Shareholder’s Current Wealth in a Company = Number of Shares र Market Price Per Share.

The following factors affect the financing decision:

(i) Cost: The cost of all the sources of finance is different. The rate of interest on debt, fixed rate of dividend to be paid on preference share capital and the expectations of the shareholders on the equity share capital are in the form of costs. If the situations happen to be favourable, the benefit of cheap finance can be availed of by choosing debt capital.

(ii) Risk: Debt capital is most risky and from the point of view of risk it should not be used.

(iii) Floatation Cost: From the point of view of floating costs, retained profit is the most appropriate source. Therefore, its use should be made.

(iv) Cash Flow Position: If the cash flow position of the company is good, the payment of interest on the debt and the refund of capital can be easily made. Therefore, in order to take advantage of cheap finance, debt capital can be given priority.

(v) Level of Fixed Operating Costs: In business, there are mainly two types of costs:

(a) Fixed Operating Costs, e.g., rent of the building, payment of salary, insurance premium, etc.

(b) Fixed Financial Costs, e.g., interest on debt, etc.

If the level of fixed operating costs is in excess, it is better to keep the fixed financial costs at their minimum. Therefore, debt capital should not be used. On the contrary, if the level of fixed operating cost is low, the use of debt capital is profitable.

(vi) Control Consideration: The ultimate control of the company is that of the equity shareholders. Greater the number of equity shareholders, the greater will be the control in the hands of more people. This is not a good situation. Therefore, from this point of view the equity share capital should be avoided.

Financial management refers to that part of the management which is concerned with the efficient planning and controlling of financial affairs of the enterprise.

Wealth Maximisation is an important decision of financial management. It means to increase the capital invested in the business by the shareholders. Market price of the shares is the index of the capital invested. If the market price of the shares increases, it can be said that capital (wealth) invested by the shareholders has been appreciating. On the contrary, fall in the market price of the shares has an adverse effect on their wealth. Wealth of the shareholders can be computed by the following formula:

Shareholder’s Current Wealth in a Company = Number of Shares × Market Price Per Share

For example, a person buys 100 shares of XYZ Co. at the rate of र 100 per share. It means that his wealth in the company is worth र 10,000 (100 ×100). After some time, market price of the share rises to र 120 per share. It means that his wealth in the company has gone up to र 12,000 (100 × 120). In other words, his wealth has increased by र 2,000. On the contrary, if the market price of the share falls to र 80 per share, then his wealth in the company will be reduced to र8,000 (100 × 80).

It is, therefore, clear that wealth maximisation is possible only when market price of the shares rises. Question arises what steps should be taken by the financial manager to raise the market price of his company’s shares? Answer to this question is that he should take all the three main financial decisions as under:

(i) Optimum Investment Decision: It means he should take such decisions regarding investment as are relatively more profitable.

(ii) Optimum Financing Decision: It means that he should make such a mix of debt capital and share capital as has the minimum cost of capital.

(iii) Optimum Dividend Decision: It means that total profits of the company should be distributed among the shareholders in such a manner that they feel satisfied and at the same time company also has sufficient reserve to meet its future requirements.

The three main financial decisions which are generally taken by a finance manager are as under: (i) Investment Decision: It refers to the selection of assets in which funds will be invested by the business. Assets which are obtained by the business are of two types, i.e., long-term assets and short-term assets. On this basis, investment decision is also divided into two parts:

(a) Long-term Investment Decision: This is referred to as the Capital Budgeting Decision. It relates to the investment in long-term assets. For example, buying a new machine. For the same purpose, the finance manager has to make a comparative study of various alternates available in the market on the basis of their cost and profitability. These decisions are very important as they affect the earning of the business over the long run.

(b) Short-term Investment Decision: This is referred to as the Working Capital Management. It relates to the investment in short-term assets, such as, cash, stock, debtors, etc. Finance manager has to ensure that there is sufficient investment in these assets as they affect the liquidity position of the business. For the same purpose, the relative profitability and liquidity of these assets are compared.

(ii) Financing Decision: It refers to the determination as to how the total funds required by the business will be obtained from various long-term sources. Long-term financial sources chiefly include equity share capital, preference share capital, retained earnings, debentures, long-term loan, etc. For taking financing decision, an analysis of the cost and benefits of all the sources is made.

(iii) Dividend Decision: It refers to the determination of how much part of the earning should be distributed among shareholders by the way of dividend and how much should be retained for meeting future needs as retained earnings.