What are Financial Decisions?
Financial decisions are the decisions that managers take with regard to the finances of a company. These are crucial decisions for the financial well-being of the company. These decisions can be in terms of acquisition of assets, financing and raising funds, day-to-day capital and expenditure management, etc. Financial decisions, therefore, affect both the assets and liabilities of a company. They can lead to profits, revenue generation, and receipt of funds and assets for the company. They can also be in terms of expenditure, the creation of liabilities, and an exodus of funds for a company.
And of course, all these financial decisions can be both for the long-term and short-term. Long-term financial decisions are decisions that are taken for a period of more than a year or more. These may include capital budgeting and investment decisions, as well as the raising of long-term capital and loans, which may run for 5-10 years.
Table of Contents
- What are Financial Decisions?
- Financial Management
- Key Financial Decisions
- Investment Decisions
- Long-Term Investment Decisions
- Short-Term Investment Decisions
- Factors Affecting Investment Decisions
- Return on Investment (ROI)
- Cash Flows
- Availability of Capital
- Financing Decisions
- Capital Structure
- Optimal Mix of Debt and Equity
- Dividend Decision
- Conclusion: Financial Decisions
- Frequently Asked Questions (FAQs)
Short-term financial decisions are decisions that are taken for a short period of time, usually less than a year. These decisions pertain to working capital management, arranging short-term funds and credits, the provision of dividends, etc.
Financial management is the stream of management that is associated with financial decisions. Professional managers plan and set goals, organize and manage financial activities to achieve these goals, and eventually perform the control function to review and, if necessary, correct these plans. They ensure that the liquidity position of the company is satisfactory and that the company remains in a sound financial position. These managers are professionals and specialize in making and executing financial plans and decisions for the company.
Also Read: What is the Relationship of Financial Management with Other Disciplines?
Key Financial Decisions
We will discuss below the most important financial decisions that these professional managers usually make:
- Investment Decisions
- Financing Decisions
- Dividend Decisions
Investment decisions are decisions that relate to the investment in different types of assets, instruments, securities, etc. Managers decide how to invest the company’s funds in different asset classes, depending on the needs of the organization. Assets can be both short-term and long-term. As each company has scarce financial resources, it is crucial to decide which asset to invest in first. Managers must make the tough call of postponing investing in some assets that are not strictly necessary at present, or that may not give the desired return.
Long-Term Investment Decisions
Capital budgeting decisions are decisions to invest in long-term assets to improve the overall production/servicing capacity of the organization. They often require heavy capital expenditure and are always for a longer term. Therefore Capex decisions need to be made very wisely. Any commitment to such assets is irreversible and leads to the blockage of a significant amount of capital. In addition, returns on such investments are very late and can take long periods of time, over a year, before such an investment yields positive returns. These expenditures include the establishment of a new unit or the expansion of an existing unit, the purchase or replacement of new machinery, investments in research and development, etc.
Short-Term Investment Decisions
Short-term investment decisions are decisions regarding the day-to-day operations and management of the company. We may loosely call it the working capital management of the company. Managers must ensure that the company has sufficient liquidity for its day-to-day activities. The managers must ensure that these funds do not dry up and there is no hindrance or bottleneck to the day-to-day activities of the company. They must also decide on the sources of short-term financing and prioritize expenditure according to the availability and urgency of the funds. Short-term investment decisions also concern receivables and payables, as well as the acquisition and use of inventories.
Factors Affecting Investment Decisions
Factors that affect the investment decisions are:
Return on Investment (ROI)
Return on investment is one of the most important factors influencing any investment decision. Managers will invest in projects with a higher ROI and lower risk than other projects.
Also Read: Functions of Financial Management
Managers will choose to invest in projects with higher positive cash flows, which will keep their liquidity position intact and comfortable.
Availability of Capital
The availability of both short-term and long-term capital in the company influences its investment decisions. Interest rates, repayment period, time of maturity of the project, quantum and start of return, etc., also influence the choice of one project over another.
Apart from investment decisions, managers make the following types of financial decisions:
Financing decisions are decisions that are made to ensure the financing of the company. They relate to the raising of equity as well as debt for the company to fund its investment decisions. It is a continuous and ongoing process, as each company regularly needs funding. Because a growing company’s needs do not cease, instead go on increasing to keep pace with the growth.
Financial managers have to make important decisions to form a proper capital structure. The capital structure of a firm is made up of equity and debt. They have to work out a perfect balance between the two so as to maximize shareholders’ value and the profitability of the firm. Going for higher equity capital reduces the tension of repayment as they become part of the firm’s own capital. But then shareholders must receive higher returns in the form of dividends, which will lead to dilution of ownership and voting rights.
On the other hand, debt includes loans from banks and financial institutions, debentures, etc. Higher debt increases the interest burden and makes the capital structure riskier. Furthermore, the company cannot rely on this source of finance permanently, as lenders can reclaim their money at any time. Any weak period of performance can play spoilsport with the company and put on it under multifold pressure.
Optimal Mix of Debt and Equity
Financial managers have to chalk out an optimal mix of debt and equity. In doing so, they have to take care of various factors such as the cost of financing, the risk involved, the floating cost in case of issuing equity, the company’s cash-flow position in the immediate future, the state of the economy, debt, and equity markets, etc.
Under dividend decisions, whenever a company makes a profit, it decides to reward its shareholders in return for their investment, trust, and confidence in the company. This reward is called a dividend. At the same time, managers must decide to retain part of the profit for the future needs of the company. This is known as retained earnings.
Managers have to make the important decision of how many portions of the profit the company should pay out in dividends and what part they should keep with them. Giving away higher dividends makes the stock attractive and increases the market price and the overall market value of the company. But they also have to take into account earnings and their stability, the growth prospects of the company, its cash flow status, dividend taxes, and above all, its own funding requirements, etc.
Conclusion: Financial Decisions
Financial decisions are the backbone of any organization’s success. The main aim and the key efficiency of the professional managers is the maximization of the financial worth/value of the company and its stakeholders. They have to increase profitability while maintaining sufficient liquidity for the company. And also to minimize the risk level of the company. It is their duty to set goals to achieve them, evaluate alternatives and choose the best possible course of action, effectively implement financial plans, continually revise, update and review those plans, and finally, where necessary, take corrective actions.
Also, read – How Macro Environment affects Financial Management Decision?
Frequently Asked Questions (FAQs)
What are the broad categories of financial decision-making?
The three main categories of financial decision-making are investment decisions, financing decisions, and dividend decisions.
What are the main areas of concern under dividend decisions?
Dividend decisions are mainly about how much to distribute as dividends and how much to retain.
List the factors affecting investment decisions.
Factors that affect investment decisions include:
1. Return on investments (ROI)
2. Cash flows
3. Availability of capital and cost thereof.
- How can a Capital Budgeting Decision Go Wrong?
- Objectives of Financial Statement Analysis
- Financial Structure – Meaning, Importance and More
- Process of Capital Budgeting
- Capex Planning
- Financial Due Diligence – Importance, Scope and Requirements
What are the 4 financial decisions? ›
- Investment Decision:
- Financing Decision:
- Dividend Decision:
- Working Capital Decision:
- Investment Decisions. Investment decisions refer to the decisions regarding where to invest so as to earn the highest possible returns on investment. ...
- Financial Decisions. ...
- Dividend Decisions.
What are the three types of financial management decisions and what questions are they designed to answer? What long-term investments or projects should the business take on? How should we pay for our assets? Should we use debt or equity?What is the definition of financial decision? ›
Financing decision is concerned with raising funds from which long-term sources, i.e., through shareholders funds or borrowed funds.What are the best financial decisions? ›
- Create a Spending Plan & Budget. ...
- Pay Off Debt and Stay Out of Debt. ...
- Prepare for the Future - Set Savings Goals. ...
- Start Saving Early - But It's Never Too Late to Start. ...
- Do Your Homework Before Making Major Financial Decisions or Purchases.
Factors Affecting Financing Decisions
Cost: Financing decisions are based on the allocation of funds and cost-cutting. The cost of fundraising from different sources differs a lot and the most cost-efficient source should be chosen.
A firm has to decide the method of funding by assessing its financial situation and the characteristics of the source of finance. For example, interest on borrowed funds have to be paid whether or not a firm has made a profit. Likewise, borrowed funds have to be repaid at a fixed time.What are the 3 major areas of financial management? ›
Finance consists of three interrelated areas: (1) money and credit markets, which deals with the securities markets and financial institutions; (2) investments, which focuses on the decisions made by both individuals and institutional investors; and (3) financial management, which involves decisions made within the ...What are the main elements of financial decision? ›
Most financial management plans will break them down into four elements commonly recognised in financial management. These four elements are planning, controlling, organising & directing, and decision making.What are the first three financial decisions that you need to make? ›
- Double-check that your retirement savings are on track. Even if you have decades until you reach retirement age, it's never too early to start preparing. ...
- Build a solid emergency fund. ...
- Establish a budget to start saving more.
What is the most important of the three financial decisions? ›
The finance manager weighs the risk against the cost and favours securities with a low-risk factor. The risk associated with borrowed funds is higher than that associated with equity funds. One of the most important parts of funding decisions is risk assessment.Which is the most important decision in financial management? ›
Dividend Policy: one of the most important financial decisions that a Financial Manager must make is related to the company's dividend policy. It concerns how much of the company's earnings will be paid out to shareholders.What are the 3 major components in the financial planning process? ›
- Budgeting: A lot has already been said about budgets. ...
- Liquidity Management: The budget helps an investor fulfill their extremely short term goals. ...
- Insurance: Insurance is a very important and often neglected part of financial planning.
Answer and Explanation: The correct answer is a. The financial manager's most important job is to make the firm's investment decisions. This, also known as capital budgeting, is the most important job for this type of manager.What is the importance of financial decisions? ›
These decisions are of great significance for the organization's financial well-being. The financial decisions pertaining to expenditure management, day-to-day capital management, assets management, raising funds, investment, etc. The assets and liabilities of the organisation are affected by financial decisions.What are the functions of financial decisions? ›
The seven popular functions are decisions and control, financial planning, resource allocation, cash flow management, surplus disposal, acquisitions, mergers, and capital budgeting.What is the goal of financial decision? ›
The goal of financial management is to maximize shareholder wealth. For public companies this is the stock price, and for private companies this is the market value of the owners' equity.How do you make wise financial decisions? ›
- Look at the numbers at least once per week. ...
- Use financial tracking software. ...
- Create a spending plan. ...
- Set savings goals. ...
- Hire a financial coach or tax strategist to help you. ...
- Focus on the numbers, not the emotions.
THINGS THAT INFLUENCE FINANCIAL DECISIONS
Some of the most common factors that influence financial decisions include age, marital status, employment status, and the number of household members. Certain factors influence financial decisions more than others.
Budgeting is one of the most important personal finance tips. Without a budget, you can easily be spending more money than you earn, which can make it challenging to: Pay off debts. Save for the future.
How many financial decisions are there? ›
There are two fundamental types of financial decisions that the finance team needs to make in a business: investment and financing.What are the six stages of financial planning? ›
- 1) Identify your Financial Situation. ...
- 2) Determine Financial Goals. ...
- 3) Identify Alternatives for Investment. ...
- 4) Evaluate Alternatives. ...
- 5) Put Together a Financial Plan and Implement. ...
- 6) Review, Re-evaluate and Monitor The Plan.
A firm has to decide the method of funding by assessing its financial situation and the characteristics of the source of finance. For example, interest on borrowed funds have to be paid whether or not a firm has made a profit. Likewise, borrowed funds have to be repaid at a fixed time.What are the four main 4 types of financial planning? ›
The four main types of financial planning are cash flow planning, tax planning, investment planning, and retirement planning.What are the 7 key components of financial planning? ›
- Budgeting and taxes.
- Managing liquidity, or ready access to cash.
- Financing large purchases.
- Managing your risk.
- Investing your money.
- Planning for retirement and the transfer of your wealth.
- Communication and record keeping.
- Managing Cash Flow and Financial Resources. This critical first pillar focuses on making sure you and your loved ones are provided for. ...
- Accumulating Wealth. ...
- Managing Income Taxes. ...
- Planning for Retirement.
- Cost: The cost of raising finance from various sources is different and finance managers always prefer the source with minimum cost.
- Risk: ...
- Cash Flow Position: ...
- Control Considerations: ...
- Floatation Cost:
- 1 of 2. Consumer Financial. ...
- Stop. Stop and give yourself time to make a good decision. ...
- Ask. Ask questions about costs and risks. ...
- 2 of 2. 4/2019.
- Verify. Now that you've gotten answers to your questions, double-check the answers on your own. ...
- Estimate. Estimate your costs. ...