Finance is a crucial and important component of any organization. Regardless of whether an organization is for profit or not, finance is an important factor to maintain regular operations and ultimately remain viable. Business need money. All the information you require regarding the many financial decisions made by an organization. Financial decision-making is primarily concerned with financing, investments, dividends and working capital management.
Making decisions enables the company to make the best use of the resources at its disposal to achieve its goals. Without meeting minimal financial performance levels, a business entity cannot endure over the long term.
As a result, financial management essentially offers an analytical and conceptual framework for making financial decisions.
The ability of an organization is to plan the financial Possibilities in a effective way , organize, direct, and regulate its financial activities is referred to as financial management. This can encompass activities like acquiring, allocating, and using money, but it’s not just restricted to those.
Roles of Financial Management Practices
A business can use financial management techniques to help it reach its objectives. The operation of the organization must be well-known to the financial management. For instance, a bakery’s financial manager needs to be knowledgeable about bakery finances. Additionally, they must have access to pertinent tax and other policies that affect their industry. Let’s examine the key functions of financial management techniques:
The organization’s financial decision-making and financial control depend heavily on financial management and financial managers. The financial managers use ratio analysis, financial forecasting, profit and loss analysis, etc. to establish the organization’s financial decisions.
The organization’s financial activities and resource planning are under the control of finance managers. In order to ascertain the organization’s needs, priorities, and general financial situation, they examine the data at hand and create plans and budgets in accordance with their findings.
Cash Flow Control
To cover everyday operating expenditures and unforeseen expenses, businesses need to have enough working capital and cash flow. In order to make sure that there is always enough money on hand for such expenditures—daily and emergency expenses-financial management keeps track of accounts payable and receivable.
How the surplus or revenue of the organizations are utilized is decided by their financial management. They decide if dividends should be paid, how much should be given, and what portion of profits must be kept and reinvested in the business.
Regular capital requirements estimation, capital structure and composition selection, and source selection are all responsibilities of the financial management process.
Accounting and Reporting
Organization’s financial records are tracked by financial management, which uses them as a database for financial forecasting and action planning. These data are also necessary for their ongoing financial reporting in accordance with government regulations.
An organization can more effectively prepare for risks, put mitigation strategies into place, and handle unforeseen emergencies and dangers with the support of financial management.
Types of Decision Making
Investment decision, financing decision, and dividend decision are the three different categories of financial decisions.
The acquisition, financing, and management of assets are all aspects of financial management that are done with a set of overarching objectives in mind. 3 fundamental decisions, firstly, the investment decision, secondly, the financing decision, and thirdly the dividend decision, make up the modern approach to financial management.
In the regular course of business, a firm makes these judgments simultaneously and continually. These decisions need to be made with the intention of maximizing shareholder wealth; the firm need not make them in that order.
This decision is more crucial than the other two. The exact amount of assets that the firm must hold must first be determined. In other terms, an investment decision involves choosing the assets on which a company will place money.
There are two categories for the necessary assets:
Long-term Assets (fixed assets, such as land, buildings, machinery, and other plant and equipment) that need a significant initial investment and produce returns over time. Investing in long-term assets is referred to as “capital budgeting” in the business world. It may be characterized as the company’s choice to spend its existing resources in fixed assets with an anticipated stream of benefits over a number of years.
Short term assets that can be changed into cash within a fiscal year without losing value. Examples are current assets including cash, debtors, finished items, and raw materials. Working capital management is a word used frequently to describe investments in current assets. Moreover it has to do with how current assets are managed.
Factors Influencing Capital Budgeting and Investment Decisions
The project’s cash flows should be taken into account and examined in order to choose the best proposal. Cash revenues and payments over the course of an investment proposal should be taken into account.
Rate of return: When choosing the best proposal, it is important to consider both the risk and the expected rewards from each one.
Investment criterion in play: Capital budgeting methods are used to assess the various investment ideas. which entail the computation of investment amounts, interest rates, cash flows, return rates, etc. Which technique to employ for project evaluation must be taken into consideration.
This decision comes into play after determining the amount needed and choosing the assets that must be purchased. The balance sheet’s right side’s composition is an issue for the financial management. It has to do with leverage, capital structure, or the financing mix. The balance between debt and equity in the capital structure must be determined by the financial manager.
Financial Decisions Are Affected by
Cost: Fundraising from various sources has varying costs. Compared to loans, equity has a higher cost. The cheapest option should only be chosen with caution.
Risk: The risk connected with various sources varies. Borrowed money carries a higher risk than owner’s money because interest is charged on it. And it must be repaid after a set length of time or at the end of its tenure.
Flotation cost – The price associated with issuing securities, such as broker commissions, underwriter fees, prospectus expenses, etc. The source of financing is less appealing the higher the flotation cost.
The business’s cash flow position. If a company has a strong enough cash flow position, it can readily borrow money.
Control considerations. If the current shareholders wish to maintain total control over the company, they can raise money by borrowing money. But if they are willing to give up whole control, equity shares can be used instead.
The condition of the capital markets: During boom times, raising capital by issuing shares is simple. But at the same time ,during downturns, it is more difficult.
Profits are available for distribution to equity shareholders and include dividends. Analysis of dividend payments should be done in light of a company’s financial choices. The distribution of net profits as dividends to common shareholders when there is no need to keep earnings or their retention within the firm itself if they are needed to fund any commercial activity are the two alternatives available when dealing with net profits of a firm.
However, the influence on the wealth of the shareholders should be considered while deciding whether to distribute dividends or keep them. The best dividend policy should be chosen by the financial manager to maximize the share’s market worth and the company’s market value. Another element of dividend policy is taking into account the variables that must be taken into account when determining payouts.
Factors influencing for Dividend Decision
Earnings—Dividends are paid from current and prior earnings, thus a company with high and stable earnings could declare a high rate of dividends.
Dividend stability- Companies often adhere to the principle of consistent dividends. If earnings change by a modest amount or if a gain in earnings is just temporary in nature, the dividend per share remains unchanged.
Growth prospects- If the company has strong growth potential in the short term, it will keep more or less of its earnings and hence, no dividend will be given.
Financial flow positions: Since dividends include a cash outflow, having enough cash on hand is a prerequisite for declaring dividends.
Shareholder preferences – When determining the dividend, shareholder preferences are also taken into consideration. If shareholders want a dividend, the corporation may go ahead and declare one. In this situation, the dividend amount is determined by the level of shareholder expectations.
Taxation regulations – A firm must pay tax on any dividends it declares. When dividend taxes are higher, businesses will choose to pay out fewer dividends. Whereas when tax rates are lower, businesses can declare a greater number of payouts.
The four decisions mentioned above may occasionally be divided into the following three categories:
1. Investment Decision, which entails working capital management and capital budgeting choice (long-term investment decision).
2. Capital Structure
3. Dividend Decision
Capital Budgeting Decision/ Investment Decision
Capital budgeting is the planning and management of a company’s long-term investments. During the capital budgeting process, the financial manager looks for profitable investment possibilities, or assets whose cash flow value surpasses their cost. The core of capital budgeting is assessing the quantity, timing, and risk of future cash flows .This includes cash inflows and outflows.
Financial Decision/Capital Structure Decision
A company’s capital structure or financial Decision is based on the need to raise money for long-term investments. It speaks of the precise proportion of long-term debt and equity that the company utilizes to fund its assets. The finance manager must choose precisely how much money to raise, from what sources, and when.
An ideal combination of the various sources of funding should be chosen after carefully evaluating all conceivable combinations of acquiring the necessary finances. The best capital structure is one that maximizes business value while lowering overall capital costs. The choice of a company’s capital structure influences its financial risk.
This Decision type is to deliver dividends comprises two considerations. Whether to do so and how much profit should be distributed as dividends. A finance manager must decide how much of the after-tax earnings should be delivered as a dividend to shareholders. And also , how much should be kept in the company to fulfil future investment needs. Should the business divide all profits, keep all profits, or keep some and distribute the rest?
The ratio used to measure whether profits were retained by the company or dispersed as a dividend is known as the retention ratio. The finance manager in this case is interested in figuring out the ideal dividend payout ratio that maximizes shareholder wealth. The availability of lucrative investment prospects, the firm’s financial requirements, shareholder expectations, legal restrictions, the firm’s liquidity condition, and other considerations all have an impact on the actual decision.
Each business is distinct from the others. Each has its own set of values and a particular method of doing things. But finance is a factor that unites all businesses, and every organization’s success is reliant on it. We’ve looked at the various categories of financial management choices a company must make to achieve its goals up to this point.
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