The concept of ‘capital’ is of fundamental importance for proper understanding and appreciation of the distinction between individual traders and partnerships on the other hand, and incorporated companies on the other hand. Strangely the word ‘capital’ is of many different applications in the economic, accounting senses and the legal with which we are concerned here.
Expressed at its simplest, we may say that whenever anyone starts a business he will put certain property into it. This property may be tangible money, land, furniture or stocks in trade or intangible as patents, copyrights, and trade secrets or the goodwill and connection of a going concern. Whatever the form of the property it will probably be convenient to place a monetary value upon it. If, for no other reason than, because this will facilitate the preparation of accounts and enable the proprietor to see what return he is getting for the property put in the business. Especially if this is so, if two or more persons are trading in partnership, the monetary valuation of their respective contribution will then become desirable in order to quantify the shares in which they are respectively entitled. The proprietors, therefore, put into the business assets which are given money value and they are credited with the value of their respective contributions in the books of the business.
Hence the owners of the business start with a fund of capital and their aim is to use this fund so that it increases and provides profits. These profits may either be taken out by the proprietors, or left in the business which in the latter case will start the next trading period with a greater capital. Of course the object of the proprietors may be defeated, the assets may not be increased by profits but may be diminished by loses. In this event the business will start the next year with a reduced capital, unless the proprietors decide to bring in further assets.
In other words, with the normal business ‘capital’ is simply a name given to the net worth of the business, the amount by which the value of the assets exceeds the liabilities. And since double-entry book-keeping has made it traditional to prepare financial statements so the debits and credits are balanced, in the old style balance sheet the assets will be shown on the right hand side and the liabilities on the left, with “capital” as the balancing item. By this process, the actual ‘capital’ of the company is known to all.