Financial Decisions
You must be aware that basically management is concerned with Decision making. Management of finance function or Financial Management is concerned with financial decisions.
A business may require funds either for funding the long-term assets which yield return over a period of time in future or for day-to-day operations. However the total fund requirement is to be looked at. When the total funds requirement is being considered, it becomes the Investment Decision to be taken. When the sources of finance are tapped for funding the investments, it becomes the Financing Decision. When the profits, as a result of Investment and Financing decisions, are considered for ploughing back into the business or for distributing as dividend, it becomes the Dividend Decision.
Investment Decision
Investment Decision involves deciding about investments to be made in the assets – long-term assets or short-term or current assets which are normally convertible into cash within a year. Deciding about the long-term assets involves Capital Budgeting and the short-term or current assets involve Working Capital Management.
Capital Budgeting
The investment proposals are appraised in terms of relative benefits & returns and magnitude, timing, risk / uncertainty of cash flows associated with it. The standard broadly expressed in investment appraisals is the cost of capital.
Working Capital Management
Working Capital Management or short-term financial management refers to the day-to-day financial activities involving current assets (inventories, trade debtors, short-term holding of marketable securities, and cash) and current liabilities (short-term debts, trade creditors and accruals). It is important because short-term survival is pre-requisite for long-term success.
A proper balance needs to be maintained between liquidity and profitability. Inadequate funds for day-to-day activities renders illiquid and more funds kept for day-day-day activities means not investing the surplus funds in more profitable options. I am sure that you carry money only to the extent required for daily expenses. None of us keep huge amounts in cash form.
Financing decision
Financing decision is concerned with identification of various sources of finance for funding the investment decisions. Long-term / Capital assets are financed through long-term funds and the current assets are financed through short-term funds.
Funds are raised from primary market, financial institutions and commercial banks
Capital Structure
Capital Structure refers to the proportion of Debt and Equity capital. A proper balance between debt and equity (optimal capital structure) is required to ensure a trade-off between risk and return with maximum returns to the shareholders.
Dividend Decision
Declaring more dividend will enhance the image of the enterprise in the stock market, instill confidence in creditors etc. but will reduce the opportunity to plough back the income which may be required considering the cost of capital of other sources of financing. Optimum dividend payout ratio needs to be arrived at considering the preference of shareholders and the investment opportunities available.
