Updated July 17, 2023
Definition of Capital Intensive
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 to increase production, resulting in higher profits and earning good returns on investment.
Explanation
Every organization needs capital to run the business. It measures on the basis of capital deployed by the organization in purchasing fixed assets. It defines as the capacity of the organization to invest in fixed assets. Higher investment leads to higher returns, which results in more investors and market share. Some businesses need higher capital to start the businesslike the airline industry. Capital-intensive companies need higher money to keep their operations going, which means the maintenance cost is also high in such industries. These companies have higher operating leverage as operating costs increase due to high investments in fixed assets and machinery. These industries usually have a larger volume of sales. The market standing of these industries is based on the services they provide, maintenance of assets, labor efficiency, productivity, risk factor, etc. In short, the organization considers this capital expenditure is much more than labor.
Examples of Capital Intensive
- Transportation sectors like railways, airways, and waterways need lots of investment in buying the transportation medium or production of transportation medium. Reinvestment reduces diversification as the funds reinvest in the same type of securities, increasing concentration and reducing portfolio variety.
The profit depends upon the operational cost, higher the operational cost like repairs and maintenance, labor cost, salaries, and admin expense, etc. Lower will be the profit. The profit also reduces due to higher depreciation costs. - ABC Incorporated imported machinery from California, which expect to boost the organization’s sales by 50% and reduce labor costs, as the machinery can produce the goods equivalent to the output of 25 workers in the current process. The company incurred a cost of $7,800,000 for the machinery and estimates a reduction in labor costs of $300,000.Out of total assets, 80% are fixed assets, including plant& machinery used for business. The above Company Ltd. is the perfect example of a highly capital-intensive industry.
Capital Intensive Measurement
This can be measured by the fixed asset-to-sales ratio that helps us measure whether the organization is high or low capital-intensive based. A high capital-based organization characterizes by a ratio of fixed assets to sales greater than 1. An organization with normal capital intensity identifies when the ratio ranges between 0.85 and 1. On the other hand, low capital intensity is observed when the ratio falls below 0.85.
Capital intensity can also measure by comparing capital and revenue expenditures. If capital expenditure is more than the revenue expenditure, then the organization is said to have a high capital intensity.
Effects of Capital Intensive
The following are the major effects of high capital intensification:
- It helps to increase labor 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.
- The Capital intensity leads to introducing new technology, as no company will invest in the asset without new and efficient technology.
Capital Intensive vs Labour Intensive
- It refers to the capital invested to increase revenue and profit. In contrast, labor-intensive refers to the amount spent on training labor to increase the efficiency of labor, which will ultimately result in increased production.
- This leads to an increase in operating and other maintenance costs, whereas labor-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
The following are the advantages :
- There is less competition in capital-intensive businesses because of the high capital requirement.
- Investors are more attracted to capital-intensive industries because of higher returns.
- These organizations mainly invest in fixed assets, plants, and machinery, which consider safer than other investments because the organization can properly utilize the assets to earn returns.
- The non-operating cost, like deprecation, is high in capital intensive, which benefits the tax payment as high depreciation results in low profit and, thereby, low tax.
Disadvantages of Capital Intensive
The following are the disadvantages :
- There is a high risk due to a large investment in this organization.
- Initially, the losses will be more due to heavy investment and depreciation.
- Liquidity remains low in 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
These organizations are those organizations that invest more in capital assets. Normally 70 to 80 percent of total assets are fixed assets, plants,s, 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 are higher, resulting in lower profits. These organizations suffer losses initially but can earn higher profits in the long run. Long-term growth is good in capital-intensive industries. The risk involved is also higher; hence the competition is considerably low.
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