Is Investment a Capital?
The term “capital” is used to describe something that has intrinsic economic value. A capital investment gives the owner a right to share in the profits of a company or to control its management. A capital asset can either be tangible, such as land, buildings, and equipment, or intangible, such as goodwill. Some examples of intangible assets are things like patents and trademarks.
Investment is not a form of capital; it’s an exchange for cash flows (also known as “returns”). The investment could take different forms: debt financing via bonds or stocks; equity financing via shares; or any other form whereby money is exchanged for future cash flows resulting from financial activities.
There are important legal, accounting, and financial reporting aspects that distinguish capital assets from investments. The distinction is important when companies use their capital assets to generate revenue or earnings.
Capital assets are added to a company’s financial statements, as well as its balance sheet, to reflect their current value.
Investing in capital assets usually gives rise to earnings (sometimes called “profit” or “earnings”) and is an important part of the overall financial picture. Earnings on investment can be reported in accounting statements alongside earnings from other activities such as sales and rental income. This is an important distinction to make when comparing different companies concerning their economic performance.
Investment decisions are made by companies and their shareholders, who exercise their rights to control the direction of the company’s financial policies.
The distinction between capital assets and investment is also important when governments consider whether to grant tax incentives for businesses to develop and use new capital assets. A “capital investment refund” (CIR) is an example of a government subsidy for capital investment. Other subsidies include tax concessions, accelerated depreciation allowances, and R&D allowances.
This can distort competition but can also be used to benefit specific groups of businesses, such as new ventures or industries. In both cases, the taxpayer or business has not necessarily received the increase in the utility value of the actual capital asset that they have acquired or funded.
Capital assets have a long-term economic value that is physical (things like machinery and structures) or intangible associated with the business (goodwill).
Some examples of intangible capital assets are patents and trademarks.
Investment does not have an intrinsic economic value; it is an input into the production process. Investment can take different forms, such as debt financing via bonds or stocks; equity financing via shares; or any other form whereby money is exchanged for future cash flows resulting from financial activities.
Financial returns from investment are sometimes called earnings, profits, or cash flows, regardless of whether they come from debt securities, equity securities, derivatives, currency trading, or other financial instruments.
The distinction between capital assets and investment relates to financial reporting. Financial values associated with capital assets are usually reported on a company’s balance sheet, while financial values associated with investment appear in its income statement.
The term “capital asset” is used to describe tangible or intangible assets that have an economic value. The term “capital investment” refers to investments in assets that are a source of future cash flows and are not traded on a stock exchange or quoted on financial markets.
A capital investment can be anything from basic plant and equipment to industrial machinery, machinery for processing raw materials, machinery for making chemicals and pharmaceuticals, machinery for producing fabricated metal products, and components for motor vehicles.
Capital investments can be classified as either current or long-term in nature. Current investments are generally the most quickly liquid form of capital; they usually mean a faster return of cash after they have been used by the company. Examples include new production equipment and machinery.
A long-term investment typically has a longer life than a current investment; that is, it generates returns over more than one year. Examples include buildings and office equipment.
A capital asset is usually accounted for on the balance sheet as an asset, but can also be reported on the income statement as an investment in long-term capital (LTC). The distinction between LTC and current investments is important because companies report their financial results over varying periods.
In general, LTC capitalizes the asset rather than depreciates it because accrued depreciation methods cannot be used to account for LTC.
LTC and current assets should balance. If the value of current assets falls below the value of LTC, the shortfall must be reported somewhere else on the balance sheet. A possible solution is to capitalize any excess current assets as LTC. This might result in a large amount of total capital being reported but it deals with the problem immediately by bringing all capital expenditures into line with their respective accounting statements.
When a company invests in another company or business as part of its involvement in long-term financing, it usually has to record its investment on its income statement as an investment expense or an investment gain for that period (sometimes called “profit” or “earnings”).