What is an Initial Investment?
Funding Your Business Start-Up
An initial investment is the money a business owner needs to start up a firm. It may include the business owner's own money, money borrowed from a variety of sources, including family and friends or banks, or money raised from investors.
The term initial investment is also used as the money a business owner uses to invest in a capital investment project, such as a piece of equipment or a building.
For example, Sam's initial investment to start up XYZ, Inc.
was $20,000 for plant and equipment and office supplies.
What is Capital?
An initial investment is also called start-up capital.
Capital for a small business is simply money. It is the financing for the small business or the money used to operate and buy assets. Cost of capital is the cost of obtaining that money or financing for the small business. The cost of capital is also called the hurdle rate.
Should very small businesses even worry about their cost of capital? The answer to that is yes! Even very small businesses need money to operate and that money is going to cost something. Companies want that cost to be as low as possible.
Capital is the money businesses use for financing their operations. The cost of capital is simply the rent, or interest rate, it costs the business to obtain financing. In order to understand the cost of capital, you must first understand the concept of capital.
Capital for very small businesses may just be the supplier credit they rely on. For larger businesses, capital may be the supplier credit and longer-term debt or liabilities, which are the firm's liabilities.
Why is Capital Important?
In order to build new plants, buy new equipment, develop new products, and upgrade information technology, businesses have to have money or capital.
For every decision like this, a business owner or Chief Financial Officer (CFO) has to decide if the return on the investment is greater than the cost of capital or the cost of the money it takes to invest in the project.
Business owners do not usually invest in new projects unless the return on the capital they invest in these projects is greater than or at least equal to the cost of the capital they have to use to finance these projects. Cost of capital is the key to all business decisions.
What is the Cost of Capital?
A company's cost of capital is simply the cost of money the company uses for financing. If a company only uses current liabilities and long-term debt to finance its operations, then it uses debt and the cost of capital is usually the interest rate on that debt.
If a company is public and has investors, then cost of capital gets more complicated. If the company only uses funds provided by investors, then the cost of capital is the cost of equity. Usually, this type of company has debt but it also finances with equity financing or money that investors supply. In this case, the cost of capital is the cost of debt and the cost of equity.