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):
- 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.
- 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.
- 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.
- 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):
- 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.
- Debt to equity ratio can be calculated as total current and long term debt plus capitalized leases divided by total stockholder's equity.
- 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):
- Minimum capital requirement – consists of determined minimal requirements of capital adequacy and include credit, optional risk and market.
- 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,
- Market Discipline – banks through procedures and reports have to disclose information about risk and the level of capitalization
- Białas M., Solek A. (2010), Evolution of capital adequacy ratio, "Economics & Sociology", no.2, 51
- Carmichael D.R., Graham L. (2004), "Accountants' Handbook, Financial Accounting and General Topics", John Wiley & Sons, 28,
- Ho T.S.Y. , Lee S. B. (2004), The Oxford Guide to Financial Modeling: Applications for Capital Markets, Corporate Finance, Risk Management and Financial Institutions, Oxford University Press, 602,
- Kendrick J.W. (1994), Total capital and economic growth, Atlantic Economic Journal, 1,
- Kotas R. (2014), Management Accounting for Hotels and Restaurants, Routledge Taylor & Francis Group, London and New York, 157-158,
- Mpanza P. (2018), The impact of forms of capital on Corporate Entrepreneurship in SOEs, Lambert academic publishing, 37
Author: Jolanta Jańczy