Question

What is financial capital?Why is it vital to decision making and the success of an enterprise?Why aren’t profits alone sufficient?

Answer 1

Financial capital is that money and that economic resource that enables a company to produce goods and provide services. In other words financial capital are those assets that are needed by a company to provide goods (if it is a manufacturing company) or provide services (if it is a service provider company). Sources of financial capital are mainly debt and equity.

Financial capital is vital to decision making and to the success of an enterprise mainly because it enables the enterprise in its pursuit of future revenue. A company undertakes several different activities to ensure generation of revenues in future and it is in this aspect that financial capital is important for a company. For example companies will acquire plants and equipment using its financial capital and the plant and equipment will produce goods in future that can be sold to generate revenue on a consistent basis.

Profits alone are not sufficient as in many cases profits (and the accumulated retained earnings balance) alone cannot allow a company to buy capital goods. Purchase of capital goods often requires use of debt or equity. Profits have a limitation in the sense that they depend on the amount of revenue earned from sale of goods and the amount of expenses incurred while selling those goods. Thus the amount of profits is often limited. On the other hand a company can raise financial capital to the required quantum either by issuing debt instruments like bonds etc. or by issuing equity shares.