What is capital?
Capital is the financial resources a business uses to fund its operations and growth — sourced primarily from equity (shareholders) and debt (lenders). Capital appears on the right-hand side of the balance sheet as a claim against the assets that produce future cash flows.
Forms of capital
- Equity capital:
- Paid-in capital — cash invested by shareholders in exchange for shares.
- Retained earnings — accumulated profits not distributed as dividends.
- Preferred equity — hybrid with debt-like features and seniority over common.
- Debt capital: bank loans, bonds, convertible notes, lease liabilities.
- Working capital: short-term operating funds — current assets minus current liabilities.
- Venture capital: equity invested in high-growth, high-risk private businesses; covered separately in venture capital.
Cost of capital
Each capital source has a cost: equity demands a return (cost of equity, modelled via CAPM); debt charges interest (cost of debt, post-tax). The blended cost is the Weighted Average Cost of Capital (WACC):
WACC = (E/V × Re) + (D/V × Rd × (1 − T))
where E and D are equity and debt market values, V is total, Re and Rd are their respective costs and T is the tax rate. WACC is the discount rate used in DCF valuations and the hurdle rate for project investment decisions.
Capital allocation
The CEO and board’s most consequential job in a mature business: deciding where invested capital earns the highest risk-adjusted return — organic growth, M&A, share buybacks, dividends, or debt repayment. Public-market investors closely track return on invested capital (ROIC) relative to WACC; a sustained gap is the source of equity value creation.
Do: calculate ROIC quarterly and compare to WACC; document major capital allocation decisions with explicit IRR thresholds.
Don’t: stockpile cash on the balance sheet earning sub-WACC returns when better internal investments or buybacks exist.