Capital Intensity Ratio
This is an advanced guide on how to calculate Capital Intensity ratio with detailed interpretation, analysis, and example. You will learn how to use its formula to evaluate how well a company is utilizing its shareholders' assets.
What is Capital Intensity?
The capital intensity ratio is an analytical tool that shows just how well a business company is utilizing its assets.
Basically, what the capital intensity ratio will indicate is how well each asset of a business is generating revenue.
Building upon the results of the calculation, an analyst or the company itself can look for ways to improve the use of assets to generate more revenues.
It should be noted that there are variety of tools that analysts can use in order to gauge the effectiveness of a company’s assets in production.
Thus, the capital intensity ratio is just one measure in this group of tools.
Capital Intensity Formula
The formula for the capital intensity ratio is probably one of the most basic formulas in finance.
The ratio is simply developed by taking the total assets of the company and dividing it by sales of the company.
Capital Intensity Ratio = Total Assets / Sales
This ratio can also be calculated by using the Total Asset Turnover Ratio. The formula looks like this:
Capital Intensity Ratio = 1 / Total Asset Turnover Ratio
This ratio will then give you an accurate indication of how many assets are being used to generate revenues for the company.
Example #1 - How To Use Capital Intensity Ratio
Company A is a capital-intensive company. This means that the company requires a large amount of assets to produce its product.
Examples of companies that would belong in this grouping are railroads, airlines, trucking firms, and auto manufacturers, etc.
These companies will often produce a high ratio simply because the company requires a large amount of assets for its product.
In this situation, company A has $200 billion in assets and sells $5 billion in product each year.
The capital intensity ratio is generally defined as follows:
Capital Intensity Ratio = $200 / $5 = 40
Therefore, the capital intensity ratio is 40 or represents $200 billion / $5 billion, which equals 40.
Example #2 - How To Calculate Capital Intensity
Company B is a non-capital intensive company. This means that the does not need a large amount of capital to produce its product.
Examples of companies that would belong in this grouping could include retailers, computer software products, and hotels, etc.
These companies will normally have a smaller ratio, simply because the amount of assets that the company needs are lower to produce its product.
However, note that these companies may require a large amount of labor to produce their product.
Labor in itself is a form of capital, but often in the capital intensity ratio analysis, you’re mostly looking at fixed assets.
In company B’s situation, it produces $5 billion in sales each year and has total assets of $10 billion.
Capital Intensity Ratio = $10 / $5 = 2
Using the equation of total assets over total sales we get a ratio of two, $10 billion / $5 billion = 2.
Note that both companies in these examples have the same amount of sales, but the assets were the main differential.
Capital Intensity Analysis
As already mentioned, the capital intensity ratio provides some insight as to how efficient the company is operating.
It should be noted that when utilizing this comparison ratio, you need to ensure that you’re comparing similar companies.
Note from the examples that one was of a capital-intensive company and the other was not.
Therefore, it would not be effective to compare these two companies to each other, because it doesn’t give you clear insight as to the effectiveness of either company’s use of capital.
The best way to utilize the capital intensity ratio is to compare an automaker with another automaker, not an automaker to an airline.
Also, both the automaker and airline are capital-intensive businesses, but to use the capital intensity ratio to compare these two companies would not be effective.