Investments: some basic considerations
Types of investment
In accounting terms, various types of investment exist:
Tangible investments: these are essentially "everything you can touch". They have significant value and a probable life of several years. For example, these could be machinery, furniture, vehicles etc.
Intangible investments: these are investments of a certain value that do not have any physical substance, i.e. they cannot be "touched".. They have a life of several years. These could be a business, patents, licences, etc.
Financial investments: such as securities (shares, bonds, etc.) held in companies in the long term.
In terms of management, a distinction is made between:
Productive investments, whose objective is to maintain a turnover or to increase it, to reduce the costs of production, or to expand the activity;
Replacement investments, compulsory to a company’s "survival";
Comfort investments, which aim to improve the quality of the work, the comfort of employees or the work environment.
The choice to invest should be made taking into account:
- the company’s objectives: to grow, to maintain itself, to increase profits, etc.
- the financial resources available or that need to be obtained;
- the risks.
A company’s financial resources are limited; priorities must be set. Generally, your resources should be primarily devoted to:
- compulsory replacement investments;
- investments that generate additional profits;
- comfort investments.
Be careful. The costs of an investment are not represented by the purchase alone. Associated costs must also be taken into account.
- The costs (in time and money) of studies, analyses and research;
- Installation costs;
- The cost of training, which is often essential;
- Maintenance and service costs;
- The costs of additional staff, etc.
- Indirect costs such as additional storage, changes to the organisation of the premises, etc.
These costs should also include "lost earnings" due to installation, setting-up, staff training etc.
Financing and profitability
Various elements must be analysed when making an investment:
- how it will be financed
- its profitability, the profits that it will generate
- the economic life of the investment or of the project
- the investment’s residual or resale value
Any investment should be funded by resources over the long term. For example, you would not finance a car with a cash advance, or a machine that had a life of five years with a two-year loan.
Generally, the duration of the loan is aligned with the subject of the financing.
Financing can come from the company’s own reserves or from outside the company.
Financing an investment with one’s own money is generally a mistake, for reasons of profitability and security.
Financing an investment with cash will deprive you of reserves in the event of an unforeseen problem (which your bank will be unlikely to want to finance, whereas they will be happy to finance an investment).
2. Profitability, profits generated
Several methods exist to check the profitability of the investment. Will it earn you money immediately or in the longer term?
The process can be broken down as follows:
- determine the real cost of the investment (see above);
- evaluate the likely additional profits, taking into account the tax impact;
- prepare a cash flow plan with all the additional incoming and outgoing cash due to the investment and generated by the investment;
- "update" the cash flow plan (i.e. adjust future values to today’s date);
- choose an evaluation method to calculate the profitability of the investment;
- compare the cost of the investment with the expected profits (or savings in costs).
This calculation is relatively straightforward for productive investments; it is much more difficult to carry out for comfort investments. Calculating the real profitability of an investment in a small business is thus not always a simple matter. You have to try to judge if overall it seems profitable, taking into account what it will cost and what it will earn.
Your professional accountant can help you with the calculations.
But good judgement is up to you!