Capital Structure of a Business

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The term capital has several meanings, and it is used in many business contexts. In general, capital is accumulated assets or ownership.

Origins of the Term "Capital" 

The roots of the term "capital" go back to Latin, where the term was capitālis, "head," and Medieval Latin capitale "wealth.".

The word "capital" is also used as a basis for other words. For example, capitalism" is a system in which wealth and property (capital) are owned by private individuals rather than a state. 

Another term based on the term "capital" is "capitalist." A capitalist, in the simplest terms, is someone who invests money in making more money - a "profit" (net income).

Capital in Business

Business owners are capitalists because they own capital. This capital is in the form of assets (things of value). Capital is a necessary part of business ownership because businesses must use assets to create products and services to sell to customers.

  • Capital is the amount of cash and other assets (things with value) owned by a business. These business assets include accounts receivable, equipment, and land/buildings of the business.
  • Capital can also represent the accumulated wealth of a business, represented by its assets minus liabilities.
  • Capital can also mean stock or ownership in a company. A capitalist is also a stockholder. 

Capital for Tax Purposes

The IRS uses the term capital assets to describe assets that are used to generate a profit. These assets aren't easily turned into cash and they are expected to last more than one year. A building, equipment, vehicles, are examples of capital assets.

Capital Structure of a Business 

The capital structure of a business is the mix of types of debt and equity the company has on its balance sheet. You can figure out the capital situation of a business by knowing how much debt it has.

Capital structure is sometimes referred to as a company's debt to equity ratio. This ratio divides the company's total liabilities by its shareholder equity. It measures how much of the company is financed by debt.

Capital Used in Other Business Terms

Other associated terms which relate to the term "capital" in a business situation are:

Capital gains and losses are increases or decreases in the value of stock and other investment assets when they are sold.

Capital improvements are improvements made to capital assets, to increase their useful life, or add to the value of these assets. Capital improvements may be structural improvements or other renovations to a building, or they may enhance usefulness or productivity.

Venture capital is private funding (capital investment) provided by individuals or other businesses to new business ventures.

A capital lease is a lease of business equipment which represents ownership and is shown in the company's balance sheet as an asset.

A capital contribution is a contribution of capital, in the form of money or property, to a business by an owner, partner, or shareholder. The contribution increases the owner's equity interest in the company.

Business Capital and Taxes

Capital Gains

Individuals and businesses that have capital gains must pay tax on them. Capital gains taxes are payable at a different rate from ordinary business gains. Short-term capital gains are taxed as ordinary income to the individual and corporations pay short-term capital gains tax at the regular corporate tax rate of 21%. Long-term capital gains (held more than a year) are taxed at different rates, depending on the individual's income .

Capital gains tax rates and rules depend on business type:

For businesses filing business income on their personal tax return, see "About Schedule D (Form 1040)"

For businesses filing a corporate tax return, see About Schedule D (Form 1120)

Capital Assets

The expense of buying or improving the asset must be capitalized. That means it must be depreciated spread out over time) rather than being taken as an expense in the first year of ownership.

Some expenses for capital assets are capitalized, and some are considered expenses. Capital improvements on an asset, which add to an asset's value, must be capitalized, are distinguished from deductible repairs, which are minor.

For example, here are some deductible repairs:

  • wallpapering and painting
  • caulking seams
  • repairing a roof
  • mending plaster
  • replacing retaining walls, tuckpointing

Here are some capital improvements:

  • installing new doors or windows or replacing doors and windows
  • replacing a roof
  • installing an air conditioning or ventilation system 
  • installing a burglar alarm system
  • improving a storefront

Business startup costs are a special situation. Most of the cost of business startup, including organization costs, must be depreciated. But there is an exception: You can deduct (as an expense) up to $5,000 of business startup costs and $5,000 of organization costs (for registering and forming your new business) in the first year.