Understanding the Fundamentals of Capital Flows
In economics, firm investment is an investment that yields a positive return; more specifically, it yields more than enough income to finance future operations and allow the owner to retain his ownership and control. On the other hand, financial leverage reduces the expected value of future income that can be realized through the efforts of the firm. This concept is widely used in business management as well as in financial planning; however, financial leverage can also be a potential source of crisis for firms and investors. To gain an insight into this concept, one must first know what it is.
Firm investment basically refers to net worth, or the value of a firm minus its liabilities. When viewed in light of current practices, firms typically invest in marketable securities (such as equities, derivatives, fixed income instruments, and financial derivatives) and assets (such as accounts receivable, inventory, short-term loans, and long-term loans). However, firms can also choose to invest in less marketable securities and assets. One example of this is the foreign direct investment, or FDI. For a country to become a firm investor, it must have stable economic systems, good policies for raising funds, and a favorable environment for international investment. As long as these conditions are present, firms will invest in both domestically and internationally.
Under a properly implemented economic policy, external financing is not a significant constraint on firm investment decisions. External financing refers to governmental or non-government organizations that provide financial support to businesses. Examples of external financing sources include the various types of financial institutions such as banks, corporations, and other monetary instruments. In addition, the value of real estate can also be supported by external financing sources, such as the rental and leasing activities of real estate brokers. The main objective of external financing is to increase the value of the firm, so the combination of proper financial constraints, stable economic policies, and adequate externalities is a key requirement for optimal investment strategies.
Economic policy is another important aspect of external finance. One of the effects of good economic policies is increased productivity, which is primarily contributed by firms with flexible working capital. Firm investment decisions are also affected by the extent of competition. With less competitive firms, investment in plant and equipment may not be able to keep up with improvements in productivity.
On the domestic front, there are several constraints on investment decisions. These include varying margins for long-term capital expenditures, the presence of large foreign banks with poor credit ratings, the absence of appropriate infrastructure development projects, and the absence of potential sources of short-term capital. In addition, firms may incur long-term obligations, such as pension obligations. Finally, some businesses may face barriers to entry due to geographical location, industry characteristics, and political concerns. Some examples of potential barriers to investment include excessive regulation and overregulation, protectionism, the absence of appropriate technology, shortages of skilled labor, high taxation, protectionist policies, depreciation, and poor distribution channels.
As you can see, capital freedom is a vital part of the process of achieving economic growth. Achieving true capital freedom requires an effective system of internal controls that provide a firm with the information it needs to make investment decisions. Without an effective control system, investment decisions are subject to a number of funding obstacles. Additionally, these obstacles can reduce total cash flow, which significantly diminishes the attractiveness of investing. To conclude, investment depends upon a number of external variables, including access to a variety of external financing sources, flexible working capital options, and firm size and flexibility for investment.
