3 Major Areas of Decision-Making | Financial Management (2024)

This article throws light upon the three major decision-making areas in financial management. The areas are: 1. Investment Decision 2. Financing Decision 3. Dividend Decision.

Decision-Making: Area # 1. Investment Decision:

It is the decision for creation of assets to earn income. Selec­tion of assets in which investment is to be made is the invest­ment decision. It has to be decided how the funds realized will be utilized on various investments.

Generally, the assets of a company are of two types — those which yield income spread­ing over a year or so and assets which are easily convertible into cash within a short time. The first type of investment deci­sion is capital budgeting and the second one is the working cap­ital management.

Capital budgeting is the allocation of funds on a new asset or reallocation of capital when an old asset becomes non-profitable. The worthiness of different investment proposals forms a vital part of capital budgeting exercise.

Risks of investment are there, so the management has to consider it with sufficient cau­tion and prudence. Capital budgeting decision has another im­portant aspect. It is to determine the norm or standard against which benefits are to be judged. This is known as cut-off rate, hurdle rate, minimum rate of return etc. This is actually cost of capital.

Working capital management relates to management of the cur­rent assets. To meet current obligations, sufficient working cap­ital may be necessary. This can be termed as liquidity. In case proper amount of working capital cannot be estimated, there may revenue lying idle or there may be dearth of capital.

Nei­ther is desirable. In case working capital remains in excess which could otherwise be utilized in the long term productive assets, profit earning would suffer a setback. The very significant point here to note is that in working capital management there is the trade-off between liquidity and profit­ability.

Decision-Making: Area # 2. Financing Decision:

This decision relates to how, when and where funds are to be acquired to meet investment needs. It is related to the capital structure or financial leverage. This is debt-equity ratio. If more recourse is taken to debt capital, shareholders’ risk is lessened and the prospects of their dividend earning are reduced. So, in financing decision, the crucial point is the trade-off between returned risks.

The financing decision— unlike investment de­cision— relates to the determination of the capital structure — the proper balance between debt and equity.

Financing deci­sion has two important dimensions:

(1) Is there an optimum capital structure, and

(2) In what proportion should funds be raised to maximize the return to the shareholders? Once the best debt-equity mix is determined, the finance manager will be on the lookout for appropriate sources for raising loans and selling shares.

Decision-Making: Area # 3. Dividend Decision:

The profit of a company can be dealt with in two alternative ways — to distribute them as dividends to shareholders or to retain them in the business. If sufficient dividend is not paid, shareholders will not be satisfied, the market value of shares will come down and there may be financial crisis.

If the profits, on the other hand, are distrib­uted to the maximum extent, the company will lose on impor­tant source of self financing. So a judicious decision is a must. There should be a good combination of distribution and reten­tion.

The dividend decision boils down to the determination of net profits to be paid out to shareholders as dividends. Here the management is to consider two major factors — preference of the shareholders and the investment opportunities in the com­pany.

The functions of financial management can be discussed from different angles but the fact remains that finance plays the piv­otal role in the whole organization. Whatever has to be done needs money and that money procurement is the financial man­ager’s function.

How to use the money, how much to use and where to use are also matters of consultation with the finance management. Even the top management personnel cannot by­pass the financial management to decide matters relating to fi­nance which is so vital to keep the organization in sound health.

Financial planning, investment of funds procured, financial con­trol and the future financial policy — all are within the preview of financial management.