January 22, 2021

SB-Accounting

Accounting + Finance Blog

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The term capital is well known to finance students and professionals. To those without this knowledge, capital may be seen as money a business uses every day. While this is true to some extent, the term capital has a broad meaning. Let’s take a look.

Definition of capital

Here, capital will be defined in three ways. The accountant definition, the economist and the finance expert. However, the focus here is the accounting and finance view.

The Accountant Definition: It is defined as the money invested to commence a business.

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According to the conceptual framework of IFRS, capital is the residual interest in the entity’s assets after deducting all liabilities.

The Finance Expert: It is the amount invested in an entity that will yield interests, dividends or gains.

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The Economist: This defines capital as the wealth used to create more wealth for an entity or country.

Key Explanations

Money used to start a business. Capital is seen by the accountant as money invested in a business. In this case, the business owner is expecting a profit or loss.

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Here, capital may be sourced from personal savings. Gratuity earned after retirement from work. Cash in kind from friends and family. Or Cash from a venture capital firm.

Money invested in an entity. For the finance expert capital is the money invested in a company. In summary, capital is an investment. Also, the capital outlay is expected to yield interest, profit, dividends or gains.

Interest arises if the capital is a fixed income investment. Examples are an investment in preference shares and bonds. The result of variable income investment is the dividend. A good example shares.

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While gains arise from the sale of the investment. For example, if the invested money is 1,200,000 Naira and the investment was sold for 1,500,000 Naira, then the investor has gained 300,000 Naira. Foreign Exchange is a perfect example.

Wealth to produce further wealth. To economics, to be regarded as capital, the money can produce more wealth to the individual or country. Here we can have money capital, human capital, machines and management.

What else to know

Capital has various types. The common ones, especially in accounting and finance, are debt or loan capital, working capital and equity capital. Debt capital is the financing of a business with loans from friends, banks and other financial institutions.

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Working capital is needed for the day-to-day running of the business. And equity capital is the finance provided by the owners of the business.

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Conclusion

Capital means different things to different people. In accounting, you should have learnt that the term capital is an investment in a business. The goal of which is to make a profit.

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