Running an organization isn’t an easy task; you have to be accountable for your finances. An organization needs to sustain its work, and even if they’re not making a profit, it has to take care of finances. Various elements in financial management are essential to achieving business goals and executing financial operations.
Correct financial decisions help you to gain profit and grow your company. Whereas a poor economic system can disturb the company’s performance. Managers take care of the expenses of a company, and there should be proper cash flow to maintain and run the company.
This post will help you understand what is financial decision and its importance. Detailed knowledge of types of financial decisions is important to know the overall financial working of a company.
Read more: Investment Decision Process
What is Financial Decision?
To understand the working of a company, the first thing you need to know is what is financial decision and how it works.
A financial decision is a decision that is taken in respect of the finances of the company. These decisions carve the path for either the success or failure of the company. Financial decisions are related to raising and financing funds, daily expenses, management, etc. Therefore the types of financial decisions affect the assets and liabilities of the company.
The financial decisions lead to revenue generation, profits, and receipt of funds for the company. They can also be directed towards the expenditure, creation of liabilities, and losses of the company. Various factors affect a company’s growth, and finance is a significant pillar. The types of financial decisions you make will decide your financial position in the market.
A company works based on a goal where they set specific targets to grow. Financial decisions are the main factors to achieve these goals. Financial decisions help you to structure a company’s progress. It also allows you to be more accountable in terms of your finances.
Types of Financial Decisions
A company’s growth is indicated by its capital budgeting or investment decisions. Everything is crucial to running a company successfully. Every company has its way of handling finances, and it’s vital to understand its choices.
There are three main types of financial decisions. These include investment decisions, financing decisions, and dividend decisions. The types of financial decisions taken will have a huge role in deciding the success and failure of a company.
1. Investment Decisions
Investment decisions are the types of financial decisions that a firm takes to invest in the correct address to receive a good return. The ability to invest in the right place is crucial. Therefore, this is one of the most important types of financial decisions.
To make the most out of the money available, a firm must make the right investment decisions to maximize wealth. Many companies consider investing in advanced technologies which ease their work and help the company to grow. The companies need to define what is a financial decision for them and make a choice. There are assets, instruments, and securities that are part of these financial decisions.
According to the resources available in the company, a financial manager will decide on the purchases to invest in. The investment decisions are further divided into two parts which are:
- Short-term investment decisions
The decisions for day-to-day operations are considered short-term investment decisions. These financial decisions are made on a short-term basis.
The managers take care of the liquidity and funds available in the company to execute the daily activities. They ensure there are sources of financing to complete day-to-day operations.
All the minor elements in a company’s management, like expenditures, receivables, and payables, are included in short-term financial decisions. The short-term financial decision goal is to get higher profit and proper liquidity.
Various factors like rate of return and cash flows are taken into account while taking these decisions.
- Long-term investment decisions
This is one of the most crucial types of financial decisions. This is because long-term financial decisions are mostly irreversible. These decisions can drastically affect a company if not taken correctly. They include long-term capital budgeting and future assets control.
A manager is accountable for making these decisions as capital expenditure for long-term assets is essential. Long-term financial decisions are based on asset risk and return.
A long-term financial decision is all about capital budgeting for long-term expenditure. The long-term findings include enhancing current assets for future expansions and improving the company’s overall production.
There are different assets for the future. A company gets these returns for one year or more. The expected profit, funds needed, and risk are the critical factors people consider while making long-term financial decisions. What is financial decision’s result, will ultimately be the deciding factor for the success of an organization.
There are different techniques used for capital budgeting and making the right decisions that will benefit the company over time.
Factors that can entail Investment decisions
- Risk and return: Companies will invest in assets with high returns and low risk as they target high ROI.
- Positive Cash flow: To keep the liquidity position comfortable, positive cash flow plays an important role.
- Investment criteria: A business has access to different proposals that can be used to enhance its business opportunities.
2. Financing Decisions
The proportion of debt and equity in a company’s capital structure is considered a financing decision. Financing decisions play an important role in balancing a company’s capital structure.
The company’s growth can be understood by its share profit. It’s a sign of victory for the company which eventually results in enhancing investors’ wealth. Financing decisions can be understood as looking up the sources to fund a company.
- Capital structure
Capital structure plays an immense role when looking for sources of funds. Knowing where the long-term finance will be raised and the proportion of the funds is important. It’s a mix of debt and equity where equity is preferred because it has good financial flexibility.
The finance managers focus on finance mix and leverage to define the capital structure. This includes debt and equity, which trade off risk and return to the shareholders. The proper balance of debt and equity creates a reasonable capital structure.
Factors that can entail financing decisions
Financing decisions are crucial for investments. Let’s understand what the factors that can entail financing decisions are.
Risk: The risk included in raising funds is pretty high. And debt is riskier than equity.
Cost: The cost included in raising money companies choose sources with minimum prices.
Cash flow: If you’re going into debt, you must make sure your cash flow is good to pay the interest quickly.
Floatation cost: Underwriter’s fees, expenses on the prospectus, and broker’s commission are considered floatation costs. The floatation cost decides the source of finance.
3. Dividend Decision
The decisions decide the amount of dividend distributed to shareholders and how much to keep for future projects. The profits are distributed to shareholders and kept if necessary to perform business activities. Many people fail to calculate the net profits and how much to allocate.
There are different types of financial decisions. Giving high dividends to shareholders eventually increases the value of a company. There are various elements a manager needs to follow to ensure they retain a certain amount for company stability. The payout to shareholders and retention money depends on the company.
Factors that can entail dividend decisions
- Earnings to distribute: Companies with higher earnings can pay a good dividend. But the companies with low dividends cannot payout. Revenues in the stock market determine the value to be distributed.
- Stable dividends: Companies pay steady compensation throughout the year. If it changes, modifications are made.
- Tax policies: The dividends offered by a company are taxed, and concerning the tax policies, dividends are paid.
- Preferences of shareholders: Shareholders play a significant role in deciding the dividend. If a shareholder expects a specific bonus, then it should be taken into consideration by the company.
- Stock rates: Stock market rates impact a lot on the company’s dividend distribution, which plays a significant role in maximizing shareholder wealth.
These types of financial decisions help a company to grow and elevate their business efficiency
Financial decisions are vital for a company’s performance in the market. People hire financial managers to make sure they’re making the right decisions for the company. It’s important to understand these decisions as it helps you to get an idea of how things work in a company.
We hope this post was helpful and you received value from it.
Types of Financial Decisions – FAQs
What is a financial decision?
To understand what is a financial decision, you need to understand the financial parts of a company. A company takes specific decisions like investment decisions, dividend decisions, and financing decisions to elevate growth. Understanding the essential elements of financial decisions is vital as it dictates a lot about your company.
What are the different types of financial decisions?
The above-explained decisions are the most important financial decisions every company should take wisely. These decisions help you to create an effective business. They impact your business, and managers develop specific plans to make these decisions. Complicated decisions like dividend distribution, capital structure, and working capital management are essential to sustain a company’s growth.
What is financial decision’s importance and what are the benefits of good financial decision-making?
Financial decisions are essential for your organization. Planning on finance keeps you ahead of your competitors. What financial decision for you will be the destiny of your company one day, hence it is the most crucial thing to understand.
Financial security is vital for every enterprise, and taking effective decisions helps you with it. A good decision will make your investment and economic structure stable.
What is a financial decision in terms of working capital management?
Working capital management is nothing but taking small decisions on an everyday basis which ensures liquidity for executing daily operations. Short-term financing sources should be transparent. They should be calculated to make sure you perform daily activities. The receivables and payables are included in the working capital management. These short-term financial decisions help sustain your daily activities and grow the company.