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Confused about what is meant by long term investments, under assets on a company’s balance sheet? Here’s all you need to know about this component of the company’s finances.
As an investor, you have probably heard all about the attributes and benefits, drawbacks and considerations linked to long term investments in your portfolio. However, this blog is not about long term investments that you - the investor - will make, but about the long term investments a company makes, or the long term investments of the companies you are likely to invest in, or have already invested in.
A serious stock market investor, intent on choosing stocks that they can rely on to grow in the long term, will usually go through the balance sheets of stock market listed companies so as to choose the ones with strong financials, and therefore a comparatively higher potential to continue to be strong financially.
As you are going through the balance sheet of a company, you might come across an account on the asset ledger that says long term investments. Indeed, companies too might invest as an additional method of income or rewards.
What are long term investments with respect to a company?
A company might invest in another company’s shares, that is, they may go for long term investment stocks; they might invest in government or corporate bonds, real estate and they might also invest in money market funds, commercial paper and treasury bills.
Long term investments are typically any that are held for more than a year. They may be sold after a year, very far into the future, or might not be sold at all. Any investment held for less than a year would be categorized under short term investments.
You’re probably wondering what all of this means for you as an investor, and you might also be asking yourself why the need to separate long term and short term investments on the balance sheet.
Implications on balance sheet
The increases and decreases in value of a long term investment do not reflect on a company’s balance sheet unlike in the case of short term investments where decreases in value are reflected, but increases are not noted on the balance sheet until the investment is either sold or redeemed.
That’s because the short term investment’s value does have a bearing on this year’s balance sheet, as it is to be sold/ redeemed this year. However, the long term investment’s value will only become apparent upon sale or maturity. Only the amount invested will show up on the balance sheet for a long term investment.
However, the rules are slightly different for held-to-maturity investments. Held-to-maturity investments do not include stocks, because stocks can be held indefinitely. Held-to-maturity investments have to come with a fixed maturity date. Any interest, premium or discounts that come to the company owning these investments, during the period of holding such an investment, will be deducted from the investment amount over time. This is called amortization. Bonds and other debt vehicles would come under this category of held-to-maturity investments, assuming the company plans to hold them till maturity. They are known as noncurrent assets.
Another sub-category of long term investments is available-for-sale investments. A lot of times such investments are short term, but given our focus on long term investments in this post, we are looking at investments that the company has plans for selling in the future (beyond one year). For such investments, the balance sheet will initially reflect their cost. Then, at the end of every reporting period, the fair value of such an investment will be recorded and updated. Even unrealised earnings and losses from such investments is recorded, under what is known as other comprehensive income. This category might include the bonds that we talked about in the previous category if the company intends to sell them before maturity. This category is sometimes also referred to as available for trading.
Also Read: Best Long Term Stocks to Invest
Implications for investors
As an investor, you might therefore want to check how these investments are performing individually. If Company ABC has shares of Company Z and Company Z manufactures tech that was the biggest thing in 2019 but is quickly becoming obsolete, this might prove to be a loss-making investment.
Alternatively, if Company Z manufactures oxygen cylinders (previously targeting the recreational diving industry), they might be in for better than before earnings given that the demand for oxygen cylinders has shot up amidst the pandemic.
Long term investments are also an indicator of deep pockets. For a company to lock in its capital for the long term, means that the company
The company is usually accepting high risk by investing in the long term, because of the common logic that risk plateaus out in the long term. However, it also means that the company has diversified its avenues for raking in earnings.
Conclusion: Long term investments are an important component of a company’s balance sheet, and like every asset, they contribute to the company’s bottomline in the long term. Investors should consider how the long term investments of a company bode for them as investors.
Disclaimer: This blog is exclusively for educational purposes and does not provide any advice/tips on investment or recommend buying and selling any stock.
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