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). 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 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
Working capital
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Firms use working capital to run their business. For example, money that they use to buy stock, pay expenses and finance credit. Factors determining working capital requirements:
- Size of business
- Stage of development
- Time of production
- Rate of stock turnover ratio
- Buying and selling terms
- Seasonal consumption
- Seasonal product
- profit level
- growth and expansion
- production cycle
- general nature of business
- business cycle
- business policies
- Debt ratio
Own and borrowed capital
Capital contributed by the owner or entrepreneur of a business, and obtained, for example, by means of savings or inheritance, is known as own capital or equity, whereas that which is granted by another person or institution via debt instruments is called borrowed capital, and this must usually be paid back with interest. The ratio between debt and equity is named leverage. It has to be optimized as a high leverage can bring a higher profit but create solvency risk.
Borrowed capital is capital that the business borrows from institutions or people, and includes debentures:
- Redeemable debentures
- Debentures to bearer
- Ordinary debentures
- bonds
- deposits
- loans
Own capital is private capital that owners of a business (shareholders and partners, for example) provide, sometimes called owners equity. The ownership interest is typically represented in preferred shares, and may be of various types, for example:
- Preference shares/hybrid source of finance
- Ordinary preference shares
- Cumulative preference shares
- Participating preference shares
- Ordinary shares
- Bonus shares
- Founders' shares
These typically have preference over the common shares. This means the payments made to the shareholders are first paid to the preference shareholder(s) and then to the equity shareholders.
Instruments
A contract regarding any combination of capital assets is called a financial instrument, and may serve as a
- medium of exchange,
- standard of deferred payment,
- unit of account, or
- store of value.
Most indigenous forms of money (wampum, shells, tally sticks and such) and the modern fiat money are only a "symbolic" storage of value and not a real storage of value like commodity money.
Valuation
Normally, a financial instrument is priced accordingly to the perception by capital market players of its expected return and risk. Unit of account functions may come into question if valuations of complex financial instruments vary drastically based on timing. The "book value", "mark-to-market" and "" conventions are three different approaches to reconciling financial capital value units of account.
Issuing and trading
Like money, financial instruments may be "backed" by state military fiat, credit (i.e. social capital held by banks and their depositors), or precious metals resources. Governments generally closely control the supply of it and usually require some "reserve" be held by institutions granting credit. Trading between various national currency instruments is conducted on a money market. Such trading reveals differences in probability of debt collection or store of value function of that currency, as assigned by traders.
When in forms other than money, financial capital may be traded on bond markets or reinsurance markets with varying degrees of trust in the social capital (not just credits) of bond-issuers, insurers, and others who issue and trade in financial instruments. When payment is deferred on any such instrument, typically an interest rate is higher than the standard interest rates paid by banks, or charged by the central bank on its money. Often such instruments are called fixed-income instruments if they have reliable payment schedules associated with the uniform rate of interest. A variable-rate instrument, such as many consumer mortgages, will reflect the standard rate for deferred payment set by the central bank prime rate, increasing it by some fixed percentage. Other instruments, such as , e.g. "U.S. Social Security", or other pensions, may be indexed to the rate of inflation, to provide a reliable value stream.
Typically commodity markets depend on politics that affect international trade, e.g. boycotts and embargoes, or factors that influence natural capital, e.g. weather that affects food crops. Meanwhile, stock markets are more influenced by trust in corporate leaders, i.e. individual capital, by consumers, i.e. social capital or "brand capital" (in some analyses), and internal organizational efficiency, i.e. instructional capital and infrastructural capital. Some enterprises issue instruments to specifically track one limited division or brand. "Financial futures", "Short selling" and "financial options" apply to these markets, and are typically pure financial bets on outcomes, rather than being a direct representation of any underlying asset.
Broadening the notion
The relationship between financial capital, money, and all other styles of capital, especially human capital or labor, is assumed in central bank policy and regulations regarding instruments as above. Such relationships and policies are characterized by a political economy – feudalist, socialist, capitalist, green, anarchist or otherwise. In effect, the means of money supply and other regulations on financial capital represent the economic sense of the value system of the society itself, as they determine the allocation of labor in that society.
So, for instance, rules for increasing or reducing the money supply based on perceived inflation, or on measuring well-being, reflect some such values, reflect the importance of using (all forms of) financial capital as a stable store of value. If this is very important, inflation control is key - any amount of money inflation reduces the value of financial capital with respect to all other types.
If, however, the medium of exchange function is more critical, new money may be more freely issued regardless of impact on either inflation or well-being.
Economic role
Socialism, capitalism, feudalism, anarchism, and other civic theories take markedly different views of the role of financial capital in social life, and propose various political restrictions to deal with that.
Financial capitalism is the production of profit from the manipulation of financial capital. It is held in contrast to industrial capitalism, where profit is made from the manufacture of goods.
Marxist perspectives
It is common in Marxist theory to refer to the role of finance capital as the determining and ruling class interest in capitalist society, particularly in the latter stages.
See also
- Capital market
- Constant item purchasing power accounting
- Financial risk management
- Financialization
- Funding
- Money supply
- List of finance topics
References
- Constant item purchasing power accounting#CIPPA as per the IASB's Framework.5B14.5D .5B15.5D Constant item purchasing power accounting
- Spillane, James P., Tim Hallett, and John B. Diamond. 2003. "Forms of Capital and the Construction of Leadership: Instructional Leadership in Urban Elementary Schools." Sociology of Education 76(1):1–17. JSTOR 3090258.
- Spillane, James P., Tim Hallett, and John B. Diamond. 2003. "Forms of Capital and the Construction of Leadership: Instructional Leadership in Urban Elementary Schools." Sociology of Education 76 (January): 1-17 [verification needed]
- The Risk Report, April 2009. Volume XXXI No. 8. IRMI Archived 2009-04-10 at the Wayback Machine. [verification needed]
- The Risk Report, April 2009. Volume XXXI No. 8. IRMI Archived 2009-04-10 at the Wayback Machine.
- Imperialism, the Highest Stage of Capitalism ibid. Finance Capital and the Finance Oligarchy Archived 2015-04-02 at the Wayback Machine
- "Monopoly-Finance Capital and the Paradox of Accumulation - John Bellamy Foster - Monthly Review". monthlyreview.org. 1 October 2009. Archived from the original on 17 March 2011. Retrieved 3 May 2018.
Sources
- Difference between Shares and Debentures
Further reading
- F. Boldizzoni, Means and Ends: The Idea of Capital in the West, 1500-1970, New York: Palgrave Macmillan, 2008, chapters 7-8
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 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 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 maintenanceFinancial 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 capitalLong 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 FactoringCapital market Long term funds are bought and sold Shares Debenture Long term loans often with a mortgage bond as security Reserve funds Euro BondsMoney 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 debtorsDifferences between shares and debenturesShareholders 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 capitalFixed 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 areaWorking capital This article needs additional citations for verification Please help improve this article by adding citations to reliable sources Unsourced material may be challenged and removed Find sources Financial capital news newspapers books scholar JSTOR June 2022 Learn how and when to remove this message Firms use working capital to run their business For example money that they use to buy stock pay expenses and finance credit Factors determining working capital requirements Size of business Stage of development Time of production Rate of stock turnover ratio Buying and selling terms Seasonal consumption Seasonal product profit level growth and expansion production cycle general nature of business business cycle business policies Debt ratioOwn and borrowed capital Capital contributed by the owner or entrepreneur of a business and obtained for example by means of savings or inheritance is known as own capital or equity whereas that which is granted by another person or institution via debt instruments is called borrowed capital and this must usually be paid back with interest The ratio between debt and equity is named leverage It has to be optimized as a high leverage can bring a higher profit but create solvency risk Borrowed capital is capital that the business borrows from institutions or people and includes debentures Redeemable debentures Debentures to bearer Ordinary debentures bonds deposits loans Own capital is private capital that owners of a business shareholders and partners for example provide sometimes called owners equity The ownership interest is typically represented in preferred shares and may be of various types for example Preference shares hybrid source of finance Ordinary preference shares Cumulative preference shares Participating preference shares Ordinary shares Bonus shares Founders shares These typically have preference over the common shares This means the payments made to the shareholders are first paid to the preference shareholder s and then to the equity shareholders InstrumentsA contract regarding any combination of capital assets is called a financial instrument and may serve as a medium of exchange standard of deferred payment unit of account or store of value Most indigenous forms of money wampum shells tally sticks and such and the modern fiat money are only a symbolic storage of value and not a real storage of value like commodity money Valuation Normally a financial instrument is priced accordingly to the perception by capital market players of its expected return and risk Unit of account functions may come into question if valuations of complex financial instruments vary drastically based on timing The book value mark to market and conventions are three different approaches to reconciling financial capital value units of account Issuing and tradingLike money financial instruments may be backed by state military fiat credit i e social capital held by banks and their depositors or precious metals resources Governments generally closely control the supply of it and usually require some reserve be held by institutions granting credit Trading between various national currency instruments is conducted on a money market Such trading reveals differences in probability of debt collection or store of value function of that currency as assigned by traders When in forms other than money financial capital may be traded on bond markets or reinsurance markets with varying degrees of trust in the social capital not just credits of bond issuers insurers and others who issue and trade in financial instruments When payment is deferred on any such instrument typically an interest rate is higher than the standard interest rates paid by banks or charged by the central bank on its money Often such instruments are called fixed income instruments if they have reliable payment schedules associated with the uniform rate of interest A variable rate instrument such as many consumer mortgages will reflect the standard rate for deferred payment set by the central bank prime rate increasing it by some fixed percentage Other instruments such as e g U S Social Security or other pensions may be indexed to the rate of inflation to provide a reliable value stream Typically commodity markets depend on politics that affect international trade e g boycotts and embargoes or factors that influence natural capital e g weather that affects food crops Meanwhile stock markets are more influenced by trust in corporate leaders i e individual capital by consumers i e social capital or brand capital in some analyses and internal organizational efficiency i e instructional capital and infrastructural capital Some enterprises issue instruments to specifically track one limited division or brand Financial futures Short selling and financial options apply to these markets and are typically pure financial bets on outcomes rather than being a direct representation of any underlying asset Broadening the notionThe relationship between financial capital money and all other styles of capital especially human capital or labor is assumed in central bank policy and regulations regarding instruments as above Such relationships and policies are characterized by a political economy feudalist socialist capitalist green anarchist or otherwise In effect the means of money supply and other regulations on financial capital represent the economic sense of the value system of the society itself as they determine the allocation of labor in that society So for instance rules for increasing or reducing the money supply based on perceived inflation or on measuring well being reflect some such values reflect the importance of using all forms of financial capital as a stable store of value If this is very important inflation control is key any amount of money inflation reduces the value of financial capital with respect to all other types If however the medium of exchange function is more critical new money may be more freely issued regardless of impact on either inflation or well being Economic roleSocialism capitalism feudalism anarchism and other civic theories take markedly different views of the role of financial capital in social life and propose various political restrictions to deal with that Financial capitalism is the production of profit from the manipulation of financial capital It is held in contrast to industrial capitalism where profit is made from the manufacture of goods Marxist perspectives It is common in Marxist theory to refer to the role of finance capital as the determining and ruling class interest in capitalist society particularly in the latter stages See alsoCapital market Constant item purchasing power accounting Financial risk management Financialization Funding Money supply List of finance topicsReferencesConstant item purchasing power accounting CIPPA as per the IASB s Framework 5B14 5D 5B15 5D Constant item purchasing power accounting Spillane James P Tim Hallett and John B Diamond 2003 Forms of Capital and the Construction of Leadership Instructional Leadership in Urban Elementary Schools Sociology of Education 76 1 1 17 JSTOR 3090258 Spillane James P Tim Hallett and John B Diamond 2003 Forms of Capital and the Construction of Leadership Instructional Leadership in Urban Elementary Schools Sociology of Education 76 January 1 17 verification needed The Risk Report April 2009 Volume XXXI No 8 IRMI Archived 2009 04 10 at the Wayback Machine verification needed The Risk Report April 2009 Volume XXXI No 8 IRMI Archived 2009 04 10 at the Wayback Machine Imperialism the Highest Stage of Capitalism ibid Finance Capital and the Finance Oligarchy Archived 2015 04 02 at the Wayback Machine Monopoly Finance Capital and the Paradox of Accumulation John Bellamy Foster Monthly Review monthlyreview org 1 October 2009 Archived from the original on 17 March 2011 Retrieved 3 May 2018 SourcesDifference between Shares and DebenturesFurther readingF Boldizzoni Means and Ends The Idea of Capital in the West 1500 1970 New York Palgrave Macmillan 2008 chapters 7 8
