Capital investments play several roles in business, however they are majorly used to purchase fixed assets such as land, machinery and business and as funds invested for business growth and expansion. A business cannot grow unless they have good capital investments, the investments generally procured in the form of debt financing or equity financing. These kinds of investments are generally provided by financial institutions and venture capitalists.
They are generally used in long term investment opportunities which has a longer tenure and yield returns for several years in an enduring rate. These investments can be in the form of new plant and machinery, factory upgradation, expanding a business, constructing a utility and many more. Although it plays a very crucial role in the growth of the business, yet it has its own benefits and risks involved.
Let Us See The Benefits And Risks Associated With Capital Investments
Capital Investment Help The Economy
The business economy grows in a few specific ways, so entrepreneurs and business owners constantly look for an option to grow and become big. This led to the discovery of oil wells in 1850. Similarly with the advancement in technology and the advent of web technologies and the internet, the economy has grown drastically and this was reflected through improved capital goods structure and increasing capital stocks.
The growth of capital goods certainly impacts in the increase of labor productivity. For example, the purchase of land and buildings for your business or any costs involved in the construction of a building or a structure. Similarly when it comes to technology, the human workforce is replaced by machinery and in recent ages, robots are replacing the place of machinery and most of the systems are automated. These changes result in increased efficiency and productivity which ultimately leads to an increase in economic growth.
Capital Investments Have Adequate Control Over The Expenses
Capital expenses typically involve elements such as money spent to purchase other companies or for research and development. They normally have a substantial effect on the short-term and long term financial growth of the business. In a nutshell, they are funds used by a business for the purchase and maintenance of long term assets that have a long lasting lifespan. It is extremely vital for an organization to determine how much you need to invest in capital expenditures. This is because of the following reasons
- Long term financial standing: The capital expenditure decisions generally extend to the future. This is usually determined based on the forecast of the past. Apparently at the same time, current decisions also provide the structure for future projects. The capital investment decisions have a huge impact on the basic essentials of the organization
- Irreversibility- Capital expenditure decisions are permanent and cannot be undone unless the organization faces losses. However, some are custom-made to meet specific requirements. For instance, you have purchased equipment that has no longer value in the market, after acquiring you cannot reverse the decision, the only possible thing you can do is to scrap the machinery. Here you reversing your buying decision however at the end of the day you are incurring a substantial loss.
- Depreciation – Capital expenditures hint an upsurge in the asset accounts of a business. Nevertheless, when you have started using your fixed assets like the machinery, vehicles, eventually it starts to depreciate, and they continue to decrease in value throughout their lifespan.
After witnessing tremendous benefits of capital investments, it’s now time to see the risk associated with it.
There Are Few Risks Involved With Capital Investments
It is the possibility of an investor suffering losses due to aspects that impact the overall performance of the financial markets in which the investor is associated with. Market risk also referred to as undiversifiable risk since it impacts all asset classes and is unpredictable. There are few primary sources of market risk such as interest rate risk, equity price risk, foreign exchange risk and commodity risk.
Liquidity risk is a financial risk that for a certain period of time a given financial asset, security or commodity, a company or bank may be unable to meet their short term financial demands. However, this risk can be mitigated by developing strategies and taking suitable steps.
Also called as a credit risk in the form of lending too much to one particular customer or type. In other words, it is the ability for a loss in an investment portfolio or a financial institution during a situation, when an individual move towards an unfavorable direction.
Capital investment basically helps to make an informed decision about an investment taking into consideration all possible options. Although there are few limitation and risks associated with it, yet they always remain as necessary for the company growth.