Describe the factors influencing financial decisions

Financial decisions will vary from company to company and sometimes from department to department in the same company. These factors are classified into Internal and external factors.

Internal factors

The internal factors influencing the financial decisions are explained below −

• Nature of business − If a company is in manufacturing services, it invests largely in fixed assets. Its capital structure has more shares in long-term capital. If a company is in trading, it invests more in current assets.

• Size of business − Financial decisions vary from large firms to small firms. Large firms need large capital to run their operations, whereas small firms need small capital and some of their assets may be obtained for lease at low cost. Small firms or new firms depend on large firms, who are having goodwill in the market.

• Legal form − Legal forms play an important role in financial decisions. Joint organizational structure will enjoy more facilities than sole proprietorship/partnership in borrowing etc.

• Business cycle − Financial manager plays an important role in taking decisions in business cycle depending on market situation

• Ownership − If the ownership is limited to few or limited members, decision making in the interest of the firm is not difficult.

• Earnings − If income is not stable or risk of earning is high, then the financial manager will go for retention of earnings to impress shareholders. On the other hand, if income is stable or risk of earning is low, then the financial manager will go for liberal dividend policy.

• Liquidity − Firms with strong liquidity will adopt liberal dividend policy. If companies have to meet their past obligations, they will go for conservative dividend policy.

• Asset − More fixed assets can obtain funds for the long term. More currents can obtain funds for the short term.

• Economic life − Preference of borrowing depends on economic life.

• Term of credit − Term of credit plays an important role in influencing financial decisions (dividend payment influences).

• Management − Finance managers will give more importance to liquidity than profitability. This approach is called conservative approach. Opposite to conservative approach is called an aggressive approach.

External factors

The external factors influencing the financial decisions are explained below −

• Economy − If the economy is going towards recovery, the financial manager will go for investment opportunities. On the other hand, if the economy is going towards slumps, the company should take a precautionary approach.

• Markets − Financial managers will go for mixed capital structure, if the market is well developed with multiple institutions and investors. Financial managers will go for liberal dividend policy if shareholders wish for more dividends

• Government regulations − Government regulations play a significant role in financial decisions. It varies from country to country or country to state.

• Taxes − Financial manager tries to minimise tax burden by shaping depreciation policy, valuation of inventory and capital structure and distributes bonuses that are exempted from taxes.