Category: 

What is Capital Efficiency?

Article Details
  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 30 October 2016
  • Copyright Protected:
    2003-2016
    Conjecture Corporation
  • Print this Article
Free Widgets for your Site/Blog
Snake charmers get snakes to “dance” because of the movement of their flute-like instruments, not their music.  more...

December 4 ,  1945 :  The United States Senate approved of US participation in the United Nations.  more...

Capital efficiency has to do with understanding the ratio of output in comparison to the amount of capital expenditure involved in maintaining the operation of a business or a product line. This simple comparison serves as a way to determine if a particular operation should be continued as is, continued with some adjustments, or abandoned and the resources diverted to other projects.

The basic formula for calculating capital efficiency involves dividing the average value of output by the rate of expenditure for the same period of time. Output divided by expenditure will help to make it clear if a venture is currently generating a modest profit, is approaching a point where profitability will be realized once expenditures are decreased, or if there is no real value in continuing to fund the venture. While the latter situation is one to avoid at all costs, the two former possible states are not situations that should be considered negative.

Because many business ventures begin with a higher level of capital expenditures, a project rarely realizes a profit in the first stages of the operation. The expectation is that after the initial launch, some expenses will be settled and not be recurring. As the rate of expenditure decreases and the output or production increases, the opportunity for profit expands. For this reason, periodic calculation of the capital efficiency of a project can help investors know that the project is heading in the right direction.

Ad

Once this forward trend results in the realization of a small profit, factoring the capital efficiency can still contribute to tracking the gradual increase in profits. Capital efficiency can also help refine the production process, by alerting officers of the project that there may be additional areas where expenses can be cut without harming the quality of the product and realize an even greater profit. Periodic calculations of the capital efficiency during the life of the project can also call attention to trends that are negatively impacting the project, allowing time to make changes before a profitable venture devolves into a project that is losing money.

Ad

You might also Like

Recommended

Discuss this Article

literally45
Post 3

Capital efficiency is actually an incentive for businesses and administrators to cut costs when they can. Sometimes seeing profit in numbers is not enough. Seeing how much profit is made compared to how much could be made is more effective. An that's precisely what capital efficiency is. It tells you about your capital utilization, that is, if you're using your money as wisely as you possibly can. If you're not, that means that you are losing out on profit that you could be making. That's a nightmare for a business.

SarahGen
Post 2

@donasmrs-- That's exactly right. Don't expect an impressive capital productivity/efficiency when starting out. When your one time costs are out of the way (like equipment), expenditure will fall and you should start seeing profits. If you're not, then you need to increase your output, otherwise your business won't make it.

Capital productivity is a great way for businesses to avoid costs and avoid bankruptcy. Sometimes, it's just not feasible to continue a business. If a business is not being productive and making profits despite all possible adjustments, it's better to quit. Because losses will quickly increase and lead to debt.

donasmrs
Post 1

I'm starting a small business. I'm in the process of buying equipment now which is going to be calculated in the capital expenditure of my first business period. From what I understand, if my capital efficiency is very low or nonexistent in the first period, I should not worry, right?

Post your comments

Post Anonymously

Login

username
password
forgot password?

Register

username
password
confirm
email