Learn, What is the Concept of Financial Decisions?
Decisions concerning the liabilities and stockholders’ equity side of the firm’s balance sheet, such as a decision to issue bonds. Decisions that involve: (1) determining the proper amount of funds to employ in a firm. (2) selecting projects and capital expenditure analysis. (3) raising funds on the most favorable terms possible, and. (4) managing working capital such as inventory and accounts receivable. Also learn, Financial Management, What is the Concept of Financial Decisions?
Definition of Financing Decision:
The Financing Decision is yet another crucial decision made by the financial manager relating to the financing-mix of an organization. It is concerned with the borrowing and allocation of funds required for the investment decisions.
The financing decision involves two sources from where the funds can raise: using a company’s own money. Such as share capital, retained earnings or borrowing funds from the outside in the form debenture, loan, bond, etc. The objective of financial decision is to maintain an optimum capital structure, i.e. a proper mix of debt and equity, to ensure the trade-off between the risk and return to the shareholders.
The Debt-Equity Ratio helps in determining the effectiveness of the financing decision made by the company. While taking the financial decisions, the finance manager has to take the following points into consideration:
- The Risk involved in raising the funds. The risk is higher in the case of debt as compared to the equity.
- The Cost involved in raising the funds. The manager chose the source with minimum cost.
- The Level of Control, the shareholders, want in the organization also determines the composition of capital structure. They usually prefer the borrowed funds since it does not dilute the ownership.
- The Cash Flow from the operations of the business also determines the source from where the funds shall raise. High cash flow enables to borrow debt as interest can easily pay.
- The Floatation Cost such as broker’s commission, underwriters fee, involved in raising the securities also determines the source of fund. Thus, securities with minimum cost must choose.
Thus, a company should make a judicious decision regarding from where, when, how the funds shall raise. Since, more use of equity will result in the dilution of ownership and whereas, higher debt results in higher risk. As the fixed cost in the form of interest is to pay on the borrowed funds.
The Concept of Financial Decisions:
Financial decisions refer to decisions concerning financial matters to a business concern. Decisions regarding the magnitude of funds to invest to enable a firm to accomplish its ultimate goal, kind of assets to acquire. The pattern of capitalization, the pattern of distribution of firm’s income and similar other matters are including in financial decisions.
These decisions are crucial for the well-being of a firm because they determine the firm’s ability to obtain plant and equipment. When needed to carry the required amount of inventories and receivables, to avoid burdensome fixed charges when profits and sales decline and to avoid losing control of the company.
Financial decisions are taking by a finance manager alone or in conjunction with his other executive colleagues of the enterprise. In principle, finance manager is held responsible to handle all such problems as involve money matters.
But in actual practice, he has to call on the expertise of those in other functional areas: marketing, production, accounting, and personnel to carry out his responsibilities wisely. For instance, the decision to acquire a capital asset is based on the expected net return from its use and on the associated risk.
These cannot give values to finance manager alone. Instead, he must call on the expertise of those in charge of production and marketing. Similarly, the decision regarding allocation of funds as between different types of current assets cannot take by a finance manager in the vacuum.
The policy decision in respect of receivables—whether to sell for credit, to what extent and on what terms is essentially financial matter and has to hand by a finance manager. But at the operating level of carrying out the policies. Sales may also involve in decisions to tighten up or relax collection procedures may have repercussion on sales.
Similarly, in respect of inventory, while determining, types of goods to carry in stock and their size are a basic part of the sales function. The decision regarding the quantum of funds to invest in inventory is the primary responsibility of the finance manager since funds must supply to finance inventory.
As against the above, the decision relating to the acquisition of funds for financing business activities is primarily a finance function. Likewise, finance manager has to take the decision regarding the disposition of business income without consulting. Other executives since various factors involving in the decision affect ability of a firm to raise funds.