Before we start discussing what is financial capital, let us first define it in simple terms. Financial capital is any particular economic resource measured in current dollars that companies and entrepreneurs use to purchase what they need to create their own products or to give their services to the economy in which their operation depends, i.e. retail, investment banking, corporate, etc., so that their operation depends on the market, consumer behaviour and supply and demand in the market. If you want to earn more profit or reduce your risk in starting a new business then you have to be able to convert your present funds into money that will serve as capital for your business.
Definition of Financial Capital
- Basically, financial capital is any tangible resource measured in monetary units that entrepreneurs can use to purchase their goods or provide their services to the market of the economy in which their business operates, e.g., retail, corporate, real estate, investment banking, etc.
- Financial capital is any financial asset measured in monetary units that are used by entrepreneurs or companies to purchase what they require to create their productive assets or to give their services to the market of the economy in which their operation is centered, i.e. retail, commercial, institutional, investment banking, etc.
There are many ways in which businesses can make use of their capital. First and foremost, they can convert their retained cash into capital employed in their businesses. Cash is considered the funds used primarily for purchasing raw materials, inventory, fixed assets, plant and machinery, goodwill and the retained earnings of the business. The latter refers to the latter portion of retained earnings that would not return to the owner in the foreseeable future. One can easily calculate his/her retained earnings by subtracting his/her fixed assets from the value of his/her retained earnings.
Second, the entrepreneurs can make use of their financial capital to purchase working capital and working expenses incurred during the startup of the business. Capitalization of capital means the extent to which the total value of all the assets and liabilities combines to determine the actual capital employed in a business. The difference between net worth is the amount of actual financial capital employed in a business. Net worth is what remains after the deductions of liabilities and the net value of the firm. Financial capital in the form of retained earnings refers to all the net profits that would not be returned to the entrepreneur due to his/her loss of investment in the business.
Third, the entrepreneur can make use of his/her financial capital to acquire other firms. Unlike the previous two options, this option does not require much information on the financial condition or history of the firms to be purchased. It only requires information about the products and services the firm wishes to sell and the price at which these products and services are sold. One major advantage of this capital structure is that it allows small businesses to acquire large firms. Also, what is the financial capital in simple terms is what one needs in order to get access to international markets.
Fourth, the entrepreneur can utilize his/her retained earnings to fund the development and expansion of the business. This capital structure also makes it possible for entrepreneurs to expand their business beyond the boundaries of their residence and city/state. However, what is the financial capital as such is not that simple. There are many restrictions and requirements that need to be fulfilled by an entrepreneur before he/she can be allowed to use retained earnings to finance his/her company’s growth.
Fifth, the entrepreneur can make use of borrowed money from financial institutions or banks in order to finance the growth of his/her business. Although the amount of loan that will be sanctioned depends on the company’s current market value, an amount above what is considered as secure and reasonable loan is what is being used as financial capital. Another option that an entrepreneur can go for is debt capital. Debt capital represents a loan from a financial institution to a company. However, what is financial capital is something that depends greatly on the current market values.
Sixth, the company can use its retained earnings to purchase raw materials that are essential in the production of its products. What is financial capital as such is not that easy to define or describe. In fact, it is a combination of different capital structures. This is why there are so many capital structures out there.
What is financial capital, then, is a very elusive concept in the world of business. Many people have tried to explain to entrepreneurs and others what capital means and has offered no solutions. Consequently, many entrepreneurs try to create their own capital structure that best fits their needs. Unfortunately, creating one’s own financial model is usually very risky. This is because one could very well end up losing everything if things don’t work out the way that they expected them to.