Investment policies have given a new perspective to the role of financial administration, this has made the subject of interest to all scholars and lovers of finance
Investment decisions are one of the great financial decisions, all decisions regarding business investments range from analysis of investments in working capital, such as cash, banks, accounts receivable, inventories and investments of capital represented in fixed assets such as buildings, land, machinery, technology, etc.
To make the right decisions, the financier must take into account evaluation and analysis elements such as the definition of the analysis criteria, the cash flows associated with the investments, the risk of the investments and the required rate of return.
Usually
The greater the risk, the greater the profit
Definition of analysis criteria in investments
In most organizations or private companies, financial decisions are focused or have a clear objective, " the maximization of wealth " through profits, this fact under current conditions, should be refocused on a criterion of " maximization of wealth ”and the creation of“ business value ”.
Faced with this, investment decisions show resources that are allocated and results that are obtained from them, costs and benefits. The criteria for analyzing investments treat the benefits and costs of an investment proposal, these benefits and costs in most cases do not occur instantly; they can be generated for more or less long periods.
When finding the costs and benefits, the criteria that will be used for its evaluation against the investment proposal must be clearly defined.
Among the criteria that have achieved a high degree of technical acceptance by the financiers are those that consider the time value of money, making a discounted treatment of the flows of costs and benefits. These include the Net Present Value, the Rate of Return, the Benefit-Cost Ratio and the Internal Rate of Return, which provide the necessary information for the analysis of investments.
Cash flows associated with investments
When making an investment, the company expects to make a series of expenses and produce certain costs to obtain a series of future benefits. The generation of these costs and obtaining benefits is known as "Cash Flows", whose components are:
- 1. Amount and time of investments
This expresses the amount of the initial investment, is made in cash or credit disbursements and its use against fixed assets or working capital.
It should also be taken into account the various additional investments during the life of the project as a consequence of the replacement of equipment, purchase of new technology, increase in working capital, to have a rough estimate of these disbursements.
- 2. Amount and time of the returns
In this it is expressed in what amount and in how long it is expected to receive the returns that it generates on the investment made by the company.
In the same way, the allocation of resources intended for investment must be foreseen, it is necessary to establish at what time and for what amount the recovery of the investments made will be made.
Most investors shy away from risk as they seek to maximize their wealth with the least possible risk
The « Cash Flows «, when taking the time value of money, is established substantively on a cash basis after taxes. The analysis is done on an incremental basis; This governs both the investments, the costs and therefore the income that they derive.
A very important aspect in the analysis of flows is given by the direct relationship that this new project may have with others that are already underway within the company, that is, a project usually affects the flow of funds from other investments., this type of effects must be incorporated into the calculation of the new flow of funds so that the normal operation of other investments is not altered.
Investment risk
The future is uncertain, everything that happens around us may change from one moment to the next, which is why when making an investment decision, the risk factor must be taken into account.
The risk of an investment is measured by the variability of the possible returns around the average or expected value of the same, that is, the risk is given by the deviation of the probability function of the possible returns.
Every investment has two risk components, one that depends on the investment itself that is related to the company and the type of sector in which it is invested, this is called Diversifiable Risk and another that is established by the market in general and affects all investments in the market and is known as non-diversifiable risk.
In making decisions regarding investments, risk is minimized if efficient risk diversification and a correct measurement of the non-diversifiable is carried out. The measure of non-diversifiable risk is given by Beta (B), which links the market returns with those of a particular investment. An investment with Beta greater than 1, means that due to a 1% increase in market returns, the asset increases returns more and if the Beta is less than 1, the opposite happens.
The contribution that a new investment can make to an efficiently diversified portfolio depends on the Beta it has, since the risk is greater the higher the Beta of the assets that comprise it.
Rate of return required for investments
The required rate of return is the minimum rate of return that must be demanded of an investment for it to be accepted. In determining this rate, all internal and external factors that influence the investment decision must be taken into account.
The assumption of financial theory in which it is stated that «investors are risk averse» takes great relevance in the sense that, as there is more risk involved in the decision to invest in a project, a higher return on investment will be required. the resources invested.
Thus, the expected return for a specific investment project depends on the risk of the evaluated project, taking into account the risk-free rate and the profitability of investing in that project.
The aspects discussed above are an effective tool in achieving proper financial administration in the area of decision-making regarding business investments, but all this must be based and complemented by technical, mathematical studies and monitoring controls implemented by the responsible for the financial area of the company.
