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Question
Give the meaning of 'Investment' and 'Financing' decisions of financial management.
Solution
Financial management means efficiently acquiring and using funds. It is concerned with main financial decisions:
1) Investment Decisions:
A firm must decide where to invest the funds such that it can earn maximum returns. Such decisions are known as investment decisions. These decisions are taken for both long term and short term.
Long-term investment decisions: These decisions affect a firm’s long-term earning capacity and profitability. They are also known as the capital budgeting decisions. For example, the decision to purchase a new machine and land
Short-term investment decisions: These decisions, also known as working capital decisions, affect the day-to-day business operations. For example, decisions related to cash or bill receivables.
2) Financial Decisions: Financing decisions involve decisions with regard to the volume of funds and identifying the sources of funds. There are two main sources of raising funds—shareholders’ funds (equity) and borrowed funds (debt). Considering factors such as cost, risk and profitability, a company must decide an optimum combination of debt and equity. Example: While debt proves to be cheaper than equity, it involves greater financial risk. Financial decisions must be taken judiciously as they have an impact on the overall cost of capital of the firm and involve financial risk.
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What is meant by ‘Investment Decision’?
State how 'Long term Investment Decision' and 'Short term Investment Decision' affect the business.
