What Is Capital?
Capital is a term for financial assets, such as funds held in deposit accounts, as well as for the physical factors of production; that is, manufacturing equipment. Additionally, capital includes facilities, including buildings used to produce and store manufactured goods. Materials used and consumed as part of the manufacturing process do not qualify as capital.
- Capital is a term for financial assets, such as funds held in deposit accounts.
- While money is used to purchase goods and services for consumption, capital is more durable and is used to generate wealth through investment.
- The four major types of capital include debt, equity, trading, and working capital.
To be considered capital, the goods must provide an ongoing service to the business to create wealth. Capital must be combined with labor, the work of individuals who exchange their time and skills for money, to create value. By investing in capital and current consumption, a business or individual can direct those efforts into future prosperity.
Tangible assets that function as capital within a business are subject to depreciation, which occurs as normal wear and tear on an item diminishing its overall value. Depreciation is often noted on a business’s financial statements and may be eligible for use as a tax deduction.
The assertion of property rights designates the value of the associated capital. Individuals or companies can claim ownership to their capital and direct its function to suit their needs. Ownership of capital can also be transferred to another individual or corporation, with any resulting proceeds from the sale being directed to the previous owner. For example, a business can sell a piece of production equipment to another facility in exchange for cash. The purchasing facility becomes the new owner of the equipment, and the selling business can include the funds as revenue.
To be qualified as capital, the goods must provide an ongoing service to the business to create wealth.
Types of Capital
Here are the top four types of capital:
A business can acquire capital through the assumption of debt. Debt capital can be obtained through private sources, such as friends and family, financial institutions and insurance companies, or through public sources, such as federal loan programs.
Equity capital is based on investments that, unlike debt capital, do not need to be repaid. This type of capital can include private investment by business owners as well as contributions derived from the sale of stock.
Defined as the difference between a company's current assets and current liabilities, working capital measures a company's short-term liquidity—more specifically, its ability to cover its debts, accounts payable, and other obligations that are due within a year. In a sense, working capital is a snapshot of a firm's financial health.
Trading capital refers to the amount of money allotted to buying and selling various securities. Generally, trading capital is distinct from investment capital because it is reserved for more speculative ventures. Trading capital is sometimes referred to as "bankroll."
Investors may attempt to add to their trading capital by employing a variety of trade optimization methods. These methods attempt to make the best use of capital by determining the ideal percentage of funds to invest each time. In particular, to be successful, it is important for traders to determine the optimal cash reserves required for their investing strategies.
Capital Versus Money
People often interchange the words "capital" and "money," believing they mean the same thing. But there's a substantial difference between the two. Capital involves the aspects of the company that helps to shape a company's development and growth. Capital also includes any of its assets that can benefit the company in the long term, whereas money refers to the instrument used to purchase goods and services and serving a more immediate purpose.
Examples of Capital
While money is used to purchase goods and services for consumption, capital is more durable and is used to generate wealth through investment. Examples of capital include automobiles, patents, software, and brand names. All of these items are inputs that can be used to create wealth. Besides being used in production, capital can be rented out for a monthly or annual fee to generate income, and it can be sold when it is no longer needed.