Further where the company is desirous of mobilizing funds from outside sources, it is required to pay interest at fixed period.
Risk – Return Trade Off
Further where the company is
desirous of mobilizing funds from outside sources, it is required to pay
interest at fixed period. Hence liquidity is reduced. A successful finance
manager has to ensure acceleration of cash receipts (cash inflows in to
business) and deceleration of cash (cash outflows) from the firm. Thus
forecasting cash flows and managing cash flows are one of the important
functions a finance manager that will lead to liquidity. The finance manager is
required to enhance his professionalism and intelligence to ensure that return
is optimized.
Return = Risk-free rate + Risk premium
Risk free rate is a compensation
for time and risk premium for risk. Higher the risk of an action, higher will
be the risk premium leading to higher required return on that action. This
levelling of return and risk is known as risk return trade off. At this level,
the market value of the company’s shares should be the maximum. The diagram
given below spells out the interrelationship between market value, financial
decisions and risk-return trade off.
Interrelationship between
market value, financial decisions and risk-return trade off

Value of Firm – Risk Return
The finance manager tries to
achieve the proper balance between, the basic considerations of ‘risk and
return’ associated with various financial management decisions to maximise the
market, value, of the firm. It is well known that “higher the
return other things being equal, higher the market value; higher the risk,
other things being equal, lower the market value’. In fact, risk and return go
together. It is quite evident from the aforesaid discussion that financial
decisions have a great impact on all other business activities. The modern
finance manager has to facilitate making these decisions in the most rational
way. The decisions have to be made in such a way that the funds of the firms /
organizations are used optimally. The financial reporting system must be
designed to provide timely and accurate picture of the firm’s activities. Relationship of Financial Decisions
The financial manager is
concerned with the optimum utilization of funds and their procurement in a
manner that the risk, cost and control considerations are properly balanced in
a given situation. Irrespective of nature of decisions, i.e. investment
decisions, financing or capital structure decisions / dividend decisions all
these decisions are interdependent. All these decisions are inter-related. All
are intended to maximize the wealth of the shareholders. An efficient financial
manager has to ensure optimal decision by evaluating each of the decision
involved in relation to its effect on shareholders wealth.
Tags : Financial Management - Finance – An Introduction
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