FINANCIAL DECISIONS

Introduction
• Financial Decisions is a comprehensive financial planning
and wealth management that helps high-net-worth
individuals and businesses achieve their financial
objectives
• 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 top three types of financial decisions are:
1. Investment decisions
 Capital budgeting
 Working capital management
2. Financing decisions
 Capital structure decisions
 Cost of capital
3. Dividend decisions
 Dividend policy
 Retained earnings
1. Investment Decisions:
Investment Decision relates to the
determination of total amount of assets to be
held in the firm, the composition of these
assets and the business risk complexions of
the firm as perceived by its investors. It is the
most important financial decision. Since
funds involve cost and are available in a
limited quantity, its proper utilisation is very
necessary to achieve the goal of wealth
maximisation.
 The investment decisions can be classified
under two broad groups:
• Long-term investment decision
• Short-term investment decision

The long-term investment decision is referred

to as the capital budgeting and the short-term
investment decision as working capital
management.
• Capital budgeting is the process of making
investment decisions in capital expenditure. These
are expenditures, the benefits of which are expected
to be received over a long period of time exceeding
one year. The finance manager has to assess the
profitability of various projects before committing
the funds.
• The investment proposals should be evaluated in
terms of expected profitability, costs involved and
the risks associated with the projects.
• The investment decision is important not only
for the setting up of new units but also for the
expansion of present units, replacement of
permanent assets, research and development
project costs, and reallocation of funds, in
case, investments made earlier do not fetch
result as anticipated earlier.
• Short-term investment decision, on the other hand,
relates to the allocation of funds as among cash and
equivalents, receivables and inventories. Such a decision
is influenced by tradeoff between liquidity and
profitability.
• The reason is that, the more liquid the asset, the less it is
likely to yield and the more profitable an asset, the more
illiquid it is. A sound short-term investment decision or
working capital management policy is one which ensures
higher profitability, proper liquidity and sound structural
health of the organisation.
• 2. Financing Decisions:
Once the firm has taken the investment
decision and committed itself to new
investment, it must decide the best means of
financing these commitments. Since, firms
regularly make new investments; the needs
for financing and financial decisions are
ongoing.
COST OF CAPITAL- The minimum rate of return that a
business earn before generating value.
• Hence, a firm will be continuously planning for new
financial needs. The financing decision is not only
concerned with how best to finance new assets, but also
concerned with the best overall mix of financing for the
firm.
• Capital structure- the mix of debt and equity is known as
capital structures.
• A finance manager has to select such sources of funds
which will make optimum capital structure. The
important thing to be decided here is the proportion of
various sources in the overall capital mix of the firm. The
debt-equity ratio should be fixed in such a way that it
helps in maximising the profitability of the concern.
• The raising of more debts will involve fixed
interest liability and dependence upon
outsiders. It may help in increasing the return
on equity but will also enhance the risk.
• The raising of funds through equity will bring
permanent funds to the business but the
shareholders will expect higher rates of
earnings. The financial manager has to strike a
balance between various sources so that the
overall profitability of the concern improves.
• If the capital structure is able to minimise the
risk and raise the profitability then the market
prices of the shares will go up maximising the
wealth of shareholders.
• 3. Dividend Decision:
The third major financial decision relates to the
disbursement of profits back to investors who
supplied capital to the firm. The term dividend
refers to that part of profits of a company which
is distributed by it among its shareholders.
Dividend Policy refers to the explicit or implicit
decision of the board of directors regarding the
amount of residual earnings (Past and
Present)that should be distributed to the
shareholders of the corporations.
• It is the reward of shareholders for investments made by them
in the share capital of the company. The dividend decision is
concerned with the quantum of profits to be distributed
among shareholders.
• Retained earnings – portions of a company’s profit that is
held or retained from net income after it has paid out
dividends to its shareholders.
• A decision has to be taken whether all the profits are to be
distributed, to retain all the profits in business or to keep a
part of profits in the business and distribute others among
shareholders. The higher rate of dividend may raise the market
price of shares and thus, maximise the wealth of shareholders.
The firm should also consider the question of dividend
stability, stock dividend (bonus shares) and cash dividend.