Difference Between Investing and Financing Activities

Edited by Diffzy | Updated on: September 28, 2023

       

Difference Between Investing and Financing Activities

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Introduction

Investing and financing activities consist of two main parts of the statement of cash flows, in which cash inflows and cash outflows from these activities are reported. The main difference between investing and financing activities is that cash flows that lead to investment profits and losses are recorded in investing activities, while cash flows that lead to a change in the company's capital structure by issuing new shares are registered in financing activities and repaying to investors.

Both of these activities directly impact the company's net cash position because they represent the majority of cash available in the organization.

Investing Activity vs. Financing Activity

The key difference between investing activity and financing activity is investing showcases the net difference between your sale and purchase of any fixed asset, short-term asset, or bonds. In contrast, financing activities showcase any change in the capital by issuance of new shares of the company.

Difference Between Investing Activity and Financing Activity in Tabular Form

Parameters of ComparisonInvesting activityFinancing activity
MeaningInvesting activity showcases the net cash flow from the investments.Financing activity showcases the net cash flow from the issuance of shares and borrowings.
ActivitiesActivities like the sale of offices/buildings, the sale of investments, purchase of investmentsActivities involved the issuance of shares, bonds, and debentures and the repayment of loans and dividends.
DecisionDecisions on investing activity are taken by top-level management.CEOs and CFOs of the company take decisions on financing activity.
FrequencyThe cash flow of investments is experienced once every few financial years, so the cash position often does not change.Financial cash flow is often modified when it includes elements such as loan repayments.
ResultInvesting activities include cash flows that result in investment gains and losses.Financing activity is one of the important activities of the organization as it is the source for the requirement of funds.
ImportanceInvesting activity is not that important activity as compared to financing activity.Activities involved issuing shares, bonds, and debentures and the repayment of loans and dividends.

What is Investing Activity?

The purchase and sale of long-term assets and other investments make up the second largest category of investment activities on the cash flow. In other words, this represents the net cash received and paid for long-term assets and investments throughout an accounting period. The above activities can be compared to how a firm invests in itself or earns money from its investments.

The two main investment activities are long-term assets and investments. Fixed assets usually consist of fixed assets such as vehicles, buildings, and machinery. When a company buys a new vehicle with cash, the cash flows are recorded in the investments section. Similarly, cash is also listed in this section if the company sells any of its vehicles.

Investing is a little more complicated than long-term funds because it depends on the source of the investment. For example, this section includes money paid for short-term investments, such as commercial securities and cash. Third-party note principles are also included. However, payments from the customer who caused the sale are usually listed in the action section, not the investment. Therefore, the FASB requires that all interest payments and income be classified as a business.

List Of Activities Included In Investing Activities 

Investing cash flow includes all purchase and sale transactions of long-term investments, real estate, and equipment. These items are found in the long-term article of the balance sheet.

  • Acquisition of tangible fixed assets (negative cash flow)
  • Sale of tangible fixed assets (positive cash flow)
  • Investments in joint ventures and subsidiaries (negative cash flow)
  • Payments from the acquired company (positive cash flow)
  • Income from the sale of assets (positive cash flow)
  • Investments in marketable securities (negative cash flow)
  • Dividend received from securities invested (positive cash flow)

Types of Investments 

Investments are asset classes, such as stocks, bonds, commodities, real estate, cash, and financial assets, in which investors invest money to earn a profit in the future. These investments largely depend on the investor's risk appetite, financial goals, and investment schedule. As stated above, each investment category has many opportunities to invest. The choice of the mentioned also depends on many factors.

Although stocks and bonds are suitable for long-term growth, cash equivalents are suitable for investors who prefer liquidity over long-term growth. A stock is an ownership instrument, while a bond is a debt instrument. An investor has different investment accounts where he can park his money, which would be beneficial for him. As discussed above, there are different types of investments, such as instruments that provide ownership rights, investments that are created by owners, lenders, or creditors, and investments that are arranged to resemble cash or that can be easily converted to cash when needed.

Today, with the growth of cryptocurrencies and many other options for investing in the stock market, three main types of investments have been prevalent for decades. Let's look at the main types of investment accounts and the advantages and disadvantages of each type through a detailed discussion below.

Stock Investment

Shares or share capital involve more risks compared to other types, but the income potential is the highest. Shares are investments that allow the buyer to own part of the assets of the Company and, therefore, are called instruments of ownership. Companies make such investments to raise capital. Yields are low compared to bonds.

Advantages

  • Liquidity of assets
  • Limited liability
  • Right and bonus shares
  • Profit from buying and selling stocks
  •  Administrative and Ownership Rights
  • The right to vote

Disadvantages

  •  High risk
  • Limited control
  • There are no fixed dividends
  • Remaining dividend claim
  •  Fluctuations in market prices

Cash and Cash Equivalents 

These are investments intended only for short-term management and conversion to cash. These include money market instruments such as certificates of deposit, commercial certificates etc. Total cash and bank receivables represent the strength and ability of the company to pay its current debts and obligations. This means they are very liquid.

Advantages

  • Low default risk Not subject to market fluctuations
  • Very liquid
  • Relatively safer compared to other investment instruments
  • Helps the company cover operating costs

Disadvantages

  •  Lower interest rate
  • Loss of potential income while it is slow to meet immediate needs. These funds struggle to keep up with inflation.

Bond Investments 

With the help of loans or loan investments, the issuer of the investment can borrow money from investors and pay it back with interest. They are a safer bet for investors than stocks because they offer a fixed rate of interest from time to time. Any instrument's main risk is default risk, which is absent when the amount is lent to the government.

Advantages

  • Fixed interest rate
  • Less risk
  • Tax incentives
  • It helps to diversify

Disadvantages

  •  Interest rate risk and default risk
  •  Owners cannot be owners; they always borrow/credit
  • Regular payment obligation to issuers: If the credit rating goes down, it will be harder to liquidate

What is Financial Activity?

Financial activities include the flow of money between the organization and its owners, creditors or investors to achieve long-term growth and financial goals that affect the debt and equity presented in the financial statements. Such activity can be viewed through the cash flow of the financial segment of the organization's cash flow statement.

Financial activities indicate the collection or return of funds raised by business owners or promoters to develop real estate and invest resources in it, such as expanding offices, hiring work, buying new, etc. These transactions are usually important to the long-term growth strategy and affect the long-term assets and liabilities of the company.

List of Financing Activities 

  • Issuance of bonds (positive cash flow)
  • Sale of shares (positive cash flow)
  • Loan from a financial institution (positive cash flow)
  • Repayment of existing loans (negative cash flow)
  • Cash from newly issued shares (positive cash flow)
  • Paying a cash dividend to shareholders (negative cash flow)
  • Purchase of own shares (negative cash flow)
  • Repurchase of existing shares (negative cash flow)
  • Bond redemption (negative cash flow)

Advantages

Financing gives companies the much-needed fuel to grow and expand into new markets. It is easy to imagine what would have happened to today's big internet giants like Instagram, Google, or even the domestic UBER if they had not raised funds for their expansion plans. Companies without capital can lose new opportunities and new customers. It provides investors with valuable information about the financial health of the company.

For example, financial activities such as regular share buybacks indicate that the promoters are very positive about the growth story and want to maintain their interest. Hence, Indian IT companies like Infosys and TCS brought buybacks in two years, and investors cheered for the same. On the other hand, if a company easily dilutes its capital, investors may assume that it is in financial trouble. And difficulties in obtaining capital from banks or other lenders.

Disadvantages 

Financial activities are often of interest to regulators because attention is often paid to how money is financed and what it is used for. Companies must be vigilant during these activities, as a small mistake can lead to regulatory scrutiny and lengthy legal misery. We can take the example of the Adani group. More than how much capital is raised, considering how that capital is raised or returned to investors.

 Auditors of these companies must always consider the tax implications. For example, financial activities such as dividend payments are taxable, but share buybacks are not. Although these mechanisms differ in the long term, they are similar in the short time, ie. they reward shareholders.

Main Differences Between Investing activity and Financing activity (In Points)

  1. Investing activities are the which showcase the cash inflow and outflow of investments held in the organization, whereas financing activity showcases the increase and decrease in the cash flow and capital structure of the company.
  2. Activities like the Sale and purchase of machinery/buildings and sale and purchase of investments come under investing activities whereas financing activities like issuance of shares and repayment are shown under the cashflow statement.
  3. The frequency of investing activities is less as compared to financing as not so often we see the sale and purchase of fixed assets but at the same time, there is the involvement of financing activities when the company needs funds.
  4. Investing activities include cash flows that result in investment gains and losses whereas financial activities reflect those cash flows that result in a change in the company's capital structure through the acquisition of new capital and repayment of borrowings.
  5. Decisions on investing activity are taken by top-level management, whereas Decisions on financing activity are taken by CEOs and CFOs of the company.

Conclusion 

We can conclude that investing and financing activities can be distinguished mainly by understanding the components of each category. Investments in fixed assets are reflected in investing activities, and changes in the capital structure are reflected in financing activities. Availability of cash is an essential part of the normal survival of a business. The net cash position becomes critically important for all types of organizations in planning future business and investment activities. In itself, the cash flow of investment and financing activities plays an important role in the availability of the total funds of the organization. Investment activities showcase how wisely the company is using its profits in investments, and financing activity showcases the ratio of debt and equity portion of the company. It is very important to regularly manage cash inflows and outflows of investing and financing activities as they represent the cash requirements and liquidity of the company. 

References

  • Desk-era Wall Street mojo

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"Difference Between Investing and Financing Activities." Diffzy.com, 2024. Tue. 16 Apr. 2024. <https://www.diffzy.com/article/difference-between-investing-and-financing-activities>.



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