How Macro Environment affects Financial Management Decision?

The macro environment is a dynamic factor and keeps changing drastically, leading to an increase in avenues, competition and complexity. Efficient financial management calls for better financial decisions. This is only possible when every factor is reviewed which can affect the decision in any way and macro environment is one of the most important factors. This has made financial management more critical and sensitive for any business.

Effective evaluation of projects and other situations is very critical in financial decisions. The evaluation calls for an analysis of various factors belonging to both macro as well as the micro environment. Financial management; a specialized field of general management is affected to a large extent by macro situations. We have to make various decisions related to finance; broadly such decisions include capital budgeting, capital structure & working capital decisions.
Capital budgeting facilitates investment decisions, the capital structure takes care of decisions relating to a mix of sources of funds and, working capital assesses the day to day needs of business.

While taking these decisions, one needs to understand the criticality of environmental forces. Since there is no single factor that makes our How Macro Environment affects Financial Management Decisionmacro environment but a group of various forces like political, legal, economical, social, technological etc, together build it. An effective financial decision needs assessment of these factors.

To evaluate various macro forces, it is necessary to be aware of the system and processes of the country constituting the economy. For e.g. a financial system of a country which plays a major role while making the financial decision. Awareness about financial environment helps us understand how its constraints or facilitate implementation of decisions. The financial environment comprises of various intermediaries as well as regulatory bodies.

A simple example will help us understand the criticality of macro factors thoroughly. A change in credit policy like tightening of prudential norms for banks (for e.g. Increase in Cash Reserve Ratio and Statutory Liquidity Ratio by the central bank of a country) will reduce the money supply in the economy. Decreased money supply will push up the interest rates and make credit costlier for people who want to borrow.

Costly credit will directly affect the capital structure decision. It will also affect capital budgeting decision while assessing the feasibility of the investment alternative. Since a higher cost of capital will increase the percentage of discounting factor (opportunity cost) with which the future cash flows are discounted. This may cause deferring or canceling the capital expenditure (CAPEX) plans.

Also, one should be updated with various changes taking place around the world. We are living in an era of globalization where nothing is stable and information technology has made the access to news and information of the world just a click away. The World is becoming a level playing field where not only national but international factor can also cause a threat. Like, “Sub-prime Crisis” brought a challenging time for almost the entire world.

To summarize, financial management and its decisions are greatly based on some major assumptions. These assumptions are greatly based on the macro factors such as country or worldwide interest rates, gross domestic product (GDP) of a country, the growth rate of the economy, production and sales figures, population census etc. It clarifies to a great extent that financial decisions may go wrong if proper study of macro factors is not done. If the foundation goes wrong, dreaming about a strong building would be equivalent to day-dreaming.

Last updated on : November 27th, 2016
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