The appropriate decisions made by the senior management play a huge role in the success of an organisation. Decisions regarding finances and investment opportunities are one such important decision. It involves purchasing or allocating resources for better growth of the company. For example, choosing and investing in projects that can be profitable in the future or acquiring strategic companies.
Finance and investment-related decisions are not only centred on funding but include several other calculations as well. The senior management is responsible for the financial choices that drive the company’s success and long-term value. If this decision-making holds such importance, individuals must look for a senior management course that can teach them in depth how to become one such leader. Let us start with understanding the importance of a financial decision for the company.
Importance of Financial and Investment Decisions
One of the essential features of financial decision-making resides in its choices that determine where resources are directed. These choices hold the power to make or break a business. It impacts everything from employee morale to the company’s reputation. The financial choices of the business can directly impact a company’s ability to;
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Drive Growth
To take a company towards its unstoppable growth, it is essential to invest in the right projects and R&D. This fuels innovation, which ultimately leads to increased market share and profitability.
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Maintain Financial Health
Accurate financial decisions result in a balance between debt and equity, ensuring that the company is well-equipped with the necessary capital to manage financial needs.
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Maximising Shareholder’s Return
It is one crucial duty of the company to provide good returns to its shareholders. Financial decisions do a lot to this as they heavily influence dividend policies and stock performances.
Risk Tolerance and Time Horizon
In this pivotal decision-making process, senior management often struggles with two important factors. One is the risk tolerance of the company, which dictates how comfortable the team is with potential losses. Another factor is the timeframe for realising investment returns.
A lot of investment decisions highly depend on the company’s risk tolerance. If a business or its management believes in high-risk, high-reward projects, they are more likely to invest in early-stage acquisitions. However, a team taking a safer road might prioritise lower-risk investments with steadier returns.
Understanding the time horizon is equally important for a business. To realise its short-term goals like funding next quarter’s operations, a company can go for less risky investments like bonds with predictable returns. Conversely, a long-term goal like building a future technology platform allows for riskier investments as venture capital.
Hence, it is up to the senior management to make informed decisions that balance potential rewards with an acceptable level of risk.
Key Considerations for Accurate Investment and Financial Decision Making
Before coming to a decision, the senior management must evaluate several facts related to the business. Here are some basic and crucial considerations to ensure a more stable financial decision;
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Market Analysis
Market analysis stands at the top of making any decision in a company. However, specifically in the financial domain, it helps in identifying investment opportunities along with anticipating potential risks. Through market analysis, the senior management will be up to date not only with the economic climate but with the industry trends and competitor’s strategies as well.
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Business’s Capabilities
Without thoroughly understanding the company’s strengths and weaknesses, it is impossible for anyone to frame any work of action in favour of the business. When the management successfully aligns their investments with the internal capabilities, the chances of return on investment get higher.
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Legal Framework
The regulatory changes can often dramatically impact the profitability of certain projects. In order to not get any sudden shocks from it, one must understand the legal and regulatory framework surrounding some potential investments.
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Core Investment Decisions
In a business, there can be investments of different types. Be it any kind of capital allocation,it is crucial for a company’s long-term success. Here, in this section, we will delve into three core investment decisions.
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Capital Budgeting Techniques
Through this, one can evaluate the potential profitability of new projects or investments that align with the company’s goal.
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Net Present Value (NPV)
With NPV, the senior management can easily determine how much an investment is worth through its lifetime discounted to today’s value. A positive NPV is a sign that the project creates value. Conversely, a negative NPV suggests the opposite.
There are both pros and cons of evaluating profitability through NPV. It is true that NPV gives emphasis on the time value of money and includes all project cash flows. But that being said, it also heavily relies on the accuracy of the discount rate, which is subjective. Also, it doesn’t consider any project’s payback period.
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Internal Rate of Return (IRR)
The senior management often calculates the return on a potential investment with the help of IRR. This number reflects the expected annual rate of growth from an investment.
One unique feature of IRR is that it provides a single metric for project evaluation. However, it can also give out multiple solutions in certain scenarios, which makes it difficult to interpret.
Another drawback to IRR is that it ignores the project’s cash flow pattern.
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Payback Period
The payback period is the time it takes for an investment to recover its initial cost. It is simple to calculate and with this one can assess short-term liquidity needs as well. But, it doesn’t take the cash flows after the payback period under consideration,
Mergers and Acquisitions
If explained in short, M&A involves combining two companies into one. Here are a few types of mergers and acquisitions, along with their primary reasons behind merging with another company.
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Horizontal
This type of integration of two or more companies is considered a strategic move as the merger happens with a company that operates in the same industry. Also, the company should be at the same stage of production.
The goal behind a horizontal merger is to increase market power, take advantage of a larger customer base and boost revenue and profits.
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Vertical
In a vertical merger, the acquisition happens between companies that produce different services along a similar supply chain to benefit the economies of both the merged and the entities.
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Conglomerate
Entirely different from the first two, conglomerate mergers involve companies that work in different industries, categories, and geographical locations. This kind of merger not only leads to diversification in revenue stream but also reduces market risk.
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Strategic Advantages of Merger and Acquisition
For a business, a M&A offers both a set of advantages and disadvantages. However, if the right merger is locked between the involved companies, the advantages can be quite extraordinary.
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Competitive Advantage
One significant benefit that merger and acquisition brings is the elimination of competition between businesses that can boost long-term growth and company value.
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Enhanced Performance
A merger combines the resources and expertise of more than one company. These resources and expertise can enhance a company’s financial capacity and performance. It can lead to both cost savings and operational efficiency.
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Access to new technologies
Another crucial advantage of merging companies or acquiring one is the access to cutting-edge technology. This helps in enhancing the research and development capabilities of the product and service.
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Financial Benefits of M&A
It is essential to see a merger and evaluate it from a financial viewpoint. Because, in the end, it’s the numbers that decide the performance of a company. There are several financial parameters to evaluate a merger on. However, we have listed a few of the important ones below.
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Valuation
Determining the valuation of the company you’re acquiring is the most crucial. To calculate this, one can use several methods like discounted cash flow analysis or comparable company analysis.
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Synergy Analysis
Another analysis that a company should run through before merging with another business is the synergy analysis. This estimates the potential cost-saving and revenue growth that the company will benefit from after the operations of merging companies get combined.
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Integration Cost
It is true that mergers and acquisitions come with a new set of expenses. These can involve integrating personnel technologies or processes. Hence, the integration cost must be factored into the overall finance of an M&A.
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Due Diligence Costs
Calculating and thoroughly investigating the target company’s financial and legal issues is essential. Apart from that, one must be familiar with the operation risks associated with the company, if any. These hidden liabilities can cause severe financial harm to the acquirer if they emerge after the deal is closed.
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Case Studies on the Impact of Investment and Financial Decisions
Here, with two real-life examples, we will see how a financial or investment-related decision taken by the senior management does to a company.
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Successful M&A
One prime example of a successful M&A is Disney's acquisition of Pixar in 2006. Since then, Disney has been at the top of its game as the deal provided them with Pixar’s animation expertise. This fueled Disney’s blockbuster releases and made his animation’s dominance.
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Unsuccessful M&A
America Online’s merger with Time Warner in 2001 was one of the biggest mergers in American business history. However, it turned out quite poorly. Both companies struggled to integrate their business models and cultures, resulting in a significant decline in shareholder value.
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Research and Development
Another core investment decision that senior management makes is to put money behind the lifeblood of innovation, which is the research and development process. It drives the creation of new products, services, and technologies. Let us go through the important features of doing a thorough R&D.
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Staying Ahead
It enables businesses to stay ahead in this competitive landscape by addressing evolving customer needs. Through R&D companies get well-equipped to cater to the unique needs of the customer and foster groundbreaking solutions that keep them ahead of their competitors.
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Boost Productivity
R&D is also used in companies to improve the existing operational procedures. The new information that the research department gathers about the current industry processes, helps in learning more about the operational tools and systems.
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Improvement in Marketing
Apart from improving products and services, research and development in the marketing department allows for a more targeted approach. This helps the business to understand its target audience more specifically, thus, preparing marketing strategies according to the customer’s preferences.
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Evaluating R&D ROI
Earlier, it was difficult to measure the return on investment for R&D projects due to their long-term results and uncertain outcomes. However, now there are several methods to calculate the ROI and provide valuable insights about the R&D process. Here, we mention two such methods that are commonly used in companies.
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Real Options Analysis
This approach views R&D as an option to develop new technologies with uncertain options. To calculate the ROI, it analyses the potential value of R&D’s success and the cost of failure. This assesses the overall attractiveness of the investment.
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Scorecard Approach
This is one method that goes beyond the traditional financial metrics. In the scorecard approach, one keeps track of non-financial indicators like patent applications, scientific publications, and market research. This helps in gauging the progress and potential future returns.
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Financial Decisions By Senior Management
Similar to investment decisions, financial decisions are also critical for senior management as they shape how a company funds its operations and growth. In this section, we will discuss two essential financial decisions, that are capital structure and dividend policy.
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Capital Structure
It is the combination of debt and equity that a company uses to finance its operations and work on its growth. Here’s a breakdown of its components.
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Debt Financing
It simply means borrowing funds from banks or issuing bonds. Debt financing offers companies the benefit of leveraging and allowing them to magnify their potential returns.
Along with its pros, debt also has its share of cons as it increases the financial risk with its fixed interest payments and repayment obligations.
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Equity Financing
In equity financing, the senior management decides to raise capital against the shares of the company. By issuing shares of ownership, management restricts the company from a debt burden. However, the ownership gets diluted and can be more expensive than debt financing due to the potential for higher returns expected by investors.
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Factors Affecting Capital Structure
Several factors are responsible for influencing the optimal capital structure of a company. A solid working capital management plan is absolutely necessary for the success of an organisation. As there is no one formula that is fit for all. Hence, a few elements must be considered before finalising the right mix of debt and equity.
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Size and Nature of Business
These two are one of the crucial factors to consider when making the capital structure. The size of the business often determines if they will be able to raise capital or not. For example, a small business can have difficulty in borrowing funds because of their less credibility.
Additionally, the nature of the business specifies the need for the capital. Bottom level businesses like that of manufacturers or farmers would need more flexible capital structures
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Business Ownership
A lot about the capital structure depends on what kind of ownership the company has. For instance, a company with sole proprietorship or with fewer partners can adjust its capital structures more easily as per the given situation.
Conversely, a public company might restrict themselves for a flexible capital structure as they have the stakes of numerous individuals.
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Earnings
The stability of revenue in a company is a crucial factor to consider when laying out its capital structure. A company with a stable revenue can afford a more significant amount of debt compared to a business that faces higher fluctuation in its sales. It also has high-income prospects and can bear the fixed financial charges.
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Risk Management
Before deciding the ratio of debt and equity in the capital structure, senior management must be aware of its risk appetite. It heavily affects the capital structure as some managers prefer a low-risk strategy and thus, go for equity shares to raise finances.
On the other hand, managers with confidence in repaying big loans prefer long-term debt instruments.
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Dividend Policy
If put simply, a dividend policy determines how much of a company’s profit is distributed to shareholders as cash dividends. Apart from the specific amount, the policy also includes specific details like how often and when the payouts will be distributed. There are essentially two main payout strategies.
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Growth Strategy
When a company goes with the growth strategy, it means there will be lower or no dividend payouts to the shareholders as the company prioritises reinvesting the profits back into the business. Often, companies do this for their future growth.
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Income Strategy
Companies often distribute a larger portion of profits to their shareholders as dividends. This mostly appeals to income-oriented investors seeking regular cash flow.
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Factors Influencing Dividend Policy
Similar to capital structuring, the management should evaluate the financial health of the company on several factors before deciding how much profit should be distributed to shareholders. In this decision, they should keep in mind the objective of maximising shareholder wealth apart from retaining profits for future growth.
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Financial Need
It is of utmost importance to first consider the financial needs of the business before planning about distributing the profits. Companies that are in need of investments should prioritise retaining their profits.
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Investor Expectations
Companies that have large income-oriented investors might get pressured to maintain a consistent dividend payout. In these situations, management has to think of the investors more than the company.
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Market Conditions
There is no denying the fact that dividends cost more when raising money is hard. Hence, firms pay lower dividends in order to raise cash and vice versa. Therefore, the ease with which a company raises money directly affects its dividend policy.
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Taxes and Regulations
It is the taxes on dividends that make them more costly for the companies. This makes the management think twice about the laws and taxes before making their dividend policy.
Wrapping Up
There are a lot of responsibilities on the shoulders of the senior management, one of which is to make crucial decisions related to finance and investment. And it is quite important to make the right financial decisions as many things related to the business depend on it. This involves evaluating the company’s capital allocation, R&D investments, and several other elements mentioned above to fuel growth, maximise returns, and manage risk profile.
It is pivotal that senior management continuously improves its financial decision-making as it can benefit the business by staying abreast of current financial trends. Additionally, it leverages data analytics for informed choices and creates a culture of critical thinking within the leadership team.
If you’re someone who wishes to acquire this set of skills and wishes to be in the senior management of a company, you must enrol for the Senior Management Program by Imarticus Learning. This senior management course not only introduces you to new-age skills but also assists in your transformation journey of becoming a leader who can make the right decisions for the company.
