The following explanation will help in understanding each finance function in detail
Investment Decision
One of the most important finance functions is to intelligently allocate capital to long term assets. This activity is also known as capital budgeting.
It is important to allocate capital in those long term assets so as to get maximum yield in future. Following are the two aspects of investment decision
- Evaluation of new investment in terms of profitability
- Comparison of cut off rate against new investment and prevailing investment.
Since the future is uncertain therefore there are difficulties in calculation of expected return.
Along with uncertainty comes the risk factor which has to be taken into consideration. This risk factor plays a very significant role in calculating the expected return of the prospective investment.
Therefore while considering investment proposal it is important to take into consideration both expected return and the risk involved.
Investment decision not only involves allocating capital to long term assets but also involves decisions of using funds which are obtained by selling those assets which become less profitable and less productive.
It is a wise decision to decompose depreciated assets which are not adding value and utilize those funds in securing other beneficial assets.
An opportunity cost of capital needs to be calculating while dissolving such assets. The correct cut off rate is calculated by using this opportunity cost of the required rate of return (RRR)
Financial Decision
Financial decision is yet another important function which a financial manger must perform. It is important to make wise decisions about when, where and how should a business acquire funds.
Funds can be acquired through many ways and channels. Broadly speaking a correct ratio of an equity and debt has to be maintained. This mix of equity capital and debt is known as a firms capital structure.
A firm tends to benefit most when the market value of a companys share maximizes this not only is a sign of growth for the firm but also maximizes shareholders wealth. On the other hand the use of debt affects the risk and return of a shareholder. It is more risky though it may increase the return on equity funds.
A sound financial structure is said to be one which aims at maximizing shareholders return with minimum risk. In such a scenario the market value of the firm will maximize and hence an optimum capital structure would be achieved.
Other than equity and debt there are several other tools which are used in deciding a firm capital structure.
Dividend Decision
Earning profit or a positive return is a common aim of all the businesses. But the key function a financial manger performs in case of profitability is to decide whether to distribute all the profits to the shareholder or retain all the profits or distribute part of the profits to the shareholder and retain the other half in the business.
Its the financial managers responsibility to decide a optimum dividend policy which maximizes the market value of the firm. Hence an optimum dividend payout ratio is calculated.
It is a common practice to pay regular dividends in case of profitability. Another way is to issue bonus shares to existing shareholders.
Liquidity Decision
It is very important to maintain a liquidity position of a firm to avoid insolvency. Firms profitability, liquidity and risk all are associated with the investment in current assets.
In order to maintain a tradeoff between profitability and liquidity it is important to invest sufficient funds in current assets. But since current assets do not earn anything for business therefore a proper calculation must be done before investing in current assets.
Current assets should properly be valued and disposed of from time to time once they become non profitable. Currents assets must be used in times of liquidity problems and times of insolvency.
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FAQs
Finance functions cover Investment (allocating funds to assets for growth), Dividend (deciding on profit distribution to shareholders), Financing (raising capital through equity or debt), and Liquidity (ensuring sufficient cash flow for operations).
What are investment decisions financial decisions and dividend decisions? ›
Managers take investment decisions regarding various securities, instruments, and assets. They take financing decisions to ensure regular and continuous financing of the organisations. The dividend decision has to do with the correct amount of reward to its shareholders.
What are the finance functions and finance decisions? ›
Financing decision
Expertise in forming financing decisions leads to optimized capital structure, enhanced performance, and growth. Financing functions deal with acquiring capital (like when and how) for the various functioning of the entity, like whether to use equity capital or debt to finance business events.
What are the 3 main decisions in finance? ›
When it comes to managing finances, there are three distinct aspects of decision-making or types of decisions that a company will take. These include an Investment Decision, Financing Decision, and Dividend Decision.
What are the 4 areas of finance? ›
The four fundamental pillars of finance are Corporate finance, Investments, Financial institutions and International finance.
What are the 4 stages of finance? ›
- Phase 1: Accumulation.
- Phase 2: Distribution.
- Phase 3: Preservation.
- Phase 4: Legacy.
An investment decision could involve purchasing new equipment, investing in research and development, buying new property, or expanding into new markets. These decisions often have long-term implications and are influenced by a multitude of factors.
What is a liquidity Decision? ›
Liquidity decision:
The liquidity decision is concerned with the management of the current assets, which is a pre-requisite to long-term success of any business firm. This is also called as working capital decision.
What is a dividend decision in finance? ›
Dividend decision relates to how much of the company's net profit is to be distributed to the shareholders and how much of it should be retained in the business for meeting the investment requirements. This decision should be taken keeping in mind the overall objective of maximising shareholders' wealth.
What is dividend and why is dividend decision important? ›
DEFINITION: DIVIDEND POLICY
It is the decision about how much of earnings to pay out as dividends versus retaining and reinvesting earnings in the firm. Dividend policy must be evaluated in light of the objective of the firm namely, to choose a policy that will maximize the value of the firm to its shareholders.
Liquidity refers to the efficiency or ease with which an asset or security can be converted into ready cash without affecting its market price. The most liquid asset of all is cash itself.
What is an example of a dividend decision? ›
Example of Dividend Decision
The firm has growth plans for diversification and needs INR 25 crore. The firm traditionally pays 30-50% of its profits as dividends. Shareholders prefer stable and uniform returns over time.
What is the financial decision-making process? ›
Financial decision-making encompasses evaluating options, making choices, and taking actions related to financial matters. It involves assessing risks, considering available resources, and aligning decisions with long-term objectives.
What is the investment decision process? ›
An investment decision-making process helps you decide how much to invest in equity, bonds, real estate, gold, etc. It provides a customised strategy for asset allocation, diversification, risk and portfolio management. For an effective investment process, you must assess: Your investment goals.
What is the relationship between investment financing and dividend decisions? ›
Investment, financing, and dividend decisions are integral components of a company's financial management, and they are closely interconnected, collectively shaping the company's overall financial strategy. 1. Investment decisions directly impact both financing and dividend decisions.
What is a financial investment decision? ›
Investment decision refers to selecting and acquiring the long-term and short-term assets in which funds will be invested by the business.
What is an investment decision in financial decision-making? ›
What is Investment Decision? Investment decision refers to the decisions that involve the investment of various resources of the firm to gain the highest possible return on investment for their investors. An investment decision is categorized as a long-term and short-term investment decision.
What does financial investment decision mean? ›
Also known as: Final investment decision. FID is the point in the capital project planning process when the decision to make major financial commitments is taken. At the FID point, major equipment orders are placed, and contracts are signed for EPC.
What is considered an investment decision? ›
An investment decision is a well-planned action that allocates financial resources to obtain the highest possible return. The decision is made based on investment objectives, risk appetites, and the nature of the investor, i.e., whether they are an individual or a firm.
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The article is Written By Prachi Juneja and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on 