Profitability is the critical factor that determines the success or failure of a business.
It is also one of the significant indicators of the operational efficiency of a firm. But most importantly, profitability defines the return on investments, which is why it hugely depends on the company’s financial decisions. Like any other situation, decision making in an organization is essential to make the best use of available resources.
It is essential to pursue and keep up with a significant financial decision because they define the route towards the organizational goals. So, all the decisions related to capital are financial decisions that help you run your company efficiently. Altogether three critical financial decisions impact your company’s profitability and ensure long-term growth. Let’s have a look at them;
1. Investment Decisions
Deciding on investment is the first step towards an effective financial plan, otherwise known as the Capital Budgeting Decision. It sets the basis of which resource to invest the capital on and so forth. Since the company has only scarce resources and should adequately utilize them, consideration of opportunity cost is essential. It would help if you decided on investing in assets that have possibly promising returns. Amongst the two types of assets, fixed and current, your investment decision must focus on funding your fixed assets. They tend to be useful for the company in the longer-term. These are the most costly assets of the company and play a significant role in maximizing profitability.
These decisions should only be carried out by professional managers and those who have a detailed knowledge of investment decisions. However, if you lack such personnel, you must hire people who have earned an online MBA in accounting or finance. It will help you with making these decisions in a better way. Investment decisions impact decisions like expansion, project costs, research and development, assets and their replacement, and much more. However, three essential aspects affect the investment decision; cash inflow and outflow, return rate, and capital budgeting criteria. The cash flow determines the business’s sustainability because it should cover daily expenses to encourage further investment in the venture. Lastly, the requirements for investment regulates the whole plan for the decisions that need to be made.
2. Financing Decisions
After the investment decisions, the company needs to decide to gather funds for the investments. The importance of this decision can be seen through its impact on profitability. If an organization’s market shares are high, only then would it develop efficiently and generate profit to attract investors further. But it isn’t an easy decision to make. The financial manager needs to ensure that if the company plans to raise funds through equity, equity holders will expect a higher return. So, to maintain the balance, financing decisions should only be taken where the risks and costs are minimized.
Many factors can affect the financing decision, such as control of the shareholder on business decisions. Similarly, the industry’s conditions are also critical because the company is excelling when the economy is booming. But at times of depression, it can be in debt. So, the company should always use up-to-date technology, which helps in making better financial decisions. Other factors could be the risk and cost associated with the investment decision and how much financial loss such decisions could bring to the company.
3. Dividend Decisions
It is essential to ensure that the shareholders, investors, and financers of those investments, receive their rightful return from their profits. The dividend is the amount that is distributed amongst the shareholders from the profit for the year. The remaining is then stored as retained earnings to be invested in any other operation later on. The importance of the dividend decision is that the higher the return rate, the more the company attracts shareholders. Hence, the market share increases, which further increases the profitability of the company.
Several factors could affect the decision regarding dividends. Foremost is the income because current and past income are taken into consideration when paying off the dividends. Moreover, political factors such as tax can also significantly impact because the more the tax payable, the less the dividends. Suppose the company wants to retain or make its place in the stock market. In that case, dividends’ decisions must lean in favor of the shareholders.
The significant decisions regarding investment, financing, and dividend can have a massive impact on profitability. Still, there sure are many other factors that impact the company’s viability. For instance, in the light of the on-going pandemic, many businesses lost their place in the industry and went bankrupt. However, after taking viable liquidity decisions, many of those failing businesses survived the unforeseen conditions. Most decisions regarding investment in the current assets help in avoiding insolvency and in efficiently carrying out operations. These, however, are short-term decisions that deal with working capital – the day-to-day running expenses.
In a nutshell, the company should try to be proactive if they want to be competitive. Still, some decisions require extensive research and knowledge to maintain and maximize the company’s profits. Devising monetary strategies is a crucial component of any business. Without proper allocation of earnings, companies might not be able to sustain their future operations. Furthermore, through strategic financial decision making, companies can expand their operations worldwide and realize increasing market growth. Thus, hiring the best finance experts helps a company make lucrative financial decisions.