Financial Capital

If you want to set up a business, you need capital to buy land, buildings, equipment and so on.  This capital which one uses to buy other assets is called Financial Capital or economic capital.  It could be in the form of money, bank deposits, equity stock and debentures and other kinds of bonds.

Equity capital:

Equity capital is the capital contributed by the shareholders.  When a business is being started or is being expanded, the owner requires funds which he himself may not have.  If the business is going to be a fairly large one, he can raise the required capital by a public issue.  He advertises this issue of equity, and people who wish to participate in the business apply for the equity shares to be issued.  If they are allotted equity shares, then they become part owners of the company.  However they cannot claim any return on their investment as a matter of right.  When the business makes profits, these may be distributed among the equity shareholders as dividend.  This kind of capital is usually raised by large companies.  Small businesses may find it difficult to issue equity as it is an expensive affair and moreover, there are regulations regarding to the minimum amount of equity capital that can be issued.

Debt capital:

 Debt capital is the Financial Capital borrowed from others.  The lenders may be a bank, an institution, bondholders or even wealthy individuals.  These lenders are paid interest at a predetermined rate.  In comparison with equity capital, this is an easier way of raising Financial Capital and many businesses both large and small adopt this route.  The catch is that interest has to be paid irrespective of whether the business is doing well or not.  In case of equity capital, dividend payment is not mandatory.

Different kinds of debt capital:

  • Loans:  A company may borrow loans from a bank or a financing institution to fund a capital purchase.
  • Debentures: A company may issue debentures to the public and those who purchase these debentures, that is, the debenture holders become creditors to the company.
  • Bonds: A company may also issue bonds for raising financial capital. The difference between a bond and a debenture is that a bond is generally secured against an asset whereas a debenture is unsecured.
  • Fixed deposits:  A company which wants to raise financial capital may also accept fixed deposits from the public. The rate of interest to be paid to the depositors is quite low compared to the rate charged by banks for loans.  It is also quite popular with members of the public as they receive higher interest than what they would have earned if they had put the money in a bank fixed deposit.
  • Financial Capital is very important for a company which is just starting business or is on the verge of expansion.  The company management will work out which kind of financial capital would suit them best and choose that option.