Six Steps of Decision-Making in Financial Management
Managers and business owners must weigh financial considerations with every major decision they make for their firm. Whether the decision involves capital expansion, hedging assets or acquiring major equipment or merging with another firm, solid financial analysis will provide the assurance that the decision is made with the best information available. There are six factors to consider.
Financial analysis begins with a thorough description of the project being undertaken. This narrative includes background of the project, the current status and how you intend to complete the project. If, for example, you are planning to expand your business by building a new facility, you should explain why you have outgrown your current location, why the proposed addition will solve your problem and how long it will take to become operational.
Your analysis will include pro forma balance sheets, income statements and projected cash flow -- with and without the expansion. This will be necessary to convince investors that you have thought through details and can justify the expense of the project being undertaken.
Financial considerations include the details regarding the cost of the project, what working capital is required and the sources of any funds that you do not already control. If you plan to borrow funds, then weigh the cost and terms of each potential lender -- venture capitalist, bank or private investor. Determine what collateral is required and if there are any special terms and conditions.
Assessing risk factors is essential. Many risks cannot be avoided. Fire, accidents on the job, business interruptions and non-performance by a contractor are just a few of the risks you may encounter. Some require insurance; others you may self-insure. In any case, you must assess probabilities and present alternatives. Market risks and some risks of operations are uninsurable. If there is an environmental impact, then that too must be factored into your risk analysis.
While the forecast is implied in your pro forma financial statements, you need to address the return on investment, presenting best-case, likely case and worst-case scenarios. Since it is impossible to project business conditions with absolute certainty, offering a range of forecasts will provide assurance to investors that even with the worst case the project will have an acceptable return.
Whatever project you are contemplating, there will be legal considerations. A physical expansion will raise environmental issues. The purchase of major equipment will require contractual agreements. There are federal, state and local ordinances and regulations that must be followed, and tax considerations that must be met at all levels.