Financial capital


Financial capital

Financial capital is money used by entrepreneurs and businesses to buy what they need to make their products or provide their services.

Financial capital vs. real capital

Financial capital refers to the funds provided by lenders (and investors) to businesses to purchase real capital like equipment for producing goods/services. Real capital comprises physical goods that assist in the production of other goods and services, eg. shovels for gravediggers, sewing machines for tailors, or machinery and tooling for factories.

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, or economic 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.

ources of capital

* Long Term - usually above 7 years
** Share Capital
** Mortgage
** Retained Profit
** Venture Capital
** Debenture
** Project Finance

* Medium Term - usually between 2 and 7 years
** Term Loans
** Leasing
** Hire Purchase

* Short Term - usually under 2 years
** Bank Overdraft
** Trade Credit
** Deferred Expenses
** Factoring

Capital market

* Long-term funds are bought and sold:
** Shares
** Debentures
** Long-term loans, often with a mortgage bond as security
** Reserve funds
** Euro Bonds

Money market

* Financial institutions can use short-term savings to lend out in the form of short-term loans:
** Credit on open account
** Bank overdraft
** Short-term loans
** Bills of exchange
** Factoring of debtors

Differences between shares and debentures

* Shareholders are effectively owners; debenture-holders are creditors.
* Shareholders may vote at AGMs and be elected as directors; debenture-holders may not vote at AGMs or be elected as directors.
* Shareholders receive profit in the form of dividends; debenture-holders receive a fixed rate of interest.
* If there is no profit, the shareholder does not receive a dividend; interest is paid to debenture-holders regardless of whether or not a profit has been made.
*In case of dissolution of firms debenture holders are paid first as compared to shareholder.

Fixed capital

This is money which is used to purchase food that will remain permanently in the business and help it to make a profit.

Factors determining fixed capital requirements

* Nature of business
* Size of business
* Stage of development
* Capital invested by the owners
* location of that area

Working capital

This is money which is used to buy stock, pay expenses and finance credit.

Factors determining working capital requirements

* Size of business
* Stage of development
* Time of production
* Rate of stock turnover ratio
* Buying and selling terms
* Seasonal consumption
* Seasonal production
* Seasonal cost

Instruments

A contract regarding any combination of capital assets is called a financial instrument, and may serve as a
*medium of exchange,
*standard of deferred payment,
*unit of account, or
*store of value

Most indigeneous forms of money (wampum, shells, tally sticks and such) and the modern fiat money is only a "symbolic" storage of value and not a real storage of value like commodity money.

Capital vs. money

Liquidity requirements of these vary significantly — leading to a diversity of contracts and financial markets to trade them on. When all four functions are served by one instrument, this is called money, which does not need to be traded on financial markets since the risk of loss of value of money is uniform across the whole society. Where no one form of money is agreed to have reliable value, and barter is undesirable, less liquid or more diverse instruments have served the four functions. This article focuses mostly on financial instruments which are not uniformly affected by native currency inflation and which are not guaranteed by a state.

Own and borrowed capital

Capital contributed by the owner or entrepreneur of a business, and obtained, for example, by means of savings or inheritance, is known as own capital, whereas that which is granted by another person or institution is called borrowed capital, and this must usually be paid back with interest.

Borrowed capital

This is capital which the business borrows from institutions or people, and includes debentures:

* Redeemable debentures
* Irredeemable debentures
* Debentures to bearer
* Ordinary debentures

Own capital

This is capital that owners of a business (shareholders and partners, for example) provide:

* Preference shares/hybrid source of finance
** Ordinary preference shares
** Cumulative preference shares
** Participating preference share
* Ordinary shares
* Bonus shares
* Founders' shares

They have preference over the equity shares.Means the Payment made to the shareholders is done by firstly paying to preference shareholder and then to the equity shareholders.

Issuing and trading

Like money, financial instruments may be "backed" by state military fiat, credit (i.e. social capital held by banks and their depositors), or commodity resources. Governments generally closely control the supply of it and usually require some "reserve" be held by institutions granting credit. Trading between various national currency instruments is conducted on a money market. Such trading reveals differences in probability of debt collection or store of value function of that currency, as assigned by traders.

When in forms other than money, financial capital may be traded on bond markets or reinsurance markets with varying degrees of trust in the social capital (not just credits) of bond-issuers, insurers, and others who issue and trade in financial instruments. When payment is deferred on any such instrument, typically an interest rate is higher than the standard interest rates paid by banks, or charged by the central bank on its money. Often such instruments are called fixed-income instruments if they have reliable payment schedules associated with the uniform rate of interest. A variable-rate instrument, such as many consumer mortgages, will reflect the standard rate for deferred payment set by the central bank prime rate, increasing it by some fixed percentage. Other instruments, such as citizen entitlements, e.g. "U.S. Social Security", or other pensions, may be indexed to the rate of inflation, to provide a reliable value stream.

Trading in stock markets or commodity markets is actually trade in underlying assets which are not wholly financial in themselves, although they often move up and down in value in direct response to the trading in more purely financial derivatives. Typically commodity markets depend on politics that affect international trade, e.g. boycotts and embargoes, or factors that influence natural capital, e.g. weather that affects food crops. Meanwhile, stock markets are more influenced by trust in corporate leaders, i.e. individual capital, by consumers, i.e. social capital or "brand capital" (in some analyses), and internal organizational efficiency, i.e. instructional capital and infrastructural capital. Some enterprises issue instruments to specifically track one limited division or brand. "Financial futures", "Short selling" and "financial options" apply to these markets, and are typically pure financial bets on outcomes, rather than being a direct representation of any underlying asset.

Broadening the notion

The relationship between financial capital, money, and all other styles of capital, especially human capital or labor, is assumed in central bank policy and regulations regarding instruments as above.

Such relationships and policies are characterized by a political economy - feudalist, socialist, capitalist, green, anarchist or otherwise. In effect, the means of money supply and other regulations on financial capital represent the economic sense of the value system of the society itself, as they determine the allocation of labor in that society.

So, for instance, rules for increasing or reducing the money supply based on perceived inflation, or on measuring well-being, reflect some such values, reflect the importance of using (all forms of) financial capital as a stable store of value. If this is very important, inflation control is key - any amount of money inflation reduces the value of financial capital with respect to all other types.

If, however, the medium of exchange function is more critical, new money may be more freely issued regardless of impact on either inflation or well-being.

Valuation

Normally, a financial instrument is priced accordingly to the perception by capital market players of its expected return and risk.

Unit of account functions may come into question if valuations of complex financial instruments vary drastically based on timing. The "book value", "mark-to-market" and "mark-to-future" conventions are three different approaches to reconciling financial capital value units of account.

Economic role

Socialism, capitalism, feudalism, anarchism, other civic theories take markedly different views of the role of financial capital in social life, and propose various political restrictions to deal with that.

Finance capitalism is the production of profit from the manipulation of financial capital. It is held in contrast to industrial capitalism, where profit is made from the manufacture of goods.

See also

*banking
*capital
*capital market
*Capitalism
*finance
*Five Capitals
*funding
*money supply
*list of finance topics
*list of accounting topics
*spiritual capital


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