MEANING OF CAPITAL

Two schools of thought or views appear to hold sway in the definition of capital. These are the accountant point of view and the economist point of view.

The Accountant Point of View: Accountants define capital as the original fund or money with which a person used to start a business. It is the net worth of a business. He considers capital as synonymous with money. Capital in this wise is the owner’s equity in a business and the excess of assets over liabilities.

The Economist Point of View: Economists define capital as the resources or wealth made by man that are used for producing further wealth. These are properties of a firm which are meant to be used in the production of other goods. It includes such assets as machines, raw materials, buildings etc. To the economists capital is just one of the factors of production.



The Layman’s Understanding: To the layman, capital is the total amount of money for running a business.

 

TYPES OF CAPITAL

  1. Authorised, Registered or Nominal Capital: This is the total amount stated in the Memorandum of Association and approved by the registrar of companies which a company can issue out for subscription. Nominal capital is the total amount of capital which a company is authorised to issue out to the public. It limits the amount that can be issued out as shares.
  2. Issued Capital: This is part of nominal capital that the company decides to issue out to the public for subscription. It is the total shares offered to the public out of the nominal capital at a particular time.
  3. Called Up Capital: This is part of the issued capital that has actually been called up, and the shareholders have been asked to make payment. It is part of the issued capital which is expected of the shareholders to pay for.
  4. Paid Up Capital: This is part of the called up capital which the shareholders have actually paid for. It is the total amount paid up or credited as paid up on the issued share capital.
  5. Uncalled Capital: This is the total amount that has not been called up on the issued share capital. It can be referred to as part of the issued capital that is yet to be called up for payment.
  6. Capital Employed: This is the total assets, both fixed and current, less current liabilities. It is the actual amount of money and other assets used in the business. It can also be referred to as the total asset of a business and can be calculated as: Total Assets – Current Liabilities.
  7. Capital Owned: Capital owned is the owner’s financial interest in a business. It is the excess of total assets of a business over the value of its total short and long-term liabilities. In a summary, it is the net worth of a business.
  8. Fixed Capital: This is the durable capital of an enterprise which is used continuously for further production. They are not intended for immediate consumption, but rather as a means of production. It comprises assets of a firm which are of durable character, e.g. furniture, fittings, building, machinery, etc. Fixed capital do not change form in the process of production.
  9. Loan Capital: This is the total amount of money a business borrowed from external sources. It is a term frequently applied to debentures and other fixed loans.
  10. Liquid Capital: This is made up of assets that can be easily converted to money, i.e ., can be turned into cash at short notice. This consists of cash, near money, debts, and bank balance.
  11. Working or Circulating Capital: This is the amount that is used for the day-to-day running of the business. It is the capital available to a business for general purposes after current liabilities have been met. Circulating capital is an accounting term used to describe the excess of current assets of a business over its current liabilities. It includes capital used for paying wages, salaries and payment for raw materials. This could be calculated as: Current Assets – Current Liabilities.

 

Importance of Working Capital

  1. Working capital serves as a check against tying down too much money for current assets.
  2. It helps to determine whether the business is solvent or not, i.e ., whether it has the ability to settle debt without selling fixed assets.
  3. Working capital helps to determine the fund that will be available for the running of the business on a daily basis.
  4. It gives an indication that the business is being financed internally and not by suppliers.
  5. It is a sign of healthiness, i.e ., it will help the investor to know whether to invest or not .
  6. Working capital can be used by a business as a basis for planning to avoid losses.
  7. It provides basis for profit making by the business since it is used to buy stock from where profit is derived.

 

Accounting Entries

Example 1

Wazobia Enterprises: Financial position as at 31 st December, 2021 is as follows:

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Question

Calculate:

(a) Capital owned.

(b) Working capital.

(c) Current liabilities.

(d) Fixed capital.

(e) Capital employed.

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Note: Since capital employed can be taken to be total assets in this example, capital employed can also be N28,000.

 

Example 2

A company had an authorised share capital of N30,000. It offered applicants N20,000 share capital out of which the company collected N15,000.

(a) What is the Nominal Capital.

(b) Issued Capital.

(c) Paid-Up Capital.

(d) Un-issued Capital.

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PROFIT

Profit is the financial benefits which accrue to a businessman. The main purpose of a business organisation is to make profit. Profit represents the gain, resulting from investing one’s capital in a business enterprise.

To an accountant, profit is the excess of income over expenditure. He views profit from two perspectives: Gross profit and net profit. But to an economist, profit represents the reward of an entrepreneur. It is a measure of business performance and a means of rewarding business managers for taking the risk.

 

Types of Profit

  1. Gross Profit: Gross profit is the excess of turnover over the cost of goods sold. It is the difference between the selling price and cost price of a particular product. This is the total profit before any expense is deducted. The gross profit can be determined through the preparation of trading account. Gross profit is calculated as opening stock plus purchases, less closing stock, and this is deducted from the sales revenue.
  2. Net Profit: The net profit is the excess of gross profit over the expenses. It is arrived at after all expenses incurred in that period have been deducted from gross profit. This is ascertained in the profit and loss account.

 

Trading Profit and Loss

This is the account drawn up to show the gross profit and net profit of a business organisation. The contents of trading profit and loss consist of:

  1. Opening Stock: This is the stock of goods at the beginning of the year.
  2. Closing Stock: This is the stock of goods available at the end of the year.
  3. Purchases: Purchases is the total value of goods (credit and cash purchases) bought for resale by an organisation.
  4. Sales: This is the total value of goods sold by a business firm. It includes credit and cash sales.
  5. Returns Inward: These are goods. returned by the customers. It must be deducted from the sales for the period.
  6. Returns Outward: These are goods returned to the suppliers. It must be deducted from the purchases for the period.
  7. Carriage Inward: This is the cost of transporting goods to the firm. It is normally added to purchases.
  8. Carriage Outward: This is the cost of transporting goods to the customers. It is called carriage on sales and must be treated as expenses.
  9. Expenses: These are the expenditure incurred in the running of a business. It is normally deducted from the gross profit in order to show the net profit.

 

Uses of Trading Profit and Loss

  1. To show the profit.
  2. For planning purposes.
  3. For income or corporation tax purpose.
  4. For comparison with other years.

 

Factors Affecting Profit

  1. The selling price of goods.
  2. The cost of goods sold, i.e ., cost price.
  3. The number of competing firms.
  4. Relationship between demand and supply.
  5. The knowledge of the seller concerning the market.

 

Example 3

The following are the trading figures of Zainab Trading Co. Ltd. for the year ended 31st December, 1986:

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TURNOVER

Turnover of a business is the total net sales during a particular period, e.g. a year. This is the value of total sales of an organisation during an accounting period, i.e ., sales less returns inward.

 

Rate of Turnover

Rate of turnover is the number of times the value of average stock of a business is sold during a period. This is used to investigate the market success of the output of a firm. The rate varies from one product to another. Expensive goods have slow turnover rate while perishable goods have rapid rate. This can be computed as:

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Example 4

A large scale retail concern had the following balances in its books as at 31st December, 1998.

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Questions

(a) You are required to calculate:

(i) Cost of goods sold.

(ii) Net Profit.

(iii) Rate of stock turnover.

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Factors That Can Affect Turnover

  1. Reduction in prices of goods (goods with high prices will have low sales while products with low prices will have high sales).
  2. Goodwill and reputation of the seller.
  3. The types of goods (foodstuff will have high turnover as compared with electronics.)
  4. Advertising, publicity and sales promotion.
  5. Nearness of the business to consumers (there will be high turnover when a business is located near the consumers.)
  6. Constant availability of goods.
  7. Credit facilities.
  8. Increase in the quantity of goods sold.
  9. The variety of goods sold by the seller.

 

OTHER IMPORTANT RATIO

1) Margin: Margin can be defined as the relationship between the profit and selling price. This is the profit expressed as a percentage of selling price. This could be derived thus:

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2) Mark-Up: Mark-up is the relationship that exist between the profit and the cost of goods sold. The gross profit will be expressed as a percentage of cost price, using the formula:

 

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3) Net Profit as a percentage of turnover.

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4) Gross profit as a percentage of turnover

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5) Expenses as a percentage of Turnover.

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6) Managers’ Commission.

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Example 5

The following information was extracted from the books of Ayoola:

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Question

Calculate the following:

(a) Net profit as a percentage of turnover.

(b) Gross profit as a percentage of turnover.

(c) Expenses as a percentage of turnover.

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(a) Net profit as a percentage of turnover.

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(b) Gross profit as a percentage of turnover.

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(c) Expenses as a percentage of turnover.

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