What Is Capital Intensive?
The term "capital intensive" refers to business processes or industries that require large amounts of investment to produce a good or service. As a result, these businesses have a high percentage of fixed assets, such as property, plant, and equipment (PP&E). Companies in capital-intensive industries are often marked by high levels of depreciation.
Understanding Capital Intensive
Capital-intensive industries tend to have high levels of operating leverage, which is the ratio of fixed costs to variable costs. As a result, capital-intensive industries need a high volume of production to provide an adequate return on investment. This also means that small changes in sales can lead to big changes in profits and return on invested capital.
Their high operating leverage makes capital-intensive industries much more vulnerable to economic slowdowns compared with labor-intensive businesses because they still have to pay fixed costs, such as overhead on the plants that house the equipment and depreciation on the equipment. These costs must be paid even when the industry is in recession.
Examples of capital-intensive industries include automobile manufacturing, oil production and refining, steel production, telecommunications, and transportation sectors (e.g., railways and airlines). All these industries require massive amounts of capital expenditures, also referred to as CapEx.
Capital intensity refers to the weight of a firm's assets—including plants, property, and equipment—in relation to other factors of production.
Measuring Capital Intensity
Besides operating leverage, the capital intensity of a company can be gauged by calculating how many assets are needed to produce a dollar of sales, which is total assets divided by sales. This is the inverse of the asset turnover ratio, an indicator of the efficiency with which a company is deploying its assets to generate revenue.
Another way to measure a firm's capital intensity is to compare capital expenses to labor expenses. For example, if a company spends $100,000 on capital expenditures and $30,000 on labor, it is most likely capital-intensive. Likewise, if a company spends $300,000 on labor and only $10,000 on capital expenditures, it means the company is more service- or labor-oriented.
Key Takeaways
- Capital intensity can be measured by comparing capital and labor expenses.
- Capital-intensive firms usually have high depreciation costs and operating leverage.
- The capital intensity ratio is total assets divided by sales.
The Impact of Capital Intensity on Earnings
Capital-intensive firms generally use a lot of financial leverage, as they can use plant and equipment as collateral. However, having both high operating leverage and financial leverage is very risky should sales fall unexpectedly.
Because capital-intensive industries have high depreciation costs, analysts that cover capital-intensive industries often add depreciation back to net income using a metric called earnings before interest, taxes, depreciation, and amortization (EBITDA). By using EBITDA, rather than net income, it is easier to compare the performance of companies in the same industry.
What types of industries are considered capital-intensive?
The automobile, energy, and telecommunications industries are examples of capital-intensive sectors. Companies operating in these industries need large amounts of capital to invest in equipment and manufacturing.
What is the difference between capital-intensive and labor-intensive businesses?
A capital-intensive business requires a large amount of capital to operate. A labor-intensive business needs a significant amount of labor to operate. A business is considered labor-intensive if employee costs outweigh capital costs.
How does capital intensity affect the profitability of a company?
Capital-intensive businesses need significant profit margins in order to remain operational. In the short-term, high capital expenditure may reduce profitability. In the long-term, the investment can lead to higher profits.
Capital-intensive businesses are also sensitive to fluctuations in sales. Even small changes can impact profits.
The Bottom Line
Capital-intensive businesses require significant amounts of capital to operate successfully. Capital intensity is determined by dividing total assets by sales. Capital intensity affects companies' profitability.
FAQs
The term "capital intensive" refers to business processes or industries that require large amounts of investment to produce a good or service. As a result, these businesses have a high percentage of fixed assets, such as property, plant, and equipment (PP&E).
What is capital intensity and an example? ›
Capital intensity measures the amount of spending on assets necessary to support a certain level of revenue. To illustrate the concept in the form of a question, “How much capital is needed to generate $1.00 of revenue?” Common examples of capital assets can be found below: Equipment.
What is an example of a capital intensity ratio? ›
A company with a lot of fixed assets will likely need more revenue than other businesses to cover those costs and make a profit. An example of a high capital intensity ratio is a company that sells luxury vehicles. This type of business often has many high-cost assets relative to the amount of revenue it brings in.
Which of the following is an example of capital intensive commodity? ›
Expert-Verified Answer
In the provided options, chemicals represent a capital-intensive commodity. This is because their production requires large manufacturing plants, advanced machinery, and a substantial investment in technology.
What are the capital intensive factors? ›
Capital intensity is the amount of fixed or real capital present in relation to other factors of production, especially labor. At the level of either a production process or the aggregate economy, it may be estimated by the capital to labor ratio, such as from the points along a capital/labor isoquant.
What are examples of capital intensive techniques? ›
Capital intensive production refers to production methods that require a high level of investment in capital equipment and technology, rather than labor. Here are some examples: Automated assembly lines in factories, which use robots and machines to assemble products with minimal human intervention.
What is an example of a capital intensive company? ›
Capital intensive companies have a higher proportion of fixed assets than the total assets. Capital intensive industries examples include oil & gas, automobiles, manufacturing firms, real estate, metals & mining.
How is capital intensity defined? ›
The capital intensity measures, for a unit, the assets needed to generate income. It is calculated by dividing gross tangible fixed assets to full-time equivalent employeses .
What is capital intensity in business? ›
FAQs. What businesses are capital intensive? Capital intensive businesses are those that require a large amount of capital to start or run. They are similar to asset intensive industries, which are also industries that require a large amount of capital to start and operate.
What is the formula for capital intensity life? ›
To calculate the capital intensity ratio, you need two different data sets from a company's balance sheet: the value of a company's total assets and the revenue in a given period. Simply divide the total assets by sales, which will provide you with the capital intensity ratio.
The business of owning and operating a McDonald's restaurant franchise is without a doubt, capital intensive. From the hefty initial investment to the steady stream of re-investments to keep your restaurant operating at peak performance, the amount of capital poured into your business is substantial.
Is Coca Cola capital-intensive? ›
In addition, the company's multi-year path to refranchising its bottling operations is helping Coca-Cola's financial health. This strategy enables the company to move away from this capital-intensive, low-margin business by selling the operations to local bottling partners.
Is retail capital-intensive? ›
With retail becoming more capital intensive, investing deeply in an ecosystem requires balance sheet scale and resilient revenue pools.
Which good is capital intensive? ›
Short Answer
The land-, labor-, and capital-intensive goods are those in whichthe land, labor, and capital usage are more, respectively. For example, corn is a land-intensive good, furniture is a labor-intensive good, and oil production is a capital-intensive good.
What are 3 advantages of capital intensive? ›
Capital-intensive production offers advantages such as increased efficiency, higher output, and reduced labour costs. Capital-intensive production refers to a process of manufacturing in which a large portion of the total production cost is invested in machinery, equipment, and technology.
Which of the following is most capital intensive? ›
Petroleum is the most capital-intensive sector among the given options. This is because the production and refining of petroleum require large amounts of capital investment in equipment, technology, and infrastructure.
