Every time we start a discussion about economics, few terms immediately come to our mind. Capital is one of those terms.
We use this term so often in economics and that tells about its significance for businesses.
A general definition of Capital is that it is a term for the financial asset of a business. We also use the capital for money but that does not imply that capital is just money.
Capital assets are primarily the assets of a business that can be found on the current or long-term portion of the balance sheet. These assets can include cash, cash equivalents, marketable securities, infrastructure, building, storage facilities.
Hence we can determine that capital covers a range of financial assets. Three different types of capital are generally discussed in economics.
In this blog, we will be discussing all about capital. We will also look at the four different types of capital. Later in the blog, we will differentiate capital and money which people often confuse.
What is Capital?
Different economists have defined Capital differently.
Capital is reckoned as goods used presently and goods that can be used in the future to satisfy our needs.
Capital is also called as all the man-made goods that are used in the further production of wealth. Reflecting on this we can also call capital as a man-made resource of production.
Everything from machinery, all kinds of tools and equipment, buildings, to transportation, communication technology, and raw materials are included in capital.
Capital has a related number of meanings in economics, finance, and accounting. In finance and accounting, capital is generally referred to as financial wealth especially the one required to start a business.
Capital in economics includes tangible assets such as machinery and equipment adopted for producing goods. Capital is often defined as the wealth or financial strength of an individual or company. While referring to capital in economics, the term implies factors of production adopted for creating goods that are not themselves a part of the production process.
“Capital consists of all those goods, existing at present time which can be used in any way, so as to satisfy wants during the subsequent years”.
-Sir John Richard Hicks, British Economist
Reflecting on Hick’s perspective, it can be said that capital is everything that satisfies human needs. This also means that both consumer goods as well as producer goods can be called as capital goods as they both satisfy human needs.
Yet when we look at it from a factual perspective, it can not be true. This is because consumer goods are consumed in a single-use and are not used in further production of wealth.
Some more highlighted definitions of Capital and Capital goods include:
“Capital is the produced means of production”
-Eugen von Böhm-Bawerk, Austrian economist
“Capital goods are produced goods that can be used as factor input for further production.”
-PROF. Paul Samuelson, American Economist
Summing all these definitions, we can say that:
Capital includes all kinds of goods (items or commodities) that are used for further production of more goods like machines, tools, factory buildings, transport equipment, etc.
Capital is a result of human efforts made on the natural resources in the past. As suggested by CAIRNCROSS, stocks, shares, government bonds, securities, etc., are also included in ‘capital’ because all these yield income to the investors.
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10 Characteristics of Capital
Capital has several important characteristics that are as follows:
1. Capital is a Passive Factor
Capital is a passive factor of production. This is so because capital is ineffective without the cooperation of labor.
A business can not operate only with capital. They need to invest equally in labor and land.
2. Capital is Man-Made
Capital is a man-made thing. Its production and supply is controlled by the efforts of man.
John Stuart Mill says, capital is the “accumulated product of past labor destined for the production of future wealth”. This means that capital is generated when human labor is applied to natural resources.
3. Capital is not Indispensable
Capital is not an indispensable factor of production like labor and land. This would mean that production can be possible even without capital.
4. Capital has high mobility
Among all the factors of production, Capital has the highest mobility. The land is immobile and labor has the least mobility, while capital has both ‘place mobility’ and ‘occupational mobility’.
5. Capital is Elastic
The elasticity of capital is high when we talk about its supply. Its supply can be adjusted quickly and easily depending on the demand.
On the other hand, the supply of land is fixed and the supply of labor can neither be increased or decreased quickly.
6. Capital Depreciates
Capital depreciates over time. For example, if a machine is used again and again its efficiency goes down and it may not be suitable for further use due to depreciation.
7. Capital is Productive
Capital helps in increasing production. When labor is given adequate capital, it effectively increases production. More capital leads to better efficiency and increased productivity.
8. Capital is Temporary in Nature
Capital is temporary. It can not last forever. Therefore, Capital needs to be reproduced and replenished from time to time. This makes capital a short-term asset.
9. Capital is Prospective
Capital is considered much prospective as the accumulation of capital yields an income. The more we invest in the accumulation of capital, the greater is the possibility of it providing aid to the business when it is needed.
10. Capital is recalled as Past Savings
Capital goods become savings when production exceeds consumption.
For example, when a farmer does not consume or sell a part of his crop production, it can be used as seeds in the future.
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4 Types of Capital
The four types of Capital are explained below.
4 types of Capital
1. Debt Capital
A business can acquire capital through the assumption of debt. Debt capital can be obtained either from government sources or a private source.
The sources of Capital can be anyone from friends, family, to financial institutions, online money lenders, credit card companies, federal loan companies, and insurance companies.
To obtain debt capital, an individual or a company must have an active credit history. Debt capital is then required to be paid at regular intervals with added interest. The interest rates vary based on the borrower’s credit history as well as the type of capital obtained.
2. Equity Capital
Equity capital can come in several forms. The three distinct forms of equities are private equity, public equity, and real estate equity.
Private and Public equity is generally available in the form of shares. When a company lists itself on the public market exchange, its public equity capital is raised.
This capital is received from the shareholders. However, private equity is not raised in the public markets. It usually comes from private investors and owners.
3. Working Capital
Working Capital is the capital available for fulfilling daily obligations. It is the most liquid capital asset available. Working capital is calculated regularly using these two methods:
Current Assets - Current Liabilities
Accounts Receivable + Inventory - Accounts Payable
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 one year.
4. Trading Capital
Trade Capital is held by firms and individuals that trade on a large scale daily. Trade capital is the amount of money allotted to buy and sell various securities.
Investors look to add their trading capital. For this, they employ a variety of trade optimization methods. These methods are intended at making the best of use of capital by determining the ideal percentage of funds to be invested with each trade.
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We can also say that it is important for investors to determine the optimal cash reserves required for their investment strategies, to be successful.
Functions of Capital
Some of the important functions of capital are listed below:
1. Provision for Subsistence
Capital helps to arrange food, shelter, and cloth for the workers involved in the production process. Because production is a long process and passes through many stages till it brings income to the manufacturers.
During this whole time, the workers are required to subsist. They are paid their wages from the capital fund. Subsequently, when money from consumers reaches the producers it is again accumulated as capital money.
2. Provision for Appliances
Capital fund also helps in arranging the required appliances for the production process. We all know that without taking the help of machines, efficient production is not possible.
3. Provision for Raw Materials
A large part of the capital fund is used to procure raw materials for production purposes. Raw materials being an essential thing, they require every concern.
A sufficient supply of raw materials of good quality and in adequate quantities is compulsory.
4. Provision for Marketing and Sales Promotion
After the production process is completed, the manufacturers confront the challenge of selling these goods in the market. For this, the produced goods are transported in the markets.
Subsequently, publicity and advertising of these goods are equally important. People must be made aware of the products. So, the companies use the money from capital funds to advertise these products.
5. Economic Development
The most important function of the capital is to promote the economic growth of the country. For the satisfactory development of the country, adequate funds are very essential.
The progress of many undeveloped and underdeveloped countries gets retarded, because of the paucity, of funds.
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Importance of Capital
Capital is considered as one of the most important factors for production. It helps in modern production systems.
Some of the factors which make Capital imperative have been discussed below:
1. Capital increases production and productivity
Capital plays a very important role in production these days. We cannot imagine a production without ‘capital’. Land (nature) and labor (man) alone are not enough for production. Companies require machines, tools, and equipment to produce.
2. Capital is the core of Economic Development
Because of its strategic role in raising productivity, capital occupies a central position in the process of economic development.
The economic development of any nation is not the same as economic growth. There are some differences between economic growth and economic development.
Economic development is not possible without a sufficient provision of machines, tools, irrigation systems, dams, bridges, factories, roads, railways, etc.
3. Capital generates more Employment Opportunities
The growing population needs to be fed and for this, there must be sufficient employment opportunities. An adequate increase in stock capital ensures the fulfillment of requirements like new machinery, tools, labor, and other important utilities.
Thus, capital helps in providing more employment opportunities.
How is Capital different from Money?
At its center, capital is money. Be that as it may, for monetary and business purposes capital is commonly seen from an operational and speculation viewpoint. Capital, for the most part, accompanies an expense.
However, we have discussed above capital includes all kinds of assets a company possesses.
For debt capital, this is the expense of interest needed in reimbursement. For equity capital, this is the expense of appropriations made to investors.
Generally speaking, capital is conveyed to help shape an organization's turn of events and development.
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Capital is an integral part of any business. In this blog, we have tried to cover everything about capital. We also reckon capital as an amount of money required to start a business.
However, Capital is not just money but it includes several other elements such as tools and equipment, infrastructure, technology, and many more.
We have explained the different functions of capital, its characteristics, and how it is vital in production. We have also highlighted the four different types of capital here.