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What are the types of Finance Functions?
Finance functions are divided into two broad functions − Long-term decisions and Short-term decisions. Long-term decisions are applicable to a tenure of more than one year, while short-term decisions are meant for one year or less.
Note − Finance functions or decisions are broadly divided into long-term and short-term decisions.
Long-term Decisions include: Investment Decision, Financing Decision, and Dividend Decision.
A company's investment decision must consider long-term budgeting or capital expenditure. This decision, therefore, is known as a capital budgeting decision. Capital budgeting consists of allocating the funds and investment decisions in general for future profits. The two major aspects of capital budgeting are 1. The probable return on investments in the future and 2. A cut of rate against which the future returns could be compared.
Although often given much importance, capital budgeting is not a perfect decision, as it is hard to interpret the future of investments.
The managers of an organization must know when, how, and form where to raise money for the company to run smoothly. The assets to be raised comprises debt and equity. The mix of debt and equity of a firm is known as capital structure. Capital structure varies from one company to the other but every organization looks for the best productivity out of the capital structure. This is known as optimum capital structuring. Apart from the mix of debt and equity, the firm must consider some other factors, such as control, loan covenants, and flexibility.
Note − Financing decisions to raise money is an important aspect for all organizations.
A company must know and decide how to distribute the funds or profits of the company to its shareholders. These are known as dividend decisions. The amount of dividend paid to the shareholders is known as the dividend payout ratio and it is important for the company. The companies usually follow an optimum dividend policy for the best result.
Liquidity Decisions − The perfect mix of debt and liquidity is important for a company's overall health. Lack of liquidity may lead to a firm's insolvency. Moreover, the firm must have current assets in its possession for having less risk.
Too much liquidity means more danger. Hence, liquidity decisions must consider the right amount of liquidity mix in order to the firm to perform at its best. For this, right amount of current assets must be held by a company.
Note − Lack of liquidity may lead to insolvency.
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