Question

What is meant by 'Financing decision'?

State any four factors affecting the financing decision.

Answer 1

Financing Decision:

This decision relates to how, when and where funds are to be acquired to meet investment needs. It is related to the capital structure or financial leverage. This is debt-equity ratio. If more recourse is taken to debt capital, shareholders’ risk is lessened and the prospects of their dividend earning are reduced. So, in financing decision, the crucial point is the trade-off between returned risks.

The financing decision— unlike investment de­cision— relates to the determination of the capital structure — the proper balance between debt and equity.

Factors Affecting Financing Decisions:

While taking financing decisions the finance manager keeps in mind the following factors:

1. Cost:

The cost of raising finance from various sources is different and finance managers always prefer the source with minimum cost.

2. Risk:

More risk is associated with borrowed fund as compared to owner’s fund securities. Finance manager compares the risk with the cost involved and prefers securities with moderate risk factor.

3. Cash Flow Position:

The cash flow position of the company also helps in selecting the securities. With smooth and steady cash flow companies can easily afford borrowed fund securities but when companies have shortage of cash flow, then they must go for owner’s fund securities only.

4. Control Considerations:

If existing shareholders want to retain the complete control of business then they prefer borrowed fund securities to raise further fund. On the other hand if they do not mind to lose the control then they may go for owner’s fund securities.