There are three types of financial decisions which a CFO has to take.

They are:

1. Investment Decisions: One of the most important financial decision is the careful selection of
assets in which funds will be invested by the firm. The two important aspects of investment
decision are :
a. Evaluation of new investment in terms of probability
b. Comparison of cut off rate against new investment and prevailing investment

It can be classified as: Long term investment decision and Short term investment decision. The
long term capital investing is known as capital budgeting while the short term capital investing is
known as working capital management.

Capital budgeting is the process of making investment decision in capital expenditure, the benefits
of which would be received over a long period of time exceeding one year. The CFO has to assess
the profitability before committing the funds.

Short term investment decision on the other hand, relates to allocation of funds as among cash
and equivalents, receivables and inventories. These decisions are influenced by tradeoff between
liquidity and profitability.

The factors affecting investment decisions are:

i. Cash flow of the project: Whenever a company is investing huge funds in an investment
proposal it expects some regular amount of cash flow to meet day to day requirement.
The amount of cash flow an investment proposal will be able to generate must be
assessed properly before investing in the proposal.
ii. Return on Investment: The most important criteria to decide the investment proposal is
the rate of return it will be able to bring back to the company as income.
iii. Risk Involved: There is a risk involved with every decision and the company must try to
calculate the risk involved the risk involved with every proposal and proposals with
moderate degree of risk should be preferred.

2. Financing Decision: The second important decision which a CFO has to take is deciding
the source of finance. A company can raise finance from various sources such as by issue of
shares, debentures or by taking loan and advances. Deciding how much to raise from which source
is concern of financing decision. Broadly speaking a correct ratio of an equity and debt has to be
maintained. This mix of equity capital and debt is known as a firm’s capital structure. The raising of more
debts will involve fixed interest liability and dependence upon outsiders. It may help in increasing
the return on equity but will also enhance the risk.

The raising of funds through equity will bring permanent funds to the business but the
shareholders will expect higher rates of earnings. The financial manager has to strike a balance
 between various sources so that the overall profitability of the concern improves. If the capital
structure is able to minimize the risk and raise the profitability then the market prices of
the shares will go up maximizing the wealth of shareholders.

The factors affecting financing decisions are:

i. Cost: The cost of raising finance from different sources is different and a CFO always
chooses the source with minimum cost.
ii. Risk: The risk associated with borrowed funds is more than that with owners’ fund. CFO’s
compares the risk with the cost involved and chooses the source with moderate risk
factor.
iii. Cash Flow Position: When a company has smooth cash flow, then they can afford
borrowed fund but if the company has a shortage of cash flow, then it must depend on
owners’ fund.
iv. State of Capital Market: During boom period it is easy to sell off equity whereas during
depression period there is a higher demand for debt securities in the market.
v. Control Considerations:If existing shareholders want to retain complete control
in the company then they prefer borrowed fund securitiesBut if they don’t
mind to lose control then they May go for owners’ fund securities.

Dividend Decisions: The third major financial decision relates to the disbursement of profits back to
investors who supplied capital to the firm. The term dividend refers to that part of profits of a company
which is distributed by it among its shareholders.

It’s the financial manager’s responsibility to decide a optimum dividend policy which maximizes the
market value of the firm. Hence an optimum dividend payout ratio is calculated. It is a common practice
to pay regular dividends in case of profitability Another way is to issue bonus shares to existing
shareholders.

If more investment opportunities are available and company has growth plans then more is kept aside

as retained earnings and less is given in the form of dividend, but if company wants to satisfy its

shareholders and has less growth plans, then more is given in the form of dividend and less is kept aside

as retained earnings.

This decision is also called residual decision because it is concerned with distribution of residual or left

over income. Generally new and upcoming companies keep aside more of retain earning and distribute

less dividend whereas established companies prefer to give more dividend and keep aside less profit.

The factors affecting the dividend decisions are:

Earning: Dividends are paid out of current and previous year’s earnings. If there are more earnings then
company declares high rate of dividend whereas during low earning period the rate of dividend is also
low

Stability of earnings: Companies having stable or smooth earnings prefer to give high rate of dividend
whereas companies with unstable earnings prefer to give low rate of earnings.

A.

Cash flow position: Paying dividend means outflow of cash. Companies declare high rate of dividend
only when they have surplus cash. In situation of shortage of cash companies declare no or very low
dividend.

B.

C. Growth opportunities:

Stability of dividend: Some companies follow a stable dividend policy as it has better impact on
shareholder and improves the reputation of company in the share market. The stable dividend policy
satisfies the investor.

D.

Preference of shareholders: Another important factor affecting dividend policy is expectation and
preference of shareholders as their expectations cannot be ignored by the company. Some of the
investors might prefer regular and stable amount of dividend whereas others might prefer
capital gain.

E.

Stock market Reaction: The declaration of dividend has impact on stock market as increase in
dividend is taken as a good news in the stock market and prices of security rise. Whereas a decrease in
dividend may have negative impact on the share price in the stock market. So possible impact of
dividend policy in the equity share price also affects dividend decision.

F.
3.