Capital Investment in Business
There Are Two Usages in Business
The term Capital Investment has two usages in business. First, capital investment refers to money used by a business to purchase fixed assets, such as land, machinery, or buildings.
Secondly, capital investment refers to money invested in a business with the understanding that the money will be used to purchase fixed assets, rather than used to cover the business's day-to-day operating expenses.
For example, to purchase additional capital assets a growing business may need to seek a capital investment in the form of debt financing from a financial institution or equity financing from angel investors or venture capitalists.
Capital Investment Objectives
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 - for example, a high-mileage delivery vehicle or an aging laptop computer.
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.
Examples of Capital-Intensive Businesses
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.
From the CN media release:
CN plans to spend approximately C$1.5 billion on track infrastructure to maintain a highly efficient and safe network. This work will include the replacement of rail, ties, and other track materials, bridge improvements, and targeted branch line upgrades.
CN will invest C$600 million in rolling stock equipment, allowing the company to tap available growth opportunities and to improve the quality of its car fleet. To handle future traffic volumes and further improve fuel efficiency, CN also expects to take delivery of 90 new high-horsepower locomotives.
The company plans to invest C$400 million this year in a range of other key initiatives to drive productivity and to improve service for its customers. CN will also spend C$400 million on the implementation of Positive Train Control (PTC) technology on portions of its U.S. rail network.
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, back-hoes, or trucks.
Non-Capital Intensive Businesses
Capital Expenditure Per Share Ratios
The difference between capital and non-capital intensive businesses is further illustrated by the capital expenditure per share ratio (fiscal year 2016/2017):
|Company||Industry||Cap. Exp. per Share|
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, etc.)
Financing a Business That Requires Capital Investment
For entrepreneurs, breaking into a capital intensive industry can be very 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 much more reluctant to lend to someone who wishes to open a restaurant (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.
Examples: Jenna agreed to make a capital investment in Bupinder's new business, specifying that the money was to be used to buy the machinery needed to start production.