Financing Decisions - Meaning, Importance, and FAQs (2024)

The Financing Decision is a crucial decision that is to be made by the financial manager, the decision is about the financing-mix of an organization. Financing Decision is focused on the borrowing and allocation of funds required for the investment decisions of the firm. We will learn in detail about these various financing decisions in the upcoming section.

The financing decision comes from two sources from where the funds can be raised – first is from the company’s own money, such as the share capital, retained earnings. Second is from borrowing funds from the outside the corporate in the form debenture, loan, bond, etc. The objective of the financial decision is to balance an optimum capital structure.

What are the Basic Financial Decisions?

Basic Financial Decisions that financial managers need to take:

Investment Decision

Also known as the Capital Budgeting Decisions. A company’s assets and resources are very rare and thus must be put to use with much analysis. A firm should pick those investments where he can gain the highest conceivable returns. Investment decision involves careful selection of the assets where funds will be invested by the corporates.

Financing Decision

Financial decision is the utmost important decision which is to be made by business individuals. These are wise decisions indeed that are to be chalked out with proper analysis. He decides when, where and how should the business acquire the fund. An organization’s increase in share is not only a sign of development for the firm but also to boost the investor’s wealth.

Dividend Decision

Dividend decisions relate to the distribution of profit that are earned by the organization. The main criteria in this decision are whether to distribute to the shareholders or to retain the earnings. Dividend decisions are affected by the earnings of the business, dependency on earnings.

Importance of Financial Decision Making

  1. Long-term Growth and Effect:

Financial decisions are concerned with the long-term use of assets. These assets are very helpful in the process of production. Profit is also earned by selling the goods that are produced. This can, therefore, be accurate decisions. The greater the growth of business in the long run, the more effective the decision needs to be. In addition to that, these affect the future prospect of the business.

  1. Large Amount of Funds Involved:

Funds are the base of this business decision. Decisions regarding the fixed assets are included in the context of capital budgeting. Huge capital is invested in these assets. If these decisions turn out to be a flaw, then it will cause heavy loss of capital which is indeed a scarce resource.

  1. Risk Involved:

Capital budgeting decisions come with risks. There are two reasons for the risk factor to be involved in it. First, these decisions are analysed for a long period, and thus the expected profits for several years are to be anticipated which even lead to fluctuations. These are human estimations which may turn out to be wrong. Secondly, as a heavy investment is involved, it is very difficult to change the decision once it has been taken.

  1. Irreversible Decisions:

Nature of these decisions is irreversible, once taken it cannot be reformed. For instance, if soon after setting up a sugar mill, the owner thought of changing it, then the old machinery used for the purpose and other fixed assets will have to be sold at a loss. In doing this, the heavy loss will have to be incurred by the owner.

A business constitutes two major things: money and the decision through which the business runs efficiently. Without money, the survival of the company could be impossible and without decisions, survival of money could be impossible. The lifetime of the company completely depends on the countless decisions an administration makes. Probably, the most important things are regarding money. The money decisions related are called ‘Financing Decisions.’

Financial managers take three kinds of decisions they are,

  • Investment Decision

  • Financing Decision and

  • Dividend Decision

Investment Decision

Investment Decision is also referred to as Capital Budgeting Decisions. The assets and resources of the company are rare and must be put into utmost utilization. In order to gain the highest conceivable returns, a firm should pick where to invest. Funds will be invested based on the careful selection of assets by the firms. In procuring fixed assets and current assets, the firm funds are invested. If the choice is taken with respect to a fixed asset it is called a capital budgeting decision.

Factors Affecting Investment Decision

  • Cash flow of the venture: If an organization starts a venture it begins to invest a large amount of capital at the initial stage. Though, the organization expects at least a source of income to meet daily expenses. Hence, within the venture, there must be some regular cash flow to sustain.

  • Profits: The fundamental criteria to start a venture is to generate income but moreover profits. The most crucial criteria in choosing the venture involve the rate of return for the organization with respect to its profit nature. For example: if venture A gets 10% return and venture В gets 15% return then project B must be preferred.

  • Investment Criteria: Various Capital Budgeting procedures are used for a business to assess various investment propositions. Most importantly, they are based on calculations with respect to investment, interest rates, cash flows, and rate of returns associated with propositions. These are applied to the investment proposals to make a decision on the best proposal.

Financing Decision

Financial decision is significant in decision-making on when, where, and how a business acquire funds. When the market estimation of an organization’s share expands the firm tends to gain more profit, it is not only a sign of development of the firm but also fastens investors’ wealth.

Factors Affecting Financing Decisions

  • Cost: Financing decisions are based on the allocation of funds and cost-cutting. The cost of fundraising from different sources differs a lot and the most cost-efficient source should be chosen.

  • Risk: The dangers of starting a venture with funds differ based on various sources. Borrowed funds have a larger risk compared to equity funds.

  • Cash flow position: Cash flow is the daily earnings of the company. A good cash flow position gives confidence to the investors to invest funds in the company.

  • Control: In this case where existing investors hold control of the business and raise finance through borrowing money, however, equity can be utilized for raising funds when they are prepared for diluting control of the business.

  • Condition of the market: The condition of the market plays a major role in financing decisions. Issuance of equity is in majority during the boom period, but debt of a firm is used during a depression.

Financing Decisions - Meaning, Importance, and FAQs (2024)

FAQs

Financing Decisions - Meaning, Importance, and FAQs? ›

The financing decision is about the amount of finance to be raised from various long-term sources, this determines the various sources of finance, as well as it also provides the cost of each source of finance. The main sources of finance are: Shareholders' Funds. Borrowed Funds.

What is the meaning and importance of financing decisions? ›

What is the Financing Decision? The Financing Decision is a crucial decision that is to be made by the financial manager, the decision is about the financing-mix of an organization. Financing Decision is focused on the borrowing and allocation of funds required for the investment decisions of the firm.

Why is it important to make financial decisions? ›

Strong financial knowledge and decision-making skills help people weigh options and make informed choices for their financial situations, such as deciding how and when to save and spend, comparing costs before a big purchase, and planning for retirement or other long-term savings.

What are the 3 main decisions in finance? ›

When it comes to managing finances, there are three distinct aspects of decision-making or types of decisions that a company will take. These include an Investment Decision, Financing Decision, and Dividend Decision.

What factors do you consider when making a financial decision? ›

While taking financing decisions the finance manager keeps in mind the following factors:
  • Cost: The cost of raising finance from various sources is different and finance managers always prefer the source with minimum cost.
  • Risk: ...
  • Cash Flow Position: ...
  • Control Considerations: ...
  • Floatation Cost:

What is most important in the financial decision-making process? ›

Before making a decision, gather relevant information from credible sources. Analyze financial data, market trends, and potential risks to make well-informed choices. Evaluate Options. Consider multiple alternatives and evaluate their potential outcomes.

What is the meaning of financing decision? ›

Financing decisions refer to the decisions that companies need to take regarding what proportion of equity and debt capital to have in their capital structure. This plays a very important role vis-a-vis financing its assets, investment-related decisions, and shareholder value creation.

What is the main goal of financial management? ›

Typically, the primary goal of financial management is profit maximization. Profit maximization is the process of assessing and utilizing available resources to their fullest potential to maximize profits. This has the greatest benefit for company shareholders hoping for the highest possible return on their investment.

What is the difference between investment and financing decisions? ›

The primary goal of both investment and financing decisions is to maximize shareholder value. Investment decisions revolve around how to best allocate capital to maximize their value. Financing decisions revolve around how to pay for investments and expenses.

What are the limitations of financial decisions? ›

Challenges and Limitations in Financial Planning and Forecasting. 1. Accuracy and Reliability of Data: One of the major challenges in financial planning and forecasting is obtaining accurate and reliable data. Without accurate data, it becomes difficult to make informed decisions and create realistic forecasts.

What are the three important decisions finance function is concerned with taking? ›

Finance functions cover Investment (allocating funds to assets for growth), Dividend (deciding on profit distribution to shareholders), Financing (raising capital through equity or debt), and Liquidity (ensuring sufficient cash flow for operations).

What are the four main areas of finance? ›

There are four main areas of finance: banks, institutions, public accounting and corporate. Courses within the finance major provide a solid background in many subjects including: Financial markets and intermediaries. Measuring the risk and return of investments.

What are the three most important decisions managers must make regarding the budgeting process? ›

Management usually must make decisions on where to allocate resources, capital, and labor hours. Capital budgeting is important in this process, as it outlines the expectations for a project.

What is the third primary decision when it comes to making financial decisions? ›

The third primary decision when making financial choices, after spending and saving, is investing. Investment decisions entail determining how to allocate one's savings among various forms of financial opportunities.

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