## Finance Functions / Finance Decisions

### Value of the Firm

The value of a firm is a function of its three key financial decisions:

$$V = f(I, F, D)$$

where I = Investment, F = Financing, D = Dividend.

Finance functions are split into long-term and short-term decisions.

### Long-Term Finance Functions

1. Investment Decisions (I)

Selecting the assets in which funds will be invested (fixed assets, current assets).
Capital budgeting is used to evaluate long-term investments.
A part of long-term funds is also committed to working capital.
Keywords: Asset selection · Capital budgeting · Working capital

2. Financing Decisions (F)

Acquiring the optimum finance to meet objectives by balancing equity and debt (capital structure).
Managers must distinguish cash flow vs. profit and assess risks (e.g., currency fluctuations, debt risk).
Hedging strategies are used to minimize these risks.
Keywords: Capital structure · Risk management · Cash flow

3. Dividend Decisions (D)

How much profit to pay out as dividends vs. retain for growth.
Dividends affect the company's market value and stock price.
The decision has both financial and growth implications.
Keywords: Dividends · Profit retention · Market value

### Short-Term Finance Functions

Working Capital Management (WCM): short-term decisions essentially reduce to the management of current assets and current liabilities (i.e., working capital management).

Worked example

### Example 1

Applying V = f(I, F, D): A firm chooses (I) profitable projects via capital budgeting, (F) an optimal debt-equity mix to minimise cost of capital, and (D) a dividend payout that satisfies shareholders while retaining enough for growth. Sound choices across all three decisions push the firm's value (V) upward; a poor decision in any one (e.g., over-borrowing) can pull V down.

⚠️ Common exam mistakes

Writing the firm-value relation incompletely — it depends on all three: Investment, Financing AND Dividend.
Classifying working capital management as a long-term function; it is a short-term finance function (management of current assets and liabilities).
Confusing cash flow with profit when evaluating financing decisions.
Forgetting that some long-term funds are also used to support working capital.

Reference:

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