Investments are simply an expenditure on goods, services or other commodities to get a return in the future. Because of how complicated different types of investments can be, be it in machinery or other businesses, businesses must think carefully about the investments they make to ensure a good return. Below, we will look at the main factors that influence investments and investment levels by firms and businesses.
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Because investments rely on either current savings or borrowing, they are strongly influenced by interest rates. Borrowing for investments is a lot costlier if the interest rate is high. In this case, businesses might opt to keep their money in a bank account if the interest rate is high enough.
To ensure an investment is worthwhile, businesses check that the interest rate on the borrowed amount is lower than the rate of return. As interest rates rise, they might be higher than the rate of return, which means the investment will lead to the investor losing money and so the level of investment is reduced accordingly.
The main reason why businesses invest is so that they can satisfy future demand and make money when the time is right. If an economy improves, businesses expect future demand to be high due to the availability of disposable incomes, and so they increase investments. If the demand falls due to an economic downturn, businesses reduce their investments.
Market and Economic Confidence
Confidence is not always rational but is one of the biggest determinants of whether a business will invest or not. Because investments are riskier than saving money in a bank account, businesses have to be confident about the economic growth, political climate, interest rates and more to determine if investing is the right choice. Any uncertainty leads to businesses holding back and waiting to see how things turn out.
Present Value of An Investment
The present value is the current value of money or a return from an investment given a certain rate of return. Present value assumes that money in the future will be worth less than it is worth right now. This means investors think about the current value of money they will end up with at the end of a certain period to determine if an investment is a good one.
The two main factors that affect the present value of an investment are inflation and discount rates. Inflation leads to an increase in the cost of goods and services, meaning that an amount of money today would buy fewer goods and services in the future. The discount rate is the rate of return of an investment and is used to calculate the amount of money that would be given up if an investor chooses to accept an amount of money today rather than in the future (investing it).
There are lots of different ways to calculate the present value of an investment, many of them utilizing accounting formulas, excel worksheets and other methods to work out the present value of an investment. To make things easier, there are calculators available to help investors calculate the present value of an investment taking the rate of return (discount rate), the future value and the investment term into account.
Technology plays a huge role in bolstering the attractiveness of an investment. New and efficient technology leads to higher productivity and higher return, meaning that industries that adopt this new technology see massive investment once it becomes mainstream.
If there are little innovation and technological changes in an industry, many investors pull back because there is not enough return on investment to make it worthwhile.
Apart from interest rates, the availability of funds also determines if investors put money in viable investments. Even when the interest rate is lowered and banks and other lenders do not have enough money to lend to investors, the rate of investment remains low.
A great example is in 2012 where a liquidity crisis left many banks and lenders short of money to lend to investors. Even with the low interest rates put in place to encourage borrowing, there simply was not enough money to go around, so investments slowed.
Credit availability is also affected by savings. If enough people are not saving money, there will be no resources to lend out. If the level of savings falls, so does liquidity and investments.
Investments in Public Sector
Although most investments are driven by what is happening in the private sector, some of them are driven by what is happening in the public sector. For example, the construction of new roads or new airports can and does lead to new investments in and around the areas where these public projects are completed.
Although businesses are always looking for new investment opportunities, they have to be careful about where, how and when they invest their money. The factors above are the main ones that businesses should consider to determine whether it is the right time to invest, how much to invest, and where to invest.