Objectives of Financing Decisions

Finance plays a critical role in every organization or institution. It serves as the means by which economic decisions are made and enables organizations to run operations successfully. Therefore, the financing decisions of a firm affect their short term and long term success. This article explores the objectives of making financial decisions, the criteria used to choose sources of finance, methods of raising finance, and evaluation of such methods to enhance effective financing decisions.

Financing decision is concerned with the methods of acquiring funds to support various business operations and investments. Financing decision is one of the four functions of finance, which we explored briefly in chapter 1. The other three functions are: working capital decisions, investment decisions, and dividend decisions. Finance managers have the role to decide when, where, and how to acquire business funds – whether through the bank or through shareholders. It is important for the company to maintain a good ratio of equity and debt in their capital structure.

Financing decision often comes from two sources of funds: internal sources which include share capital and retained earnings (from profits); while external sources include borrowings from outside providers such as loans, bonds, debentures, and venture capital.

A firm tends to benefit most when the market value of a company’s share maximizes this not only is a sign of growth for the firm but also maximizes shareholders wealth. On the other hand the use of debt affects the risk and return of a shareholder. It is more risky though it may increase the return on equity funds.

A sound financial structure is said to be one which aims at maximizing shareholders return with minimum risk. In such a scenario the market value of the firm will maximize and hence an optimum capital structure would be achieved.

In summary, the objective of the financing decision is to achieve a balance between debt and equity, which leads to an optimum capital structure. An optimal capital structure occurs when company gets the best mix of debt and equity to maximize the value of the firm and minimize its cost of capital. So, financial managers require sound financing decisions to achieve the following objectives:

  • Profit maximization
  • Cost minimization and risk reduction
  • Maximizing value of the firm
  • Long term growth of the firm
  • Smooth operations for the business
  • Ensuring liquidity and effective cash flow
  • Proper asset management and efficient utilization of resources
  • Adequate access to capital and funding

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