What is 'Capital Commitment'
Capital commitment is future capital expenditures that a company has committed to spend on long-term assets over a period of time. It also refers to securities inventory carried by a market maker, and may refer to investments in blind pool funds by venture capital investors, which they contribute over time when requested by the fund manager.
BREAKING DOWN 'Capital Commitment'Capital commitment revolves around the designation of funds for a particular purpose. Regardless of the circumstances in which the term is used, it relates to funds being held or directed in a particular manner.
Capital Commitment as Accounting Liabilities
From an accounting perspective, capital commitments include any expenditures planned over time in which an organization intends to partake. Most commonly, this includes various regular operating expenses such as property-related costs, necessary equipment and production materials. Capital commitments can also include future business ventures being planned, such as the beginning of an expansion project. They are generally the highest for companies in capital-intensive industries such as power generation.
Capital commitments of this nature can come with a variety of risks, even if the funds have not been released as payment toward the associated commitments. A company has to exercise the utmost care in structuring its capital commitments, since an inordinately high amount puts undue strain on the company’s finances.
If a company overcommits, and then experiences a sudden unexpected decline in capital, it may have to direct a higher portion of the profits toward these commitments than originally intended or it may be unable to meet all of the intended obligations in entirety. Proper planning requires the company to ensure operating cash flow is sufficient to meet capital expenditures, and if it is not, to make arrangements to ensure it can raise the additional funds on the capital markets.
Due to these risks, these forms of commitments are disclosed within the released financial statements, often listed as a footnote in regards to the balance sheet. This allows investors to better assess the overall risk to the provided investment, allowing them to determine if the associated risks are acceptable for the potential return.
Capital Commitment in the Stock Market
From a stock market perspective, capital commitments can refer to the shares held by a financial organization that are currently available for sale. They are representative of the entirety of the stock inventory, and can be considered a form of risk as the associated values of the shares vary with market conditions.