Nobody's infallible: Even the smartest business budget may be wrong about what the next year holds. That's why a business's planned investment in its assets is often different from its actual investment. The relationship between the two may say a lot about how well the year went for a given business. Economists also use the difference between planned and actual investment to size up the health of the economy.
Planned investment refers to the money a company plans to spend in the coming year on inventory and capital goods. Inventory investment includes both raw materials and finished items. Capital goods are business purchases -- distinguished from consumer goods -- such as new company trucks or manufacturing equipment. When a business owner makes out her budget, she has to estimate how much of the company funds will go into investment. The amount depends on what she thinks she can sell and how much equipment she needs to buy.
If sales are slow and inventory doesn't move as fast as expected, a business may end up with a greater actual investment than it expected. As inventory is an investment, too much inventory counts as an unplanned investment. When the company adds that to the planned investment, the total is the actual investment. If a company underestimates how much inventory it needs and runs short, that represents an actual investment smaller than the planned investment.
Slow-moving inventory isn't the only reason actual and planned investment don't match up. If interest rates rise, a business may decide to keep its older equipment in service rather than take out a loan for new machinery. If the market suddenly improves, a firm may increase its inventory more than it expected to. When capital goods break down or wear out faster than anticipated, the company may have to buy new equipment.
Business investment, like consumer purchasing, influences how well the economy performs. Keynesian economics looks at the difference between actual and planned investment of entire business sectors or national economies to judge their strength. When actual investment comes off exactly equal to planned investment, it means businesses are putting exactly as much into their inventory as they need to. The economy, in this scenario, is in equilibrium, with business output equaling expenditures. The further away from equilibrium it moves, the more unstable the economy gets.
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