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Unit 9: Financial Management Decisions

enterprise. It implies application of general management principles to financial resources of Notes

the enterprise. The key aspects of financial decision-making relate to investment, fi nancing and
dividends.

Investment decisions also called as capital budgeting includes investment in fixed assets.
Financial decisions are related to the raising of finance from various resources which will depend

upon decision on type of source, period of financing, cost of financing and the returns thereby.

In dividend decision the finance manager has to take decision with regards to the net profi t
distribution. While undertaking all these above decision in order to attain the ultimate goal of
shareholders wealth maximisation a firm always considers these decisions from the point of view

of taxation.

Financing decisions are concerned with quality of finance basically focusing on achieving
an optimum mix between debts and equity. Capital structure decision is a matrix of three
considerations namely the risk, cost of capital and tax planning Thus the tax planner should
properly make a balance between risk, cost of capital and tax saving consideration in such a
manner, which ensure maximum shareholder’s return with optimum risk.
In this unit, we will study the relationship between the two main important fi nancing decisions
namely the finance and dividend decision and importance of taxation in taking such decisions.

9.1 Capital Structure Decisions

An organisation employs different types of funding to run a business smoothly. Capital structure

is a composition of different types of financing employed by a firm to acquire resources necessary

for its operations and growth. Capital structure primarily comprises of long-term debt, preferred
stock, and net worth. It can be quantified by taking how much of each type of financing a company

holds as a percentage of all its financing. Capital structure is different from financial structure as
this includes short-term debt, accounts payable, and other liabilities.
Most of the companies raises fund by equity or debt. Debt comes in the form of bond or long-

term notes payable, whereas equity is classified as common stock, preferred stock, or retained

earnings. Both the financing has advantages and disadvantages over each other. The founders
hold the ownership rights and control of the company if they raise capital by debt. The company
has to pay the principal and interest to the concerned debt holders. This privilege will be lost in
equity, as the shareholders become an integral part of the company. Debt financing is easier and

less expensive for small firms. Payment of interest on regular becomes burden for a company
and reduces their earnings. There is no obligation in equity financing to repay the money.

Shareholders take a chance on good ideas for better growth opportunities of the fi rm.
Did u know? Capital structure is a mix of a company’s long-term debt, specifi c short-term
debt, common equity and preferred equity. Debt comes in the form of bond issues or long-

term notes payable, while equity is classified as common stock, preferred stock or retained
earnings. Short-term debt such as working capital requirements is also considered to be
part of the capital structure.
Therefore you can say that capital structure is referred to as the ratio of different kinds of securities

raised by a firm as long-term finance. The capital structure involves two decisions:
(a) Types of securities to be issued are equity shares, preference shares and long term
borrowings (Debentures).
(b) Relative ratio of securities can be determined by process of capital gearing. On this basis,
the companies are divided into two:

(i) High geared companies: Those companies whose proportion of equity capitalisation is
small.

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