Capital Intensive

Loading the player...

What does 'Capital Intensive' mean

Capital intensive refers to a business process or an industry that requires large amounts of money and other financial resources to produce a good or service. Once the upfront investments are made, there may be economies of scale with regards to ongoing expenses and sales growth, but the initial hurdle to get into the business tends to keep the list of competitors small, creating high barriers to entry. Companies in capital-intensive industries are often marked by high levels of depreciation and fixed assets on the balance sheets.

BREAKING DOWN 'Capital Intensive'

A business is considered to be capital-intensive based on the ratio of the capital required to the amount of labor that is required. Some capital-intensive industries include oil production and refining, telecommunications, and transportation, such as railways, autos and airlines. In all of these industries, a large financial commitment is required to fund the operation. A company's capital expenses are generally judged in relation to its labor expenses; that is, some industries such as tax preparation or marketing require more input from labor.

The Impact of Capital Intensity on Earnings

Capital-intensive firms generally have high leverage ratios, but much of the debt is backed by equipment. The company uses the equipment as collateral. This allows companies to carry large amounts of equipment for only a fraction of the cost. These companies also tend to expense a large amount of sales to depreciation. Analysts that cover capital-intensive industries often add depreciation back to net income in a metric called earnings before interest, taxes, depreciation and amortization (EBITDA). Instead of using net income in performance ratios, analyst use EBITDA to mitigate the impact of depreciation, a non-cash expense, on net earnings.

Measures of Capital Intensity

There are several ways to measure and compare capital intensity. One way to measure a firm's capital intensity is compare capital expenses to labor expenses. For example, if a company spends $100,000 on capital expenditures and $30,000 on labor, it means the company 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.

A company that needs more assets to produce a dollar of sales has a higher capital intensity than a company that needs fewer assets to produce the same dollar. As a result, analysts like to measure capital intensity by looking at a variation of return on assets (ROA) calculated by dividing total assets by sales. Instead of looking at the level of net income created by each dollar of assets, which is what ROA measures, it looks at the level of revenue created by each dollar of assets. In this way, it is a measure of asset efficiency rather than management's efficient use of assets.

Trading Center