Every business has some form of capital investment in one way or another. The only difference between one business capital investment and another is the amount.
Why is knowing how to calculate capital investment so important?
One major reason is that it helps you come tax time, so that you keep yourself out of jail.
But it also helps you keep abreast of the health of your business longterm.
So what is capital investment?
Capital investment is spending that has long term value to a business. This is often contrasted with expenses that have value to the business today. The following are common types of capital investment.
Land & Buildings
The purchase of land and buildings for your business.
Any costs that go into constructing a building or structure is a capital investment.
Productive changes to land such as an irrigation system for a farm.
Maintenance is expensed. Significant improvements tocapital that significantly extend its lifespan are capital investments.
Furniture & Fixtures
Anything that goes into the interior of a building such as a couch or painting that is part of the decor.Infrastructure such as networking equipment for a data center.
Machines such as an industrial robot.
Computing equipment and devices.
Vehicles used in your business.
Software development can often be capitalized for software that is successfully operationalized. A failed project is expensed. As such, a project needs to be finalized before it can be capitalized.
Software you buy from other firms is typically considered acapital investment. Recurring as-you-go license fees are expensed.
Acquiring another company that adds value to your business.
A brand purchased from another company is a capital investment. Developing your own brand is typically viewed as an expense.Intellectual property purchased from another company such as a patent. Your own research and development is typically viewed as an expense with some exceptions. via 14 Examples of Capital Investment – Simplicable
Objectives of Capital Investment
There are typically three main reasons for a business to make capital investments:
- To acquire additional capital assets for expansion, enabling the business to, for example, increase unit production, create new products, or add value
- To take advantage of new technology or advancements in equipment or machinery to increase efficiency and reduce costs
- To replace existing assets that have reached end-of-life (a high-mileage delivery vehicle or an aging laptop computer, for example)
Capital Investment and the Economy
Capital investment is considered to be a very important measure of the health of the economy. When businesses are making capital investments it means they are confident in the future and intend to grow their businesses by improving existing productive capacity. On the other hand, recessions are normally associated with reductions in capital investment by businesses.
Capital intensive businesses require a lot of investment in areas such as labor, facilities, equipment, along with repair and upgrades.
Rail companies are notoriously capital intensive, requiring regular investments in line upgrades, rolling stock, and facilities. For example, in 2016 CN Rail outlined $2.9 billion in capital improvements for the year, which included $1.5 billion on track infrastructure such as replacement of rail, ties, and other track materials, bridge improvement, and branch line upgrades. Other investments were related to improving traffic volume, fuel efficiency, and service.
Even small businesses can be capital intensive. A small earth-moving or landscaping firm, for instance, may require a substantial capital investment in machinery such as bulldozers, backhoes, or trucks.
Note that capital expenditures can fluctuate greatly from year to year due to various factors such as the business cycle, the financial health of the business, and one-off expenditures, such as emergency expenses due to natural disasters.
Non-Capital Intensive Businesses
It would follow that non-capital intensive businesses don’t require a great deal of monetary investment to maintain. Examples of non-capital intensive businesses include consulting, software development, finance, or any type of virtual business. These businesses don’t have large amounts of facilities or equipment to invest in or maintain.
Businesses that require a large financial investment to start and run are capital intensive, whereas companies that don’t need much money to start or maintain are not capital intensive.
Financing Capital Investment
For entrepreneurs, breaking into a capital-intensive industry can be difficult as it requires a great deal of up-front capital. Even with a great idea and a strong business plan, financing a capital-intensive business can be challenging, depending on the type of business.
For example, banks may have no problem financing a builder for a new townhouse project, particularly in a strong real estate market, but might be reluctant to lend to someone who wishes to open a restaurant, which is an industry with a notoriously high rate of failure. In terms of securing the loan with collateral, a townhouse development is likely more appealing to the bank than a restaurant.
If you are unable to secure debt financing from a lending institution and do not have wealthy relatives or friends willing to invest in your business, you will most likely need to find angel investors who can provide equity financing for your business.
Angel investors will take an equity position in your new venture in exchange for providing funding. The most suitable angel investor would be someone whom you know, trust, and who trusts you. Someone who is familiar with your line of business would be especially useful as they may be able to provide advice and guidance with your new venture.
Hollman Inc. is a company that currently produces a narrow range of iron products. Recently, the Board of Directors approved an investment in new machinery that will help the company expand to additional product lines. In addition, the firm will also purchase new technology that is expected to increase efficiency in several core production processes. With these investments the firm aims to reach new customers and reduce the average production time.
The new capital investment totals US$420,000 that will be sourced from bank loans. Despite the large debt, the Board considers that this decision will benefit the company over the long-term. The firm will have a broader diversity, will increase the average price of its product and will improve its competitive position. The expanded product portfolio is foreseen to generate additional sales of US$70,000 per year. In short, the business is predicted to grow and improve profitability as a result of this new capital investment.