Everything you need to know about the types of financial decisions
taken by a company. The key aspects of financial decision-making
relate to financing, investment, dividends and working capital
management.
Decision making helps to utilise the available resources for achieving
the objectives of the organization, unless minimum financial
performance levels are achieved, it is impossible for a business
enterprise to survive over time.
Therefore financial management basically provides a conceptual and
analytical framework for financial decision making.
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The types of financial decisions can classified under:- 1. Long-Term
Finance Decisions 2. Short-Term Finance Decisions.
There are four main financial decisions:- 1. Capital Budgeting or Long
term Investment Decision 2. Capital Structure or Financing Decision
3. Dividend Decision 4. Working Capital Management Decision.
Types of Financial Decisions: Investment
Decision, Financing Decision, Dividend Decision
and Working Capital Management Decision
Types of Financial Decisions – That Every Company is
Required to Take: Investment Decision, Financing
Decision and Dividend Decision
Every company is required to take three main financial
decisions, they are:
1. Investment Decision
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2. Financing Decision
3. Dividend Decision
1. Investment Decision:
A financial decision which is concerned with how the firm’s funds are
invested in different assets is known as investment decision.
Investment decision can be long-term or short-term.
A long term investment decision is called capital budgeting decisions
which involve huge amounts of long term investments and are
irreversible except at a huge cost. Short-term investment decisions are
called working capital decisions, which affect day to day working of a
business. It includes the decisions about the levels of cash, inventory
and receivables.
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A bad capital budgeting decision normally has the capacity to severely
damage the financial fortune of a business.
A bad working capital decision affects the liquidity and profitability of
a business.
Factors Affecting Investment Decisions / Capital Budgeting
Decisions:
1. Cash flows of the project- The series of cash receipts and payments
over the life of an investment proposal should be considered and
analyzed for selecting the best proposal.
2. Rate of return- The expected returns from each proposal and risk
involved in them should be taken into account to select the best
proposal.
3. Investment criteria involved- The various investment proposals are
evaluated on the basis of capital budgeting techniques. Which involve
calculation regarding investment amount, interest rate, cash flows,
rate of return etc. It is to be considered which technique to use for
evaluation of projects.
2. Financing Decision:
A financial decision which is concerned with the amount of finance to
be raised from various long term sources of funds like, equity shares,
preference shares, debentures, bank loans etc. Is called financing
decision. In other words, it is a decision on the ‘capital structure’ of the
company.
Capital Structure Owner’s Fund + Borrowed Fund
Financial Risk:
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The risk of default on payment of periodical interest and repayment of
capital on ‘borrowed funds’ is called financial risk.
Factors Affecting Financing Decision:
1. Cost- The cost of raising funds from different sources is different.
The cost of equity is more than the cost of debts. The cheapest source
should be selected prudently.
2. Risk- The risk associated with different sources is different. More
risk is associated with borrowed funds as compared to owner’s fund as
interest is paid on it and it is also repaid after a fixed period of time or
on expiry of its tenure.
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3. Flotation cost- The cost involved in issuing securities such as
broker’s commission, underwriter’s fees, expenses on prospectus etc.
Is called flotation cost. Higher the flotation cost, less attractive is the
source of finance.
4. Cash flow position of the business- In case the cash flow position of
a company is good enough then it can easily use borrowed funds.
5. Control considerations- In case the existing shareholders want to
retain the complete control of business then finance can be raised
through borrowed funds but when they are ready for dilution of
control over business, equity shares can be used for raising finance.
6. State of capital markets- During boom period, finance can easily be
raised by issuing shares but during depression period, raising finance
by means of debt is easy.
3. Dividend Decision:
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A financial decision which is concerned with deciding how much of the
profit earned by the company should be distributed among
shareholders (dividend) and how much should be retained for the
future contingencies (retained earnings) is called dividend decision.
Dividend refers to that part of the profit which is distributed to
shareholders. The decision regarding dividend should be taken
keeping in view the overall objective of maximizing shareholder s
wealth.
Factors affecting Dividend Decision:
1. Earnings- Company having high and stable earning could declare
high rate of dividends as dividends are paid out of current and past
earnings.
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2. Stability of dividends- Companies generally follow the policy of
stable dividend. The dividend per share is not altered in case earning
changes by small proportion or increase in earnings is temporary in
nature.
3. Growth prospects- In case there are growth prospects for the
company in the near future then, it will retain its earnings and thus, no
or less dividend will be declared.
4. Cash flow positions- Dividends involve an outflow of cash and thus,
availability of adequate cash is foremost requirement for declaration
of dividends.
5. Preference of shareholders- While deciding about dividend the
preference of shareholders is also taken into account. In case
shareholders desire for dividend then company may go for declaring
the same. In such case the amount of dividend depends upon the
degree of expectations of shareholders.
6. Taxation policy- A company is required to pay tax on dividend
declared by it. If tax on dividend is higher, company will prefer to pay
less by way of dividends whereas if tax rates are lower, then more
dividends can be declared by the company.