borrowings.
To calculate capital employed, you take the total shareholders’ equity and add long-term debt liabilities. This metric gives a sense of how much capital is tied up in running the business. High capital employed can mean substantial assets and financial resources available.
But it also means more risk for shareholders and creditors should the business underperform. Companies balance capital employed to ensure sufficient funding is available for growth without overleveraging the business with too much debt.
Owner’s Capital: Equity of Sole Proprietors or Partners
Now let’s talk about owner’s capital. This applies to companies like sole proprietorships or partnerships that are not separate legal entities from their owners. With these structures, the owner’s personal assets are under shared company and personal ownership.
Owner’s capital refers to the owner’s equity invested in the business. This includes assets like cash, property, equipment, etc. that the owner puts towards the company. Owner’s capital accounts track contributions owners make, along with withdrawals and share of profits/losses.
If a company with owner’s capital is dissolved, the remaining equity goes back to owners after debts are settled. Owner’s capital allows sole proprietors to bootstrap their businesses with personal assets and finances.
Loan Capital: Borrowed Funds from Lenders
Lastly, loan capital refers to money businesses access via different types of loans and borrowing. Loans are a broad type of debt financing from banks, investors, government programs, or other lenders.
Common loan capital examples include bank loans, overdraft facilities, lines of credit, and bonds. Borrowed capital provides businesses with cash flow to cover expenses before revenue comes in. Loan payments with interest must be repaid over time per the loan terms.
Loans can provide companies with large lump sums for major investments and expansions. The catch is loans also introduce debt obligations and repayment risks that must be managed. Building relationships with lenders improves chances of securing loan capital when needed.
Final Thoughts
There you have it! The major types of capital that businesses utilize are working capital, share capital, capital employed, owner’s capital, and loan capital. Each source has unique pros and cons for funding operations, growth, expenses, and investments.
Understanding the ins and outs of capital gives you more financial literacy as an entrepreneur or professional. Implementing smart capital strategies is crucial for taking businesses to the next level while carefully managing risks.
I hope this overview gave you a helpful introduction to capital in business.
