How companies make financial decisions

paraphrase part one

PART ONE: HOW COMPANIES MAKE FINANCIAL DECISIONS 

Introduction

Financial decision making forms an important part of the normal operations of a company. These financial decisions are facilitated by the management in consultation with the finance department. The financial team needs to understand that these decision are essential and thus the overall goal of maximizing the shareholder’s value is achieved (Suto et al. 2007P). Therefore, financial decisions should be appreciated as an important aspect in investment because they play a vital role in the overall operations and management of the company.

Making Financial Decisions

Financial decisions can be categorized into four essential groups. These groups are;

• Determination of the financial value of the given assets
• Determination of the viability of the project in terms of financial benefits – this is an investment decision
• Raising of the additional capital for the identified investment- this is a financial decision
• Dividend policy

Determining the financial value of an asset

One of the basic methods used in financial decision making is valuation. Valuation involves the determination of the net worth of the available financial assets.  These financial assets involve; stocks, options, patents, and trademarks. The value of an asset is therefore determined based on various factors. Such factors include; expected cash flow, required rate of return, and riskiness of the cash flow.  The expected cash flows include the appreciation of the assets, dividends, interest, and bonds (Ingersoll, 1987). On the other hand, the required rate of return is based on the risks associated with the available assets.

Investment decisions

These are central decisions that govern the manner in which a company can reallocate the available resources and funds. Investment decisions are divided into two major groups namely; short term and long term reallocation. An example of short term investment decision is the determination of the level of current assets needed in maintaining daily business operations. Conversely, typical examples of long term investment decisions include; expansion, reorganization, and capital expenditure.  Short term investment decisions are based on techniques such as the ratio analysis and liquidity analysis. Effective management of current assets is attained through the utilization of all the above outlined techniques so as to facilitate decision making. Long term investment decisions include; capital investment decisions which is based on the capital budgeting method. Prior to making a decision, the company decides on what capital budgeting techniques. Such techniques include; NPV, MIRR, and IRP (Ingersoll, 1987). The technique to be applied depends on the type and nature of the project at hand and the benefits that the method would yield. Moreover, cost analysis is also conducted to determine the best discount rate to be used in the cost analysis. It is at this stage where the concept of weighted average cost of capital is used.

Financing decisions

Financing is a crucial component of the financial decision-making in an organization. Each part of a business requires money for it to function. While investigating financing alternatives, the speculator or business needs to settle on a choice based on how the organization intends to work. Financing decisions are reliant on a few factors. These factors are; the organization’s area, financing decisions that are accessible to the organization, the organization’s capital needs, and the size of the organization. Small firms have less options with regards to raising extra capital (Suto et al. 2007). They mostly depend on family and companions to raise working capital. On the other hand, large firms can source extra financing from loans, issuing corporate securities, and issuance of stocks. To settle on ideal financing decision, managers need to decide on the financing mix for the organization. They have to decide the amount to acquire (obligation financing) and the offers to issue (value financing) with a specific end goal to minimize the cost of additional financing.

Dividend policy