How much has already been said about investing is hard to imagine. There are a lot of advice on where to invest money, on the choice of investment currency, the legislative framework for investment, and so on. But few people dwelled on how economic entities — legal entities — increase their income through investment. What are the main sources of financing investment activities and what can be said about the features of such legal investment?
What are the sources of financing?
Of course, you need to start with the basics. Researchers identify their own and borrowed sources of financing investment activities. If in the first case we are talking about funds received by the company in the course of its business activities, then in the second case we mean any funds taken by the company at a percentage with an obligation to return. It is difficult to say unequivocally which of these sources is preferable: on the one hand, own funds are not always enough, and on the other, if investing in loans does not bring the expected results, you will have to deal with lenders.
Assessment of the effectiveness of financing
In order to understand whether sources and methods of financing investment activity are effectively used, there are special criteria.
The first of these is the net present effect, which is an indicator of the number of net assets arising from an investment. This criterion is considered to be the main one, because inflation, fluctuations in exchange rates and other factors affecting the value of money are reflected in the assets, therefore, the net present effect takes into account all these changes. Investments were effective if this indicator is greater than zero.
The next option is return on investment. If the net present effect measures the volume of assets, then this criterion considers the ability to provide an increase in these assets. Usually, profitability is the main factor when choosing from several similar projects - it demonstrates how the funds invested in the project will increase or decrease. If the return on investment is more than a hundred, the project can be considered successful.
Another criterion, without which the characterization of sources of financing investment activity is impossible, is the payback period of investments. This criterion shows how many years the invested funds will return net income. This indicator is very important in determining how risky and liquidated an innovative project is.
How is money invested?
What are the sources of financing the investment activity of the enterprise? Often, invested funds are taken from net profit, depreciation charges, own reserves; loans from national and interstate banks, investor funds and many other sources of financing are used.
This money is invested either in the form of venture capital, or as project financing. In the first case, investing is a rather risky undertaking, but if successful, the investor will receive profit in the shortest possible time. In project financing, investment takes place in a certain project, which in the future will bring profit to the person who invested in it. The second method is considered much less risky, but nevertheless due to its long-term nature, many investors are inclined to risk capital.
Self-financing
Now you can dwell in more detail on each type of source. Own sources of financing investment activities are considered much more reliable: they significantly reduce the risk of bankruptcy and prevent the company from becoming dependent on creditors.
Specialists single out the company's net profit as one of the main sources of financing. Naturally, after receiving income, the company distributes it based on its needs. One of the most popular ways of investing profit is to invest in developing your own technical potential - upgrading existing equipment, acquiring new equipment, training personnel, and so on. One of the advantages of this method of investing is that such investments will not be taxed on income.
Depreciation charges as the main form of self-financing
Another popular own source of financing the investment activity of the enterprise is the capital used for depreciation. Depreciation is the depreciation of fixed assets of the enterprise, and the costs of it, that is, to maintain the material base in good condition, are already invested in the value of the goods when they are sold. If the company does not always have a profit, then the depreciation expenses will to some extent pay off in any case. One of the new-fangled ways to get depreciation is to reduce the depreciation period: the amount of depreciation coverage remains the same, but because it is allocated for a shorter period, its share in the value of the goods increases. That is, the company at the same cost makes a big profit.
The main mistake in using depreciation as a source of financing is their misuse. Many enterprises allow them to support the budget, instead of actually spending them on the modernization of production. Usually these funds are not used to invest in other, external, projects. Therefore, we can safely say that depreciation deductions represent sources of financing investment activity of an internal use enterprise.
External sources of financing
It is time to make out what external sources of financing investment activity are. Conventionally, they can be divided into three groups: joint-stock, state financing and lending. And now more about each of these methods.
Equity financing begins with an additional issue of securities. The advantage of this form of investment is that the bank does not need to take loans to obtain funds, and market debt obligations are much easier to fulfill. The main instruments of this investment method are ordinary and preferred shares (in the second case, the share has some properties of a bond), debt obligations with options (the right to acquire an enterprise’s asset at a specified price at a certain point in time), as well as ordinary and convertible bonds (a bond, which can be converted into a share form).
State Financing
Speaking about what are the sources of financing investment activities, one cannot but mention budget financing. It is carried out in the following forms:
- A competition is held in which the winner and, therefore, the recipient of the investment selects the most attractive project for the state.
- Programs that are in any way related to the design, production, socio-economic development of the country receive partial or full centralized funding. They are found in the form of grants and subsidies, which need not be returned.
- Some of the projects interesting to the state receive loans, and investments must be repaid within the agreed period of time with payment of interest.
- A symbiosis of state and commercial organization investments is also possible - each of them allocates a certain part of project financing.
- In rare cases, the state becomes the guarantor of the solvency of the investment project: if it cannot pay off its debt on loans, the state pays all the missing amounts.
Lending
The list, which includes external sources of financing the investment details of the enterprise, would be incomplete without lending. In this case, financial resources on terms of repayment, material security (that is, the presence of an object, which, in case of default on the loan can be confiscated in the payment of debts) and payment (return of debt with interest) are given to the enterprise by a banking institution. Loans are divided into short-term (up to one year) and long-term.
It is worth noting that this source of external financing is not preferred. Due to the high risk of investment projects, banks prefer to give loans at high interest rates, which enterprises cannot always repay. Therefore, mutual lending is gaining popularity: enterprises exchange goods and services, receiving loans, not financial, for them.
Another repulsive factor in lending is the obligation of the borrower to finance at least 30% of the entire project - far from all enterprises can afford it.
How to choose a financing method?
The composition and structure of investment activity has its effect on sources of financing. Each company decides for itself where to attract additional resources from or how to properly manage its own savings. If a company makes a choice in favor of external sources of investment, then it will have to weigh all the pros and cons of a particular method.
Pros and Cons of External Financing
For example, lending is good because banks do not control exactly how the funds issued to the enterprise are used, in addition, you can pay off debts at any time by repaying the loan ahead of schedule; on the other hand, banks need collateral in case their borrower cannot fulfill their obligations, and it is also not easy for the company to constantly live with the additional costs of credit payments.
As for public investment, it can be said that it will be a salvation for the one who was denied by commercial organizations; You can pay off your obligations in smaller amounts due to the fact that loans are given for a long period of time. At the same time, the state will constantly monitor how its funds are spent, while allocating not so large amounts so that they can significantly change something.
The last option, which involves external sources of financing investment activity, is equity financing. Here, the company will maintain its relative independence and will not be burdened by constant payments of its obligations. At the same time, a certain amount of funds will have to be spent on the issue of securities that can be sold, and it is not a fact that these securities will still be sold on the market. So here are the most risks.
How to optimize funds?
Is it possible to optimize sources of financing investment activity? Of course. If an enterprise has free funds, it is better to direct them to payments on debt obligations, rather than personal needs - the sooner a business gets rid of its dependence on banks, the faster it will be able to fully develop.Ideally, over time, the company should abandon external sources of investment, limiting in most cases its financial freedom, and switch to self-financing, in which there will be no need to account for the money spent.
Conclusion
One cannot call unambiguously good or unambiguously bad sources of financing investment activity. Each of them has its advantages and disadvantages. In the case of self-financing, we can say that it is not available to all companies. But on the other hand, external financing will almost certainly limit the freedom of the enterprise. You can always find a balance between these two options and the success in the market largely depends on what it will be.