Definition: 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.
What Does Capital Investment Mean?
All companies need assets to produce goods and services that generate profits. Those assets represent the business’ capital investment and differ from materials, inputs and work force required to maintain day-to-day operations.
For example, a manufacturing firm initially has land, building and machinery as capital investment. Over the years, that firm is likely to make additional capital investments by purchasing other machinery to expand its production capacity. There are capital-intensive industries whose economic activities require larger amounts of capital expenditures to function.
In contrast, other business activities operate with lower capital investments. For example, a consulting firm has capital investments mainly in the form of office buildings and computer equipment. Also, a capital investment is assumed to enable one or more of the following purposes: to provide either initial or additional production capacity, to improve efficiency or to replace assets at the end of their useful lives.
Example
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.
