What are capital goods?
– Capital goods are physical assets a business uses to make other goods or to deliver services. Examples include factories, industrial machines, delivery trucks, and tools used by service providers. These items are durable and are intended to be used repeatedly in production rather than sold directly to end consumers.
Key distinctions
– Capital goods vs. consumer goods: Capital goods enable production. Consumer goods are the finished products bought by households (food, clothing, appliances). Some items can serve both roles depending on who buys them — for example, an airplane is a capital good for an airline but may be purchased by some consumers.
– Accounting treatment: Capital goods are treated as long-lived fixed assets on a company’s balance sheet, commonly recorded under property, plant, and equipment (PPE).
Common types and examples
– Heavy machinery and factory equipment
– Buildings and warehouses
– Industrial electronics and specialized instruments
– Vehicles used in operations (trucks, delivery vans)
– Tools and equipment for service providers (hair clippers, musical instruments)
– Industrial assemblies ranging from wiring harnesses to imaging systems
What are “core capital goods”?
– Core capital goods are a subset of capital goods that exclude certain volatile categories such as civilian aircraft and defense-related equipment. Statistical reports (for example, durable-goods surveys) often track core capital-goods orders as a proxy for business investment in equipment and nondefense structures.
Why businesses buy capital goods
– Increase production capacity or efficiency
– Replace worn-out equipment to maintain output or quality
– Adopt new technology to reduce unit costs
– Expand into new products or services
Investing in capital goods is a way firms convert cash today into future productive capability.
How depreciation affects a company
– Depreciation is an accounting method that spreads the initial cost of a capital asset over its expected useful life. It reduces reported net income each year as a non-cash expense and lowers taxable income (producing a tax shield), while the cash outflow occurred when the asset was purchased.
– Net book value is the original cost minus accumulated depreciation; over time that book value declines until the asset is fully depreciated or sold.
Simple worked example (straight-line depreciation)
Assumptions
– Purchase price: $100,000
– Estimated salvage (residual) value: $10,000
– Useful life: 5 years
Straight-line annual depreciation = (Cost − Salvage) / Useful life
= ($100,000 − $10,000) / 5
= $90,000 / 5
= $18,000 per year
Accounting effects, year 1 (illustrative)
– Cash outflow at purchase: −$100,000 (capital expenditure, appears in investing cash flow)
– Annual depreciation expense: $18,000 (expense on income statement; non-cash)
– Tax shield (if marginal tax rate = 25%): $18,000 × 25% = $4,500 lower tax in year 1
– Book value at end of year 1 = $100,000 − $18,000 = $82,000
Short checklist for evaluating a capital-goods purchase
1. Define purpose: capacity expansion, replacement, or productivity improvement?
2. Estimate total cost: purchase price, installation, training, and shipping.
3. Estimate useful life and salvage value for depreciation planning.
4. Assess operating costs: energy, maintenance, spare parts, and downtime risk.
5. Calculate expected benefit: increased output, cost savings, or revenue lift.
6. Run simple payback and more rigorous metrics (NPV, IRR) using realistic cash flows.
7. Check financing and tax implications: available capital, lease vs. buy, depreciation rules.
8. Consider scalability and technological obsolescence risk.
9. Compare vendors, warranties, and service/support options.
10. Ensure compliance with regulations and safety standards.
Practical notes
– Statistical indicators such as durable-goods orders and “core” capital-goods orders are commonly used to gauge business investment trends in the economy.
– Depreciation methods vary (straight-line, declining-balance, tax-specific systems like MACRS in the U.S.); the choice affects reported profit and tax timing but not the initial cash outflow.
Sources for further reading
– Investopedia — Capital Goods
https://www.investopedia.com/terms/c/capitalgoods.asp
– U.S. Census Bureau — Manufacturers’ Shipments, Inventories, & Orders (M3)
https://www.census.gov/manufacturing/m3/
– IRS Publication 946 — How To Depreciate Property
https://www.irs.gov/publications/p946
– Bureau of Economic Analysis — Gross Private Domestic Investment (data and definitions)
https://www.bea.gov/data/gdp/gross-private-domestic-investment
Educational disclaimer
This explainer is for educational purposes only. It does not constitute personalized investment, tax, or accounting advice. For decisions about acquiring capital assets or tax treatment, consult a qualified accountant, tax advisor, or financial professional.