EDUCBA

Home » Finance » Blog » Corporate Finance Basics » Capital Intensive

Capital Intensive

Definition of Capital Intensive

The capital intensive is the capacity of the business organization measured on the basis of capital invested by the organization in its plant and machinery and other fixed assets in order to increase the production that results in to the earnings of the higher profits and earning good returns on investment.

Explanation

Every organization needs capital to run the business. The capital intensive is measured on the basis of capital deployed by the organization in purchasing the fixed assets. It is defined as the capacity of the organization to invest in fixed assets. Higher investment leads to higher returns and which results in more investors and more market share. Some businesses need higher capital to start the businesslike airlines industry. The capital intensive companies need higher money to keep the operations going that means the maintenance cost is also high in such industries. These companies have higher operating leverage as operating cost becomes higher due to high investments in fixed assets and machinery. Capital intensive industries usually have a larger volume of sales. The market standing of these industries is based on the services they provide, maintenance of assets, labour efficiency, productivity, risk factor etc. In short, if capital expenditure is much more than the labour expenditure then the organization is said to be capital intensive.

Start Your Free Investment Banking Course

Download Corporate Valuation, Investment Banking, Accounting, CFA Calculator & others

Examples of Capital Intensive

There are many examples of capital intensive industries; some of them are as under:

  • Transportation sector like railways, airways, waterways need lots of investment in buying the transportation medium or production of transportation medium. The receipts are freight charges charged and the volume of receipts depends upon the quality of services the organization gives to its passengers. The profit depends upon the operational cost, higher the operational cost like repairs and maintenance, labour cost, salaries and admin expense etc. Lower will be the profit. The profit also reduces due to higher depreciation cost.
  • Company ABC incorporation imported machinery from california through which the sales of an organization are expected to boost by 50% and even the labour costs are expected to reduce as the machinery has the capacity to produce the goods which the 25 workers can produce from the current process. The cost of machinery is $7,800,000 and the reduction in labour cost is estimated to be$300,000. Out of total assets, 80% of the assets are fixed assets including plant& machinery used for business. The above company an Ltd. is the perfect example of high capital intensive industry.

Capital Intensive Measurement

Capital intensive can be measured by the fixed asset to sales ratio that helps us to measure whether the organization is high capital intensive based or low capital intensive based. If the ratio of fixed assets to sales is greater than 1 then the organization is said to be high capital based organization, if the ratio ranges between 0.85 to 1 then the organization is said to have the normal capital intensity and if the ratio is below 0.85 the capital intensity is said to be low.

Capital intensity can also be measured by comparing the capital expenditure and revenue expenditure if capital expenditure is more than the revenue expenditure then the organization is said to have a high capital intensity.

Effects of Capital Intensive

Following are the major effects of high capital intensive:

  • Helps to increase labour productivity and production capacity.
  • High capital intensity leads to long term economic growth.
  • High capital intensity improves the market standing and growth in market share.
  • Capital intensity leads to the introduction of new technology as unless there is new and efficient technology no company will invest in the asset.

Capital Intensive vs Labour Intensive

  • Capital intensive refers to the amount of capital invested so as to increase the revenue and profit whereas labour intensive refers to amount spent on training to labour so as to increase the efficiency of labour which will ultimately result in the increased production.
  • Capital intensive leads to an increase in operating and other maintenance costs whereas the labour intensive leads to optimum utilization of resources which reduces the production cost.
  • To be capital intensive organization requires lots of money whereas to be Labour intensive organization requires an efficient and motivational workforce.

Advantages of Capital Intensive

Following are the advantages of being a capital intensive organization:

  • There is less competition in capital intensive businesses because of the high capital requirement.
  • Investors are more attracted to the capital intensive industries because of higher returns.
  • The investment of capital intensive organization majorly consist of investment in fixed assets mainly plant and machinery which is considered as safe than the other type of investment as the organization can properly utilize the asset to earn the returns.
  • The non-operating cost like deprecation is high in capital intensive which gives the benefit in the tax payment as high depreciation results in low profit and thereby low tax.

Disadvantages of Capital Intensive

Following are disadvantages of capital intensive:

  • There is a high risk due to a large investment in capital intensive organizations.
  • Initially, the losses will be more due to heavy investment and depreciation.
  • The liquidity remains low in the capital intensive organizations as more than 60 percent of assets normally consist of capital assets.
  • The maintenance cost is high in capital intensive companies as the fixed assets and machinery needs continuous maintenance.

Conclusion

Capital intensive organizations are those organizations which invest more in capital assets. Normally 70 to 80 percent of total assets consist of fixed assets, plant and machinery. These organizations require lots of money to survive in the industry. The operating and maintenance cost is higher in these organizations as the assets need continuous servicing. But these organizations can save the tax as the depreciation and other cost is higher which results in lower profits. These organizations suffer the losses initially but in the long run, the organizations can earn higher profits. The long term growth is good in capital intensive industries. The risk involved is also higher hence the competition is considerably low.

Recommended Articles

This is a guide to Capital Intensive. Here we also discuss the definition and examples of capital intensive along with advantages and disadvantages. You may also have a look at the following articles to learn more –

  1. Working Capital Loan
  2. Capital Reserve 
  3. Capitalization Ratio
  4. Capitalizing vs Expensing
0 Shares
Share
Tweet
Share