The Three Basics of Financial Management. Finance is a key area of professional practice. It is said that, to become a master in any subject, you should be very clear on the basics of that subject. Now scroll down below n check more details about The Three Basics of Financial Management. Here, we have compiled a list of three basic concepts with which the subject ‘Financial Management’ deals:
- Basic Decisions Involved in Financial Management
- Concept of Risk vs. Return
- Profit Maximizations vs. Wealth Maximization
Let us have a detailed look on what do these concepts involve:
Basic decisions Involved in Financial Management
Investment Decisions:
Investment, in simple terms, means utilization of money for profits or returns. They include matters which involve the concepts of Capital Budgeting, Cost of Capital,- Measuring Risk, Management of Liquidity and Current Assets.
- Investments lead to exchange of current funds for future benefits.
- Capital is a scarce resource and its supply cost is very high.
- Optimal investment decisions need to be made after considering factors like:
- Estimation of Cash Outflows & Inflows; an
- Availability of capital and estimating cost of capital.
Financing Decisions:
Dividend Decisions:
The dividend decision is a major area of financial management.Concept of Risk Vs. Return:
- Higher the return, other things being equal, higher the market value; higher the risk, other things being equal, lower the market value.
- The financial manager tries to achieve the proper balance between the considerations of risk and return associated with various financial management decisions to maximize the market value of the firm.
- Risk and Return go together. This implies that a decision alternative with high risk tends to promise higher return and the reverse is also true.
Profit maximizations vs. Wealth maximization:
The following table shows a comparative distinction between the two concepts:Goal | Objective | Advantages | Disadvantages |
Profit maximization | Large amount of profits | 1. Easy to calculate profits. 2. Easy to determine the link between financial decisions and profits. | 1. Emphasizes the short term. |
Shareholder wealth maximization | Highest market value of common stock | 1. Emphasizes the long term. | 1. Offers no clear relationship between financial decisions and stock price. |