Total capital

From CEOpedia | Management online

Total capital is a total sum of resources which are employed in a business (R. Kotas 2014, 158). Capital can be defined as an income or output producing capacity (J.W.Kendrick 1994, 1). Term "capital" also refers to accumulated wealth. Usually it is also defined as alienable objects, buildings and machines. In economics "capital" originally referred to accumulated sum of money, which could be invested (P. Mpanza 2018,37).

Capital has many different definitions(R. Kotas, 2014, 157-158):

  1. Capital may be defined as total capital, that is any investment and total fixed and current assets. Correct definition of profit in this case would be total of all dividends, debentured interest and undistributed profit.
  2. Defining capital as ordinary share capital the definition is the sum of dividends with undistributed profits. It also means there's a need to exclude debenture interest and preference dividends.
  3. Another, different definition of capital regards long-term capital. Correct defining of profit would be then the sum of all dividends, debentured interest and undistributed profit, same as in total capital.
  4. Finally, if we want to define capital as the total of shareholders’ capital, preference as well as ordinary ones, we must describe profit as the sum of dividends which are paid plus undistributed profits.

Small businesses may only have ordinary shares in cases like that capital base is taken as total capital or ordinary shareholders’ capital. Contrary to that, a business which have ordinary and preference shares have three ways of measuring return on capital (R. Kotas 2014, 158).

Capital in accounting

Company's capital structure usually is presented in a capitalization table. This table shows proportion of capital issues and their position. Each capital issue is shown in relation to total capital of the company and each other(D.R. Carmichael, L.Graham 2004,28).

There are three debt ratios - debt to total capital, total debt at book value and debt to equity (D.R. Carmichael, L.Graham 2004,27-28):

  1. Debt to total capital ratio based on the balance sheet can be calculated as total current and long term debt plus capitalized leases divided by total capital consisting of total debt, stockholder's equity and leases.
  2. Debt to equity ratio can be calculated as total current and long term debt plus capitalized leases divided by total stockholder's equity.
  3. Total debt at book value can be defined as total debt at book value divided by total debt and preferred stock plus common stock at market.

They are used to estimate relationship between equity and debt.

Capital Adequacy Ratio

In 1988 The Basel Agreement established minimum level of capital of companies. Minimum level of capital was that could cover financial risk. Next, in 1996 Committee amended the agreement from 1988. This amended added a capital charge so either standardized and the internal methods have the same market risk. Banks can evaluate and adjust capital charge for market risk based on internal models or provided models. Banks can also calculate market risk also by procedures conformed to particular qualitative and quantitative standards. Bank should add their market risk charge to credit risk charge, to obtain total capital adequacy requirement (T.S.Y Ho, B.L. Sang 2004, 602)

Credit risk is calculated based on the system of weights for either off-balance and for balance items. Based on this division assets have been spilt into four groups. Weights of risk (0%, 20%, 50%, 100%) have been assigned to them according to connected to hem risk. This system was a big step in calculating capital's adequacy ratio but also was criticized for identical treatment of non-financial entities and the credits (A. Białas, A. Solek 2010, 51).

Final version of new document regarding the capital adequacy measurement was presented in 2004 in the New Capital Accord. The committee proposed to present three complementary pillars of capital adequacy(A. Białas, A. Solek 2010, 51):

  1. Minimum capital requirement - consists of determined minimal requirements of capital adequacy and include credit, optional risk and market.
  2. Supervisory Review Process - authorities gain additional opportunities to assess if capital is satisfactory for the scale of risk, they can monitor the state of capital,
  3. Market Discipline - banks through procedures and reports have to disclose information about risk and the level of capitalization

Examples of Total capital

  • Financial capital: This is the amount of money that a business has available to use for investments, operations, and other expenses. Financial capital can include cash, investments, and other liquid assets.
  • Human capital: This refers to the skills, knowledge, and abilities of the employees in a business. This includes the expertise of the staff in a certain industry, their education and qualifications, and their ability to work effectively as part of a team.
  • Intellectual capital: This is the collective knowledge and experience that a business has accumulated over time. This can include patents, trademarks, and copyrights owned by the business, as well as any research and development undertaken by the company.
  • Physical capital: This refers to the tangible assets that a business owns, such as buildings, equipment, vehicles, and machinery. It also includes any raw materials or inventory that the business has on hand.

Advantages of Total capital

Total capital is an important measure of a business’s financial and operational health. It includes all of the financial and physical assets of the business, along with other resources such as intangible assets, human capital, and intellectual property. Having a strong total capital base provides many advantages, including:

  • Increased liquidity: Having a large total capital base enables the business to have access to more liquid assets, such as cash and marketable securities, which can be used to finance operations and meet short-term debt obligations.
  • Increased financial flexibility: Having a larger total capital base allows the business to finance more projects and investments, giving it more financial flexibility. This can be beneficial in uncertain business environments, where businesses need to be able to quickly adjust to changing markets.
  • Reduced risk: Having a larger total capital base can help to reduce risk, as the business will have more resources to fall back on in the event of unexpected losses or liabilities.
  • Improved credit rating: Having a larger total capital base can improve the business’s credit rating, which can help to reduce the cost of borrowing and make it easier to access capital.
  • Increased access to capital markets: Having a larger total capital base can also help to increase the business’s access to capital markets, as investors may be more willing to provide financing to a business with a large total capital base.

Limitations of Total capital

Total capital has certain limitations, which are as follows:

  • It does not provide a complete picture of a company’s financial health, since it does not include intangible assets such as intellectual property, goodwill, or brand recognition.
  • Total capital does not take into account the costs associated with debt, such as interest payments and principal payments.
  • Total capital does not adequately reflect the actual potential for growth and profitability of a company, since it does not account for external factors such as the competitive environment, economic factors, and regulatory changes.
  • Total capital does not measure the efficiency of a company’s operations and may not provide an accurate picture of the company’s performance over time.
  • Total capital may not accurately reflect the actual value of a company’s assets, since it does not factor in market conditions or the current economic climate.

Other approaches related to Total capital

Total capital is a total sum of resources which are employed in a business (R. Kotas 2014, 158). Other approaches related to total capital are:

  • Physical capital, which includes all of the tangible assets such as buildings, equipment and inventory.
  • Financial capital, which includes all of the financial resources such as cash, marketable securities and accounts receivable.
  • Human capital, which includes the knowledge, skills, and abilities of an organization’s employees.
  • Intellectual capital, which includes the intangible assets like patents, copyrights and trademarks.
  • Natural capital, which includes renewable and non-renewable resources, such as land, water, minerals and forests.

In summary, total capital is an important concept in business and it consists of various different types of capital including physical, financial, human, intellectual, and natural capital.

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Author: Jolanta Jańczy