The term ‘capital investment’ has two uses in business. ‘Capital investment’ can refer to money used by a company to buy capital or fixed assets, such as equipment, land or buildings.
A capital or fixed asset is any tangible property held for business use which is usually held for a long period and cannot be converted easily into cash.
In its second usage, the term can also refer to cash invested in a company with the understanding that it will be used to acquire fixed assets, rather than used to cover the company’s routine operating expenses. This money is invested into the business enterprise with the hope of making an income, and recovered through earnings produced by the company over a number of years.
A capital investment is made any time a company buys supplies that will help the operation of the company, but will not be used to cover its operational costs. The fixed assets referred to above are expected to have long lives of use before they have to be repaired or replaced. They may carry any type of inherent worth. The key attribute of this type of investment is the fact that the asset is not necessary to the usual expenses associated with operating the business, so there is no minimum value connected with it.
A capital investment is usually made for the purpose of furthering a company’s business goals. This type of investment includes a broad diversity of funding options. Banks, equity and angel investors, venture capital and other financial institutions are just a few of the manifold sources of capital investment. Convertible or straight debt is one of the options for funding for capital investment, although it is generally done through common or preferred equity issuance. Other sources include technology licensing agreements, international trade agreements, real estate and project financing, private equity placements and joint venture agreements.
Venture capitalists and other investors who provide capital investment funding may be eligible for tax benefits in some jurisdictions, for example in the US State of Indiana. The state provides tax credits as an additional incentive to individual and corporate investors to put money into early stage start-ups in order to provide these fast growing firms with access to capital.
Capital investment in a company can make a big difference to its success. The decisions a company takes regarding its capital investment are crucial as they impact the company in the long term. Businesses must therefore consider the impact of any capital investment on business profitability in the long term. When calculating return on capital investment, it’s important to take into consideration factors such as interest rate on loans, inflation and the opportunity cost of money.
The economic feasibility of capital investment can be calculated by discounting its cash returns to reflect the time value of money, calculating the current value of cash needed to acquire the asset and the net cash flows and annual benefits within the useful lifetime of the asset. You will also need to compute the current value of the annual net cash flows. The last thing you need to do is to subtract the current value of the investment from the net current value of the investment returns. A capital investment should only be approved if this last computation is positive.