Recording Investing and Financing Transactions for a Business
Though few in number, investing and financing transactions for a business are important and usually involve big chunks of money. The investing and financing transactions are reported in the statement of cash flows.
Suppose a business recorded 10,000 transactions during the year. The large majority would be sales and expense transactions and the set-up and follow-up transactions for sales and expenses. Perhaps fewer than 100 would be investing and financing transactions.
Investing and financing activities
Investing activities include the purchase and construction of long-term operating assets, such as land, buildings, machines, equipment, vehicles, and so on. In general, these investments are called capital expenditures. (The term capital refers to the large amounts of money invested in the assets as well as the long-term nature of these investments.)
These economic resources are also called fixed assets. They’re not held for sale in the normal course of business; rather, they’re held for use in the operations of the business. When grouped together in a balance sheet, fixed assets are typically labeled property, plant, and equipment. Eventually, the business disposes of these assets by trading them in for new assets, selling them off for residual value, or just having the junk collector come and haul them away.
Investing transactions include acquisitions of other long-term assets, such as intangible resources (patents, for example), rental real estate, and research projects in the development stage. For example, a business could invest in a sports franchise, such as the Oakland Raiders.
Financing activities basically fall into three categories:
A business borrows money on the basis of interest-bearing debt and either pays these loans at their maturity dates or renews them.
A business raises capital (usually money) from shareowners and may return some of the invested capital to them.
A business distributes cash to its shareowners based on its profit performance.
These are the three basic kinds of financing activities. Large public corporations engage in much more complex and sophisticated financing deals and instruments than these types.
Investing and financing: a business example
As an example, the investing and financing activities for the year of a new, start-up business corporation are summarized as follows:
Received $10,000,000 from a venture capital (VC) firm; in exchange, the business signed a $5 million note payable (interest-bearing, of course) to the VC firm and issued shares of stock to the VC firm equal to 10 percent of the total number of shares of stock issued by the business.
Purchased various long-term operating assets for total cash payments of $6,000,000.
The journal entries for these investing and financing activities are as follows:
|Owners’ Equity — Invested Capital||$5,000,000|
|Property, Plant, and Equipment||$6,000,000|
One-half of the money invested in the start-up business by the VC firm is secured by a note payable on which the business has to pay interest. This transaction is recorded in the Notes Payable liability account to indicate that the business has the legal obligation to pay interest and to pay the loan at its maturity date. The other half of the money that the VC firm put in the business is attributed to the account for capital stock shares issued by the business.
The account title Property, Plant, and Equipment is a generic title for long-term operating assets. The business would maintain more-specific accounts for each major asset purchased, such as buildings, machinery, vehicles, and so on.