Types of Financial Capital

Sep 21, 2022 By Triston Martin

Equity, specialty and debt are the three kinds of financial capital available. There is also something known as "sweat equity," which, even though it is more difficult to quantify, is nonetheless important to bear when examining a tiny or newly established company.

Equity Capital

This represents a company's assets minus its liabilities, also known as the "net worth" or the "book value." Some companies only use stock capital as a source of funding. This may take the shape of funds invested by the company's shareholders or owners in a business that does not have any obligations that those investments may offset.

The fact that they don't have to pay this sort of capital back makes it the preferred method of financing for most companies, even though it may be rather pricey. Growing a business that has been supported in this manner might also require a significant amount of effort on the part of the business owner.

Debt Capital

A loan is a kind of financial assistance given on the condition that the money is repaid within a certain amount of time. Most of the time, a bank, a bondholder, or a rich individual will be the owner of the capital. Because you are utilizing their money, they are willing to receive interest payments from you in return.

Imagine the cost of "renting" the money to develop your firm as the interest charge your company incurs. The phrase "cost of capital" is often used to refer to this factor. It is estimated that over eighty percent of small firms in the United States depend on loans at least somewhat.

The Small Business Administration (SBA) is in charge of administering various programs that provide start-ups and small enterprises with access to venture capital. Long-term loans and loan-guarantee schemes fall into this category; they assist small firms in acquiring finance from other sources.

The difference between the rate of return on capital and the amount it took to create that capital is known as a company owner's profit. For instance, if a company borrowed $100,000 at a rate of 10% interest but made 15% after taxes, that company would not have been able to make a profit of 5%, which is equivalent to $5,000, if it did not have access to debt capital.

Specialty Capital

This is the gold standard, and as a business owner, you would be wise to find out more about it as soon as possible. There are a few different sources of capital that have almost no financial cost and have the potential to remove growth constraints.

Negative Cash Conversion

Let's say you run a retail outlet of some kind. To establish a new site, you need to have a capital investment of one million dollars. Most of the funding will go into purchasing or renting the land, purchasing product displays and equipment, purchasing merchandise to replenish your shelves, and hiring additional employees.

You throw open your doors, hoping that people will walk through them and purchase the products you have for sale. While this is going on, a portion of your capital is being held in the form of inventory. This capital might be in the form of debt or equity, or it could be a combination of the two.

Imagine if you could collect payment from your clients before you shell out money for the goods they purchased. Because of this, you would be able to stock a far larger variety of items than your current capitalization structure would normally permit. It is possible to do this via vendor financing.

Example of Vendor Financing

Imagine if the ABC firm successfully persuaded its suppliers to allow them to stock their wares in the company's stores while retaining ownership of the items until a client brought them to the register and paid for them. At this very time, the dealer is making a sale to ABC. In the end, ABC is the one who sells them to the client.

Because of this, ABC sites can grow at a far faster rate, and they can also return more money to the business's shareholders in the form of share repurchases. The payment of dividends in the form of cash is another possibility. They don't need to keep hundreds of millions of dollars in inventory, which frees up their capital.

One way to evaluate the level of vendor financing available is to compare the proportion of inventory to the number of accounts payable. The better off you are, the bigger the proportion. In addition to this, you will need to analyze the cash conversion cycle. A greater number of "negative" days is preferable in this particular scenario.

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