Browse Category

Investment

WHAT FACTORS TO CONSIDER WHEN ANALYZING INVESTMENTS

An investment is an exposure of cash that has the objective of producing cash inflows in the future. The worthiness of an investment is measured by how much cash the investment is expected to generate.
The analysis of return on investment is a financial forecasting tool that assists the business manager in evaluating whether a proposed investment opportunity is worthwhile within the context of the company’s business objectives and financial constraints.

The investments to be analyzed have some of the following characteristics:

  • A major amount of money is involved.
  • The financial commitment is for more than one year.
  • Cash flow benefits are expected to be achieved over many years.
  • The strategic direction of the company may be affected.
  • The company’s prosperity may be significantly affected if the investment is made or not made.

Investment decisions should be analyzed carefully because such analysis is of assistance in the decision-making process and because the decisions are irreversible, have long-term strategic implications, are uncertain, and involve considerable financial exposure.

Assistance – Forecasting the future performance of a proposed investment requires the analyst to identify all the issues and effects, both positive and negative, associated with the investment. While this does not eliminate risk, it does lead to a more intelligent, betterinformed decision-making process. Facts and expectations based upon research and strategic thinking are incorporated into the forecast. The results of the financial analysis do not make the decision. People make decisions based upon the best available information. A capital expenditure requires significant funds and corporate commitment. It is vital that these decisions be well informed.

Irreversible – Operating decisions, such as scheduling overtime or purchasing larger amounts of raw materials, can be changed when the environment or circumstances change or when it becomes obvious that a mistake was made. With these decisions, the need for correction can be readily determined and the actual change can be implemented quickly, with minimal financial penalty. A capital expenditure decision, such as purchasing machinery, can also be changed. In this case, however, the financial penalty can be substantial. Having installed equipment sit idle because customer orders dried up or never materialized can be severely damaging. Changes in customer preferences that are not recognized before assets are purchased and installed can be even more damaging if the company cannot or is unwilling to admit the mistakes and take corrective actions. The discipline of analysis and forecasting should minimize the occurrence of this type of event.

Long-Term Strategic Implications – Locating an operation in a certain part of the country or of the world, building a factory in a certain configuration, and deciding what kinds of machines are needed and how many are all decisions that will affect the way the company conducts its business for many years to come. These decisions may very well contribute to the company’s future prosperity, or the lack of it. Companies can face such risks as:

  • Critical raw materials becoming depleted
  • Rail transportation service being terminated
  • Manpower and/or skills shortages occurring

The discipline of the forecasting process forces companies to identify, evaluate, and resolve these risks and vulnerabilities.

Uncertainty – The ability to predict the future is becoming more difficult and complex for businesses. Markets, customers, competitors, and technology have made the need for strategic discipline more critical than ever before.

Financial Exposure – In addition to the uncertainties and risks involved, the sheer amount of funds that must be committed to a major investment requires that all available facts and issues be identified and evaluated. If additional debt is directly or indirectly involved, the analytical process is even more critical. Involving banks or other sources of external financing is often very helpful. Banks are riskaverse businesses. They will not lend money unless they are convinced of the merits of the proposed investment. Lenders often protect their clients by identifying risks that the clients had not identified or had underemphasized. In this situation, the forecast becomes a selling document as well as a decision-making tool.…

THE EASY WAYS TO BUILD YOUR PERSONALIZED INVESTMENT PLAN

In this article, I discuss the beginnings of the investment process. Selecting securities isn’t the first thing investors do; choosing investments is just one of many elements in the process.

The following checklist outlines how you can build a successful investment plan that meets your individual needs and goals:

Setting realistic expectations

When you start your investment program, don’t expect to become a millionaire overnight. History has shown that the market has many ups and downs. However, when looking at the long term (five years or more), investors have been rewarded for their patience. Additionally, riskier investments held over the long term provide higher rewards than low-risk investments. As you can see from the following statistics, less risk equals less return. For example, the 73-year average annual return (1926 to 1998) for U.S. Treasury bills was 5.7 percent, the return for long-term corporate bonds was 5.7 percent, and the return on the S&P 500 Index was 11.2 percent.

Determine where you stand.

Gain a good understanding of what your financial commitments are now and in the future. Make certain that you have an emergency fund and a savings plan.

Clearly state your financial goals.

How much do you need? When do you need it? How much risk can you tolerate? If you lost the principal of an investment, could you mentally recover and invest again?

Determine the appropriate allocation of your personal assets for your age (young adult, middle-aged, retiree, and so on). Develop a regular investing program and stick to it regardless of market volatility.

Select the investments that meet your financial goals and risk-tolerance level.

How much time do you have (in years) to invest? Should you be an active trader and invest often during the day or a passive investor with a buy-and-hold policy?

Analyze your investment candidates.

Before you call your online broker, make certain that you can tell a child in two minutes or less why you want to own a particular investment. Determine how long you plan to hold the security and decide at what price you will sell (and take your profits or cut your losses).

Select an online broker that suits your needs.

Avoid mutual fund loads (a sales charge added to the purchase or sale of a mutual fund) and high fees. Use automatic investment plans, dividend reinvestment programs, investment clubs, and other programs to reduce brokerage commissions.

Monitor your portfolio and reevaluate your goals on a regular basis.

Rank the performance of your investments and make the appropriate changes. You can expect that changes in general market conditions, new products that are introduced, and new technology will change how established businesses operate. Use this information to gain an understanding of when to hold and when to fold.…