Meaning of Investment Decision
Investment decisions concerned with the allocation of funds into different investment opportunities for the purpose of earning the highest possible return. It simply assists firms in selecting the right type of assets for deploying their funds. These decisions are taken by the investor or top-level managers who properly analyses each opportunity before investing any fund into them.
Investment decisions are crucial decisions for every organization as it determines its profitability. It should be ensured that a proper study is done regarding the risk and return before committing any capital into available investment avenues. Investment decisions are of two types: Long term and short term investment decisions.
Long term investment decisions are concerned with the investment of funds in long term assets and are termed as Capital budgeting. Whereas, short term decisions relate to investment in short term assets which is also called working capital management.
Nature of Investment Decisions
- Require Huge Funds: Investment decisions requires a large amount of funds to be deployed by firm for earning profits. These decisions are very imperative and requires due attentions as firms have limited funds but the demand for the funds is excessive. Every firm should necessarily plan its investment programmes and control its expenditures.
- High Degree of Risk: These decisions involve a high amount of risk as they are taken on the basis of estimated return. Large funds are invested for earning income in future which is totally uncertain. These return fluctuates with the changes in fashion, taste, research and technological advancement thereby leading to a greater risk.
- Long Term Effect: Investment decisions have a long lasting effects on future profitability and growth of firm. These decisions decide the position of a firm in future. Any wrong decision may have very adverse effects on return of an organization and may even endanger its survival. Whereas, right decision taken brings good returns for firm leading to better growth.
- Irreversibility: Decisions related to investment are mostly irreversible in nature. It is quite difficult to revert back from decisions once taken related to the acquisition of permanent assets. Disposing off these high value assets will cause heavy losses to firm.
- Impacts Cost Structure: Investment decisions widely impacts the cost structure of an organization. Firms by taking these decisions commit themselves to various fixed cost such as interest, rent, insurance, supervision etc. for the sake of earning profits. If these investments do not provide the anticipated return, then firm overall cost will raise thereby causing losses.
- Long term Commitment of Funds: Funds are deployed for a longer term by organisations through these decisions. Firm deployed high amount of capital for long period on permanent basis. Financial risk in investment decisions increases due to long term commitment of funds. A firm should properly plan and monitor all of its capital expenditures.
- Complexity: Investment decision are most complex decisions as they are based on future events which is totally uncertain. Future cash flows of an investment cannot be estimated accurately as they are influenced by changes in economic, social, political and technological factors. Therefore, uncertainty of future conditions makes it difficult to accurately predict the future returns.
Scope of Investment Decisions
- Selection of Right Assets: Investment decisions help in choosing right type of investment plan for deploying the funds. Each of available opportunity is properly analyzed by management while taking investment decisions. This way every aspect of asset available for investment is taken into consideration which leads to building up a strong portfolio.
- Identify Degree of Risk: These decisions help in identifying the level of risk associated with an investment opportunity. Decisions are taken on the basis of expected return and risk required for earning such return. Managers properly evaluate assets using various tools for finding out the risk while taking investment decisions.
- Determines firm Profitability: Decisions regarding investment plans determines the future profit earning potential of a firm. A right decision may bring large amount of funds to an organization leading to better growth. Whereas, any wrong decision regarding deployment of funds may cause heavy losses and even adversely affect the continuity of firm.
- Enhance Financial Understanding: Investment decisions imparts large amount of beneficial financial knowledge to individuals taking these decisions. Investors while choosing the asset uses a variety of tools and techniques for analyzing its profitability. It provides a lot of information which enhances the overall financial knowledge and enables investors in taking rational decisions regarding investment.
- National Importance: These decisions are of national importance for a nation as it leads to overall development and growth. Investment decisions taken determines the level of employment, economic growth and economic activities in a country. More amount of investment creates better supply of funds in an economy which increase the pace of overall economic development.