What Capital Is in Corporate Finance
Everything that makes up a corporation and everything a corporation owns, including the building, equipment, office supplies, brand value, research, land, trademarks, and everything else, are considered assets. Believe it or not, when you start a corporation, that company’s assets aren’t just included in a Welcome Letter; you have to go out and acquire them. Generally speaking, you start off with cash, which you then use to purchase other assets.
For most new companies, this cash consists of a combination of the following:
The owner’s own money: This money is considered equity because the owner can still claim full possession over it.
Small loans, such as business and personal loans from banks, business and personal lines of credit, and government loans: The money obtained through loans is considered a liability because the corporation has to pay it back at some point. In other words, these loans are a form of debt.
The combination of these two funding sources leads to the explanation of the most fundamental equation in corporate finance:
Assets = Liabilities + Equity
The total value of assets held by a company is equal to the total liabilities and total equity held by the company. Because the total amount of debt a company incurs goes into purchasing equipment and supplies, increasing debt through loans increases a company’s liabilities and total assets.
As an owner contributes his own funding to the company’s usage, the total amount of company equity increases along with the assets. Note: Capital, assets, money, and cash are basically all the same thing at this point; after a company raises the original capital, or cash, it exchanges that cash for more useful forms of capital, such as erasable markers.
Unlike liabilities, equity represents ownership in the company. So if a company owns $100,000 in assets and $50,000 was funded by loans, then the owner still holds claim over $50,000 in assets, even if the company goes out of business, requiring the owner to give the other $50,000 in assets back to the bank.
For corporations, the equity funding varies a bit, however, because the owners of a corporation are the stockholders. The equity funding of corporations comes from the initial sale of stock, which exchanges shares of ownership for cash to be used in the company.