Determining the best capital structure or Financing decision is the next step in financial management for executing the investment decision once taken. A look at the balance-sheet of a sample company indicates that it obtains finances from shareholders, ordinary or preference, debenture holders on a long-term basis, financial institutions as long-term loans, banks and others as short-term loans, and the like. Financing decisions are concerned with the determination of how much funds to procure from amongst the various avenues available i.e. the financing mix or capital structure. Efforts are made to obtain an optimal financing mix for a particular company. This necessitates the study of the capital structure as also the short and intermediate-term financing plans of the company.
In more advanced companies, financing decision today has become fully integrated with top-management policy formulation via capital budgeting, long-range planning, evaluation of alternate uses of funds, and establishment of measurable standards of performance in financial terms.
Financial decision making is concerned more and more with the questions as to how the cost of funds be measured, proposals for capital using projects be evaluated, or how far the financing policy influences cost of capital or should corporate funds be committed to or withheld from certain purposes and how the expected returns on projects are measured.
Optimal use of funds has become a new concern of financing decisions and top management in the corporate sector are more concerned with planning the sources and uses of funds and measuring performance. New measurement techniques, utilizing computers, have facilitated efficient capital allocation through financing decisions. Investment decisions and financial decisions are jointly made as an effective way of financial management in corporate units. No doubt, the purview of these decisions is separate, but they affect each other. Financial decisions, as discussed earlier, encompass the determination of the proportion of equity capital to debt to achieve an optimal capital structure, and to balance the fixed and working capital requirements in the financial structure of the company. This important area of financing decision making aims at maximizing returns on investment and minimizing the risk. The risk and return analysis is a common tool for investment and financing decisions for designing an optimal capital structure of a corporate unit. It may be mentioned that debt adds to the riskiness of the capital structure of a firm. This part of financial management is the analysis of a company through earnings before interest and taxes, variable costs, contribution. It is called a study of operating leverages. Further, the earnings per share to be given to shareholders is analyzed through the technique of financial leverage. When the study of both these aspects is made it is known as combined leverage.
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