The following are the two decisions of financial management.:
(i) Investment decisions: This term refers to the decisions regarding where to invest so as to earn the highest possible returns on investment and maximize shareholder wealth. These decisions can be taken for both long term and short term. Longterm investment decisions, also known as Capital Budgeting decisions, affect a business' long term earning capacity and profitability. For example, investment in a new machine is a long term investment decision. Short term investment decisions, also knownas Working Capital decisions, affect a business' day to day working operations. For example, decisions regarding cash or bill receivables are short term investment decisions. These are very important for the company.
(ii) Financial decisions: Such decisions involve identifying various sources of funds and deciding the best combination for raising the funds. The main sources for raising funds are shareholders' funds (referred to as equity) and borrowed funds (referred to as debt). Based on the cost involved, risk and profitability, a company must judiciously decide the combination of debt and equity to be used. For example, while debt is considered to be the cheapest source of finance, higher debt means high financial risk thus high debt is also risky for the business. Financial decisions of a company affect its overall cost of capital and financial risk so it is also carefully taken.