Financial capital
Economic resources used to buy what is needed to make products or provide services
From Wikipedia, the free encyclopedia
Financial capital (also simply known as capital or equity in finance, accounting and economics) is any economic resource measured in terms of money used by entrepreneurs and businesses 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 internal retained earnings generated by the entity or funds provided by lenders (and investors) to businesses in order to purchase real capital equipment or services for producing new goods 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).
IFRS Concepts of Capital Maintenance
To provide useful information, it may be necessary to classify equity claims separately if those equity claims have different characteristics.[1] Under the International Financial Reporting Standards (IFRS), the choice of the "Capital Maintenance" concept determines the accounting model used for preparing financial reports.
The Three Concepts of Capital Maintenance
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. |
Defining Financial and Physical Capital
Financial capital generally refers to saved-up financial wealth, especially that used in order to start or maintain a business. 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.[3][4]
Conversely, 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. This requires a measurement basis of current cost rather than historical cost.
Nature and Sources of Financial Capital
Financial capital is provided by lenders for a price: interest. It represents any liquid medium or mechanism that represents wealth, 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]
Subcategorization of Financial Capital
Academics and practitioners often subcategorize financial capital based on its operational or regulatory function:[6]
- Productive capital: Assets necessary for daily business operations.
- Signaling capital: Used to signal a company's financial strength to shareholders and the market.
- Regulatory capital: Capital maintained to fulfill mandatory capital requirements (e.g., for financial institutions).