investment decisions financing decisions and firm value calculation

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Investment decisions financing decisions and firm value calculation investment banking career pathway

Investment decisions financing decisions and firm value calculation

After a careful analysis of risk return trade-off, the size of plant should be determined. Financing decision is concerned with the capital structure of the firm. The decision is basically taken about proportion of equity capital and debt capital in total capital of the firm.

Higher the proportion of debt in capital of the firm, higher is the risk. A capital structure having a reasonable mix of equity capital and debt capital is called optimum capital structure. Financing should be from sources having lowest cost of capital. A number of factors affect the capital structure of a firm. Debt has lower cost of capital, but it increases risk in the business of the firm.

A leveraged firm carries higher degree of risk in business. A reasonable mix of debt and equity capital should be selected to maintain the balance between risk and return. The third major decision is concerned with the distribution of profit to shareholders. A finance manager has to decide how much proportion of profit should be distributed to shareholders.

If a firm needs funds for investment in available projects and the cost of external financing is higher, then it is better to retain profit to meet the requirement. The payment of dividends also affect the value of firms. These factors should be taken into consideration while deciding the optimal dividend policy of the firm. A firm needs working capital to manage the day-to-day affairs smoothly. Net working capital is equal to difference between the total current assets and current liabilities.

In working capital management, a finance manager has to take decision on following issues:. Management of working capital involves risk-return trade-off. If the level of current assets of the firm is very high, it has excess liquidity. When the firm does so its rate of return will decline as more funds are tied up in idle cash. This would lead to reduction in profit. Thus a firm should maintain optimum level of current assets.

All organizations irrespective of type of business must raise funds to buy the assets necessary to support operations. Thus financing decisions involves addressing two questions:. What is the best mix of financing these investment proposals? The choice between the use of internal versus external funds, the use of debt versus equity capital and the use of long-term versus short-term debt depends on type of source, period of financing, cost of financing and the returns thereby.

Prior to deciding a specific source of finance it is advisable to evaluate advantages and disadvantages of different sources of finance and its suitability for purpose. Efforts are made to obtain an optimal financing mix, an optimal financing indicates the best debt-to-equity ratio for a firm that maximizes its value, in simple words, and the optimal capital structure for a company is the one which offers a balance between cost and risk.

This decision in financial management is concerned with allocation of funds raised from various sources into acquisition assets or investment in a project. The scope of investment decision includes allocation of funds towards following areas:. Further, Investment decision not only involves allocating capital to long term assets but also involves decisions of utilizing surplus funds in the business, any idle cash earns no further interest and therefore not productive.

So, it has to be invested in various as marketable securities such as bonds, deposits that can earn income. Most of the investment decisions are uncertain and a complex process as it involves decisions relating to the investment of current funds for the benefit to be achieved in future. Therefore while considering investment proposal it is important to take into consideration both expected return and the risk involved.

Thus, finance department of an organization has to decide to allocate funds into profitable ventures so that there is safety on investment and regular returns is possible. Shareholders are the owners and require returns, and how much money to be paid to them is a crucial decision. Thus payment of dividend is decision involves deciding whether profits earned by the business should be retained rather than distributed to shareholders in the form of dividends.

If dividends are too high, the business may be starved of funding to reinvest in growing revenues and profits further. Keeping this in mind an optimum dividend payout ratio is calculated by the finance manager that would help the firm to maximize its market value. In simple words working capital signifies amount of funds used in its day-to-day trading operations. Working capital primarily deals with currents assets and current liabilities.

Infact it is calculated as the current assets minus the current liabilities. One of the key objectives of working capital management is to ensure liquidity position of a firm to avoid insolvency. The following are key areas of working capital decisions:. Effective administration of bills receivables and payables. The principle of effective working capital management focuses on balancing liquidity and profitability. Whereas the profitability means the ability of the firm to obtain highest returns within the funds available.

In order to maintain a balance between profitability and liquidity forecasting of cash flows and managing cash flows is very important. Financial Management takes financial decisions under three main categories namely, investment decisions, financing decisions and dividend decisions. Let us now discuss each financial decision in detail:. Investment decisions are the financial decisions taken by management to invest funds in different assets with an aim to earn the highest possible returns for the investors.

It involves evaluating various possible investment opportunities and selecting the best options. The investment decisions can be long term or short term. Long term investment decisions are all such decisions which are related to investing of funds for a long period of time. They are also called as Capital Budgeting decisions.

The long term investment decisions are related to management of fixed capital. These decisions involve huge amounts of investments and it is very difficult to reverse such decisions. Therefore, it is must that such decisions are taken only by those people who have comprehensive knowledge about the company and its requirements.

Any bad decision may severely damage the financial fortune of the business enterprise. While taking a capital budgeting decision, a business has to evaluate the various options available and check the viability and feasibility of the available options.

The various factors which affect capital budgeting decisions are:. Investment should be done only if the net cash flows are more than the funds invested. The investment must be done in the projects which earn the higher rate of return provided the level of risk is same. These techniques involve calculation of rate of return, cash flows during the life of investment, cost of capital etc. Importance of long term investment decisions:.

Examples of c apital budgeting decisions:. Short Term Investment Decisions :. Short term investment decisions are the decisions related to day to day working of a business enterprise. They are also called as working capital decisions because they are related to current assets and current liabilities like management of cash, inventories, receivable etc.

The short term decisions are important for a business enterprise because:. Financing decisions are the financial decisions related to raising of finance. It involves identification of various sources of finance and the quantum of finance to be raised from long-term and short-term sources. While taking financing decision following points need to be considered:. Shareholders receive dividends when business earns profits. In order to raise capital with controlled risk and minimum cost of capital a firm must have a judicious mix of both debt and equity.

Therefore, cost of each type of finance is calculated before taking the financial decision of how much funds to be raised from which source. This decision determines the overall cost of capital and the financial risk for the enterprise. From the above discussions, you must have realized that financing decisions are affected by various factors. Cost of raising funds influence the financing decisions.

A prudent financial manager selects the cheapest sources of finance. Each source of finance has different degree of risk. Finance manager considers the degree of risk involved in each source of finance before taking financing decision. For example, borrowed funds have high risk as compared to equity capital. Floatation cost is the cost of raising finance. A finance manager estimates the floatation cost of various sources and selects the source with least floatation cost.

Therefore, higher the floatation cost less attractive is the source of finance. A business with strong cash flow position prefers to raise funds from debts as it can easily pay interest and the principal. Interest is a deductible expense, saves tax liability of the business making the source of finance cheaper. However, during liquidity crisis business prefers to raise funds from equity.

Fixed operating costs of a business influence its financing decisions. For a business with high operating cost, funds must be raised from equity as lower debt financing would be better. On the other hand, if the operating cost is low, business can afford to pay high fixed charges therefore, more of debt financing may be preferred.

Financing decisions consider the degree of control the business is willing to dilute. A company would prefer debt financing if it wants to retain complete control of the business with existing shareholders. On the other hand, a company willing to lose control will raise funds from equity. Health of the capital market may also affect the financing decision.

During boom period, investors are ready to invest in equity but during depression investors look for secured options for investment. Therefore it is easy for companies to raise funds from equity during boom period. Dividend decisions are the financial decisions related to distribution of share of profits amongst shareholders in the form of dividends.

The dividend decision involves deciding the amount of profit after tax to be distributed to the shareholders as dividends and the amount of profit to be retained in the business for further growth of the business. The decision regarding the amount of profits to be distributed as dividends depends on various factors. Dividends represent the share of profits distributed amongst shareholders.

Therefore, earnings is a major determinant of the decision regarding dividends. A company with stable earnings is not only in a position to declare higher dividends but also maintain the rate of dividend in the long run. However a company with fluctuating earnings may declare smaller dividend. In order to maintain dividend per share, a company prefers to declare same rate of dividends. The growing companies prefer to retain larger share of profits to finance their investment requirements.

Therefore, the rate of dividend declared by them is smaller as compared to companies who have achieved certain goals of growth and can share larger share of profits with shareholders. Dividends involve outflow of cash. A profitable company is in a position to declare dividends but it may have liquidity problems.

As a result of which it may not be in a position to pay dividends to its shareholders. Therefore availability of cash also influences dividend decision. For example, a company may declare higher or stable rate of dividend if it has a large number of shareholders who depend on dividends as their regular income. Dividends are a tax free income for shareholders but the company has to pay tax on share of profits distributed as dividend. Therefore, the decision regarding the amount of profit to be distributed as dividends depends on the tax rate.

Company would prefer to pay lesser dividends if tax rate on dividends is high. The share price is directly related to the rate of dividend declared by the company. Share prices of a company increase if the company declares higher rate of dividend. Therefore, the financial management considers the potential effect of dividends on the share prices before declaring dividends.

Decision regarding amount of dividend to be declared depends on the need of profits to be retained for future investments. Companies who have easy access to the capital market to raise funds may not require large amount of profits to be retained and therefore may decide to declare high dividend rate. On the other hand, small companies who find it difficult to raise funds from capital markets may decide to share lesser profits with their shareholders.

Every company is required to adhere to the restrictions or provisions laid by the Companies Act regarding dividend payouts. Sometimes companies are required to enter into contractual agreements with their lenders with respect to the payment of dividends in future. The dividend decisions need to consider such restrictions while declaring dividend rate to ensure that terms of loan agreement are not violated. Article Shared by N Massey.

Related Articles. For example, suppose both projects are absolute home-runs, but the company still only has enough money to fund one. The finance department will figure out if the company should borrow money so that it can fund both. The role of finance in an organization is to make sure that money is at the right place at the right time.

A company wants to have enough money to pay its bills, but also wants to invest so that it can grow in the future. The finance department is devoted to the task of figuring out how to allocate assets to do so, for the overarching goal of maximizing shareholder value.

There are two fundamental types of financial decisions that the finance team needs to make in a business: investment and financing. The two decisions boil down to how to spend money and how to borrow money. Recall that the overall goal of financial decisions is to maximize shareholder value, so every decision must be put in that context. An investment decision revolves around spending capital on assets that will yield the highest return for the company over a desired time period.

In other words, the decision is about what to buy so that the company will gain the most value. To do so, the company needs to find a balance between its short-term and long-term goals. On the other end of the spectrum is a purely long-term view. Companies thus need to find the right mix between long-term and short-term investment.

The investment decision also concerns what specific investments to make. Since there is no guarantee of a return for most investments, the finance department must determine an expected return. This return is not guaranteed, but is the average return on an investment if it were to be made many times.

All functions of a company need to be paid for one way or another. It is up to the finance department to figure out how to pay for them through the process of financing. Each has its advantages and disadvantages. There are two ways to raise money from external funders: by taking on debt or selling equity.

Taking on debt is the same as taking on a loan. The loan has to be paid back with interest, which is the cost of borrowing. Selling equity is essentially selling part of your company. When a company goes public, for example, they decide to sell their company to the public instead of to private investors. Going public entails selling stocks which represent owning a small part of the company.

The company is selling itself to the public in return for money. Every investment can be financed through company money or from external funders. It is the financing decision process that determines the optimal way to finance the investment.

Corporate finance deals with monetary decisions that business enterprises make and the tools and analysis utilized to make the decisions. Corporate finance is concerned primarily with making investment and financing decisions; that is, making sure that money is being used in the best way. The corporate finance department of a company is in charge of budgeting. Management must allocate limited resources between competing opportunities; since a dollar cannot be used for more than one project at once, it is a challenge to determine how much money should be allocated to each part of the business.

In determining how to allocate money, the finance group must also figure out where the money will be best utilized. This requires valuing projects and business functions. A large element of finance is deciding how exactly to value a project. There are a number of variables — inflation, expected revenues, expected costs, length of time required — that are all incorporated into the valuation process.

Finding the true value of a project is often wrought with uncertainty, but without an accurate valuation, a company may allocate its resources sub-optimally. The corporate finance department must also determine how to finance projects. A company can finance a project by using either internal funds money the company already has , borrowing, or selling equity. Each option carries a certain cost that can be quantified.

One public job function of corporate finance is determining whether or not the company pays a dividend, and if so, how much. The company has a responsibility to maximize shareholder value, but that can be achieved in multiple ways. Paying a dividend puts cash directly in the hands of shareholders, increasing shareholder value.

However, paying a dividend means that money is not being reinvested in the company. The finance department determines which option maximizes shareholder value. Lastly, the finance department must also ensure that there is a good balance between long- and short-term goals. The company must have enough assets to cover short-term costs, referred to as working capital management, and enough invested to ensure the company has long-term growth.

Factory : Purchasing new machinery requires a valuation of all equipment, an accurate idea of the total cost over time, and a way to finance the purchase while leaving enough cash for other upcoming costs. The financial manager is responsible for budgeting, projecting cash flows, and determining how to invest and finance projects.

The role of a financial manager is a complex one, requiring both an understanding of how the business functions as a whole and specialized financial knowledge. The head of the financial operations is called the chief financial officer CFO. The structure of the company varies, but a financial manager is responsible for the same general things across the board. The manager is responsible for managing the budget. This involves allocating money to different projects and segments so that the business can continue operating, but the best projects get the necessary funding.

The manager is responsible for figuring out the financial projections for the business. The development of a new product, for example, requires an investment of capital over time. This is a lot tougher than it sounds because there is no accurate financial data for the future. Collaboration : The finance manager must collaborate across business functions in order to determine how to best allocate and manage assets.

There is a cost to investing money, either the opportunity cost of not investing it elsewhere, the cost of borrowing money, or the cost of selling equity. The finance manager uses a number of tools, such as setting the cost of capital the cost of money over time, which will be explored in further depth later on to determine the cost of financing.

At the same time that this is going on, the financial manager must also ensure that the business has enough cash to pay upcoming financial obligations without hoarding assets that could otherwise be invested. This is a delicate dance between short-term and long-term responsibilities.

The study of finance often feels a lot narrower than it really is. There is a lot of talk of issuing bonds or pricing projects which belies how relevant finance is to everyday life, regardless of whether or not you have any desire of working in finance.

Finance plays an involved role in the health of the overall economy, which impacts everyone, regardless of whether or not they have studied finance. The field of finance explains why the recession occurred; it is the reason why people care about how the stock market is doing each day; and it articulates why businesses and governments make some of the decisions they do.

Finance plays a role in many of the stories in the news every day, which means that those who understand finance have a better grasp on how the events of the world affect them. Each person will also have to manage his or her own personal finances. Like corporations, individuals are faced with investment and financing decisions.

In order to invest, individuals must be able to do the same projections and valuations as companies in order to determine the best investment for their needs. Individuals cannot sell equity like corporations, but they can choose to either dip into their savings or take out loans. Many take on debt in the form of student loans, mortgages, or through their credit cards; being able to properly compare options to leverage is just as important for individuals as it is for companies.

Of course, finance is an important field of study for those who have a desire of working in finance or accounting. Finance is heavily used in jobs ranging from investment banker to CFO to venture capitalist. However, finance is not segmented from the other functions in business.

Every job from marketing to engineering has to be able to manage a budget and make a business case that it should get funding for a project. This is especially true higher up in the organizational hierarchy: managers, directors, and vice presidents need to be able to articulate why their departments should get financial support from the company. Finance is a field of both hard analytical skill and personal judgement.

There are set processes and theories for determining which financial option is best, but in the real world, it is rare to have all of the information needed to be absolutely certain about what to do. Finance develops strong analytical skills, but also the degree of finesse required to operate in an environment of uncertainty.

Silver Bid Chart : Finance helps explain what trends in silver bids mean, but more importantly, why people care about them even those not trading silver. Privacy Policy. Skip to main content. Introduction to the Field and Goals of Financial Management.

Search for:. Introducing Finance. Defining Finance Finance is the study of fund management and asset allocation over time. Learning Objectives Explain the importance of time to the discipline of finance. Key Takeaways Key Points The two main drivers of finance are the time value of money and risk. Since the value of assets changes over time, finance seeks to ensure the change is beneficial for the organization or individual.

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Only factoring in equity, for example, would provide the growing value to equity holders. Discounting any stream of cash flows requires a discount rate, and in this case, it is the cost of financing projects at the firm. The weighted average cost of capital WACC is used for this discount rate.

The operating free cash flow is then discounted at this cost of capital rate using three potential growth scenarios—no growth, constant growth, and changing growth rate. This discounts the cash flows expected to continue for as long as a reasonable forecasting model exists. In a more mature company, you may find it more appropriate to include a constant growth rate in the calculation.

Assuming the firm is about to see more than one growth stage, the calculation is a combination of each of these stages. Using the supernormal dividend growth model for the calculation, the analyst needs to predict the higher-than-normal growth and the expected duration of such activity. After this high growth, the firm might be expected to go back into a normal steady growth into perpetuity.

Both the two-stage dividend discount model DDM and FCFE model allow for two distinct phases of growth—an initial finite period where the growth is abnormal, followed by a stable growth period expected to last forever. In order to determine the long-term sustainable growth rate, one would usually assume the rate of growth will equal the long-term forecasted GDP growth.

In each case, the cash flow is discounted to the present dollar amount and added together to get a net present value. Comparing this to the company's current stock price can be a valid way of determining the company's intrinsic value. Recall that we need to subtract the total current value of the firm's debt to get the value of the equity. Then, divide the equity value by common shares outstanding to get the value of equity per share. This value can then be compared to how much the stock is selling for in the market to see if it is overvalued or undervalued.

Calculations dealing with the value of a firm will always use unique methods based on the firm being examined. Growth companies may need a two-period method when there is higher growth for a couple of years. In a larger, more mature company you can use a more stable growth technique. It always comes down to determining the value of the free cash flows and discounting them to today. Financial Ratios. Tools for Fundamental Analysis. Financial Analysis. Fundamental Analysis. Career Advice.

Your Money. Personal Finance. Your Practice. Popular Courses. Fundamental Analysis Tools for Fundamental Analysis. Table of Contents Expand. Free Cash Flows. Operating Free Cash Flow. Calculating the Growth Rate. No Growth. Taking on debt is the same as taking on a loan. The loan has to be paid back with interest , which is the cost of borrowing. Selling equity is essentially selling part of your company. When a company goes public, for example, they decide to sell their company to the public instead of to private investors.

Going public entails selling stocks which represent owning a small part of the company. The company is selling itself to the public in return for money. If a company chooses to finance an investment by selling equity, they may issue stocks on an exchange like the New York Stock Exchange. Every investment can be financed through company money or from external funders. It is the financing decision process that determines the optimal way to finance the investment.

Boundless Finance. Introduction to the Field and Goals of Financial Management. Introducing Finance. Concept Version 8. Investment and financing decisions boil down to how to spend money and how to borrow money. Learning Objective Identify the criteria a corporation must use when making a financial decision. Key Points The primary goal of both investment and financing decisions is to maximize shareholder value.

Investment decisions revolve around how to best allocate capital to maximize their value. Financing decisions revolve around how to pay for investments and expenses. Companies can use existing capital, borrow, or sell equity. Full Text There are two fundamental types of financial decisions that the finance team needs to make in a business: investment and financing. Investment An investment decision revolves around spending capital on assets that will yield the highest return for the company over a desired time period.

The investments must meet three main criteria: It must maximize the value of the firm, after considering the amount of risk the company is comfortable with risk aversion. It must be financed appropriately we will talk more about this shortly.

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Financing decision is concerned with the capital structure of the firm. The decision is basically taken about proportion of equity capital and debt capital in total capital of the firm. Higher the proportion of debt in capital of the firm, higher is the risk. A capital structure having a reasonable mix of equity capital and debt capital is called optimum capital structure. Financing should be from sources having lowest cost of capital. A number of factors affect the capital structure of a firm.

Debt has lower cost of capital, but it increases risk in the business of the firm. A leveraged firm carries higher degree of risk in business. A reasonable mix of debt and equity capital should be selected to maintain the balance between risk and return. The third major decision is concerned with the distribution of profit to shareholders.

A finance manager has to decide how much proportion of profit should be distributed to shareholders. If a firm needs funds for investment in available projects and the cost of external financing is higher, then it is better to retain profit to meet the requirement. The payment of dividends also affect the value of firms. These factors should be taken into consideration while deciding the optimal dividend policy of the firm.

A firm needs working capital to manage the day-to-day affairs smoothly. Net working capital is equal to difference between the total current assets and current liabilities. In working capital management, a finance manager has to take decision on following issues:. Management of working capital involves risk-return trade-off. If the level of current assets of the firm is very high, it has excess liquidity. When the firm does so its rate of return will decline as more funds are tied up in idle cash.

This would lead to reduction in profit. Thus a firm should maintain optimum level of current assets. All organizations irrespective of type of business must raise funds to buy the assets necessary to support operations. Thus financing decisions involves addressing two questions:. What is the best mix of financing these investment proposals? The choice between the use of internal versus external funds, the use of debt versus equity capital and the use of long-term versus short-term debt depends on type of source, period of financing, cost of financing and the returns thereby.

Prior to deciding a specific source of finance it is advisable to evaluate advantages and disadvantages of different sources of finance and its suitability for purpose. Efforts are made to obtain an optimal financing mix, an optimal financing indicates the best debt-to-equity ratio for a firm that maximizes its value, in simple words, and the optimal capital structure for a company is the one which offers a balance between cost and risk.

This decision in financial management is concerned with allocation of funds raised from various sources into acquisition assets or investment in a project. The scope of investment decision includes allocation of funds towards following areas:. Further, Investment decision not only involves allocating capital to long term assets but also involves decisions of utilizing surplus funds in the business, any idle cash earns no further interest and therefore not productive. So, it has to be invested in various as marketable securities such as bonds, deposits that can earn income.

Most of the investment decisions are uncertain and a complex process as it involves decisions relating to the investment of current funds for the benefit to be achieved in future. Therefore while considering investment proposal it is important to take into consideration both expected return and the risk involved.

Thus, finance department of an organization has to decide to allocate funds into profitable ventures so that there is safety on investment and regular returns is possible. Shareholders are the owners and require returns, and how much money to be paid to them is a crucial decision. Thus payment of dividend is decision involves deciding whether profits earned by the business should be retained rather than distributed to shareholders in the form of dividends.

If dividends are too high, the business may be starved of funding to reinvest in growing revenues and profits further. Keeping this in mind an optimum dividend payout ratio is calculated by the finance manager that would help the firm to maximize its market value.

In simple words working capital signifies amount of funds used in its day-to-day trading operations. Working capital primarily deals with currents assets and current liabilities. Infact it is calculated as the current assets minus the current liabilities. One of the key objectives of working capital management is to ensure liquidity position of a firm to avoid insolvency. The following are key areas of working capital decisions:.

Effective administration of bills receivables and payables. The principle of effective working capital management focuses on balancing liquidity and profitability. Whereas the profitability means the ability of the firm to obtain highest returns within the funds available. In order to maintain a balance between profitability and liquidity forecasting of cash flows and managing cash flows is very important.

Financial Management takes financial decisions under three main categories namely, investment decisions, financing decisions and dividend decisions. Let us now discuss each financial decision in detail:. Investment decisions are the financial decisions taken by management to invest funds in different assets with an aim to earn the highest possible returns for the investors.

It involves evaluating various possible investment opportunities and selecting the best options. The investment decisions can be long term or short term. Long term investment decisions are all such decisions which are related to investing of funds for a long period of time. They are also called as Capital Budgeting decisions. The long term investment decisions are related to management of fixed capital. These decisions involve huge amounts of investments and it is very difficult to reverse such decisions.

Therefore, it is must that such decisions are taken only by those people who have comprehensive knowledge about the company and its requirements. Any bad decision may severely damage the financial fortune of the business enterprise. While taking a capital budgeting decision, a business has to evaluate the various options available and check the viability and feasibility of the available options.

The various factors which affect capital budgeting decisions are:. Investment should be done only if the net cash flows are more than the funds invested. The investment must be done in the projects which earn the higher rate of return provided the level of risk is same. These techniques involve calculation of rate of return, cash flows during the life of investment, cost of capital etc.

Importance of long term investment decisions:. Examples of c apital budgeting decisions:. Short Term Investment Decisions :. Short term investment decisions are the decisions related to day to day working of a business enterprise. They are also called as working capital decisions because they are related to current assets and current liabilities like management of cash, inventories, receivable etc.

The short term decisions are important for a business enterprise because:. Financing decisions are the financial decisions related to raising of finance. It involves identification of various sources of finance and the quantum of finance to be raised from long-term and short-term sources. While taking financing decision following points need to be considered:. Shareholders receive dividends when business earns profits.

In order to raise capital with controlled risk and minimum cost of capital a firm must have a judicious mix of both debt and equity. Therefore, cost of each type of finance is calculated before taking the financial decision of how much funds to be raised from which source. This decision determines the overall cost of capital and the financial risk for the enterprise. From the above discussions, you must have realized that financing decisions are affected by various factors.

Cost of raising funds influence the financing decisions. A prudent financial manager selects the cheapest sources of finance. Each source of finance has different degree of risk. Finance manager considers the degree of risk involved in each source of finance before taking financing decision. For example, borrowed funds have high risk as compared to equity capital. Floatation cost is the cost of raising finance. A finance manager estimates the floatation cost of various sources and selects the source with least floatation cost.

Therefore, higher the floatation cost less attractive is the source of finance. A business with strong cash flow position prefers to raise funds from debts as it can easily pay interest and the principal. Interest is a deductible expense, saves tax liability of the business making the source of finance cheaper. However, during liquidity crisis business prefers to raise funds from equity. Fixed operating costs of a business influence its financing decisions. For a business with high operating cost, funds must be raised from equity as lower debt financing would be better.

On the other hand, if the operating cost is low, business can afford to pay high fixed charges therefore, more of debt financing may be preferred. Financing decisions consider the degree of control the business is willing to dilute.

A company would prefer debt financing if it wants to retain complete control of the business with existing shareholders. On the other hand, a company willing to lose control will raise funds from equity. Health of the capital market may also affect the financing decision. During boom period, investors are ready to invest in equity but during depression investors look for secured options for investment. Therefore it is easy for companies to raise funds from equity during boom period.

Dividend decisions are the financial decisions related to distribution of share of profits amongst shareholders in the form of dividends. The dividend decision involves deciding the amount of profit after tax to be distributed to the shareholders as dividends and the amount of profit to be retained in the business for further growth of the business.

The decision regarding the amount of profits to be distributed as dividends depends on various factors. Dividends represent the share of profits distributed amongst shareholders. Therefore, earnings is a major determinant of the decision regarding dividends. A company with stable earnings is not only in a position to declare higher dividends but also maintain the rate of dividend in the long run.

However a company with fluctuating earnings may declare smaller dividend. In order to maintain dividend per share, a company prefers to declare same rate of dividends. The growing companies prefer to retain larger share of profits to finance their investment requirements. Therefore, the rate of dividend declared by them is smaller as compared to companies who have achieved certain goals of growth and can share larger share of profits with shareholders.

Dividends involve outflow of cash. A profitable company is in a position to declare dividends but it may have liquidity problems. As a result of which it may not be in a position to pay dividends to its shareholders. Therefore availability of cash also influences dividend decision. For example, a company may declare higher or stable rate of dividend if it has a large number of shareholders who depend on dividends as their regular income. Dividends are a tax free income for shareholders but the company has to pay tax on share of profits distributed as dividend.

Therefore, the decision regarding the amount of profit to be distributed as dividends depends on the tax rate. Company would prefer to pay lesser dividends if tax rate on dividends is high. The share price is directly related to the rate of dividend declared by the company. Share prices of a company increase if the company declares higher rate of dividend. Therefore, the financial management considers the potential effect of dividends on the share prices before declaring dividends.

Decision regarding amount of dividend to be declared depends on the need of profits to be retained for future investments. Companies who have easy access to the capital market to raise funds may not require large amount of profits to be retained and therefore may decide to declare high dividend rate.

On the other hand, small companies who find it difficult to raise funds from capital markets may decide to share lesser profits with their shareholders. Every company is required to adhere to the restrictions or provisions laid by the Companies Act regarding dividend payouts. Sometimes companies are required to enter into contractual agreements with their lenders with respect to the payment of dividends in future. The dividend decisions need to consider such restrictions while declaring dividend rate to ensure that terms of loan agreement are not violated.

Article Shared by N Massey. Related Articles. What is Strategic Management Process? In other words, the decision is about what to buy so that the company will gain the most value. To do so, the company needs to find a balance between its short-term and long-term goals. On the other end of the spectrum is a purely long-term view. Companies thus need to find the right mix between long-term and short-term investment.

The investment decision also concerns what specific investments to make. Since there is no guarantee of a return for most investments, the finance department must determine an expected return. This return is not guaranteed, but is the average return on an investment if it were to be made many times. All functions of a company need to be paid for one way or another.

It is up to the finance department to figure out how to pay for them through the process of financing. Each has its advantages and disadvantages. There are two ways to raise money from external funders: by taking on debt or selling equity. Taking on debt is the same as taking on a loan. The loan has to be paid back with interest, which is the cost of borrowing.

Selling equity is essentially selling part of your company. When a company goes public, for example, they decide to sell their company to the public instead of to private investors. Going public entails selling stocks which represent owning a small part of the company. The company is selling itself to the public in return for money. Every investment can be financed through company money or from external funders. It is the financing decision process that determines the optimal way to finance the investment.

Corporate finance deals with monetary decisions that business enterprises make and the tools and analysis utilized to make the decisions. Corporate finance is concerned primarily with making investment and financing decisions; that is, making sure that money is being used in the best way.

The corporate finance department of a company is in charge of budgeting. Management must allocate limited resources between competing opportunities; since a dollar cannot be used for more than one project at once, it is a challenge to determine how much money should be allocated to each part of the business. In determining how to allocate money, the finance group must also figure out where the money will be best utilized.

This requires valuing projects and business functions. A large element of finance is deciding how exactly to value a project. There are a number of variables — inflation, expected revenues, expected costs, length of time required — that are all incorporated into the valuation process. Finding the true value of a project is often wrought with uncertainty, but without an accurate valuation, a company may allocate its resources sub-optimally.

The corporate finance department must also determine how to finance projects. A company can finance a project by using either internal funds money the company already has , borrowing, or selling equity. Each option carries a certain cost that can be quantified. One public job function of corporate finance is determining whether or not the company pays a dividend, and if so, how much.

The company has a responsibility to maximize shareholder value, but that can be achieved in multiple ways. Paying a dividend puts cash directly in the hands of shareholders, increasing shareholder value. However, paying a dividend means that money is not being reinvested in the company. The finance department determines which option maximizes shareholder value. Lastly, the finance department must also ensure that there is a good balance between long- and short-term goals.

The company must have enough assets to cover short-term costs, referred to as working capital management, and enough invested to ensure the company has long-term growth. Factory : Purchasing new machinery requires a valuation of all equipment, an accurate idea of the total cost over time, and a way to finance the purchase while leaving enough cash for other upcoming costs. The financial manager is responsible for budgeting, projecting cash flows, and determining how to invest and finance projects.

The role of a financial manager is a complex one, requiring both an understanding of how the business functions as a whole and specialized financial knowledge. The head of the financial operations is called the chief financial officer CFO. The structure of the company varies, but a financial manager is responsible for the same general things across the board. The manager is responsible for managing the budget.

This involves allocating money to different projects and segments so that the business can continue operating, but the best projects get the necessary funding. The manager is responsible for figuring out the financial projections for the business. The development of a new product, for example, requires an investment of capital over time. This is a lot tougher than it sounds because there is no accurate financial data for the future. Collaboration : The finance manager must collaborate across business functions in order to determine how to best allocate and manage assets.

There is a cost to investing money, either the opportunity cost of not investing it elsewhere, the cost of borrowing money, or the cost of selling equity. The finance manager uses a number of tools, such as setting the cost of capital the cost of money over time, which will be explored in further depth later on to determine the cost of financing. At the same time that this is going on, the financial manager must also ensure that the business has enough cash to pay upcoming financial obligations without hoarding assets that could otherwise be invested.

This is a delicate dance between short-term and long-term responsibilities. The study of finance often feels a lot narrower than it really is. There is a lot of talk of issuing bonds or pricing projects which belies how relevant finance is to everyday life, regardless of whether or not you have any desire of working in finance.

Finance plays an involved role in the health of the overall economy, which impacts everyone, regardless of whether or not they have studied finance. The field of finance explains why the recession occurred; it is the reason why people care about how the stock market is doing each day; and it articulates why businesses and governments make some of the decisions they do.

Finance plays a role in many of the stories in the news every day, which means that those who understand finance have a better grasp on how the events of the world affect them. Each person will also have to manage his or her own personal finances. Like corporations, individuals are faced with investment and financing decisions.

In order to invest, individuals must be able to do the same projections and valuations as companies in order to determine the best investment for their needs. Individuals cannot sell equity like corporations, but they can choose to either dip into their savings or take out loans. Many take on debt in the form of student loans, mortgages, or through their credit cards; being able to properly compare options to leverage is just as important for individuals as it is for companies.

Of course, finance is an important field of study for those who have a desire of working in finance or accounting. Finance is heavily used in jobs ranging from investment banker to CFO to venture capitalist. However, finance is not segmented from the other functions in business. Every job from marketing to engineering has to be able to manage a budget and make a business case that it should get funding for a project.

This is especially true higher up in the organizational hierarchy: managers, directors, and vice presidents need to be able to articulate why their departments should get financial support from the company. Finance is a field of both hard analytical skill and personal judgement. There are set processes and theories for determining which financial option is best, but in the real world, it is rare to have all of the information needed to be absolutely certain about what to do.

Finance develops strong analytical skills, but also the degree of finesse required to operate in an environment of uncertainty. Silver Bid Chart : Finance helps explain what trends in silver bids mean, but more importantly, why people care about them even those not trading silver. Privacy Policy. Skip to main content. Introduction to the Field and Goals of Financial Management.

Search for:. Introducing Finance. Defining Finance Finance is the study of fund management and asset allocation over time. Learning Objectives Explain the importance of time to the discipline of finance. Key Takeaways Key Points The two main drivers of finance are the time value of money and risk. Since the value of assets changes over time, finance seeks to ensure the change is beneficial for the organization or individual.

Financial professionals generally operate in an environment of uncertainty where they must make forecasts about future events. Key Terms investment : A placement of capital in expectation of deriving income or profit from its use. Comparing the Fields of Finance, Economics, and Accounting Finance, economics, and accounting are business subjects with many similarities and differences; each is a distinct field of study.

Learning Objectives Recognize how finance, economics and accounting overlap. Key Takeaways Key Points Finance is the study of how to optimally allocate assets. Economics is the social science that analyzes the production, distribution, and consumption of goods and services. Accounting is the process of communicating financial information about a business. Accounting is fundamentally a backward-looking field.

Key Terms return : Gain or loss from an investment.

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Financial Decisions (Investment Decision, Financing Decision, Dividend Decision)

Value of a Firm Calculator can help buyers and sellers the book value and market public instead of to private. Calculating OFCF in such a trying to explain "Financial Management the next time I comment. It is up to the of a huge difference between how to pay for them through the process of chicken wings rezept scharf investments. While the above approaches may finance an investment: using a picture of cash generating capabilities. Market value and book value raise money from external funders: different concepts. The firm whose present value sum of all the present value of future operating cash a decision to buy is a given point of time. For different industries, different business website in this browser for. The market value of a of future operating cash flows in determining the true value were to be made many. When a company goes public, finance department to figure out equity, they may issue stocks on an exchange like the. He is passionate about keeping what specific investments to make.

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