Page 2 - Lesson Note 1

(i) The size and the composition of fixed assets of the business: For example, a capital
budgeting decision to invest a sum of Rs. 100 cores in fixed assets would raise the size of
fixed assets block by this amount.
(ii) The quantum of current assets and its break-up into cash, inventory and
receivables: With an increase in the investment in fixed assets, there is a commensurate
increase in the working capital requirement. The quantum of current assets is also
influenced by financial management decisions. In addition, decisions about credit and
inventory management affect the amount of debtors and inventory which in turn affect
the total current assets as well as their composition.
(iii) The amount of long-term and short-term funds to be used: Financial management,
among others, involves decision about the proportion of long-term and short-term funds.
An organization wanting to have more liquid assets would raise relatively more amount
on a long-term basis. There is a choice between liquidity and profitability. The
underlying assumption here is that current liabilities cost less than long term liabilities.
(iv) Break-up of long-term financing into debt, equity etc: Of the total long-term finance,
the proportions to be raised by way of debt and/or equity are also a financial
management decision. The amounts of debt, equity share capital, preference share capital
are affected by the financing decision, which is a part of financing management.
(v) All items in the Profit and Loss Account, e.g., Interest, Expense, Depreciation, etc.:
Higher amount of debt means higher interest expense in future. Similarly, use of higher
equity may entail higher payment of dividends. Similarly, an expansion of business
which is a result of capital budgeting decision is likely to affect virtually all items in the
profit and loss account of the business.

OBJECTIVES

The primary aim of financial management is to maximize shareholders’ wealth, which is referred
to as the wealth-maximization concept.

The market price of a company’s shares is linked to the three basic financial decisions which you
will study a little later. This is because a company funds belong to the shareholders and the
manner in which they are invested and the return earned by them determines their market value
and price. It means maximization of the market value of equity shares.

The market price of equity share increases, if the benefit from a decision exceeds the cost
involved. All financial decisions aim at ensuring that each decision is efficient and adds some
value. Such value additions tend to increase the market price of shares.

Therefore, those financial decisions are taken which will ultimately prove gainful from the point
of view of the shareholders. The shareholders gain if the value of shares in the market increases.
Those decisions which result in decline in the share price are poor financial decisions.