INVESTMENT, FINANCING, AND DIVIDEND DECISIONS

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There are three important decisions that financial managers need to make in business, namely: financing decisions, investment decisions and dividend decisions

Investment decision

Investment decision involves deciding on what asset to invest in to maximize the return on the investment.

To put it in another way, investment decision involves deciding on what to buy with the company limited resources in order to earn the highest possible return.

Investment decision also relates to how company resources and funds are invested in various assets.

Investment decisions can be short term and long term.

Short term investment decisions are concerned with the liquidity and profitability of a business.

They are decisions that ensure that a company has enough resources to meet its day-to-day expenses.

Short term is essentially any decision relating to the working capital management of a firm.

It is for this reason that short term investment decisions are sometimes called working capital decisions.

Long term investment decisions are decisions that relate to committing funds to fixed assets over a long period.

Examples of long term investment decisions are buying equipment, machinery.

Long term investment decisions are sometimes known as capital budgeting decisions because they involve investment decisions concerning a company's fixed asset.

Factors Affecting Investment Decisions

1. Operational Cash flow: When a company invests, it expects to generate some cash flow to meet everyday expenses.

This cash flow may be in the form of payment or cash receipt or payment.

Therefore, the amount of cash flow should be carefully considered while making an investment decision.

2. Rate of return: This is the most important factor in most investment decisions.

The rate of return is the net gain (or loss) of an investment expressed as a percentage of the original cost of the investment.

To illustrate, suppose there are two projects A and B and both have the same number of risks. Suppose that Project A has a 24% rate of return and project B has a 20% rate of return

Then, under normal circumstances Project A will be chosen over the project B.

3. Investment criteria involved: When a business wants to make an investment decision, it must consider different investment criteria.

Generally, businesses usually consider the following investment criteria

1. Will the investment maximize the value of the firm, considering the amount of risk involved in the investment.

2. How will the investment be financed appropriately?

Financing decision

Every business function (marketing, human resources, etc) requires one form of payment or another. 

Hence, financial managers must also make financing decisions.

Financing decisions involves determining which sources of funding are accessible to a company.

It entails determining the amount of money that can be raised from both short and long-term sources.

It involves deciding on when, where and how to acquire funds to meet the firm's investment needs.

It also entails determining the various sources of capital available to a business.

These sources of capital can be in two forms: shareholders funds and debt funds

Shareholders funds consist of the equity capital and the retained earnings.

Debt funds are monies received through debt instruments such as debentures. Debt funds are usually repaid with interest.

In making a financial decision, a firm has to decide on its capital structure. 

That is, it must decide on what proportion of its funds would come from shareholders and debt funds.

Because it entails deciding on the capital structure or mix of the business, a financing decision is also called a capital mix decision.

Factors Affecting Financing Decision

1. Cost: The cost of raising funds varies. Borrowed money, for example, frequently come with interest (the cost of borrowing funds), which is usually paid whether or not a company makes a profit.

However, finance from shareholders is usually cost-effective as there do not attract interest.

As such, a prudent financial manager should select the most cost-effective funding option.

2. Risk involved: The risk associated with various sources of finance differ. The risks associated with financing decisions are primarily financial.

Usually, borrowed funds come with higher financial risk than equity funds

It is up to the financial manager to identify the different available sources of finance and compare them in terms of the associated risks

3. Floatation cost: Firms usually incurred floatation costs when they issue securities in the primary market.

Floatation costs are costs incurred when new securities are issued.

Usually, the higher the floatation cost, the less attractive the source of finance and vice versa.

4. Cash flow position of the company: Cash flow is the movement of cash in and out of the business.

If the organization wants to borrow money from outside sources, it needs to have a more stable cash flow.

5. Business cycle: When the economy is growing, individuals tend to invest in equity, making it easier to access capital from the capital market.

When there is a recession, however, it becomes more difficult to raise funds from the equity market since people are less willing to invest

As a result, the business would have to rely on debt financing to stay afloat.

Dividend decision

Dividend refers to the portion of a company profit distributed to shareholders.

Dividend decisions involve determining how much of a company's profit should be distributed to shareholders and how much should be reinvested in the company (as retained earnings).

When making dividend decisions, financial managers must decide whether to distribute all profits, retain them, or distribute a portion and retain the balance.

It should be noted that dividend decision is also called profit allocation decision because it involves deciding on what percentage of profit should be allocated to the shareholders (dividend) and the business ( retained earnings).

Factors affecting dividend decisions

1. Profit of the business: Dividends are paid to shareholders depending on the company's current and previous earnings.

As a result, profit is an important consideration when deciding whether or not to pay a dividend

2. Stability of earnings: As noted earlier, a company paid dividends from present and past earnings.

So, therefore, a company with stable earnings is in a better position to pay dividends than one with unstable earnings

3. Cash flow position: Dividend represents an outflow of cash. 

As a result, to pay dividends, a corporation must have sufficient cash.

Hence, the availability of cash is necessary for the declaration of dividends.

4. Growth opportunities: Companies with strong growth prospects usually prefer to retain their earnings to fund those prospects

Therefore, dividend payments in companies with growth prospects will be lower than in organizations with no growth prospects.

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5. Shareholder preference: When declaring dividends, the corporation must take the shareholders' preferences into account.

If a majority of shareholders request that a portion of the company's income be distributed as dividends, the business is likely to comply.

This ensures that shareholders who rely on dividend income to stay afloat are adequately compensated.

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