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 澳洲幸运5官方开奖结果体彩网:property, plant, and equipment (PP&E). Companies in capital-intensive industries are often marked by high levels of 澳洲幸运5官方开奖结果体彩网:depreciation.

Understanding Capital Intensive

Capital-intensive industries tend to have high levels of 澳洲幸运5官方开奖结果体彩网:operating leverage, which is the ratio of 澳洲幸运5官方开奖结果体彩网: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 chan🧜ges in profits and return on invested capital.

Their high operat𒆙ing 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 澳洲幸运5官方开奖结果体彩网:capital expenditures, also referred to as CapEx.

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 gen༺erate revenueꦓ.

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.

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 澳洲幸运5官方开奖结果体彩网:collateral. However, having both high operating leve꧙rage 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, de🍒preciation, and amortization (EBITDA). By uꦆsing EBITDA, rather than net income, it is easier to compare the performance of companies i♉n the same industry.

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.