Investment Decision: Meaning and Factors affecting Investment Decision (original) (raw)

Last Updated : 25 Apr, 2023

What is Investment Decision?

Investment decision refers to the decisions that involve the investment of various resources of the firm to gain the highest possible return on investment for their investors. An investment decision is categorized as a long-term and short-term investment decision.

Financial Management is concerned with the management of the flow of funds and involves decisions related to the acquisition and application of funds in long-term and short-term assets. It is concerned with two aspects, they are procurement of funds as well as usage of finance. There are three major decisions that every financial management takes Investment Decision, Financial Decision, and Dividend Decision.

Investment Decision

Investment decision refers to the decisions that involve the investment of various resources of the firm to gain the highest possible return on investment for their investors. An investment decision is categorized as a long-term and short-term investment decision. A firm has to also keep in mind the scarcity of resources. It involves carrying out financial decisions on a long-term basis. This type of investment is known as a Capital Budgeting Decision.
For example, investing in a new machine to replace an existing one or getting a new fixed asset or opening a new branch, etc. Such decisions are extremely important for any organization as they control the decisions regarding its earning capacity in the long run.

The size of assets, profitability, and competitiveness are all influenced by investment decisions. These decisions generally involve vast amounts of investment and are mostly irreversible except when there is a huge cost. Therefore, once the decisions are made, it is almost impossible for a business to avoid such decisions, and they need to be managed with extreme caution. Such decisions should be taken by some who is thorough with the organization and its work. A poor capital budgeting decision has the power to seriously damage the financial fortune of any business. The everyday working of a business is affected by such decisions. They also influence the liquidity and the probability of a business. The necessary elements of sound working capital management include Efficient cash management, inventory management, and receivables management. A long-term decision is very important as they affect the earning capacity of the business in the long run and usually involves a large outflow of the fund.

A short-term investment decision is known as a Working Capital Decision. Such decisions involve decisions regarding the levels of cash, inventory, and receivables. Short-term decisions are required in the everyday working of a business and also influence the liquidity as well as the profitability of a business. The essential elements of sound working capital management are efficient cash management, inventory management, and receivables management. There are several projects available for the firm to invest in. The projects have to be analyzed cautiously and are selected or rejected based on the volume of return.

Factors affecting Capital Budgeting Decisions

• Cash Flows of the Project: Whenever an investment decision involving a huge amount is taken, the firm looks forward to generating some cash flows over a period. The form in which such cash flows are presented is usually in the form of a series of cash receipts and payments over the life of an investment. Before taking any capital budgeting decision, these cash flows should be properly measured and evaluated.
• The Rate of Return: In any project undertaken by the firm, the most important part of it is the rate of return received from them. The evaluation of such projects is done based on the returns expected from them. Also, the estimation of risk is done depending on the returns. For example, if there are two projects, X and Y (with the same risk involved), with a rate of return of 10 percent and 15 percent, respectively, under any normal circumstance, project Y should be opted for. This is because project Y has a higher rate of return and therefore, more profit.
• The Investment Criteria Involved: The decision of investment in any of the projects is concerned with the calculation and evaluation of several elements, such as the amount of investment, interest rate, cash flows, and rate of return. The selection of any particular project is based on different evaluation techniques known as capital budgeting techniques. Such techniques are applied to the projects before choosing a certain one.