Believe it or not, but there is no recipe for making your business successful. It is a combination of hard work, efforts, and innovations, which helps the business climb the stairs of success. Every company is working towards the same goal by adopting different strategies. Some move towards diversification while others try their luck with mergers and acquisitions. In this blog, you will know financial decisions impact long term business profitability.
However, the decisions you make have an impact on the profitability of businesses, especially financial decisions. After all, some companies struggle after getting their hands dirty on the loan while others are struggling to manage their expenses. Hence, owners have to be very careful before passing any decision. Look below to see financial decisions and their impact on long-term business profitability.
1. Investment Decisions
There is always a need for new machinery and equipment in businesses. Well, coughing up money for assets come under the category of investment decision. They could either be short-term assets or fixed assets. It is essential to analyze the current position of a company with prospects before investing in a fixed asset. Even though they bring economic benefits to the business, but it should be worth the price you are paying for it. After all, it calls for a huge investment.
Usually, people invest in these assets for long-term success and growth. You have to see whether it is worth investing in it or not. So, how about you conduct an analysis? Consider the cost and life of an asset and calculate the returns you would generate. Perhaps, the returns would be higher than the cost, but it is not enough to give a green signal.
Therefore, an in-depth financial analysis would help you understand the present value of future returns and whether it is higher than today’s value or not. Similarly, don’t forget to charge depreciation to see net income vs. operating cash flow, improving liquidity. These smart analysis result in smarter investment decisions that have a positive impact on the profitability of the business.
Besides, these days many businesses are also considering investing money in technology. If you think your business has the potential to manage technology, then investing in it would make your way towards success.
2. Financial Decisions
Unfortunately, not every business has the finances to foot the bills for purchasing an asset. Hence, companies make financing decisions where they decide ‘how to acquire funds.’ There are many sources of external financing available, but a good decision revolves around an efficient source. You have to look for options that are not heavy on pockets. Thus, the ones offering feasible ‘interest rates’ and flexible repayments.
You can explore commercial loans, payday loans, crowd funding, capital ventures, etc. Sometimes, even after getting a loan, businesses fail to achieve the desired results, ending up in losses also. Do you know why? It happens because of wrong financing decisions, either you chose a wrong source, or your entire decision of external financing is wrong. Perhaps, your business is not capable of repayments.
Therefore, take a look at your current and future financial situation before making any decisions. You should prepare a future cash flow and business credit report, along with projected financial statements to see where your business stands in the future. Honestly, the negative cash flow would give a red signal for financing. Alongside making repayments difficult, it would become impossible to cough up money on interest payments, having a drastic impact on profitability. Thus, these decisions have to be made very carefully, keeping all factors in mind.
3. Dividend Decisions
Do you like sharing profits? Of course, not, but companies have to share their profits with shareholders. After all, they are the owners of the business. It is the management’s call to decide the amount of dividend they would pay to the shareholder, considering it gets deducted from the profits. It is vital to set out an appealing pay-out ratio to encourage future investments.
Well, many people think these dividend decisions reduce the profitability of a business, but things are different in the long run. By maximizing the wealth of shareholders, you open doors for future investment opportunities while boosting your image in the market. After all, it helps in establishing a good name while coming under the list of ‘best investment companies.’ These things always have a positive impact on the profitability of the business.
However, you have to be careful while distributing profits. Rather than giving out all profits to shareholders, you have to keep some for the business too. You have the option to open a ‘general reserves’ accounts or keep some profits for re-investing in the business as part of retained earnings. It would ensure that you have funds available, instead of looking for loans when business needs financing. Besides, maintaining a balance is essential.
4. Working Capital Management
Unsurprisingly, managing short-term assets is equally important. There are businesses with spectacular profits on the ‘profit and loss statements’ but negative cash flow statements. Well, this happens because of poor working capital decisions. Companies have heaps of money tied up in inventory, resulting in cash flow problems.
Hence, you have to put all efforts into predicting demand to avoid producing excess inventory. After all, a lot of inventory leaves you at the threat of losses too. At the same time, you have to encourage customers to pay you within the specified time. Companies tend to pay suppliers from their own pockets while receivables are on pending, running short of cash. You have to foot supplier’s bills once receivables clear their dues, eliminating liquidity problems.
The finance manager would hold the bag for managing working capital while managing cash for day to day expenses. Liquidity and profits have a direct relationship. So, the higher the liquidity, the higher the profits since the company won’t be at the risk defaults. Even though these decisions are about short-term assets, it can have a huge impact on long-term profitability if made wrong.
Four major financial decisions have a major impact on business growth and profitability. If these decisions are made right, then nothing can stop businesses from climbing the stairs of success. At the same time, one minor mistake can cost millions. Thus, these are very crucial decisions, and you can look above to see how they have an impact on long-term business profitability.