1.7 The Fundamental Principles of Financial Management
1.7.1 Cost benefit principle
Financial decisions require an analysis of the costs and benefits associated with a company. This decision making is not based only on the cost of resources but also on how resources can be most economically utilised.
The cost benefit principle may be used by means of the following steps:
- Obtain clarity about the objective to be attained.
- Identify alternative ways in which the objective may be attained.
- Calculate the cost and benefits of each of the alternatives.
- Determine the effectiveness of the benefits of each alternative.
- Decide on a criterion or standard to be used against which the acceptability of an alternative may be assessed.
- Make a decision about the most appropriate course of action. In situations where there is enough time to do so, this step may have to be preceded by consultations with certain members of staff with the relevant expertise.
1.7.2 The risk return principle
Risk is a fundamental factor of any decision-making process; it refers to the likelihood that the actual result of a decision may deviate from the planned result, with an associated financial loss or waste of funds.
Think Point
To gain some clarity on this principle please watch this video:
Case Studies
To have a better understanding of the time value of money concept especially with regards to its formula and examples which would then assist you in the preparation of the next chapter please have a look at this video: