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 4 routine functions in financial management? ›
- Estimating Capital Expenses. While estimating the capital expense, a company must keep the following points in mind: ...
- Determining Capital Structure. One of the functions of financial manager is determining the capital structure. ...
- Choosing Sources of Funds. ...
- Procurement of Funds. ...
- Investment of Funds. ...
- Surplus Disposal.
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 five key functions of a financial system are: (i) producing information ex ante about possible investments and allocate capital; (ii) monitoring investments and exerting corporate governance after providing finance; (iii) facilitating the trading, diversification, and management of risk; (iv) mobilizing and pooling ...
What are the 4 areas of 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 are the three major decisions of financial management? ›
There are three primary types of financial decisions that financial managers must make: investment decisions, financing decisions, and dividend decisions.
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 dividend and dividend decision? ›
Dividend decision relates to how much of the company's net profit is to be distributed to the shareholders and how much of it should be retained in the business for meeting the investment requirements. This decision should be taken keeping in mind the overall objective of maximising shareholders' wealth.
What are the 4 C's of financial management? ›
Character, capital, capacity, and collateral – purpose isn't tied entirely to any one of the four Cs of credit worthiness. If your business is lacking in one of the Cs, it doesn't mean it has a weak purpose, and vice versa. Instead, the four categories come together to constitute purpose.
The Four elements of Financial Management
- Planning. Identify the steps that align with the association or individual objectives. ...
- Controlling. Ensure each aspect of the association follows the established plan. ...
- Organizing and directing. ...
- Decision making.
Most financial management plans will break them down into four elements commonly recognised in financial management. These four elements are planning, controlling, organising & directing, and decision making.
What are the three main functions of financial management? ›
It comprises three essential components, namely investment decisions, financing decisions, and dividends. It helps the firm maximize profit, liquidity, and earnings per share.
What is an example of a liquidity decision? ›
Liquidity decision:
If a firm does not have adequate working capital, it may become illiquid and consequently fail to meet its current obligations thus inviting the risk of bankruptcy. On the contrary, if the current assets are too enormous, the profitability is adversely affected.
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 primary functions of finance? ›
The primary functions of the department are accounting and reporting, accounts receivable, accounts payable, payroll, cash receipts, cash management and investments. The department is also responsible for the issuance of debt for capital projects, the retirement fund, purchasing, and budget preparation.
What are the 4 functions of money? ›
Money serves four basic functions: it is a unit of account, it's a store of value, it is a medium of exchange and finally, it is a standard of deferred payment.
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