Hello welcome to this blog on meaning and types of capital and their importance
Table Of Contents
- Meaning Of capital
- Types of capital
- Importance of working capital
Meaning and Types of Capital
Three schools of thought or views appear to hold sway in the definition or meaning of capital. These are the accountant point of view, the economist point of view and the layman’s point of view.
Accountant point of view: Accountants define capital as the original fund or money with which a person used to start a business. It is the net worth of a business. He considers capital as synonymous with money. Capital in this wise is the owner’s equity in a business and the excess of asset’s over liabilities.
The Economist point of view: Economist define capital as the resources or wealth made by man that are used for producing further wealth. These are properties of a firm which are meant to be used in the production of other goods. It includes such assets as machines, raw materials, buildings etc. To The economist capital is just one of the factors of production.
The Layman’s point of view: On the meaning of capital, to the layman, capital is the total amount of money for running a business.
Types of Capital
- Authorized, registered or nominal capital: This is the total amount stated in the memorandum of association and approved by the registrar of companies which a company can issue out for subscription. Nominal capital is the total amount of capital which a company is authorized to issue out to the public. It limits the amount that can be issued out as shares.
- Issued Capital: This is part of nominal capital that the company decides to issue out to the public for subscription. It is the total share offered to the public out of the nominal capital at a particular time.
- Called up capital: This is the part of the issued capital that has actually been called up, and the shareholders have been asked to make payment. It is part of the issued capital which is expected of the shareholders to pay for.
- Paid up capital: This is part of the called up capital which the shareholders have actually paid for. It is the total amount paid up or credited as paid up on the issued share capital.
- Uncalled capital: This is the total amount that has not been called up on the issued share capital. It can be referred to as part of the issued capital that is yet to be called up for payment.
- Capital employed: This is the total assets, both fixed and current, less current liabilities. It is the actual amount of money and other assets used in the business. It can also be referred to as the total assets of a business and can be calculated as Total Assets – Current Liabilities.
- Capital owned: Capital owned is the owner’s financial interest in a business. It is the excess of total assets of a business over the value of its total short and long-term liabilities. In a summary, it is the net worth of a business.
- Fixed capital: This is the durable capital of an enterprise which is used to continuously for further production. They are not intended for immediate consumption, but rather as a means of production. It comprises assets of a firm which are of durable character, e.g, furniture, fittings, building, machinery, etc. Fixed capital do not change form in the process of production.
- Loan capital: This is the total amount of money a business borrowed from external sources. It is a term frequently applied to debentures another fixed loans.
- Liquid capital: This is a types of capital made up of assets that can be easily converted to money, i.e, can be turned into cash at short notice. This consists of cash, near money, debts, and bank balance.
- Working or circulating capital: This types of capital is the amount that is issued for day-to-day running of the business. It is the capital available to a business for general purposes after current liabilities has been met. Circulating capital is an accounting term used to describe the excess of current assets of a business over its Current liabilities. It includes Capital used for paying wages, salaries and payment for raw materials. This could be calculated as: Current Assets – Current Liabilities.
Importance of working capital
- Working capital serves as a check against tying down too much money for current assets.
- It helps to determine whether the business is solvent or not, i.e, whether it has the ability to settle debt without selling fixed assets.
- Working capital helps to determine the fund that will be available for the running of the business on a daily basis.
- It gives an indication that the business is being financed internally and not by suppliers.
- It is a sign of healthiness, i.e, it will help the investor to know whether to invest or not.
- Working capital can be used by a business as a basis for planning to avoid losses.
- It provides basis for profit making by the business since it is used to buy stock from where profit is derived.
Revision Questions on the meaning and types of capital
- Define capital in three different ways
- Distinguish between the following, fixed capital and liquid capital,
- Explain the meaning and importance of working capital