What is capital?
A business is often likened to a ship. A ship needs a sturdy frame (infrastructure or physical capital), a tank full of fuel (financial capital) and a skilled crew (human capital) to keep it afloat and ensure it completes every voyage successfully. The ship will also need intellectual capital, like navigation tools, maps and reputation, to get more business and continue to flourish.
Key takeaways
Capital encompasses all financial resources and assets, both tangible and intangible, that enable wealth generation, including cash, machinery, employee skills, and business networks, serving as the underlying resource base for revenue and profit.
Business capital consists of three main types: financial capital (working capital, equity, and debt), human capital (the collective skills and knowledge of the workforce), and social capital (networks and relationships with stakeholders).
For traders, capital is used to buy and sell assets and serves as collateral for leverage in CFD trading, where it amplifies both potential profits and losses and directly influences position size and risk management capabilities.
Effective capital management requires businesses to maintain sufficient liquidity and avoid excessive debt, while traders must implement risk management strategies including setting loss limits, diversifying investments, and avoiding impulsive decisions to protect their capital.
Businesses strategically allocate capital to acquire assets, upgrade technology, and fund expansion, while traders must ensure adequate capital to avoid margin calls and forced liquidation, with insufficient capital limiting opportunities regardless of potential.
A business has the same needs to launch, operate, grow, and ultimately reach its profit goals. So, the meaning of capital in business goes much beyond just finances. As a trader, your business is trading. So, here’s everything you must know to manage your capital effectively.
What is capital and why is it important in business?
The term ‘capital’ often gets confused with concepts like revenue or profit. Revenue is the income generated from sales, while profit is what remains after expenses are deducted from revenue. Capital, on the other hand, is the underlying resource base that enables the generation of both revenue and profit. Think of it as the engine of the ship from the beginning of this guide. Without it, the ship cannot move, regardless of how much fuel (revenue) is in the tank.
For a start-up, initial capital is essential to cover registration fees, rent, inventory and marketing. For an established enterprise, capital is needed for research and development, upgrading technology, or expanding into new markets.
In trading, capital is the basis on which you make investment decisions and open positions. Without adequate capital, opportunities will remain out of reach for both traders and businesses, regardless of their potential.
Learn more about using your capital smartly via risk management.
Types of capital in business
Money isn’t the only capital a business depends on, although it might be the most important type of capital in business.
Financial capital
This is perhaps the most straightforward and tangible form of capital. It can be further categorised into working capital, equity and debt. Working capital is the difference between current assets and current liabilities. It’s the short-term capital needed for day-to-day operations, such as paying suppliers, managing inventory, and covering payroll.
Equity is the capital contributed by the owners or shareholders of a business. It represents ownership stakes. Finally, debt, as the name suggests, is capital obtained through loans. Since loans need to be repaid, higher debt capital can adversely impact working capital.
Human capital
Often overlooked in traditional accounting, human capital is the collective skills, knowledge, experience and abilities of a company’s workforce. Highly skilled employees, innovative thinkers and experienced leaders are vital capital resources in business that drive productivity, creativity and problem-solving. Investing in training and development is an investment in human capital.
Social capital
This intangible form of capital encompasses the networks, relationships and trust that a business has cultivated with its customers, suppliers, partners and the wider community. Strong social capital can lead to valuable collaborations, referrals, market insights and good brand reputation, ultimately contributing to financial success.
How do businesses use capital?
Allotting capital to different aspects of a business is a strategic exercise. It can make or break a business’ trajectory and potential for growth. The largest part of capital in business is used to acquire new assets, upgrade technology, improve operational efficiency and fund expansion plans. These investments are crucial for driving productivity, scaling operations and staying competitive.
What does capital mean in trading?
For traders, capital is used to buy and sell assets, whether it’s stocks, commodities or forex. Adequate capital allows traders to open larger positions, diversify their portfolios, and withstand market volatility.
In CFD trading, capital serves as collateral for positions to access leverage. However, remember that while leverage allows you to control larger positions with a relatively small amount of your own capital, it also amplifies both potential profits and losses. The amount of capital you have in your trading account directly influences the size of positions you can open and your ability to manage risk effectively. Insufficient capital can lead to margin calls and forced liquidation of positions.
Traders often refer to the funds allocated for market activities as ‘trading capital’. Efficient use of this trading capital involves understanding leverage (also known as margin trading), setting appropriate stop-loss orders and not overextending your financial resources.
Learn more about leverage and CFD trading.
Managing and growing your capital
Effective management of capital is crucial for long-term success in any business endeavour, including trading.
For businesses, prudent capital management involves maintaining sufficient liquidity, avoiding excessive debt and making sound investment decisions. Reinvesting profits back into the business can fuel organic growth and strengthen its capital base.
In trading, risk management is non-negotiable. It involves protecting your capital by setting limits on potential losses per trade, diversifying investments, and avoiding impulsive decisions. A robust risk management strategy ensures that even a series of losing trades doesn’t wipe out your entire capital.
Businesses regularly review their capital allocation to ensure that it aligns with the company’s strategic goals. This might involve divesting underperforming assets or reallocating funds to more promising ventures. Traders, on the other hand, focus on achieving greater profits than losses, while maintaining discipline in trading. They withdraw only a portion of their profits, allowing the remaining capital to compound over time.
Practice risk management and trading strategies on a demo account before risking real capital.
Conclusion
Ready to start your trading journey? Open a live account.
FAQs
Equity capital
Equity capital is the backbone of the modern company’s financial structure. It does not have to be publicly quoted on a stock exchange, nor does it have to provide the bulk of the capital of the firm concerned.
Equity, quite simply, is a type of financial investment in a business and usually carries ownership rights in that business. These rights may be seen as compensation for the fact that the investment does not need to be repaid.
Commonly, equity capital will be initially subscribed by the founders of the company, with each receiving shares in proportion to their investment. Later, if the company is successful, some (or all) of the stock may be offered to the public in an initial public offering (IPO) or via special purpose acquisition company (SPAC) , but the principle remains the same – in return for the risk that the investors are taking, they are usually (but not always) given a piece of the ownership and control of the business.
They will be entitled also to any dividends that may be paid, although these can be distributed only once all debt obligations, such as interest on loans, have been met.
Debt capital
As the name suggests, debt capital in all its various forms describes a loan of one sort or another. It doesn’t have to be a bank loan (although that would certainly qualify) nor, on the other hand, need they be corporate bonds with a maturity date some years in the future (although these, too, count as debt capital).
Essentially, debt capital forms the part of a company’s financial structure that is ultimately owed to external creditors, who will also be entitled to interest payments or bond dividends. Unlike dividends on equity, the payments due on debt capital are almost always fixed. Debt holders, unlike equity owners, do not normally enjoy any ownership rights in the business.
Corporate bonds are probably the best-known type of lending to companies. Debt capital markets have greatly expanded over the years, and are deep and liquid, allowing reputable firms to meet their financing needs at a reasonable cost.
In a typical structure, holders of senior debt would be paid first, of subordinated debt last and those owning ‘mezzanine debt’ (so called because it is slotted between the two) would rank in the middle.The buyers of lower-ranked debt would usually expect a higher return to compensate for the greater risk.
Elsewhere in debt capital markets, companies can seek buyers for commercial paper, a much shorter-dated debt instrument, essentially an IOU payable, typically, in 30 or 90 days’ time.
Working capital
Working capital is distinct from debt and equity capital in that it is an overall measure of a company’s short-term assets, regardless of their origin. Deducting a business’s short term liabilities from its short-term assets gives a ratio for working capital.
Thus, anything over 1 suggests the company is in good shape to cover its short-term debts and generally pay its way. Anything under 1 means the company has negative working capital and may well find it hard to meet its obligations in the short term.
Ultimately, the inability to pay debts as they fall due is the definition of insolvency.
A secondary use of the working capital ratio is to gauge the efficiency of the company - too high a ratio may suggest either that it is slow to collect what is owed to the firm, or is failing to invest surplus money – or both.
Trading capital
Trading capital is quite different from the other forms of capital that we have examined, in that it represents funds set aside for the buying and selling of securities.
This type of capital would be typical for firms who engage in high volumes of trading activity, for example hedge funds, asset managers and brokerages.
What does capital mean in economics?
In economics, capital generally refers to any goods currently in use, or that can be used, for production and wealth. This would cover machinery, tools, equipment, buildings, transportation, technology, raw materials, and much more.
In the words of British economist Sir John Richard Hicks:
What are examples of capital?
An example of capital would be any asset used by a company. For instance, company stocks and corporate bonds are examples of equity and debt capital respectively. Businesses can sell their shares and bonds, converting them into cash to fund business investment.
Cash held in bank accounts, or money easily accessible - for example, undeposited client checks - is an example of working capital as it can be used promptly to fund day-to-day business operations.
Any business equipment such as machinery, tools, and even real estate, can also be considered business capital from an economic standpoint, as these are goods used for production.
Conclusion
Capital is an important concept to grasp for understanding corporate balance sheets as part of fundamental analysis of stocks. It’s a key metric in accessing a company’s financial health.
There are four main sources of business capital are equity, debt, government grants and business revenues.
Meanwhile, the four types of capital are based on its source or use case. These include equity capital, derived from selling company stock; debt capital sourced from debt such as corporate bonds; working capital that is used for funding day to day business expenses; and trading capital that’s typically set aside by financial institutions for trading securities.
In economics, capital can also refer to machinery and other equipment used by businesses for production.
FAQs
Is capital an asset?
Capital is the total stock of financial assets available to an individual or a business. It can describe everything from cash in the bank, equity capital, debt capital, plant, machinery, warehouses, vehicles and even valuable brand names.
What is capital in a business?
In business, capital can be cash and cash equivalents, and assets in the form of equity, debt, and equipment used for production.
What are the sources of capital?
The four sources of capital are equity, debt, government grants and revenues.
Why is capital important in business?
Capital can be used either to fund day-to-day operations (via working capital), for expanding business or as a set-aside emergency fund to weather economic storms. A high level of capital is a sign of financial health.
What are examples of capital?
For instance, company stocks and corporate bonds are examples of equity and debt capital respectively. Businesses can sell their shares and bonds, converting them into cash to fund business investment. Meanwhile, cash held in bank accounts, or money easily accessible - for example, undeposited client checks - is an example of working capital as it can be used promptly to fund day-to-day business operations. Plus, any business equipment such as machinery, tools, and even real estate, can also be considered business capital from an economic standpoint, as these are goods used for production.