What is a Capital Investment?
A capital investment is money allocated by a firm in assets that makes possible achieving the business’ financial objectives. A capital investment usually refers to fixed assets required to accomplish the organization’s mission. Real estate, manufacturing plants, and machinery are among the assets that are purchased as capital investments.
The capital used may come from a wide range of sources from traditional bank loans to venture capital deals.
Definition and Examples of Capital Investment
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.
How Capital Investment Works
Capital investment gives businesses the money they need to achieve their goals. There are typically three main reasons for a business to make capital investments:
- To acquire additional capital assets for expansion, which enables 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 can come from various sources, such as financial institutions, angel investors, and venture capitalists, among others. Generally, startups and new companies are the ones who seek capital investments.
However, after having received investments, the invested amount must be utilized to develop and push the business ahead. In the same line, if a company announces to go public, the large amount of funds pooled in from the investors is also considered as a form of capital investment.
Capital investment has its own disadvantages. While capital investment is made to improve a company’s cash flow in operations, it may sometimes be insufficient to cover the expected costs. In such cases, the company could be forced to borrow funds from an external financier to cover for the miscalculations.
The company expects capital investment to help build its future in the long-run. However, capital investment results in the earnings of stakeholders being subdued in the short-term. In the same line, stockholders also keep track of the company’s debts which is why capital investments are not favorable to many stakeholders.
Sources of Capital Investment
Capital investment can take the form of debt, equity, or a mix of the two. It can come from a variety of sources, including angel investors, venture capitalists, lenders, and public offerings of securities. The amount of capital investment is usually planned for well in advance through the annual budgeting process, though smaller investment amounts may be allowed at the local level with little advance warning, in order to respond more quickly to local conditions.
The Aim of Capital Investment
Ultimately, capital investment in both forms is used to improve the current projected growth of a business. This has the clear intended result of creating a business that is better able to produce and generate more revenue.
While this may seem obvious, there are additional ways that a capital investment can be beneficial not only to the business involved, but to the local economy, the management, and employees:
- Economic benefit: Inevitably, the addition of capital investment in the form of funds provides a clear financial boost to the business. When this occurs, it can aid in improving production efficiency, for example, thereby also potentially contributing to the economy.
- Employment opportunities: Increased production can lead to the option to hire more employees, providing jobs.
- Wealth generation: A capital investment that goes towards a business that is then able to use this to grow the business and increase revenue. This can mean better income for both management and employees as well as potentially for shareholders and open future investment opportunities.
- Increased market competition: When a business faces a certain amount of competition in the market regarding a product or service, this causes that business to make improvements in their offerings, benefiting the customers.
These are just a few of the main benefits that can result from the successful use of a capital investment.
Disadvantages of Capital Investments
While a capital investment might seem like an easy and assured way to improve a business, there are potential downsides involved in both cases.
- High stress: When capital investment is added to a business or made on an asset, this puts added pressure on management to ensure that this will go towards benefiting the business.
- High risk: The stress that comes from pressure to obtain success through a capital investment is based primarily on the fact that businesses tend to be fairly high risk. There is potential for failure, not only in the part of the capital investment serving its purpose, but in the business as a whole.
- High visibility: When a business takes out a loan for a capital investment or receives funds, this causes increased attention to be paid to the business by banks/investors, which can have an impact on efficient operation.
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.