Financial Decisions are not independent; they are closely interconnected and affect each other. The three main decisions – investment, financing, and dividend must be taken together to achieve the goal of wealth maximization. A change in one decision directly affects the others. For example, if the firm decides to invest in a new project, it will need funds, which affects financing decision, and if funds are retained, it affects dividend decision. Therefore, the finance manager must maintain proper coordination among all decisions for balanced growth and financial stability.
Internal Relation of Financial Decisions:
1. Relation Between Investment and Financing Decisions
Investment and financing decisions are closely related because every investment requires funds. The finance manager first decides where to invest and then decides from where to arrange funds. If the firm selects a large project, it will need more funds, which may increase debt or equity. The cost and availability of funds also affect the choice of investment. A project is accepted only if its return is more than the cost of capital. If funds are costly, even a good project may be rejected. Thus, investment decisions depend on financing decisions, and financing decisions depend on investment needs.
2. Relation Between Investment and Dividend Decisions
Investment and dividend decisions are directly connected through retained earnings. Profit can either be distributed as dividend or retained for investment. If the firm has profitable investment opportunities, it will retain more profit and pay less dividend. If it has no good projects, it will distribute more profit as dividend. The finance manager must balance the need for growth and shareholder expectations. Too much retention may dissatisfy shareholders, while too much dividend may stop growth. Therefore, investment plans decide how much profit should be retained, and dividend policy decides how much is available for investment.
3. Relation Between Financing and Dividend Decisions
Financing and dividend decisions are interrelated because dividend payment affects the need for external finance. If the firm pays high dividend, it will have less internal funds and will need to borrow more or issue new shares. This increases cost and risk. If it pays low dividend, it can use retained earnings and reduce dependence on external funds. The capital structure also affects dividend capacity. A firm with high debt must pay interest first, leaving less for dividend. Therefore, the finance manager must coordinate financing and dividend decisions to maintain liquidity, reduce cost, and protect shareholder wealth.
4. Combined Effect on Wealth Maximization
All three financial decisions together determine the wealth of the firm. A good investment increases earnings, a good financing decision reduces cost of capital, and a good dividend decision increases investor confidence. If any one decision is wrong, it will affect the others and reduce market value. For example, wrong investment wastes funds, wrong financing increases risk, and wrong dividend policy reduces trust. Therefore, these decisions must be taken as a single integrated system. Proper coordination among them ensures optimum use of funds, stable growth, and maximum shareholder wealth.
5. Relation with Liquidity Decisions
All financial decisions affect the liquidity of the firm. Investment in fixed assets blocks funds for a long time and reduces cash available for daily needs. Financing decision affects liquidity because debt creates fixed interest and repayment obligations. Dividend decision also affects cash because payment of dividend reduces cash balance. If the firm invests too much, borrows too much, and pays high dividend together, it may face cash shortage. Therefore, the finance manager must keep enough working capital while taking these decisions. Proper coordination ensures that the firm can pay its short-term obligations on time and run operations smoothly.
6. Relation with Risk and Return
Financial decisions are also connected through risk and return. Investment decision determines the level of return and risk of the firm. Financing decision determines financial risk because more debt increases risk but also increases return. Dividend decision affects the risk perception of investors. A stable dividend reduces risk and increases share price, while irregular dividend increases uncertainty. The finance manager must balance risk and return in all three decisions. A high-return project with high debt and low dividend may increase wealth but also increase risk. Therefore, all decisions must be balanced to achieve optimum risk-return trade-off.
7. Example of Interdependence
Suppose a firm decides to start a new expansion project. This is an investment decision. To finance it, the firm may take a bank loan, which is a financing decision. To repay the loan, it may decide to retain more profit and pay less dividend, which is a dividend decision. If the project succeeds, profit increases, share price rises, and the firm can pay higher dividend in future. If it fails, the firm faces debt burden and loss of goodwill. This example shows that one decision creates the need for another. Hence, no financial decision can be taken in isolation.
8. Need for Coordination
Because of this close interdependence, there is a great need for coordination among financial decisions. The finance manager should prepare an integrated financial plan covering investment, financing, and dividend together. He should evaluate the combined effect on profitability, liquidity, risk, and market value. Lack of coordination may lead to over-borrowing, shortage of funds, or dissatisfaction of shareholders. Proper coordination helps in optimum utilization of funds, reduction in cost, and balanced growth. It ensures that all decisions support the common goal of wealth maximization and long-term survival of the firm.
