Financial Capital: Role, Types, Sources

About financial capital: Financial capital refers to credit, money, and other ways of funding that helps in building wealth. Individuals use this capital to carry out investment, by making down payments on a car or home or by creating the holding for retirement. Companies use this capital to surge its revenue.

Sources of Financial Capital

  • Long term – usually above seven years
    – Retained Profit
    – Mortgage loan
    – Project finance
    – Venture capital
    – Debenture
    – Share Capital
  • Medium-term – generally between 2 and 7 years

– Term Loans
– Hire Purchase
– Leasing
– Revenue-based financing

  • Short term – typically under two years
    – Deferred Expenses
    – Trade credit
    – Bank Overdraft
    – Factoring

Capital market

  • Long-term funds are purchased and sold.
    – Shares
    – Reserve funds
    – Long-term loans, provided with the mortgage security
    – Debenture
    – Euro Bonds

Money market

Financial organizations use short-term savings to give out loan in the form of short-term loans:

– Factoring of debtors
– Bank overdraft
– Commercial paper
– Credit on open account
– Bills of exchange
– Short-term loans

Capital in Business

In business terms capital refers to how firms invest in their companies. They use financial capital to purchase buildings, equipment, or raw material and use these things to manufacture goods and provide services. The business assets include investments and cash in addition to facilities and equipment. These details of assets are written in the balance sheet.

Types of Business Capital

There are three main types of financial capital when talking about the business world:

  • Debt capital
  • Equity capital
  • Working capital

Each of the above types is funded differently, but they all help in the growth of the company.

Debt Capital

Debit capital or loan capital is the money used by the company, borrowed from external sources for a fixed period by issuing the fixed-interest commercial securities (such as Debentures).

Advantage

The loan lender does not share the profits incurred by the company but is compensated by the regular interest amount. These interest payments are pre-decided, and payment is made within the period of contract.

Disadvantage

The disadvantage of debt capital is that if the business fails, the company will still have to repay the amount of loan.

Equity Capital

The second type of business capital is equity. In this, the investor provides cash to the firm in exchange for equity or share of profit in future.

Most entrepreneurs or contractors use their cash to start the firm. They put his amount into business, hoping that they will receive 100% return later. If the firm is profitable, they sacrifice spending the cash flow in the present and instead use the money to invest it in the business.

Another way (known are Initial public offering) to receive equity is from a venture capitalist or partners. In this type, the company takes cash form the investor and gives some ownership or control of the business in exchange. Once a firm becomes successful and huge, it gets extra capital from issuing stocks. It means any investor can buy company stock; this is the reason why shares are sometimes referred to as equity.

Working Capital

It includes all the most liquid capital securities of the company that it needs to fulfil its daily obligations. One can calculate it regularly by using the following two formulas.

Current Assets – Current Liabilities

Inventory + Accounts Receivable – Accounts Payable

Working capital calculates the short-term liquidity of a company, more particularly, it’s capacity to cover its accounts payable, other obligations and debts that are due in the current year.

Bottom line

Sometimes capital financing is referred to as the fifth factor of production.

However, it is not accurate because it provides income to the companies for production and makes production possible rather than functioning as a production factor.

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