What Is Capital Investment?

Capital Investment Explained in Less Than 5 Minutes

Capital investment is the money used by a business to purchase fixed assets, such as land, machinery, or buildings. The money may be in the form of cash, assets, or loans.

Without capital investment, businesses may have a hard time getting off the ground. Learn more about capital investment, how it works, and how it relates to the economy.

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 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.

Capital-Intensive Businesses

Capital-intensive businesses require a lot of investment in areas such as labor, facilities, and equipment, along with repair and upgrades.

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, which included $1.5 billion on track infrastructure, such as the replacement of rail, ties, and other track materials, bridge improvement, and branch line upgrades. Other investments were related to improving traffic volume, fuel efficiency, and service.

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, backhoes, or trucks.

Note

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.

Non-Capital Intensive Businesses

It would follow that non-capital intensive businesses don't require a great deal of monetary investment to maintain. Examples of non-capital intensive businesses include consulting, software development, finance, or any type of virtual business. These businesses don't have large amounts of facilities or equipment to invest in or maintain.

Financing Capital Investment

For entrepreneurs, breaking into a capital-intensive industry can be 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 they might be reluctant to lend to someone who wishes to open a restaurant, which is 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 and 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.

Key Takeaways

  • Capital investment is the money used by a business to purchase fixed assets, such as land, machinery, or buildings. The money may be in the form of cash, assets, or loans.
  • Businesses that require a large financial investment to start and run are capital intensive, whereas companies that don't need much money to start or maintain are not capital intensive.
  • Entrepreneurs who are unable to secure debt financing from a lending institution and do not have wealthy relatives or friends willing to invest in their business will most likely need to find angel investors who can provide equity financing.