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Financial capital (also simply known ascapital orequity infinance,accounting andeconomics) is anyeconomic resource measured in terms ofmoney used byentrepreneurs andbusinesses 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 (e.g. retail, corporate,investment banking). In other words, financial capital is internalretained earnings generated by the entity or funds provided bylenders (andinvestors) to businesses in order to purchasereal capital equipment or services for producing newgoods 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).
To provide useful information, it may be necessary to classify equity claims separately if those equity claims have different characteristics.[1] Under theInternational Financial Reporting Standards (IFRS), the choice of the "Capital Maintenance" concept determines the accounting model used for preparing financial reports.
Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.[2] Accordingly, IFRS recognizes three distinct concepts:[2]
| Concept | Definition | Measurement Unit | Basis for Profit |
|---|---|---|---|
| Financial (Nominal) | Capital is synonymous with net assets/equity. | Nominal Monetary Units | Profit is earned if nominal money equity increases. |
| Financial (Purchasing Power) | Capital is the invested purchasing power. | Units of Constant Purchasing Power | Profit is earned if invested purchasing power increases. |
| Physical Capital | Capital is the productive/operating capacity. | Physical Units (e.g., output/day) | Profit is earned if physical productive capacity increases. |
Financial capital generally refers to saved-up financialwealth, especially that used in order to start or maintain a business. Under a financial concept of capital, such asinvested money orinvested purchasing power, capital is synonymous with thenet assets orequity of the entity.[3][4]
Conversely, under aphysical concept of capital, such as operating capability, capital is regarded as theproductive capacity of the entity based on, for example, units of output per day. This requires a measurement basis of current cost rather than historical cost.
Financial capital is provided by lenders for a price:interest. It represents any liquid medium or mechanism that representswealth, usually in the form of money available for the production or purchasing of goods. Capital can also be obtained by producing more than what is immediately required and saving the surplus.
Additionally, financial capital can take the form of purchasable items—such as computers or books—that contribute directly or indirectly to obtaining other types of capital.[5]
Academics and practitioners often subcategorize financial capital based on its operational or regulatory function:[6]
Fixed 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:
Firms use working capital to run their business. For example, money that they use to buy stock, pay expenses and finance credit. Factors determining working capital requirements:
Capital contributed by the owner or entrepreneur of a business, and obtained, for example, by means of savings or inheritance, is known as own capital orequity, whereas that which is granted by another person or institution via debt instruments is called borrowed capital, and this must usually be paid back with interest. The ratio between debt and equity is namedleverage. It has to be optimized as a high leverage can bring a higher profit but createsolvency risk.
Borrowed capital is capital that the business borrows from institutions or people, and includes debentures:
Own capital is private capital that owners of a business (shareholders and partners, for example) provide, sometimes called owners equity. The ownership interest is typically represented inpreferredshares, and may be of various types, for example:
These typically have preference over thecommon shares. This means the payments made to the shareholders are first paid to the preference shareholder(s) and then to the equity shareholders.
Acontract regarding any combination ofcapital assets is called afinancial instrument, and may serve as a
Most indigenous forms of money (wampum, shells, tally sticks and such) and the modernfiat money are only a "symbolic" storage of value and not a real storage of value like commodity money.
Normally, 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.
Like money, financial instruments may be "backed" by statemilitary fiat,credit (i.e.social capital held by banks and their depositors), or precious metals resources. Governments generally closely control the supply of it and usually require some "reserve" be held by institutions granting credit. Trading between various nationalcurrency instruments is conducted on amoney market. Such trading reveals differences in probability ofdebt collection orstore of value function of that currency, as assigned by traders.
When in forms other than money, financial capital may be traded onbond markets orreinsurance markets with varying degrees of trust in thesocial capital (not just credits) 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 calledfixed-income instruments if they have reliable payment schedules associated with the uniform rate of interest. A variable-rate instrument, such as manyconsumer mortgages, will reflect the standard rate for deferred payment set by thecentral bankprime rate, increasing it by some fixed percentage. Other instruments, such ascitizen entitlements, e.g. "U.S. Social Security", or other pensions, may be indexed to the rate of inflation, to provide a reliable value stream.
Typically commodity markets depend on politics that affect international trade, e.g. boycotts and embargoes, or factors that influencenatural 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" (in some analyses), and internal organizational efficiency, i.e. instructional capital andinfrastructural 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.
The relationship between financial capital,money, and all other styles ofcapital, especiallyhuman capital orlabor, is assumed incentral bank policy and regulations regarding instruments as above. Such relationships and policies are characterized by apolitical economy –feudalist,socialist,capitalist,green,anarchist or otherwise. In effect, the means ofmoney 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 perceivedinflation, or onmeasuring well-being, reflect some suchvalues, reflect the importance of using (all forms of) 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.
Socialism,capitalism,feudalism,anarchism, and othercivic 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 toindustrial capitalism, where profit is made from the manufacture of goods.
It is common inMarxist theory to refer to the role of finance capital as the determining and ruling class interest in capitalist society, particularly in thelatter stages.[1][2]
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