What are the factors involved in financial decision making?
- Cash: Focus is always on cash flows, not accounting earnings.
- Time: Money has a time value. Decisions must take account of the timing of the cash flows.
- Risk: Risk refers to variability of a cash flow stream. Greater variability means greater risk.
- The role of the financial manager is to deal with the uncertainty associated with investment decisions.
- Certainty:
- Where the projected cash flows occur as they are expected to occur
- Uncertainty:
- Where the projected cash flows may not occur as they are expected to occur
- Cannot assign any probabilities or estimate the likelihood of variations from expected outcomes
- Assessing the risk associated with expected future cash flows is critical to investment decisions.
- The positive risk-return relationship must always be kept in mind
Note: Cash flow and timing matters as a dollar today is worth more than a dollar at some future date.