As you begin to seek funding for your business, exploring the different types of capital will allow you to make an informed choice. Within this context, capital refers to anything that benefits the owner, from economic assets to holdings such as intellectual property. If you can invest resources in something else to increase business profits, those resources are capital. In this guide, we explore and provide examples of four primary forms of capital: Financial capital, natural capital, human capital, and social capital.
Reviewing the facts about financial capital
Sometimes called investment capital or simply capital, financial capital is the funding you need to run your business. It covers the cost of inventory, equipment, real estate, marketing, and everything else you need to run your business. Financial capital examples include cash, credit lines, and stock holdings. Even hard company assets such as real estate are an example of financial capital when converted to cash flow.
Businesses have two main options for acquiring financial capital:
● Debt financing, which involves selling company bonds to investors in exchange for repayment on a regular schedule with interest, as well as traditional business loans and credit lines
● Equity financing, where you sell shares in the company’s future profits to interested investors, who may also have a stake in the firm’s operations
Access to these and other examples of financial capital provides an important measure of a company’s economic health. Financial capital has to cover the cost of working capital, which encompasses the daily operating expenses of the business. To calculate available working capital, you can either:
● Subtract the company’s current liabilities from its current assets; or
● Add the available inventory and accounts receivable and subtract the outstanding accounts payable
The main components of this form of capital—assets, debts, and equity—are outlined on the firm’s balance sheet and give insight into key performance metrics such as your company’s return on equity, debt to capital ratio, debt to equity ratio, and weighted average cost of capital (WACC), which measures how much your company pays to access financing.
Some experts define financial capital as internal economic capital. They designate external economic capital as other, different types of capital, including those described below.
Assessing reliance on natural capital
This type of capital is perhaps the most often overlooked in the corporate sector. Every business uses resources derived from nature, from forested paper goods to fresh water and fuel. Regulatory processes such as environmental licensing are also considered natural capital. The Corporate Finance Institute designates ecology, vegetation, animal life, and commodities such as minerals and oil as the four main categories of natural capital.
Understanding the value of this so-called natural capital can help ensure the sustainability of your business. When we consider natural resources complementary and take them for granted, we threaten the foundations of our economic stability.
The nonprofit organization Conservation International has developed a framework businesses can use to value their natural capital through its Capitals Coalition program. The Natural Capital Protocol outlines a process that involves:
● Determining how the company’s objectives depend on and impact natural resources
● Measuring the extent of these impacts and dependencies
● Collecting data about changes to the business model or operations to reduce these dependencies and impacts
● Measuring the resulting impact on natural resource reliance
Examples of common business impacts on natural resources include waste disposal, gas and chemical emissions, water and land use, and environmental disturbances such as light and noise pollution. In addition, your business may require natural capital for raw materials, recreation purposes, energy, water, utilities, and protection from floods and storms.
Evaluating the use of human capital
Employees are the prime example of this type of capital, which also encompasses each person’s knowledge, skills, experience, intellectual property, and other skills and characteristics. The Corporate Finance Institute divides human capital into a few subcategories, including social capital, skills-based capital, physical capital, and intellectual capital.
The Capitals Coalition has also developed a Social & Human Capital Protocol to guide the analysis of your business’s impact and dependence on individuals and societies. It follows a similar process as the Natural Capital Protocol but shifts the focus to corporate reliance on human resources.
The Forbes Tech Council stressed the importance of attention to this type of capital in the changing economic landscape in an editorial published in late 2020. Its author highlights the new Securities and Exchange Commission rule requiring public corporations to report human metrics alongside their financial health metrics. While key performance indicators for human capital use vary by industry, common questions to start your analysis may include:
● Are you able to attract qualified candidates for open positions?
● Is your hiring rate stagnant, or has it increased as the company grows?
● Do you struggle with absenteeism?
● Do you have a high turnover rate?
As noted by Forum for the Future, a healthy economy requires investment in human benefit, education, reward, training, and motivation. Investments in human capital can also lead to healthy business growth. For example, well-trained and motivated employees are often willing to invest the time and energy needed to develop new product ideas, go the extra mile for customers, or focus on maintaining high product quality.
Understanding the impact of social capital
Political Scientist Robert Putnam popularized the term social capital in the 1990s when he described it as “social networks and the norms of reciprocity associated with them.” The concept originated 100 years earlier, in recognition of the importance of relationships in business settings. Social capital is the value, either tangible or intangible, that comes from positive human interactions. This form of capital can lead to benefits like preferential treatment, valuable information, team building, and collaboration.
Of all the various forms of capital, social capital is the most difficult to quantify, since the connections to financial results are not always obvious and may not be fully realized for many years. This ambiguity sometimes leads businesses to leave building social capital to chance, relying on the personalities and natural abilities of employees to establish positive relationships both inside and outside the organization. Businesses can cultivate social capital proactively when they:
● Prioritize employee well-being and work-life balance.
● Foster transparent communication both inside the organization and when interfacing with suppliers, contractors, and customers.
● Encourage employees throughout the business to give honest feedback.
● Provide opportunities to support the community through volunteering and charity work.
● Promote diversity and equal opportunities at all levels of the organization.
● Invest in training, skill development, and career advancement initiatives.
Emphasizing ethical and socially responsible practices also builds social capital by improving company reputation and standing in the community. The team dynamics established through these positive activities also improves morale and employee retention, while establishing a more adaptive culture.
All forms of capital working together
The term capital is most often associated with financial capital, including assets, equity, and debt, but it is important to recognize the significance of each capital form and its impact on business success. Sustainable practices, resource preservation, and ecology, which generate natural capital, must be considered on a global scale, but each business can generate their own natural capital by reducing their emissions and waste. Human capital has been a hot topic for HR teams, especially in recent years, as companies seek out new ways to retain top talent.
Social capital, although less tangible than other forms of capital, demonstrates how the various types of capital interrelate. For example, a positive reputation garnered through ethical and honest business communication practices may help to attract workers. Retaining valuable talent will in turn help businesses to grow and innovate, thereby generating more financial capital in the long term. In this way, metrics like sustainability become more than buzzwords as the symbiotic relationships between capital types allow investments in each to improve the others.
Types of capital FAQs
Which type of capital is the most important?
Each type of capital is valuable, but human capital is often viewed as the most important and irreplaceable form of capital. The innovation, leadership, and experience brought by employees is what differentiates each business from its competitors.
When did the concept of natural capital originate?
The idea of natural capital was first introduced in the 1970s when economists including David Pearce challenged business leaders to include ecology, natural resources, and the environment within the context of business capital assessments.
What are some important elements of intellectual capital?
As a subset of human capital, intellectual capital can be thought of as the sum of a company’s collective knowledge. Elements of intellectual capital include employee experience and training, patents, trademarks, inventions, and elements of the culture that support innovation.
Are there other ways to acquire financial capital?
In addition to debt financing and equity financing, companies can secure additional funding by offering royalties in exchange for a lump sum investment, utilizing crowdfunding campaigns, securing government grants, and forging strategic partnerships or joint ventures with other companies.
What is the most valuable aspect of social capital?
Social capital encompasses many interactions that impact business outcomes. This includes the nurturing of key relationships over time. The honesty and trust factors that underpin these relationships should be considered the most important elements, since they ensure social capital continues to grow.