GODSON PUBLIC SCHOOL

GRADE: XII DATE: 25/01/2022

Business studies

Note: copy down the below given notes in your c/w note neatly

Chapter 9 – Financial Management ( cont…..)

Financial Decisions

The financial decision is one of the most important decisions that the finance managers of an
organization exercise. The financial decisions of the company are determined by and are concerned with
the three important decisions taken:

• Investment decision
• Financing decision
• Dividend decision

A. Investment Decision
• Each and every organization has limited resources in comparison to the uses of the resources.
So it is very important for a firm to decide the source in which the funds should be invested in so
as to fetch the best returns.
• Investment decisions in an organization are taken in both long term and short term.
• There are two types of decisions:
➢ Long term investment decisions: These are also called capital budgeting decisions. This
also implies that the funds are invested in a resource for a longer period of time. These
decisions affect the profitability and size of assets.
➢ Short term investment decision: These are also known as working capital decisions. This
also implies that the funds are invested in a resource for a shorter period of time. These
decisions affect the day to day operations and activities of the organization. It also
affects the liquidity and profitability of the business.
• The essential contents in a working capital are:
➢ Inventory management,
➢ Receivables management and
➢ Efficient cash management.

Factors affecting Capital budgeting decisions.

There are a huge number of ventures and businesses available in the market for the purpose of
investment. It is important to evaluate each and every venture carefully to assess the profitability and
return on investment. The factors affecting the decisions are:

• Cash flow of the project: It is important to analyse the pattern of cash flows in terms of inflows
and outflows over a period of time.
• Rate of return: This is one of the most important factors to be considered before investing in
any venture. These are based on expected returns and the risk involved in each proposal.
 • The investment criteria involved: It is important to evaluate various investment proposals by
considering factors like interest rate, cash flows, etc.
B. Financing Decision
• Under this the Financial managers of the organization decide the sources from which to raise
long-term funds. The main source of funding is shareholders’ fund and borrowed funds.
➢ Shareholders’ funds include share capital, reserves and surpluses and retained earnings.
➢ Borrowed funds refer to funds raised through issue of debentures and other forms of debt.
• The decision of raising funds from various sources in appropriate proportion lies in the hands of
the financial managers
• Interest on loan has to be paid regardless of the profitability of the project
• Debt is considered to be the cheapest form of finance.

Factors affecting Financing Decision

• Cost: Cost of raising funds influences the financing decisions. A prudent financial manager
selects the cheapest source of finance.
• Risk: Each source of finance has a different degree of risk. For example, borrowed funds have
high financial risk as compared to equity capital.
• Floatation cost: A finance manager estimates the flotation cost of various sources and selects
the source with least flotation cost.
• Cash Flow position of the company: A business with a strong cash flow position prefers to raise
funds from debts as it can easily pay interest and the principal.
• Fixed operating costs: For a business with high operating cost, funds must be raised from equity
and lower debt financing would be better.
• Control consideration: A company would prefer debt financing if it wants to retain complete
control of the business with the existing shareholders. On the other hand if a company is ready
to lose control, it can raise funds from equity.
• State of capital markets:
• During boom periods investors are ready to invest in equity but during depression investors look
for second options for investment.

C .Dividend Decision

Dividend is that part of profit which has to be distributed among the shareholders of a company. This
decision relates to the distribution of dividends among various groups. In this decision, it must be
decided that,

• If all profits are to be dispersed,

• Whether all earnings will be retained in the business, or
• Whether a portion of profits will be retained in the business and the remainder distributed
among shareholders.

Factors affecting dividend decision

Amount of earning: Dividend represents the share of profits distributed amongst shareholders. Thus,
earning is a major determinant of dividend decisions.

Stability Earnings: A company with stable earnings is not only in a position to declare higher dividend
but also maintain the rate of dividend in the long run.

Stability of Dividends: In order to maintain dividend per share a company prefers to declare the same
rate of dividend to its shareholders.

Growth Opportunities: The growing companies prefer to retain a larger share of profits to finance their
investment requirements, hence they prefer distributing less dividends.

Cash Flow position: A profitable company is in a position to declare dividend but it may have liquidity
problems as a result of which it may not be in a position to pay dividends to its shareholders.

Shareholders’ Preference: Management of a company takes into consideration its shareholders

expectations for dividend and try to take dividend decisions accordingly.

Taxation policy: Dividends are a tax free income for shareholders but the company has to pay tax on the
share of profit distributed as dividend.

Legal Constraints: Every company is required to adhere to the restrictions and provisions laid by the
companies Act regarding dividend payouts.

Contractual Constraints: Sometimes companies are required to enter into contractual agreements with
their lenders with respect to the payment of dividend in future.

Stock Market: A bull or bear market, also affects the dividend decision of the firm.