Capital Base
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Capital base- it is a term that describes a company's capital structure used a way of assessing the company's worth. Used by individual investors publicly traded companies, and banks to refer to a base level of funding. In the financial sector, it refers to a specific amount.It is the basis for measuring profitability, which allows you to gather basic information about a given company[1].
The capital base is the foundation for the work of a banking institution. Equity or capital base is the number of funds that will be distributed among the shareholders of a banking institution in the event of bankruptcy of the enterprise (loss of license, closure). The presence of equity guarantees banking institution stability in the banking sector and complete independence. Equity or capital base is the number of funds that will be distributed among the shareholders of a banking institution in the event of bankruptcy of the enterprise (loss of license, closure)[2].
Capital base in the overall structure of the bank’s resources
Commercial banking institutions for the normal conduct of business need financial resources, that is, certain resources. Moreover, the bank's capital can be represented as a combination of finances that are at the disposal of the structure and are used to carry out certain banking transactions. According to the peculiarities of formation, the capital of a banking institution can be divided[3]:
- own funds (capital base): money received from the shareholders of the company at the time of creation and in the process of doing business, available reserves and so on. A feature of such capital is the possibility of its use without any time limit. In turn, the share of equity (capital base) is about 20%. In the best case, this indicator can reach 30%.
- attracted funds: customer money that is received in the form of deposits for a specific period of time or on-demand. In addition, borrowed capital obtained from credit enterprises can also be attributed to this category. As a rule, the total share of such funds is about 80% of all resources of the institution.
The main functions of the capital base
The capital base performs several important functions[4]:
- Protective function. The presence of equity is a certain security buffer for a banking institution, which allows covering current losses (if any) before global decisions are made by the management of the banking institution. At the same time, the bank can continue its activities, not paying attention to current losses.Also, the presence of a powerful capital base allows the bank to make risky transactions to increase its capital. This is a big plus, because losses that occur in the process of unsuccessful transactions will always be covered by equity. In turn, customer money remains intact. If the bank loses its license, it will always be able to compensate for current debts to depositors or lenders.
- Regulatory function. The capital base is a powerful regulator of the bank, through which certain standards of economic behavior are set. Thanks to this, the bank is reliably protected from increased risks. If you look at the current legislation, the basic economic norms are based on the volume of the capital base of a banking institution. The scale of the structure's activity depends on this factor. The more personal funds, the greater the volume of active operations a bank can perform.
- Operational function. Own funds are the main source of the formation of material resources and the development of the capital base of a banking institution. For example, at first, the authorized capital performs the function of start-up funds, which are used to purchase the necessary equipment, rent or erect buildings, hire workers, and so on. Without such funds, the bank simply cannot begin its activities.As it develops, the company expects to receive additional capital, expand the range of its services, as well as introduce the latest banking technologies. In this case, the bank's funds also act as the main source.
- Pricing function. The larger the capital base of the bank, the stronger the trust on the part of the client and the less the risk of cooperation with a financial institution. In turn, a banking institution, as a lender, will be able to satisfy all requests for consumer and commercial loans. In the case when a bank is organized in the form of a joint-stock company, the value of its shares largely depends on the amount of equity. And the most important thing. In the case of assessing the total value of a banking institution, the main parameter is always the number of net assets, that is, the capital base.
Sources of Capital Base
- Equity Capital: Equity capital is the money that is invested in a company by stockholders. It is the capital that is raised by issuing shares, and is generally used to fund the growth and operations of the business.
- Debt Capital: Debt capital is the money that is borrowed from an external lender. It is typically used to fund a company’s expansion or to finance operations. The debt capital is usually paid back with interest.
- Retained Earnings: Retained earnings are the profits that are accumulated over time and are not paid out to shareholders. These earnings are reinvested back into the company to finance growth and operations.
- Venture Capital: Venture capital is a type of financing that is provided by venture capitalists, who are typically individuals or firms that are willing to invest in a company in exchange for a stake in the company. Venture capital is often used to fund the development of new products or to finance the growth of a company.
- Angel Investors: Angel investors are individuals or groups of individuals who invest in a company in exchange for equity. Angel investments typically involve a large sum of money, and the investors may be involved in the day-to-day operations of the company.
Advantages of Capital Base
The capital base is an important tool for investors to assess the financial health of a company. It provides a base level of funding and offers several advantages, including:
- Increased Financial Stability – A higher capital base can provide a company with more financial stability, allowing it to withstand market volatility and unexpected costs. This can give investors more peace of mind since they know their investments are more protected.
- Enhanced Credibility – Having a strong capital base can increase a company’s credibility in the eyes of potential investors and lenders, making it easier to access capital in the future.
- Increased Profitability – A higher capital base can help a company increase its profitability. This is because a company can reinvest more of its profits and use the additional capital to pursue new opportunities.
- More Flexible Financing – A higher capital base can provide a company with access to more flexible financing options. This can be especially beneficial for companies that need to make quick decisions and need access to capital quickly.
Limitations of Capital Base
The capital base of a company can have several limitations. These include:
- The capital base might not be sufficient to finance a company's growth and expansion plans. This can limit a company's potential to increase its market share and increase profits.
- The capital base may be too small to attract investors and potential buyers. This can prevent a company from raising additional funds to fuel its growth.
- The capital base may be too large and thus not be efficient in terms of its allocation. This can lead to a company having too much money tied up in assets that are not generating returns.
- The capital base may be difficult to adjust in a timely manner to take advantage of market opportunities. This can lead to missed opportunities and reduced profits.
- The capital base may be subject to changes due to macroeconomic conditions, government regulations, and other external factors. This can lead to sudden and unexpected changes in the capital structure of a company.
Capital base is a term that describes a company's capital structure used as a way of assessing the company's worth. Other approaches related to capital base include:
- Asset Based Financing: Asset based financing is a form of financing that relies on the value of a company’s physical assets, such as accounts receivable, inventory, and equipment, to secure a loan.
- Equity Financing: Equity financing is a type of financing that involves selling ownership stake in the company in exchange for capital.
- Debt Financing: Debt financing is a type of financing in which a company borrows money from a lender in exchange for regular payments.
- Venture Capital: Venture capital is a type of financing in which an investor provides capital to a company in exchange for an ownership stake.
In summary, capital base is a term used to refer to a company's capital structure, but there are other approaches related to it such as asset based financing, equity financing, debt financing, and venture capital.
Footnotes
References
- Bahalla V.K., (2008), Working Capital Management, Uniwersity of New Delhi, New Delhi.
- Franse de Weert, (2011), Bank and Insurance Capital Management, J.Wiley & Sons Ltd., Chichester.
- Imeokparia L., (2015), Capital Base and Performance of Money Deposit Banks in Nigeria: Pre and Post Consolidation Era
- Kahn M.Y., Jain P.K., (2005), Basic Financial Management, McGraw-Hill Offices, New Delhi.
- Kashyap A., Stein J., (2004), Cyclical implications of the Basel II capital standards
- Prachi Juneja” and Reviewed By Management Study Guide Content Team, (2019), Managerial Economics.
- Rakhi S., (2019), Notes on Managerial Economics.
Author: Andrii Poliman
