The Role of Capital Goods in Business Growth

Key Takeaways

• While capital goods do not directly produce buyer satisfaction, they are used to build final products, which do promote satisfaction.  

• A leading economic indicator, capital goods often help spark business growth and promote creation of novel manufacturing jobs.

• A capital good is used to produce final products, while a consumer good is a final good that is sold to customers and used as they see fit.

When businesses invest in capital goods, their ability to create products and services expands. Such goods are mainly physical assets that are used to produce consumer products and services. Increased capital goods production tends to bolster demand for capital and thus results in increased overall investments. 

The following explains the concept of capital goods, and why they play an important role in today’s economy.

What are Capital Goods?

Capital goods are the goods used to make goods. That’s the simplest definition. To elaborate, capital goods are mainly the manmade, physical assets a company uses to produce goods and services for later consumer use.

Examples of what are mostly fixed, tangible assets include tools, vehicles, machinery, construction equipment, and buildings. Note that these are considered “unfinished” goods; “finished” goods are what they help manufacture.

Not all capital goods are fixed, however. The industrial electronics industry, for example, manufactures an array of disparate devices that range from digital imaging systems to computer monitors and stereo component wiring.

Another characteristic of capital goods is that they are often durable items used by companies to produce items that other companies, suppliers for example, can use to manufacture finished goods. Producers of vehicles, machinery, and aircraft are considered capital goods because what they create are used by businesses that manufacture, ship, and provide other services.

Capital goods are also manufactured for the service sector. Such goods can include coffee machines for coffee shops, hair clippers used by hairstylists, and vacuum cleaners for car washes. They can also include, say, musical instruments for musicians, and paint for painters.

Therefore, while capital goods do not directly produce buyer satisfaction, they are used to build a final product, which does promote satisfaction.  

Capital goods are one of four factors of production, meaning that companies cannot run without them. The other three are natural resources such as oil, land, and water; employee labor; and entrepreneurship, which is the drive to start new businesses.

Capital Goods and the U.S Economy

A leading economic indicator, capital goods are high-investment products that often help spark business growth and promote creation of novel manufacturing jobs. The development of new capital goods means demand for new workers with new skill sets.

Each month, economists, investors, and other stakeholders await the U.S. durable goods orders report, provided by the U.S. Census Bureau. The report, which is based on company surveys, gauges capital goods production. Specifically, it tracks capital goods shipments, inventory, and new orders. 

Core capital goods, which exclude U.S. Defense Department equipment and aircraft, reveal the overall health of the nation’s businesses. For example, increased orders of capital goods signal expectations of increased production. In turn, this indicates potential economic and gross national product growth.

From the cotton gin to drones, the nation has long been in the vanguard of technological innovation. Since the last quarter century or so, California’s Silicon Valley has been at the heart of such innovation. The United States’ success as a capital goods provider has given the nation a competitive edge, helping it to remain the largest global economy. 

Real-World Example of Capital Goods?

Say, for example, that a person is seeking to open a pizzeria. That person would need capital goods in the form of an oven for cooking, chairs and tables for dining, and counters for assembling and displaying the pies. They will also likely need cutting boards, pizza paddles, and dough preparation equipment such as dough presses, dough sheeters, and proofing cabinets.

A problem is that capital goods are sometimes relatively pricey. For instance, a top-shelf pizza oven can run $80,000 or more. That is why capital goods are treated separately in terms of accounting. Thus, if that top-of-the-line pizza oven is expected to last a couple of decades, the pizzeria that purchases it would reflect just $3,500 in its initial year of ownership and for each following year, until it is time for the oven to be replaced. This means that the pizzeria has “capitalized” the oven’s cost, then will depreciate it over the next two decades.

Capital Goods vs. Consumer Goods

There are generally two types of goods: capital and consumer. A capital good is used to produce final products, while a consumer good is a final one that is sold to customers who then use them as they see fit.

Note that while the two types of goods are different, both can be durable goods. They also can be both capital and consumer based, depending on how they are used. Consider a simple orange. Purchased at a grocery store to be eaten later, an orange is a consumer good. When a company buys an orange to make orange juice, though, the orange then becomes a capital good.

Going back to the differences between the two types of goods, a capital good is basically any good that is used for production. By contrast, consumer goods are final goods that are purchased for consumption and are not subsequently used to produce other goods. Many of these products – food, apparel, and electronics, for example – are part of everyday life. 

Shipments of consumer goods are included in the country’s gross domestic product, meaning consumer spending is responsible for nearly 70 percent of the GDP.

There are three types of final goods:

1. Durable. These goods have a lifespan of more than three years and play a major role in a company’s capacity to build products. With such goods, companies can manufacture products speedily and in big quantities. Examples include refrigerators, cars, and clothes dryers.
2. Nondurable. These goods have a lifespan of under three years. Examples include paper products, clothing, linens, and disposable diapers.
3. Services. These are haircuts, house cleaning services, and consulting services, for example.

Such goods can be further broken down into these categories, mostly from a marketing standpoint:

• Convenience.  These are goods bought without a lot of thought having been put in the purchases. They include gasoline, grocery items, and newspapers and magazines.
• Shopping. These are store items that are purchased less frequently, are durable, and typically cost more than convenience goods. Examples include televisions and furniture.
• Unsought. These are goods that the consumer either is not aware of or does not regularly think of purchasing. They are also purchases that come about due to real or perceived danger, rather than to desire. Such goods include life insurance, encyclopedias, funeral services, reference books, and fire extinguishers.  

Why are Capital Goods Important for a Company’s Success?

Nearly every company requires capital goods to produce products to be sold to consumers. Consider the hairdresser sector, in which stylists need an array of tools such as shears, blow dryers, razors, and curling irons. Such goods allow the stylist to meet their clients’ needs. Otherwise, the stylist will not be in business for very long.

Also, say a person is considering becoming a dairy farmer. To process the cheese, milk, butter, and cream, he must purchase certain tools and equipment such as milk tanks, cream separators, and butter churns. Such capital goods are vital to the company’s success.

It is worth underscoring that because the price of some products – namely, tools and equipment – are prohibitive for some companies, assistance is sought from other companies that can supply such products.

What Capital Goods Does a Startup Need?

Typically, small-business owners, when they are just starting out, create a “capital equipment list” of the materials needed for business operation. While such equipment likely already appears in the owner’s business plan, having a list handy can help keep the entrepreneur on track budget-wise. 

Unlike, say, permanent bookcases, capital equipment is generally not a part of the company’s physical buildings, which are not considered capital equipment, but real property. Capital equipment would include products such as chairs, desks, software, printers, and software and the like. A capital equipment requirement is that the items must have a lifespan – typically a year or longer, although that can depend on the industry.

Generally, capital equipment lists do not include expendable items such as paper, pens, and related office supplies.

Once the business is operating and successful, it can start receiving investments from alternative investors. These are investors who have holdings in alternatives — asset classes other than stocks, bonds, or cash, and which include art, real estate, and more. Investors are increasingly turning to alternatives to offset stock market volatility, protect against inflation, and diversify holdings.

Alternative Investments and Portfolio Diversification

Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform. However, that meant the potentially exceptional gains these investments presented were also limited to these groups.

To democratize these opportunities, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $10,000.

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

Summary

Without capital goods, there would not be any goods or services to speak of. In fact, increased orders and shipments of capital goods usually indicate that businesses anticipate more demand and that the economy will expand. Most investors watch for such signs and adjust their positions accordingly. Further, innovations in capital goods can spur business growth, a positive development for investors.