CAPITAL OF THE CORPORATION 1. Care in the use of terms.—In considering cor poration finance it is necessary at the outset, to learn its language and to distinguish carefully certain terms relating to capital and capitalization, particu larly the following: Capital Capital Funds Capital Investment Capital Assets Capitalization Capital Stock Authorized Capital Outstanding Capital The first four of these expressions refer to capital, the last four to capitalization.
The capital of a corporation consists of its assets. Land, buildings, machinery, stock, cash, patents and all other forms of property owned by the company constitute its capital. Throwing aside fine economic distinctions, we may state that, for practical pur poses, the value of assets is determined either by their earning power or by the price which they will bring in the market. The market price in turn is itself de termined mainly by earning power, since investors purchase securities for the dividends which they will bring, after making due allowance for depreciation, risk, etc. Productive efficiency, or earning ability, is therefore the prime test of the value of assets. In fact, the actual capital is seldom accurately known, altho it may be closely approximated by modern ac counting methods.
2. Capital literally, the words capital investment apparently refer to the actual or iginal cost of the assets of the company, the total amount invested in the business from every source. Since the assets fluctuate constantly in value, they are likely to be worth at any given time more or less than their original cost, and accordingly the capital in vestment and the capital have no fixed relation, ex cept at the time the investment is originally made. If a new company gets its money's worth, its capital in the beginning should equal the capital investment.
A less accurate, but more commonly used, defini tion refers to capital investment as the total amount received from the sale of the corporate securities. This definition eliminates the investment of new cap ital out of the profits of the business itself, on the theory that profits do not belong to the stockholders until they have been declared in the form of dividends, and that the investment consists only of contributions which security holders have made from outside sources. It is, of course, apparent that an increase
of capital out of earnings changes neither the cap italization nor the investment. On the other hand, the payment of unearned dividends reduces both assets and investment without affecting the extent of cap italization.
In this Text, we shall use the more popular defi nition, and refer to capital investment as the actual amount received by the company from the sale of its securities. Funds thus secured are known as capital funds, because they are invested permanently in the business and have been secured by increasing the out standing capitalization.
3. Capital and current capital of a concern consists partly of assets which are fixed or are essential to the business, known as capital assets, and partly in assets of a current nature, employed from day to day in conducting the business, but no partic ular part of which is essential to its continuance. These latter are known as current assets. Some com panies, such as steel mills, have a greater percentage of capital assets, whereas others, such as wholesale groceries, have a greater percentage of current as sets. Both together equal the capital of the concern.
Land, buildings, machinery and other similar items not regularly bought and sold by the company are capital assets. Raw and finished stock, cash, ac counts receivable, etc., are current assets. Current assets are not a part of the plant.
4. word "capitalization" is one of the most misused expressions in corporation finance. In addition to capital stock, corporations issue other securities known as notes and bonds. Capital secured from the sale of stock is called owned capital, where'as capital secured from the sale of notes and bonds is called loaned or borrowed cap ital. The ownership, control, management and risk of the enterprise is divided in various proportions among these securities. The term "capitalization" refers to the amount and character of the securities and. should be distinguished carefully from the key word "capital," which relates to the assets of the com pany and not to its securities.