Macro environment factors affect a business in many ways. The macro-environment is a dynamic factor and keeps changing drastically, increasing 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 and the macro environment is one of the most critical factors. This has made financial management more vital 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 the macro and the microenvironment. Financial management, which specializes in the field of general management gets affect 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, and 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 the business.
While making these decisions, one needs to understand the criticality of environmental forces. Since no single factor makes our macro environment, a group of various forces like political, legal, economic, 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, e.g., a financial system of a country that plays a significant role while making the financial decision. Awareness about the financial environment helps us understand how its constraints or facilitate the implementation of decisions. The financial environment comprises 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 (e.g., Increase in Cash Reserve Ratio and Statutory Liquidity Ratio by the country’s central bank) 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 decisions 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 aware of various changes taking place around the world. We live 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 national and international factors 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 significant assumptions. These assumptions are greatly based on macro factors such as country or worldwide interest rates, gross domestic product (GDP) of a country, the economy’s growth rate, production and sales figures, population census, etc. It clarifies to a great extent that financial decisions may go wrong if the proper study of macro factors is not done. If the foundation goes wrong, dreaming about a strong building would be equivalent to day-dreaming.