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A capital investment refers to money used by a business to purchase fixed assets such as land, machinery, equipment or buildings, rather than used to cover the business's day-to-day operating expenses such as paying fuel bills or staff wages.
When considering investment in such capital items, particularly for complex projects such as a new building or a replacement parlour, budgeting is essential. A partial budget will isolate and analyse the effect on the business's finances from the investment and help to calculate when the return from the investment will cover the initial cost (payback) and by estimating the profit potential of the investment, to calculate the Return on Investment figure.
Careful consideration must be made of what type of capital investment is made, not least of the planned return from the investment, but also of the tax implications from capital projects.
Capital allowances are a tax relief that allow the costs of capital assets to be written off against a business's taxable profits. They are accounted for in terms of asset depreciation in the commercial accounts. Depreciation is calculated on a defined scale, depending upon the type of capital asset. For example, buildings are depreciated at 4% per year, whereas machinery is depreciated at 20% on a 'reducing balance' formula.
There are several schemes from Her Majesty's Revenue and Customs (HMRC) which give important tax allowances for certain types of capital investment such as plant and machinery, information technology and certain projects which encourage environmentally-aware investment, particularly for small or medium-sized businesses.