Investing activities are business activities related to growing a business and bringing profits to the company in the long term. It involves buying and selling long-term assets and other business investments. When adding a new machine, for example, the company can produce more output. Likewise, with acquisitions, it makes a company more efficient or increases revenue.
Cash flow from investing activities
In the financial statement, investing activities are one of three categories in the cash flow statement. The other two are operating activities and financing activities.
Operating activities are about how companies make money from the supply of goods and services. Investment activities are about how to grow a business and make more money in the future. Investment can be through the purchase of new machines or acquisitions, and both require payment. And financing such investments, for example, by issuing shares or bonds, is a cash flow component of financing activities.
Buying and selling fixed assets
Buying and selling fixed assets is an example of an investment activity. Fixed assets are various tangible assets to support operational activities. Examples of fixed assets are buildings and property, machinery, equipment, vehicles, and computers. They have economic benefits of more than one year. Therefore, the company presents it in the non-current assets section.
Purchases of fixed assets represent cash outflows. To buy a machine, for example, a company must spend money to pay for it.
However, asset purchases often spend a large nominal. Therefore, companies prefer to buy them on credit. When making payments, the company records cash outflows, and it will appear in the investment activity section.
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The opposite of buying fixed assets is selling fixed assets. It represents cash inflows; in a sense, the company receives some money from the sale.
Long-term financial asset investment
But I hope you remember. Investments in highly liquid securities (cash equivalents) are excluded from investing activities. Companies often buy them to trade. Therefore, buying and selling activities of cash equivalents that are highly liquid and securities for trading purposes are not part of investment activities. Instead, they fall into the category of cash flow from operating activities.
Why are investing activities important?
Investment activities are essential in supporting future business growth. By investing, companies expect to get more revenue and make higher profits. The prospect of higher profits is undoubtedly attractive to stock investors, which will see a rise in stock prices. For creditors or banks, more profit means more cash inflow, so the company has a higher ability to repay loans.
To grow production, companies need to buy new machines or build new factories. It all costs a lot of cash. Therefore, the negative cash flow of investing activities is one good indication that businesses invest in capital assets. You will see their income growth in the future.
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What is the relationship between investment activities and capital expenditure
Changes in fixed assets in the balance sheet are a representation of investment activities. In collective, the cash spending on the investment of capital assets refers to as capital expenditure.
You can find capital expenditure figures in the cash flow section of investment activities. Analysts observe this figure in stock valuations. An increase in capital expenditure indicates a company is investing in future operations. Although capital spending represents cash outflows, analysts often see companies with a significant amount of capital expenditure in a state of growth. That will ultimately support earning power in the future.
Is the negative cash flow from investments bad?
Negative net cash flow from investing activities is not always bad. As a previous explanation, companies need to sacrifice money now to grow business in the future. By spending money, the company should generate large cash inflows in the future. Imagine, production machines are obsolete, and the company does not buy new ones, what will happen?
Cash flow from investment activities also depends on the type and age of the company. High-growth young companies may have negative net cash flow. They need significant capital expenditure to develop their business and be competitive in the market.
But, capital expenditure may not be efficient if it does not increase profits. Therefore, you need to learn about the company’s specific investment strategy. For example, you can use internal rate of return (IRR) to assess whether purchasing a machine or building a new facility is profitable or not.