What exactly is capital again?
Fundamentally, capital is the way that wealth is measured. It also includes any assets that individuals and companies use to increase wealth. Capital is often found in liquid assets or cash reserves, and the things that lead to the procurement of both. Generally speaking, capital can also extend into inventory, real estate, and operational equipment. Anything a company can use to increase its equity or wealth might be considered capital.
There are many different types of capital. Each ensures that the business itself will remain profitable and sustainable and that it can continue to procure income. Fundamentally, all types of capital tend to fall within four categories. Here are four types of capital everyone should know about:
Debt Capital
In business, the age-old phrase, “You have to have money to make money” stands tall. But where is all of that money supposed to come from? Debt capital allows businesses to grow by borrowing money in the form of a loan or line of credit directly from a financial source whether that be a bank, financial institution, governmental organization, or private source.
It is not uncommon for smaller startups to rely on money from familial sources, credit card companies, or smaller, more lenient organizations that provide more financial flexibility.
So what’s the catch? Receiving debt financing is not a one-and-done process. Business owners have to regularly repay their principal, interest (cost of debt) included. If a company struggles to make their interest payments, they can end up in more debt than they can manage to pay back.
While interest can feel burdensome to many, debt capital is actually one of the easiest ways for small businesses to hit the ground running without crowded feedback and input from other stakeholders.
Aside from freedom and ownership, a business loan can actually be the most affordable option vs. equity capital. Repayment usually happens over a longer period of time and a loan allows a company to raise a large sum of money upfront, which is crucial for prompting investor interest. Once debt funds have been invested in growth, businesses are able to leverage additional revenue to pay down their debt over time.
Equity Capital
You probably know about equity, but let’s set some parameters.“Equity capital” describes any funds given to a company in exchange for a given percentage of ownership. A well-understood way companies raise equity capital is through the stock market — each purchase of a stock in a publicly traded company represents a share of equity.
But equity capital also refers to private transactions. Early-stage startups can raise equity, typically from venture capital funds or from friends and family. When investors invest in startups, they are assuming the value of the company will increase as the company scales (in effect, the cost of equity or rate of return). The growth returns a profit back to the investor.
Although business owners don’t technically need to pay back equity investors like they would with a lender, equity capital can come at a high cost. For example, if a direct-to-consumer brand sells 90% of its company to investors, it might not enjoy much of any financial benefit by any future exits. At that point too much of the company has already been sold for an acquisition or a listing on a stock exchange to be at all fruitful.
When evaluating whether equity capital is right for your business, it’s important to ensure your growth projections are aligned with the expectations of your investor. Relationships with investors are long-term partnerships. Everyone should be on the same page.
Working Capital
Working capital is less of a source of capital and more of an accounting term. Rather than a source of funds or investment, working capital refers to the liquid assets a company uses to perform its day-to-day operations.
Typically, net working capital is calculated by calculating the difference between current assets and current liabilities. Current assets include inventory, cash, production tools, accounts receivable, or anything else that is used to create profit in the short-term while current liabilities refers to accounts payable directly.
For e-commerce and CPG companies, maintaining enough working capital can be a constant challenge. To do so requires companies to align revenues with COGS, which can be difficult for young brands that aren’t yet able to negotiate favorable terms with suppliers.
Human Capital
Yes! This one counts too. While all the other three fundamental sources of capital are financial, the importance of human capital cannot be understated. You’ve probably heard it said before — people can be the greatest capital asset of any company.
It’s not just about how many hires you have. The term “human capital” refers to the collective intelligence and skills of the individual contributors at a company. A deficit of human capital can be just as risky as not having enough financial capital. Even if you have enough funds to invest in growth, you need a team of people to bring that strategy to life.
In traditional cases, human capital can refer to physical work that people do within a company, such as manual labor, social influence, and operation of tools. People who work in these functions ensure that the company stays operational. For tech companies, human capital could refer less to operational skills and more to the intellectual contributions of the team. Regardless, investing and measuring human capital is essential to the success of any small business.
How to Capitalize on cash flow management
A business is fueled by its capital sources — but its success is contingent on cash flow management. Whether funding takes the form of debt, equity, working, or human capital, the flow of funds is critical to keeping your business operational and growing.
Settle is the all-in-one payment platform that helps new and established businesses streamline finances to scale faster. Unlike other payment platforms, Settle helps free up capital by providing companies the option to pay vendors upfront, so they can align their COGS (cost of goods sold) with their revenue from sales.
Settle makes it easy to pay all your bills in one place, and gives you the flexibility to scale your business without giving up ownership or agreeing to difficult loan terms. You get cash sooner and can use it to grow your business without taking out bank loans or seeking more venture funding.
Sources:
- What is Capital? | Corporate Finance Institute
- Capital | Investopedia
- Equity capital definition | AccountingTools.com.
