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When a business has surplus funds that aren't immediately needed for its core operations, it often allocates these funds to investments. These investments represent capital placed outside the business to generate returns, rather than being used for internal requirements. Understanding the fundamentals of investment is crucial for any firm looking to optimize its financial resources.

What Are Business Investments?

Investments are essentially a firm's surplus funds that are not currently required for its day-to-day business activities. These funds are placed into various financial instruments with the expectation of generating income or capital appreciation.

Investments typically take the form of legal claims known as securities. These can include:

Various institutions engage in significant investment activities. Banks, for instance, acquire approved securities to meet statutory liquidity requirements. Insurance companies and public utilities also invest a large portion of their funds in external securities. Investment trusts, such as the Unit Trust of India (historically), may hold almost all their assets in securities. Even other business units invest their surplus funds outside their primary operations, depending on their liquidity needs.

How Do You Plan an Investment Strategy?

A financial planner's role involves developing, implementing, and monitoring a long-term investment strategy tailored to help clients achieve their financial objectives. This process begins with a thorough understanding of the client's unique requirements and comfort level with risk.

Key steps in planning an investment include:

Investment planning should always be approached from a long-term perspective with clear, long-term objectives. Once these objectives are established, they should only be altered to reflect significant changes in a client's situation, such as impending retirement or divorce, rather than in response to short-term market fluctuations or emotional reactions. While technology and expertise play a significant role, investment planning ultimately remains an art, not a precise science.

Are Investments Fixed or Current Assets?

Investments are classified as either fixed assets or current assets, depending on the intention behind their acquisition and how long they are expected to be held.

What Types of Securities Can You Invest In?

Securities commonly purchased as investments can be broadly classified based on the regularity of the income they provide:

  1. Fixed-Income Bearing Securities: These securities carry a predetermined rate of return, payable periodically. Examples include government bonds and corporate debentures. Investments made for specific purposes, like sinking funds, are often placed in such securities due to their predictable income stream.
  2. Variable-Income Bearing Securities: Securities such as shares (equities) do not guarantee specific rates of return. The dividend paid by the issuing company can vary from year to year, or may not be paid at all if profits are insufficient.

How Do You Buy and Sell Investments?

Investments in securities can be acquired in two main ways:

The sale of investments is typically conducted in the secondary market through brokers or bankers.

Purchases or sales of investments can occur at par, at a premium, or at a discount:

Expenses incurred during acquisition, such as brokerage fees, stamp duty, and transfer fees, should be added to the cost of the investment. Therefore, an investment must be recorded at its purchase price, adjusted for these acquisition expenses. Similarly, when investments are sold, the sale proceeds should be reduced by any related expenses like brokerage and other incidental costs.

It's important to note that the capital cost of investments, along with acquisition expenses, constitutes the true cost of the investment. However, any amount paid to the seller for accrued interest or dividend should not be included as part of the investment's cost. Likewise, when investments are sold, any interest or dividend received along with the sale price should be excluded when calculating the profit or loss on the sale of the investment.

Understanding Cum-Interest and Ex-Interest Prices

Interest on fixed-interest bearing securities, like government bonds and debentures, is typically paid once every six months. When investment transactions occur on interest payment dates, the quoted price is solely for the securities themselves.

However, if the transaction takes place on any other date, the seller is entitled to receive not only the value of the securities but also the accrued interest from the previous interest payment date up to the transaction date.

The capital cost of an investment, or its real price, can be calculated as:

Special Considerations for Equity Share Investments

Maintaining an investment account for equity shares involves unique features:

Rights Issues

Holders of equity shares may be granted the opportunity to subscribe for additional shares of a company on a "rights" basis. Each shareholder can pay the required amount as per the terms of the issue to acquire the shares for which they are eligible. A shareholder can also renounce their right to subscribe in favor of another party, receiving consideration for this renouncement.

Cum-Dividend Purchase

Unlike fixed-income securities where interest can be precisely calculated, the exact dividend amount for equity shares cannot be determined until it is declared and received. Therefore, when purchasing shares cum-dividend, the entire amount paid is initially recorded as the cost of the purchase.