The Financial Management Decision Process

1. The Financial Management Decision Process. What are the three types of financial management decisions? For each type of decision, give an example of a business transaction that would be relevant.

* There are three types of financial management decisions: Capital budgeting, Capital structure, and Working capital management.

* Capital budgeting is the process of planning and managing a firm's long-term investments. The key to capital budgeting is size, timing, and risk of future cash flows is the essence of capital budgeting. For example, yesterday I received a call from our manager over our Sand & Gravel Operations. He is looking into buying a new crusher (to crush stone into gravel and sand). I helped him today evaluate the return on investment for this opportunity. It quite a lot of work, but we determined that buying the new crusher would bring in 60,000 more tons of production/sales within the 1st year of owning the machine.

* Capital Structure refers to the specific mixture of long-term debt and equity the firm uses to finance its operations. There are two main questions when looking at the capital structure - 1) How much $ do we need to borrow to buy this long-term asset? 2) What are the least expensive sources of funds for the firm? For example, since we are thinking of buying this new crusher, we need to decide how we are going to afford this new machine. In this example, we determined that if we cut back a little bit on labor and in other areas, we would be able to afford the new machine. In regards to where the money will come from, we do not take out loans to buy long-term assets. We borrow from our company, and repay overtime.

* Working Capital Management refers to a firm's short-term assets, such as inventory, and its short-term liabilities, such as money owed to suppliers. This is more of an everyday activity. For example, we just converted to a new ticketing system at work. One of the issues we had is how to handle cash sales or if we should have them at all. Another issue that appeared when we converted was how to monitor and process inventory. These types of items are key to keeping a company successful.

My company faces similar choices each year for capital budgeting, as far

as deciding to replace or overhaul current equipment. For an overhaul, we

have to decide if repairing the equipment exceeds the price of purchasing it

new. Overhauling ties up a lot of labor hours as well, so that is another

factor that has to be considered.

You bring up a good point about accepting cash sales, too. It may seem

like a no brainer, but accepting cash sales can be a lot of trouble. It

involves finding someone to take cash payments, applying those payments to

customer accounts, and reconciling the cash accounts on a monthly basis.

It's a lot of hassle, especially for a company that deals in large dollar

purchases.

On a much smaller scale with purchasing new equipment, my company (we

are very small) was faced with the possible purchase of a new copier.

Although we didn't do a formal ROI, I still had to collect all of the

info on how much had been paid out for the copier at inception and how

much we have spent on contracts, etc. since then. It was not formal by

any means, but still something