Capital Cost: What Is It?
July 28, 2023
When building a business, there are plenty of costs on your mind. From cash flows to interest rates to tax rates to daily operational costs to financing repayment, and the list goes on and on. Some of these costs are ongoing, while others are one-and-done. Knowing the difference between these cost types can be helpful for a variety of reasons, but most importantly, it can help you keep your balance sheet orderly and your operations smooth.
One cost that is often discussed is capital cost. Capital is a common word that is used when discussing business finances, but exactly what are capital costs, and why are they so crucial for a business owner to understand? In this blog, we will break down a few things about various cost structures, define capital cost, and how it might pertain to you and your business.
Capital Cost Definition
To understand what capital cost is, it helps to know its definition. The definition of a capital cost is a one-time expense used in the production of goods or services for your business. This cost is a fixed cost, meaning it is an established cost that will be written in your balance sheet and not be ongoing.
Capital costs are not recurring costs, and they can pertain to a wide range of items. They can refer to land or buildings, for example. They can refer to the materials used in manufacturing a new facility or office complex. They can be parts or labor for a particular project
They can even be items purchased for incorporation into your larger processing (if goods are your game). Basically, these are the fixed costs (or fixed assets, if you will) that make your operation commercially productive. You cannot continue without these expenses. Therefore, it goes without saying that they are extremely important.
It Takes Money to Make Money
The old saying about how it takes money to make money is absolutely true, and capital costs are the definition of that statement. Without these capital costs, you would not be able to get your business off the ground, whatever type of business that might be.
Whatever items you need to make your business operational, from building materials to physical labor to digital services, all fall into your capital cost bucket. And if you have not budgeted for these capital costs, this is the first place you should start. Calculate the cost of what you need and take it from there.
Different Types of Capital
Capital costs are only one aspect of business finances. There are certainly ongoing costs that keep a business operational. If you are looking to secure financing for your business, whether for capital costs to get it up and running or for ongoing costs to sustain the business during a period of growth, it is worth understanding the various types of capital that play a role.
There are all kinds of capital, but some are more common than others. Here are three types of capital that are worth keeping top of mind.
For those in the accounting department who are focused on making sure the books are balanced at the end of every month, equity capital is an important measure to be aware of. The cost of equity is essentially the current value of your business. In terms of equations, it is your assets minus your liabilities.
You likely see this referenced often when it comes to large businesses or public enterprises, but it is just as significant with small operations as well. It represents what your business is worth, which plays a role in many decisions going forward on your business journey.
Debt capital is a common form of expense that shows how much a business owes to its bank or lender. If you take out a loan to get your business off the ground, for instance, then your debt capital (or debt financing) is the total cost of debt that you owe back.
There are all sorts of rates of return and various details that play a role in how you pay back your debt, but debt capital is the total sum of those payments. Whether you took a significant long-term loan that will take you years to pay, or you took a short-term loan that you intend to pay back after the first quarter of profit, this is your debt capital.
Working capital is sometimes confused with equity capital, though the two are vastly different. The reason that some people conflate the two is the fact that they both consider assets minus liabilities. The difference is that equity capital focuses on the entire value of the business overall, and working capital focuses on day-to-day operations.
Working capital is the amount of money it takes to run to business. Everything from your payroll to your utility bill to the cost of manufacturing your products (or services) falls into the working capital category. After all, long-term growth is the overall goal, but you need enough capital to keep the lights on.
Capital assets differ by company and by industry, but they are always necessary. Understanding not only what a capital cost is, but also the various forms of capital is crucial to operating a successful business. Additionally, capital assets don’t just fall out of the sky.
Remember, it takes money to make money, and the professionals at Yarrow Financial can help you navigate your capital expenditures in a way that makes the most sense for you, and for your business.
Check your rate with our loan calculator, and get started on your journey toward capital growth today.