When you are making an investment, you need to know that you are going to make a return on the cash and time spent. If you don’t, you could end up making a loss which can have negative consequences on your business and on growth you intend to achieve.
The wrong investment, as seen by the investment in Boo.com by the Omnia Fund, can cost your business millions. Some bad investments have even forced investors to declare bankruptcy and go out of business.
To avoid this, you need to estimate the return for your business. There are several ways to do this. Here are those ways and what they can tell you.
1. Discounted Cash Flow
This is the main form of investment potential calculation used in investment finance, real estate development, corporate financial management and patent valuation.
This process estimates the future cash flows and discounts them through the cost of capital to obtain a present value. When you subtract the investment value from the incoming present value, you’ll have your returns.
This is a good method because the value of money today will not be the same in the future. Therefore, this prevents you from making an investment believing the returns will be positive when in today’s values they will not.
2. Weighted Average Cost of Capital
A company’s assets are often financed through debt or equity. WACC calculates the average of these finance sourcing costs and weights them based on how the financing was obtained.
Doing this allows you to determine how much interest your business has to pay for every pound it spends. Normally, this is used internally by companies and their leadership teams to determine the feasibility of mergers or expansionary opportunities.
3. Actual Cash Flow
Another common way to determine the feasibility of an investment is to consider the incoming cash flow over the long term. Then compare this to the expenses, including the initial costs, and any maintenance required during the investment period.
This can be an effective way to determine the return on investment, especially if there are ongoing costs over the longer period. However, it does assume that costs of financing will remain consistent, and low, and that the incoming financial benefits can be estimated over a protracted term.
4. Future Business / Asset Valuation
Considering the impact the investment will have on the value of your assets or business is also a good indicator.
5. Other Benefits
It is not just financials or value of the business / assets that is important to consider. There are also other benefits that may be worth investment. This could include an improvement in the quality of the work your staff produce, form part of your social contribution or a reduction in the cost to manufacture each unit.
This is sometimes a highly undervalued aspect of investments as many organisations concentrate on the bottom line. Yet the long term impact of these fringe benefits can provide secondary financial benefits. For instance, a better quality of end product can yield better industry reputation and therefore an increase in orders, helping you expand your business.
And time may well be saved because of investment which can then increase the capacity of your team – thus allowing you to earn more from the same period of time.
Investing in your businesses is important. Without it, your business may not expand. At the same time, the wrong investment could potentially ruin your organisation. Therefore, during the planning process you need to consider carefully how the investment can impact your business.
Using the above techniques, you have several different ways to find out if any future investments could be of benefit to your business.
At Tectona we understand how to do this; if you are considering a particular investment in your business let Tectona help you understand all the implications. Contact us today to learn how we can help you.