Financial capital (also simply known as capital or equity in
finance
Finance refers to monetary resources and to the study and Academic discipline, discipline of money, currency, assets and Liability (financial accounting), liabilities. As a subject of study, is a field of Business administration, Business Admin ...
,
accounting
Accounting, also known as accountancy, is the process of recording and processing information about economic entity, economic entities, such as businesses and corporations. Accounting measures the results of an organization's economic activit ...
and
economics
Economics () is a behavioral science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services.
Economics focuses on the behaviour and interac ...
) is any
economic resource measured in terms of
money
Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The primary functions which distinguish money are: m ...
used by
entrepreneur
Entrepreneurship is the creation or extraction of economic value in ways that generally entail beyond the minimal amount of risk (assumed by a traditional business), and potentially involving values besides simply economic ones.
An entreprene ...
s and
business
Business is the practice of making one's living or making money by producing or Trade, buying and selling Product (business), products (such as goods and Service (economics), services). It is also "any activity or enterprise entered into for ...
es 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
Investment banking is an advisory-based financial service for institutional investors, corporations, governments, and similar clients. Traditionally associated with corporate finance, such a bank might assist in raising financial capital by und ...
). 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 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
Wealth is the abundance of valuable financial assets or physical possessions which can be converted into a form that can be used for transactions. This includes the core meaning as held in the originating Old English word , which is from an ...
, 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
Net worth is the value of all the non-financial and financial assets owned by an individual or institution minus the value of all its outstanding liabilities. Financial assets minus outstanding liabilities equal net financial assets, so net w ...
or
equity of the entity. Under a physical concept of capital, such as operating capability, capital is regarded as the
productive capacity
Productive capacity is the maximum possible output (economics), output of an economy. According to the United Nations Conference on Trade and Development (UNCTAD), no agreed-upon definition of maximum output exists. UNCTAD itself proposes: "the pr ...
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.
[ Constant item purchasing power accounting#CIPPA as per the IASB's Framework.5B14.5D .5B15.5D Constant item purchasing power accounting] 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
In finance and economics, interest is payment from a debtor or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is distinct f ...
. Also see
time value of money
The time value of money refers to the fact that there is normally a greater benefit to receiving a sum of money now rather than an identical sum later. It may be seen as an implication of the later-developed concept of time preference.
The time ...
for a more detailed description of how financial capital may be analyzed. Furthermore, financial capital, is any liquid medium or mechanism that represents
wealth
Wealth is the abundance of valuable financial assets or physical possessions which can be converted into a form that can be used for transactions. This includes the core meaning as held in the originating Old English word , which is from an ...
, 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
An economy is an area of the Production (economics), production, Distribution (economics), distribution and trade, as well as Consumption (economics), consumption of Goods (economics), goods and Service (economics), services. In general, it is ...
or "
productive capital" necessary for operations,
signaling capital which signals a company's financial strength to shareholders, and regulatory capital which fulfills
capital requirement
A capital requirement (also known as regulatory capital, capital adequacy or capital base) is the amount of capital a bank or other financial institution has to have as required by its financial regulator. This is usually expressed as a capital ...
s.
Sources of capital
* Long term – usually above 7 years
**
Share Capital
A corporation's share capital, commonly referred to as capital stock in the United States, is the portion of a corporation's equity that has been derived by the issue of shares in the corporation to a shareholder, usually for cash. ''Share ...
**
Mortgage loan
A mortgage loan or simply mortgage (), in civil law (legal system), civil law jurisdictions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners t ...
**
Retained Profit
**
Venture capital
Venture capital (VC) is a form of private equity financing provided by firms or funds to start-up company, startup, early-stage, and emerging companies, that have been deemed to have high growth potential or that have demonstrated high growth in ...
**
Debenture
**
Project finance
* Medium term – usually between 2 and 7 years
**
Term Loans
**
Revenue-based financing
**
Leasing
A lease is a contractual arrangement calling for the user (referred to as the ''lessee'') to pay the owner (referred to as the ''lessor'') for the use of an asset. Property, buildings and vehicles are common assets that are leased. Industrial ...
**
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
Commercial paper, in the global financial market, is an Unsecured debt, unsecured promissory note with a fixed Maturity (finance), maturity of usually less than 270 days. In layperson terms, it is like an "IOU" but can be bought and sold becaus ...
** Credit on open account
** Bank overdraft
** Short-term loans
**
Bills of exchange
** Factoring of debtors
Differences between shares and debentures
*
Shareholders
A shareholder (in the United States often referred to as stockholder) of corporate stock refers to an individual or legal entity (such as another corporation, a body politic, a trust or partnership) that is registered by the corporation as the ...
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
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
Solvency, in finance or business, is the degree to which the current assets of an individual or entity exceed the current liabilities of that individual or entity. Solvency can also be described as the ability of a corporation to meet its long- ...
risk.
Borrowed capital is capital that the business borrows from institutions or people, and includes debentures:
*
Redeemable debentures
*
Irredeemable 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
In financial markets, a share (sometimes referred to as stock or equity) is a unit of equity ownership in the capital stock of a corporation. It can refer to units of mutual funds, limited partnerships, and real estate investment trusts. Sha ...
, 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
A contract is an agreement that specifies certain legally enforceable rights and obligations pertaining to two or more parties. A contract typically involves consent to transfer of goods, services, money, or promise to transfer any of thos ...
regarding any combination of
capital assets is called a
financial instrument
Financial instruments are monetary contracts between parties. They can be created, traded, modified and settled. They can be cash (currency), evidence of an ownership, interest in an entity or a contractual right to receive or deliver in the form ...
, and may serve as a
*
medium of exchange,
*
standard of deferred payment,
*
unit of account
In economics, unit of account is one of the functions of money. A unit of account is a standard numerical monetary unit of measurement of the market value of goods, services, and other transactions. Also known as a "measure" or "standard" of ...
, or
*
store of value.
Most indigenous forms of money (wampum, shells, tally sticks and such) and the modern
fiat money
Fiat money is a type of government-issued currency that is not backed by a precious metal, such as gold or silver, nor by any other tangible asset or commodity. Fiat currency is typically designated by the issuing government to be legal tende ...
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 "
mark-to-future" 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
Social capital is a concept used in sociology and economics to define networks of relationships which are productive towards advancing the goals of individuals and groups.
It involves the effective functioning of social groups through interper ...
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
A currency is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins. A more general definition is that a currency is a ''system of money'' in common use within a specific envi ...
instruments is conducted on a
money market
The money market is a component of the economy that provides short-term funds. The money market deals in short-term loans, generally for a period of a year or less.
As short-term securities became a commodity, the money market became a compo ...
. 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
Social capital is a concept used in sociology and economics to define networks of relationships which are productive towards advancing the goals of individuals and groups.
It involves the effective functioning of social groups through interper ...
(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
A central bank, reserve bank, national bank, or monetary authority is an institution that manages the monetary policy of a country or monetary union. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the mo ...
prime rate, increasing it by some fixed percentage. Other instruments, such as
citizen entitlements, 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
Social capital is a concept used in sociology and economics to define networks of relationships which are productive towards advancing the goals of individuals and groups.
It involves the effective functioning of social groups through interper ...
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
In finance, being short in an asset means investing in such a way that the investor will profit if the market value of the asset falls. This is the opposite of the more common Long (finance), long Position (finance), position, where the inves ...
" 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
Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The primary functions which distinguish money are: m ...
, and all other styles of
capital, especially
human capital
Human capital or human assets is a concept used by economists to designate personal attributes considered useful in the production process. It encompasses employee knowledge, skills, know-how, good health, and education. Human capital has a subs ...
or
labor, is assumed in
central bank
A central bank, reserve bank, national bank, or monetary authority is an institution that manages the monetary policy of a country or monetary union. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the mo ...
policy and regulations regarding instruments as above. Such relationships and policies are characterized by a
political economy
Political or comparative economy is a branch of political science and economics studying economic systems (e.g. Marketplace, markets and national economies) and their governance by political systems (e.g. law, institutions, and government). Wi ...
–
feudalist,
socialist
Socialism is an economic ideology, economic and political philosophy encompassing diverse Economic system, economic and social systems characterised by social ownership of the means of production, as opposed to private ownership. It describes ...
,
capitalist
Capitalism is an economic system based on the private ownership of the means of production and their use for the purpose of obtaining profit. This socioeconomic system has developed historically through several stages and is defined by ...
,
green
Green is the color between cyan and yellow on the visible spectrum. It is evoked by light which has a dominant wavelength of roughly 495570 nm. In subtractive color systems, used in painting and color printing, it is created by a com ...
,
anarchist
Anarchism is a political philosophy and Political movement, movement that seeks to abolish all institutions that perpetuate authority, coercion, or Social hierarchy, hierarchy, primarily targeting the state (polity), state and capitalism. A ...
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
In economics, inflation is an increase in the average price of goods and services in terms of money. This increase is measured using a price index, typically a consumer price index (CPI). When the general price level rises, each unit of curre ...
, or on
measuring well-being, reflect some such
values
In ethics and social sciences, value denotes the degree of importance of some thing or action, with the aim of determining which actions are best to do or what way is best to live ( normative ethics), or to describe the significance of different a ...
, 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
Socialism is an economic ideology, economic and political philosophy encompassing diverse Economic system, economic and social systems characterised by social ownership of the means of production, as opposed to private ownership. It describes ...
,
capitalism
Capitalism is an economic system based on the private ownership of the means of production and their use for the purpose of obtaining profit. This socioeconomic system has developed historically through several stages and is defined by ...
,
feudalism
Feudalism, also known as the feudal system, was a combination of legal, economic, military, cultural, and political customs that flourished in Middle Ages, medieval Europe from the 9th to 15th centuries. Broadly defined, it was a way of struc ...
,
anarchism
Anarchism is a political philosophy and Political movement, movement that seeks to abolish all institutions that perpetuate authority, coercion, or Social hierarchy, hierarchy, primarily targeting the state (polity), state and capitalism. A ...
, 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
Marxism is a political philosophy and method of socioeconomic analysis. It uses a dialectical and materialist interpretation of historical development, better known as historical materialism, to analyse class relations, social conflic ...
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
Financial risk management is the practice of protecting Value (economics), economic value in a business, firm by managing exposure to financial risk - principally credit risk and market risk, with more specific variants as listed aside - as well ...
*
Financialization
*
Funding
Funding is the act of providing resources to finance a need, program, or project. While this is usually in the form of money, it can also take the form of effort or time from an organization or company. Generally, this word is used when a firm use ...
*
Money supply
*
List of finance topics
References
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
{{Authority control
Asset management
Business terms