Under capitalism, private owners invest their own capital in business enterprises, hoping to increase owner value.
The term capital is used frequently and in different ways in business management, finance, and economics.
All of these uses have in common a reference to large sums of money, or costly acquisitions or actions. The most basic business meaning of the word capital, itself, is simply another term for privately owned funds or other resources of value.
Note that the term also lends its name to a form of economic system—capitalism. Capitalist economies are characterized by free market trading and the use of privately owned capital to create business enterprises. Under capitalism, owners invest capital specifically for the purpose of increasing owner value.
Explaining Popular Capital Terms
Sections below further define and explain specific uses of the term capital, as used with the following terms:
For in-depth coverage of each example, please see the linked Encyclopedia articles in each section.
- What is capital? What are the different meanings of capital in business?
- What is the meaning of capital in business finance?
- How is the term working capital used in business management and business analysis?
- What are capital assets? What is a capital gain?
- Capital projects? What makes the project a capital project?
- Capital leases vs. Operating leases: What are the differences?
- What is the meaning of capital in budgeting, and what are the differences between capital and operating budgets?
- How is the term capital used in economics?
- See Capital and Financial Structure for more on the role of capital investment in creating financial leverage and increasing profitability
- The article Capital Intensive further describes the asset structure and capital structure of companies in industries which, by nature, require substantial investment in capital assets.
In business, the term capital refers to the investment in a company for the purpose of conducting business. The company's capital appears on the Balance sheet, composed of long term debts, preferred and common stock, and retained earnings.
Capital structure refers to the composition of the company's total capital, specifically the balance between funding from equities and funding from debt. It is assumed that funds from both sources are used for acquiring income-producing assets. Owners and creditors share both the risks and the rewards of funding the business in proportion their contribution to the company's underlying value (capital).
Capital structure is also known as capitalization. For more on capital structure and the sharing of risks and rewards (leverage), see the encyclopedia article Capital and Financial Structure.
In business management and in business analysis, the term working capital refers to the difference between two Balance sheet figures, current assets and current liabilities (i.e., Working capital = current assets less current liabilities). The financial metric working capital is thus a measure of how well prepared a company is to meet its near term financial obligations.
The working capital metric has the same input figures, and addresses the same issues, as another financial metric, the current ratio. Current ratio and Working capital both measure the firm's liquidity. For more on the meaning of working capital and its measurement, see the Encyclopedia article Liquidity.
The term capital asset refers to assets that have these characteristics:
- The firm acquires the asset at high cost. Companies and organizations sometimes set threshold values for cost, which the purchase must exceed, in order for the acquisition to qualify as a capital asset.
- The firn intends to keep the asset will kept for the long term, more than a year at least.
- The asset is not easily converted to cash (i.e., it is not a Current asset).
Assets appearing on the Balance sheet as "Property, Plant, and Equipment," for instance are capital assets. For many capital assets in many categories, asset purchase cost converts to expense, over time, through the depreciation process. Each year of the asset''s depreciable life, asset book value decreases as depreciation expense applies.
When a capital asset is sold for more than its purchase price, the seller is said to benefit from a capital gain. For an introduction to the tax implications, see the article Capital Gain."
In the expression capital project, the term word capital is simply a stand-in for "large" or "costly." A capital project, in other words, is a project that has large capital requirement, or requires a large investment of capital. Capital projects may require taking on debt (e.g., through issuing bonds), or they may require new issues of stock, in order to obtain funding.
The purpose of a capital project, however, may be to create a long-lasting, tangible capital asset, such as a complex large-scale computing system, built for a specific purpose. A capital project may obtain part or all of its funding from a capital budget.
Leases for using assets generally fall into two categories: Firstly, Capital leases and secondly, Operating leases. The differences between lease categories have to do with (1) Balance sheet ownership of the asset, and (2) Ownership of the asset when after the life of the lease.
- With an operating lease, the original owner (the lessor) retains ownership, while the lessee uses the asset. With an operating lease, the user is essentially hiring, or renting the asset for a limited time period.
- Under a capital lease, ownership transfers to the asset user, the lessee. With a capital lease, the asset user is essentially financing purchase of the asset.
For more on the differences between capital and operating leases, see the Encyclopedia article Lease, Operating and Capital Leases, and FASB-13 Explained.
In accounting, the designation capital is used to distinguish capital budgeting from the budgeting of operating expenses.
- The capital budgeting process results in the firms plans for capital expenditures (CAPEX) in the next budgetary period.
Most CAPEX spending results in acquisition of capital assets. Acquisitions that meet the firm's criteria for capital" items are almost always long lasting, expensive items, which contribute to the value of Balance sheet assets.
- The operating budget process results in the plan for spending on operating expenses (CAPEX).
Most of the firm's CAPEX spending is used for non-capital purchases, such as purchase of office supplies, paying employee wages, and paying the firm's utility bills.
CAPEX and OPEX do not overlap. The two kinds of budgets handle completely different spending items. Whether an expense item is CAPEX or OPEX depends on the nature of the purchase and how owners use it. And, the country's tax laws may also help determine what is a capital item and what is not
Moreover, firms create capital and operating budgets through different processes, involving different managers. Those preparing funding requests should keep in mind these points:
- Firstly, capital and operating budgets usually apply different criteria for prioritizing requests and deciding spending.
- Secondly, many proposals include both CAPEX and OPEX spending. As a result, those asking for funding in such cases must show specifically what they need in CAPEX funds and what they need in OPEX funds.
- Thirdly, as a result, the wise manager therefore writes the funding request and its business case with an eye on both sets of decision criteria.
See the article Budget for in-depth coverage of CAPEX and OPEX budgeting.
In economics, capital refers to any economic resource or wealth, and the term may apply to the financial strength of individuals, companies, or countries.
In a capitalist economy, the means of production and distribution are privately owned by individuals or corporations, and economic development is based on the accumulation and reinvestment of free market profits.