What is the fundamental nature of financial decision making?

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Lorraine Caplan | College Teacher | (Level 1) Educator Emeritus

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The fundamental nature of decision-making in finance is balancing the tension between maximizing profit and minimizing risk.  All of the decisions within the domain of financial management involve this tension. 

Financial managers are responsible for investment of capital, which means they must maximize returns with as little risk as possible.  They must make decisions about investment in the company itself, for capital acquisitions and research and development, for example, always weighing the risk of affecting cash flow and profitability against the odds of their internal investment decisions yielding profits.

Additionally, financial managers serve more than one master, often, the company itself, a board, a CEO, and shareholders.  Maximizing profitability for one sometimes involves less profitability for another, which is in and of itself a risky proposition.  A CEO maximizing his or her own profits does not necessarily have concerns about the shareholders' dividends.  The maximization of profits for the company sometimes means paying smaller or no dividends.  It is up to the finance manager to smooth out all of this, weighing profitability for all stakeholders against risks internal and external. 

And as though that were not enough to worry about, the finance manager must also maximize profits and minimize risks in a way that does the company some good from a socially responsible and environmentally conscientious way, taking care, for example, not to make investments in companies that outsource to child labor factories or that notoriously pollute. 

No matter what is within the purview of the finance manager, it's about the profit, and it's about the risks. 

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