- Elon Musk, Investor & Entrepreneur
Capital investment is the engine that makes the business world run. It’s typically quantified as the amount of money or, sometimes, physical assets that are invested in a company to grow its business. This commonly takes the form of stock, securities, or other assets of a given company. But it can also refer to longer-term assets like real estate or manufacturing equipment that can either improve a company’s performance or boost its profit margin.
CAPITAL INVESTMENT BASICS
In general, companies decide to make capital investments to grow their business. This can take a variety of forms:
- Operating expenses. Companies can use an investment of capital to cover its day-to-day operations, including covering inventory costs or paying employee salaries.
- Fixed-asset purchases. A business can use funds from capital investment to buy what’s called fixed assets — buildings, land, or equipment.
- Expansion. Capital investment will allow the business to create new products, increase production of existing products, open another location, grow its current distribution network, buy another company, or otherwise turn a profit.
- Technological advances. A capital investment can be used to purchase better equipment, machinery, or other evolving aspects of the marketplace that help to reduce long-term costs.
- Upgrades. A business can use capital investment to replace end-of-life and outdated equipment such as old computers, vehicles, and other tools to help keep the company competitive.
When a company makes a capital investment, it usually signifies an intent to grow its business by increasing operations or attempting to capture a larger share of the market. In short, it means the company thinks it can earn more revenue, demonstrating confidence in the future of the business.
In this way, capital investment is an important part of a healthy economy.
Due to a variety of factors, including the overall health of the business, the general business cycle, and large unexpected or emergency expenses, a company’s expenditures of capital can vary widely from year to year. It’s worth noting that in a recession, companies typically reduce capital investments.
HOW CAPITAL INVESTMENT WORKS
Generally speaking, startup companies and new corporations often look for capital investment to get the business off the ground. Typically, a given investor’s capital investment in a company comes in the form of a loan.
A company can gain a capital investment from numerous different sources, including the personal assets of the owners or partners, family and friends, banks and other financial institutions, professional investors, including venture capital companies and angel investors. The phenomenon of crowdfunding is another means for start-ups to acquire capital investment. Most of these sources come with some expectation of repayment.
Established companies have similar options, but can also choose to take capital investment money from their own cash reserves or opt to go public and issue stock. In return, these investors, known as shareholders, can decide to earn income from their investment through scheduled repayments or through profits paid out from the invested business.
No matter what method is used, upon securing the requested capital investment, these monies are used in business development and to get its products to the market.
CAPITAL INVESTMENT BENEFITS
Generally, a capital investment in a company will be used to improve the business and help it achieve growth projections. The result of this is a more efficient company, one that will produce more goods and generate more revenue. There are, however, other ways capital investment will prove to be of benefit to the business in question as well as its own employees and the economy.
When a business uses capital investment to grow business and increase revenue, this can mean more income for the employees. With the increased production comes an increased demand for workers, and capital investment gives the company the ability to hire more employees. This provides jobs in the local economy and can also result in more efficient production.
A growth in business can also mean increased revenue. This has the potential for higher stockholder earnings (albeit in the long long term) and also opens the door to more investment opportunities in the future.
Capital investment can offer additional benefits in a competitive marketplace. For instance, a business that employs capital investment for improvements ultimately benefits its customers with higher quality products and better prices, thereby increasing overall competition in the marketplace.
CAPITAL INVESTMENT DISADVANTAGES
Capital investment is a long-term business strategy, and that can open a company up to some short-term repercussions to the bottom line. Aggressive capital investment, while generating operating capital, can significantly reduce a company’s earnings in the short term. This isn’t a favorable outcome for the company’s investors and stockholders, who often expect a decent rate of return on their investment.
So when looking for capital investment opportunities, the first source should always be a company’s operating cash flow. If this isn’t enough to cover business costs, then the company often turns to outside financing to bridge the gap. And when that happens, a company takes on debt. The amount of debt a company carries on its balance sheet is closely monitored by stock owners and analysts. Too much capital investment can negatively affect a company’s stock price and even its operations.
There can also be a human toll with capital investment. Taking on such an investment can result in a lot of stress for the management team to turn the acquired funds into a success. Businesses, even stable ones, can be high-risk ventures often at the whim of external market forces. So it’s always possible that a business venture, even one well-funded, can fail.
Capital investment is a powerful tool that a business can employ to help it grow in an advantageous market. It can have far-reaching effects on not only the business that obtains the investment, but also the economy of the surrounding community. As part of an overall business strategy, it’s best used to foster a company’s long-term growth. While it can be a net-positive force in a company’s growth strategy, it doesn’t come without a few drawbacks. Before taking on a capital investment it’s best to carefully consider how it will affect a company’s bottom line in both the long- and short-term.
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