Capital Intensity Ratio Formula: How to Calculate CIR

The capital intensity ratio (CIR) is a measurement of the financial efficiency of a company. By looking at the number of assets or capital a company needs to generate a dollar of revenue, it’s possible to learn about its business model's overall health and stability. The capital intensity ratio is significant when looking at the financial statements of highly capital-intensive businesses.

There are three different ways to calculate the capital intensity ratio. Each uses a different formula to calculate the metric:

1. 1. Divide the total assets by sales. To calculate the capital intensity ratio, you need two different data sets from a company’s balance sheet: the value of a company’s total assets and the revenue in a given period. Simply divide the total assets by sales, which will provide you with the capital intensity ratio.
2. 2. Divide capital expenditure by labor costs. The second method involves using the corporation’s capital expenditure and labor costs. Divide capital expenditure, or what a company has spent on assets in a given period, by the labor costs over that same period.
3. 3. Use the total asset turnover ratio. Finally, you can calculate the CIR using the total asset turnover ratio. The asset turnover ratio is the inverse of the CIR; calculate it by dividing the total amount of sales by total assets. If you want to derive the CIR from this number, simply divide 1 by the asset turnover ratio.

Power companies need a huge amount of capital investment to operate and large cash flows to remain profitable, leading to high capital intensity ratios. Consider the following example:

• Power company A: Power company A has total assets of $245 million and sales of $76 million. Calculating the capital intensity ratio (245/76) gives you $3.22.
• Power company B: Power company B has total assets of $189 million and sales of $80 million. The capital intensity ratio (189/80) equals $2.36.

In comparison, company B is more efficient since it is a lower numerical value. This means the company is investing less to produce revenue. Company B generates $1 for every $2.36 of assets it expends.

Consider the following when analyzing capital intensity ratios and comparing businesses:

1. 1. Consider industry costs. The capital intensity ratios of different companies can vary widely across industries. For example, companies in the service industry are heavily labor-intensive and require less overall capital. Others, like large manufacturers, construction companies, or power companies, are in capital-intensive industries and will have higher CIRs, by necessity.
2. 2. Observe how technology shifts CIRs. Innovation can lead to significant changes in the CIR of companies. A manufacturing company using a new production process can increase its CIR in the short term, but a boost in revenue will compensate for this in the long term, shifting the CIR lower. Companies using older technology will have to contend with more depreciation as their infrastructure ages.
3. 3. Recognize that companies measure value differently. The CIR does not take into account how assets are valued. If two capital-intensive firms use different ways of valuing their assets, you will need additional data beyond the CIRs to compare the companies. Analyzing the debt ratio can provide a more accurate financial picture.
4. 4. Look for high operating leverage. Another essential feature of companies with high CIRs is their high operating leverage. This is a measure of their fixed assets to their variable assets. Highly capital-intensive companies have set costs regardless of the state of the economy. To help mitigate this aspect of their business model, these businesses will utilize economies of scale, maximizing output to lower overall costs.

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