Definition of capital (economics): Capital in economics represents the wealth of tangible assets and other resources which can be put to use to provide goods and services.
Definition of capital (finance): Capital in finance refers to the total collection of finance a company or individual has at their disposal.
Definition of capital (accounting): Capital in accounting is used to mean ‘share capital’, meaning the funding provided by equity investors by buying shares issued by the company.
What does capital mean, and how is it used in a sentence?
The three definitions above have slightly different meanings within the different financial disciplines.
Economics ‘capital’ is the broadest usage of the term. Anything that a business owns could be considered capital.
When you hear the phrase, ‘It is very capital intensive‘, this is the economic usage. The speaker is implying that a lot of property, machinery and other assets are needed to perform a process.
The accounting definition of capital is the most specific. Share capital is a very specific form of obligation formed from ordinary shares being issued by a company to shareholders.
Share capital is often quoted on the face of the balance sheet as follows:
Share capital: £3,000,000 (2020), £3,000,000 (2019).
The finance definition of capital lands somewhere in between. It expands beyond the accounting definition of share capital to encompass any financing that a company has raised. This could include loans as well as equity.
If you hear references to the ‘capital structure‘ of a company or comments that a business is ‘under-capitalised’, this is the finance definition at play.
The capital structure refers to the balance between equity (low risk) and debt (high risk) which a company uses. Debt is always seen as higher risk, because borrowers often have the right to take a company to court and liquidate its assets if it is unable to pay. Shareholders have no such right.
When a commentator gives the opinion that a company or bank is under-capitalised, they are stating that the company has accumulated a dangerous level of debt, and should raise more equity finance (or pay back the debt) to restore the balance.
About this definition of capital
As you will have realised, it may be quite easy to read the word capital in a piece of financial commentary and be confused as to exactly what the author means.
In a general sense, you can always replace the word ‘capital’ with ‘resources’ if this helps you make sense of the sentence.
How does the definition of capital relate to investing?
Venture Capital Trusts are a type of investment vehicle which provide loans or equity investments to private businesses. These are an exotic asset class which is restricted to sophisticated investors.
You will also notice that a lot of fund managers, particularly hedge funds include the word ‘capital’ in their name. This merely emphasises that they manage the wealth of others.