Capital Investment

Updated on January 12, 2024
Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

Capital Investment Definition

Capital investment refers to any sum of money usually provided to a company to help it achieve and further its business objective. The term may also refer to long-term acquisition by the business, such as real estate, machinery, industries, etc.

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It, no doubt, stands to be a good economic booster by being a value-adding catalyst and creating jobs for the people of the country to provide goods and services to meet the demands of the public and better their living standards. However, there is no doubt that there is significant exposure to risk and the necessary scrutiny by all the stakeholders.

Capital Investment Explained

The term capital investment refers to the amount of funds required for a business to expand and grow. If the business is able to perform well in the market, then this amount can be recovered in the form of a return after covering all costs. However, the process takes a number of years.

The investment may either be made by the owners or founders of the business from their own resources or raise funding from the market. The process is easy if the contribution is made by owners but getting funds from outside sources requires a good business plan, an idea that has great future potential to succeed and also good credit rating of owners themselves. The owners with any background of financial setbacks in the past will find it difficult to secure funds for capital investment plan or loan for capital investment.

The capital amount should be such that it is able to improve the company’s performance by a significant level. It is interesting to note that investors putting money into a business can earn income which they accept as loan repayment amount.

The outside sources of investment can be from various financial institutions, angel investors who usually finance startups, or venture capitalists who may finance startups, small existing businesses or already growing companies. But it is necessary for the business to be able to use this capital professionally and ethically so that it helps the company to grow.

Companies, after being in the market for quite some time, issue Initial Public Offer(IPO) of shares as a part of the capital investment plan, which may be subscribed to by the public and is an excellent source of capital for the business, resulting in a massive pool of fund.

Types

Usually, capital investments that are undertaken may fall under two broad categories:

So, the above is a broad classification of the types, which may include many forms of investment. However, it is necessary for the stakeholders to definitely keep track of the proper usage of such funds so that they are used for productive purposes and generate capital investment return.

How To Calculate?

Let us now understand how to calculate the value of capital that has to be invested into the business to generate capital investment return.

In case of a simple business set-up, the investment will not be of much amount. The proprietor will mostly contribute money from their own pockets or from borrowing from family and friends. In such cases, funds will be calculated based on total of amount required for storage space lease or rent, purchase of furniture, equipment, employment of human resources, renovation of the space, funds needed for inventory purchase and storage, etc.

In case of growing business, it may be calculated also by using the operating approach, which is a summation of the net working capital, property plant and equipment and any intangible asset, including goodwill. The net working capital, in this case, will be calculated by deducting the current liabilities that do not have any interest charges from the current operating assets. The intangibles and goodwill form a part of branding, copyright, etc, that are assets for the business acquired through good marketing, customer services and creation of products that are unique in nature and service.

The amount of capital investment fund can also be calculated using financial approach, where the capital will be a summation of debt, equity, non-operating cash and investments.  

Example

Let us understand the concept of capital investment fund with the help of a suitable example, as given below:

Mr. Smith wants to set up an FMCGFMCGFast-moving consumer goods (FMCG) are non-durable consumer goods that sell like hotcakes as they usually come with a low price and high usability. Their examples include toothpaste, ready-to-make food, soap, cookie, notebook, chocolate, etc.read more trading business. He goes on to appropriate his budget towards the following items. Commercial space $150000, Storage 15000$, Inventory 5000$, Vehicles-20000$, Amount borrowed-25000$. Calculate Mr. Smith’s total capital investment.

The total capital investment of Mr. Smith towards his establishment can be calculated as follows: –

Capital Investment Example 1
  • Total Capital Investment = 215000

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Advantages

Here are some advantages of the concept of capital investment decision explained in detail.

Disadvantages

The disadvantages of the investment concept are as follows:

Capital Investment Vs Capital Expenditure

Both the concepts are related to funds that are used within a business. However, there are some differences between them, as given below:

  • The capital investment decision is related to the fund that is put into the business or the incoming fund. But the latter is related to the fund that moves out of the business.
  • The former leads to the latter. Without investment of capital in the form of cash, cash equivalent or assets, it is not possible to run the company whatever nature and size it may be. This operation will automatically lead to various forms of capital expenditure that is necessary to maintain a smooth work process.
  • The former is typically decided by the owners and funds are acquired from various sources like general public, angel investors, venture capitalists, financial institutions, etc. But the decision for the latter is taken by analysis and management, or operations manager, who decide how much money has to be spent on buying heavy machinery, assets, plant, equipment, etc.

Thus, the above points clearly highlight the important differences between the two.

However, suppose an environment is created that is business-friendly, allows more investors to pump in money, and provides capital to move freely into the right ventures. Moreover, ensuring they are efficiently managed may help them steer the business towards success for the benefit of all the stakeholders and society.

This article is a guide to Capital Investment and its definition. We explain it with example, how to calculate it, types & differences with capital expenditure. You can learn more about finance from the following articles: –

Reader Interactions

Comments

  1. Augustine zibuka says

    an exciting explanation of the capital investment cons and pros.

    • Dheeraj Vaidya says

      Thanks for your kind words!

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