Financial Management

Financial Management: Comprehensive Chapter Notes

Meaning of Business Finance

**Business finance** is the money required for carrying out business activities. It is essential at every stage in the life of a business entity.

**When is finance required?**

Establishing a business — purchase of land, building, machinery

Running daily operations — buying materials, paying salaries, collecting cash from customers

Modernising the business — upgrading technology and infrastructure

Expanding or diversifying the business — opening new branches, entering new markets

Buying tangible assets — factories, buildings, machinery, vehicles

Buying intangible assets — patents, trademarks, technical expertise, software

**Key Point:** Availability of adequate finance is crucial for the survival and growth of a business. Without proper financing, even the best business idea cannot be executed.

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Financial Management: Definition and Importance

**Financial Management** is concerned with optimal procurement (raising) and optimal usage (deployment) of finance.

**Three Core Objectives of Financial Management:**

1. **Reducing the cost of funds procured** — by identifying and comparing different sources of finance in terms of their costs and risks

2. **Keeping risk under control** — managing financial risk associated with different financing options

3. **Achieving effective deployment of funds** — investing procured funds in such a manner that returns exceed the cost of procurement, and ensuring availability of funds when required without idle finance

**Importance of Financial Management:**

Financial management directly affects the financial health of a business. Almost all items in the financial statements (Balance Sheet and Profit & Loss Account) are affected directly or indirectly through financial management decisions:

**Fixed Assets:** Capital budgeting decisions determine the size and composition of fixed assets. Example: Tata Steel's decision to invest $12 billion in acquiring Corus affected its fixed asset base.

**Current Assets:** Working capital decisions (cash, inventory, receivables management) determine the quantum and break-up of current assets. Example: If credit policy is liberal, receivables increase; if inventory policy is stringent, inventory decreases.

**Debt vs Equity Mix:** The proportion of long-term and short-term funds determines the capital structure. A company wanting more liquidity raises relatively more long-term funds.

**Capital Structure:** The decision to raise debt, equity, or preference share capital affects the composition of liabilities.

**Profit and Loss Account Items:** Higher debt means higher interest expenses; higher equity means higher dividend payments. Depreciation is also affected by capital budgeting decisions.

**Example:** In the Tata Steel-Corus acquisition case, Tata Steel raised $8 billion debt + $2 billion equity. This financing decision directly affected:

Its capital structure (debt-to-equity ratio)

Future interest expenses (profit & loss account)

Financial risk of the company

Market value of equity shares

**Conclusion:** Financial health is determined by the quality of financial management. Good financial management aims at mobilising financial resources at lower cost and deploying them in most lucrative activities.

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Objectives of Financial Management

**Primary Objective:** **Maximisation of Shareholders' Wealth** (Wealth-Maximisation Concept)

This is the most widely accepted objective in modern business finance.

**What does wealth maximisation mean?**

Maximising the market value of equity shares

Ensuring that the current price of shares increases over time

Maximising the wealth of owners (shareholders) of the company

**How is this achieved?**

The market price of a company's equity shares is linked to three basic financial decisions:

1. **Investment Decision** — How funds are invested

2. **Financing Decision** — How funds are raised

3. **Dividend Decision** — How profits are distributed

The market price of shares increases if the benefit from a decision exceeds the cost involved. Therefore, all financial decisions must aim at ensuring that:

Each decision is **efficient** (best among available alternatives is selected)

Each decision **adds value** (benefits > costs)

Value addition ultimately increases the market price of equity shares

**Application Examples:**

**Investment Decision:** When deciding to invest Rs. 100 crores in a new machine, the financial manager ensures that expected returns from the machine exceed its cost plus financing cost. If returns are 15% and financing cost is 10%, value addition is 5%.

**Financing Decision:** When raising funds, the manager chooses the cheapest source (e.g., debt at 8% instead of equity at 12%) to reduce cost and increase returns available to shareholders.

**Dividend Decision:** A company retains 60% earnings for growth and distributes 40% as dividend. If retention leads to growth that increases share price by 20%, wealth is maximised.

**Poor Financial Decisions:** Those decisions which result in decline in share price are considered poor financial decisions, as they destroy shareholder wealth.

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Financial Decisions: Three Major Areas

Financial management is concerned with three major financial decisions:

1. Investment Decision

**Definition:** The decision relating to how the firm's funds are invested in different assets.

**Types of Investment Decisions:**

**A) Long-Term Investment Decisions (Capital Budgeting Decisions)**

Committing finance on a long-term basis for fixed assets

Examples: Investing in new machinery, replacing old equipment, acquiring a new business, opening new branch, purchasing land and building

Impact: Affect earning capacity in the long run, size of assets, profitability, and competitiveness

Characteristics: Involve huge amounts of investment, are largely irreversible (costly to reverse), have long-lasting effects

Criticality: Must be taken with utmost care as wrong decisions can severely damage financial fortune

**B) Short-Term Investment Decisions (Working Capital Decisions)**

Decisions about levels of cash, inventory, and receivables (current assets)

Examples: How much cash to maintain, inventory levels, credit terms for customers

Impact: Affect day-to-day working, liquidity, and profitability

Essential for sound working capital management

**Factors Affecting Capital Budgeting Decisions:**

1. **Cash Flows of the Project:** When a company makes an investment decision involving huge amount, it expects to generate cash flows (series of cash receipts and payments) over the investment's life. These must be carefully analysed before decision. Example: A textile unit investing in new looms expects cash flows from increased production for 10 years.

2. **Rate of Return:** The most important criterion. Projects are evaluated based on expected returns and risk involved. Example: If Project A offers 10% return and Project B offers 12% (with same risk), Project B should be selected as it creates more shareholder value.

3. **Investment Criteria/Capital Budgeting Techniques:** Different methods are used to evaluate investment proposals (NPV, IRR, Payback Period, Profitability Index). Each proposal is evaluated using these techniques before selection.

2. Financing Decision

**Definition:** The decision about the quantum (amount) of finance to be raised from various long-term sources.

**Key Aspect:** This decision determines the **capital structure** of the firm (mix of debt and equity).

**Main Sources of Funds:**

**Shareholders' Funds:** Equity capital + Retained earnings (no fixed obligation to pay returns or repay capital)

**Borrowed Funds:** Debentures, loans, bonds (fixed obligation to pay interest and repay principal)

**Key Characteristics of Each Source:**

**Debt Financing:**

Requires fixed payment of interest regardless of profit

Principal must be repaid at fixed maturity

Creates **financial risk** (risk of default if company cannot pay)

Tax deductible (interest is expense, reducing taxable profit)

Cheaper source (due to tax benefit and lower risk to lender)

**Equity Financing:**

No fixed obligation to pay dividends (discretionary)

No repayment obligation

Lower financial risk

More expensive source

May dilute management control

**Decision:** Firm must decide the judicious (wise) mix of debt and equity based on cost, risk, floatation cost, cash flow position, control considerations, and market conditions.

**Example:** Tata Steel in Corus acquisition raised debt of $8 billion and equity of $2 billion. This 4:1 debt-to-equity ratio reflected:

Strong cash flow position (ability to service debt)

Lower cost of debt (cheaper than equity)

Tax benefits of debt

Control considerations (avoiding excessive equity dilution)

**Factors Affecting Financing Decisions:**

1. **Cost:** Different sources have different costs. Debt is generally cheaper due to tax deductibility of interest. Financial managers prefer the cheapest source. Example: If debt costs 8% and equity costs 12%, debt is preferred.

2. **Risk:** Each source carries different financial risk. Higher debt increases financial risk (risk of unable to meet fixed obligations). Equity involves no such risk but dilutes ownership.

3. **Floatation Costs:** Cost of raising funds (underwriting fees, registration, administrative costs). Higher floatation cost makes a source less attractive. Example: Equity floatation cost is typically 5-10%; debt floatation is 1-2%.

4. **Cash Flow Position:** Strong cash flow position makes debt financing viable (ability to pay interest and principal). Weak cash flow requires equity to reduce fixed obligations. Example: A growing company with rising cash flows can afford more debt.

5. **Fixed Operating Costs:** If business has high fixed costs (rent, salaries, insurance), it should reduce fixed financing costs (interest on debt). Hence, lower debt is better. Conversely, low fixed operating costs allow more debt. Example: A software company with low fixed costs can take more debt than a manufacturing company.

6. **Control Considerations:** Issuing more equity dilutes management control and ownership percentage. Debt financing has no such implication. Companies afraid of takeover prefer debt to equity. Example: Family-owned businesses often prefer debt to protect control.

7. **State of Capital Market:** During bull market (rising stock prices), equity is easily sold at good prices. During bear market (falling prices), equity financing becomes difficult and expensive. Example: In 2008 financial crisis, many companies could not raise equity and had to rely on debt or internal funds.

3. Dividend Decision

**Definition:** The decision about distribution of dividend — how much profit is distributed to shareholders and how much is retained in the business.

**Key Concept:** Dividend is the portion of profit distributed to shareholders. Retained earnings increase firm's future earning capacity.

**Trade-off:**

**Dividend Distribution:** Provides current income to shareholders, increases their wealth immediately

**Retained Earnings:** Finances future growth, increases firm's earning capacity, increases share price in future

**Decision Aspect:** How much of after-tax profit to distribute vs retain, keeping in view overall objective of maximising shareholder wealth.

**Impact:** Extent of retained earnings influences the financing decision. If earnings are retained, firm needs less external financing.

**Factors Affecting Dividend Decision:**

1. **Amount of Earnings:** Dividends paid from current and past earnings. Higher earnings allow higher dividends. Example: If company earns Rs. 100 crore, it can pay dividend from this amount; if it earns Rs. 50 crore, dividend will be lower.

2. **Stability of Earnings:** Companies with stable earnings can declare higher dividends confidently. Companies with unstable/volatile earnings declare lower dividends to maintain sustainability. Example: IT company with growing stable earnings declares 30% dividend payout; cyclical company in trough year declares only 10%.

3. **Stability of Dividend Policy:** Companies generally stabilise dividend per share (not change it frequently). Dividend increase is made only when management is confident about sustained higher earnings, not temporary spike. Example: A company raises dividend from Re. 1 to Rs. 1.50 per share only if it believes future earnings support this permanently.

4. **Growth Opportunities:** Growth companies (with good investment opportunities) retain more earnings to finance growth, hence pay lower dividends. Mature companies with fewer growth opportunities pay higher dividends. Example: A startup tech company retains 90% of earnings for growth and pays 10% dividend; an established company pays 50% dividend.

5. **Cash Flow Position:** Dividend requires actual cash outflow. A company may be profitable but cash-poor. Adequate cash availability is necessary. Example: A real estate company may have high paper profits but low cash; it pays lower dividend due to cash constraints.

6. **Shareholders' Preference:** Management must consider shareholders' preferences. Some shareholders want regular income (prefer dividends); others want growth (prefer retention). Companies balance both. Example: Retired investors prefer dividend-paying stocks; young investors prefer growth stocks.

7. **Taxation Policy:** Tax treatment of dividends vs capital gains affects dividend decision. If dividends are heavily taxed, companies may retain earnings; if capital gains are taxed more, companies pay dividends. Example: In some years, dividend distribution tax affects dividend decisions.

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Financial Planning

**Meaning:** Financial planning is the process of estimating the financial resources required by a business and determining how these resources will be allocated.

**Objectives of Financial Planning:**

1. **Ensuring Availability of Funds:** Planning ensures that adequate funds are available at the right time for various business activities and contingencies.

2. **Proper Allocation of Funds:** Funds are allocated to various activities (investment, operations, dividends) based on priorities and expected returns.

3. **Avoiding Idle Finance:** Planning prevents accumulation of idle/surplus funds that earn no return, reducing wastage.

4. **Achieving Financial Goals:** Planning helps achieve short-term goals (liquidity, working capital) and long-term goals (growth, profitability, maximisation of shareholder wealth).

5. **Facilitating Control:** Planning establishes benchmarks and standards against which actual performance is measured and controlled.

**Importance of Financial Planning:**

**Survival:** Without adequate financial planning, business cannot survive in competitive environment

**Growth:** Planning enables systematic expansion and diversification

**Efficiency:** Planning optimises use of financial resources

**Risk Management:** Identifies financial risks and provides contingency plans

**Decision-Making:** Provides systematic basis for major financial decisions

**Limitations of Financial Planning:**

1. **Rigidity:** Once a financial plan is made, it becomes rigid and difficult to change. If business environment changes, plan becomes outdated. Example: A company plans to raise equity at price of Rs. 500 per share; if market crashes to Rs. 300, plan cannot be executed.

2. **Ineffective in Dynamic Environment:** In rapidly changing business environment, long-term financial plans become irrelevant quickly. Technology disruption, market changes, policy changes make plans obsolete. Example: In 2020 COVID-19 pandemic, all financial plans made in 2019 became invalid.

3. **Based on Assumptions:** Financial plans are based on assumptions about future (growth rate, inflation, interest rates, demand). If assumptions prove wrong, entire plan fails. Example: A plan based on 8% inflation becomes ineffective if actual inflation is 15%.

4. **Ignores Human Factors:** Planning focuses on numbers and ignores human behaviour, motivation, organizational changes. Example: A plan may assume certain productivity levels that are not achieved due to poor workforce motivation.

5. **Expensive and Time-Consuming:** Developing comprehensive financial plans requires expert resources, data collection, analysis — all expensive and time-consuming. Example: Strategic financial planning may take 2-3 months.

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Capital Structure: Meaning and Definition

**Capital Structure** is the composition of long-term sources of finance used by a business. It refers to the mix of debt (long-term borrowings) and equity (share capital and retained earnings) used to finance the firm's assets.

**Example:**

Total long-term finance: Rs. 100 crore

Debt: Rs. 60 crore (60%)

Equity: Rs. 40 crore (40%)

**Capital Structure Ratio (Debt:Equity) = 60:40 or 3:2**

**Why is Capital Structure Important?**

1. **Affects Cost of Capital:** Different sources have different costs. Optimal capital structure minimises overall cost of capital.

2. **Determines Financial Risk:** Higher debt increases financial risk. Capital structure determines the risk profile.

3. **Influences Profitability:** Leverage (use of debt) can increase returns to equity but increases risk.

4. **Affects Share Price:** Capital structure decisions directly impact market value of equity shares (objective of financial management).

5. **Influences Dividend Policy:** Lower debt servicing costs allow higher dividends.

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Factors Affecting Capital Structure

The choice of appropriate capital structure is affected by various factors:

Internal Factors (Company Specific)

1. **Cash Flow Position of the Company**

Strong positive cash flows allow higher debt (ability to pay interest and principal)

Weak cash flows require more equity (lower fixed obligations)

Example: Tata Steel with strong cash flows could afford $8 billion debt for Corus acquisition

2. **Interest Coverage Ratio (Times Interest Earned)**

Ability of company to pay interest from operating profits

Higher ratio indicates safer debt levels

Formula: EBIT ÷ Interest Expense

If ratio is 5x, company earns 5 times interest expense, allowing more debt

If ratio is 1.5x, company barely covers interest, limiting debt

3. **Debt Service Coverage Ratio (DSCR)**

Ability to service total debt (interest + principal repayment)

Formula: Net Cash Flow ÷ Total Debt Service

Higher DSCR allows higher debt

Lenders require minimum DSCR of 1.25-1.5x

4. **Return on Equity (ROE)**

If ROE from operations exceeds debt cost, more debt can be taken

If ROE is 15% and debt cost is 8%, leverage is beneficial

If ROE is 6% and debt cost is 8%, leverage is harmful

5. **Tax Rate**

Interest on debt is tax-deductible (reduces taxable profit)

Higher tax rate makes debt more attractive (greater tax shield)

Lower tax rate reduces debt advantage

Example: In 30% tax bracket, Rs. 100 interest saves Rs. 30 tax; effective cost = Rs. 70

6. **Cost of Debt**

Lower cost of debt (lower interest rates) makes debt more attractive

Higher cost of debt makes equity preferable

Cost varies with creditworthiness (credit rating)

7. **Floatation Costs**

Costs of raising funds (underwriting, registration, legal fees)

Equity floatation typically 5-10% of amount raised

Debt floatation typically 1-2%

Higher floatation costs make that source less attractive

8. **Risk Tolerance**

Conservative management prefers lower debt (less financial risk)

Aggressive management comfortable with higher debt

Risk-averse investors in company demand lower debt

9. **Flexibility Requirements**

Company needing financial flexibility (for opportunities) should maintain debt capacity

Higher debt reduces flexibility to raise additional debt

10. **Control Considerations**

Issue of more equity dilutes management control

Debt financing preserves control

Family businesses prefer debt to protect control

Companies fearing takeover prefer debt

External Factors (Market and Regulatory)

11. **State of Capital Market**

Bull market (rising): Equity easily raised at good valuations → equity preferred

Bear market (falling): Equity difficult to raise → debt or internal funds preferred

Example: Post-2008 crisis, companies reduced equity issuance and relied on debt

12. **Regulatory Framework**

Regulatory limits on debt ratios for certain industries

Banking sector has regulatory capital requirements

Insurance companies have prescribed solvency ratios

These affect capital structure options

13. **Stock Market Conditions**

Depressed stock market makes equity issuance difficult and expensive

Rising stock market provides good window for equity issuance

Companies time equity issuance with market conditions

14. **Industry Norms**

Companies in same industry tend to have similar capital structures

Capital-intensive industries (utilities, infrastructure) have higher debt

Service industries have lower debt

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Fixed Capital and Working Capital

Fixed Capital

**Meaning:** Long-term capital (assets) required by a business for establishing and expanding productive capacity. Fixed capital is invested in fixed assets.

**Fixed Assets include:** Land, buildings, machinery, equipment, vehicles, furniture, intangible assets (patents, trademarks)

**Characteristics:**

Long life (several years)

Capital budgeting decision

Largely irreversible

Affect long-term earning capacity

**Factors Affecting Fixed Capital Requirement:**

1. **Nature of Business**

Capital-intensive industries need high fixed capital: Steel, Oil & Gas, Power, Telecom

Labour-intensive industries need low fixed capital: Software, Consulting, Services

Example: Steel plant needs Rs. 500 crore fixed capital; software company needs Rs. 10 crore

2. **Scale of Operations**

Larger scale operations require higher fixed capital

Company operating in one city needs less fixed assets than pan-India operator

Example: Single factory vs multi-factory operations

3. **Technology Employed**

Advanced automated technology requires more fixed capital

Labour-intensive technology requires less fixed capital

Example: Automated garment factory requires more investment than manual factory

4. **Growth Prospects and Business Plans**

High growth plans require higher fixed capital investments

Expansion plans increase fixed asset base

Example: Company planning 30% annual growth needs more machinery than steady-state company

5. **Diversification Plans**

Diversification into new product lines requires additional fixed assets

Example: Tata Steel diversifying into specialty steel required additional plant and equipment

6. **Funding Mix**

Fixed capital is financed through long-term sources (debt, equity, retained earnings)

Availability of long-term finance affects fixed capital investment

Working Capital

**Meaning:** Short-term capital required for financing day-to-day operations of business. Working capital is the difference between current assets and current liabilities.

**Formula:** Working Capital = Current Assets - Current Liabilities

**Current Assets:** Cash, Inventory, Accounts Receivable (Debtors)

**Current Liabilities:** Accounts Payable (Creditors), Short-term loans, Accrued expenses

**Example:**

Current Assets: Cash Rs. 10 cr, Inventory Rs. 30 cr, Receivables Rs. 20 cr = Rs. 60 cr

Current Liabilities: Payables Rs. 25 cr, Short-term loans Rs. 10 cr = Rs. 35 cr

**Working Capital = Rs. 60 cr - Rs. 35 cr = Rs. 25 cr**

**Importance of Working Capital:**

1. **Day-to-day Operations:** Ensures smooth running of business operations

2. **Liquidity:** Ensures company can meet short-term obligations

3. **Profitability:** Efficient working capital management increases profitability

4. **Growth:** Expansion requires additional working capital

5. **Survival:** Inadequate working capital leads to business failure even if profitable

**Factors Affecting Working Capital Requirement:**

1. **Nature of Business**

Trading business (retail, wholesale) needs high working capital (inventory, receivables)

Service business needs low working capital

Example: Retailers need 2-3 months operating expenses as working capital; consultancy needs 1 month

2. **Scale of Operations**

Larger scale requires higher working capital

Volume of inventory, receivables, cash increases with scale

Example: Scaling from 100 units to 1000 units daily requires 10x working capital

3. **Length of Business/Operating Cycle**

Operating cycle = Days inventory + Days receivables - Days payable

Longer cycle requires more working capital

Example: Business cycle of 90 days needs more working capital than 30-day cycle

Manufacturing has long cycle (raw material → production → sales → collection)

Retail has short cycle (quick inventory turnover)

4. **Seasonal Factors**

Seasonal businesses need higher working capital during peak season

Agricultural businesses, ice cream companies, holiday retailers have seasonal requirements

Example: Sugar industry needs high working capital during crushing season

5. **Credit Policy**

Liberal credit policy (generous payment terms) increases receivables → higher working capital

Stringent credit policy (strict terms) reduces receivables → lower working capital

Example: If company allows 90 days credit instead of 30 days, receivables triple

6. **Inventory Management Policy**

High inventory levels increase working capital

Low inventory levels reduce working capital

Trade-off: High inventory ensures availability but ties up capital

Example: Stockist keeping 3 months inventory vs 1 month inventory

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Leverage: Operating and Financial

**Leverage** refers to using fixed costs (operating or financing) to magnify returns. There are two types:

Operating Leverage

**Meaning:** Use of fixed operating costs to magnify changes in operating profits (EBIT) from changes in sales.

**Formula:** Degree of Operating Leverage (DOL) = % Change in EBIT / % Change in Sales

**Example:**

Company A: Sales increase 10%, EBIT increases 30%

DOL = 30% ÷ 10% = 3

This means 1% change in sales causes 3% change in EBIT

**Operating Leverage Impact:**

High fixed operating costs (rent, depreciation, salaries) create operating leverage

When sales increase, fixed costs remain same, so profit increases proportionally more

When sales decrease, profit decreases proportionally more (higher risk)

Example: Manufacturing company with high depreciation has high operating leverage

Example: Service company with low fixed costs has low operating leverage

Financial Leverage

**Meaning:** Use of fixed financial costs (interest on debt) to magnify changes in earnings per share (EPS) from changes in operating profits (EBIT).

**Formula:** Degree of Financial Leverage (DFL) = % Change in EPS / % Change in EBIT

**Example:**

Company B: EBIT increases 20%, EPS increases 40%

DFL = 40% ÷ 20% = 2

This means 1% change in EBIT causes 2% change in EPS

**Financial Leverage Impact:**

Higher debt increases financial leverage

When EBIT increases, after paying fixed interest, profit per share increases more

When EBIT decreases, profit per share decreases more (higher financial risk)

Example: Company with Rs. 50 cr equity and Rs. 50 cr debt at 10% interest

EBIT Rs. 10 cr: After interest Rs. 5 cr, profit = Rs. 5 cr

If EBIT increases 50% to Rs. 15 cr: After interest Rs. 5 cr, profit = Rs. 10 cr (100% increase)

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EBIT-EPS Analysis

**Purpose:** To choose between equity and debt financing by comparing how each option affects Earnings Per Share (EPS).

**Concept:** Determines the break-even point where both financing options result in same EPS. Above break-even point, debt financing is better (higher EPS); below it, equity financing is better.

**Key Formula:**

**EBIT = Break-even point where EPS is same for both options**

At EBIT levels above break-even, debt financing yields higher EPS

At EBIT levels below break-even, equity financing yields higher EPS

**Example Analysis:**

Company considering raising Rs. 100 crore through:

**Option 1 (Equity):** 100 crore at Rs. 100 per share = 1 crore shares

**Option 2 (Debt):** Rs. 100 crore at 10% interest = Rs. 10 crore annual interest

Scenario Comparison:

**If EBIT = Rs. 20 crore (above break-even):**

Equity: EPS = Rs. 20 crore ÷ 1 crore shares = Rs. 20 per share

Debt: EPS = (Rs. 20 - Rs. 10) ÷ 1 crore shares = Rs. 10 per share

**Debt financing yields higher EPS**

**If EBIT = Rs. 5 crore (below break-even):**

Equity: EPS = Rs. 5 crore ÷ 1 crore shares = Rs. 5 per share

Debt: EPS = (Rs. 5 - Rs. 10) = Loss of Rs. 5 crore (negative EPS)

**Equity financing is better** (avoids loss from fixed interest obligation)

**Decision Rule:**

If company expects EBIT above break-even consistently → Use debt (higher EPS, wealth maximisation)

If company expects EBIT below break-even or uncertain → Use equity (safety, avoid fixed obligations)

**Risk-Return Trade-off:** Debt offers higher return but higher risk; equity offers safety

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Summary: Financial Management Integration

All three financial decisions (Investment, Financing, Dividend) are interconnected:

1. **Investment Decision** determines how much capital is needed (fixed + working capital)

2. **Financing Decision** determines how that capital is raised (debt vs equity mix)

3. **Dividend Decision** determines how profits are distributed vs retained

Together, these decisions determine:

Capital structure of firm

Cost of capital

Financial risk

Market value of equity shares

Overall financial health and shareholders' wealth

**Exam Tip:** For case-based questions, always identify which decision area is involved, analyze factors affecting that decision, and explain how it impacts the financial objective of wealth maximisation.