Do you know about 5 ways to define capital? if not, you’ll get to know at the end of this post. Actually, Capital is the amount of injection by the owner(s) into a business. Suppose Marta is starting out her own hair salon, she needs an initial investment. This investment will be used to buy an office on rent, some supporting staff, furniture and other equipment required for a saloon. This initial investment by Marta to buy some assets for her business is nothing but a ‘Capital’.
Definition of Capital
Sacred Accounting is bringing you definitions of capital from different authoritative resources. We can define capital in 5 different ways:
- The amount of money invested in a business to generate income is called capital. (Business Dictionary)
- Total contribution to the business by the owner(s) is called capital.
- The large sum of money which is available to start a business, or which can be invested to earn money is called capital. (Collins Dictionary)
- Capital is simply the net worth of a business, that is the excess of total assets over the liabilities. (Merriam Webster)
- Cash or other assets injected by the owner into a business is called capital. (Debitoor)
Do you know? It’s also known as Equity.
Two Concepts of Capital:
Why does Marta inject capital into her business? Yes, you’re right, she wanted a return in the form of profits. Capital is injected to get a decent return. Let me introduce you to two separate concepts of capital:
- A financial concept of Capital, and
- A physical concept of capital.
Financial concept of Capital
According to this concept, a profit is not earned unless the amount of capital at the end of the period is not greater than the amount of capital at the beginning of the period.
Sounds confusing? It’s okay, Suppose Marta injected a Capital of $30,000 at 1st Jan 2019. Now at the end of the period i.e. at 31st Dec 2019, she calculated her capital:
- and it was $46,000. The difference of $16,000 is actually her profit.
- If in case, the amount at the end of the period was $30,000, then there is no profit.
- Similarly, if the amount was $23,000, it means she incurred a loss of $7,000 during the period.
How To Calculate Closing Capital?
You might be wondering how is this capital calculated? Like how do we know the capital at a particular time? Well, that’s simple, we just add or less the amount of profit/loss form the initial capital and we get the ending capital in the result.
Physical Concept of Capital
According to Physical concept of capital, a profit is not earned unless the operating capability of business at the end of the period is not greater than the operating capability at the beginning of the period.
Suppose, Marta had the capacity to handle 2 customers at a time at the begging of the period, whilst at the end of the period,
- It has the capacity to handle 4 customers at a time (it means Saloon earned a profit),
- It had the capacity to handle the same 2 customers at a time (it means the entity has no profit/loss), and
- If it has the capacity to handle only 1 customer at a time (it means the saloon earned a loss for the period).
Difference between Capital and Working Capital
Capital is just the amount of investment in business whilst working capital is an entirely different concept. Working capital is the amount of we get when we subtract current liabilities from our current assets. Suppose we have current assets of $7,000 and current liabilities of $3,000. Then our working capital would be $7,000-$3,000=$4,000.
Working capital can be negative. (where current liabilities are greater than current assets).
How to Raise the Capital?
Capital is raised using different methods which depends on the type of business requiring the capital,
- For sole proprietorship- Capital is Raised by its sole owner. Such capital is usually limited in amount.
- For Partnership- Capital is raised by its owners/partners. Such capital is also limited.
- For a Company- Capital is provided by its shareholders. Some companies raise their capital from the stock market.
Is there anything else confusing you? Just comment and Sacred Accounting is ready to help !!