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Types Of Decisions Made By A Finance Manager

The Investment Decision

Management must allocate limited resources between competingopportunities (projects) in a process known as capitalbudgeting.Making this investment, or capital allocation, decisionrequires estimating the value of each opportunity or project, which isa function of the size, timing and predictability of future cash flows.

a. Project Valuation:

In general, each project's value will be estimated using a discounted

cash flow (DCF) valuation, and the opportunity with the highest value,as measured by the resultant net present value (NPV) will beselected. This requires estimating the size and timing of all of theincremental cash flows resulting from the project.

b. Valuing Flexibility:

In many cases, for example R&D projects, a project may open (orclose) various paths of action to the company, but this reality will not(typically) be captured in a strict NPV approach. Management will

therefore (sometimes) employ tools which place an explicit value onthese options.

c. Quantifying Uncertainty:

Given the uncertainty inherent in project forecasting and valuation,analysts will wish to assess the sensitivity of project NPV to thevarious inputs (i.e. assumptions) to the DCF model. In a typicalsensitivity analysis the analyst will vary one key factor while holding

all other inputs constant.

The Financing Decision

Achieving the goals of corporate finance requires that any corporateinvestment be financed appropriately. The sources of financing are,generically, capital self-generated by the firm as well as debt and

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equity financing sourced form outside investors. As above, since bothhurdle rate and cash flows (and hence the riskiness of the firm) willbe affected, the financing mix will impact the valuation of the firm aswell as long-term financial management decisions.

The Dividend Decision

Whether to issue dividends, and what amount, is calculated mainly onthe basis of the company's unappropriated profit and its earningprospects for the coming year. The amount is also often calculatedbased on expected free cash flows i.e. cash remaining after allbusiness expenses, and capital investment needs have been met.Management must also decide on the form of the dividenddistribution, generally as cash dividends or via a share buyback.Various factors may be taken into consideration: where shareholdersmust pay tax on dividends, firms may elect to retain earnings or toperform a stock buyback, in both cases increasing the value ofshares outstanding.

Working Capital Management

Decisions relating to working capital and short term financing arereferred to as working capital management. These involve managing

the relationship between a firm's short-term assets and its short-termliabilities. The goal of Working Capital (i.e. short term) management istherefore to ensure that the firm is able to operate, and that it hassufficient cash flow to service long term debt, and to satisfy bothmaturing short-term debt and upcoming operational expenses. In sodoing, firm value is enhanced when, and if, the return on capitalexceeds the cost of capital. Management will use a combination ofpolicies and techniques for the management of working capital:

a. Cash Management:

Identify the cash balance which allows for the business to meet dayto day expenses, but reduces cash holding costs.

b. Inventory Management:

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Identify the level of inventory which allows for uninterruptedproduction but reduces the investment in raw materials andminimizes reordering costs and hence increases cash flow; seeSupply chain management; Just In Time (JIT); Economic orderquantity (EOQ); Economic production quantity (EPQ).

c. Debtors Management:

Identify the appropriate credit policy, i.e. credit terms which will attractcustomers, such that any impact on cash flows and the cashconversion cycle will be offset by increased revenue and henceReturn on Capital (or vice versa); see Discounts and allowances.

d. Short Term Financing:

Identify the appropriate source of financing, given the cashconversion cycle: the inventory is ideally financed by credit grantedby the supplier; however, it may be necessary to utilize a bank loan(or overdraft), or to "convert debtors to cash" through "factoring".

Financial Risk Management

Risk management is the process of measuring risk and thendeveloping and implementing strategies to manage that risk.Financial risk management focuses on risks that can be managed("hedged") using traded financial instruments (typically changes incommodity prices, interest rates, foreign exchange rates and stockprices).