Capital investment decisions are long-term funding decisions that involve capital assets, while current asset decisions are short-term funding decisions essential to a firm’s day-to-day operations. Capital investment decisions look at many components, such as project cash flows, incremental cash flows, pro forma financial statements, operating cash flow, and cost cutting and asset replacement. Only after reviewing the various components, can a firm make an informed decision on which investment to use. The objective is to find the investment that yields the highest return, while ignoring any sunk costs. The investment decision involves various accounting measures, including capital investments, current assets and return on investment capital.

A capital investment is money tied up in a company with the goal of advancing its commercial objectives. It may also refer to capital assets such as equipment and machinery the company plans to use for several years. Capital investments can come from many sources, including angel investors, banks, equity investors and venture capital. A capital investment is typically used for long-term assets, but some companies use it to finance working capital.

Current assets are essential to the ongoing operations of companies because they are used to finance daily operations and cover recurring expenses. Depending on the line of business the company is in, a current asset can be anything from a hamburger at a fast food restaurant to gasoline at a gas station. Current assets include cash and short-term investments such as bonds and term deposits. They can be converted into cash to cover current liabilities without the need to sell fixed assets.

Return on investment capital is a calculation used to look at how efficient a firm is at earmarking its capital in profitable investments. This financial measure is a gauge for how a company is doing at using its money to turn a profit. Measuring a firm’s return on investment capital against its cost of capital shows how effectively funds are being used. The basic formula is net income less dividends divided by total capital. Total capital consists of long-term liabilities and common and preferred shares.

Incremental return on investment capital is the additional return on capital a firm receives from investing in a capital investment. It helps firms decide where to invest their money. Using incremental analysis, a firm can figure out the differences in cost between different investment options. It is also referred to as “differential analysis,” “marginal analysis” and “relevant cost approach.” Incremental analysis does not take into account sunk costs and identical costs between the different investment options. For example, if a company is considering replacing its old computers with new models, it does not consider the cost of the old computers. Instead, it looks at factors such as the cost of monitors and keyboards.

  1. How is working capital different from fixed capital?

    Understand the differences between working capital and fixed capital, including definitions and examples of how businesses ... Read Answer >>
  2. What can working capital be used for?

    Find out what working capital is used for, including how to calculate this financial metric by subtracting current liabilities ... Read Answer >>
  3. What does a low working capital ratio show about a company's working capital management?

    Find out the significance of working capital management for a company and look at the working capital ratio analysts use ... Read Answer >>
  4. Can Working Capital be Negative?

    Negative working capital can arise under certain circumstances. Working capital can be negative if a company's current assets ... Read Answer >>
  5. What's the difference between capital expenditures (CAPEX) and net working capital?

    Learn more about capital expenditures (CAPEX) and net working capital, two distinct but related measurements of a company's ... Read Answer >>
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