Kinds of Financial Decisions
What is Financial Decision?
The decisions regarding the financial matters of any organization are known as Financial Decisions. In simple terms, it refers to the decision regarding the investment of the funds of the business in various assets. Financial management focuses on providing solutions to three significant problems concerned with the firm’s financial operations corresponding to the three questions of investment, financing, and dividend decision. In financial terms, financial decisions refer to finding the best solutions to financial or investment problems from various alternatives.
Kinds of Financial Decisions
The management of an organization takes several financial decisions to maximize its profits. The finance function deals with three main kinds of decisions are:
- Investment decisions
- Financing decisions
- Dividend decisions
1. Investment Decision
As resources are scarce, a firm has a lot more use of resources than them being present. Thus, a firm has to decide where to invest these resources to earn the highest possible returns for its investors. Therefore, the investment decisions reveal how the firm’s funds are invested in different assets. Investment decisions are of two types- short-term and long-term. A long-term investment decision is also known as a Capital Budgeting decision. Short-term investment decisions deal with the decisions about the levels of cash, inventory, and receivables. They are also known as Working capital decisions.
2. Financing Decision
Financing decisions are concerned with the determination of financial sources, the amount to be obtained from each source, and the value of each source of finance from various long-term sources. The short-term sources come under working capital management. Financing decisions are concerned with the identification of various accessible sources. A firm obtains its main sources of funds from its shareholders or by borrowing funds. The shareholders’ funds refer to the equity capital and the retained earnings. The finance raised through debentures or any other form of debt is known as a borrowed fund. Based on the basic characteristics of each source of funds, the firm determines the proportions of funds raised through them. Whether the firm earns a profit or not, it is bound to pay the interest on the borrowed funds. Similarly, the repayment of the borrowed funds has to be done at a predetermined time. The risk of default on payment is known as a financial risk that has to be taken care of by a firm that probably has insufficient shareholders to make these fixed payments. On the other hand, the funds of the shareholders have no pressure concerning the payment of returns or the repayment of capital.
3. Dividend Decision
The decision that every financial manager has to undertake is concerned with the distribution of dividends. This is known as a dividend decision. The part of the profit which is distributed among the shareholders is known as a dividend. A dividend decision is concerned with how much of the profit earned by the company (after paying tax) is to be given to the shareholders and how much of it is to be reserved by the business. While the dividend comprises the current income, reinvestment, as retained earnings expand the scope of the firm’s future earnings. The financing decision of the firm is also affected by the extent of retained earnings. Since the fund is not needed by the firm to the degree of re-invested retained earnings, the final goal of widening the shareholder’s funds should be taken into consideration while deciding dividends.
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