Essay Example on Fundamental Concepts of Finance: The Soul and Blood of Any Company

Introduction

Finance is the soul and blood of any company, and there is no enterprise can survive without finance. Fundamentally, finance is concerned with managing a company's monetary resources, assessing how money can be raised for the business, the best terms of securing the money, and the best way to use the secured money. Therefore, finance can be explained as arranging and applying business funds. Taking note of how vital is finance, it becomes crucial for one to understand essential concepts in finance. These include capital budgeting and dividend policy. The paper will evaluate the importance of selecting the right project to invest in, analyzing factors in capital budgeting decisions and incentives and signals in dividend policy.

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Capital Budgeting

Capital budgeting is a corporate finance technique that is used to evaluate the authenticity of investing in a project. Business continuity is determined by long-term investments made by the firm. As a result, companies must critically evaluate potential business venture to certify that they invest in a sound and profitable business. The main objective of capital budgeting is to maximize profits for business owners (Bierman & Smidt, 2007). There is no point that investors want to channel their money in a potential business if they do not make profits. Therefore business owners always select those projects that will generate the highest return on investment. It is for this reason that the value of every project is considered in capital budgeting decisions. There are several capital budgeting methods that are used in finance. One of these methods is the Net Present Value which is used to make sure that the wealth of shareholders is maximized from business projects. If a project has a negative Net Present Value, it is deemed unsuitable and vice versa if it has a positive value. However, if two projects in contention have a positive value, the one with the highest value is selected.

Despite capital budgeting decisions being made in reference to returns, there are other factors that are considered in project appraisal. One of these factors is project life, and this mainly involves selecting the project with the most extended lives. The other factor is the weighted average cost of capital, and this involves selecting projects which have less impact on owners (Bierman & Smidt, 2007). For instance, businesses should consider investing in projects which do not dilute the firm's capital.

Dividend Policy

Dividend policy is a crucial business consideration that is used to assess the amount of money which will be shared among shareholders and the one that will be channeled back to business. Historically, companies have been giving out dividends to investors, but it is not a must that they do so. However, firms are incentivized to do so to ensure that shareholders keep investing in the company (Frankfurter, Wood & Wansley, 2003). If shareholders get a continuous flow of income from their dividends, they will be motivated to continue investing even more, and this is what businesses target. Formulating the best dividend policy is crucial in any company. The better the policy, the more attractive it is to an investor who always wants to get the maximum from their invested money. In that regard, a dividend policy signals the investors the returns they will get from their investment.

Conclusion

Factors in capital budgeting decisions and incentives and signals in dividend policy are important factors of consideration in finance. Business owners always select those projects that will generate the highest return on investment. However, apart from returns, project life and the weighted average cost of capital are also important factors to consider in capital budgeting. A dividend policy on its part acts as an incentive to attracting investors as it signifies the amount of returns they gain from their investments. Every business should ensure that they make sound business decisions as this is the only way they can have continuity

References

Bierman, H., & Smidt, S. (2007). The capital budgeting decision: Economic analysis of investment projects. New York: Routledge.

Frankfurter, G. M., Wood, B. G., & Wansley, J. W. (2003). Dividend policy: Theory and practice. Amsterdam: Boston.