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
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:
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.
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 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, 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
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
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
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.
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.
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
The cash flow position is the company's daily earnings. A strong cash flow position encourages investors to put money into the company.
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.
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.
The risks of starting a business with funds vary depending on the source. Borrowed funds are riskier than equity funds.
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
