Real capital is equipment and machinery reported on a company’s balance sheet. These items are used in the production process of a company, making the goods or services sold to consumers. Financial capital — the cash generated from normal business operations — is how a company will pay for real capital. Major equipment or machine acquisitions may require funds from external sources, such as banks, lenders bond issuance, or sale of stock to investors.
Almost all companies will use some type of real capital in their business operations. These items are the long-term assets found on the company’s balance sheet. Long-term assets are traditionally classified as property, plant, or equipment. This breakdown helps create a separation for investors to know what assets the company owns and uses for its business. For example, manufacturing companies will be heavy on production machinery and equipment, whereas a distributor will have more warehouse facilities and moving equipment such as trucks or forklifts.
A downside to real capital is the amount of fixed expenses that can result from the acquisition of equipment and machinery. If a company requires external financing from a bank or lender to purchase these long-term assets, the company is subject to consistent monthly payments with interest. Banks are often unwilling to relieve companies from these monthly payments. This would result in financial loss to the financial institution. Therefore, the fixed costs from these bank loans result in a higher need for sales revenue.
Using external funds to finance equipment and machines will require companies to report this information on their balance sheets. Bank loans represent a portion of long-term liabilities, as the company will often have several years to repay the bank. Shareholder’s equity includes the sale of common and preferred stock to private investors or other companies. This results in a symbiotic relationship between real capital and financial capital. Equipment and machines will help generate revenues for the company. Generating financial capital for items that do not add value to the company can result in higher fixed costs that will eat away at the company’s profits.
The economic wealth of a company also involves the real capital information from a company’s balance sheet. A basic economic wealth formula is total assets less total liabilities. This figure represents more than just the company’s net income, which is an accounting figure. Economic wealth is often a more important figure because net income is an intangible figure. The physical assets and value generated over and above liabilities is what many investors often look at when valuing a company.
