Capital Investment

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.

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.

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.

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 angel investor. It is handed over with expectations of returns from the sum contributed by the individual. Even investors who subscribe to the share capital of the company through stocks have the expectation of earning dividends from them.
• 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.
• These may include land and buildings that may provide office spaces, warehousing facilities or factory and production areas, furniture, fixtures, machines, computers, etc., that will be used in all departments to do work faster and create an atmosphere of smooth functional performance.

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.

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.  

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 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.

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

• Total Capital Investment = 215000

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

• 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 income 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 IRR 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.

The disadvantages of the investment concept are as follows:

• 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 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 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.

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: -

• Accredited Investor
• Institutional Investors Definition
• Investment in Fixed Income
• Cash Investment Options