The following explanation will help in understanding each finance function in detail
Investment Decision
One of the most important finance functions is to intelligently allocate capital to long term assets. This activity is also known as capital budgeting.
It is important to allocate capital in those long term assets so as to get maximum yield in future. Following are the two aspects of investment decision
- Evaluation of new investment in terms of profitability
- Comparison of cut off rate against new investment and prevailing investment.
Since the future is uncertain therefore there are difficulties in calculation of expected return.
Along with uncertainty comes the risk factor which has to be taken into consideration. This risk factor plays a very significant role in calculating the expected return of the prospective investment.
Therefore while considering investment proposal it is important to take into consideration both expected return and the risk involved.
Investment decision not only involves allocating capital to long term assets but also involves decisions of using funds which are obtained by selling those assets which become less profitable and less productive.
It is a wise decision to decompose depreciated assets which are not adding value and utilize those funds in securing other beneficial assets.
An opportunity cost of capital needs to be calculating while dissolving such assets. The correct cut off rate is calculated by using this opportunity cost of the required rate of return (RRR)
Financial Decision
Financial decision is yet another important function which a financial manger must perform. It is important to make wise decisions about when, where and how should a business acquire funds.
Funds can be acquired through many ways and channels. Broadly speaking a correct ratio of an equity and debt has to be maintained. This mix of equity capital and debt is known as a firms capital structure.
A firm tends to benefit most when the market value of a companys share maximizes this not only is a sign of growth for the firm but also maximizes shareholders wealth. On the other hand the use of debt affects the risk and return of a shareholder. It is more risky though it may increase the return on equity funds.
A sound financial structure is said to be one which aims at maximizing shareholders return with minimum risk. In such a scenario the market value of the firm will maximize and hence an optimum capital structure would be achieved.
Other than equity and debt there are several other tools which are used in deciding a firm capital structure.
Dividend Decision
Earning profit or a positive return is a common aim of all the businesses. But the key function a financial manger performs in case of profitability is to decide whether to distribute all the profits to the shareholder or retain all the profits or distribute part of the profits to the shareholder and retain the other half in the business.
Its the financial managers responsibility to decide a optimum dividend policy which maximizes the market value of the firm. Hence an optimum dividend payout ratio is calculated.
It is a common practice to pay regular dividends in case of profitability. Another way is to issue bonus shares to existing shareholders.
Liquidity Decision
It is very important to maintain a liquidity position of a firm to avoid insolvency. Firms profitability, liquidity and risk all are associated with the investment in current assets.
In order to maintain a tradeoff between profitability and liquidity it is important to invest sufficient funds in current assets. But since current assets do not earn anything for business therefore a proper calculation must be done before investing in current assets.
Current assets should properly be valued and disposed of from time to time once they become non profitable. Currents assets must be used in times of liquidity problems and times of insolvency.
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FAQs
Finance functions cover Investment (allocating funds to assets for growth), Dividend (deciding on profit distribution to shareholders), Financing (raising capital through equity or debt), and Liquidity (ensuring sufficient cash flow for operations).
What are investment decisions financial decisions and dividend decisions? ›
Managers take investment decisions regarding various securities, instruments, and assets. They take financing decisions to ensure regular and continuous financing of the organisations. The dividend decision has to do with the correct amount of reward to its shareholders.
What are the 3 main decisions in finance? ›
When it comes to managing finances, there are three distinct aspects of decision-making or types of decisions that a company will take. These include an Investment Decision, Financing Decision, and Dividend Decision.
What are the 7 finance functions? ›
The seven popular functions are decisions and control, financial planning, resource allocation, cash flow management, surplus disposal, acquisitions, mergers, and capital budgeting.
What are the four 4 functions of the financial system? ›
The financial system serves four main functions: providing a payment system, matching borrowers and lenders, enabling individuals to manage their finances across lifetimes and generations, and sharing and managing risk.
What are the 4 areas of finance? ›
What is finance? Finance is the management of money which includes investing, borrowing, lending, budgeting, saving and forecasting. There are four main areas of finance: banks, institutions, public accounting and corporate.
What is an example of a financial investment decision? ›
An investment decision could involve purchasing new equipment, investing in research and development, buying new property, or expanding into new markets. These decisions often have long-term implications and are influenced by a multitude of factors.
What is a liquidity decision? ›
Liquidity decision:
The liquidity decision is concerned with the management of the current assets, which is a pre-requisite to long-term success of any business firm. This is also called as working capital decision.
What is the function of investment decision in financial management? ›
Investment decision refers to the decisions that involve the investment of various resources of the firm to gain the highest possible return on investment for their investors. An investment decision is categorized as a long-term and short-term investment decision.
What is dividend and why is dividend decision important? ›
DEFINITION: DIVIDEND POLICY
It is the decision about how much of earnings to pay out as dividends versus retaining and reinvesting earnings in the firm. Dividend policy must be evaluated in light of the objective of the firm namely, to choose a policy that will maximize the value of the firm to its shareholders.
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.
What affects financial decisions? ›
Some of the most common factors that influence financial decisions include age, marital status, employment status, and the number of household members. Certain factors influence financial decisions more than others.
What is a finance function? ›
The finance function manages a business' finances and helps with decision-making. This allows businesses to manage in the modern world. Part of BusinessOperations, finance and influences on business.
What is the function of liquidity in finance? ›
Liquidity in finance refers to the ease with which a security or an asset can be converted into cashat market price.
What are the three main functions of financial management? ›
Maintaining liquidity. Analyzing the financial status of the company or business from time to time. Disposal of surplus assets.
What are the 4 primary components of a financial system? ›
The main financial system components include financial institutions, financial services, financial markets, and financial instruments.
What are the 4 major functions of accounting explain each? ›
The primary functions of an accounting system are to track, report, execute, and predict financial transactions. The basic function of financial accounting is to also prepare financial statements that help company leaders and investors to make informed business decisions.
What are the four 4 functions of money explain? ›
whatever serves society in four functions: as a medium of exchange, a store of value, a unit of account, and a standard of deferred payment.
What are the four main functions of financial planning? ›
4 Key Steps Of Successful Financial Planning
- Step 1 – Set SMART Goals. This step in financial planning involves defining your financial goals. ...
- Step 2 – Budget Your Expenses. ...
- Step 3 – Find Out Where To Invest. ...
- Step 4 – Monitoring And Rebalancing.
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The article is Written By Prachi Juneja and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on 