What Is a Capital Intensity Ratio?
The capital intensity ratio is a financial calculation measuring how much a company is invested in total assets compared to how much it is earning in revenue. It is calculated by dividing the value of its total assets in a specific time period by the amount of revenue it has earned in the same period. What the capital intensity ratio shows is just how much capital it takes a firm to generate a single dollar of revenue. Like all financial ratios, this one is best used when comparing companies in a single industry to one another.
Companies have to attempt to balance out how much money they spend with home much they earn. It seems like an obvious truth, but when it comes to firms dealing in huge amounts of money, it can be difficult to keep track of the relationship between assets and revenue. This is important not only for the companies themselves, but also for the investors inspecting the value of those companies. One way to measure the relationship between assets and revenue is the capital intensity ratio.
As an example of how this works, imagine that a company has amassed $200,000 US Dollars (USD) in revenue in a single year's time. Over that same period of time, the value of the total assets which the company possesses equals $500,000 USD. In this case, the capital intensity ratio is $500,000 USD divided by $200,000 USD, leaving a ratio of 2.5.
What the capital intensity ratio means in this example is that the company in question must spend approximately $2.50 USD for every single dollar of revenue it earns. Ideally, a company could lower the ratio as much as possible. A company that continues to invest heavily in its assets without eventually returning revenue in the neighborhood of the amount spent will struggle to stay afloat. Such companies that have high ratios are highly capital intensive and must find a way to strike a better balance as time goes by.
There are some caveats that should be considered when dealing with the capital intensity ratio. The circumstances of companies often dictate their ratios. For instance, a company just starting out will likely be highly capital intensive, since their business has not had time to amass great revenue. In addition, companies in different industries should not be compared to each other, since their industries likely dictate to some extent how capital intensive they must be.
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