The economic capital is defined as the sum of own resources needed to produce profits. It is not just about the money the company has to be able to function.
It also includes the tools that are going to be used to develop the corresponding work and without which the company could not work.
In general, capital refers to the possessions that one has, but there are several types depending on their function.
In this way, we speak of human capital (workers), financial capital (the investments that are made), stockholders' equity (the difference between profits and expenses) or economic capital.
Main features
The most widespread explanation of economic capital presents it within the so-called factors of production, along with labor and land.
It is made up of all the goods necessary for profit to occur: from tools to available money.
This economic capital should not be limited to what you have at a given time, but must be calculated for the company to be viable.
For this reason, certain calculations must be carried out to help the forecast to be as accurate as possible in the medium term, taking into account certain factors that may occur during those months.
How is economic capital calculated?
In order to correctly calculate the economic capital that a company has, the difficulties it will have to face in the following months must be taken into account.
In this way, it is best to consider the worst possible case, calculating what various problems would cost. In the case of physical tools, the company must have enough to carry out its work.
For example, if it is a painter, he would need brushes, rollers, a car to get around, calculate the necessary gasoline, among other elements.
But you must also have spare parts in case something breaks down and you must take into account a possible breakdown of the car, or even the need to acquire another.
If we are talking about other types of companies, they must also carry out the same calculations and have to take into account different economic risks.
These include market risks (losses due to bad investments), credit (because the customer is late paying an invoice), operational (due to errors in work) and other types.
Reserve and financial plan
It is important to add a reserve percentage to the previous scenarios. This percentage serves to be used as an economic cushion in the event that it is necessary to recapitalize the company for whatever reasons.
With all these elements, the company has to prepare a financial plan for one year, which takes into account the profits that are provided.
You have to add the investment money that has been made. The subtraction between this profit forecast and all the risks that have been previously indicated, is what will show the economic capital of the company.
The objective is that it helps the operation of the company to be the most appropriate so that there are no debts, but rather that there is performance.
References
- Amaro, Cesar. Economic capital. Obtained from analytica.com.do
- I am SME. Economic capital: the assets of my company. Retrieved from yosoypyme.net
- Investopedia. Economic Capital. Retrieved from investopedia.com
- Financial Time. Definition of economic capital. Retrieved from lexicon.ft.com
- Milliman. Economic Capital Modeling: Practical Considerations. Recovered from milliman.com