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Dictionary
Debitoor's accounting dictionary
Capital investment

Capital investment - What is a capital investment?

A capital investment is a sum of money that goes towards furthering the objectives of a business or towards purchasing long-term assets for the business

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There are technically two different ways that the term ‘capital investment’ is used in a business context. The first refers to funds put toward helping the business to achieve its goals. The second refers to funds used to purchase fixed assets for the business, not for daily operations.

In either case, a capital investment typically involves a lump sum that is to be used with the growth of the company in mind.

Sources of capital investment

Because the term can be used to describe two different concepts in business, we’ll take a look at where capital investments can originate in both cases:

Financial capital investment

A capital investment generally involves a large amount of money being invested into a business, whether before the launch of the business or over the course of time, especially in the case of businesses that rely heavily on capital for continued (not daily) operation.

Often, a capital investment is associated with sources such as venture capital firms, or even private backers such as business angels. This can certainly be the case when an entrepreneur gains attention for a particularly winning idea with a strong business plan.

However, capital can also come from traditional sources such as bank loans, however, it can be challenging to secure necessary capital for a business. Often, some form of collateral is required, which can be risky.

Physical capital investment

In other circumstances, a capital investment is made in the form of purchasing long-term assets with the aim of these providing growth for the business over time. In this situation, the purchase decision is generally made by the management of the company.

The aim of capital investment

Ultimately, capital investment in both forms is used to improve the current projected growth of a business. This has the clear intended result of creating a business that is better able to produce and generate more revenue.

While this may seem obvious, there are additional ways that a capital investment can be beneficial not only to the business involved, but to the local economy, the management, and employees:

  • Economic benefit: Inevitably, the addition of capital investment in the form of funds provides a clear financial boost to the business. When this occurs, it can aid in improving production efficiency, for example, thereby also potentially contributing to the economy.

  • Employment opportunities: Increased production can lead to the option to hire more employees, providing jobs.

  • Wealth generation: A capital investment that goes towards a business that is then able to use this to grow the business and increase revenue. This can mean better income for both management and employees as well as potentially for shareholders and open future investment opportunities.

  • Increased market competition: When a business faces a certain amount of competition in the market regarding a product or service, this causes that business to make improvements in their offerings, benefiting the customers.

These are just a few of the main benefits that can result from the successful use of a capital investment.

Example of a capital investment

Tim’s gardening business in the Cairngorms has taken off and he successfully provides lawn and gardening services throughout the warmer months. However, due to seasonality, he would like to expand his business to provide winter services as well.

He makes a capital investment in a snow plough to attach to his lorry as part of a number of snow removal and winter service options. The cost of the plough is £989. This is a major cost for his business, however, it is a long-term investment that will allow him to expand his business and service offers.

Disadvantages of capital investments

While a capital investment might seem like an easy and assured way to improve a business, there are potential downsides involved in both cases.

  • High stress: When capital investment is added to a business or made on an asset, this puts added pressure on management to ensure that this will go towards benefiting the business.

  • High risk: The stress that comes from pressure to obtain success through a capital investment is based primarily on the fact that businesses tend to be fairly high risk. There is potential for failure, not only in the part of the capital investment serving its purpose, but in the business as a whole.

  • High visibility: When a business takes out a loan for a capital investment or receives funds, this causes increased attention to be paid to the business by banks/investors, which can have an impact on efficient operation.

Capital investment and Debitoor

The best way to understand your business finances and how a capital investment could benefit your business is by staying on top of your accounts. With online accounting & invoicing software like Debitoor, it’s simple to record payments and manage expenses from anywhere.

Assets added to your account can be marked as such with automatic depreciation applied based on the useful life and estimated residual value. Graphics on your dashboard give you an instant visual indication of your income and expenses, allowing you to easily keep track of how your business is doing financially.