Types of Financial Decisions in Financial Management (2024)

Every business – small, medium, or large – must have good financial management practices in place if it is to succeed and grow. A successful business requires sound financial management. But what does it take to make good, informed financial decisions?

Financial management is the process of making decisions about how to use a company’s financial resources best. It includes the planning, organizing, and controlling of a company’s financial activities. The goal of financial management is to maximize a company’s shareholder value by making the best possible decisions about how to use its financial resources. There are three primary types of financial decisions that financial managers must make: investment decisions, financing decisions, and dividend decisions.

In this article, we will discuss the different types of financial decisions that are taken in order to manage a business’s finances. We will explore the pros and cons of each type and how each decision affects the overall financial picture. Read on to find out more.

Introduction To Financial Management

Financial management is a process that involves making decisions about how to allocate financial resources in order to achieve organizational objectives. The financial manager must decide on the organization's financing mix in the financing decision, which is a crucial decision. A financing Decision is concerned with the borrowing and allocating of funds required for the firm's investment decisions.

Financial management has an impact on all aspects of organizational activity, including both profit and non-profit organizations. Several different activities, including

  • Fund acquisition,
  • Resource allocation
  • Financial performance tracking.

As a result, it has come to play an essential role in all types of organizations. The financing decision is based on two sources of funds:

  • The first is capital owned by the business, including shareholding and retained earnings.
  • The second source of funds is borrowed from outside the corporate entity in the form of debenture, loan, bond, and so on. The goal of the financial decision is to achieve an optimal capital structure.

Financial Management Concept

Financial management entails making plans for a person's or a business's future in order to maintain a positive cash flow. It involves the administration and upkeep of financial assets. Financial management also includes the process of determining and controlling risks.

Financial management is more concerned with evaluation than with financial quantification techniques. A financial manager examines available data to assess the performance of businesses. Managerial finance is a diverse discipline that draws on managerial accounting and financial analysis.

Financial management is sometimes referred to as the "science of money management" by some experts. This term is most commonly used in the community of financing financial transactions. On the other hand, financial management is crucial at all stages of human creation because every entity must manage its finances.

Evolution and Emergence of Financial Management

The scope and nature of financial management have evolved and broadened over time. Its evolution can be broadly classified into three stages:

1. Traditional phase

2. Transitional phase

3. Modern phase.

1. Traditional phase

The Traditional period lasted roughly four decades until the early 1940s. During this period, the emphasis of financial management was primarily on episodic events such as capital procurement, engagement with major lenders such as banks, debt servicing, issuance of securities, expansion, merger, and compliance with legal aspects. The approach was primarily descriptive.

2. Transitional phase

The Transitional phase started in the 1940s and lasted until the early 1950s. During this phase, financial management was almost identical in nature and scope to that of the traditional stage.

However, there was a growing emphasis on organizing, procuring, managing and controlling funds to fulfill the business's day-to-day financial needs. Financial issues have begun to be examined within an analytical framework.

Types of Financial Decisions in Financial Management (1)

3. Modern phase

Due to increased competition, growth opportunities, globalization, breakthroughs in economic theories, and the development of quantitative methods of analysis, the mid-1950s labeled the start of the modern phase in financial management.

This resulted in the development of an increasingly analytical and empirical approach to financial decision-making. The management or insider's point of view has become core to financial management.

Key Objectives of Financial Management

Financial management is concerned with acquiring, allocating, and controlling a business's financial resource management.

Financial management may have a variety of key objectives, including.

To ensure a steady and adequate supply of funds.

To guarantee adequate returns.

To ensure efficient utilization of funds.

To ensure investment security.

To establish solid financial leverage, and so on.

Scope and Extent of Financial Management

Financing a business necessitates numerous short- and long-term decisions, expanding financial management's scope.

  • Short-term Financial Decisions

Short-term financial decisions are primarily concerned with the business firm's day-to-day capital requirements or working capital management. These decisions have an impact on the firm's liquidity and profitability.

  • Long-term Financial Decisions

Long-term financial decisions, on the other hand, are concerned with financing the enterprise, investing funds, and managing earnings.

Types of Financial Decisions

Financial decisions are divided into three types. These types are referred to as the basics of financial decisions that the financial manager must make:

  • Investment Decisions
  • Financing Decisions
  • Dividend Decisions
  • Working Capital Decisions

Investment Decisions

Any prospective investment made by a business unit must be assessed regarding the risk, the cost of capital, and the expected benefits. As a result, the two key elements of investment decisions are

  • Capital budgeting
  • Liquidity.

Simply put, capital budgeting is the dedication and allocation of funds to long-term investments that will generate earnings in the future.

It also considers decisions regarding the replacement and renovation of old assets. A finance manager's primary responsibility is to balance current and fixed assets to maximize profitability while maintaining the desired level of liquidity for the component.

Making these decisions is not for the faint of heart; it entails extensive estimation of expenses and benefits that cannot be determined with surety and are unknown.

Factors Influencing Investment Decisions

  • Venture cash flow

When a company launches a new venture, it begins by investing a large sum of money. However, the organization anticipates at least one source of revenue to cover daily expenses. As a result, there needs to be some consistent cash flow within the venture to sustain it.

  • Investment Criteria

A business utilizes multiple Capital Budgeting procedures to evaluate various investment propositions. Most notably, they are based on calculations involving investment, cash flows, interest rates, and the rate of return on propositions. These are applied to investment proposals in order to select the best one.

  • Profits:

The primary reason for starting a business is to earn revenue but also profits. The essential criteria in selecting the venture are the organization's rate of return in relation to its profit essence. For example, project B should be preferred if venture A earns 10% and venture B earns 15%.

Financing Decisions

Firm financing decisions are concerned with an organization's financing mix or financial structure. Financing a company necessitates significant decisions regarding methodologies and finance sources relative to the proportion and selection of sustainable resources, period of floatation of equities, and so on

Numerous funds can be used to meet an organization's investment needs. The finance manager is responsible for designing the optimal combination of finance structures for an organization that involves the least amount of money to raise and maximizes the long-term market prices of the company's shares.

Furthermore, while financing, a balance of debt and equity must be maintained in order to generate a sufficient return on equity with the least amount of risk. The utilization of debt or leverage ratio affects both the rates of return and risk of capital investment.

To maximize the per-share value of equity stock, the financial manager is tasked with making the best decisions possible regarding the means of issuing debt securities and the timing of raising funds for the company.

Factors Influencing Financial Decisions

  • Cash flow position.

The cash flow position is the company's daily earnings. A strong cash flow position encourages investors to put money into the company.

  • Control

In this case, where existing investors have control of the company or organization and raise funds by borrowing money, equity can be used to raise funds if they are willing to give up control of the business.

  • Cost

Financing decisions are made based on fund allocation and cost-cutting. The cost of raising funds from various sources varies greatly, so the most affordable source should be used.

  • Risk

The risks of starting a business with funds vary depending on the source. Borrowed funds are riskier than equity funds.

  • Market condition

The market condition has a significant impact on financing decisions. During a boom period, the majority of equity is issued, but during a depression, a firm's debt is used Read More

Types of Financial Decisions in Financial Management (2024)

FAQs

Types of Financial Decisions in Financial Management? ›

There are three primary types of financial decisions that financial managers must make: investment decisions, financing decisions, and dividend decisions. In this article, we will discuss the different types of financial decisions that are taken in order to manage a business's finances.

What are the types of financial decisions? ›

There are three types of financial decisions- investment, financing, and dividend. Managers take investment decisions regarding various securities, instruments, and assets. They take financing decisions to ensure regular and continuous financing of the organisations.

What are the 3 main financial decisions undertaken in a company? ›

Notably, there are three primary aspects of financial decisions: Investment decisions, financing decisions, and dividend decisions. Investment Decisions: These are decisions about how the funds of the firm should be invested.

What are the 4 types of financial management explain? ›

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. With a structure and plan that follows this, a business may find that it isn't as overwhelming as it seems.

What are the 3 fundamental decisions in financial management and why are they important? ›

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 types of decisions? ›

There are four decision-making styles, analytical, directive, conceptual, and behavioral. One of the keys to developing strong leadership is moving between decision-making styles to fit the situation and needs of the time.

What are the three major types of financial management decisions? ›

There are three primary types of financial decisions that financial managers must make: investment decisions, financing decisions, and dividend decisions. In this article, we will discuss the different types of financial decisions that are taken in order to manage a business's finances.

What are the types of strategic financial decisions? ›

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.

What are the 3 areas of corporate financial management decision-making? ›

What Are the 3 Main Areas of Corporate Finance? The main areas of corporate finance are capital budgeting (e.g., for investing in company projects), capital financing (deciding how to fund projects/operations), and working capital management (managing assets and liabilities to operate efficiently).

What are the three major types of financial? ›

The finance field includes three main subcategories: personal finance, corporate finance, and public (government) finance.

What is a financial decision? ›

The Financing Decision is a crucial decision that is to be made by the financial manager, the decision is about the financing-mix of an organization. Financing Decision is focused on the borrowing and allocation of funds required for the investment decisions of the firm.

What are the decision functions of financial management? ›

The correct answer is investment, financing, and asset management. There are three major decision areas in financial management i.e. investment decision, financing decision, and dividend decision. It's asset creation for revenue. Investment decisions involve asset selection.

What are the 4 phases of financial management? ›

The Financial Management Cycle includes four phases that are essential for the overall evaluation of the financial management of any firm. The four phases are Planning, Budgeting, Managing Operations, and Annual Reporting.

What is the three main categories of financial management? ›

What Are the Three Types of Financial Management?
  • Capital budgeting. Relates to identifying what needs to happen financially for the company to achieve its short- and long-term goals. ...
  • Capital structure. Determine how to pay for operations and/or growth. ...
  • Working capital management.
Sep 4, 2023

Which type of decision is the most important in financial management? ›

Financing Decision

Because a firm tends to profit most when the market estimation of an organization's share expands and this is not only a sign of development for the firm but also it boosts investor's wealth. Consequently, this relates to the composition of various securities in the capital structure of the company.

What are the three steps in financial decision-making? ›

Organization, efficiency and discipline can be considered as three primary steps of financial planning. Organization is knowing where your money comes and goes.

What are the 5 economic decisions? ›

The 5 basic economic principles include scarcity, supply and demand, marginal costs, marginal benefits, and incentives. Scarcity states that resources are limited, and the allocation of resources is based on supply and demand. Consumers consider marginal costs, benefits, and incentives when purchasing decisions.

What are the four decisions of finance function? ›

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 is an example of a major financial decision? ›

Funding your retirement. Paying off large debts (e.g., credit cards, student loans, mortgage, etc.) Saving for a child's college education. Paying for a major vacation.

References

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