Capital Intensive

What Is Capital Intensive?

The term "capital intensive" alludes to business processes or industries that require large measures of investment to deliver a decent or service and hence have a high percentage of fixed assets, for example, property, plant, and equipment (PP&E). Companies in capital-intensive industries are in many cases set apart by high levels of depreciation.

Figuring out Capital Intensive

Capital-intensive industries will generally have high levels of operating leverage, which is the ratio of fixed costs to variable costs. Thus, capital-intensive industries need a high volume of production to give an adequate return on investment. This likewise 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 substantially more helpless against economic lulls compared with labor-intensive businesses since they actually need to pay fixed costs, like 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.

Instances of capital-intensive industries incorporate automobile manufacturing, oil production, and refining, steel production, telecommunications, and transportation sectors (e.g., rail routes and carriers). This multitude of industries require huge measures of capital expenditures.

Capital intensity alludes to the weight of a company's assets — including plants, property, and equipment — corresponding to different factors of production.

Measuring Capital Intensity

Other than operating leverage, the capital intensity of a company can be measured by computing the number of assets that are expected to deliver a dollar of sales, which is total assets partitioned by sales. This is the inverse of the asset turnover ratio, an indicator of the effectiveness with which a company is sending its assets to produce revenue.

One more method for measuring a company's capital intensity is to compare capital expenses to labor expenses. For instance, in the event that a company burns through $100,000 on capital expenditures and $30,000 on labor, it is undoubtedly capital-intensive. Similarly, on the off chance that a company burns through $300,000 on labor and just $10,000 on capital expenditures, it means the company is more service-or labor-situated.

The Impact of Capital Intensity on Earnings

Capital-intensive firms generally utilize a ton of financial leverage, as they can involve plant and equipment as collateral. Notwithstanding, having both high operating leverage and financial leverage is extremely hazardous should sales fall out of the blue.

Since capital-intensive industries have high depreciation costs, analysts that cover capital-intensive industries frequently add depreciation back to net income utilizing a measurement called earnings before interest, taxes, depreciation, and amortization (EBITDA). By utilizing EBITDA, as opposed to net income, looking at the performance of companies in a similar industry is simpler.

Highlights

• Capital-intensive firms as a rule have high depreciation costs and operating leverage.
• The capital intensity ratio is total assets partitioned by sales.
• Capital intensity can be measured by contrasting capital and labor expenses.