Capital

Capital Definition

The term "capital" has different meanings. Economists speak of capital as a third economic factor for production as a whole. In business, the term appears as equity or debt in corporate balance sheets.

Capital in economics

In economics, capital is a production factor. In this context, the capital of an economy describes the stock of production resources that can be used to produce goods or services (capital stock). Capital also includes the following, and not only include money.

• machinery


• Tools


• Company buildings


• Infrastructures such as computer systems or created processes

The other two factors of production in economics are labor and land. The latter is fixed by natural conditions such as the availability of mineral resources. The labor, on the other hand, is variable: it brings together all potentially active persons of an economy.

The combination of labor, capital, and land comes in simplified ratios to produce the gross domestic product or the potential performance of an economy. This is known as optimal allocation of resources Because the land is fixed. Hence, labor and capital can be exchanged to a certain extent. The best example of this is industrialization. 150 years ago many farmers had to cultivate a single field. Today, thanks to machines, many fields are handled by a single person, just because capital has taken the place of labor.

Capital in the commercial sense

Capital also plays a major role in the business administration. In the balance sheet, capital is shown on the liabilities side and designated as claims on the assets of a company. For example, a company that owns shares is the capital investor for a stock corporation and is entitled to have the share in company profits or the redemption of its capital when the securities are sold.

Capital Must be distinguished from the liquidity. Liquidity describes the possibility of a company to properly fulfill its claims against third parties. An example will illustrate the difference between capital and liquidity:

• A company purchases goods from a supplier for EUR 15,000. The supplier then supplies the goods and makes an invoice, which must be settled within two weeks.


• The company has a lot of equity, a total of more than 3 million. The problem is that equity is in the form of machines and buildings. These three million euros are therefore not directly available to the company - if no machines or buildings are sold.


• The settlement of the account of the supplier can only be settled by means of capital, which has a high liquidity, i.e. availability. The company must have at least € 15,000 in the form of cash or bank deposits in order to settle the claims.


• If the liquidity is not available, the company is threatened with insolvency - even though on balance sheet, three million euros of equity are listed.

Types of Capital

There are important delimitations between capital types both in business administration theory and in the economic sense. In business economics, a distinction must be made between leverage and equity:

• The differentiation between the types of capital is justified by the legal position of the investors.


• Equity owners participate in the company's profits and leave their capital for an indefinite period within the Group. In the event of a company insolvency, equity investors are not entitled to repay the invested capital. Examples: transfer of private assets to individual companies, purchase of shares, participation in a limited liability company


• However, borrowers provide their capital only for a limited period of time. They receive their capital completely, including a consideration - usually an interest rate. If the company has to file for insolvency, the debtor's claims are fulfilled before anyone else. Examples: bank loans, corporate bonds

In the economic sense, we can differentiate between real capital and human capital. Both terms are also used in business administration. The Real capital describes all means of production such as machines or tools as well as money since this can be used directly to finance production resources.

Human capital, however, is the performance potential of the labor force, which is affected by training and education. Training and education increase the efficiency of this factor of production.

For example, the earning power of workers can be encouraged by a high degree of schooling or vocational training. Which requires high financial expenditures - that is, the use of capital. For this reason and because human capital is difficult to measure, economists consider both the concepts separately.