09.
FINANCIAL MANAGEMENT
Max. Marks 01 03 04 06 Total
Weightage as per CBSE curriculum 2022-23
No of questions -
02 08
There is ONE internal choice question for 04 marks, from this chapter only
Business Finance -Money required for carrying out business activities.
Financial Management- It is concerned with optimal procurement as well as the usage of finance.
IMPORTANCE/ROLE OF FINANCIAL MANAGEMENT
01
The size and the composition of
fixed assets
A capital budgeting/financial management decision to invest in
Fixed assets would raise the size of fixed assets.
The quantum of current assets The quantum of current assets is also influence the financial
02 and its break-up into cash, management decision. The decision credit and inventory
inventory and receivables Imanagement affect the amount of debtors and inventory.
03
The amnount of long-term and It involves the proportion of long term and short term funds to be
short- term funds to be used invested
04
Break-up of long-term financing Of the total LT finance, the proportions to be raised by way of debt
into debt, equity etc and equity is also a financial management decision
Allitems in the Profit and Loss Higher amount of debt means higher amount of interest in future.
05 Account, e.g., Interest, Expense, Similarly, use of equity may entail dividends. Expansion of
Depreciation. business which is a result of capital budgeting decision is likely to
affect virtually all items in the profit and loss account
OBJECTIVES OF FINANCIAL MANAGEMENT
To maximize shareholders' wealth. It is achieved through
(a) Ensuring effective utilization of funds.
(b)Ensuring safety of funds procured by creating reserves, reinvesting profits, etc.
INVESTMENT/CAPITAL BUDJETING/LONG TERM INVESTMENT DECISION
(as a part of Financial Decision)
The investment decision, therefore, relates to how the firm's funds are invested in different fixed assets.
Investment decision may be long-term or short-term. Long-term investment decision is called capital
budgetiHgdecision and short-term investrnent decision is called working capital decision.
FACTORS AFFECTING CAPITAL BUDGETING DECISION
01 Cash flow of the project The series of cash receipts and payments.over the life of an investment
proposal should be considered and analyzed for selecting the best proposal.
02 The rate of return The expected returns from each proposal and risk involved in them should be
taken into account to select the best proposal.
The investment criteria The various investment proposals are evaluated on the basis of capital
03 involved budgting techniques. These involve calculation. regarding investment
lamount, interest rate, cash flowS, rate of return etc.
FINANCING DECISION (as a part of Financial Decision)
Financing decision It deals with quantum of finance to be raised from long-term sources, viz debt and
equity.In other words, it refers to the determination as how the total funds reguired by the business will be
obtained from various long-term sources. It involve decision whether or not to use a combination of
Ownership and borrowed funds and determining their precise ratio. It needs a judicious mix of debt and
equity.
FACTORS AFFECTING FINANCING DECISION
01 Cost The cost of raising funds from different sources is different. The cheapest source shoula
be selected (usually cheapest is debt )
Uhe riSk associated with different sources is different. More risk is_associated with
02
Risk borrowed funds as compared to owner's fund as interest is paid on it and It is repaid
lalso, after a fixed period of time or on expiry of its tenure. (usually loW risk is equity)
25
FACTORS AFFECTING FINANCING DECISION
The costs involved in issuing securities such as brokers Commission, underwriters" fees.
03 Floatation cost expenses on prospectus etc. are called flotation costs. Higher the flotation cost. less
Jattractive is the source of finance. (usually floatation cost is low if it is debt)
04
Cash flow In case the cash flow position of a company is good enough then it can easily use
position borrowed funds and pay interest on time.
05 Cost
Fixed operating|If a business has high fixed operating cost then it must reduce fixed finarncing costs.
Hence lower debt financing is better.
Control In case the existing shareholders want to retain the complete control of business then
06 considerations |finance can be raised through borrowed funds but when they are ready for dilution of
control over business, equity can be used for raising finance.
State of capital|During boom, finance can easily be raised by issuing shares but during depression
07 market period, raising finance by means of debt is easy.
DIVIDEND DECISION (as a part of Financial Decision)
The decision involved here is (how much of the profit earned by company (after paying tax) is to be
distributed to the shareholders and how much of it should be retained in the business. Must be done keeping
in mind the firms overall objective of maximizing the shareholders wealth.
FACTORS AFFECTING DIVIDEND DECISION
01
Amount of Companies having high and stable earning could declare high rate of dividends as
Earnings dividends are paid out of current and paste earnings.
02 Stability If a company having stable earnings it is better to declare higher dividends, if the
Earnings company is having unstable earnings is likely to pay smaller dividend
03
Stability
Dividends
of Companies generally follow the policy of stable dividend. The dividend per share is not
altered and changed in case earnings change by small proportion or increase in
earnings is temporary in nature
04
Growth In case there are growth prospects for the conmpany in the near future them it will
Opportunities retain its earning and thus, no or less dividend will be declared.
Cash Flow Dividends involve an outflow of cash and thus, availability of adequate cash is for most
05
Position requirement for declaration of dividends.
Shareholders While deciding about dividend the preference of shareholders is also taken into
06 Preference account. In case shareholders desire for dividend then company may go for declaring
the same.
Taxation Acompany is required to pay tax on dividenddeclared byit. If tax on dividend is
07 Policy |higherompany will prefer to pay less by way of dividends whereas if tax rates are
lower than more dividends can be declared by the company.
Stock Market If th¿ companies are declaring more amounts of dividend and stock prices react
O8 Reaction positively to it. Similarly, a decrease in dividend may have a negative impact on the
share price in the stock market.
Access to Large companies having easy access to the capital market may depend less on retained
09 Capital Market warnings, these companies tend tO pay higher dividends than the smaller companies
|which have relatively low access to the market.
Legal Under provisions of Companies Act, all earnings can't be distributed and the company
10 Constraints |has to provide for various reserves. This limits the capacity of company to declare
dividend.
Contractual While granting loans _to a company the lender may impose certain restrictions on the
11 Constraints payment of dividends in future. The companies are required to ensure that the dividend
does not violate the terms of the loan agreement
FINANCIAL PLANNING
AFinancial planning is a blueprint of an organization's future operations. It is the process of estimating
the fund requirement of a business and determining the possible sources from which it can be raised.
OBJECTIVESOF FINANCIAL PLANNING
To ensure availability of funds whenever required:
ITosee that the firm does not raise esources unnecessarily.
IMPORTANCE OF FINANCIAL PLANNING
01 It helps in forecasting what may happen in future under different business situations
02 It helps in avoiding business shocks and surprises and helps the company in preparing for the future
03 It helps in co-coordinating various business functions,e
IMPORTANCE OF FINANCIAL PLANNING
04 Reducing waste, duplication of efforts, and gaps in planning.
05 It tries to link the present with the future
06 It provides a link between investment and financing decisions on a continuous basis.
07 It Making the evaluation of actual performance easier.
CAPITAL STRUCTURE
Capital Structure refers to the mix between owners and borrowed funds. These shall be referred as equity
land debt in the subsequent text. It can be calculated as debt-equity ratio or as the proportion of debt out of
the total capital. The proportion of debt in the overall capital is also called Financial Leverage.
TRADINGON EQUITY
Trading on Equity refers to the increase in profit earned by the equity shareholders due to the presence of
fixed financial charges like interest.
Statement showing EBIT - EPS Analysis
DEBT REOUIREMENTS DEBT OPTIONS
Funds required Int. Rate Tax Rate Situation 1 Situation 2 Situation 3
30,00,000 10% 30% NIL 10,00,000 20,00,000
This is a situationof Favorable Financial This is a situation of Unfavorable
leverage Financial leverage
Situation Situation Situation
Situation Situation Situation
1 2 1 2
EBIT 4,00,000 4,00,000 4,00,000 EBIT 2,00,000 2,00,000 2,00,000
Interest@10% NIL 1,00,000 2,00,000 Interest@10% NIL 1,00,000 2,00,000
EBT 4,00,000 3,00,00o 2,00,000EBT 2,00,000 1,00,000 NIL
Tax (@30%) (1,20,000) (90,000) (60,000) Tax (@30%) 60,000 30,000 NIL
EAT 2,30,000 2,10,000 1,40,000 EAT 1,40,000 70,000 NIL
No of shares 3,00,000 2,00,000 1,00,000 No of shares 3,00,000 2,00,000 1,00,000
EPS 0.93 1.05 1.40 EPS 0.47 0.35 NIL
ROI 0s 13.33% (4/30*100) and Kd is 10% ROI is 6.67% (2/30*100) and Kd is 10%
FACTORS AFFECTING CAPITAL STRUCTURE
Cash Flow Size of projected cash flows must be considered before borrowing. Cash flows must not
01
Position lonly cover fixed cash payment obligations but there must be sufficient buffers also.
Interest The interest coverage ratio refers to the number of times earnings before interest and
02
COverage ratio taxes of a company coversthe interest obligation.
Debt service Debt Service Coverage Ratio takes care of the deficiencies referred to in the Interest
03 coverage ratio Coverage Ratio (ICR). The cash profits generated by the operations are compared with
the total cash required for the service of the debt and the preference share capital.
04
Return on If the ROI of the company is higher, it can choose to use trading on equity to increase
linvestment its EPS
Cost of debt Afirm"s ability to borrow at a lower rate increases its capacity to employ higher debt.
05
Thus, more debt can be used if debt can be raised at a lower rate.
06 Tax rate JA higher tax rate makes debt relatively cheaper vis-a-vis equity
07
Cost of equity Stock owners expect a rate of return fromthe equity which is commensurate with the
risk they are assuming.
08
Floatation costs Process of raising funds involves some costs, these considerations may affect the choice
between debt and equity, hence the capital structure.
09
risk Business risk depends upon fixed operating cost. Fixed operating costs result in higher
consideration business risk and vice-versa. Total risk depends upon business risk and financial risk.
10 Flexibility To maintain flexibility it must maintain some borrowing powers to take care of
unforeseen circumstances.
11 Control Debt normally does not cause a dilution of control where as equity dilute the control
12 Regulatory The companies have to operate within aregulatory frame work provided by the law at
frame work the time of opting debt and or equity
13
Stock Market Stock market conditions often affect the choice between equity and debt.
conditions
27
FACTORS AFFECTING CAPITAL STRUCTURE
Capital stru It has been observed that the capital structure of competing companies also affect the
14 cture of other capital structure of the company in question.
companies
FIXED CAPITAL
The amount of capital investment in fixed assets is called fixed capital, e.g. plant and machinery, land and
building, etc. which is to be used over along period of time and it also affects the growth, profitability and
Irisk of the business in the long run.
FACTORS AFFECTING FIXED CAPITAL REQUIREMENTS
01
Nature of |A tradingconcern needs lower fixed capital since it does not require purchasing fixed
business assets. A manufacturing concern would require heavy investment in fixed assets etc.
Scale of Alarge organization operating at a higher scale needs higher investment in fixed assets
02
Operations ]when compared with the smallorganization.
Choice of |Here, two types of techniques exist, such as capital intensive and labour intensive.
03
Technique Capital intensive organization needs higher investment and labour intensive less
linvestment in fixed assets.
Some assets such as computers become obsolete faster and are replaced much sooner
04 Technology than other fixed assets say furniture. Thus, such organizations which use assets which
Upgradation are prone to obsolescence require higher fixed capital to purchase such assets.
05
Growth If an organization expects higher growth prospects, it will require higher investment in
Prospects fixed assets to create higher capacity of production.
More fixed capital will be required in case of companies which have diversity of
06 Diversification production lines as compared to companies which do not have much of diversification.
07 Financing Instead of purchasing fixed assets a developed companies may took the same on lease
Alternatives basis which requires less investment.
Level of If some business organizations share each others facilities, these organizations will
08
collaboration require lesser fixed capital. If there is no collaboration, an organization will require
more fixed capital to rim its business smoothly.
WORKINGCAPITAL
Working capital is the amount that the company uses in its day to day trading operations. It is a measure of
company's efficiency and short term financial health or liquidity. It is that part of total capital which is
required for holding current assets. It may also be defined as an excess of current assets over current
liabilities. It refers to afirm's investment in short term assets such as cash, short term securities, account
|receivable and inventories.
FACTORS AFFECTING WORKING CAPITAL REQUIREMENTS
|Nature of |Manufacturing firm requires high amount of working capital as compared to a trading
01 Business organization, to convert raw materials into finished goods
Scale of Large amount of working capital is required by firms operating on a large scale of
02 Operations Joperations in terms of debt, inventory, etc. as compared to small scale firms.
03 Business Cycle During boom period, whensales are high, higher amount of working capital is required as
|compared to depression period.
Seasonal
04 Factor |Higher amount of working capital is required by the organization during its peak season
as the level of activities is higher as Compared to lean season.
Production Operating cycle refers to the length of the manufacturing cycle, i.e. the periods taken to
05 Cycle |convert rawmaterials into finished products. Longer period means more working capital
|is required and vice-versa.
Credit Ifliberal credit terms are given anda liberal policy is followed, then the company would
06 Allowed require more working capital as there is less cash inflow and vice-versa.
02Credit Availed r it is difficult to avail credit by the firm (on its purchases) from suppliers then, higher
lamount of working capital is required.
Operatirng Less requirements of working capital will be there in a firm in the presence of best sales
08Efficiency efforts, ideal debtors turnover ratio and higher inventory turnover ratio.
Availability of Higher lead time (i.e. time lag between the placement of order and actual receipt of the
09 Raw Material materials) and interrupted availability of raw materials will raise the requirement of
|working capital.
Growth If an organization has planned for higher growth prospects then its requirement for
10 Prospects working capital will be higher.
28
FACTORS AFFECTING WORKING CAPITAL
11
Level of Working capital requirements will be more if level of REQUIREMENTS
competitions is high.
Competition
12 Inflation |At a higher rate of inflation, working capital requirement will also be higher.
