Financial Capital vs. Real Capital

Financial Capital vs. Real Capital

Capital is the lifeblood of a business.  Capital is required at every stage- for starting a business, for running the business as well as for expanding the business.

Capital can be classified as financial capital and real capital.

Financial capital is the amount invested in the company which allows it to carry on its activities.  The funds provided by lenders and investors to the business forms its financial capital. Eg: Equity capital.
Real capital comprises physical goods belonging to the business that assist in running the business by producing other goods and services. Eg: machinery and equipment.

Financial Capital vs. Real Capital

  • Financial Capital represents funds or money while real capital represents physical goods such as equipment or machinery.
  • Financial Capital represents the amount due from the business and appears on the Liabilities side of the balance sheet.  On the other hand, real capital belongs to the company and appears on the Assets side of the balance sheet.
  • Financial Capital represents purchasing power while real capital represents the purchases made which help the business to run its day to day activities.
  • Unlike real capital, a business has to give some kind of return on financial capital – compulsorily in case of borrowed capital and optional in case of owned capital.

Financial Capital may be owned capital or borrowed capital.

Owned Capital:

This is the capital which is not borrowed by contributed by the owners of the company.

  • Promoter’s Money: The money which the promoter has contributed to the business is owned capital.
  • Equity Capital: The business owner may want to expand his business but may not have the required funds.  In that case, he may want to raise fresh capital by issuing equity shares to the public.  People who wish to invest in the company can apply for the company’s shares.  People who are allotted equity shares- the equity shareholders- are part owners of the company.  When the company makes profits, the management may distribute dividend to these shareholders. They can also profit by selling the shares when the share price rises.  The liability of the shareholders is limited to the amount of capital contributed by them.

Borrowed Capital:

A company’s financial capital may be borrowed capital also called as debt capital.  This may take the form of loans taken, fixed deposits accepted or debentures issued.

  • Loans : The company may obtain funds by taking loans from banks and other financial institutions.
  • Fixed Deposits: Often, companies which require funds for a specific purpose accept fixed deposits from the public. These are popular among the public as the interest rate offered by such companies is higher than that paid by banks.
  • Debentures: Companies can borrow funds from the public by issuing debentures.  Debentures are of various types.  They may be secured by assets of the company, some can be converted into equity shares in the future while some others may be repaid after a specified period.

Interest would have to be paid on all borrowed capital irrespective of whether a company makes profits or losses.

A company requires both financial capital and real capital for running a business successfully.