Corporate Capital

What Is Corporate Capital?

Corporate capital is the mix of assets or resources a company can draw on in financing its business.

Corporate capital results from debt and equity financing. In deciding on and managing their capital structure, a company's management has important decisions to make on the relative extents of debt and equity to maintain.

Understanding Corporate Capital

A corporation has several options for sourcing capital. Equity capital is one broad source with multiple components. Common shares and preferred shares issued by the company, as well as additional paid-in capital, are part of a company's equity capital. These types of equity permit outside investors the opportunity to take partial ownership in the company. Retained earnings, accumulated profits that have been reinvested in the business instead of paid out to shareholders, are another form of equity.

Debt capital is money borrowed from another entity that is due to be paid back at a later date, commonly with additional interest. Borrowings include fixed income securities, for example, loans, bonds, and notes payable. A company's capital structure could likewise include hybrid securities like convertible notes.

The decisions a company makes with respect to its corporate capital can affect the two its access to and cost of financing, tax liability (because of the favorable tax treatment, or tax shield, that debt receives), its credit rating, and ultimately its liquidity. In coming up with an optimal mix of debt and equity for its corporate capital structure, companies generally give critical weight to how much flexibility, in maintaining ownership control, financing, and managing the business, a given structure will provide them.

Managing Corporate Capital

How a company manages its corporate capital can reveal a great deal about the quality of its management, financial health, and operational efficiency. It's likewise an important part of valuation.

For example, a company whose retained earnings are growing could signal one with high growth prospects, for which it expects to use those accumulated earnings. It could signal one operating in a capital-intensive sector that needs to retain the vast majority of its profits rather than paying them out as dividends or returning them to shareholders by means of buybacks. It could likewise indicate a company with a lack of profitable investment opportunities. Consequently, retained earnings (RE) should constantly be reviewed in combination with other metrics of a company's financial health.

Key ratios to calculate for these purposes are total debt to equity (D/E), and long-term debt to equity. Both can provide a picture of a company's financial position by revealing how much financial leverage or risk is present in the capital structure.

The level and trend of the ratios over time is important. It is additionally important to assess how they compare to other companies operating in the same industry. Overly leveraged capital structures can point to developing or potential liquidity problems. Under leveraged structures could mean a company's cost of capital is too high.

Highlights

• Corporate capital includes any assets a company might use to finance its operations, and it could be derived through debt or equity sources.
• How a company manages its corporate capital can reveal a great deal about the quality of its management, financial health, and operational efficiency.
• Capital structure is the particular mix of debt and equity that make up a company's corporate capital.

FAQ

For what reason Does Debt Capital Cost Less than Equity Capital?

Debt capital, on average, is less costly than equity capital. One reason is that debt capital is often secured with collateral, so assuming the company neglects to pay its obligations, creditors can seize its assets. Creditors likewise have preference over equity shareholders in the event that a company goes bankrupt. A third reason is that interest on debt is often tax-deductible, lowering the company's tax bill.

What Is the Weighted Average Cost of Capital?

The weighted average cost of capital, or WACC, describes how much a company pays for the two its debt and equity capital. This is likewise the hurdle rate at which a company must generate revenues in order to be profitable.

What Is Capital?

In general, capital refers to the durable goods or assets (property, machinery, equipment, money) that are used as productive inputs for further production of goods and services. For a company, capital can be raised by issuing either debt (as a loan or by means of bonds) or equity (stock).