Business Capital | Capital, Credit, Profits, Turnover, Hire purchase

Capital

Certainly! The term “capital” has different meanings and implications depending on the context in which it is used, such as economics, accounting, and in everyday language.

1. Economics Definition:

In economics, “capital” refers to the assets, resources, or financial wealth that can be used to generate income or production. It can be broadly categorized into three main types:

1. Physical Capital: This includes tangible assets like machinery, equipment, factories, and infrastructure that are used in production processes.
2. Human Capital: This refers to the skills, knowledge, education, and expertise of individuals that contribute to their productivity and earning potential.
3. Financial Capital: This involves money, funds, or investments that are used to support business operations, make investments, or generate returns.

In the context of economics, capital is a critical factor in economic growth and development.

2. Accounting Definition:

In accounting, “capital” is generally used to refer to the financial value invested in a business by its owners or shareholders. It is also known as “equity” or “owner’s equity.” It represents the difference between a company’s assets (what it owns) and its liabilities (what it owes). In simpler terms, it’s the residual interest in the assets of the company after deducting its liabilities. It’s essential for determining the financial health and net worth of a business.

3. Layman’s Definition:

Capital in business refers to all the assets and property of a firm.

TYPES OF CAPITAL

1. FIXED CAPITAL: This category pertains to the tangible assets owned by a company that are consistently utilized in its income-generating operations. Examples include buildings, machinery, fixtures, and fittings.
2. CIRCULATING OR FLOATING CAPITAL: This form of capital is essential for ongoing production and continually shifts as the business functions. It encompasses resources like raw materials and finished goods (such as stock, cash, and debtors).
3. LIQUID CAPITAL: Liquid capital comprises the immediate cash, debtors, and bank balances held by a firm. These assets are considered liquid because of their ease of conversion into cash.
4. WORKING CAPITAL: Working capital is calculated by deducting current liabilities from current assets. It signifies the surplus of resources available for day-to-day operations.
5. CAPITAL EMPLOYED: This denomination represents the capital infused into the business by the proprietor(s). It can be determined by subtracting current liabilities from total assets.
6. OWNERS’ EQUITY, NET WORTH, or OWNED CAPITAL: This term designates the surplus resulting from the subtraction of total assets from liabilities—specifically, the excess of combined fixed and current assets over the entirety of liabilities, encompassing both long-term and current liabilities.
7. LOAN CAPITAL or BORROWED CAPITAL: This category pertains to liabilities of a long-term nature. For instance, it includes debenture stocks and long-term loans from banks that are repayable beyond the span of one year.
8. RESERVE CAPITAL: This constitutes the segment of the issued capital that has not yet been called upon. It is alternatively recognized as uncalled capital. The formula for Reserve Capital is Issued Capital minus Paid-Up Capital.
9. NOMINAL or AUTHORIZED CAPITAL: This denotes the upper limit of capital that a company is legally sanctioned to raise, as indicated in its Memorandum of Association. It is also referred to as nominal capital or registered capital.
10. ISSUED CAPITAL: This represents the proportion of the authorized capital that has been allocated to shareholders through subscriptions. It may equal or be less than the authorized capital.
11. CALLED-UP CAPITAL: This signifies the section of the issued capital that shareholders have been obligated to pay up to the present date. For instance, if a company has issued shares totalling N115,000 from an authorized capital of N200,000, and shareholders have been summoned to pay N0.60 for each share out of the N1 due per share, the called-up capital would amount to N90,000, leaving an uncalled capital of N60,000.
12. PAID-UP CAPITAL: This corresponds to the portion of the called-up capital that shareholders have actually remitted. It denotes the sum physically received in cash by the company in response to the payment call. For instance, from the called-up capital of =N=90,000, the actual amount paid by shareholders might be =N=87,000.
13. UNCALLED CAPITAL: This encompasses the complete amount yet to be invoked from the issued capital. It signifies the difference between the called-up capital and the issued capital. This component may be solicited in the future when additional capital becomes necessary.
14. CALLS IN ARREARS: This encapsulates the variance between the called-up capital and the paid-up capital. It represents the section of the called-up capital that remains unpaid by shareholders even after the call for payment has been initiated.
15. CALLS PAID IN ADVANCE: This constitutes funds received before the official issuance of payment calls—essentially, sums collected by the company prior to requesting payments from shareholders.

IMPORTANCE OF WORKING CAPITAL

1. Working capital helps to determine the liquidity position of an organization.
2. It determines the fund available for the day-to-day running of the business.
3. Since it is used to purchase stock for sale more working capital indicates higher profit.
4. It checks against the tying down of capital.
5. It is used to determine the solvency of the organization.
6. It indicates that the organization is not relying on finances from suppliers.

Credit

Credit refers to the arrangement allowing a customer to obtain goods or services without immediate payment, relying on the belief that payment will be made in the future. Credit materializes when a seller authorizes a buyer to possess and utilize a product, with the expectation of eventual payment. This process involves the transfer of goods and services from the seller to the buyer for utilization without an immediate exchange of value.

Basis for credit:

Before granting credit, the following considerations are crucial:

1. Payment sources
2. Buyer’s income
3. Personal integrity
4. Payment timeframe
5. Present employment status

Benefits of credit-based sales:

The advantages of selling on credit encompass:

1. Promotion of bulk purchases: Credit stimulates customers to acquire larger quantities compared to their original intentions.
2. Access to goods without upfront payment: Customers can own and enjoy goods without an immediate monetary exchange.
3. Enhanced living standards: Credit sales enable buyers to afford items they initially deemed unattainable.
4. Addressing temporary cash needs: Credit serves as a solution for short-term cash requirements, allowing buyers to allocate available funds elsewhere.
5. Potential improvement of quality of life: For instance, credit is frequently used to purchase homes, making it possible to pay for items through installments.

Drawbacks of credit-based sales:

There are several disadvantages associated with credit sales:

1. Potential for excessive purchasing: Credit sales may tempt customers to surpass their intended purchases.
2. Price inflation: Buying on credit can result in sellers adding extra charges, leading to higher prices.
3. Capital immobilization: Selling on credit might tie up the seller’s capital in customers’ hands, potentially impacting business operations.
4. Non-payment issues: Some buyers struggle to repay their credit purchases.
5. Increased record-keeping demands: Credit sales require meticulous record-keeping of both sales and cash transactions.
6. Legal actions possible: Unpaid credit can lead to legal actions if the buyer refuses to pay.

Types of credit sales:

There are different categories of credit sales, including:

1. Hire purchase:

Hire purchase involves the buyer having possession and use of goods while the owner retains ownership until the final payment.

Characteristics of hire purchase:

1. Involves hire charges
2. Suitable for durable items
3. Requires documentation
4. Clearly states cash and hire purchase prices
5. Seller can reclaim goods if the buyer defaults
6. Ownership transfers only after the final instalment payment.

Advantages of hire purchase for the seller:

1. Accelerated turnover rate
2. Increased profitability through higher goods pricing
3. Facilitated promotion of durable products
4. Encouragement of large-scale production

Disadvantages of hire purchase for the seller encompass:

1. Possibility of legal actions
2. Challenge in reselling repossessed goods
3. Capital immobilization potential
4. Risk of customers defaulting, leading to bad debts

Mortgage:

A mortgage is a credit system in which building societies or mortgage banks assist individuals in purchasing property or houses by lending them a portion of the purchase price.

Key aspects (features) of a mortgage

1. The property serves as collateral security.
2. Interest is paid by the borrower (mortgagor).
3. The lender is referred to as the mortgagee.

Loan and Overdraft:

Loan refers to borrowed money from financial institutions or individuals, repaid over an agreed period at a set interest rate. An overdraft is a type of credit provided by banks, permitting customers to withdraw more than the funds available in their accounts.

1. Book-me-down:

Common among low-income earners, particularly in underdeveloped countries like Nigeria, book-me-down entails purchasing goods on credit and recording names. Payment is often made at the end of the month after receiving a salary.

2. Leasing:

Leasing involves a property owner granting exclusive possession to another for a fixed period in return for regular payments. For example, leasing houses.

3. Factoring:

Factoring involves selling trade debts to a factoring firm (bank) for immediate cash at a lower amount than the actual debt value. It pertains to purchasing and collecting accounts receivable or advancing cash based on accounts receivable.

4. Budget Account:

A budget account operates in departmental stores, where customers commit to monthly payments, enabling credit up to eight times that amount. Features of a budget account include its prevalence in advanced countries, limited shopping options, and popularity among high-income earners.

5. Conditional Credit Sales:

Conditional credit sales refer to agreements for goods sales (not hire) where full ownership is retained by the seller until all installment payments are made. The buyer gains ownership upon fulfilling certain conditions, usually complete payment of the purchase price.

6. Trading Cheque or Voucher:

In this credit system, a club issues vouchers allowing members to buy from specified local shops, with an added percentage paid at an agreed rate.

7. Finance House:

A finance house is a financial institution lending to individuals or businesses to facilitate purchases such as cars or machinery. While often part of commercial banks, finance companies operate independently.

8. Club Trading: Club Trading is a credit arrangement in which certain entities establish clubs to gather regular contributions from participants. These pooled funds can then be withdrawn at intervals to facilitate purchases at various stores.

9. Deferred Payment: Deferred Payment refers to a credit mechanism in which ownership and possession promptly transfer from the seller to the buyer upon an initial down payment. The remaining balance is settled at a later point. In this setup, if the buyer defaults on payment, the seller’s recourse is through legal action rather than reclaiming the goods directly.

Similarities between hire purchase and deferred payment

1. Involvement of durable goods in both hire purchase and deferred payment.
2. Requirement of an initial deposit in both systems.
3. Incorporation of installment-based payments and credit options.
4. Allowance for the hirer or buyer to utilize and enjoy the goods before full payment.
5. Assurance that the buyer gains possession of the goods in both credit methods.

Differences between Hire purchase and deferred payment

| Aspect               | Hire Purchase                  | Deferred Payment               |

| 1. Pricing            | Higher price charged           | Lower price charged            |

| 2. Goods              | Goods are on hire               | Goods are sold                  |

| 3. Favorability       | Favors the seller               | Favors the buyer                |

| 4. Repossession       | Seller can repossess goods      | Seller cannot repossess goods   |

| 5. Goods Durability   | Involves durable goods          | Involves less durable goods     |

LEASES/RENTALS:

In a lease arrangement, one party (lessee) is granted the privilege of utilizing an item and concurrently makes periodic payments (rentals) to the owner (lessor). Two primary types of leases exist:

1. Finance Lease: In this type, ownership of the asset is handed over to the lessee at the conclusion of the lease term.
2. Operating Lease: In this variation, the asset continues to be the property of the lessor even after the lease agreement concludes.

Rental and lease bear resemblance, albeit rentals typically encompass brief durations, while leases extend over longer periods.

CREDIT INSTRUMENTS

Credit instruments are written documents utilized for extending credit or effecting repayments in credit-related transactions. They encompass various forms such as:

1. Bill of exchange
2. Money order
3. Bank drafts
4. Cheques
5. Promissory Notes
6. Credit Cards
7. Letter of Credit
8. Debentures
9. Bonds
10. I. O. U

Profit

Profit refers to the financial gain or positive difference between the revenue generated from a business’s activities and the expenses incurred in running that business. It is essentially the amount left over after deducting all costs and expenditures from the total revenue. Profit is a key indicator of a business’s financial performance and success, as it reflects the ability of the business to generate more income than it spends to operate.

Types of profit:

1. Gross Profit: This is calculated by subtracting the cost of goods sold (COGS) from the total revenue. COGS includes all the direct costs associated with producing or acquiring the goods that were sold. Gross profit provides insight into a business’s ability to produce goods efficiently and manage production costs.

Gross Profit = Total Revenue – Cost of Goods Sold

2. Net Profit: Also known as the “bottom line” or “net income,” net profit takes into account all expenses, both direct and indirect, associated with operating the business. This includes operating expenses such as salaries, rent, utilities, marketing, and other overhead costs. Net profit provides a more comprehensive view of a business’s overall profitability.

Net Profit = Total Revenue – Total Expenses

Both gross profit and net profit are crucial measures for assessing the financial health of a business. High profits indicate that a business is generating healthy revenue and managing its costs effectively, while low or negative profits can signal potential financial issues and the need for improvements in operations, pricing, or cost management.

Turnover

This refers to the total net sales during a period.  The turnover is variously referred to as the stock turn, sales turnover or stock turnover.

THE RATE OF TURNOVER (or Rate of Stock – turn)

This refers to the number of times average stock is sold during a given period, usually a year.

It is calculated by dwindling the cost of goods sold by average stock.  This means that to find the rate of turnover first, the cost of goods sold must be calculated thus:

COST OF GOODS SOLD                                       N

Opening Stock                                                5,000

Add purchases                                               35,000

40,000

less: Closing stock                                          8,000

COST OF GOODS SOLD                                  32,000

 

OR

COST OF GOODS SOLD:                                          N

Sales                                                                            50,000

Less: Gross profit                                                      18,000

32,000

Secondly, the average stock must be calculated thus:

AVERAGE STOCK =          OPENING STOCK + CLOSING STOCK

2

=          5000 + 8000      =   13000  =  N 6,500

2                         2

Finally, find the rate of turnover:

Rate of Turnover =   Cost of goods sold

Average Stock

=          32,000

6,500

FACTORS AFFECTING THE RATE OF TURNOVER OF A BUSINESS

The number of times a trader buys goods and resells them determines the size of his gross profit.  In other words, a trader’s gross profit can be increased by boosting his rate of turnover.  The various measures to be applied to increase the rate of turnover of a business can be inferred by considering the following factors which affect the rate of turnover.

1. Nature of the product.
2. Advertisement and Sales Promotion
3. Location of the business.
4. Goodwill or reputation of the seller
5. Prices
6. Wide variety of products offered for sale
7. Reliability and frequency of supply
8. Credit facilities.
9. Application of modern sales techniques e.g. self services that encourage impulse buying
10. Number of sales outlets or branches of the business.

See also:

PARTNERSHIP: TYPES, ORDINARY PARTNERSHIP & LIMITED PARTNERSHIP

PARTNERSHIP: FORMATION, ADVANTAGES, DISADVANTAGES & CHARACTERISTICS

BUSINESS UNITS & SOLE PROPRIETORSHIP

COMMUNICATION

STOCK EXCHANGE