FINANCIAL DECISIONS

Financial management focuses on solving three major issues that are directly related to financial operations of a firm corresponding to three questions of investment, financing and dividend decision.

If we see from a financial context then it means best investment alternative. The finance function is concerned with three broad decisions.

We will discuss those decisions in a very summaried form:

1) INVESTMENT DECISION: Investment decision is related to employment of a firm’s resources to an efficient place so that the investment earns maximum returns. A firm has limited resources and all of those need to be put in such a way that all must have a good return as well as their value increases.

Now, investment decision can be of two types-

a) A long term decision, it involves investing money on a long term basis like purchasing new machinery or assets so that they can be utilised for a long time and give benefit to firm.

Although these investments are very risky and irreversible, suppose a $10000 machine broke down and is not repairable then the whole investment goes in dump. These decisions need to be taken very carefully as they can affect the financial position of an organisation.

b) A short term decision, short term generally means time period less than one year, all those decisions that affect day to day working of a business are short term decisions like cash flow management, debtors, liquid assets( that can be converted into cash in less than one year).

2) FINANCING DECISION: Financing means to raise funds from various sources, so financing decision means the decision related to the amount to be raised(finance) from different and reliable sources. It involves looking for various available sources from which funds can be raised.

The main sources of finance for a company are shareholder’s funds and borrowed funds.

Shareholder’s funds refers to the equity capital or retained earnings.

Borrowed funds are other kind of debt taken from outside the firm. 

There is a risk involved in case if we raise funds by borrowing because in this case we have to repay the amount plus interest on time otherwise interest will go on increasing and that will affect our profit. Whereas, shareholder’s funds have no commitments regarding repayment.

3) DIVIDEND DECISION: The another important decision needed to be taken is dividend decision.

Dividend is that part of profit that is needed to be distributed among shareholders.

The decision is concerned about how much money is to be distributed among shareholders and how much should be retained in business. Since if we retain more funds then it will affect financing decision, thus dividend decision primarily aims at maximising shareholders wealth.

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