What is the difference between capital and debt, and why is the distinction important?
One important distinction is that capital represents the amount of funds introduced by shareholders, partners or sole traders plus any retained profits that the business has created at any particular date. Debt on the other hand is a liability, an amount of money that has to be repaid and subject to an interest charge.
Debt is generally owed to institutions, for example banks, whereas the capital of smaller business that are not floated on a stock exchange belongs to the business, its shareholders, partners or sole traders.
The current pandemic has brought this distinction into sharp focus as businesses with substantial debt, low capital and minimal reserves will have no fat on the bone to fund loss making activity for extended periods. Businesses with significant reserves and lower debt will have had the funds to better cope with periods of reduced activity.
Once we start to emerge from lockdown, businesses would do well to set realistic targets for retaining profits just in case we encounter future COVID or similar challenges.