Investing by Business Firms

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Investing by Business Firms

Many people, when they hear the term "investment", probably think of investing in financial securities. However, investing is not only limited to financial securities. It is a broad term referring to the process of putting money in something of value for future returns. In other words it is acquiring an asset or item with the objective of producing income. The basic process of investment always involves an initial outflow of some assets (such as money, time, etc.) with the expectation of an increased return in the future in terms of income or increase in capital.

Why do Companies Invest?

There are many reasons for the investments made by businesses. The main ones are:

• Strategic and/or Tactical Reasons: For example companies invest in new projects for capturing new markets. They invest in property, plant, and equipment for expanding their productive capacities, consequently exploiting economies of scale. They invest in technology for improving their products, services, and making their business processes more efficient. They also invest in research and development for improving existing products and introducing new and better products through innovation.
• Cash Management: Companies also invest cash for managing their cash which they have in excess. They create cash reserves, invest in other corporations bonds or stocks or purchase other securities.
• Increasing their Income: Companies also invest in increasing their income and sources of income (interest, dividends, and capital gains).

Characteristics Of Investment

An investment is characterized by the following elements.

• Return: every investor invests in the expectation of future return which could be in the form of income or capital gain or losses.
• Risk: investments and their returns are future oriented and the future is uncertain. Therefore, investments involve some certain degree of risk which could result in a gain or loss.
• Time: time is a vital element of investment. As the time passes, investors revalue their money because of the changing circumstances and inflation.
• Liquidity: investors like the facility to convert their investments in cash whenever they want.

Types Of Investments

Investments (and assets) can be classified in three major ways:

1. Convertibility: These investments are distinguished based on how easy it is to convert them into cash. They are either classified as Current Assets (e.g., Cash, Cash equivalents, Short-term deposits, Stock, Marketable securities, Office supplies) or as Fixed Assets (e.g., Land, Buildings, Machinery, Equipment, Patents, Trademarks). An alternative expression of this concept is short-term vs. long-term assets.
2. Physical Existence: These investments are distinguished based on their physical existence. They are either classified as Tangible Assets (e.g., Land, Buildings, Machinery, Equipment, Cash, Office supplies, Stock, Marketable securities) or as Intangible Assets (e.g., Goodwill, Patents, Brands, Copyrights, Trademarks, Trade secrets, Permits, Corporate intellectual property).
3. Usage: These investments are distinguished based on their business operation usage/purpose. They are either classified as Operating Assets (e.g., Cash, Stock, Buildings, Machinery, Equipment, Patents, Copyrights, Goodwill) needed for the daily operation of a business to generate revenue from a company's core business activities, or as Non-operating Assets (e.g., Short-term investments, Marketable securities, Vacant land, Interest income from a fixed deposit) not required for daily business operations but still generating revenue.

Sources:
Book: Modern Financial Investment Management (2020) By Ephraim Matanda, Cambridge Scholars Publishing.
Book: Norman D. Moore , 1975, Dictionary of Business, Finance and Investment
Book: Roberto G. Medina, 1988, Business Finance