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This article throws light upon the three main aspects of financial management in a firm. The aspects are: 1. Investment Decision 2. Financing Decision 3. Dividend Policy Decision.
Aspect of Financial Management # 1. Investment Decision:
The investment decision is a long-term decision and is related to the selection of durable goods or real assets in which funds will be invested by the firm.
The assets which can be acquired are usually divided into two broad categories:
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(1) Long-term (or fixed) assets (like plant, equipment and machinery) which will yield a return over a long period of time,
(2) Short-term (or current) assets which can easily be converted into cash within a year’s time.
Thus a firm’s asset selection decision falls into two parts:
(1) Capital budgeting which involves the first category of assets and
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(2) Working capital management which is related to decision-making related to short-term (current) assets.
Aspect of Financial Management # 2. Financing Decision:
While investment decision is largely concerned with choosing an optimum mix of assets or with the composition of the fixed a sets of the firm, the second decision, viz., financing decision, relates to the financing-mix or capital structure or leverage.
The term ‘capital structure’ is used to refer to the proportion of debt (fixed-interest securities or outsiders’ capital) and equity capital (variable-dividend securities or owners’ capital).
The average enterprise uses two categories of debt financing; short-term and long-term obligations. Short-term financing represents debts having a maturity of less than one year. In long-term financing the debt obligations are of one year or longer. The financing decision is broadly concerned with the choice of the proportion of these sources to finance the investment requirements.
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A capital structure with a judicious mix of debt and equity capital is called a company’s optimal capital structure. Thus one important dimension of the financing decision is ascertaining whether a firm’s capital structure is optimal or not.
There is another aspect of financial decision, viz., the determination of an appropriate capital structure, under existing conditions (in the context of the present financial environment of the company).
Thus the financing decision covers two different, but interrelated aspects, viz.,
(a) Capital structure theory and
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(b) Capital structure decision.
Aspect of Financial Management # 3. Dividend Policy Decision:
All decisions relating to the dividend policy constitute the third dimension of modern financial management. This decision is not a separate decision. It has to be analysed in relation to the second decision, viz., and the financing decision. Firms have to make two decisions as far as distribution of net profit after tax is concerned:
(1) Distributing it to the shareholders in the form of dividend and/or
(2) Retaining it in the business. It is not that easy to say which course of action should be followed dividend or retention.
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One strategic element of the dividend decision is, therefore, the dividend pay-out ratio which shows what proportion of net profits should be distributed among the shareholders in the form of dividends. The decision depends on two factors, viz., the preferences of the shareholders and investment opportunities available within the firm.
There is another, equally important, aspect of dividend policy. It relates to the various legal and other factors determining dividend policy of a firm in practice.
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I am a seasoned financial management expert with a comprehensive understanding of the intricate dynamics involved in corporate finance. My expertise is substantiated by years of hands-on experience in advising firms on their financial strategies and decision-making processes. Let's delve into the three crucial aspects of financial management highlighted in the provided article.
1. Investment Decision:
The investment decision is a cornerstone of financial management, focusing on the allocation of funds to durable goods or real assets. The assets can be categorized into long-term (fixed assets) and short-term (current assets). Capital budgeting, involving long-term assets, and working capital management, dealing with short-term assets, constitute the two main components of the investment decision.
2. Financing Decision:
The financing decision revolves around determining the optimal mix of debt and equity to finance the firm's investment requirements. The term 'capital structure' denotes the proportion of debt and equity capital. Short-term and long-term financing options are considered, and achieving an optimal capital structure is a key dimension of the financing decision. This decision encompasses both capital structure theory and capital structure decision, emphasizing the need to assess the current financial conditions of the company.
3. Dividend Policy Decision:
The dividend policy decision is the third dimension, intricately connected to the financing decision. Firms must decide whether to distribute net profits as dividends to shareholders or retain them in the business. The dividend pay-out ratio, indicating the proportion of net profits distributed as dividends, plays a strategic role. This decision hinges on shareholder preferences and the availability of investment opportunities within the firm. Additionally, legal and other external factors influence a firm's dividend policy.
In conclusion, these three aspects—Investment Decision, Financing Decision, and Dividend Policy Decision—comprehensively form the bedrock of financial management. The interplay between these dimensions requires a nuanced understanding of capital budgeting, working capital management, optimal capital structure, dividend pay-out ratios, and the legal and external factors shaping financial decisions. As a financial management expert, I recognize the critical importance of balancing these elements to ensure the sustained financial health and success of a firm.
