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Capital Investment - Types, Advantages and Limitations

  • Pragya Soni
  • Mar 02, 2022
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“The greatest enemies of equity investors are expenses and emotions”


- Warren Buffett 


Growth and continuity are the key requirements for a company to maintain its quota in the market. That’s why it is essential for the companies to analyze different types of capital investment projects and choose the most required one for its profits. 


Despite the size and type of organization, it is essential for it to invest in its business. The investments help in ensuring improvement and optimizing the performance of the company.


In this blog, we will study about capital investment. The advantages and disadvantages of capital investment for a company.


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What is a Capital Investment?


Capital investments are sometimes treated as equity investments. Capital investment may be defined as the funds invested by the owners to expand their business and improve its productivity. In simple words, it is the fund used by the organization to acquire fixed assets. 


It is used to serve long-term business goals and objectives. Some long term capital investments are the investments done for the purchase of assets like real estate, manufacturing plants, and machineries. Unlike, equity investment capital investment is made after a detailed analysis of all clear and precise costs. This helps in increasing profits and reducing the loss. 


Without capital investment the companies or organizations can’t fulfill their economic and financial objectives. The continuous capital investment is essential to maintain the productivity in the market as well as quality products.


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Sources of capital investment


The organization can avail capital investment from a wide range of sources.  It can approach traditional banks as well as venture capital deals. The major sources of capital investments are angel investors, loan, venture capitals, lenders, and public offerings.


Working of capital investment


You all might be wondering, how does capital investment work? Well, its working is quite similar to other investments. The first step is raising money for the investments, a new company can arrange money from a number of resources like, capital firms, angel investors, and other financial institutions. 


On the other hand, an established company can arrange cash from its own cash flows. It can also issue bonds or stocks to finance the required amount. There is no fixed amount required for capital investment. It can vary from a few lakhs to billions and trillions. 


Startups require a low amount of capital investment while industries like mining, utilities and infrastructure comparatively require a high sum of money. During the fund-raising process, a company’s operating cycle can run at minimum and sometimes, even blocked too. This decrease in production is responsible for less revenues. 


Sometimes, even the employees have to suffer during this time. But as soon as the fund is raised, the operating cycle of the company returns to normal with greater capabilities. This results in better profits, satisfied employees and more investors. The demands of customers now are met with quality products and more satisfactory services.


Also Read | Business Cycle and Its Effect



Types of Capital Investment


On a major basis capital investment is classified into three types. But there can be different ways to differentiate capital investment depending on the company's needs. These types are classified after analyzing the asset conversion cycle. The major three types of capital investment are mentioned below.

1. Diversification

Diversification is the type of capital investment that requires the evaluation of proposals. It is done to diversify new product lines and new markets. It can also be defined as a technique to reduce risk of failure while dealing with different products and market operations.

It manages the risk involved in capital by allocating investments in different financial investments and industries. The aim of diversification is to maximize returns by allowing investments in different areas. These areas and investments react differently to the same event.


2. Replacement and Modernization

Replacement and modernization is the second kind of capital investment. It is done to improve the operation efficiency and reduce the intermediate costs. Replacement investment may be defined as capital investment done to replace old machineries. The plants and machinery employed in the market should be replaced regularly after it is used and has a good life.

Technology is used to upgrade machineries more modern and advanced. The organization and market should take efforts for modernization in order to beat competitiveness in the market. Investment made in this procedure is called modernization investment and is also called cost reduction investments.


3. Expansion

Expansion is the investment made to existing companies. It experiences growth and meets the demand required for improving the product lines. When an established company experiences shortage or delay in delivery of their services or degradation in the product qualities. In order to stay in the market, the company must add capacity and strength to the existing product.


Money invested for the above purpose is classified as expansion investment. Expansion investment helps the company to improve its productivity. At the same time, it also assists in maintaining the production and meeting the increasing demand. In simple words, expansion ensures continuity of an organization in the market.

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Advantages and Limitations of Capital Investments

Advantages of capital investment areFinancial profitsGenerates wealthHealthy market competition.Attract customers and investors

Advantages of capital investment


Advantages of Capital Investments


Technically, capital investments are done to enhance the company's growth. Apart from the growth and maintenance the benefits of the capital investments are as follows:


1. Financial Profits


There's no doubt that capital investments boost the financial cause of businesses. It helps in improving production efficiency. The overall economy of organizations and markets is improved by capital investments. The improvement of productivity indirectly helps in better employment management.


2. Generates wealth


Capital investments boost the wealth generation. Wealth generation further helps the company to grow and maintain as per the market trends. When capital investments are spent well by following the guidelines of the project. 


It translates the efforts into wealth. The wealth this generates serves as a better income for both management, shareholders and the employees. This wealth can also be used in new investments.


3. Healthy market Competition


Capital investments boost competition in the market. This competition is healthy for growth and maintenance. Competition in the market is essential to pressurize the companies to build quality products. Capital investments become essential when a product faces competitors and critics in the market. 


4. Attract Customers and Investors


By maintaining healthy competition in the market and continuous supply of quality products. Capital investments attract the customers and investors in the market. While investors come into the market to increase their share profits. Customers are attracted by the quality products to fulfill and satisfy their needs.


Also Read | Perfect and Imperfect Competition



Limitations of Capital Investments


The reasons which make capital investments a bit doubtful are as follows:


  1. Capital investments acquire fixed assets.


  1. The improvement in existing investments also needs a huge amount of money.


  1. The financing of huge amounts of capital is also a risk. Especially to big organizations and firms.


  1. Sometimes, the self cash flow of the form or organization is not sufficient enough to meet the money required for capital investments. 


  1. The insufficient cash flow can also reduce the liquidity of financial assets of the organization increasing the risk factor.


  1. If the organization chooses a loan to fulfill its money requirements this may require a guarantee.


  1. The business loans often end up with large interest rates.


  1. If a company earns profit well and good. But, if the plan turns off, the organization can lose its autonomy and dignity. So, do its investors and shareholders.


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Concluding the blog, the amount invested in capital investments is always an amount invested well. For the most of time, it returns with big profits and popularity. Capital investment is essential to ensure the continuity and integrity of a company in the market. Organizations and companies should do annual evaluation to check their growth and maintain their productivity.

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