Factors Influencing Financial Decisions¶
Financial decisions can vary between companies and even among departments within the same company. These decisions are influenced by a combination of internal and external factors.
Internal Factors
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Nature of Business: The type of business significantly influences financial decisions. For example, a manufacturing company may invest heavily in fixed assets, leading to a capital structure with more long-term capital. In contrast, a trading company may invest more in current assets.
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Size of Business: The size of a business also plays a crucial role. Large firms require substantial capital to run their operations, while small firms may require less capital and can lease some assets at a lower cost. Small or new firms often rely on larger, more established firms with a strong market presence.
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Legal Form: The legal structure of a business impacts financial decisions. Joint organizational structures may enjoy more favorable borrowing terms than sole proprietorships or partnerships.
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Business Cycle: Financial managers must consider the stage of the business cycle when making decisions. Market conditions during expansion, recession, or recovery can significantly affect financial choices.
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Ownership: The ownership structure of a company can influence decision-making. Companies with limited ownership may find it easier to make decisions in the best interests of the firm.
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Earnings: The stability of a company's income and the level of earnings risk play a role in financial decisions. Unstable income or high earnings risk may lead to a preference for retaining earnings to reassure shareholders. Conversely, stable income or low earnings risk may result in a more liberal dividend policy.
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Liquidity: Companies with strong liquidity positions may adopt a more liberal dividend policy. Companies facing obligations or short-term financial commitments may opt for a conservative dividend policy.
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Asset Composition: The composition of assets in a company's balance sheet can influence financing decisions. More fixed assets may lead to long-term financing, while a higher proportion of current assets may require short-term financing.
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Economic Life: The expected economic life of assets affects borrowing preferences. Companies may align borrowing terms with the expected economic life of assets.
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Term of Credit: The availability and terms of credit impact financial decisions. Companies consider credit terms when determining dividend payments.
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Management Philosophy: The financial management philosophy within an organization can affect decisions. Some financial managers prioritize liquidity over profitability, following a conservative approach, while others adopt a more aggressive approach.
External Factors
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Economic Conditions: Economic conditions have a significant impact on financial decisions. During periods of economic recovery, financial managers may seek investment opportunities, whereas during economic downturns, a more cautious approach is necessary.
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Financial Markets: The state of financial markets influences decisions. Developed markets with diverse institutions and investors may lead financial managers to adopt a mixed capital structure. Shareholder preferences in such markets may favor a liberal dividend policy.
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Government Regulations: Government regulations play a crucial role in financial decisions. These regulations can vary from one jurisdiction to another, impacting borrowing, reporting, and other financial aspects.
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Taxation: Tax considerations drive financial decision-making. Financial managers may adjust depreciation policies, inventory valuation methods, capital structures, and bonus distributions to minimize tax burdens and take advantage of tax exemptions.
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