Financial capital is any economic resource measured in terms of money used by entrepreneurs and businesses to buy what they need to make their products or to provide their services to the sector of the economy upon which their operation is based, i.e. retail, corporate, investment banking, etc. In other words, financial capital is internal retained earnings generated by the entity or funds provided by lenders to businesses in order to purchase real capital equipment or services for producing new goods and/or services.
In contrast, real capital comprises physical goods that assist in the production of other goods and services, e.g. shovels for gravediggers, sewing machines for tailors, or machinery and tooling for factories.
IFRS concepts of capital maintenanceFinancial capital generally refers to saved-up financial wealth, especially that used in order to start or maintain a business. A financial concept of capital is adopted by most entities in preparing their financial reports. Under a financial concept of capital, such as invested money or invested purchasing power, capital is synonymous with the net assets or equity of the entity. Under a physical concept of capital, such as operating capability, capital is regarded as the productive capacity of the entity based on, for example, units of output per day.
Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power. Accordingly, there are three concepts of capital maintenance in terms of International Financial Reporting Standards :
- Physical capital maintenance;
- Financial capital maintenance in nominal monetary units; and
- Financial capital maintenance in units of constant purchasing power.
Financial capital can also be in the form of purchasable items such as computers or books that can contribute directly or indirectly to obtaining various other types of capital.Financial capital#cite%20note-3| Financial capital has been subcategorized by some academics as economic or "productive capital" necessary for operations, signaling capital which signals a company's financial strength to shareholders, and regulatory capital which fulfills capital requirements.
- Long-term funds are bought and sold:
- * Shares
- * Debenture
- * Long-term loans, often with a mortgage bond as security
- * Reserve funds
- * Euro Bonds
- Financial institutions can use short-term savings to lend out in the form of short-term loans:
- * Commercial paper
- * Credit on open account
- * Bank overdraft
- * Short-term loans
- * Bills of exchange
- * Factoring of debtors
Differences between shares and debentures
- Shareholders are effectively owners; debenture-holders are creditors.
- Shareholders may vote at AGMs and be elected as directors; debenture-holders may not vote at AGMs or be elected as directors.
- Shareholders receive profit in the form of dividends; debenture-holders receive a fixed rate of interest.
- If there is no profit, the shareholder does not receive a dividend; interest is paid to debenture-holders regardless of whether or not a profit has been made.
- In case of dissolution the firm's debenture holders are paid first, before shareholders.
Types of capital
Fixed capitalFixed capital is money firms use to purchase assets that will remain permanently in the business and help it make a profit. Factors determining fixed capital requirements:
- Nature of business
- Size of business
- Stage of development
- Capital invested by the owners
- location of that area
- Size of business
- Stage of development
- Time of production
- Rate of stock turnover ratio
- Buying and selling terms
- Seasonal consumption
- Seasonal product
- profit level
- growth and expansion
- production cycle
- general nature of business
- business cycle
- business policies
- Debt ratio
Own and borrowed capital
Borrowed capital is capital that the business borrows from institutions or people, and includes debentures:
- Redeemable debentures
- Irredeemable debentures
- Debentures to bearer
- Ordinary debentures
- Preference shares/hybrid source of finance
- * Ordinary preference shares
- * Cumulative preference shares
- * Participating preference shares
- Ordinary shares
- Bonus shares
- Founders' shares
InstrumentsA contract regarding any combination of capital assets is called a financial instrument, and may serve as a
- medium of exchange,
- standard of deferred payment,
- unit of account, or
- store of value.
ValuationNormally, a financial instrument is priced accordingly to the perception by capital market players of its expected return and risk. Unit of account functions may come into question if valuations of complex financial instruments vary drastically based on timing. The "book value", "mark-to-market" and "mark-to-future" conventions are three different approaches to reconciling financial capital value units of account.
Issuing and tradingLike money, financial instruments may be "backed" by state military fiat, credit, or commodity resources. Governments generally closely control the supply of it and usually require some "reserve" be held by institutions granting credit. Trading between various national currency instruments is conducted on a money market. Such trading reveals differences in probability of debt collection or store of value function of that currency, as assigned by traders.
When in forms other than money, financial capital may be traded on bond markets or reinsurance markets with varying degrees of trust in the social capital of bond-issuers, insurers, and others who issue and trade in financial instruments. When payment is deferred on any such instrument, typically an interest rate is higher than the standard interest rates paid by banks, or charged by the central bank on its money. Often such instruments are called fixed-income instruments if they have reliable payment schedules associated with the uniform rate of interest. A variable-rate instrument, such as many consumer mortgages, will reflect the standard rate for deferred payment set by the central bank prime rate, increasing it by some fixed percentage. Other instruments, such as citizen entitlements, e.g. "U.S. Social Security", or other pensions, may be indexed to the rate of inflation, to provide a reliable value stream.
Trading in stock markets or commodity markets is actually trade in underlying assets which are not wholly financial in themselves, although they often move up and down in value in direct response to the trading in more purely financial derivatives. Typically commodity markets depend on politics that affect international trade, e.g. boycotts and embargoes, or factors that influence natural capital, e.g. weather that affects food crops. Meanwhile, stock markets are more influenced by trust in corporate leaders, i.e. individual capital, by consumers, i.e. social capital or "brand capital", and internal organizational efficiency, i.e. instructional capital and infrastructural capital. Some enterprises issue instruments to specifically track one limited division or brand. "Financial futures", "Short selling" and "financial options" apply to these markets, and are typically pure financial bets on outcomes, rather than being a direct representation of any underlying asset.
Broadening the notionThe relationship between financial capital, money, and all other styles of capital, especially human capital or labor, is assumed in central bank policy and regulations regarding instruments as above. Such relationships and policies are characterized by a political economy - feudalist, socialist, capitalist, green, anarchist or otherwise. In effect, the means of money supply and other regulations on financial capital represent the economic sense of the value system of the society itself, as they determine the allocation of labor in that society.
So, for instance, rules for increasing or reducing the money supply based on perceived inflation, or on measuring well-being, reflect some such values, reflect the importance of using financial capital as a stable store of value. If this is very important, inflation control is key - any amount of money inflation reduces the value of financial capital with respect to all other types.
If, however, the medium of exchange function is more critical, new money may be more freely issued regardless of impact on either inflation or well-being.
Economic role, capitalism, feudalism, anarchism, other civic theories take markedly different views of the role of financial capital in social life, and propose various political restrictions to deal with that.
Financial capitalism is the production of profit from the manipulation of financial capital. It is held in contrast to industrial capitalism, where profit is made from the manufacture of goods.