Operating a business requires a lot of financial policies in place. The financial policies must direct the organization in a smooth manner which must also support the business during the winter period if there are any.
Businesses run with huge capital and the capital must be obtained and utilized effectively to assist other supporting functionalities of the business too. There are many ways capital investment can happen and at times, capital investments required to be paid back in a certain period.
The cash inflow and outflow must balance each other for the successful operation of a business. There are many elements need to be considered while accounting the cash inflow and outflow, at times outflow can be profitable while inflow also incurs cost.
The two prominent elements of cash in and outflow is investing and financing activities. They both contribute to the success of the business while they have their differences when it comes to profitability.
Investing vs Financing Activities
The main difference between investing and financing activities is that investing activities record the cash flow in and out as gains as well as losses respectively from the investment made whereas financing activities will restructure the capital investment making the cash inflow as obtained funds from the investors and outflow as payback funds to them.
Comparison Table Between Investing and Financing Activities (in Tabular Form)
| Parameter of Comparison | Investing | Financing |
|---|---|---|
| Meaning/Definition | Investing activity, the one which records the cash inflow and cash outflow as gains and losses through the investments made. | Financing activity is the one that restructures the capital investment through investors and records the cash inflow as funds obtained and outflow as repayment to the investors. |
| Main Components | Purchasing and selling of fixed assets and any long term investments are the main components of investing activity. | Issuing shares, Borrowing funds from investors are major components of Financing activities. |
| Frequency/ Regularity | The cash position from investing activity does not change frequently as the activity may occur once in a few periods of accounting. | There may be frequent alterations in the cash flow especially if there is repayment of the loan to be done. |
| Amount of Cash Flow | The cash flow is usually huge as the investments made are from huge entities | The cash flow is not as huge as investing activity but repayment can affect the overall profitability. |
| Effects/Impacts | Investing activity hugely impacts capital assets. | Financing activities hugely affects capital structure. |
What are Investing Activities?
Investing activity is one of the major elements of the business that raises capital asset of an organization. It is an activity that records cash inflow and outflow as gains and losses from the investment made.
In simple words, investing activity is buying or selling of long-live assets. It may also be buying and selling equity securities of other companies.
Indeed, the buying and selling of long-live assets happen for business operations. Many businesses would require different categories of assets like land, equipment, patents, copyrights – all these come under investing activities.
Cash inflows happen through various means of investing activity. They are selling fixed assets, selling intangible assets, selling investments, and also a collection of loans offered to different entities.
Cash outflows happen through various means too. They are payments to purchased fixed assets, payment for purchased intangible assets, payments to purchase investments, offering loans to other entities.
There are many norms placed during any purchase. Purchase of fixed assets is recorded as an expense until the investment comes for independent economic benefit. Thus, it includes cost which is for installation, delivery along with the purchase price.
Long term investments are always preferred as it is accountable for more than one accounting year. These are all the shares, stocks, and bonds which may account for many accounting periods.
What are Financing Activities?
Financing activities are one of the necessities to run a successful business. Financing activities restructure the capital structure and the cash inflow is recorded as money obtained and outflow as money paid back to the investors.
Cashflow for a company shows the strength to the investors. In simple words, financing activity is getting funds from others to run a business.
The relationship in such activities is with the bank or the investors who aim to invest in the business for want of good returns. The amount paid back in the name of loan EMI or dividends is the cash outflow.
Cash inflow from financing activities happens through many means. They are issuing notes payable, issuing bonds, issuing common stock.
Cash outflow from financing activities can be recorded for many reasons. They are repaying the loan, payment of cash dividends, buying stock from the treasury.
Cash dividends are the cash paid towards the share of profits to the shareholders. Some companies pay the dividend annually and some companies also pay interim dividends.
The periodic payments are made for the money borrowed. These payments include both the principal and interest which majorly accounts for the cash outflow.
Main Differences Between Investing and Financing Activities
- The main difference between the investing and financing activities is, investing activity records the cash inflow and outflow are recorded as the gains and losses from the investments made while financing activities record the cash inflow and outflow as the amount obtained through investors and paid back to the investors.
- The investing activity changes the capital asset while financing activity gets the capital restructured.
- Purchasing of long-term assets and selling of the same is the main component of investing activity while the financing activity revolves around borrowing funds from the investors and issuing shares.
- The cash flow from an investing activity does not change frequently while the cashflow in financing activity will alter itself in quick successions depending on the repayments to be done.
- The cash flow from investing activity is huge while financing activity cannot guarantee that huge but the transactions between in and outflow will happen often.
Conclusion
The capital investments require a huge amount of money. Businesses run collaboratively too. Investing activities shall offer large cash flow, however running capital is through financing activities.
The strategy of obtaining a loan with less interest and right time payback ensures credibility. This credibility shall also help the business expand faster with the investor’s help. It all requires perfect accounting of the cash in and outflow.
The businesses will run in such a way that cash outflow shall guarantee profits and take the cash inflow positively to add up to the capital assets. Building valuable assets through the process is worthwhile for any organization.
References
- https://archivefda.dlib.nyu.edu/bitstream/2451/27556/2/SSRN-id897524.pdf
- https://www.economie.gouv.fr/files/rapport_demarigny_en.pdf
- https://smartech.gatech.edu/handle/1853/10681