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Financial Decisions of a Business Firm

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Business financing: Small business financing refers to an investment in the startup company that aspire a business owner to start a new business, acquire any existing small business or the additional investment in the current or future venture of an existing business. Every business has its different needs and finance requirements and with different sources it can be financed with its benefits and limitations. The small business financing basically can be divided into two categories, which are as follows:

Traditional small business financing can be done in two ways, which are debt financing and equity financing. Whereas the new ways of financing are crowd funding and peer to peer lending. The other ways of financing are:

  • Factoring
  • Bank loan
  • Credit card
  • Pledge some future earnings
  • Funding through angel investors
  • Small Business Administration
  • Microloan

Capital structure: is the decision of a firm about the division and use of business finance in different operations and growth of the company. mainly a firm raise the funds through debt and equity sources, debt is raised in the form of bonds or long term notes payable on the other hand, equity is classified as common stock, preferred stock or retained earnings of the company. short term debt refers to working capital of the company required to operate day to day requirements and it is also a part of the capital structure of a company. The proper combination of debt and equity can improve the value of an organization, on the basis of relationship between debt and equity a number of theories has been created by the thinker, which are as follows:

  • Net Income approach theory
  • Net Operating Income Approach
  • Traditional Theory Approach
  • M & M Approach (Modigliani and Miller)

Dividend decisions is the major idea taken by a finance manager to retain or payout the profits to shareholders of the company. Payout is the part of profits to be given to the shareholders in form of Earning Per Share, which is ordinarily known as Dividends. A company has two options whether to pay the dividend in form of earnings to the shareholders or retain their earnings for the future growth and expansion of a business.

The payout ratio determines the profitability of shareholders and based upon the concept of profit maximization motive of shareholders to invest. Whereas, the rate of retained earnings shows the rate of future development and it is based upon the wealth maximization concept of shareholders.

The most optimal dividend decision refers to the combination, which will increase the value of shares in the company. Thus, the decision of dividend payout must be taken after analyzing investment, financing and dividend. It depends upon integrity and growth prospective of the company. if the company has wide opportunities to grow its business, the shareholders of the company will be ready to give off the payout and reinvest the amount for further growth and development. But the management is required to consider the value of stock of the company. it must not be declined and adversely affected due to low or no payout ratio to the shareholders.

There are two main theories to analyze the impact of payout ratio of the company. the theories are:

Theory of Irrelevance refers to the scenario, which shows that there is no relation between payout ratio of the company and share value. Thus, dividend does not add value to the stock price of a company. Modigliani and Miller Approach is the theory of irrelevance.

Theory of Relevance: This theory states that there is direct relation between dividend payout ratio and share price of the company. investors focus on the dividend payout ratio of the company while deciding the investment portfolio.

Walter’s and Gordon’s model are the theories of relevance of dividend decisions.

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