What is Investment Analysis? Definition of Investment Analysis, Investment Analysis Meaning and Concept
Investment analysis is an exhaustive study that consists of approximating the expected result of a possible investment, in order to determine whether or not it is convenient to undertake said project, taking into account criteria such as its viability or expected profitability.
An investment is understood to be a project that requires an economic outlay and that, if launched, would allow a certain benefit to be obtained in the near future.
The accounting profit, income and expenses, is displaced by cash flows, collections and payments.
Investment analysis is generally related to the business world.
Objectives of investment analysis
A good investment analysis should be approached from two study angles, one qualitative and the other quantitative.
The qualitative part must take into account the strategic evaluation to ensure that the investment is consistent with the company's strategy in the short, medium or even long term. On the contrary, the quantitative part, under the prism of certain mathematical calculations, will try to determine the profitability, risk and liquidity necessary to undertake the project.
- Qualitative analysis: Regarding the qualitative aspect, its characteristics, advantages and disadvantages and relationships with other living or incipient projects within the same organization are taken into account, among many other aspects, before starting the project.
- Quantitative analysis: On the quantitative aspect, the objective is to determine if the investment will generate more money than it absorbs. For this, three key criteria are evaluated: the expected profitability of the project, the risk to be assumed through its implementation and the necessary liquidity. The simulation of the results is carried out under different points of view or different scenarios, generally optimistic, neutral and pessimistic.
Quantitative analysis methods
Investment analysis takes into account cash flows or cash-flow, not accounting profits. The accounting profit does not necessarily reflect the true financial situation of the company, so planning should not be made based on it.
In addition, you must consider the value of money in time or inflation, as it will weigh down the profitability of the project when it is high. Therefore, the higher inflation or risk, the higher profitability we will demand from the project.
They are classified into two groups: static methods and dynamic methods.
- Static methods: They do not take inflation into account. Among them, the payback method or investment recovery period, the net cash flow and the accounting rate of return stand out.
- Dynamic methods: They do take inflation into account and, for this, they apply a discount rate. These include the NPV, the internal rate of return, the discounted recovery payback (incorporating inflation) and the criterion of total net cash flow per monetary unit invested.
Types of investments
Investments can be classified according to different criteria. In this case, the role that the project will fulfill within the company is addressed.
Thus, some examples of business investments and on which such analyzes are carried out are usually the following, although the range is much broader:
- Strategic investments : Aligned with the company's strategy in the medium or long term. They can be mergers and acquisitions or the sale of own businesses or strategic infrastructure for the organization.
- Growth investments: Oriented to increase sales levels. Either through increases in the production of goods, or through the opening of new sales channels, national or foreign.
- Replacement investments: Through the acquisition of new production machinery. Which incorporates new technologies aimed at increasing efficiency and reducing costs.
- Maintenance investments: Through the purchase of new equipment due to the deterioration of the current ones. These being necessary to give continuity to the production of the good or service.
- Imposed investments: In which case they are not motivated by economic reasons. But due to other external factors such as compliance with laws or adaptation to new regulations, for example.
The investment analysis should be carried out not only by those companies seeking to expand their activity, but also by future entrepreneurs who are considering starting a business, regardless of its nature. After all, investment and entrepreneurship have a very close relationship.