Difference between Financing Decision and Investment Decision.
Financing is the decision of which resources or funds are to be brought into the business from external investors and creditors in order to be invested in profitable projects.
The first external source of finance is debt, which includes loans from banks and bonds purchased by bondholders.
The debt creditors take less risk of non-repayment because the business must repay them if there are funds available to do so when the debt becomes due.
Also read | Accounting concepts.
The second external source of finance is equity, which includes common stock and preferred stock.
The equity investors in the business take more business risk and may not receive payment until the creditors are repaid and the management of the business decides to distribute funds back to the investors.
The goal of the financing decision is to obtain all the resources necessary, to make all the investments that yield a return in excess of the cost of the funds invested or the required rate of return, and to obtain these funds at the lowest average cost, so as to reduce the required rate of return and increase the net present value of the projects selected
Finance manager must decide how to acquire funds to meet the firm’s investments needs. The central issue focuses on the appropriate proportion of equity and debt.
Also read | Accounting Standards Meaning, and it’s needed.
The mix of debt and equity is known as the firm’s Capital structure. The idea lies to obtain the best financing mix called as the Optimum capital structure.
The firm’s capital structure is considered optimum when the market value of shares is maximized.
The investment decisions involve capital expenditures. They are, therefore, referred as capital budgeting decisions.
A Capital budgeting decision involves the decision of allocation of capital or commitment of funds to long term assets that would yield benefits (cash flows) in the future. Investment decision relates to:
Also read | Valuation of Preference Shares.
- Management of working capital.
- Capital budgeting decision.
- Management of mergers, reorganization and disinvestment.
- Buy or lease decision.
- Securities analysis and portfolio management.