What is Capital Maintenance?

Capital maintenance is a concept that maintains that profit can only be accounted for when there is proper maintenance of capital and when costs have been fully recovered or restored.  

Capital maintenance, otherwise called Capital recovery, is an accounting concept that when the closing amount of capital of a company at the end of a fiscal year is the same as the amount of capital the company has at the beginning of the accounting period, capital maintenance has been achieved.

How is Capital Maintenance Used?

Capital maintenance is when a company's capital at the beginning of an accounting period is the same as the capital at the end of an accounting period. This shows that the company maintained its assets and capital for the period and there is a full recovery of all costs. Hence, to calculate the profit of a company, the capital of a company must be restored to its initial level and an additional monetary amount or net assets recorded at the end of a period. It is the excess amount that is calculated as the company's profit.

Financial Capital Maintenance

There are two main subsections of capital maintenance, these are;

• Financial capital maintenance, and
• Physical capital maintenance.

Financial capital maintenance deals with the actual funds that a company has. When the funds are adequately maintained in such a way that the amount recorded at the end of an accounting period is more than the amount recorded at the beginning of the period, profit is recorded. The International Financial Reporting Standards (IFRS) when calculating profit earned through financial capital maintenance excludes contributions and distributions. The Financial capital maintenance measures profit using net assets, excess net assets translate to profit.

Physical Capital Maintenance

The ability and effectiveness of a business to maintain cash flows, including managing assets that generate revenue for the business are known as physical capital maintenance. Unlike financial money maintenance, physical money maintenance is not concerned with the actual funds or money of a firm, rather, it pays attention to how well the business maintains its income-generating assets. Physical capital maintenance also excludes contributions and distributions when determining the profit earned by a firm at the end of an accounting period.

Capital Maintenance and Inflation

Whether directly or indirectly, inflation has effects on capital maintenance. Inflation affects the value of net assets of a company, despite that the assets have not changed in appearance, condition or mode of operation. During inflationary periods, there is a high tendency that a company would record low value of net assets, it is, therefore, essential that the adjusted values of the assets are recorded.

Related Topics

• Trend Analysis of Financial Statements
• Common-Size Analysis (Vertical Analysis) of Financial Statements
• Common-Size Financial Statement
• Net Dollar Retention
• Horizontal Analysis
• Per Share Basis
• Profitability Ratios
• Gross Margin Ratio
• Profit Margin
• After Tax Profit Margin
• Return on Assets
• Total Shareholder Return
• Cash on Cash Return
• Earnings Per Share
• Diluted Earnings Per Share
• Asset Turnover Ratio
• Berry Ratio
• Break-Even Analysis
• Liquidity Ratio
• Current ratio  (Working Capital Ratio)
• Working Ratio
• Quick Ratio
• Quick Assets
• Days Sales Outstanding
• Cash Ratio (Operating Cash Flow Ratio)
• Receivables turnover ratio (often converted to average collection period)
• Accounts Payable Turnover Ratio
• Inventory turnover ratio (often converted to average sale period)
• Solvency (Coverage Ratios)
• Leverage Ratio (Debt Ratio)
• Asset Coverage Ratio
• Debt to Equity
• Debt to Income Ratio
• Debt Coverage Ratio
• Times Interest Earned
• Market Capitalization
• Price to Equity Ratio
• Book-To-Market Ratio
• Price to Earnings Ratio
• Price to Earnings Growth (PEG) Ratio
• Price to Earnings Growth Payback Ratio
• CAPE Ratio
• Price to Cash Flow Ratio
• Capital Maintenance
• Book to Bill Ratio
• Asset Turnover Ratio
• Plowback Ratio 
• Days Inventory Outstanding
• Days Payable Outstanding
• Days Sales Outstanding
• Non-financial Performance Measures: The Balance Scorecard