Financial Management In Business Perspective.

A prominent feature of large corporations is that the owners (the stakeholders) are usually not directly involved in making business decisions, particularly on a day-to-day basis. Instead, the corporation employs managers to symbolize the owners’ interests and make decisions on their behalf. The financial manager, in a large corporation, must be concerned with the solutions of the three major decisions a firm must make - the investment decision, the financing decision and the working capital management decision.

Source: Google Images

The first decision concerns the firm’s long-term investments. The process of planning and managing the firm’s long-term investments is called capital budgeting. In capital budgeting, the financial manager will try to indentify investment opportunities that are worth more to the firm than their cost to acquire. Loosely speaking, this means that the value of the cash flow generated by an asset should exceed the cost of the asset acquired by the firm.

The type of investment opportunities that would typically be considered depend on the nature of the firm’s business. For example, a large retailer such as Tesco or Carrefour, deciding whether or not to open another store would be an important investment decision. Similarly, for a software company such as Microsoft, the decision to develop and market a new spreadsheet would be a major investment decision.

These actions can create enormous value for stakeholders, but they can also bankrupt the company. By learning Financial Management, one can learn how to decide which investment opportunities to pursue in a firm. Evaluating the size, time and risk of future cash flows is the essence of investment decision. These are, by far, the most important things which will need to be considered by financial managers in large corporations. Probably nothing that financial manager do is more important to the long-term success of a company than making good investment decisions.

The investment decision focuses on how firms should invest money, but it is particularly silent on where the firms attained the money to spend in the first place. The second decision which needs to be made by the financial manager concern methods in which the firm obtains the money to invest. A firm’s financing decision is the specific mixture of long-term debt and equity the firm uses to finance its operations. The firm’s financing structure determines what percentage of the firm’s cash flow goes to creditors and what percentage goes to shareholders. Firms have a great deal of flexibility in choosing a financial structure. The question of whether one structure is better than any other for a particular firm is the heart of the capital structure issue.

In addition to deciding on the financing mix, the financial manager in the firm has to decide exactly how and where to raise the money. The expenses associated with raising long-term financing can be considerable, so different possibilities must be carefully evaluated. Also, corporations borrow money from a variety of lenders in a number of different, and sometimes exotic, ways. Choosing among lenders and among loan types is another job handled by the financial manager.

By studying Financial Management an individual can understand the importance of financing decisions as to control risk and magnify returns for the firm’s owners and to understand capital structure theory so that they can make decisions about the firm’s optimal capital structure. Moreover, financial manager could identify the types of dividends, arguments about the relevance of dividends, the factors that affect dividend policy, and types of dividend policies to make appropriate dividend decisions for the firm.

The third decision concerns working capital management. The term working capital refers to a firm’s short-term assets, such as inventory, and its short-term liabilities, such as money owed to suppliers. Managing the firm’s working capital is a day-to-day activity that ensures that the firm has sufficient resources to continue its operations and avoid costly interruptions. This involves a number of activities related to the firm’s receipt and disbursement of cash. This decision is directly interconnected with the investment and financing decision. To ensure the firm has sufficient resources, financial manager must invest on resources, and to carry out this, the financial manager must initially decide on how to finance for it.

Financial managers in a huge business need to understand the management of working capital so that they can effectively manage the current assets and decide whether to finance the firm’s funds requirements aggressively or conservatively. They also need to know the sources of short-term loans so that, if short-term financing is needed, they will understand its availability and cost. Active management of the firm’s net working capital and current assets should positively contribute to the firm’s goal of maximizing its stock price.

The three areas of financial management I have described above - investment, financing and working capital management - need to answer one fundamental question: How does the decision under consideration affect the value of the stock? This is due to the fact that, the goal of financial management in a for-profit business is to make decisions that increase the value of stock, or, more generally, increase the market value of the equity. As their objectives are same, the decisions are said to be interrelated.

Source: Google Images

A company having profitable investment opportunities, generally prefer lower dividend payout ratio. On the other hand having a good investment means profit of the company would be more and more dividend can be paid to shareholders. Cost of capital plays a major role whether to accept or not an investment opportunity. Financing decisions also dependent on amount of to be retained in the profit. So, we can presume that investment, financing and working capital management decisions are interrelated and are to be taken jointly keeping in view their joint effect on the shareholders wealth in the business.

In a nut shell, the decision to invest in a new capital project, for example, necessitates financing the investment. The financing decision in turn, influences and is influenced by the working capital management. With a proper conceptual framework, combined decisions that tend to be optimal could be reached in any large corporations day-to-day operations, In Sha Allah.