Capital Investment Definition
Capital Investment refers to any sum of money that is usually provided to a company to help it achieve and further its business objective. The term may also refer to any sort of long term acquisition by the business such as real estates, machinery, industries, etc.
Types of Capital Investment
Usually, capital investments that are undertaken may fall under 2 broad categories.
- Financial Capital – Under this method, the cash/amount is handed over to a business by an individual, venture capital or angel investor. 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 FMCG 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.
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The total capital investment of Mr. Smith towards his establishment can be calculated as follows –
- Total Capital Investment = 215000
Advantages of Capital Investment
By investing capital in a business there are certain advantages that will occur.
- Economic Boost – When an entrepreneur invests in any business, it goes on to boost the economy owing to the increased economic activity. Goods and services will be now delivered in accordance with the needs of the society, or a business may be run to solve a particular problem
- Employment Generation – When capital is invested to start 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 business that would be a competition to the existing business in the same line would tend to bring about efficiency as 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 income in the economy. The entrepreneur if successful may make 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 which would not have been otherwise possible in their regular jobs. The investors will prudently compare the return on investments and the IRR and thereby make the right decision of investing in the right business. And if all goes well it tends to be a wealth creator for the capital investors and also to the employees in the form of bonuses.
Disadvantages of Capital Investment
The disadvantages of capital investments are listed below as under
- Resorting to Borrowing – It is often noted that the capital being the lifeblood of any business may not be sufficient to take care of 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. This will put the owner under further stress of debt since it has to be owed back to the lender along with interest.
- Possibility of Failure – Businesses are usually a risky venture altogether. A small mistake or miscalculation may cost the entrepreneur everything that he ever invested. Sometimes even due to market circumstances, a business may fail and even declare bankruptcy. Thus it will take away the jobs along the way.
- Psychological Stress – All business involves an element of risk. An entrepreneur even though at vacation, may continuously worry about his capital investments in his business. He may be required to attend all the phone calls be it late at night or even on vacation. He/she 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 investors 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 in its smooth functioning
Limitations of Capital Investment
- Capital investment no doubt would boost the economy, but one wrong move into a wrong 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 really good economy booster by being a value-adding catalyst along with creating jobs for the people of the country to provide goods and services to meet the demands of the public and better their standards of living. There is no doubt that there is significant exposure to risk and the necessary scrutiny by all the stakeholders.
However, if an environment is created which is business-friendly that will allow more investors to pump in money and thereby allow capital to move freely into the right ventures, and ensuring they are efficiently managed may help them steer the business towards success for the benefit of all the stakeholders and society as a whole.
This has been a guide to what is Capital Investment and its definition. Here we discuss examples of capital investment along with its types, advantages, disadvantages, and limitations. You can learn more about finance from following articles –