Capital recovery is an important concept to understand because it affects cash outflows and taxes. In the monetary world, especially concerning business, capital can refer to both cash and assets. However, when discussing recovery options, it means cash. Therefore, capital recovery is a means to recoup an outflow of money. Most people and businesses would consider this to be very important.
Recovery of Capital for Investments
In making certain investments, you contribute a portion of your after-tax dollars to an account in order to purchase securities such as stocks, bonds or mutual funds. Over time, the investments will hopefully produce a return through capital gains, dividends and interest payments. These amounts do not equate to a contribution of capital, but the after-tax dollars do. The returns will be taxed by the federal and state governments upon distribution, whereas the capital contributions will not. The Internal Revenue Service recognizes this as a return, or recovery, of capital.
Many businesses must purchase equipment and machinery to help in producing income, whether it supplies a service or goods. These items include computers, servers, heavy machinery, plant equipment and buildings. In order to encourage production, the IRS permits businesses to recoup the cost, or recover the initial capital expenditure, via depreciation. Depreciation is a tax deduction that the company takes, usually using a system known as the Modified Accelerated Cost Recovery System.
Capital Recovery for Debt
Capital recovery also refers to the retrieval of owed funds by a business. When a borrower defaults on funds lent through the use of credit, some businesses seek to collect the amount using a collection service. Generally, when it reaches this point, the company is merely looking to collect the amount it lent to the borrower, without worrying over the interest that is owed as a cost of borrowing. Recouping the borrowed amount is a recovery of capital.
Recovering capital saves the business or person money that would otherwise be lost, whether it is by a tax deduction or collection of monies lent to another party. This is important in maintaining an adequate cash flow in order to keep a business operating. Without adequate cash flow and savings, then the company would cease to be able to pay its expenses or its obligations as they come due. Eventually, this would compromise the ability of the company to continue production.