how capital investment works
capital investment is a broad term that can be defined in two distinct ways in either case the money for capital investment must come from somewhere a new company might seek capital investment from any number of sources including venture capital firms angel investors or traditional financial institutions when a new company goes public it is acquiring capital investment on a large scale from many investors an established company might make a capital investment using its own cash reserves or seek a loan from a bank it might issue bonds or stock shares in order to finance capital investment there is no minimum or maximum capital investment it can range from less than 100 000 in seed financing for a start up to hundreds of millions of dollars for massive projects undertaken by companies in capital intensive sectors such as mining utilities and infrastructure capital investment is meant to benefit a company in the long run but it nonetheless can have short term downsides capital investments for businessa decision by a business to make a capital investment is a long term growth strategy a company plans and implements capital investments in order to ensure future growth capital investments generally are made to increase operational capacity capture a larger share of the market and generate more revenue the company may make a capital investment in the form of an equity stake in another company s complementary operations for the same purposes in many cases capital investments are a necessary and normal part of an industry consider an oil drilling company that relies on heavy machinery to extract raw materials to be processed as opposed to a law firm that will have low to no capital investment requirements capital intensive businesses usually need specific assets in order to operate in addition there are strategic components for a business to consider when deciding whether or not to invest in a capital asset for instance consider how certain heavy machinery such as a company vehicle could be leased should the company be willing to incur debt and tie up capital the company may spend less money in the long term by incurring a capital investment as opposed to a periodic rental expense types of capital investmentscompanies often acquire capital investments for diversification modernization or business expansion this may mean buying capital investments different from existing aspects of its business or capital investments that simply do things better than before some specific types of capital investments include because land does not deteriorate in a similar manner compared to other capital investments it is not depreciated advantages and disadvantages of capital investmentsthe advantages of capital investments can vary depending on the specific situation however most companies embark on capital investments for productivity by investing in new equipment or technology companies can improve their efficiency thus lower costs and increasing output these types of investments may also improve the quality of goods produced capital investments can also lead to cost savings over time for example a new piece of equipment may be more energy efficient than an older model which can result in lower utility bills similarly new technology may streamline processes and reduce the need for manual labor last companies may decide the long term discounted cash flow is favorable when comparing the upfront investment of a capital investment compared to the long term ongoing cash outlay of a recurring expense by investing in their long term assets companies can also gain a competitive advantage in the market this can make it more difficult for competitors to catch up and can help the company to maintain its market position over the long term if a company is willing to take a risk and incur a large investment to strengthen its business this may create a barrier to entry that competitors can not overcome or compete against the preferred option for capital investment is always a company s own operating cash flow but that may not be sufficient to cover the anticipated costs it is more likely the company will resort to outside financing therefore there is usually a little more risk to capital investments this is especially true for capital investments that are customized or hard to liquidate once the company has bought the capital investment it may be hard to exit the investment capital investment is meant to benefit a company in the long run but it nonetheless can have short term downsides capital investments tends to reduce earnings growth in the short term and that never pleases stockholders of a public company this may be especially true for capital investments that also incur operating costs i e the acquisition of land will be accompanied by a potentially hefty annual property tax assessment in addition if a company does not have sufficient capital on hand to make a large investment there are downsides to each of its financing options issuing additional stock shares which is often the funding option for public companies dilutes the value of its outstanding shares existing shareholders generally dislike finding that their stake in the company has been reduced alternatively the total amount of debt a company has on the books is closely watched by stockholders and analysts the payments on that debt can stifle the company s further growth may increase productivity if capital investment is more efficient than prior methodsmay result in higher quality manufactured goodsmay be cheaper in the long run when compared against rented or monthly expensed solutionsmay create a barrier to entry that yields a competitive advantagemay be too expensive for the company to outright purchase on their own may limit or restrict short term profitability of the companymay be accompanied by additional operating expensesmay reduce the liquidity of the company should it be difficult to sell the capital assetaccounting for capital investmentsaccounting practices for capital investments involve recording the cost of the asset allocating the cost over its useful life and carrying the investment as the difference between cost and accumulated depreciation the accounting treatment can vary depending on the type of asset as land is not depreciated but many other capital investments are depreciated the cost of the asset should be recorded in the company s accounting records this can include the purchase price of the asset as well as any additional costs related to the purchase such as installation or transportation costs companies may record the fair market value for certain capital investments under certain circumstances but capital investments must initially be recorded at cost if the asset has a cost that meets the company s capitalization policy the cost of the asset will be recorded as a capital asset on the balance sheet this allows the company to spread the cost of the asset over its useful life and to recognize the expense over time this is the primary difference between the assets mentioned earlier and normal operating costs as operating costs are expensed in the period they are incurred while capital investment costs are spread over time the useful life of a capital investment is an estimate of the number of years that the asset will be used by the company the depreciation method used will depend on the asset and the company s accounting policies but commonly used methods include straight line declining balance and sum of the years digits companies may also record impairments to reduce the value of a capital investment should a loss be incurred in addition whereas operating expenses may simply be stopped companies have a series of entries to post when a capital investment is disposed of example of capital investmentas part of its year end financial statements amazon com reported the following assets it owned for fiscal year 2021 and 2022 1this format of the balance sheet is standard where assets are reported by liquidity starting with the most liquid assets because capital investments are not liquid they are often reported lower in the list at year end 2022 amazon reported a net asset balance of 186 7 billion for property and equipment this figure is net because capital investments aside from land are often depreciated and reported as their cost less any accumulated depreciation note that this 186 7 billion is also being excluded from current assets because of the long term nature of capital investments they are reported as noncurrent assets 1