Financial management is based on three broad financial decisions. What are these?

Financial management refers to the efficient acquisition, allocation and usage of funds of the company. It deals in three main dimensions of financial decisions namely, Investment decisions, Financial decisions and Dividend decisions.

Investment Decisions: Investment decisions refer to the decisions regarding where to invest so as to earn the highest possible returns on investment. Investment decisions can be taken for both long term as well as short term.

Long term investment decisions also known as Capital Budgeting decisions affect a business’ long term earning capacity and profitability. For example, investment in a new machine, purchase of a new building, etc. are long term investment decisions.

Short term investment decisions also known as working capital decisions affect a business’ day to day working operations. For example, decisions regarding cash or bill receivables are short term investment decisions.

Financial Decisions: Such decisions involve identifying various sources of funds and deciding the best combination for raising the funds. The main sources for raising funds are shareholders’ funds (referred as equity) and borrowed funds (referred as debt). Based on the cost involved, risk and profitability a company must judiciously decide the combination of debt and equity to be used. For example, while debt is considered to be the cheapest source of finance, higher debt increases the financial risk. Financial decisions taken by a company affects its overall cost of capital and the financial risk.

Dividend Decisions: The decision involves the decision regarding the distribution of profit or surplus of the company. A company can distribute its profit to the equity shareholders in the form of dividends or retain it with itself. Under dividend decision, a company decides what proportion of the surplus to distribute as dividends and what proportion to keep as retained earnings. It is aimed at maximising the shareholders’ wealth while keeping in view the requirement of retained earnings that are needed for re-investment.

Financial management is concerned with the’ solution of three major issues relating to the financial operations of a firm corresponding to the three questions of Investment, Financing and Dividend decision. In a financial context, it means the selection of best financing alternative or best investment alternative. 

The finance function, therefore, is concerned with three broad decisions which are as follows:

1. Investment Decision: The investment decision relates to how the firm’s funds are invested in different assets. 

2. Financing Decisions: This decision is about the quantum of finance to be raised from various long term sources and short term sources. It involves identification of various available sources of finance. 

3. Dividend Decision: This decision relates to distribution of dividends. Dividend is the portion of profit which is distributed to shareholders. The decision involved here is how much of the profit earned by company is to be distributed to the shareholders and how much of it should be retained in the business for meeting investment requirements