To understand what firm investment really means, one has to first understand what firm investment is not. Firm investment is not a part of venture capital and/or private equity. Firm investment is basically the buying of company stocks as an active component of an overall capital structure for the purpose of creating value. By value, we mean the amount that can be recovered from the purchase price less the amount that has been paid in capital to date. This definition is not as simple as it sounds because some firms will use the funds for an active purpose (buying low and selling high at a profit) while others will use the funds for passive purposes (buying high and selling low at a profit).
The goal of capital structure planning is to create value by using the firm investment funds to add to or add value to existing operations, products, technology, infrastructure, etc., through new research and development, innovations, acquisitions and partnerships. Financial leverage relates to the ability to leveraging another person’s assets so that the owner of this additional financial asset, the owner’s partner, loses control of the additional financial asset. It’s also been seen that the effect of firm investment on firm investment results is quite significant for high-innovation, high-paying companies. Examples include technology firms where firms tend to purchase other technology firms that are considered to be low-cost and highly profitable. Another example of this would be hospitals where large firms purchase smaller hospitals that provide health care services that are high quality, but operate at a lower cost.
Private equity firms typically make their firm investment decisions based on the results of that decision. They evaluate the return on their own investment over the short-term and the impact on their domestic credit rating. In doing so, they realize that they may also need to increase their firm investment funds in order to compensate for the losses that they have incurred, or to even come up with more capital to support their current projects, depending on the nature of the project and its attractiveness to other private firms. The increase in firm funds can be done by raising equity from the current shareholders or by issuing preferred stock.
Firm growth and development depends on how well the firm is able to serve its customers. In addition, the value creation and efficiency of the firm also depends on how well the internal funds have been used to support that growth and development. In a market-driven economy, profitability is not necessarily the only standard of measure of success. A company’s ability to create cash flow depends on the use of firm investment funds.
A company’s ability to generate cash flow usually depends on its size, industry classification, customer mix, management philosophy, flexibility, growth opportunities, and other factors. These factors determine the amount of money that can be raised from the investors. Many companies look to hedge their exposure to risk through leveraged buyouts and other forms of buy-out arrangements. This gives them access to external capital and avoids them from potentially losing too much of their own funds to other activities. Leveraged buyouts have also increased the number of firms in the buying category, giving them a greater freedom in terms of investment strategy.
All managers strive to build economic freedom by increasing productivity. But it is important to remember that this cannot happen if the market-based valuation of a certain company is lower than the real value of its assets. The only way to achieve this is through effective management of external resources, especially firm capital. Proper financial management also means that a firm is able to make the most of its productive assets. Otherwise, economic growth will be limited to what the firm can obtain from external sources. Therefore, although the concept of economic freedom is an abstraction, it can be said that a free-market system always ensures a level of freedom through the efficient utilization of capital.