Financial Decisions

The financing decisions are decisions concerned regarding the method that are used to raise funds which would be used for making acquisitions. The financing decisions are decisions concerning the liabilities and stockholders’ equity side of the firm’s balance sheet, such as a decision to issue bonds.

The financing decisions involve various factors. They are determining the proper amount of funds to employ in a firm, selecting projects and capital expenditure analysis, raising funds on the most favorable terms possible and finally managing working capital such as inventory and accounts receivable. The goals of corporate finance can be achieved only when the corporate investment is financed appropriately. The financing mix will make an impact the valuation. The company should therefore identify an optimal mix of financing i.e. the one which results in maximum value.

The sources of finance are usually comprised of a combination of debt and equity financing. A project that is financed through debt results in a liability and obligation. When the projects are financed through equity is less risky with respect to cash flow commitments. The cost of equity is always higher than the cost of the debt. The equity financing may result in an increased hurdle rate which will offset any reduction in thecash flow risk. The management of the company must match the financing mix to the asset that is being financed.

1 Define the decision. What are you trying to accomplish? State it clearly.

2 What’s the need or want behind the decision? Why do you think you have to make this decision now?

3 What’s non-negotiable? What things are you not willing to compromise on if you decide to take action on this decision? If you are buying a car and you have a large family, the vehicle has to accommodate at least seven passengers. Or, your commute to work is far and you need a car that gets good gas mileage.

4 Identify alternatives. Have you carefully considered all the options? Yes, your older car is increasingly in need of repairs. But if you can plan the repairs so you aren’t stranded, it’s still probably cheaper than buying another car. Is public transportation an option? Do you absolutely need a car?

5 Assess the various alternatives. Once you’ve identified them, examine each one carefully. Don’t rule anything out. Often bad decisions are made because you settle on a particular solution before considering your options.

6 What’s the cost and can you afford it? Calculate what each alternative would cost. If it’s buying a used or new car, consider everything, including gas mileage, insurance premiums and reliability/repair records for the vehicle you’re thinking about buying.

7 Take a step back. Give yourself time to think about the decision. Be patient! If it’s the right decision today, it will be right tomorrow. If the car you wanted has been sold, there will always be another one.

8 Make a decision. If you can say with certainty that you have followed the first seven steps, then proceed with confidence knowing you did all you could. Don’t look back with regret.

If you apply a systematic way of looking at financial decisions, you can avoid a lot of the bad ones that come back to haunt you.