Corporate Capital

What is Corporate Capital?

Corporate capital is the mix of assets or resources a company can draw on in financing its business. Corporate capital results from debt and equity financing. In deciding on and managing their capital structure, a company's management has important decisions to make on the relative proportions of debt and equity to maintain.

Understanding Corporate Capital

A corporation has several options for sourcing capital. Equity capital is one broad source with multiple components. Common shares and preferred shares issued by the company, as well as additional paid in capital, are part of a company’s equity capital. These types of equity allow outside investors the opportunity to take partial ownership in the company. Retained earnings, accumulated profits that have been reinvested in in the business instead of paid out to shareholders, are another form of equity.

Debt capital is money borrowed from another entity that is due to be paid back at a later date, typically with additional interest. Borrowings include fixed income securities such as loans, bonds, and notes payable. A company’s capital structure might also include hybrid securities such as convertible notes.

The decisions a company makes with respect to its corporate capital can affect both its access to and cost of financing, tax liability (because of the favorable tax treatment, or tax shield, that debt receives), its credit rating, and ultimately its liquidity. In coming up with an optimal mix of debt and equity for its corporate capital structure, companies generally give significant weight to how much flexibility, in maintaining ownership control, financing, and managing the business, a given structure will provide them.

Managing Corporate Capital

How a company manages its corporate capital can reveal a lot about the quality of its management, financial health, and operational efficiency. It’s also an important part of valuation. For example, a company whose retained earnings are growing might signal one with high growth prospects, for which it expects to use those accumulated earnings. It might signal one operating in a capital-intensive sector that needs to retain most of its profits rather than paying them out as dividends or returning them to shareholders via buybacks. It might also indicate a company with a lack of profitable investment opportunities. For these reasons, retained earnings should always be reviewed in combination with other metrics of a company’s financial health.

Key ratios to calculate for these purposes are total debt to equity, and long-term debt to equity. Both can provide a picture of a company’s financial position by revealing how much financial leverage or risk is present in the capital structure. The level and trend of the ratios over time is important. It is also important to assess how they compare to other companies operating in the same industry. Overly leveraged capital structures can point to developing or potential liquidity problems. Under leveraged structures might mean a company’s cost of capital is too high.