Investment and Financing Strategies for Businesses
Investment
Definition
Investment is the act of committing resources (time, money, effort) to acquire an asset with the expectation of generating future income or increasing value.
Features of Investment
- Initial Outlay: The amount paid to purchase an asset.
- Length of Investment: The duration of the investment (e.g., number of years).
- Net Cash Flows: The difference between cash inflows and outflows generated by the investment.
- Residual Value: The value of the asset at the end of its useful life.
Classification of Investments
By Asset Type
- Tangible Asset Investment: Acquisition of physical assets like buildings, machinery, and equipment.
- Intangible Asset Investment: Investment in non-physical assets such as patents and software.
- Financial Asset Investment: Acquisition of financial instruments like stocks and bonds.
By Time Period
- Long-Term Investment: Investment lasting longer than one fiscal year.
- Short-Term Investment: Investment lasting less than one fiscal year.
By Purpose
- Replacement Investment: Replacing old assets with new ones.
- Expansion Investment: Increasing production capacity to meet growing demand.
- Strategic Investment: Modernizing operations or entering new markets.
By Relationship with Other Investments
- Alternative Investment: Choosing one investment excludes others.
- Complementary Investment: One investment facilitates another.
- Independent Investment: One investment does not affect others.
Investment Selection Methods
Static Methods
Static methods assume the value of money remains constant over time. Examples include:
- Payback Period: Time to recover the initial investment.
- Total Cash Flow per Monetary Unit Invested: Ratio of total cash flows to initial investment.
- Average Cash Flow per Monetary Unit Invested: Average annual cash flow relative to initial investment.
Dynamic Methods
Dynamic methods consider the time value of money. Examples include:
- Net Present Value (NPV): The present value of future cash flows minus the initial investment.
- Internal Rate of Return (IRR): The discount rate that makes the NPV equal to zero.
Investment Risk
Investment decisions should consider the potential return relative to the risk involved. Higher-risk investments typically require a higher potential return to be considered worthwhile.
Financing
Definition
Financing refers to acquiring the funds necessary for business operations and investments.
Sources of Financing
By Term
- Short-Term Financing: Repayment within one year (e.g., supplier credit).
- Long-Term Financing: Repayment over more than one year (e.g., long-term loans).
By Origin
- Internal Financing: Funds generated within the company (e.g., retained earnings).
- External Financing: Funds obtained from outside sources (e.g., loans, equity).
By Ownership
- Equity Financing: Funds from owners (e.g., capital contributions).
- Debt Financing: Funds from lenders (e.g., loans, bonds).
Internal Financing (Self-Financing)
- Capital: Contributions from the company’s owners.
- Reserves: Accumulated profits not distributed to shareholders.
- Depreciation: Allocation of the cost of fixed assets over their useful life.
- Provisions: Funds set aside for anticipated future expenses or losses.
External Financing (Long-Term)
- Long-Term Loans: Borrowed funds from financial institutions with a fixed repayment schedule and interest rate.
- Bonds: Debt securities issued by companies to raise capital.
- Leasing: Renting an asset with an option to purchase at the end of the lease term.
- Lease: Similar to leasing but without a purchase option.