Operating a business requires a lot of financial policies in place. The financial policies must direct the organization smoothly and 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 are 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 that need to be considered while accounting for the cash inflow and outflow; at times, outflow can be profitable, while inflow also incurs cost.
Investing and financing activities are the two prominent elements of cash in and outflow. They both contribute to the success of the business, but they have their differences when it comes to profitability.
Key Takeaways
- Investing activities involve acquiring and disposing of long-term assets, such as property, plant, equipment, and investments. In contrast, financing activities involve transactions related to a company’s capital structure, such as issuing or repaying debt and equity.
- Investing activities can impact a company’s growth and asset base, while financing activities affect the company’s capital structure and financial stability.
- Both investing and financing activities are essential components of a company’s cash flow statement, providing insights into how it allocates resources and raises capital.
Investing vs Financing Activities
The 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.
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Comparison Table
| 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 | The main components of investing activity are purchasing and selling fixed assets and any long-term investments. | Issuing shares, Borrowing funds from investors are significant components of Financing activities. |
| Frequency/ Regularity | The cash position from investing activity does not frequently change 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 massive as the investments made are from huge entities. | The cash flow is not as massive as an investing activity, but repayment can affect the overall profitability. |
| Effects/Impacts | Investing activity hugely impacts capital assets. | Financing activities hugely affect capital structure. |
What are Investing Activities?
Investing activity is one of the significant elements of the business that raises the 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 long-lived assets. It may also be buying and selling equity securities of other companies.
Indeed, the buying and selling of long-lived assets happen for business operations. Many businesses would require different categories of assets like land, equipment, patents, and copyrights – all these come under investing activities.
Cash inflows happen through various means of investing activity. They are selling fixed assets, intangible assets, investments, and a collection of loans offered to different entities.
Cash outflows happen through various means too. They are payments to purchased fixed assets, payments for purchased intangible assets, payments to purchase investments, and offering loans to other entities.
There are many norms placed during any purchase. The purchase of fixed assets is recorded as an expense until the investment comes for independent economic benefit.
Thus, it includes the cost which is for installation and 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.
Cash flow for a company shows 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, and issuing common stock.
Cash outflow from financing activities can be recorded for many reasons. They are repaying the loan, payment of cash dividends, and buying stock from the treasury.
Cash dividends are the cash paid towards the share of profits to the shareholders. Some companies pay dividends 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 the financing activity gets the capital restructured.
- Purchasing long-term assets and selling 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 frequently change, while the cash flow in a financing activity will alter itself in quick succession 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.
- 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
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.
I totally agree that while having some savings in the bank, it’s important to keep investing especially when there are chances with attractive prices.
You never know when bad times will come so its important to keep a balance about money. You should always have some money in your waallet/bank (also known as liquidity)