Capital Intensity Ratio

What is Capital Intensity Ratio ?

Capital Intensity Ratio is an efficiency ratio which gives the amount of assets required to be employed to generate a single dollar of sales. It is a tool to analyze the effectiveness with which a company is using its assets to generate sales. A company is said to be capital intensive if it deploys a major portion of its total capital in assets. The significance of capital intensity ratio is high in such companies in order to understand if the assets employed are able to generate sufficient revenue to cover the cost involved in investment of assets.

The Capital intensity ratio takes into consideration both fixed assets and current assets in its calculation. It is calculated by dividing the Total assets by the sales / revenue generated in a period.

 

How do you calculate Capital Intensity Ratio ?

Capital Intensity Ratio is calculated using the formula

Capital Intensity Ratio = Total Assets / Total Sales

 

The above ratio is nothing but an inverse of the Total assets turnover ratio.

We know that the total assets turnover ratio is = Total Sales / Total Assets 

Thus Capital Intensity ratio = 1 / ( Total Sales / Total Assets  ) = Total Assets / Total Sales

 

What is a low capital intensity ratio ?

A low capital intensity ratio means a company requires less than a dollar of investment in assets to generate one dollar of sale. A low capital intensity ratio is usually less than 1. This phenomenon is seen in companies that are not capital intensive. Those companies which do not rely heavily on capital investment in assets to generate sales, generally have a low capital intensity ratio. Such companies are labor intensive and have high labor costs.

 

What is a high capital intensity ratio ?

A high capital intensity ratio means a company requires more than a dollar of investment in assets to generate one dollar of sale. A high capital intensity ratio is usually greater than 1. This phenomenon is seen in companies that are heavily capital intensive. Examples of heavily capital intensive industries are oil refineries, power generation plants, Mining, airlines etc.,

A company with a high capital intensity ratio employs a large number of assets. This enables the company to claim a high amount of depreciation as cost.

 

Example 1 :

Harold switch Inc. has reported a Total assets of $ 600,000 and Sales of $ 800,000 for the current year. What is its Capital Intensity Ratio ? ( Round the ratio two decimal places )

Solution :

The formula for calculating the Capital Intensity Ratio is

Capital Intensity Ratio = Total Assets / Total Sales

 

Applying the above information in the formula we have capital intensity ratio as

= $ 600,000 / $ 800,000

= 0.75

It is inferred that Harold switch Inc. has a low capital intensity ratio of 0.75. It implies that the company requires $ 0.75 of assets to generate $ 1.00 of sales. It shows the effectiveness of the company in usage of its assets to generate a good amount of sales.

 

Example 2 :

Harvey’s Inc. has reported a Total assets of $ 1,200,000 and Sales of $ 800,000 for the current year. What is its Capital Intensity Ratio ? ( Round the ratio to two decimal places )

Solution :

As per the information provided in the question

Total Assets = $ 1,200,000   ;   Total Sales = $ 800,000  ;

 

Applying the above information in the formula we have capital intensity ratio as

= $ 1,200,000 / $ 800,000

= 1.50

It is inferred that Harvey’s Inc. has a high capital intensity ratio of 1.50. It implies that the company requires $ 1.50 of assets to generate $ 1.00 of sales. It shows the ineffectiveness of the company in usage of its assets to generate a good amount of sales.

 

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