What is the importance of investment decisions

investment

The key interest rate cut by the ECB is intended to encourage companies to invest more in order to stimulate the economy (GDP). But what is actually one investmentwhat connections exist to financing and what should you watch out for when making an investment? Like financing, so is the investment Part of the financial sectorwhich can be explained from two perspectives. On the one hand from an economic point of view (macroeconomics and microeconomics) and on the other hand from the point of view of business administration (BWL).

Investment term

Several investment terms are used in the literature, of which, however, only the definition of asset-based and payment-based investment terms are considered in this article. The wealth-determining investment concept lets out accounting perspective to explain. An investment is the conversion of capital into assets (fixed and current assets), which are on the assets side of the balance sheet. With the investment there is thus a use of funds from the capital available through the financing. Usually between Replacement investment and Expansion investments differentiated. The following graphic shows the difference between financing and investment from a balance sheet point of view.

Infographic: breakdown by type of investment

The payment-related investment term can, however, from the financial point of view to explain. Investments are viewed as a series of payments, where it is common for the first payment to begin with a payout, with future payments usually being a series of deposits. In the case of financing, on the other hand, the series of payments begins with a deposit that is linked to future payouts.

Type of investment

Financial resources are used in investing to raise wealth. The division of fixed assets into tangible assets, financial assets and intangible assets enables investments according to the Type of asset to be classified on the assets side of the balance sheet.

In addition, a further subdivision of the investment property can be made. A distinction is made between the different motivations for the investment decision.

  • Start-up investment
  • Expansion investment
  • Replacement investment
  • Rationalization investment
  • Diversification investment
  • Conversion investment

It is advisable for investors to be clear about what type of investment they are and what motivation is actually behind the capital employed. Depending on these two factors, there are various calculation methods that should be adapted to these in order to make the right investment decision.

Investment calculation

The investment calculation is an important part of making investment decisions. Investments are usually made for the long term and thus have a future-oriented character. As a result, the deposits and withdrawals associated with the investment are insecure. Investments therefore also involve risks for the company's liquidity and profitability. But it is also clear that companies have to take risks in order to maintain or even increase their profitability in the future. The monetary as well as the non-monetary objectives play an important role in the decision-making process. In the investment calculation, however, only the monetary target is taken into account.

As part of the investment calculation some questions have to be dealt with in order to be able to weigh up the risks just mentioned. First off is the question of who Advantage of the investment of vital importance. This is about evaluating a single investment opportunity. It is thus decided whether the investment should be carried out or whether it makes sense to forego it. At a absolute advantageousness the investment object should be acquired. However, if there are several investment opportunities, this occurs Selection problem on. This raises the question of which investment variant is relatively more advantageous. Here, too, it is essential to check whether it makes sense, because even if there are several investment options to choose from, this does not mean that a variant is economically appropriate at all. If two alternative investment projects are not mutually exclusive, a combination of the two alternatives can also be implemented. In such situations, the person who makes the investment decision has the opportunity to carry out various combinations of a certain number of individual projects. However, it is important that here, too, it is checked whether it is a sensible decision that fits the objectives of the investor.

Problems Investment decisions are naturally fraught with uncertainty. The calculation itself is not a problem. In fact, it is difficult to obtain the necessary data. In addition, the time difference is a challenge, as the payments at the different points in time must be made comparable. There are two approaches to the calculation that are available here.

Investment calculation method

This is a profitability calculation in which the static as well as that dynamic calculation methods is possible. The static procedure impresses with its simple calculation. Incoming and outgoing payments are not included, but rather the periodized largest costs (such as depreciation). Typical procedures are:

  • Cost comparison calculation
  • Profit comparison calculation
  • Profitability comparison calculation
  • static amortization (duration) calculation

Essentially, the calculations are based on a Average period from. This is the disadvantage of the static calculation, since the time differences between the variables included in the calculation are not taken into account. This makes the results inaccurate and unrealistic. The procedure is still useful to get an initial overview.

That is much more precise dynamic calculation methods, which delivers very exact results, but also requires a higher computational effort. The different payment times are used with this calculation method. Deposits and withdrawals that have the same amount but occur at different times have different values. The dynamic calculation has discounting as a characteristic and thus falls within the field of financial mathematics. Typical calculation methods are:

  • Net present value method
  • Internal rate of return method
  • Annuity method

Net investments are essential for companies to continue generating income in the future. They lead to economic growth and are special atlow interest ratesmade because the credit costs are also low here. Investors should be clear about the type of investment they are making and the motivation behind the investment. This is necessary in order to be able to select the appropriate investment calculation method in order to make a meaningful investment decision.


swell:

  • Bieg, H .; Kussmaul, H. (2000): Investment and Financing Management, Vahlen Verlag, Munich 2000. ISBN: 3 8006 262 41