What’s it: Business investment is about investing to make more money. You can identify it with an increase in the company’s assets or productive capacity.
We associate it with capital expenditures. We might also categorize inventory investment as a business investment, as when we measure gross domestic product.
Capital investment is for long-term projects. Examples are:
- Build factories
- Set up sales offices in new markets
- Buy production vehicles
- Take over another company
- Build research and development facilities
Business investment objectives
Investing is essential to making more money in the future. For example, when building a new factory, the company hopes to sell more volume. The company gets more revenue.
Apart from profit, other business investment objectives are:
- Maintaining current production capacity. The company spends money equal to the depreciation of existing capital assets. Thus, production capacity does not change.
- Reaching higher economies of scale. Expansion into new markets or building new production facilities makes the size of the company bigger.
- Reducing costs. Higher economies of scale reduce average costs. Additionally, the company may acquire its current distributors or suppliers, allowing for savings from the existing value chain.
- Improve market position. For example, a company acquiring a competitor. As a result, the market share and customer base will be more significant.
Types of business investments
Business investment takes various forms, including:
- Purchasing capital goods
- Acquiring another company
- Residential investment
- Marketing expansion
Investment in capital goods
The company buys several fixed assets such as:
- Production machine
- Operational vehicles
Investments in capital goods do not generate interest or increase sales. But, it helps companies maintain or increase production capacity, lower costs, and increase business profits.
Taking over another company is a fast way to grow business. The target companies may be their competitors – we call these horizontal acquisitions. Or it is the company’s existing distributor or supplier (vertical acquisition). Finally, the target may be companies in other businesses, which are not related to the current business (conglomerate acquisition).
Acquisition motives vary, including:
- Develop synergies with existing capabilities and resources
- Secure the supply chain
- Ensuring efficient and effective distribution
- Improve market position
Companies invest by, for example, building office buildings, retail stores, warehouses, or marketing representative offices. It might be more reasonable in the long run to own than rent.
This investment is more than just running a promotion or buying an ad. Building internal capacity for research and development is an example. It may require facilities such as a laboratory.
Another example is building a distribution channel. That may be through setting up stores in several regions or marketing representative offices overseas.
Sources of funding for business investment
Business investment requires significant money. Usually, companies rely on external financing. Internal cash is often insufficient to finance investment.
Sources of investment financing can come from:
- Internal cash
- Bank loans
- Stock shares
- Debt securities issuance
- Financial leasing
Internal cash can come from retained earnings. Or, the company may sell some of its existing assets, raise cash, use it to finance investments.
Companies can also raise equity capital by selling shares to the public through stock exchanges. If they do it for the first time, we will call it the initial public offering (IPO).
Issuing shares allows the company to earn a lot of money quickly. Also, the company does not need to pay interest.
It is different from accumulating debt capital, such as borrowing from a bank or issuing debt securities. Even if funds are raised quickly, companies are required to pay interest regularly, even when their income is zero.
Then, financial leasing is the following alternative way of financing. In this case, the company doesn’t buy assets directly. Instead, the leasing company (lessor) buys assets and leases them out to the company. As compensation, the company must make a series of payments, including interest, by the agreed contract.
Evaluating business investment feasibility
Investments involve significant capital. The success of these investments has an essential influence on the future prospects of the company.
Therefore, companies make a capital budget before investing. It aims to measure investment feasibility. Ideally, the money generated from investing should be more than the money invested.
Management considers the estimated cash outflows and inflows to assess the feasibility of investment. Then, they can choose several alternatives to measure the feasibility of investing, including:
- Net Present Value (NPV)
- Internal Rate of Return (IRR)
- Payback Period
- Profitability Index