Capital Intensity

Capital Intensity Definition

Capital intensity is the infusion of high amounts of capital in a business or production process. It therefore requires a higher proportion of fixed assets (land, property, plant, and equipment) to produce goods and services. Industries or companies that require such large capital investments are known as capital intensive businesses. Some examples of capital-intensiveCapital-intensiveCapital intensive refers to those industries or companies that require significant upfront capital investments in machinery, plant & equipment to produce goods or services in high volumes and maintain higher levels of profit margins and return on investments. Examples include oil & gas, automobiles, real estate, metals & mining.read more businesses are oil factories, chemical and petroleum plants, power generation plants, aircraft manufacturing, etc.

Capital Intensity Ratio Formula

The capital intensity ratio can be measured by the amount of capital infused in a business to produce revenue. Below are the two formulas that are frequently –

Capital Intensity Ratio #1 = Total Assets / Total Revenue

It gives the number of assets needed to produce every dollar in revenue.

It is also used by analysts as a measure of how much capital, as opposed to labor, is required to make specific dollars in sales.

Capital-Intensity

Examples of Capital Intensity

Let’s take some examples.

You can download this Capital Intensity Excel Template here – Capital Intensity Excel Template

Example #1

For the year 2018, the following data is available for aircraft and aerospace industry giants Boeing and Airbus group. Determine the capital intensity ratios for each and comment.

Data (FY 2018)BoeingAirbus
Total Assets101,127115,198
Revenue93,49663,707

Source: Boeing annual report 2018 (investors.boeing.com), Airbus annual report 2018 (www.airbus.com)

Solution:

Notice that Boeing is a US aircraft maker, and Airbus is a French aircraft maker but has a similar business model for a viable comparison.

Calculation of Capital Intensity for Boeing will be –

Example 1.1.0

For Boeing, CI = 101,127/93,496 = 1.082

Calculation of Capital Intensity for Airbus will be –

Capital Intensity Example 1.2

For Airbus, CI= 115,198/63,707= 1.808

Since the capital intensity for Airbus is greater in numeric value than Boeing, it means that Boeing has efficiently utilized its assets to generate revenue. For every $1.083 of assets used, $1 of revenue is generated by Boeing.

Example #2

The capital intensity ratios for two detergent manufacturing firms are 1.1 and 1.6. manufacturer with a greater ratio has $2 million in sales, whereas the other firm has $2.1 million in sales. Analyze the efficiency of both firms.

Solution:

Since we have capital intensity ratios given in the question, we are sure that manufacturer A has utilized its assets such that every $1.1 of assets produced $1 in revenue. Whereas for manufacturer B, it was spending $1.6 of assets to make the same revenue.

Further, we can calculate the assets of both the manufacturers;

Calculation of Capital Intensity for Manufacturer A will be –

Example 2

Manufacturer A, assets = 1.1 x $2.1 million = $2,310000

Calculation of Capital Intensity for Manufacturer B will be –

Capital Intensity Example 2.1

Manufacturer B, assets = 1.6 x $2 million = $3,200000

Thus, B has more assets but poor asset utilization for the purpose of revenue generation.

Advantages

Some of the advantages are as follows:

Disadvantages

Some of the disadvantages are as follows:

Important Points

Conclusion

Massive investments in businesses can cause the replacement of labor by mechanized or machine production. It can result in short-term or long-term unemployment. However, capital intensity in businesses also brings in new professionals in the picture, such as AI engineers, microcomputer technologists, etc.

Capital intensive production came thudding because of the need to increase profit marginsProfit MarginsProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. read more, which was brought about by more mechanized production. The advent of the industrial revolution saw more and more machinery in factories and farmlands. Increased efficiency, reduced production time, and optimized costs made even the labor-intensive businesses take a shift towards the capital-intensive structure.

Recommended Articles

This article has been a guide to what is the capital intensity and its definition. Here we discuss formula to calculate the capital intensity ratio along with examples, advantages, and disadvantages. You can learn more about accounting from the following articles –