Capital investment decision
In any business, an investment is made to procure some resource or technique that will aid in better production and ultimately help to increase revenue. It is a kind of expenditure to the company. Usually, expenditure is of two types, one is the general operating transactions expenses which is called current expenditure and the expenditure of buying assets for the better production process which is the capital expenditure.
Current expenditure benefits can be achieved in a short period of one year and the capital expenditure helps to get results in the future. Making the decision between this two expenditure is a task which the finance department will deal with.
What are capital investment proposals?
Before fetching profits there is a long way to decide what could be done for the profit achievement. The required investment proposals can be as follows:
- Purchase of land or equipment or new building for acquiring a new business.
- Replacement and maintenance of an existing capital asset.
- Expenses for better research and development required.
- Leasing or buying any project
The significance of capital investment decisions
These decisions are the ones, which justify how well an investment aimed at future will benefit the company and in what ways. Some of the significances of these decisions are:
- Investment-linked decisions: if the objective of an industry is to survive and grow then it decides to invest in buying fixed assets which are an investment for better production.
- Long-term projects: some projects are the ones which are decided now and they reap the benefits in future, such long-term projects are also an objective of most businesses.
- Never think back: it is not at all an easy task to reverse a capital decision.
There are some valuation techniques which are used to calculate the capital investment measures. These work with certain unique formulas and have accurate ratios and numerical analysis. Some of the common methods are
- Payback period: this is a technique which calculates the number of years to get back returns on an investment.
- Present worth method: this is the most significant method and accurate one that calculates the present value of the new equipment. Thus to compare future prices are calculated at today’s rate.
- The rate of return method: this method calculates the average annual net income is expressed as a percentage of capital investment.
These are commonly used to find the values of the capital investment decisions and their effects.
Now so far we have all been made familiar with how to make investments and what best methods would help us have the best choice of investment. Here there is another remedy for all your confusions. Yes, it is nothing but the financial model presented by a company that details a blueprint of how each asset of that particular company would perform when a financial situation is presented to them from the market. This is, in fact, a realistic understanding of the asset wherein there is a foreplay organized by the company to show and test the asset and its movements in the market which would be productive information to all the traders who plan to have their investments in the company.
How should a company do this?
A business or a financial model is basically the forecasted performance of the company through the performance of the asset. It is basically the assumptions made by the company expecting the business or the financial model to work and get executed in a particular way. Given below is a simple guide trying to explain the various different approaches to building a financial model.
- Bottom-up analysis – this approach is where the company starts from the market, ie, it starts monitoring the market traffic that would be created for a particular asset, then the market share it would have, and then monitors the market segments based on the number of customers, their preferences, needs, and expectations. Now, this information and facts would be slowly injected into the financial model plan.
- Regression analysis – now this is something that is done by comparing and contrasting the revenue of the business with the various market factors like market and demand for a particular asset or product, the price expected by a trader or a customer expectation with the help of Excel and its regression analysis.
- Top-down analysis – this is an approach just the opposite of the first one wherein a company first calculates its revenue for an asset or a product that is expected to be traded in the market and then tries to relate this to the market performance, customer reactions to the prices in the market etc…
- Year-over-year growth analysis – this is the most basic and the simplest form of analysis followed by a company in understanding the market.
These four are the most commonly used analysis by a company before they market their assets for trading or any other product or service for customer consumption.
Not all business owners or entrepreneurs come with a good financial knowledge. They start their business with roughly an idea of how it would go and it is mainly the ideas about the business and its growth that is filled in them. It is for this reason that every business has a financial advisor to help the owners in such critical financial terms and knowledge. That being said, it sometimes, in fact, every time and all time important and mandatory for a business owner to at least have a clean and clear idea and knowledge about few important basic financial terms which would help him in his business decisions too. Now here is a brief on what these terms and important concepts of finance are for every businessman.
- Balance sheet– this is a simple listing of all that a business has with it or has had in the whole financial year. This is a statement that is reviewed every now and then and mainly at the end of the year to come down at the profit numbers. It is a sheet with assets and liabilities of a firm in clear terms. This is considered an important report for a business because predictions about how the business would be in the next few months, the availability of funds for the business operations for the rest of the year, etc.. and such other important numbers for a business are derived from this.
- Cash flow– another very important concept. This is generally understood as the difference in the cash that comes in and the cash that goes out. Yes, of course, it is this in a broader sense, but a businessman is expected to be mindful of what he spends. He should make sure that all his expenses are matched with an income then and there to avoid any unexpected and unbearable losses.
- Business costs – the costs at which the deliveries are made to the customers keep changing abreast with the changes in the shipping charges, transport charges, and even economical changes. So it is important for a businessman to constantly have an eye for all these changes and he should be quick and swift enough to make necessary changes in the prices of his products based on all these so that he does not run his business on a loss.
- Fund capitalization – this is nothing but retaining some amount as a back up to cover up the loss or weak sales periods to keep the business decently going on an income scale.
Issues are a part of all projects. Finding out the best solution to these issues is the victory point of a project. Here, we are going to discuss the techniques used to evaluate uncertainty issues faced during capital budgeting of a business.
- The Break-Even Analysis: As an entrepreneur, business person or student, you should definitely know the factors that lead a project to a money making business and also the lacking qualities that can simply risk your money. There also exists a stand-still or neutral point where neither of the money processes occurs. If you are able to identify this specific level, then you can confidently move on with your project.
For example, imagine a project is for $40000 that earns $2 per unit sold out. Now you expect to make a huge profit by selling 27,000 units. This might be a mistake in your decision leading to a loss. But if you know a particular safe zone like selling 7000 units, it would be an appreciated decision. Further, this account for a good starting point and is referred to as the Break-even analysis.
Cons: The result is not specific and it is based on probabilities.
- The Sensitivity Analysis: This is based on the outcome sensitivity of a project or a way to answering our questions about the project.
While accounting for budgeting of a project, we usually get into a bunch of thoughts like how many units will be sold, the completion period of a project and so on.
Here we use this analyzing technique to encounter an assumption leaving all other queries as such. This can be explained with an example.
You are going to buy a washing machine which cost $1000 extra compared to the base model. At the same time, this machine offers you a cost saving in terms of power consumption. Now you really begin to make out the assumptions and calculations about whether you be profited from the purchase or not. At this state, you can use the sensitivity analysis to iterate on cost savings leaving all other parameters to remain.
- The Scenario Analysis: This is an often used method as we are always unsure about more assumptions. We extend the sensitivity analysis to check on a number of varying parameters and are coined as scenario analysis.
Here we expect to meet the best case, the better than expected scenario. For this, we step into extreme decisions.
Even though all these examples of analysis are mind calculations, we use a real-time approach of NPV while capital budgeting.
Bitcoin was created first in the year 2007 and it is the first decentralized currency in the world. It is now accepted as a form of payment in most countries. The technology is very innovative and this could cause Bitcoin to become the new global currency.
Investors keep wondering if it is the new bubble. Or is it just a cutting edge of the technology of today? Technology is here to stay but what happens with Bitcoin is something that only time will tell.
It rose exponentially and a single unit of the currency is more than three times what an ounce of gold would cost you. Experts predict that the currency has more highs to see.
There are various uses of Bitcoin
- It is today a unit of account – Bitcoin indeed serves this purpose. It is also divided further into Satoshi; similarly, the dollar is divided into cents. This is what is known as the power of divisibility and it will allow Bitcoin to become unit of account
- Bitcoin stores value – When you talk about storing values then bitcoin is a step higher than any traditional currency. The traditional currencies have to deal with the inflationary pressure and thus they depreciate in value. This does not serve the store value purpose. However, it has a limited supply and thus it will store its value. Bitcoin value has to rise further because its supply is limited and demand high.
- Bitcoin is a medium of exchange – It can be used to do transactions to buy goods and services. It also has a very low transaction fee as compared to the fiat currencies when it is transacted through a bank. It definitely shows that bitcoin is here to stay.
The scene could twist based on what laws the government passes. If the government allows payments to be done anonymously then this currency has a future. Also, competitors Bitcoin has to be researched on and whether they would give this cryptocurrency a tough competition.
The technology that is used in digital currency has a wider application for cybersecurity and this is indeed a challenge to the global financial system.
It is just a wait and watches the game to see if Bitcoin will be allowed to take the stage and replace the currency that is backed by the central bank. The government allows small transactions through digital currency will it be allowed for any large-scale transactions?
Just like weight gain or aging, inflation’s effects are profound and gradual. It is by the passage of time inflation creeps on us, as all the people will be still continuing with their normal spending. However, the impact of inflation would be huge. It not only affects a person’s salaries and the purchasing cost of a home; it hits a business or an individual from every angle. Transportation price will increase, the price of the food goes up and cost of many other services and goods shoots up. Let us understand more about inflation.
As the currency gets devalued, the price of services and goods rise up in long-term, this is called as inflation. It happens when the business or the individual’s earnings does not increase along with the increase in the price of items. Hence, the purchasing power will get reduced and it will, in turn, leads to a stagnant economy.
How the inflation will be affecting the business
- Investment- All the business organization will get deeply affected by inflation. To upgrade any of their equipment or machinery will seem impossible. The office would be needing a new desktop or a makeover, but it won’t be possible during this time. The inflation not only reduces profit but also makes normal everyday cost also expensive. High inflation prevents investment. The confidence level of the investor in the economy is reduced. This impacts the growth of the organizations.
- Foreign exchange-When the inflation occurs, the value of the currency drops down and the other country’s currency will be still constant. When the business is procuring raw materials from other countries, they will still need to pay the same amount but will be only receiving a lesser quantity of goods than earlier days. This will result in shooting up the raw material costs. The same thing happens when the business imports the goods. The price of the goods will be high because of inflation and other countries will either stop buying the product or buy less from them. It affects the economy badly.
- Wages of employees– Wages are the most important cost of any business organization. Employees will be suffering the most because of the inflation. The employees usually are due for a hike in salary once a year. If the country is hit by inflation, the current salary would be not sufficient to maintain the same lifestyle as earlier. Over time, people will be facing a financial struggle. The business organization will usually increase the wages at a lower rate when compared to inflation’s rate.