Borrowed Capital

Borrowed capital consists of money that is borrowed and used to make an investment. It differs from equity capital, which is owned by the company and shareholders. Borrowed capital is also referred to as “loan capital” and can be used to grow profits but it can also result in a loss of the lender’s money.

Businesses need capital to operate. Capital is wealth that is used to generate more wealth. For businesses, capital consists of assets property, factories, inventories, cash, etc. Businesses have two options to acquire these: debt financing and equity financing. Debt is money that is borrowed from financial institutions, individuals, or the bond market. Equity is money the company already has in its coffers or can raise from would-be owners or investors. The term “borrowed capital” is used to distinguish capital acquired with debt from capital acquired with equity.

There are many different borrowing methods that constitute borrowed capital. These can take the form of loans, credit cards, overdraft agreements, and the issuance of debt, such as bonds. In all instances, a borrower must pay an interest rate as the cost of borrowing. Typically, debt is secured by collateral. In the case of a home purchase, the mortgage is secured by the house being acquired. Borrowed capital may also take the form of a debenture, however, and in that case, it is not secured by an asset.

Borrowed capital is commonly used in the economy whether that be for personal reasons or for business reasons.

The upside of investing with borrowed capital is the potential for greater gains. The downside is the potential for greater losses, given that the borrowed money must be paid back somehow, regardless of the investment’s performance.

Capital contributed by the owner or entrepreneur of a business, and obtained, for example, by means of savings or inheritance, is known as own capital or equity, whereas that which is granted by another person or institution is called borrowed capital, and this must usually be paid back with interest. The ratio between debt and equity is named leverage. It has to be optimized as a high leverage can bring a higher profit but create solvency risk.

Borrowed capital is capital that the business borrows from institutions or people, and includes debentures:

• Redeemable debentures
• Irredeemable debentures
• Debentures to bearer
• Ordinary debentures
• Bonds
• Deposits
• Loans