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Q.1 What are the 4 finance decisions taken by a finance manager.


Answer:
Finance functions deal with the functions performed by the finance manager. They are closely related to financial decisions. In the course of performing these functions, finance manager takes several decisions


  • Finance decisions
  • Investment decisions
  • Liquidity decisions
  • Dividend decisions
·         Organization of a finance function


Finance decisions:
Financing decisions relate to the acquisition of funds at the least cost. Cost has two dimensions:

Explicit Cost
Implicit cost
Explicit cost refers to the cost in the form of coupon rate, cost of floating and issuing the security.

Implicit cost is not a visible cost but it may seriously affect the company’s operations especially when it is exposed to business and financial risk.

In India, if a company is unable to pay its debts, creditors of the company may use legal means to sue the company for winding up. This risk is normally known as risk of insolvency. A company which employs debt as a means of financing normally faces this risk especially when its operations are exposed to high degree of business risk.
In all financing decisions, a firm has to determine the proportion of equity and debt. The composition of debt and equity is called the capital structure of the firm.
Debt is cheap because interest payable on loan is allowed as deductions in computing taxable income on which the company is liable to pay income tax to the Government of India.

An investor in a company’s shares has two objectives for investing:
  • Income from capital appreciation (capital gains on sale of shares at market price)
  • Income from dividends

It is the ability of the company to give both these incomes to its shareholders that determines the market price of the company’s shares.

The most important goal of financial management is maximization of net wealth of the shareholders. Therefore, management of every company should strive hard to ensure that its shareholders enjoy both dividend income and capital gains as per the expectation of the market.
Financing decision involves the consideration of managerial control, flexibility and legal aspects and regulatory and managerial elements.

Investment decisions
To survive and grow, all organizations have to be innovative. Innovation demands managerial proactive actions. Proactive organizations continuously search for innovative ways of performing the activities of the organization. Innovation is wider in nature. It could be:

·         expansion through entering into new markets
  • adding new products to its product mix
  • performing value added activities to enhance customer satisfaction
  • adopting new technology that would drastically reduce the cost of production
  • Rendering services or mass production at low cost or restructuring the organization to improve productivity these innovations change the profile of an organization. These decisions are strategic because they are risky. However, if executed successfully with a clear plan of action, investment decisions generate super normal growth to the organization.

A firm may become bankrupt, if the management fails to execute the decisions taken. Therefore, such decisions have to be taken after taking into account all the facts affecting the decisions and their execution.

There are two critical issues to be considered in these decisions.
• Evaluation of expected profitability of the new investments.
• Rate of return required on the project.

The Rate of Return required by an investor is normally known as the hurdle rate or the cut-off rate or the opportunity cost of capital.
Investments in buildings and machineries are to be conceived and executed by a firm to enter into any business or to expand its business. The process involved is called Capital Budgeting. Capital Budgeting decisions demand considerable time, attention and energy of the management. They are strategic in nature as the success or failure of an organization is directly attributable to the execution of Capital Budgeting decisions taken.

Investment decisions are also known as Capital Budgeting Decisions and hence lead to investments in real assets.

Dividend decisions:
Dividends are pay-outs to shareholders. Dividends are paid to keep the shareholders happy. Dividend decision is a major decision made by a finance manager. It is based on formulation of dividend policy. Since the goal of financial management is maximization of wealth of shareholders, dividend policy formulation demands the managerial attention on the impact of its policy on dividend and on the market value of its shares.

Optimum dividend policy requires decision on dividend payment rates so as to maximize the market value of shares. The payout ratio means what portion of earnings per share is given to the shareholders in the form of cash dividend. In the formulation of dividend policy, the management of a company will have to consider the relevance of its policy on bonus shares.

Dividend policy influences the dividend yield on shares. Dividend yield is an important determinant of an investor’s attitude towards the security (stock) in his portfolio management decisions.

The following issues need adequate consideration in deciding on dividend policy:
• Preferences of share holders – Do they want cash dividend or capital gains?
• Current financial requirements of the company
• Legal constraints on paying dividends
• Striking an optimum balance between desires of share holders and the company’s funds requirements

Liquidity decision
Liquidity decisions deals with Working Capital Management. It is concerned with the day-to-day financial operations that involve current assets and current liabilities.

The important elements of liquidity decisions are:
• Formulation of inventory policy
• Policies on receivable management
• Formulation of cash management strategies
• Policies on utilization of spontaneous finance effectively
Organization of finance function
Financial decisions are strategic in character and therefore, an efficient organizational structure is required to administer the same. Finance is like blood that flows throughout the organization. In all organizations, CFOs play an important role in ensuring proper reporting based on substance of the stake holders of the company. Finance functions are organized directly under the control of board of directors, because of the crucial role these functions play. For the survival of the firm, there is a need to ensure both long term and short term financial solvency.
Weak functional performance by financial department will weaken production, marketing and HR activities of the company. The result would be the organization becoming anemic. Once anemic, unless crucial and effective remedial measures are taken up, it will pave way for corporate bankruptcy. Under the CFO, normally two senior officers manage the treasurer and controller functions.

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