Explaining the word “Capital” in Business

The word “capital” when used by economists, investors or accountants can be tricky. The word itself has a single use. It is defined as the money invested in a business and used to finance the assets used by the business to produce goods and services for sale. From an accounting perspective, a balance sheet contains two columns of accounts valued in terms of money. On the debit side (the left-hand column) are all assets the business owns. They include such items as cash, accounts receivable, inventory, equipment, buildings and land. On the credit side (the right-hand column) are the means of financing the assets. Liabilities are amounts owed for services and money borrowed. Owners’ Equity shows amounts received from issuing shares of stock, and accumulated earnings since the business was started. All the assets of the company have been financed by all the liabilities, capital stock and accumulated earnings. Below are some ways in which investors, accountants, economists and sometime journalists use the word capital.

  1. The money which purchases shares of a company’s stock is often called capital and furthermore the stock purchased may be called capital stock
  2. Companies that have been in business long enough to have accumulations of earnings have an account called Accumulated Earnings. This account is a part of the businesses capital structure, which also includes capital stock.
  3. Every business has working capital. These are assets that include cash and other items that generally convert to cash over a short period of time. When a product is sold from inventory the purchaser is sent an invoice, which represents an account receivable by the seller. When the purchase is paid for, the money goes into the bank. The assets in these three accounts are called working capital.
  4. Companies need money to construct or purchase long-lived assets, which are assets expected to be useful from as long as perpetually to maybe as short as five years to so. There is an axiom of finance that long-lived assets should be paid for with long-term money, which means long-term borrowing or from the Capital structure accounts. The assets are often called capital assets, on account of the means of their financing.
  5. A single item, cash, is sometimes called capital. its use can be confusing.
  6. Some businesses have special lingo. A person that trades stocks, option contracts, commodities and the like often sets aside a fund of money to be employed in the days’ trading. It represents a limit to the days activity and is called “trading capital”.

Publiustoo March 5, 2020