Major financial decisions taken by finance managers

Financial management deals with three major problems, corresponding to the questions of investment, financing and dividend decisions: procuring funds at the lowest cost, investing them profitably, and distributing returns to the shareholders.

1. Investment decision. It concerns the asset composition of the firm: where to invest.
   • Capital budgeting: investment in long-term assets whose benefits come over many years, such as buying an asset, choosing between alternatives, buying or leasing, or acquiring a firm. Its aim is to pick assets worth more than their cost.
   • Working capital management: investment in current assets (inventory, credit to customers), balancing profitability against liquidity.
2. Financing decision. When, where from and how to raise the funds the investments need. The two main sources are shareholders' funds and borrowed funds, and the central issue is the proportion of each, the firm's capital structure.
3. Dividend decision. How much of the profit to distribute to the shareholders and how much to retain for reinvestment, so as to satisfy shareholders' expectations while funding growth.

All three are taken with one aim: to maximise the shareholders' wealth, that is, the market value of the shares.

Interrelation. The three decisions are not independent. An investment proposal can be accepted only if it earns more than the cost of the funds raised for it, which depends on the financing decision; and a decision to retain more profit (the dividend decision) is also a decision to finance investment internally. The finance manager therefore takes them jointly, so that together they maximise the value of the firm.