Financial Capital

Financial capital is any economic resource measured in terms of money used by entrepreneurs 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, i.e. retail, corporate, investment banking, etc. Financial capital or just capital/equity in finance, accounting and economics, is internal retained earnings generated by the entity or funds provided by lenders (and investors) to businesses to purchase real capital equipment or services for producing new goods/services. Real capital or economic 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. Capital, in the financial sense, is the money that gives the business the power to buy goods to be used in the production of other goods or the offering of a service. (The capital has two types of resources, Equity and Debt). The deployment of capital is decided by the budget. This may include the objective of business, targets set, and results in financial terms, e.g., the target set for sale, resulting cost, growth, required investment to achieve the planned sales, and financing source for the investment.

A budget may be long term or short term. Long term budgets have a time horizon of 5–10 years giving a vision to the company; short term is an annual budget which is drawn to control and operate in that particular year. Budgets will include proposed fixed asset requirements and how these expenditures will be financed. Capital budgets are often adjusted annually (done every year) and should be part of a longer-term Capital Improvements Plan. A cash budget is also required. The working capital requirements of a business are monitored at all times to ensure that there are sufficient funds available to meet short-term expenses.

The cash budget is basically a detailed plan that shows all expected sources and uses of cash when it comes to spending it appropriately. The cash budget has the following six main sections:

  1. Beginning Cash Balance – contains the last period’s closing cash balance, in other words, the remaining cash from last years earnings.
  2. Cash collections – includes all expected cash receipts (all sources of cash for the period considered, mainly sales)
  3. Cash disbursements – lists all planned cash outflows for the period such as dividend, excluding interest payments on short-term loans, which appear in the financing section. All expenses that do not affect cash flow are excluded from this list (e.g. depreciation, amortization, etc.)
  4. Cash excess or deficiency – a function of the cash needs and cash available. Cash needs are determined by the total cash disbursements plus the minimum cash balance required by company policy. If total cash available is less than cash needs, a deficiency exists.
  5. Financing – discloses the planned borrowings and repayments of those planned borrowings, including interest.

Financial capital generally refers to saved-up financial wealth, especially that used to start or maintain a business. A financial concept of capital is adopted by most entities in preparing their financial reports. Under a financial concept of capital, such as invested money or invested purchasing power, capital is synonymous with the net assets or equity of the entity. Under a physical concept of capital, such as operating capability, capital is regarded as the productive capacity of the entity based on, for example, units of output per day. Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power. There are thus three concepts of capital maintenance in terms of International Financial Reporting Standards (IFRS):

(1) Physical capital maintenance

(2) Financial capital maintenance in nominal monetary units

(3) Financial capital maintenance in units of constant purchasing power. Framework for the Preparation and Presentation of Financial Statements,

Financial capital is provided by lenders for a price: interest. Also see time value of money for a more detailed description of how financial capital may be analyzed. Furthermore, financial capital, is any liquid medium or mechanism that represents wealth, or other styles of capital. It is, however, usually purchasing power in the form of money available for the production or purchasing of goods, etcetera. Capital can also be obtained by producing more than what is immediately required and saving the surplus. Financial capital can also be in the form of purchasable items such as computers or books that can contribute directly or indirectly to obtaining various other types of capital. Financial capital has been subcategorized by some academics as economic or “productive capital” necessary for operations, signaling capital which signals a company’s financial strength to shareholders, and regulatory capital which fulfills capital requirements.