The Concept of Financial Decisions, The Factors Influencing Financial Decisions: 1. External Factors, and 2. Internal Factors, Fully Explain It by PDF and Free Download, and What is the Importance of Financial Decisions? Definition: 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. Also learned, The Factors Influencing and Importance of Financial Decisions!
Learn and Understand, The Factors Influencing and Importance of Financial Decisions!
The financing decision involves two sources from where the funds can be raised: 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 Concept of Financial Decisions:
Financial decisions refer to decisions concerning financial matters to a business concern. Decisions regarding the magnitude of funds to be invested to enable a firm to accomplish its ultimate goal, kind of assets to be acquired, the pattern of capitalization, pattern of distribution of firm’s income and similar other matters are included 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 taken by a finance manager alone or in conjunction with his other executive colleagues of the enterprise. In principle, the 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 be given values by the 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 be taken 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 be handled by a finance manager. But at the operating level of carrying out the policies, sales may also be involved since decisions to tighten up or relax collection procedures may have repercussion on sales.
Similarly, in respect of inventory, while determining types of goods to be carried in stock and their size are a basic part of the sales function, a decision regarding the quantum of funds to be invested in inventory is the primary responsibility of the finance manager since funds must be supplied 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, the finance manager has to take a decision regarding the disposition of business income without consulting other executives since various factors involved in the decision affect the ability of a firm to raise funds. In sum, financial decisions are looked upon as cutting across functional, even disciplinary boundaries. It is in such an environment that a finance manager works as a part of total management.
The Factors Influencing Financial Decisions:
A finance manager has to exercise a great skill and prudence while taking financial decisions since they affect the financial health of an enterprise over a long period of time. It would, therefore, be in the fitness of things to take the decisions in the light of external and internal factors. We shall now give a brief account of the impact of these factors on financial decisions.
External factors refer to environmental factors within which a business enterprise has to operate. These factors are beyond the control and influence of the management. A wise management adopts policies that will be most suited to the present and prospective socio-economic and political conditions of the country.
The following external factors enter into decision-making process:
- The State of Economy.
- Structure of Capital and Money Markets.
- State Regulations.
- Taxation Policy.
- Requirements for Investors, and.
- Lending Policy of Financial Institutions.
Internal factors refer to those factors which are related with internal conditions of the firm such as nature of business, size of business, expected return, cost and risk, asset structure of business, structure of ownership, expectations about regular and steady earnings, age of the firm, liquidity in company funds and its working capital requirements, restrictions in debt agreements, control factor and attitude of the management.
Within the economic and legal environment of the country finance manager must take the financial decision, keeping in mind the numerous characteristics of the firm.
Impact of each of these factors upon financial decisions will now be discussed in the following lines.
- Nature of Business.
- Size of Business.
- Expected Return, Cost, and Risk.
- Asset Structure of the Firm.
- Structure of Ownership.
- Probabilities of Regular and Steady Earnings.
- Age of the Firm.
- Liquidity Position of the Firm and Its Working Capital Requirements.
- Restrictions in Debt Agreements, and.
- Management Attitude.
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What is the Importance of Financial Decisions?
These decisions are relatively more important because of the following reasons:
(1) Long-term Growth and Effect:
These decisions are concerned with long-term assets. These assets are helpful in production. Profit is earned by selling the goods so produced. It can, therefore, be said the more correct these decisions are, the greater will be the growth of business in the long run. In addition to that, these affect the future possibilities of the business.
(2) Large Amount of Funds Involved:
Decisions regarding fixed assets are included in the preview of capital budgeting. A large amount of capital is invested in these assets. If these decisions turn out to be wrong, there occurs the heavy loss of capital which is a scarce resource.
(3) Risk Involved:
Capital budgeting decisions are full of risk. There are two reasons for it. First, these decisions refer to a long period, and as such expected profits for several years are to be anticipated. These estimates may turn out to be wrong. Second, because of the heavy investment involved, it is very difficult to change the decision once taken.
(4) Irreversible Decisions:
Nature of these decisions is such as cannot be changed so quickly. For instance, if soon after setting up a cotton mill, it is thought of changing it, then the old machinery and other fixed assets will have to be sold at the throwaway price. In doing so, the heavy loss will have to be incurred. Changing these decisions, therefore, is very difficult.