Long-term investments are assets that a company intends to hold for a period exceeding one year. They appear on the asset side of the company’s balance sheet, indicating the firm’s commitment to securing financial stability and growth over the long term.
Types of Long-Term Investments
Equity Investments
These include shares or stakes in other companies. By holding equity, a company may benefit from dividends and capital gains over a prolonged period.
Real Estate Investments
Property investments made for the purpose of generating rental income or for future sale at a profit. Real estate typically appreciates over time, contributing to asset value.
Debt Instruments
Investments in corporate or government bonds, which provide periodic interest income and are held until maturity to realize gains.
Special Considerations
Valuation Methods
Long-term investments are evaluated using different methods such as amortized cost, fair value, or equity method, depending on the nature of the investment.
Amortized Cost: Primarily used for debt instruments held to maturity. It reflects the acquisition cost adjusted for amortization.
Fair Value: Investments like equities are often marked to market, showing their current market price on the balance sheet.
Equity Method: Used for significant influence stakes (usually 20% to 50%) in other companies, reflecting a share of the investee’s net income.
Impairment
If the market value of an investment significantly declines and is not expected to recover, the asset must be written down to reflect its impairment.
Examples and Historical Context
Example: Berkshire Hathaway
Berkshire Hathaway is renowned for its strategy of holding long-term equity investments, including significant stakes in companies like Coca-Cola, American Express, and Apple.
Historical Context: Long-term Investment Trends
Historically, long-term investments have been a marker of robust financial strategy, with companies like General Electric and IBM using them to fuel growth and innovation.
Applicability in Financial Strategy
Long-term investments are integral to a company’s broader financial strategy, aiding in portfolio diversification, risk management, and capital appreciation.
Comparison with Short-term Investments
Short-term investments are intended to be converted into cash within a year and include money market instruments, Treasury bills, and marketable securities. Long-term investments, however, are held for several years and are pivotal for strategic financial planning.
Related Terms
- Asset Management: The process of planning and directing long-term investments to maximize returns.
- Equity Method: An accounting method for investments, reflecting proportional shareholding.
- Impairment: A permanent decline in the value of an asset.
FAQs
What is the main difference between long-term and short-term investments?
Why are long-term investments important for a company?
How are long-term investments reported on the balance sheet?
References
- Damodaran, A. (2002). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset. John Wiley & Sons.
- Myers, S. C., & Majluf, N. S. (1984). Corporate Financing and Investment Decisions When Firms Have Information That Investors Do Not Have. Journal of Financial Economics.
Summary
Long-term investments represent a critical component of a company’s financial strategy, appearing on the balance sheet under non-current assets. They encompass various types, such as equity, real estate, and debt instruments, each holding strategic importance for financial stability and growth. Comprehensive understanding and prudent management of these investments are essential for the sustained success and profitability of any enterprise.
