In business, capital refers to the non-human assets held by a person, company, or economy to that can be used to generate income. This is distinct from human capital which refers to the production value of the skills and knowledge of people working for the organization in question. In the day-to-day workings of a business, capital is the collective term for resources that produce value for the business, typically with the goal of covering short and long-term operating costs. While money is sometimes referred to as capital, this only applies if the money is contributed to the business for the purchase of assets which are used to grow its value through investments, spent to obtain assets that generate more value, or used to cover operational costs. Capital is also referred to as capital assets, which fall under two types: long-term assets, assets held for more than a year before converting to cash; and short-term assets, assets held for less than a year before converting to cash, often central to the day-to-day workings of a business.
Capital is divided into multiple categories that have different functions in a business environment. All forms of capital assets are reported on a company's balance sheet, a financial statement that indicates a business's health and management of capital assets. Human capital, as a distinct resource from capital assets, is not recorded on the balance sheet. A business's balance sheet can reflect how the company manages capital assets in the following contexts: capital gains, capital losses, capital structure, capital improvements, capital expenditure, and capital tax.
Different resources a business has can be counted as capital, such as:
- Physical assets, like buildings and machinery, used in a business setting to produce value.
- Money invested in stocks and bonds, or used to expand a business's production capabilities.
- Most assets that generate value for a person or business are capital, with the exception of human abilities.
- Intellectual property, patents, and trademarks.
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Capital Gains
Capital gains are the profits made from the sell of a capital asset or investment. Capital gains, unlike revenue, are accumulated over a long period of time through the possession of an asset. A common capital gain process involves the purchase of a building for one sum of money, holding the building for a period of more than one year, followed by the sale of the same building at a profit. Another example for the digital age is purchasing a domain name for a website and then selling it to another party for more money than was paid originally.
Capital Loss
Capital losses are any losses a business incurs through the turnover of capital assets. Whereas capital gains are associated with an increase in income, capital losses are a loss of income for the business. For example, when a building or domain name is sold for less money than the business paid for it originally, this incurs a capital loss.
Capital Structure
In the finances of a business, capital structure refers to the ways that the business uses debt and equity to obtain and manage capital assets, typically reflected on the balance sheet. The balance of debt and equity, the business's capital structure, is an easy way to assess a business's relationship with risk and profit. For example, investors may use the capital structure of a business to decide whether or not they would risk losing money by investing.
Capital Improvements
When a business invests time and money into permanently improving a capital asset, this is called a capital improvement. Capital improvements come with specific tax exemptions from the IRS and can lead to capital gains if the asset is later sold for a higher profit than it would have before the capital improvement. Going back to buildings and websites as examples, adding a new production wing to a building through a permanent construction project, or permanently upgrading a website's HTML format to a newer version, could be counted as capital improvements.
Capital Expenditure
Unlike money as capital (when money is used to increase profit), capital expenditures are funds used to maintain a capital asset so that it retains its value. Maintenance costs can vary by industry and asset, but when a business spends money on existing capital assets to keep its regular operations functioning like normal, the money spent is a capital expenditure. For example, repairing the broken bay door of a warehouse, thereby enabling dock workers to move additional product out of the warehouse, would be a capital expenditure.
Capital Tax
A capital tax, sometimes "long-term capital gains tax," is a specific type of tax payment required by the government that is applied to profit made on the sale of capital assets and is typically a much lower tax rate than income tax. To qualify for a capital tax rate, the asset must be in the business's possession for over one calendar year. Capital taxes can apply to physical capital like buildings and cars, or to money as capital like investments and stocks.
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