Management of company investments 2/2 (how to finance investments and what influence company investment decisions)
Sources of investment funding
from own “pocket” (internal)
-Using a company retained earnings from previous years
-future cash flow (preferably more to finance short-term investments, respectively, depending on the type of business, eg. different balance sheet structure in the banking sector and fully different in the manufacturing sector)
-Put new capital and increase share of existing shareholder
-cofunding, joint venture (ie. connection with another entities)
from foreign “pocket” (external)
-equity financing: new investors (eg. venture angel, seed, venture capital investors, ..) in the case of larger firms consider access to capital markets (IPO) and emit securities (stocks, ..)
-miscellaneous types of loans (mainly from banks), leasing
-combination of internal and external resources: Consider leverage mechanism (described below)
Interests are an important aspect of the investment evaluation, as it can significantly decrease the profitability of investments(or, in the extreme case of certain amounts borrowed, interest may exceed profit more see the mechanism of financial leverage). It could leads to reassessment of investments (ie. To review the priorities of investments in the portfolio and select a different funding structure, or revise the business model of investment- eg. to reduce size of targeted market segment..).
Impacts on company investment decisions
for operational needs and risk coverage is wise to keep a certain amount of capital in high liquid form (the most liquid: cash/bank account or less liquid eg. securities with a maturity of up to 1 year).
-it’s important to balance the ratio of liquidity to investments because not invested money losing value by at least inflation, and there exist profitable but unrealized investment company loss profit from unrealized investment.
– A non-negative cash flow: plan cash flow in a way to avoid negative cash flow
Investment controlling influence tax optimization, which is part of financial management. It’s important to consider in tax optimisation by investment controlling: connection between investment, reinvestment, their timing, form and procuring funding sources .. in order to pay the lowest taxes.
external financing has over self-financing advantage that loans are tax deductible cost which contributes to the reduction of paid tax. Tax shield is one of the most frequently used methods of tax optimization.
gives general advices when is it appropriate to borrow capital for investment.
ROE = EBIT/A : Peace capitalize on own resources reflects
EBIT : earnings before interest and taxes,
A : own resources
ROE reflects how much profit falls on one unit (for euro: 1 euro) invested equity (or ROE*100 express how much % we can capitalize on invested capital).
outputs of leverage mechanism:
-positive action leverage: if ROE>r (while r is the interest paid to external subjects) then it’s advisable to borrow capital from an external subject.
-negative action leverage: if ROE
Let us consider an example: a company is making profits 2eur for 10eur investment and possible interest loans represent 5%
Solution: ROE = 200/10000 = 0.02 * 100 = 2% so that the company
generate interest on invested capital 2% and a possible loan is 5%. so ROE
Selected very common cases that may occur:
1.If Company has capital and borrow due to the positive financial leverage, so in case of failure of investment in comparison with self-funding in addition to the lost investment ‘deplete self’ about interest paid on external capital.
2.If Company has capital but don’t borrow, despite the positive action of financial leverage and then if successful investment the company foregone profits.
3.If Company have capital but don’t borrow despite the positive effect of financial leverage, so in case of failure of the investment, the company loss investment(and may thus have lower dividends).
4.If The company don’t have enough own capital and borrows external resources, so then in case of failure of the investment may go (and usually also occurs) to company crash. Therefore it’s important to be considered of risks and decide whether to invest.
It express about how much change output variables (eg. profit, cash flow) when change the input variables (eg. variable costs) about specified unit (eg. an increase of 1%).
Sensitivity analysis can be used to determine the impact of key attributes to an improvement of output variable (typically profit, cash flow), or the optimization of investment controlling (choice of appropriated funds at a suitable height).
For the realization of the sensitivity analysis is required economic business model which includes the key attributes affecting the business and the description of their relationship ie. each dependent attributes of cash flow eg. the number and prices of the outputs, fixed / variable costs, EBITDA of investment; possibly predicted values of attractiveness and competitive position.