September 29, 2022

What is a Capital Investment? – Pros and Cons

Capital Investment can be best described as the amount invested by the investors to enhance the company’s long-term business objectives. Capital investment can be physical assets like machinery, real estate or manufacturing plant.

The working and functionality of capital investment are a bit similar to other investments. For example, looking into the first step which is raising money, a company can raise money from angel investors, financial institutions or capital firms. A well-established firm/ company can arrange money from its own finances. It can also get the required money in exchange for stocks or by issuing bonds. In other words, an individual or a financial organization might make a capital investment as a loan or in exchange for a share of the profits down the road. Here capital means money. On the other hand executives of a corporation can make a capital investment within the business. In exchange for long-term assets that may facilitate the firm to run more efficiently or grow quicker. Here capital means physical assets.

The investing amount can depend on how well established your company is, if you are a start-up you can look to raise smaller amounts, whereas high industries like infrastructure and mining can look for huge amounts. The investment amount can also depend on the type of Capital investment. There are majorly 3 classifications for Capital Investment. However, depending on the company’s need the capital investment can be differentiated in different ways. These classifications depend on the asset conversion cycle.

Now looking into 3 types of capital investment first comes:

Diversification: This is the type of capital investment that helps in effective risk management by dividing the investment into different industries or various financial investments. Diversification of capital investment helps you in diversifying into new markets and product lines. By diversifying your investment into different areas, you can maximize your returns.
Replacement and Modernization: This type of capital investment is done to beat the competitiveness and upgrade your industry. Replacement and modernization capital investments are usually taken to replace old machinery or to upgrade the company with the latest technology. This helps the company to work efficiently and helps reduce costs, which is why this type of investment is also called cost reduction investment.
Expansion: Expansion investment as the word suggests is for expanding the existing business/ company to meet the increasing demands or improve the product line. In other words, expansion investment helps in maintaining production, meeting growing demands and improving productivity.

Well, Capital investment does hold its own advantages and disadvantages. Let’s have a look at:

Advantages of Capital Investment

As we have learned capital investments help a company’s growth but there are advantages too:

Capital investments once applied to its objective can promote healthy competition. As the company enhances its products/ services it faces competition and gives the company the idea of its progress.
Once the capital investment is used adequately towards its objectives we see the company flourish, this will attract investors and potential customers from the market.

Disadvantages of Capital Investment

When it comes to capital investment it a much preferred to depend on the company’s cash flow, but that might not fulfill the anticipated requirements. So it’s very likely that companies resort to external financing. Capital Investments as mentioned are known to help the company in long term, but they might show some short-term problems:

An intensive capital investment can affect the earning growth of the company in the short term and this is unpleasant for the public stockholders of the company.
To gain the capital investment issuing additional shares, might reduce the value of the shares. This might cause some tension as the stakes of the shareholders might also reduce.

In concluding the blog we summarize capital investment as a decision made by the company as a long-term growth strategy. As we have learned about capital investment and its advantages and disadvantages that gives us a clear idea that capital investments are vital and these investments should be adequately utilized to develop and push the company forward.