Capital Investment

Updated on 2023-08-29T11:55:23.750303Z

What is Capital Investment?

Capital Investment basically refers to the funds invested by a company towards acquisitions or enhancement of its business. This capital can be recovered through earnings made by the company over the years.

The term ‘capital investment’ is also called as ‘capital budgeting’. Without capital investment, a business may face a difficult time getting off the ground.

There are two ways to understand capital investment.

First, capital investment can be made in the form of physical assets like property, plant and equipment (PP&E), furniture. It also helps to enhance the business performance.

Second, the capital investment can also be made in loan form. In this case, investors get their returns by way of repayment of loan or profits from the business.

Who are the sources of Capital Investments?

Generally, capital investment is sought by new companies or startups in any sector. Investors in these businesses can be angel investors, centre capitalists, financial institutions, etc.

As investors mostly invest in a company which has future potentials, they do their due diligence before making any investment. Therefore, the companies must use the money for development of their business to give good returns to the investors in the long term. Similarly, when a company goes for an IPO to list on stock exchanges, the large amount of money pooled in by the investors is also known as capital investment.

How Capital investment is important for Economy?

Investment always plays an important role in boosting a country's economy. It is a component of AD (Aggregate Demand). Therefore, if investment increases, it will increase AD and eventually help in economy growth in the short term.

For example, when a company makes capital investments, it means they are sure about the future growth of businesses. And when a business grows, it will call for more employment. Therefore, if there is a reduction in capital investment, it will increase the risk of recessions.

What are the types of Capital Investment?

Financial capital Investment

Generally, a large amount of money is invested in a business. It can be invested before or during the operations especially when a business is completely relying on the capital to continue.

The sources of capital investment can also be venture capital firms or angel investors who gain attention in some of the companies of their interest which have winning ideas. Other traditional source of capital are bank loans.

Physical Capital Investment

Physical capital investment includes the investment done in the form of buying long-term assets like land, machinery, furniture etc to increase or continue growth of the company.

In both the cases, purchase decision is taken by the management.

What is the aim of Capital Investment?

Capital investment is used to improve the growth of a company. A company which has been performing well, and can produce and generate more revenue, can go for further capital investment.

This is how capital investment helps an economy, employees, and the management to grow in the future and add shareholder value.

• Economy: An additional fund (capital investment) provides financial boost to a company’s business. Obviously, it helps to increase production and ultimately helps in improving economy as capital serves to improve the GDP and per capital income.
• Employment: Increasing production in a company will lead to an increase in the number of employees. Therefore, it will generate employment opportunities.
• Wealth Generation: When a company grows, it reports better revenue and profit in its financial books. This ensures higher income for employees and management as well as potentially for future investors and current shareholders of the company.
• Market competition: When there is a huge competition in market regarding the same product and services of a company, then it becomes necessary for that firm to make improvements and try to remain unique to maintain its reputation in the market. Therefore, a company needs capital to continue to survive in the competitive environment.
• Wealth Creation: If a company runs well and generates good profits, the owners may take a hefty share of the earnings that would not have been possible in regular jobs. For the next round of fundraising, if a startup performs really well, investors calculate the ROI (return on investment) and IRR to invest more. That turns out to be a win-win situation for everyone including financial investors, employees, founders, and others.

What are the disadvantages of Capital Investment?

It is universally accepted that everything has few pros as well as cons. We have already discussed the benefits of capital investment, let’s now talk about few disadvantages of the same.

• High stress: Raising funds for a company is a highly stressful time for the management, owing to the pressure of generating revenue and turning profitable.
• High Risk: Not all businesses manage to grow and generate profits. There is always a risk of failure as capital investment is not the only factor that can ensure a company’s ability to thrive. There can be other factors that can heighten the risk of failure.
• High Visibility: When a bank provides loan or an investor invests in a company, it adds to the business’s visibility, grabbing the attention of more and more investors. .
• Failure: There is always a possibility for businesses to fail, as they are fraught with a plethora of risks. Any wrong step or small mistake can drive business to loss or put the entrepreneur at stake. Failures are not necessarily caused due to the mistakes of owner, sometimes business may also fail due to bad market circumstances.