Saturday, 4 January 2020

Unit 9: Financial Management Decisions

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Unit 9: Financial Management Decisions


Financial management decisions include the decisions relating to planning, organising, directing and controlling the financial activities such as procurement and utilisation of funds of the enterprise.

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

The key aspects of financial decision-making relate to investment, financing and dividends.


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.


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.


For the real growth of the company the financial manager of the company should plan an optimum capital for the company.

The optimum capital structure is one that smaximises the market value of the fi rm.


Interest on debt finance is a tax-deductible expense.

Hence, finance scholars and practitioners agree that debt financing gives rise to tax shelter which enhances the value of the fi rm.

The tax advantage of debt should not persuade one to believe that a company should exploit its debt capacity fully.


Capital structure decisions are likely to affect companies’ tax payments, since corporate taxation typically distinguishes between different sources of finance.

Interest payments can generally be deducted from taxable profits while such a deduction is not available in the case of equity financing.

Taxation of capital income at the shareholder level often differentiates between the types of capital as well.

Therefore, it can be expected that the relative tax benefits of different sources of finance have an impact on financing decisions.


A dividend policy shows how a company determines the amount of earnings to be paid out as dividends to its shareholders on a regular basis.

It is characterised by its dividend payout ratio, which is the percentage of net earnings paid out to shareholders.


The decision to pay dividends to investors does not have an impact on a company’s corporate tax.

Large investors can sometimes pressure the corporate board of directors, influencing their decision to pay dividends or not.

During years when dividend taxes are lower than capital gains taxes, more companies use their excess cash to pay investor dividends.

During times when dividend taxes are high relative to capital gains tax, fewer companies pay investor dividends.

When a company pays you a cash dividend, it reduces stockholder’s equity for each share of stock.

Stockholder’s equity is calculated by subtracting company liabilities from assets.

Paying dividends reduces cash, which is an asset.

Reducing equity represented by each share of stock can have a negative impact on the stock’s share price.

In other words, paying dividends transfers some of the company’s value directly to shareholders in the form of cash instead of capital gains.

Because dividend taxes are lower than short-term capital gains taxes, companies can reduce the tax liability for some of their investors by issuing dividends.


Dividend distribution tax is the tax levied by the Government on companies according to the dividend paid to a company’s investors.

Every domestic company is liable to pay Dividend Distribution Tax @ 15% on the amount declared, distributed or paid by such company by way of dividends.

The effective rate of tax works out to 16.995%.


A bonus issue or scrip issue is a stock split in which a company issues new shares without charge in order to bring its issued capital in line with its employed capital.

This usually happens after a company has made profits, thus increasing its employed capital.

Therefore, a bonus issue can be seen as an alternative to dividends.

No new funds are raised with a bonus issue.


The tax benefit provided by issue of bonus shares holds the concern for every company whose in the process of dividend declaration.

Firms opt for issue of bonus shares due to a number of reasons as stated above however among them the one related to tax benefit also hold a significant importance.

An issue of bonus shares on capitalisation of profits does not entail payment of any tax either for the company or its shareholders.


Capital budgeting decision: It is a decision relating planning process an organisation’s long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth pursuing.

Capital structure: It refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities.

Dividend decision: It is a decision made by the directors of a company about the amount and timing of any cash payments made to the company’s stockholders.

Dividend: A share of the after-tax profit of a company, distributed to its shareholders according to the number and class of shares held by them.

Equity shares: Equity shares means that part of the share capital which is not a preference share capital.

It means all such shares which are not preference shares.

Equity shares are also called as ordinary shares.

Finance decision: The 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 etc.

Finance: It is the study of how money is managed and the actual process of acquiring needed funds.

Financial management: It implies planning, organising, directing and controlling the financial activities such as procurement and utilisation of funds of the enterprise.

Interim dividend: A dividend payment made before a company’s AGM and final financial statements.

This declared dividend usually accompanies the company’s interim financial statements.

Payout ratio: It is the amount of earnings paid out in dividends to shareholders.

Preference shares: Preference shares are those shares which fulfil both the following two conditions: (i) They carry preferential share right in respect of dividend at a fixed rate, (ii) They also carry preferential right in regard to payment of capital on winding up of the company.

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