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Financial capital - an overview

We will continue the financial advisory series by talking about financial capital this week.

What is a financial capital?

In finance, accounting, and economics, financial capital (also known as capital or equity) is any monetary resource utilized by entrepreneurs and businesses to purchase the materials they require to manufacture their products or deliver their services to the segment of the economy in which they operate, such as retail, corporate, investment banking, and so on.

Financial capital, in other words, is the firm's internal retained earnings or cash granted by lenders (and investors) to firms to acquire real capital equipment or services for the production of new goods and/or services. Financial capital is any liquid medium or mechanism that symbolizes wealth or other forms of capital. Financial capital can also take the shape of purchasable commodities like computers or books, which can help people gain many other forms of capital, either directly or indirectly.

Lenders or investors supply financial capital for a fee: interest or dividends/return, respectively.

Financial capital vs economic capital

The word "financial capital" encompasses a far broader definition than "economic capital." In certain ways, everything may be considered a type of financial capital if it has a monetary value and is utilised to generate future revenue.

The word "financial capital" refers to the assets that a firm needs to offer goods or services, as assessed in terms of money worth, while economic capital is the amount of money believed to be required to cover potential losses from unanticipated risk. The economic capital of a company may also be viewed as a measure of its solvency.

Financial capital is a term that refers to money that has been saved for a specific purpose, such as starting or maintaining a business. Real capital (or economic capital) on the other hand, consists of tangible assets that aid in the creation of other products and services, such as shovels for gravediggers, sewing machines for tailors, or factory gear and tooling.

Determinants of financial capital

The major determinants of financial capital include: -

  • Capital market imperfections

  • Factors mitigating capital market imperfections

  • Firms and Sector related factors - according to Logan and Tian (2012) the firms characteristics are the size of the firm, the firm’s liquidity, its sales growth, asset growth leverage and its turnover.

Types of Financial Capital

There are different types of financial capital. However, the most common ones are debt and equity.

Debt - a loan or financial commitment that must be returned at some point in the future. It comes with an interest cost, which is the cost of borrowing money. The funds obtained by borrowing money are subsequently utilized to acquire an asset and support a company's activities, resulting in revenue generation. It also reflects credit from a lender, or creditor, and is generated when a creditor agrees to advance a debtor a certain amount of money. Any sort of postponed payment is considered debt.

Equity - ownership share in a firm, with equity investors receiving the company's residual value if it is sold or shut down. It does not require repayment and does not incur interest costs, unlike debt. To produce income, equity is utilized to fund the firm and acquire assets i.e., it is used to fund the operations of businesses and organizations to buy assets and produce income. Net worth capital is another name for equity.

It is critical for businesses to understand that anything may be considered financial capital if it has a monetary worth and can be used in the future.

Once you have chosen the best financing option for your business, you need to examine the results and their impact on your business. Is your company suffering from the drawbacks of your financing alternatives or benefiting from them? These and other financial structure and performance data are used to calculate the company's financial situation, the company's competitive strategy and its overarching financial plan. Next week, we would discuss Reviewing your Financial Capital Strategy.

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