By William Cao. Edited by Swastik Patel
Overview/Introduction
“Capital” is a very broad term that is commonly mistaken for money— capital/financial assets are used to generate money while money is used to purchase goods and services. In general, capital is an essential part of the day-to-day management of a firm and funding its future expansion. There are three sources/types of capital: debt, working, and equity. In fact, financial firms consider trading capital as another source of capital.
Understanding the “Big 3”
Debt Capital
Debt capital is capital obtained by a business through borrowing from private or government sources. More specifically, the business takes on debt in exchange for the provided funds— hence the name debt capital. For established businesses, these sources of capital can come through the issuing of bonds or borrowing from financial organizations such as banks. In order to be profitable, debt capital must be repaid on a regular basis with interest. Additionally, capital for startups may come from friends & family, federal loan programs, and other sources. As long as debt does not reach unbearable amounts for the company, debt capital is the only option to receive a large amount of money to pay for a company’s major investment(s) in the future. The debt to capital ratio (calculated by debt / [debt + shareholder equity]) can be used to track the debt capital too.
Working Capital
Working capital is a simple accounting term that can be considered as the backbone of a company’s success. In short, working capital assesses the company’s short-term capital ability to fulfill obligations such as covering debt, paying employees and vendors, or planning for long-term growth. The primary way to calculate working capital is to subtract a company’s current assets by its current liabilities (all of which can be found on the balance sheet). Note that if a company has more liabilities than assets, it is possible that they will run out of working capital.
Equity Capital
Equity capital, as the term implies, refers to funds invested into a business in exchange for a preferred stock. This is a company’s primary source of funding, and equity capital can come in several forms: public, private, etc. Typically, public and private equity are in the form of a stock representing a company with shares available to be purchased. Public equity is raised by listing the company’s shares on a stock exchange whereas private equity is raised within a limited group of investors. This concept is similar to trading capital as trading capital is the amount of money given to an individual or business to buy and sell different assets.
Fun fact: the best time to raise equity capital is when a firm goes public and does an initial public offering (IPO). For instance, if Finatic hypothetically were to become a public business, I would be more than happy to purchase a bunch of shares :).
Conclusion
Capital and money can be confused with each other, but their respective functionalities are different. There are three main types of capital: debt, working, and equity capital. Debt capital is the capital received by borrowing from private or government sources, working capital measures a company’s ability to meet short-term financial obligations, and equity capital refers to the money invested in exchange for a preferred stock. Numerous other opportunities, like assessing how effectively a company is employing its resources, can be taken advantage of when having a solid understanding of these different sorts of capital. If there is one thing to takeaway from this article, it’s that the term “equity capital” relates to initial public offerings, and if Finatic were to go public, make sure to buy some shares in it (I personally will).
