Definition of Capital

Where the Word "Capital" Is Used Changes Its Exact Meaning

Gold coins on scale
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The meaning of "capital" is one of those slippery concepts that change somewhat depending upon the context. It's probably more confusing than not that all these meanings are closely related. Despite that, in each context the significance of capital is unique.

The General Meaning of "Capital"

In everyday speech, "capital" is used freely to denote something like (but not quite the same as) "money." A rough equivalent might be "monetary wealth" -- which distinguishes it from other forms of wealth: land and other property, for example.

This is different from its meanings in finance, accounting and economics. 

This isn't a call for more precise use of language in informal discourse -- in these situations this rough understanding of the meaning of "capital" will suffice. In specific areas, however, the meaning of the word becomes both more limited and more precise.

"Capital" in Finance

In finance, capital means wealth used for a financial purpose. "Start-up capital" is a well-known phrase that expresses the concept. If you're going to start a business, you're almost always going to need money; that money is your start-up capital."Capital contribution" is another phrase that can clarify what capital means in finance. Your capital contribution is the money and related assets you bring to the table in support of a business enterprise.

Another way of clarifying the meaning of capital is to consider money that's not being used for a financial purpose.

If you buy a sailboat, unless you're a professional sailor the money spent isn't capital. In fact, you might withdraw this money from a reserve set aside for financial purposes. In that case, although you're spending your capital, once it's spent on a sailboat, it's no longer capital because it's not being used for financial purposes.

"Capital" in Accounting

The word "capital" is used in accounting to include monetary and other assets used for business purposes. A businessperson, for example, might join partners in a construction company. His capital contribution might be money or a mixture of money and equipment or even equipment alone. In all cases, he has contributed capital to the enterprise. As such, the assigned value of the contribution becomes that person's equity in the business and will appear as a capital contribution on the company balance sheet. This isn't exactly different from the meaning of capital in finance; in the 21st Century, however, capital as used in financial circles generally means monetary wealth used for financial purposes.

"Capital" in Economics

Classical economic theory begins for all practical purposes with the writings of Adam Smith (1723-1790), especially Smith's Wealth of Nations. His view of capital was specific. Capital is one of the three components of wealth that define output growth. The other two are labor and land. 

In this sense, the definition of capital in classical economics may partially contradict the definition in contemporary finance and accounting, where land used for business purposes would be considered in the same category as equipment and facilities, that is, as another form of capital.

 

Smith compressed his understanding of the meaning and use of capital into the following equation:

Y = f (L, K, N)

where Y is the economic output that results from L (labor), K (capital) and N (sometimes described as "T", but consistently meaning land).

Subsequent economists have tinkered with this definition of economic output that treats land as separate from capital, but even in contemporary economic theory it remains a valid consideration. Ricardo, for instance, noted one significant difference between the two: capital is subject to unlimited expansion, whereas the supply of land is fixed and limited.

Other Terms related to Capital:

  • Capital consumption
  • Capital deepening
  • Capital intensity
  • Capital ratio
  • Capital structure
  • Capital augmenting
  • Human capital
  • Social capital