What is a Capital-Intensive Industry or Company?
Companies in capital-Intensive industries can Improve Return on Assets ROA by increasing asset returns or reducing the asset base
Every business has an asset base, that is, properties it owns and uses to earn income. Firms can describe and analyze the makeup of their asset base in terms of an asset structure. The asset structure description, in turn, reveals which kinds of assets account for the largest and smallest percentages of the overall asset base. That information is essential for evaluating the firm's success or failure with it's chosen asset strategy. Capital Intensive is one such asset strategy.
Define Capital Intensive
A capital-intensive (capital heavy) industry or company, is one whose greatest capital costs result from investments in equipment, machinery, or other expensive capital assets.
For capital-intensive companies, assets such as land, buildings, plants, equipment, vehicles, or heavy equipment represent the largest components of the firm's asset structure.
Mining, utilities, railroads, construction, and heavy manufacturing are typically capital-intensive industries in this respect. For such companies, the option to lease rather than purchase assets sometimes plays a central role in asset planning and financial strategy. Acquiring the use of assets under an operating lease raises operating expenses but adds nothing to the asset base.
By contrast, companies in sectors such as financial services and software development, usually avoid investing heavily in such assets and are not capital-intensive.
- What is a capital-intensive industry or company?
- Can companies choose their level of capital intensity?
- How do companies reduce their asset base?
- For broader coverage of asset structure (the relative sizes of asset categories in a company's total asset base), and return on assets (ROA), see the Asset Structure.
- For more on the several meanings of capital in business, finance, and economics, see the article Capital.
- See the article Assets for more on the nature of capital and other assets.
- The article Capital Review Process explains how many firms budget and prioritize capital acquisitions.
Visit the Master Analyst Shop and download premier business analysis ebooks, templates, and apps today!
Can Companies Choose Their Level of Capital Intensity?
Many companies have some freedom to choose or at least modify their level of capital intensity. In other words, many companies have some freedom to choose or modify their capital structure and asset structure.
For example, many companies choose to own buildings, vehicles, aircraft, and large computer systems, while other companies in the same industries choose to obtain the use of such assets through operating leases.
How do Companies Reduce Their Asset base?
Reducing the asset base by leasing assets can in some cases improve the company's business performance in several ways:
- If the firm reduces the overall asset base while earnings remain constant or grow, profitability metrics will show better return on assets figures.
- If the firm sells assets such as buildings and then uses an operating lease to replace them, it can reinvest the new cash assets from the sale in other assets or other expenditures with a greater return. The firm may reinvest, for instance, in research and development or new service contracts.
- The purchase of assets and the leasing of assets typically have different tax consequences. One such tax difference results from reducing annual depreciation expenses by acquiring capital assets through operating lease rather than purchase. Lowering depreciation expense increases end-of-period profits but also increases income tax liabilities on the income increase.
- Leasing rather than purchasing assets may give the company more flexibility and freedom to upgrade or modernize assets frequently. This kind of flexibility is especially helpful with assets that quickly "show their age", such as computer systems or vehicles.
The term asset structure refers to relative sizes of asset categories in a firm's total asset base. For more on asset structure and strategies in different industries, see the article Asset Structure. The article also shows how to measure and track the firm's Return on Assets ROA.