Capital

What Is Capital?

Capital is what the owners commit to the business, as distinct from what it borrows. When a proprietor pays cash into the firm, or a company issues shares, that injection is capital. It funds the assets the business needs and represents the owners' claim on them. Over time, retained profits add to it, so the base grows without a fresh injection whenever the firm trades well.

A Pune manufacturer meets it at incorporation, when the promoters subscribe to shares, and again whenever they plough profits back rather than draw them out. Banks study the base closely: a firm asking for a large term loan on a slim owner cushion looks risky, while one where the owners have committed substantial funds of their own is treated as a safer bet — skin in the game.

Types of Capital

It takes several genuine forms, depending on source and purpose:

• Owner's / equity capital — Funds the proprietor, partners or shareholders contribute to the business.
• Working capital — Money tied up in day-to-day operations — current assets less current liabilities.
• Fixed capital — Funds locked into long-term assets such as a factory or machinery.
• Debt capital — Borrowed funds such as term loans; strictly a liability but part of the total capital employed.
• Reserve capital — Profits retained and set aside rather than distributed as dividend.

How Capital Works in the Books

Owner funds enter and move through the accounts along a defined route:

1. 1Owner injects funds

   Cash or assets brought in are evidenced by a bank credit or share application, the source event.

2. 2Record the entry

   Cash or the asset is debited and the capital or share-capital account credited.

3. 3Post to the owner's account

   The owner's or shareholders' ledger updates with the contribution.

4. 4Add retained profit

   At year-end, profit not withdrawn is transferred in, increasing the base.

5. 5Present within equity

   The closing balance appears under owners' funds or shareholders' funds on the balance sheet.

Capital: A Practical Example

A Pune trader starts with ₹15,00,000 of his own money, earns and retains ₹6,00,000 of profit during the year, and withdraws ₹2,00,000 for personal use, leaving a closing balance of ₹19,00,000. That figure is his real stake in the firm — the money at risk before any lender is repaid. When he approaches his bank for a cash-credit limit, this base is the first thing the manager checks.

Capital Under Indian Accounting Rules

For a company, share capital is issued and altered under the Companies Act 2013 and presented within 'Shareholders' Funds' on the Schedule III balance sheet, distinct from reserves and surplus. Owner funds and retained profit are measured on the accrual, double-entry basis required by Section 128 of the Act. For non-corporate entities the concept is the same, though the presentation follows the proprietor's or partners' capital accounts rather than a statutory format.

• Companies Act 2013 — Governs the issue, classes and alteration of a company's share capital.
• Schedule III — Presents share capital under Shareholders' Funds, separate from reserves.
• Section 128 — Requires owner funds and profit to be recorded on the accrual, double-entry basis.

Common Mistakes With Capital

Owner funds are misstated when personal and business dealings blur:

• Mixing personal and business money — Paying personal bills from the firm without recording drawings overstates the stake → route them through the drawings account.
• Calling a loan capital — Treating a repayable owner loan as capital overstates the stake → show it as a liability.
• Not transferring retained profit — Leaving profit unallocated understates the closing balance → transfer it at year-end.
• Ignoring drawings — Failing to deduct withdrawals inflates the owner's stake → reduce the balance by all drawings.

Related Accounting Terms

Terms that feed or sit beside capital:

• Revenue — Income that, once retained, grows capital.
• Expenses — Costs that reduce profit available to retain.
• Accrual Accounting — The measurement basis for capital and profit.
• Accounting Terms Glossary — Browse every accounting term in one place.