Financial capital refers to economic resources, in terms of money, that individuals, companies, and governments have to finance their needs. Individuals use it, for example, to buy daily necessities. The company uses it to purchase equipment and raw materials.
Examples and characteristics
Money is a form of financial capital. Other examples are stocks and bonds. Although not all parties want it, you can exchange it for some cash. Financial capital provides a flow of future benefits in the form of interest, coupons, or capital appreciation.
The two main characteristics of financial capital are:
- Has monetary value
- Provides a flow of future benefits
For example, suppose you invest Rp1 million in shares in a company. You cannot use stocks to buy goods or services directly. By buying shares, you expect stock prices to rise in the future so that your money increases. When you need it, you can convert it to cash to buy some goods and services.
Furthermore, in business, companies use financial capital to buy physical capital, such as machinery or equipment. From cash inflows, they hold it as cash, and the rest they invest in deposits or other financial instruments.
When a company doesn’t have enough internal cash, they can choose the option to issue shares or debt securities. That way, they can raise funds from the capital market.
This type of capital can take the form of bank loans, bonds, or medium-term notes. Borrowers, both individuals, companies, and the government, must pay the loan principal along with interest.
The advantage of debt is that the borrower does not have to share profits because it does not represent ownership. But, they have to pay back the principal plus interest, regardless of their financial condition.
Failure to repay can lead to bankruptcy and confiscation of the borrower’s assets.
Unlike debt, equity represents ownership of the company. And because of that, the owner of the company must share profits with investors.
Companies can obtain share capital by issuing initial shares. Or, the alternative is from partners, venture capitalists, or angel investors.