Business capital: types and sources: WASSCE Commerce

Every business, from a roadside kiosk to a mining company, needs money before it can earn any: to buy stock, rent premises and pay workers. That money is the business's capital. This lesson explains the different kinds of capital and where a business can get it.

Learning objectives

By the end of this lesson you should be able to:

define business capital
distinguish fixed, working, owned, borrowed and employed capital
explain the types of share capital in a company
describe the internal and external sources of business capital
classify sources of finance as short, medium or long term

What is business capital?

Definition

Business capital is the money and other assets used to start and run a business. It includes cash, stock, equipment, buildings and vehicles owned by the business.

Types of capital

Type	Meaning	Example
Fixed capital	Assets kept for a long time and used to produce or sell; not bought to resell	Buildings, machinery, vehicles, furniture
Working (circulating) capital	Current assets minus current liabilities: the funds that keep day-to-day operations going	Stock, debtors and cash, less creditors and overdraft
Liquid capital	Cash and assets quickly turned into cash	Cash in hand and at the bank
Capital owned	The owner's investment in the business: total assets minus liabilities	The trader's own money plus retained profit
Borrowed capital	Funds obtained from outsiders that must be repaid	Bank loans, debentures
Capital employed	Fixed assets plus working capital: the total funds used in the business

Share capital (companies)

Term	Meaning
Authorised (nominal or registered) capital	The maximum share capital the company may issue, stated in its Memorandum of Association
Issued capital	The part of the authorised capital actually offered to shareholders
Called-up capital	The part of the issued capital that shareholders have been asked to pay so far
Paid-up capital	The amount actually paid by shareholders
Uncalled capital	Issued capital not yet called up

Worked example

A company's share capital. A company is authorised to issue 1,000,000 shares of NLe 1 each. It issues 600,000 shares and calls up NLe 0.75 per share; shareholders have paid NLe 420,000.

Authorised capital = NLe 1,000,000
Issued capital = NLe 600,000
Called-up capital = $600000 \times 0.75 =$ NLe 450,000
Paid-up capital = NLe 420,000
Calls in arrear (called but unpaid) $= 450000 - 420000 =$ NLe 30,000
Uncalled capital $= 600000 - 450000 =$ NLe 150,000

Figure 1. Each kind of share capital is part of the one above it. WASSCE Tutor diagram.

Sources of business capital

Internal sources (from within the business)

Personal savings of the owner.
Retained (ploughed-back) profit: profit kept in the business instead of being withdrawn or paid as dividends.
Sale of unwanted assets.
Depreciation provisions set aside to replace assets.

External sources (from outside)

Source	How it works	Period
Family and friends	Informal loans or gifts	Short to medium
Bank overdraft	Permission to withdraw more than is in a current account, up to a limit	Short
Bank loan	A fixed sum repaid with interest over an agreed period	Short to long
Trade credit	Suppliers allow goods now and payment later (for example 30 days)	Short
Hire purchase	Use an asset while paying in instalments; ownership passes at the end	Medium
Leasing	Renting an asset (vehicle, machine) instead of buying it	Medium
Shares	Selling part-ownership of a company to investors	Long (permanent)
Debentures	Long-term loans to a company at a fixed interest	Long
Microfinance and cooperatives	Small loans to traders and small firms, often in groups	Short to medium
Government grants and schemes	Grants or cheap loans for priority sectors	Medium to long
Venture capital	Investors fund new, risky firms in exchange for a share of ownership	Long

Choosing a source

A business considers: the amount needed; the purpose and period (a building needs long-term funds; stock needs short-term); the cost (interest, dividends); security demanded by the lender; and whether the owners are willing to share control (selling shares brings in new owners).

In Sierra Leone

A woman who sells cooking gas in Bo may start with her own savings, add stock on trade credit from the depot, take a microfinance loan for a second set of cylinders, and later borrow from a commercial bank to buy a delivery tricycle on hire purchase. As her firm grows, so do the sources open to her.

Common mistake

Do not confuse working capital with capital employed. Working capital is only current assets minus current liabilities; capital employed adds the fixed assets as well.

Key points

Capital is the money and assets used to run a business.
Types: fixed, working (circulating), liquid, owned, borrowed, employed; companies also have authorised, issued, called-up and paid-up capital.
Internal sources: savings, retained profit, sale of assets. External sources: overdrafts, loans, trade credit, hire purchase, leasing, shares, debentures, microfinance, grants.
Sources are short, medium or long term; the choice depends on amount, purpose, cost, security and control.

WASSCE examination focus

WAEC tests this

Common questions: define and distinguish types of capital (especially fixed and working capital, or authorised, issued, called-up and paid-up capital), and explain the sources of capital for a sole trader or a company. Calculations on share capital often appear; set out each figure clearly with its name.

Quick check

What is working capital?
Distinguish called-up capital from paid-up capital.
Give two internal and two external sources of capital for a sole trader.
Why is an overdraft unsuitable for buying a building?

Answers: 1. Current assets minus current liabilities. 2. Called-up capital is the amount shareholders have been asked to pay; paid-up capital is the amount they have actually paid. 3. Internal: personal savings, retained profit (or sale of assets). External: any two of bank loan, overdraft, trade credit, hire purchase, family loans, microfinance. 4. An overdraft is short-term and repayable on demand, while a building is a long-term asset that needs long-term finance.

Business capital: types and sources