The Differences Between Physical & Financial Capital

At its core, a business can be defined by assets. One way to describe assets is to break them down into categories, and two broad breakdowns are physical and financial capital. Physical capital is a tangible asset that can be touched in a real sense, while financial capital refers to the legal ownership of assets such as physical capital.

A vision of factories and equipment often comes to mind when the term "physical capital" is invoked, and this also includes the inventory sitting in stockrooms or warehouses, equipment from the tiniest screwdriver to the fleet of 18-wheel trucks, and fixed structures like office buildings, shopping malls, or factories. Physical capital includes tangible items used for actual production of the good or service provided by a company.

Financial capital, on the other hand, is the legal ownership of all physical capital, as well as the monetary value of any asset that could be liquidated for cash. In fact, cash on hand is a form of financial capital, but so are stock shares, land titles, and other forms of property ownership. Financial capital might exist in large part as electronic entries in a computer database somewhere that denote how much money exists in a company's checking or savings accounts.

Human capital, which exists solely in the form of intelligence, education and knowledge stored in the brains of company owners and employees, is a type of business capital that shouldn't be overlooked. The tricky part is figuring out where to classify it. Since human capital makes physical capital more productive, it is often considered closely related to those assets.

Physical and financial capital, though distinctly different, are also joined at the hip when it comes to the business world. A company would not last long trying to use one or the other exclusively. Physical capital is needed, even if it is only an office, desk and computer, to actually provide goods and services. Without financial capital, paying regular bills would be a mighty inconvenience. Having to sell a few dozen desks each time the utility bill came due would get tiresome quickly.