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.
Table of contents
Types of Capital Investment
Usually, capital investments that are undertaken may fall under two broad categories:
- Financial Capital – Under this method, the cash/amount is handed over to a business by an individual, venture capital, or Venture Capital, Or Venture capital (VC) refers to a type of long-term finance extended to startups with high-growth potential to help them succeed exponentially. angel investorAngel InvestorAngel investors refer to wealthy investors who supply capital to budding businesses in return for a portion of their equity. . It is handed over with expectations of returns from the sum contributed by the individual.
- Physical Capital – Under this method, the executives may go on to make certain capital investments in the business through the purchase of long term assets that will help the company grow faster by running more efficiently.
Example of Capital Investment
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. 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: –
- Total Capital Investment = 215000
Advantages of Capital Investment
- Economic Boost – When an entrepreneur invests in any business, it boosts the economy due to increased economic activity. They will now deliver goods and services goods and services per the needs of society, or they may run a business to solve a particular problem.
- Employment Generation – When capital is invested in starting a business, the owner may go on to employ certain staff to run the day-to-day activity. Thus, additional employment goes on to be created in the country and helps tackle the problem of unemployment.
- Efficiency in Markets and Competition – Had it not been for risk-takers who invest in a business, there would be no products and services to solve the day-to-day needs of the consumers. Moreover, investing in a similar company that would compete with the existing business in the same line would tend to bring about efficiency. They would now go on to better themselves to grab the maximum pie in the market by enhancing their market share.
- Value Creation – When new capital is invested in the business, there seems to be self-employment that would further boost the GDP, and per capita incomePer Capita IncomeThe per capita income formula depicts the average income of a region computed by dividing the total income of that area by the total population of the region. It is used to figure out the average income of a city, provision, state, country, etc. in the economy. The entrepreneur, if successful, may make a way to build a business empire altogether. There will be further value creation in the economy.
- Wealth Creation – The investors may go on to build on wealth if all goes well with the business. The owners may make a hefty amount that would not have been otherwise possible in their regular jobs. The investors will prudently compare the return on investments and the IRRIRRInternal rate of return (IRR) is the discount rate that sets the net present value of all future cash flow from a project to zero. It compares and selects the best project, wherein a project with an IRR over and above the minimum acceptable return (hurdle rate) is selected. and thereby decide to invest in the right business. And if all goes well, it tends to be a wealth creator for the capital investors and employees in the form of bonuses.
Disadvantages of Capital Investment
- Resorting to Borrowing – The capital is the lifeblood of any business that may not be sufficient to meet the requirements or day-to-day operations. Hence, it becomes imperative that the entrepreneur resorts to sources of debt financing to keep his business afloat. It will put the owner under further debt stress since it has to be owed back to the lender and interest.
- Possibility of Failure – Businesses are usually a risky venture altogether. A small mistake or miscalculation may cost the entrepreneur everything he ever invested. Sometimes even due to market circumstances, a business may fail and even declare bankruptcy. Thus, it may take away jobs along the way.
- Psychological Stress – All business involves an element of risk. Even though on vacation, an entrepreneur may continuously worry about his capital investments in his company. He may be required to attend to all the phone calls, be it late at night or even on vacation. They may be required to be the first to come to the office and the last to leave. The work-life balance may go haywire. All of this may have a bearing on the psychological and mental peace of the capital investor.
- Subject to Scrutiny – Once a certain business is set up, it is always subject to the scrutiny of the income tax department, pressure, and interference by activist investorsActivist InvestorsAn activist investor is a person who purchases a large stake in a company in order to gain control or a board seat with a view to bring about significant changes in the company to reduce costs, increase sales, improve efficiency, and thus maximize profits and shareholder wealth. Activist investors usually enter a company when the existing management is ineffectively managing the business and there exists a large scope of improvement. or private equity investors, restrictions and covenants by banks and lenders, and also necessary disclosure by regulators as in the case of a public company. Hence, a venture is always under constant scrutiny and observation that may interfere with its smooth functioning.
- Capital investment, no doubt, would boost the economy, but one wrong move into a bad venture or into the purchase of inappropriate assets that do not value-adding may erode the wealth of the capital contributor.
Capital investment, 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.
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 what Capital Investment is and its definition. Here, we discuss capital investment examples and their types, advantages, disadvantages, and limitations. You can learn more about finance from the following articles: –