What is capital investment analysis? Your guide to business growth

Capital investments are a key to a long-term financial strategy and can position your business for sustained growth for years. Making the right decisions about when, where, and how much to invest can help you prevent major setbacks that could take time to overcome. 

However, 41% of businesses say the availability of financing has gotten more difficult or more expensive. As capital becomes harder and pricier to obtain, it is increasingly important for businesses to make wise investment decisions. Strong capital investment analysis helps business executives make informed, impactful decisions that can save the company time and money.

Learn how to evaluate capital investments and the challenges businesses face when analyzing them. This information, in combination with enterprise accounting software, can help leadership make informed decisions about capital investment opportunities.

What is capital investment analysis?

5 key metrics to evaluate capital investments

Why capital investment analysis matters for your business

Common challenges in capital investment analysis and how to overcome them

Tools to simplify the analysis process

Boost productivity and enhance profitability

What is capital investment analysis?

Capital investment analysis is a budgeting process that helps a company accurately evaluate the profitability of long-term ventures. Capital investments differ from financial investments in that capital investments focus on core business objectives. Financial investments focus on financial instruments, such as stocks and bonds.

Investment capital can cover a broad range of assets a business may need to fuel future growth, including:

• Real estate
• Equipment
• Machinery
• Reach and development
• Employee training
• Facility construction
• Vehicles
• Strategic acquisitions

The goal of capital investment analysis is to identify the investments that are most likely to yield the highest return on invested capital. 

5 key metrics to evaluate capital investments

A capital investment analysis is ultimately a cost-benefit analysis that companies use. The analysis helps businesses determine whether the benefits of a long-term investment are high enough to justify the costs as part of the capital budget. When conducting this analysis, a business may use these five methods to evaluate capital investment opportunities.

1. Net present value (NPV)

Net present value (NPV) measures how much future expected revenue (cash flows) is worth today’s dollars. You'll estimate future cash flows via demand planning and then discount these estimated cash flows to present value. The initial investment cost is subtracted from the discounted present value, resulting in the project's NPV. 

A positive NPV means the project is financially worthwhile, while a negative NPV suggests that the financials cannot justify the investment. 

2. Internal rate of return (IRR)

The internal rate of return (IRR) is the discount rate at which the NPV equals zero. This rate, or the hurdle rate, is the amount a project must earn to be profitable. 

A capital investment with an expected rate of return higher than the IRR would produce a positive NPV and be profitable for the business. Projects with rates of return below the IRR are not profitable. 

3. Payback period

The payback period is the expected time to recoup the initial investment. It is a quick, simple assessment of an investment's liquidity, with longer payback periods correlating with more illiquid ventures. 

4. Discounted cash flow (DCF)

Discounted cash flow (DCF) stipulates that a dollar today is worth more than a dollar tomorrow due to its earnings potential. DCF accounts for this by discounting future cash flows back to present value via a discount rate. 

DCF is a core component of the NPV calculation discussed earlier. DCF provides the present value of expected future cash flows. The NPV of a capital investment is the DCF less the initial investment costs. 

5. Other important considerations for investment analysis

In addition to the financial considerations previously mentioned, there are additional factors that should enter into a capital investment analysis: 

• Sensitivity analysis: A sensitivity analysis evaluates how a change in one factor can change the expected profitability of a project. For example, a sensitivity analysis may shift the discount rate up or down a percentage point to gauge how that would impact the NPV of the project.
• Real options: NPV decisions assume a fixed decision. Flexibility is a key element of the business decision-making process. Real options add value by recognizing that businesses are not obligated to take a certain action but can defer, switch, or abandon a project altogether. 
• Decision trees: These trees map out all possibilities, decisions, and outcomes in a branching path structure. Decision trees help businesses measure the expected value of each step and better incorporate probabilities and risk into their analysis. 
• Environmentally sustainable investment analysis: Making a profit is a business's fundamental purpose, but it isn’t the only issue that companies must consider. The final capital investment analysis should incorporate any social and financial costs related to environmental impact.

Why capital investment analysis matters for your business

Capital investment analysis provides powerful benefits for businesses, no matter the size or industry in which they operate. These benefits include:

Informed decision-making

The size and scope of major capital investments make these decisions more challenging and more important to get correct. Without proper analysis, a company may make these choices based on gut feelings or internal company politics. 

Instead, businesses must move their capital investment analysis beyond intuition. Leveraging objective financial metrics, including NPV, IRR, and DCF, companies can ensure they’re making smart, profitable investment decisions. 

Optimizing resource allocation

A common bottleneck for corporate growth is raising and accessing capital, which can limit your company’s growth opportunities. Capital investment analysis can help your business allocate capital toward high-impact projects and away from lower, less-profitable opportunities, which is a key to sustained profit growth. 

Strategic planning

Profitable projects are about more than just making the financial work, although this is a critical component. Capital investment decisions should also align with your strategic financial planning process to help you make decisions that fit into and reinforce your long-term growth plans. 

Maximizing shareholder value

Companies that excel at capital investment analysis invest in projects that are consistently profitable. Thus, they can feel more confident that their capital investments will provide the highest returns to owners.

Not only does effective capital investment analysis improve shareholder value, but it also improves shareholder confidence in the firm. If your company makes decisions based on trusted financial metrics, you can easily communicate to investors and shareholders that you're carefully evaluating the risks and rewards of every opportunity.

Common challenges in capital investment analysis and how to overcome them

Capital investment analysis can prove to be difficult, but with proper planning, you can overcome these challenges:

Projecting accurate future cash flows

The foundation of any capital investment analysis is the expected future cash flows that the project will produce. Estimating these future cash flows is part of that process. 

While no company can guarantee how much revenue an investment will produce, thorough research and preparation can lead to more accurate estimates and higher-quality analyses. 

Determining the appropriate discount rate

Getting the discount rate right is an important and nuanced step in the capital investment analysis process. An appropriate discount rate directly impacts how a firm values future cash flows. 

Sensitivity analysis, industry benchmarks, and market data can all help you verify whether you’re using a fair discount rate in your analysis. 

Accounting for unexpected events

No matter how well you plan, the unexpected will occur. Contingency planning and regular re-evaluation will help your growing organization remain agile and productive in evolving circumstances. 

Tools to simplify the analysis process

The value of a capital investment analysis hinges on its accuracy. Today, businesses can use a wealth of tools to streamline the capital investment analysis and feel more confident about the accuracy of their analysis. 

These resources include the following: 

Dedicated calculators for core metrics

Capital investment analysis involves a lot of complex math. Fortunately, user-friendly calculators on the market can handle the heavy lifting when calculating NPV, IRR, and payback periods. You can find these tools online, within spreadsheet software, or integrated with financial planning tools, like Intuit Enterprise Suite. 

Resources for advanced analysis

Deeper analytical tools provide valuable insights for complex or higher-risk investments. Sensitivity analysis tools help evaluate how changes in key assumptions, such as sales volume, impact profitability metrics like NPV and IRR. Monte Carlo simulations can model various scenarios and outline their probabilities of success. 

You can integrate these tools with dimensional forecasting software to resolve more complicated analyses and build robust future profitability projections. 

Frameworks for structured approaches

Established guides and frameworks offer structured methodologies for approaching capital investment analysis. Examples include:

• Reputable financial guides: These guides provide step-by-step processes and best practices from identification to decision.
• Holistic evaluation: Frameworks often consider nonfinancial factors, such as environmental impact or the project's strategic alignment. 
• Internal procedures: Well-established internal processes are useful for setting up consistent evaluation processes within your business.

Leveraging Intuit Enterprise Suite for seamless financial data management

Comprehensive business intelligence is the bedrock of any accurate investment analysis. Intuit Enterprise Suite can bring your financial data management to the next level by making it easier to:

• Track costs and revenues: Track all project-related expenditures and expected income streams directly within the Intuit Enterprise Suite.
• Monitor cash flow: Understand the timing of cash inflows and outflows using its reporting features.
• Categorize expenses: Use custom categories or tags to isolate and analyze costs related to specific capital projects.

Boost productivity and enhance profitability

Capital investment is more than just the numbers. It’s about deciding to further your company’s long-term strategic goals. Combining financial data with real-world insights, you can confidently evaluate opportunities, make intelligent business decisions, and improve business efficiency. 

The Intuit Enterprise Suite (IES) integrated accounting software offers industry-specific solutions that can enhance profitability, boost productivity, and help your company scale confidently. Learn more about how IES can help simplify your complex business operations.