Capital – SS2 Commerce Lesson Note (Third Term)

Capital in business refers to all the assets and property of a firm. Types of capital include fixed, circulating, liquid and working capital, as well as owner’s equity, loan capital and the share capital terms used by companies, such as nominal, issued, called-up and paid-up capital.

Behavioural objectives

By the end of the lesson, students should be able to:

• define capital in business;
• explain fixed, circulating, liquid and working capital, and capital employed;
• state the importance of working capital;
• explain owner’s equity, loan capital and reserve capital;
• distinguish between nominal, issued, called-up, paid-up and uncalled capital, calls in arrears and calls paid in advance.

What are the main types of capital?

1. Fixed capital: This refers to the assets of a firm with which the business is carried on, and which are used continuously in the process of earning income, e.g. buildings, machinery, fixtures and fittings.
2. Circulating or floating capital: This is the capital which is required regularly for production and which is always changing as the business operates, e.g. raw materials, finished goods (stock), cash and debtors.
3. Liquid capital: This is made up of cash-in-hand, debtors and bank balances of a firm. These are liquid assets because they can easily be converted into cash.
4. Working capital: This is the excess of the current assets over the current liabilities. To calculate working capital, the current liabilities are subtracted from the current assets.
5. Capital employed: This is the amount of capital invested by the owner or owners in the business. It is calculated by subtracting current liabilities from the total assets.

Why is working capital important?

1. Working capital helps to determine the liquidity position of an organisation.
2. It determines the funds available for the day-to-day running of the business.
3. It is used to purchase stock for sale, so more working capital indicates higher profit.
4. It helps to prevent capital from being tied down.
5. It is used to determine the solvency of the organisation.
6. It indicates that the organisation is not relying on finances from suppliers.

What are the other types of capital?

6. Owner’s equity, net worth or capital owned: This refers to the excess of total assets over total liabilities, i.e. the excess of fixed and current assets over total liabilities (long-term and current liabilities).
7. Loan capital or capital borrowed: This refers to long-term liabilities, for example debenture stocks and long-term bank loans, which are repayable after one year.
8. Reserve capital: This is the part of issued capital not yet called up. It is also known as uncalled capital. Reserve capital = Issued capital – Called-up capital.
9. Nominal or authorised capital: This is the maximum amount of capital which a company is authorised to raise, as stated in its Memorandum of Association. It is also called registered capital.
10. Issued capital: This is the part of the authorised capital that has been issued to shareholders for subscription. It may be the same as, or less than, the authorised capital.
11. Called-up capital: This is the part of the issued capital that shareholders have been required to pay up to date.

Example: A company has issued shares of ₦150,000 out of a nominal capital of ₦200,000. It may require shareholders to pay ₦0.60 for the time being out of the ₦1 due on each share. In this case, the called-up capital will be ₦90,000 and the remaining ₦60,000 will be the uncalled capital.

12. Paid-up capital: This is the part of the called-up capital which shareholders have paid. It refers to the sum received in cash by the company when it called on the shareholders to pay.

Example: Out of the ₦90,000 called up, the amount paid up by (or received from) shareholders might be ₦87,000.

13. Uncalled capital: This is the total amount of the issued capital that has not been called up. It is the balance between the issued capital and the called-up capital. It may be called on later when more capital is required.
14. Calls in arrears: This is the difference between the called-up capital and the paid-up capital. It is the part of the called-up capital which is yet to be paid by the shareholders after the call for payment has been made.
15. Calls paid in advance: This is the money received in advance of calls, i.e. the sum the company receives before calls are made for payment.

Evaluation

1. Define working capital and state how it is calculated.
2. Distinguish between fixed capital and circulating capital.
3. State three reasons why working capital is important.
4. Distinguish between nominal capital and issued capital.
5. A company has called up ₦90,000 and received ₦87,000 from shareholders. What is the amount of calls in arrears?

Assignment

1. The amount of capital which a new company proposes to be registered is called ___
   (a) called-up capital (b) nominal capital (c) issued capital (d) fixed capital
2. The excess value of the assets of a business over its liabilities is ____
   (a) capital owned (b) working capital (c) issued capital (d) reserve capital
3. Debenture is an example of ______
   (a) fixed capital (b) share capital (c) loan capital (d) working capital
4. Assets of a business which cannot be changed easily to cash are known as _____
   (a) floating capital (b) fixed capital (c) working capital (d) current capital
5. Capital owned is the same as _________
   (a) authorised capital (b) issued capital (c) net worth of a business (d) fixed assets of a business