Introducing Finance: Types of Financial Decisions: Investment and Financing | Saylor Academy (2024)

Introducing Finance

Read this introductory article, which will help you understand what the field of finance encompasses. What do you learn in a course in finance that you do not learn in financial accounting? How does finance build on what you learned? What does a financial manager do?

Types of Financial Decisions: Investment and Financing

Investment and financing decisions boil down to how to spend money and how to borrow money.

Learning Objective

  • Identify the criteria a corporation must use when making a financial decision

Key Points

  • The primary goal of bothinvestmentandfinancingdecisions is to maximizeshareholdervalue.
  • Investment decisions revolve around how to bestallocatecapitalto maximize their value.
  • Financing decisions revolve around how to pay for investments and expenses. Companies can use existing capital, borrow, or sellequity.

Terms

  • equity

    Ownership, especially in terms of net monetary value, of a business.

  • expected return

    Considering the magnitude and likelihood of exogenous events, the yield that an investor predicts s/he will earn on average.

  • financing

    A transaction that provides funds for a business.


    There are two fundamental types of financial decisions that thefinanceteam needs to make in a business: investment and financing. The two decisions boil down to how to spend money and how to borrow money. Recall that the overall goal of financial decisions is to maximize shareholder value, so every decision must be put in that context.

    Investment

    An investment decision revolves around spending capital onassetsthat willyieldthe highestreturnfor the company over a desired timeperiod. In other words, the decision is about what to buy so that the company will gain the most value.

    To do so, the company needs to find a balance between its short-term and long-term goals. In the very short-term, a company needs money to pay its bills, but keeping all of its cash means that it isn't investing in things that will help it grow in the future. On the other end of the spectrum is a purely long-term view. A company that invests all of its money will maximize its long-term growth prospects, but if it doesn't hold enough cash, it can't pay its bills and will go out of business soon. Companies thus need to find the right mix between long-term and short-term investment.

    The investment decision also concerns what specific investments to make. Since there is no guarantee of a return for most investments, the finance department must determine anexpected return.This return is not guaranteed, but is the average return on an investment if it were to be made many times.

    The investments must meet three main criteria:

    1. It must maximize the value of the firm, after considering the amount ofriskthe company is comfortable with (risk aversion).
    2. It must be financed appropriately (we will talk more about this shortly).
    3. If there is no investment opportunity that fills (1) and (2), the cash must be returned to shareholder in order to maximize shareholder value.

    Financing

    All functions of a company need to be paid for one way or another. It is up to the finance department to figure out how to pay for them through the process of financing.

    There are two ways to finance an investment: using a company's own money or by raising money from external funders. Each has its advantages and disadvantages.

    There are two ways to raise money from external funders: by taking ondebtor selling equity. Taking on debt is the same as taking on a loan. The loan has to be paid back withinterest, which is the cost of borrowing. Selling equity is essentially selling part of your company. When a company goes public, for example, they decide to sell their company to the public instead of toprivateinvestors. Going public entails sellingstockswhich represent owning a small part of the company. The company is selling itself to the public in return for money.

    Every investment can be financed through company money or from external funders. It is the financing decision process that determines the optimal way to finance the investment.

    Introducing Finance: Types of Financial Decisions: Investment and Financing | Saylor Academy (2024)

    FAQs

    What types of financing and investing decisions do you take? ›

    Investment decisions revolve around how to best allocate capital to maximize their value. Financing decisions revolve around how to pay for investments and expenses. Companies can use existing capital, borrow, or sell equity.

    What are the types of financial management decisions and what questions are they designed to answer? ›

    There are three primary types of financial decisions that financial managers must make: investment decisions, financing decisions, and dividend decisions. In this article, we will discuss the different types of financial decisions that are taken in order to manage a business's finances.

    What is the role of a financial manager investment of funds? ›

    The financial manager must decide how much money is needed and when, how best to use the available funds, and how to get the required financing. The financial manager's responsibilities include financial planning, investing (spending money), and financing (raising money).

    What is an investment decision in business finance? ›

    Investment decision refers to selecting and acquiring the long-term and short-term assets in which funds will be invested by the business.

    What are the 3 main decisions in finance? ›

    When it comes to managing finances, there are three distinct aspects of decision-making or types of decisions that a company will take. These include an Investment Decision, Financing Decision, and Dividend Decision.

    What is the difference between finance and financial management? ›

    Explanation: Business finance deals primarily with rising administering and disbursing funds by privately owned business units operating in non-financial fields of industry whereas Financial management involves planning, organizing, and controlling the financial activities of an organization.

    What is the primary goal of financial management? ›

    Typically, the primary goal of financial management is profit maximization. Profit maximization is the process of assessing and utilizing available resources to their fullest potential to maximize profits. This has the greatest benefit for company shareholders hoping for the highest possible return on their investment.

    What is the first step in financial planning? ›

    1. Assess your financial situation and typical expenses. An important first step is to take stock of your current financial situation. Even if you're not where you'd like to be, be honest with yourself about the income you're currently generating, savings you've accumulated and your general spending habits.

    How do financial managers take financing and investment decisions? ›

    What is the Financing Decision? The Financing Decision is a crucial decision that is to be made by the financial manager, the decision is about the financing-mix of an organization. Financing Decision is focused on the borrowing and allocation of funds required for the investment decisions of the firm.

    What is the difference between a financial decision and an investment decision? ›

    Financing Decisions includes an Inflow of cash. Investment Decisions include outflow of cash. In financing decisions, How much debt and equity sell, When to pay a dividend. capital decisions: related to buying the inventory (Stock), expenses for day-to-day activities.

    What is an example of an investment decision in finance? ›

    An investment decision could involve purchasing new equipment, investing in research and development, buying new property, or expanding into new markets. These decisions often have long-term implications and are influenced by a multitude of factors.

    What are the financing decisions? ›

    What is the Financing Decision? The Financing Decision is a crucial decision that is to be made by the financial manager, the decision is about the financing-mix of an organization. Financing Decision is focused on the borrowing and allocation of funds required for the investment decisions of the firm.

    Which is an example of a financing decision? ›

    Financing decisions =how a firm will raise capital. Examples:securing a bank loan or selling debt in the public capital markets. Capital budgeting involves deciding which productive assets the firm invests in, such as buying a new plant or investing in the renovation of an existing facility.

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