Business Studies Part I
Business Studies Part II

Financial Decisions

In a financial context, it means the selection of best financing alternative or best investment alternative. Financial decision-making is concerned with three broad decisions which are as under:

Investment Decision A firm’s resources are scarce in comparison to the uses to which they can be put. A firm, therefore, has to choose where to invest these resources, so that they are able to earn the highest possible return for their investors. The investment decision, therefore, relates to how the firm’s funds are invested in different assets. Investment decision can be longterm or short-term.

 A long-term investment decision is also called a Capital Budgeting decision. It involves committing the finance on a long-term basis. For example, making investment in a new machine to replace an existing one or acquiring a new fixed asset or opening a new branch etc. These decisions are very crucial for any business since they affect its earning capacity over the long run. The size of assets, the profitability and competitiveness are all affected by the capital budgeting decisions. Moreover, these decisions normally involve huge amounts of investment and are irreversible except at a huge cost. Therefore, once made, it is often almost impossible for a business to wriggle out of such decisions. Therefore, they need to be taken with utmost care obviously. These decisions must be taken by those who understand them comprehensively. A bad capital budgeting decision normally has the capacity to severely damage the financial fortune of a business.Short term investment decisions (also called working capital decisions) are concerned with the decisions about the levels of cash, inventories and debtors. These decisions affect the day to day working of a business. These affect the liquidity as well as profitability of a business. Efficient cash management, inventory management and receivables management are essential ingredients of sound working capital management.

Financial management is concerned with the solution of three major issues relating to the financial operations of a firm corresponding to the three questions of Investment, financing and dividend decision. In a financial context, it means the selection of best financing alternative or best investment alternative. The finance function therefore, is concerned with three broad decision which are as follows

  1. Decision: The investment decision relates to how the firm’s funds are invested in different assets.
  2. Financing Decision: This decision is about the quantum of finance to be raised from various long term sources and short term sources. It Involves identification of various available sources of finance.
  3. Dividend Decision: This decision relates to distribution of dividend. Dividend is that portion of profit which is distributed to shareholders the decision involved here is how much of the profit earned by company is to be distributed to the shareholders and how much of it should be retained in the business for meeting investment requirements.