Class 12 Commerce Business Studies - Financial Management

What do you mean by capital structure?

Capital structure refers to the types of securities the company has issued to finance its capital. It consists of two types of securities or capital namely, loan capital and share capital.

The capital structure of a company may consist only of share capital or of a mixture of share capital and loan capital.

State the steps involved in financial planning?

Step 1: Determine Your Current Financial Situation

In this first step of the financial planning process, you will determine your current financial situation with regard to income, savings, living expenses, and debts. Preparing a list of current asset and debt balances and amounts spent for various items gives you a foundation for financial planning activities.

Step 2: Develop Financial Goals

You should periodically analyze your financial values and goals. This involves identifying how you feel about money and why you feel that way. The purpose of this analysis is to differentiate your needs from your wants.

Specific financial goals are vital to financial planning. Others can suggest financial goals for you; however, you must decide which goals to pursue. Your financial goals can range from spending all of your current income to developing an extensive savings and investment program for your future financial security.

Step 3: Identify Alternative Courses of Action

Developing alternatives is crucial for making good decisions. Although many factors will influence the available alternatives, possible courses of action usually fall into these categories:

Continue the same course of action.

Expand the current situation.

Change the current situation.

Take a new course of action.

Not all of these categories will apply to every decision situation; however, they do represent possible courses of action.

Creativity in decision making is vital to effective choices. Considering all of the possible alternatives will help you make more effective and satisfying decisions.

Step 4: Evaluate Alternatives

You need to evaluate possible courses of action, taking into consideration your life situation, personal values, and current economic conditions.

Consequences of Choices. Every decision closes off alternatives. For example, a decision to invest in stock may mean you cannot take a vacation. A decision to go to school full time may mean you cannot work full time. Opportunity cost is what you give up by making a choice. This cost, commonly referred to as the trade-off of a decision, cannot always be measured in dollars.

Decision making will be an ongoing part of your personal and financial situation. Thus, you will need to consider the lost opportunities that will result from your decisions.

Evaluating Risk

Step 5: Create and Implement a Financial Action Plan

In this step of the financial planning process, you develop an action plan. This requires choosing ways to achieve your goals. As you achieve your immediate or short-term goals, the goals next in priority will come into focus.

To implement your financial action plan, you may need assistance from others. For example, you may use the services of an insurance agent to purchase property insurance or the services of an investment broker to purchase stocks, bonds, or mutual funds.

Step 6: Reevaluate and Revise Your Plan

Financial planning is a dynamic process that does not end when you take a particular action. You need to regularly assess your financial decisions. Changing personal, social, and economic factors may require more frequent assessments.

When life events affect your financial needs, this financial planning process will provide a vehicle for adapting to those changes. Regularly reviewing this decision-making process will help you make priority adjustments that will bring your financial goals and activities in line with your current life situation.

What is the link between operating cycle and working capital?

The link between the operating cycle and working capital-

A working capital requirement of a firm depends upon its operating cycle. Here, Operating Cycle is the total period considered starting from the purchase of the raw materials till the final payment has been collected from the debtors. Longer the operating cycle, larger will be the working capital requirement. For example an organisation that deals in services or trading will not require much of working capital. This is because such organisations involve small operating cycle and there is no processing done. Herein, the raw materials are the same as the outputs and the sales transaction takes place immediately. In contrast to this, a manufacturing firm involves large operating cycle and the raw materials need to be converted into finished goods before the final sale transaction takes place. Thereby, such firms require large working capital.

Name the factor due to which a petro chemical company requires much higher investment in fixed capital than an information technology company. However both may generate same amount of revenue.
Explain any two factors affecting fixed capital requirement?

Factor due to which a petrochemical company requires much higher investment in fixed capital than an information technology company are-

1. Nature of Business:

The type of business Co. is involved in is the first factor which helps in deciding the requirement of fixed capital. A manufacturing company needs more fixed capital as compared to a trading company, as a trading company does not need the plant, machinery, etc. Hence petrochemical company requires fixed capital in huge as compared to information technology.

2. Scale of Operation:

The companies which are operating at large scale require more fixed capital as they need more types of machinery and other assets whereas information technology company will not operate at that level where the manufacturing company operates.

Following are some factors affecting fixed capital requirement-

(a) Growth Prospects:

Companies which are expanding and have higher growth plan require more fixed capital as to expand they need to expand their production capacity and to expand production capacity companies need more plant and machinery so more fixed capital.

(b) Diversification:

Companies which have plans to diversify their activities by including more range of products require more fixed capital as to produce more products they require more plants and types of machinery which means more fixed capital.

If companies can arrange financial and leasing facilities easily then they require less fixed capital as they can acquire assets on easy installments instead of paying a huge amount at one time. On the other hand, if easy loan and leasing facilities are not available then more fixed capital is needed as companies will have to buy plant and machinery by paying huge amount together.

How does 'Trading on Equity' affect the Capital structure of a company? Explain with the help of a suitable example.

Trading on equity is basically finding that balance between debt financing and equity financing. So choosing equity financing for more than 50% and debt financing for the remaining or the other way around is bound to affect the capital structure.

This is also known as Gilt edge financing.

Choosing equity financing would require to give voting rights to the holders.

Debt financing wouldn't have the problem of ownership but interest payments can be a big problem if the cash inflow of the company isn't sufficient.

Pankaj is engaged in Warehousing-Business. Identify the working capital requirements of Pankaj stating the reason in support of your answer. Pankaj is also planning to start his Transport business.
Explain any two factors that will affect his fixed capital requirements.

Factors determining the working capital requirement

(i) Nature of business A trading business needs less amount of working capital because there is no processing of goods. On the other hand, the working capital requirement would be more in case of manufacturing business where raw materials are converted into finished goods.

(ii)Scale of operation A large-scale organisation requires a large amount of working capital as compared to small-scale organisation because the quantum of inventory, debtors and cash required is generally high.

(iii)Seasonal factors Business operations are affected by seasonal changes. As during peak season higher are the level of activities and higher the requirements of working capital, on the other hand, during lean season requirements of working capital will be lower.

(iv)Production cycle It cycle is the time span between the receipt of raw materials and their conversion into finished goods. Length of production cycle affects the working capital requirement. If the duration of the production cycle is longer, the working capital requirements to meet day to day expenses would be higher and vice-versa.

Warehousing can be a significant demand on capital and the point needs to be reinforced, that two things dictate the number, size, and configuration of a warehouse network. Firstly the customer service offer, as that quite simply dictates how close to customers stock must be held, and secondly the supply base. If supply is close and consistent then less buffer stock may be required. If the suppliers are overseas and their service is inconsistent, this can drive higher buffer stock and warehouse capacity. It’s not brain surgery.

Facility Ownership should also be considered. The outsourcing of warehouses is probably now at about 80-85%. Therefore, 15% of businesses for whatever reason are choosing to own and operate their own warehouses. Many for good reason of course, because they see it as a core part of their business. However, for those businesses that do not need to own their warehouses, most will buy, design, build and leaseback. When warehousing needs are generic, the rental will usually make sense.

Factors affecting fixed capital requirements- ( any two )

(i) Nature of business The type of business has a bearing upon the fixed capital requirements, e.g. a trading concern needs lower investment in fixed assets compared with a manufacturing organisation, since it does not require to purchase plant and machinery, etc.

(ii) Growth prospects Higher growth of an organisation generally requires higher investment in fixed assets. Even when such growth is expected, a company may choose to create higher capacity in order to meet the anticipated higher demand quicker. This entails larger investment in fixed assets and consequently larger fixed capital.

(iii)Diversification If a firm diversify its operations, its fixed capital requirements increases.

(iv) Level of collaboration Usually organisations show each other’s facilities as it is feasible and reduces the level of investment in fixed assets, e.g. PNB bank may use ATM of Andhra Bank.

Enumerate three important decisions taken in financial management?

1. Investment Decisions:

Investment Decision relates to the determination of total amount of assets to be held in the firm, the composition of these assets and the business risk complexions of the firm as perceived by its investors. It is the most important financial decision. Since funds involve cost and are available in a limited quantity, its proper utilisation is very necessary to achieve the goal of wealth maximisation.

2. Financing Decisions:

Once the firm has taken the investment decision and committed itself to new investment, it must decide the best means of financing these commitments. Since, firms regularly make new investments; the needs for financing and financial decisions are ongoing.Hence, a firm will be continuously planning for new financial needs. The financing decision is not only concerned with how best to finance new assets, but also concerned with the best overall mix of financing for the firm.

3. Dividend Decision:

The third major financial decision relates to the disbursement of profits back to investors who supplied capital to the firm. The term dividend refers to that part of profits of a company which is distributed by it among its shareholders.

It is the reward of shareholders for investments made by them in the share capital of the company. The dividend decision is concerned with the quantum of profits to be distributed among shareholders.

Chandra Ltd, is a manufacturer of Laptops. It made a profit of 1000 crores. The director have proposed a dividend of 38%. As a finance manager of the company, what factors would you consider while formulating a dividend policy of the company?

Following factors should be considered while formulating a dividend policy of the company.

Factor # 1. General State of Economy:

As a whole, it affects the decision of the management to a great extent whether the dividend should be retained or the same should be distributed amongst the shareholders.

Factor # 2. Capital Market Considerations:

This also affects the dividend policy to the extent to which the firm has access to the capital market In other words, if easy access to the capital market is possible whether due to financially strong or, big in size, the firm in that case, may adopt a liberal dividend policy.

In the opposite case, i.e., if easy access to capital market is not possible, it must have to adopt a low dividend pay-out ratio, i.e., they have to follow a conservative dividend policy. As such, they must have to rely more on their own funds, viz retained earnings.

Factor # 3. Legal, Contractual Constraints and Restrictions:

This is one of the most significant factors which are to be taken into account while considering dividend policy of a firm since it has to be evolved within the legal framework and restrictions. It is not legally binding on the part of the directors to declare dividends.

Dividend shall be declared or paid only out of current profit or past profits after charging depreciation although the Central Government has empowered to allow any company for paying dividends out of current profits for any financial year before charging depreciation.

Factor # 4. Tax Policy/Tax Consideration:

The tax policy which is followed be a Government also affects the dividend policy of a firm. Whether it is better to declare and pay dividend in cash or by the issue of bonus shares, depends to some extent on the tax policy. Because, cash dividends are not even so attractive to the investors who are in higher tax brackets.

Factor # 5. Inflation:

Inflation may also affect the dividend policy of a firm. With rising prices, funds which are generated by way of depreciation may fall short in order to replace obsolete equipment. The shortfall may be made from retained earnings (as a source of funds). This is very significant when the assets are to be replaced in the near future. As such, the dividend pay-out ratio tends to be low during the periods of inflation.

Factor # 6. Stability of Dividends:

It should be given due weight-age for this purpose although the same may differ from one firm to another. The dividend policy, of course, should have a degree of stability, i.e., earnings/profits may fluctuate from year to year but not the dividend since the equity shareholders prefer to value stable dividends than the fluctuating ones.

Factor # 7. Dividend Pay-Out (D/P) Ratio:

Dividend Pay-out (D/P) ratio (i.e., percentage share of the net earnings/profits distributed to the shareholders by way of dividends) also affects the dividend policy of a firm. It involves the decisions either to pay out the earnings or to retain the same for re-investment within the firm. Needless to mention that retained earnings also constitute a reliable source of funds.

Therefore, if dividend is paid, cash will be reduced to that extent. For maintaining assets level and financing investment opportunities, a firm should obtain necessary funds either from the issue of additional equity shares or from debt and consequently if the firm fails to raise funds from outside, its growth will be adversely affected.

Factor # 8. Owner’s Considerations:

The dividend policy is also to be affected by the owner’s consideration of:

(a) Their opportunities of investment; and

(b) The dilution of ownership.

(a) Owner’s opportunities of Investment:

If the rate of return which is earned by a firm is less than the return which have been earned by the investors from outside investment, a firm should not retain such funds, which in other words, will be detrimental to the interest of the members although it is difficult to ascertain the rate of alternative investment as well as alternative investment opportunities of its shareholders.

Of course, the firm may evaluate such external rate from the firms belonging to the same risk class.

And if is found that the said rate is comparatively high, it should opt for a high (D/P) ratio or vice-versa. Thus, while deciding dividend policy of a firm, external investment opportunities should also be carefully considered.

"During annual general meeting of Prakash Ltd CEO, Mr. Rajnesh put the expansion plan for the coming year before shareholders and asked for suitable source of finance to finance manager. Finance manager Mr. Kant proposed issue of debentures than equity with a plan that they can be paid back whenever requirement of funds is over."
In the above paragraph, which component affecting financing decision has been highlighted?
Explain the component?

Flexibility

Define financial management.

Financial management may be defined as planning, organising, directing and controlling the financial activities of an organisation. According to Guthman and Dougal, financial management means, “the activity concerned with the planning, raising, controlling and administering of funds used in the business.” It is concerned with the procurement and utilisation of funds in the proper manner.

There are three major decisions which an organisation has to take in respect of financial management. Enumerate and explain these decisions in brief.

1. Investment Decisions:

2. Financing Decisions:

3. Dividend Decision:

It is the reward of shareholders for investments made by them in the share capital of the company. The dividend decision is concerned with the quantum of profits to be distributed among shareholders.

State the objectives of financial management.

The financial management is generally concerned with procurement, allocation and control of financial resources of a concern. The objectives can be-

To ensure regular and adequate supply of funds to the concern.
To ensure adequate returns to the shareholders which will depend upon the earning capacity, market price of the share, expectations of the shareholders.
To ensure optimum funds utilization. Once the funds are procured, they should be utilized in maximum possible way at least cost.
To ensure safety on investment, i.e, funds should be invested in safe ventures so that adequate rate of return can be achieved.
To plan a sound capital structure-There should be sound and fair composition of capital so that a balance is maintained between debt and equity capital.

Explain factors affecting the dividend decision.

The following are the some major factors which influence the dividend policy of the firm.

1. Legal requirements

There is no legal compulsion on the part of a company to distribute dividend. However, there certain conditions imposed by law regarding the way dividend is distributed. Basically there are three rules relating to dividend payments. They are the net profit rule, the capital impairment rule and insolvency rule.

2. Firm's liquidity position

Dividend payout is also affected by firm's liquidity position. In spite of sufficient retained earnings, the firm may not be able to pay cash dividend if the earnings are not held in cash.

3. Repayment need

A firm uses several forms of debt financing to meet its investment needs. These debt must be repaid at the maturity. If the firm has to retain its profits for the purpose of repaying debt, the dividend payment capacity reduces.

4. Expected rate of return

If a firm has relatively higher expected rate of return on the new investment, the firm prefers to retain the earnings for reinvestment rather than distributing cash dividend.

5. Stability of earning

If a firm has relatively stable earnings, it is more likely to pay relatively larger dividend than a firm with relatively fluctuating earnings.

Describe the two objectives of financial planning.

Financial Planning has got many objectives to look forward to:

Determining capital requirements- This will depend upon factors like cost of current and fixed assets, promotional expenses and long- range planning. Capital requirements have to be looked with both aspects: short- term and long- term requirements.
Determining capital structure- The capital structure is the composition of capital, i.e., the relative kind and proportion of capital required in the business. This includes decisions of debt- equity ratio- both short-term and long- term.

Explain the role of financial planning in corporate financial management.

Determining capital requirements- This will depend upon factors like cost of current and fixed assets, promotional expenses and long- range planning. Capital requirements have to be looked with both aspects: short- term and long- term requirements.
Determining capital structure- The capital structure is the composition of capital, i.e., the relative kind and proportion of capital required in the business. This includes decisions of debt- equity ratio- both short-term and long- term.
Framing financial policies with regards to cash control, lending, borrowings, etc.
A finance manager ensures that the scarce financial resources are maximally utilized in the best possible manner at least cost in order to get maximum returns on investment.

Discuss about working capital? How is it calculated? Discuss five important determinants of working capital requirements.

Unless otherwise specified is the net working capital. Net working capital is the excess of current assets over current liabilities. Thus, Net Working Capital = Current Assets - Current Liabilities or

NWC = CA - CL

Factors affecting working capital:

Nature of Business

The basic nature of a business influences the amount of working capital. A trading organisation and a service industry firm usually need a smaller amount of working capital as compared to a manufacturing organisation.

Scale of Operations

Organisations which operate on a large scale, their quantum of inventory and debtors required is generally high. Such organisations, therefore, require large amount of working capital as compared to the organisations which operate on a lower scale.

Business Cycle

Different phases of business cycles affect the requirement of working capital by a firm. In case of a boom, the sales, as well as production, are likely to be larger and, therefore, larger amount of working capital is required. As against this, the requirement for working capital will be lower during the period of depression, since the sales as well as production will be less.

Seasonal Factors

Some of the businesses have seasonal operations. During peak season, larger amount of working capital is required because of higher level of activity.

As against this, the level of activity, as well as the requirement for working capital, will be lower during the lean season.

Production Cycle/Operating Cycle

Production cycle is the time span between the receipt of raw material and their conversion into finished goods. 4

Some businesses have a longer production cycle while some have a shorter one. Duration and the length of production cycle affect the amount of funds required for raw materials and expenses.

Credit Allowed '

Different firms allow different credit terms to their customers. These depend upon the level of competition that a firm faces, as well as the credit worthiness of their client.

A liberal credit policy results in higher amount of debtors, increasing the requirement of working capital.

Credit Availed

Just as a firm allows credit to its customers, it also may get credit from its suppliers. To the extent, it avails the credit on purchase, the working capital requirement is reduced.

Availability of Raw Materials

If the raw materials are easily and readily available, lower stocks will have to be maintained. Whereas,

when the raw materials are scarce or not readily available, higher stock levels have to maintained, thus increasing the need for working capital requirement.

Time Lag

It is also known as lead time and is an important factor as to how much working capital is required. Time lag is the time taken between the placement of order and actual receipt of material.

If the time lag is more, more working capital will be required, as larger amount of materials will have to be stored.

A sound financial plan is the key to Success of sound financial management of the company.
Discuss?

Every organization, in order to remain profitable and in compliance with applicable laws, needs a sound and transparent financial management system. After all, finances are at the core of every enterprise, from purchasing materials and supplies to paying staff, and ultimately, delivering value to stakeholders. If you are responsible for developing a financial management plan, here are five key principles for success-

(a)- Rigorous Internal Controls-

Internal controls ensure that the organization is in compliance with laws and regulations and protects assets against theft and misappropriation. In general, segregation of financial duties to provide a set of checks and balances, proper authorization of expenditures, physical control of hard assets, and maintenance of records and documents supporting financial activities are the foundation of an adequate control environment.

(b) Regular Reporting-

There are strict regulations on financial reporting for publicly traded companies, but all organizations should follow a system of regular internal reporting to ensure it is meeting its financial goals and objectives. At a minimum, organizations should review the financial statement, with special attention to the income statement and balance sheet on a monthly basis and complement these reports with department and organization-specific reporting as needed.

Unlike external audits, which evaluate the accuracy of the financial documents and assess for problems in financial reporting, an internal audit carried out by an experienced business accountant goes beyond numbers and looks at processes and controls to assess risks and identify areas for improvement. Internal audits are essential to sound financial management; they determine risks to the organization’s profitability and overall financial health and suggest ways to mitigate them.

(d) A Policy of Transparency-

While transparent accounting policies are required for publicly traded companies, an internal policy of transparency goes beyond official regulations. Transparent financial records are accessible and easy to read and understand, contain no gimmicks or hidden entries, and fully disclose all relevant transactions and information. Creating a culture of transparency throughout the accounting and finance departments is the foundation of sound financial management.

(e) Careful Budgeting-

The budget is the overall financial framework that serves as the performance benchmark for all financial decisions. A realistic budget ensures that an organization can fund its ongoing commitments, meet financial objectives, and control its spending. It enables you to measure each department’s performance and identify potential problems before they result in a catastrophe. It relies on accurate forecasting of sales and direct and fixed costs.

Financial management is based on three broad financial decision. What are these?

Financial management refers to the efficient acquisition, allocation and usage of funds of the company. It deals in three main dimensions of financial decisions namely, Investment decisions, Financial decisions and Dividend decisions.

Investment Decisions: Investment decisions refer to the decisions regarding where to invest so as to earn the highest possible returns on investment Investment decisions can be taken for both long term as well as short term Long term investment decisions also known as Capital Budgeting decisions affect a business' long term earning capacity and profitability. For example, investment in a new machine, purchase of a new building, etc. are long term investment decisions. Short term investment decisions also known as working capital decisions affect a business' day to day working operations. For example, decisions regarding cash or bill receivables are short term investment decisions.

Financial Decisions: Such decisions involve identifying various sources of funds and deciding the best combination for raising the funds. The main sources for raising funds are shareholders funds (referred as equity) and borrowed funds (referred as debt). Based on the cost involved, risk and profitability a company must judiciously decide the combination of debt and equity to be used. For example, while debt is considered to be the cheapest source of finance, higher debt increases the financial risk. Financial decisions taken by a company affects its overall cost of capital and the financial risk.

Dividend Decisions: The decision involves the decision regarding the distribution of profit or surplus of the company. A company can distribute its profit to the equity share holders in the form of dividends or retain it with itself. Under dividend decision, a company decides what proportion of the surplus to distribute as dividends and what proportion to keep as retained earnings it is aimed at maximizing the shareholders wealth while keeping in view the requirement of retained earnings that are needed for re-investment.

What is meant by working capital? How is it calculated?
Discuss five important determinants of working capital requirements.

NWC = CA - CL

Factors affecting working capital:

Nature of Business

Scale of Operations

Business Cycle

Seasonal Factors

Some of the businesses have seasonal operations. During peak season, larger amount of working capital is required because of higher level of activity.

As against this, the level of activity, as well as the requirement for working capital, will be lower during the lean season.

Production Cycle/Operating Cycle

Production cycle is the time span between the receipt of raw material and their conversion into finished goods. 4

Some businesses have a longer production cycle while some have a shorter one. Duration and the length of production cycle affect the amount of funds required for raw materials and expenses.

Credit Allowed '

Different firms allow different credit terms to their customers. These depend upon the level of competition that a firm faces, as well as the credit worthiness of their client.

A liberal credit policy results in higher amount of debtors, increasing the requirement of working capital.

Credit Availed

Just as a firm allows credit to its customers, it also may get credit from its suppliers. To the extent, it avails the credit on purchase, the working capital requirement is reduced.

Availability of Raw Materials

If the raw materials are easily and readily available, lower stocks will have to be maintained. Whereas,

when the raw materials are scarce or not readily available, higher stock levels have to maintained, thus increasing the need for working capital requirement.

Time Lag

It is also known as lead time and is an important factor as to how much working capital is required. Time lag is the time taken between the placement of order and actual receipt of material.

If the time lag is more, more working capital will be required, as larger amount of materials will have to be stored.

What is meant by 'Capital Structure' of a company?
State any two factors which affect the capital structure of a company.

Capital structure means the proportion of debt and equity used for financing the operations of business.

Capital structure = Debt / Equity

In other words, capital structure represents the proportion of debt capital and equity capital in the capital structure. What kind of capital structure is best for a firm is very difficult to define. The capital structure should be such which increases the value of equity share or maximizes the wealth of equity shareholders.

Factors Determining the Capital Structure:

The various factors which influence the decision of capital structure are:

1. Cash Flow Position:

The decision related to composition of capital structure also depends upon the ability of business to generate enough cash flow.

The company is under legal obligation to pay a fixed rate of interest to debenture holders, dividend to preference shares and principal and interest amount for loan. Sometimes company makes sufficient profit but it is not able to generate cash inflow for making payments.

The expected cash flow must match with the obligation of making payments because if company fails to make fixed payment it may face insolvency. Before including the debt in capital structure company must analyse properly the liquidity of its working capital.

A company employs more of debt securities in its capital structure if company is sure of generating enough cash inflow whereas if there is shortage of cash then it must employ more of equity in its capital structure as there is no liability of company to pay its equity shareholders.

2. Interest Coverage Ratio (ICR):

It refers to number of time companies earnings before interest and taxes (EBIT) cover the interest payment obligation.

ICR= EBIT/ Interest

High ICR means companies can have more of borrowed fund securities whereas lower ICR means less borrowed fund securities.

Define working capital.

Working capital is a common measure of a company's liquidity, efficiency, and overall health. Because it includes cash, inventory, accounts receivable, accounts payable, the portion of debt due within one year, and other short-term accounts, a company's working capital reflects the results of a host of company activities, including inventory management, debt management, revenue collection, and payments to suppliers.

You are the finance manager of a newly established company. The directors of the company have asked you to plan the capital structure of the company. State any five factors that you would consider while planning the capital structure.

5 factors to consider while planning the capital structure:

(i) Position of cash flow Size of projected cash flow must be considered before issuing debt. Cash flow must not only cover fixed cash payment obligations but there must be sufficient cash for smooth working of the business.

(ii) Return on Investment (Ro!) It refers to the earning expected from the investment. If Rol of a company is high, it can opt for trading on equity to increase the earning per share. Thus, it is an important determinant of the extent of trading on equity.

(iii) Cost of capital It may be defined as the payment made by company to obtain capital. Thus, interest is the cost of debentures or loan and dividend paid by the company is the cost of equity and preference share capital. The rate of dividend on preference shares is fixed which is generally lower than that of equity shares. The cost of debentures is generally lower and tax deductible.

(iv) Risk Consideration While deciding the capital structure, risk must be analysed and considered. Total risk consists of two types of risks:

(a)Financial risk It refers to a position when a company is unable to meet its fixed financial charges namely, interest payment, preference dividend and payment obligations. It arises when a company borrows. Use of debt increases the financial risk of a business.

(b)Business risk It depends upon fixed operating costs. Higher fixed operating cost means higher business risk and vice-versa. If a firm’s operating risk is lower, its capacity to use debt is higher and vice-versa.

(v)Flexibility To maintain flexibility, a firm should not use its debt potential in full, So that it can borrow in unforeseen circumstances.

Name the major determinant of dividend decision.

Factors Affecting Dividend Decision:

The finance manager analyses following factors before dividing the net earnings between dividend and retained earnings:

1. Earning:

Dividends are paid out of current and previous year’s earnings. If there are more earnings then company declares high rate of dividend whereas during low earning period the rate of dividend is also low.

2. Stability of Earnings:

Companies having stable or smooth earnings prefer to give high rate of dividend whereas companies with unstable earnings prefer to give low rate of earnings.

3. Cash Flow Position:

Paying dividend means outflow of cash. Companies declare high rate of dividend only when they have surplus cash. In situation of shortage of cash companies declare no or very low dividend.

4. Growth Opportunities:

If a company has a number of investment plans then it should reinvest the earnings of the company. As to invest in investment projects, company has two options: one to raise additional capital or invest its retained earnings. The retained earnings are cheaper source as they do not involve floatation cost and any legal formalities.

5. Stability of Dividend:

Some companies follow a stable dividend policy as it has better impact on shareholder and improves the reputation of company in the share market. The stable dividend policy satisfies the investor. Even big companies and financial institutions prefer to invest in a company with regular and stable dividend policy.

Explain how the (i) Cost of debt and (ii) Cost of Equity affect the choice of capital structure.

Cost of Equity- Equity shareholders expect a return on their investment, i.e. Earning Per Share (EPS). When a company increases debt, the financial risk faced by the equity shareholders increases and then EPS starts decreasing with inclusion of debt, then beyond this point, cost of equity may go up sharply and share price may decrease.
Cost of debt- It may be defined as the payment made by company to obtain capital. Thus, interest is the cost of debentures or loan and dividend paid by the company is the cost of equity and preference share capital. The rate of dividend on preference shares is fixed which is generally lower than that of equity shares. The cost of debentures is generally lower and tax deductible.

Explain factors affecting financing decision.

Factors Affecting Financing Decisions:

While taking financing decisions the finance manager keeps in mind the following factors:

1. Cost:

The cost of raising finance from various sources is different and finance managers always prefer the source with minimum cost.

2. Risk:

More risk is associated with borrowed fund as compared to owner’s fund securities. Finance manager compares the risk with the cost involved and prefers securities with moderate risk factor.

3. Cash Flow Position:

The cash flow position of the company also helps in selecting the securities. With smooth and steady cash flow companies can easily afford borrowed fund securities but when companies have shortage of cash flow, then they must go for owner’s fund securities only.

4. Control Considerations:

If existing shareholders want to retain the complete control of business then they prefer borrowed fund securities to raise further fund. On the other hand if they do not mind to lose the control then they may go for owner’s fund securities.

5. Floatation Cost:

It refers to cost involved in issue of securities such as broker’s commission, underwriters fees, expenses on prospectus, etc. Firm prefers securities which involve least floatation cost.

Explain the meaning of Financial Planning. Why is it important? Give any two reasons.

Financial Planning is the process of estimating the capital required and determining it’s competition. It is the process of framing financial policies in relation to procurement, investment and administration of funds of an enterprise.

Importance of Financial Planning

Financial Planning is process of framing objectives, policies, procedures, programmes and budgets regarding the financial activities of a concern. This ensures effective and adequate financial and investment policies. The importance can be outlined as-

Adequate funds have to be ensured.
Financial Planning helps in ensuring a reasonable balance between outflow and inflow of funds so that stability is maintained.
Financial Planning ensures that the suppliers of funds are easily investing in companies which exercise financial planning.

What is meant by 'financial management'?

Name the financial decision which will help a businessman in opening a new branch of its business.

Investment decision The investment decision relates to how the firm’s funds are invested in different assets. Investment decision may be long-term or short-term. Long-term investment decision is called capital budgeting decision and short-term investment decision is called working capital decision.

Therefore, opening of a new branch is capital budgeting decision.

State whether the working capital requirement of business manufacturing the following items are big or small. Justify your answer:-
(i) Bread (ii) Coolers
(iii) Sugar (iv) Furniture
(v) Motor Car (v) Locomotives

(i)- Bread- a requirement of working capital will be less because it has quick cash turnover.

(ii)- coolers- working capital requirement will be more as it is a seasonal product.

(iii)- sugar- working capital required for manufacturers will be more as a ration of raw material cost to total cost is more.

(iv)- Furniture- less amount of working capital needed as it doesn't require large stock.

(v)- motor car- requires more capital as the gestation period is more.

(vi)- locomotives- requires more capital as the gestation period is more in compare with motor car.

Explain the following factors which affect the choice structure of a company:-
(a) cash flow position (b) Tax rate.

Position of cash flow Size of projected cash flow must be considered before issuing debt. Cash flow must not only cover fixed cash payment obligations but there must be sufficient cash for smooth working of the business
Tax rate Interest is a deductible expense. Cost of debt is affected by the tax rate. A higher tax ratemakes debt relatively cheaper and increases its attraction in relation to equity.

State any two objective of financial planning.

Financial management is generally concerned with procurement, allocation and control of financial resources of a concern. The objectives can be-

To ensure regular and adequate supply of funds to the concern.

To ensure adequate returns to the shareholders which will depend upon the earning capacity, market price of the share, expectations of the shareholders.

Explain the term 'Financial Management'. Briefly explain any three of its objectives.

Financial management may be defined as planning, organizing, directing and controlling the financial activities of an organisation. According to Guthman and Dougal, financial management means, “the activity concerned with the planning, raising, controlling and administering of funds used in the business.” It is concerned with the procurement and utilization of funds in the proper manner.

Objectives of Financial Management

The financial management is generally concerned with procurement, allocation and control of financial resources of a concern. The objectives can be-

To ensure regular and adequate supply of funds to the concern.
To ensure adequate returns to the shareholders which will depend upon the earning capacity, market price of the share, expectations of the shareholders.
To ensure optimum funds utilization. Once the funds are procured, they should be utilized in maximum possible way at least cost.

Harish is engaged in warehousing business and his warehouses are generally used by businessmen to store fruits. Identify the working capital requirements of Harish giving reason in support of your answer. Further Harsh wants to expand and diversify his warehousing business.
Explain any two factors that will affect his capital requirements.

The working capital requirement will be less as ire is engaged in a 'Service Industry'. A service firm needs less working capital as it do not have to maintain inventory and has least operating cycle.

Factors which will affect his fixed capital requirements are:

(i) Scale of operation.

(ii) Growth Prospects.

(iii) Financial alternatives

(iv) Diversification

Factors affecting fixed capital requirements are explained below:

(i) Nature of business: A manufacturing concern requires more fixed capital to purchase fixed assets. For example, plant and machinery, etc. as compared to a trading concern.

(ii) Scale of operations: A larger organisation operating at a higher scale needs bigger plant, more space, etc., and therefore requires more fixed capital as compared to the smaller organisations.

(iii) Choice of technique: The business organisations using capital intensive techniques require more fixed capital whereas companies using labourintensive techniques require less capital.

(iv) Technology upgradation: Industries in which technology upgradation is fast need more amount of fixed capital as when new, technology is invented, old machines become obsolete and they need to buy, new plants and machinery whereas companies where technological upgradation is slow they require less fixed capital as they can manage with old machines.

(v) Growth prospects : Companies which are expanding and have high growth plan require more fixed capital, to invest in more plant and machinery and other fixed assets in comparison to the companies having slow growth track or less growth prospects.

(vi) Diversification: Companies which have plans to diversify their business activities by including more range of products require more fixed capital. For producing more products they require more plants and machinery which means more fixed capital is required in comparison to the companies having no diversification plans.

(vii) Level of Collaboration: If companies are preferring collaborations, joint ventures then companies will need less fixed capital as they can share plant and machinery with their collaborations but if company prefers to operate as independent unit then there is more requirement of fixed capital.

(viii) Financing alternatives: Availability of leasing facility reduces the requirement of fixed capital to be invested in outright purchase of the fixed asset.

What is meant by 'Financial Management'?
Explain any three decisions involved in financial management.

Financial Management means planning, organizing, directing, and controlling the financial activities such as procurement and utilization of funds of the enterprise. It means applying general management principles to the financial resources of the enterprise.

The types are 1. Investment decisions 2. Financing decisions 3. Dividend decisions.

1. Investment Decisions:

Investment Decision relates to the determination of the total amount of assets to be held in the firm, the composition of these assets, and the business risk complexions of the firm as perceived by its investors. It is the most important financial decision. Since funds involve cost and are available in a limited quantity, their proper utilization is very necessary to achieve the goal of wealth maximization.

2. Financing Decisions:

Once the firm has taken the investment decision and committed itself to new investment, it must decide the best means of financing these commitments. Since firms regularly make new investments; the needs for financing and financial decisions are ongoing.

3. Dividend Decision:

The third major financial decision relates to the disbursement of profits back to investors who supplied capital to the firm. The term dividend refers to that part of the profits of a company that is distributed by it among its shareholders.

What is meant by an investment decision?
Give two examples?

Investment decision It relates to as how the funds of a firm are to be invested into different assets, so that the firm is able to earn highest possible return for the investors. Investment decision can be long-term, also known as capital budgeting where the funds are commited into long-term basis. Short-term investment decision also known as working capital decision and it is concerned with the levels of cash, inventories and debtors.

Investment decision can be long-term and short-term.

'Determining the overall cost of capital and financial risk of the enterprise is affected by many factors.' Explain any five such factors.

Following are the factors determining the relative proportion of various types of funds, or the capital structure:

(i) Position of cash flow: Size of projected cash flow must be considered before issuing debt. Cash flow must not only cover fixed cash payment obligations but there must be sufficient cash for the smooth working of the business.

(ii) Return on Investment (Rol): It refers to the earning expected from the investment. If the Rol of a company is high, it can opt for trading on equity to increase the earning per share. Thus, it is an important determinant of the extent of trading on equity.

(iii) Cost of capital: It may be defined as the payment made by company to obtain capital. Thus, interest is the cost of debentures or loan and dividend paid by the company is the cost of equity and preference share capital. The rate of dividend on preference shares is fixed which is generally lower than that of equity shares. The cost of debentures is generally lower and tax-deductible.

(iv) Risk of consideration: While deciding the capital structure, risk must be analyzed and considered. Total risk consists of two types of risks:

(a)Financial risk- It refers to a position when a company is unable to meet its fixed financial charges namely, interest payment, preference dividend, and payment obligations. It arises when a company borrows. Use of debt increases the financial risk of a business.

(b)Business risk- It depends upon fixed operating costs. Higher fixed operating cost means higher business risk and vice-versa. If a firm’s operating risk is lower, its capacity to use debt is higher and vice-versa.

(v) Flexibility- To maintain flexibility, a firm should not use its debt potential in full, So that it can borrow in unforeseen circumstances.

Explain how 'cost of debt' affects the choice of capital structure of a company?

Cost of debt A firm’s ability to borrow at a lower rate of interest increases its capacity to employ higher debt. Thus, more debt can be used if debt can be raised at lower rate.

Explain any four factors which affect the fixed capital requirements of company.

The requirement of fixed capital depends upon various factors which are explained below:

1. Nature of Business:

The type of business Co. is involved in is the first factor that helps in deciding the requirement of fixed capital. A manufacturing company needs more fixed capital as compared to a trading company, as the trading company does not need a plant, machinery, etc.

2. Scale of Operation:

The companies which are operating at a large scale require more fixed capital as they need more machinery and other assets whereas small-scale enterprises need less amount of fixed capital.

3. Technique of Production:

Companies using capital-intensive techniques require more fixed capital whereas companies using labor-intensive techniques require less capital because capital-intensive techniques make use of plant and machinery and the company needs more fixed capital to buy plants and machinery.

4. Technology Up-gradation:

Industries in which technology up-gradation is fast need more amount of fixed capital as when new technology is invented old machines become obsolete and they need to buy new plants and machinery whereas companies where technological up-gradation is slow they require less fixed capital as they can manage with old machines.

'Determining the relative proportion of various types of funds depends upon various factors.'
Explain any five such factors.

Following are the factors determining the relative proportion of various types of funds, or the capital structure:

(ii) Return on Investment (Rol) It refers to the earning expected from the investment. If Rol of a company is high, it can opt for trading on equity to increase the earning per share. Thus, it is an important determinant of the extent of trading on equity.

(iv) Risk of consideration While deciding the capital structure, risk must be analysed and considered. Total risk consists of two types of risks:

(v) Flexibility To maintain flexibility, a firm should not use its debt potential in full, So that it can borrow in unforeseen circumstances.

Manish is engaged in the business of garments manufacturing. Generally, he used to sell his garments in Delhi. Identify the working of your answer. Further Manish wants to expand and diversify has garments business.
Explain any two factors that will affect his fixed capital requirements.

The working capital requirement of Manish will be high as he is engaged in 'manufacturing industry' in which raw material needs to be converted into finished goods before sale.

Factors which will affect his fixed capital requirements are:

(i) Scale of operations

(ii) Growth prospects

(iii) Financial alternatives

(iv) Diversification.

Factors affecting fixed capital requirements are explained below:

(i) Nature of business: A manufacturing concern requires more fixed capital to purchase fixed assets. For example, plant and machinery, etc. as compared to a trading concern.

(ii) Scale of operations: A larger organisation operating at a higher scale needs bigger plant, more space, etc., and therefore requires more fixed capital as compared to the smaller organisations.

(iii) Choice of technique: The business organisations using capital intensive techniques require more fixed capital whereas companies using labour intensive techniques require less capital.

(viii) Financing alternatives: Availability of leasing facility reduces the requirement of fixed capital to be invested in outright purchase of the fixed asset.

What is meant by 'Financial Planning'?
Explain any five points which highlights its importance.

Financial planning is the process of estimating the fund requirements, specifying the sources of funds and utilising them in an optimum manner. Financial planning is basically concerned with preparation of financial blueprint of an organisation's future operations.

Importance of financial planning is as follows:

(a) It helps the company to prepare for the future.

(b) It helps in avoiding business shocks and surprises.

(d) It helps in reducing waste, duplication of efforts, gaps in planning and confusion.

(e) It links the present with the future.

(f) It provides a link between investment and financing decisions.

(g) It serves as a control technique.

Explain briefly any four factors which affect the working capital requirement of a company.

Factors affecting working capital:

Nature of Business

The basic nature of a business influences the amount of working capital. A trading organization and a service industry firm usually need a smaller amount of working capital as compared to a manufacturing organization. -

Scale of Operations

For organizations that operate on a large scale, their quantum of inventory and debtors required is generally high. Such organizations, therefore, require a large amount of working capital as compared to the organizations which operate on a lower scale.

Business Cycle

Different phases of business cycles affect the requirement of working capital by a firm. In case of a boom, the sales, as well as production, are likely to be larger and, therefore, a larger amount of working capital is required. As against this, the requirement for working capital will be lower during the period of depression, since the sales, as well as production, will be less.

Seasonal Factors

Some of the businesses have seasonal operations. During peak season, a larger amount of working capital is required because of a higher level of activity.

As against this, the level of activity, as well as the requirement for working capital, will be lower during the lean season.

The size of assets, the profitability and competitiveness are affected by one of the financial decisions. Name and state the decision.

The size of assets, profitability and competitiveness are all affected by capital budgeting decision/investment decision.

Rahim was working in an enterprise on daily wages basis. It was difficult for him to fulfill the basic needs of his family. His daughter fell ill. He had no money for his daughter's treatment. To meet the expenses of her treatment, he participated in a cycle race and won the prize money. The cycle company offered him a permanent pensionable job which he happily accepted.
(i) By quoting the lines from the above para identify the needs of Rahim that are satisfied by the offer of cycle company.
(ii) Also, explain two other needs of Rahim followed by above that are still to be satisfied.

(i) "The cycle company offered him a permanent pensionable job". According to above line Rahim is able to fulfil his following needs:
(a) Physiological Needs
(b) Safety or Security Needs
(ii) The other needs followed by the above stated needs that arc still to be satisfied are:
(a) Affiliation need: It refers to the need for affection, sense of belongingness, acceptance and friendship.
(b) Esteem need: It refers to the need for self-respect, autonomy, status, recognition and attention.

Huma is working in a company on a permanent basis. As per the job agreement she had to work for 8 hours a day and was free to work overtime. Huma worked overtime, due to which she fell ill and had to take leave from her work. No one showed concern and enquired about her health. She realised that she was fulfilling only some of her needs while some other needs still remained to be fulfilled.
(i) By quoting the lines from the above pars, identify the needs of Huma which she is able to fulfil.
(ii) Also explain two other needs of Huma folloWed by the above needs, which still remained to be satisfied.

(i) 'Huma is working in a company on a permanent basis'. According to above line Huma is able to fulfil her following needs:
(a) Physiological needs
(b) Safety or Security needs
(ii) Needs of Huma which still remained to be satisfied are:
(a) Affiliation Need: It refers to the need for affection, sense to belongingness, acceptance and friendship.
(b) Esteem Need: It refers to the need for self-respect, autonomy, status, recognition and attention.

What is a Balance Sheet?

Balance Sheet is a statement reflecting financial position of an entity at a single specific time at the end of reporting period. It is also known as Position Statement. Generally, balance sheet is prepared in vertical format.

What is a Financial Instrument?

A Financial Instrument is anything that ranges from cash, deed, negotiable instrument or any written document that shows existence of a transaction or agreement. These are assets that can be traded or they can also be seen as packages of capital that may be traded.

What is meant by 'Financial Risk'?

Financial risk refers to the probability that the company would not be meet its fixed financial obligations such as interest payment, preference divided and other such repayment obligations.

Give the meaning of 'Investment ' and 'Financing' decision of financial management.

The following are the two decisions of financial management.

(i)Investment decision: This term refers to the decisions regarding where to invest so as to earn the highest possible returns on investment. These decision can be taken for both long term and short term. Long term investment decision, also known as capital budgeting decision,affect a business'long term earning capacity and profitability.For example,investment in a new machine is a long term investment decision. Short term investment decision,also known as working capital decision,affect a business' day to day working operations.For example,decision regarding cash or bill receivables are short term investment decisions.

(ii)Financial decisions: Such decision involves identifying various sources of funds and deciding the best combination for raising the funds. The main sources for raising funds are shareholders funds (referred to as equity) and borrowed funds(referred to as debt).Based on the cost involved,risk and profitability,a company must judiciously decide the combination of debt and equity to be used. For example, while debt is considered to be the cheapest source of finance,higher debt increases financial risk . Financial decisions taken by a company affect its overall cost of capital and financial risk.

What do you mean by Blue Chip Companies?

Blue Chip companies are those companies which are well established, large in size of operations, financially sound and provide good returns to their investors in form of dividend and increased share price. The price volatility of shares of such companies is moderate and are considered to be carrying low risk.

State the objective of 'Financial Management'.

The basic objective of financial management is maximising the shareholders' wealth. In other words, the financial management for a company is to opt for those financial decision that prove gainful from the point of view of the shareholders.

What is meant by Diversification?

Diversification is a technique of investment to reduce the financial, systematic risk on the overall portfolio of investment. Every stock or other security has different systematic risk associated with it which becomes part of the overall portfolio risk. Diversification of portfolio is an effective way to maximise returns and minimise risks.

What do you mean by Break-even Point?

Break-even Point is amount of total revenue which is equal to total expenses. At break-even point, the net income is 0 and total contribution = total fixed cost. It can also be calculated in the form of number of units required to be sold to cover all costs.

What is a Hedge?

Hedge is a strategy that is used to minimise the risk of a particular investment and maximise the returns of an investment. It is a strategy that is implemented with the help of a hedge fund, using financial instruments and market strategies to offset the risk of any adverse price movements.

What is Return on Investment (ROI)?

Return on investment (ROI) is a measure of performance which is used to evaluate the efficiency or profitability of the business, an investment opportunity, or compare the profitability of a number of different investment opportunities. It is computed by dividing the Net income by Total Assets/Investment. It is usually presented in percentage terms.

Define Price-Earnings Ratio.

The Price Earnings Ratio (P/E Ratio) states the relationship between a companys stock price and earnings per share (EPS). It is calculated by dividing current market price of share with the earnings per share. It is used by investors and analysts to determine the relative value of a company's shares vis-a-vis the amount required to purchase those shares.

Who is a Financial Intermediary?

A Financial Intermediary is basically a party or person who acts as a link between the provider/issuer of securities and the investor who purchases these securities. Share brokers, banks, depository participant, etc. are some of the examples of financial intermediary.

Which are the two types of finance required by the business concerns? Give examples.

Business concerns require two types of finance which are:

1. Long-term finance:-The funds which are not paid back within a period of less than a year are referred to as long-term finance. Certain long-term finance options directly form a part of the permanent capital of the firm. In such cases, the repayment obligation does not even arise. such as bank loans, bonds, leasing, and other forms of debt finance. and public and private equity instruments. The primary purpose of obtaining long-term funds is to finance capital projects and carrying out operations on an expansionary scale. Such funds are normally invested into avenues from which greater economic benefits are expected to arise in the future.

2. Short-term finance:- Short-term finance refers to financing needs for a small period normally less than a year. In businesses, it is also known as working capital financing. This type of financing is normally needed because of the uneven flow of cash into the business, the seasonal pattern of business, etc. It refers to funds needed to meet day-to-day requirements and for holding stocks of raw materials, spare parts, etc. to be used for current operations.

Match the following.
List I: (Financial institutions)
List II: (Nature of Activity)

$$ECGC$$=The main functions of the corporation are to provide insurance to export risks and to finance exports.$$E.C.G.C.$$ helps exporters by furnishing guarantees to the financial banks in order to enable them to provide sufficient credit facilities.

$$GIC$$=To carry on the general insurance business other than life, such as accident, fire etc

$$HUDCO$$=To provide long term finance for construction of houses for residential purposes or finance or undertake housing and urban development programmes in the country.

$$ICICI$$ bank is a private bank established in india

Match the items in Column - 1 with the items in Column - II

A.Debt to Equity Ratio = (short term debt + long term debt + fixed payment obligations) / Sharehoders’ Equity

B.proprietary ratio=share holders fund/capital employed

C.intrest coverage ratio=earning before intrest and tax /intrest

D.capital gearing ratio=long term liablities /capital employed

The Debt-Equity Ratio of a company is 2:In this relation, match the following

A) Issue of equity shares, numerator increases but total assets same. If numerator increases denominator same, therefore, ratio reduces. A-2

B) If cash received from debtors, total assets is unchanged therefore ratio remains unchanged. B-3

C) Redemption of debentures means, total debt reduces and numerator less, denominator more, therefore ratio reduces. C-4

D) Purchased goods on credit, has no change on the ratio. D-1

Sika Ltd., a reputed industrial machines manufacturer, needs Rupees twenty crores as additional capital to expand the business. Mr. Amit Joshi, the Chief Executive Officer (CEO) of the company wants to raise funds through equity. The Fiance Manager, Mr. Narinder Singh, suggested that the shares may be sold to investing public through intermediaries, as the same will be less expansive.

Name the method through which the company decide to raise additional capital.

The method through which the company decide to raise additional capital is 'Offer for Sale'

Explain briefly any four factors that affect the Working capital requirements of a company.

The following are five factors that affect the working capital requirement of a company.
i) Type of Business: Working capital requirement of a firm depends on its nature of business. An organisation that deals in services or trading will not require much of working capital. This is because such organisations involve small operating cycle and there is no processing done. Herein, the raw materials are the same as the outputs and the sales transaction takes place immediately. In contrast to this, a manufacturing firm involves large operating cycle and the raw materials need to be converted into finished goods before the final sale transaction takes place. Thereby, such firms require large working capital.
ii) Scale of Operations: Another factor affecting the working capital requirement is the scale of operations the firm deals in. If a firm operates on a big scale, the requirement of the working capital increases. This is because such firms would need to maintain high stock of inventory and debtors. In contrast to this, if the scale of operation is small, the requirement of the working capital will be less.
iii) Fluctuations in Business Cycle: Different phases of business cycle alter the working capital requirements by a firm. During boom period, the market flourishes and thereby, there is higher sale, higher production, higher stock and debtors. Thus, during this period the need for working capital increases. As against this, in a period of depression there is low demand, lesser production and sale, etc. Thus, the working capital requirement reduces.
iv) Production Cycle: The time period between the conversion of raw materials into finished goods is referred as production cycle. The span of production cycle is different for different firms depending on which the requirement of working capital is determined. If a firm has a longer span of production cycle, i.e. if there is a long time gap between the receipt of raw materials and their conversion into final finished goods, then there will be a high requirement of working capital due to inventories and related expenses. On the other hand, if the production cycle is short then requirement of working capital will be low.
v) Growth Prospects: Higher growth and expansion is related to higher production, more sales, more inputs, etc. Thus, companies with higher growth prospects require higher amount of working capital and vice versa.

In the paint industry, various raw materials are mixed in different proportions with petroleum from manufacturing different kinds of paints. One specific raw material is not readily and regularly available to the paint manufacturing companies. Bonler Paints Company is also facing this problem and because of this there is a time lag between placing the order and the actual receipt of the material. But, once it receives the raw materials, it takes less time in converting it into finished goods.
Identify the factor affecting the working capital requirements of this industry.

The factors affecting the working capital requirements of this industry is availability of raw materials and efficiency of operating in the industry. The non-availability of the raw material leads to lag in the production process and affects the efficiency of operating and delivering the paints as per schedule.

Ramnath Ltd. is dealing in import of organic food items in bulk. The company sells the items in smaller quantities in attractive packages. Performance of the company has been up to the expectations in the past. Keeping up with the latest packaging technology, the company decided to upgrade its machinery. For this, the Finance Manager of the company. Mr. Vikrant Dhull, estimated the amount of funds required and the timings. This will help the company in linking the investment and the financing decisions on a continuous basis.
Therefore, Mr. Vikrant Dhull began with the preparation of a sales forecast for the next four years. He also collected the relevant data about the profit estimates in the coming years. By doing this, he wanted to be sure about the availability of funds from the internal sources. For the remaining funds he is trying to find out alternative sources.

Identify the financial concept discussed in the above paragraph. Also, state any two points of importance of the financial concept, so identified.

The financial concept discussed in the paragraph is Financial Planning. Its importance can be highlighted from the following factors:
a. Helps in facing eventual situations: Financial planning helps in forecasting the future situations. In this way, it prepares an organisation to cope with the adverse situations in a better manner.
b. Helps in avoiding surprises and shocks: Through financial planning, an organisation can detect situations of shortage or surplus of funds that may arise in future. Therefore, it prepares the managers in advance for such situations.

Attempt the following
What are the factors affecting requirement of fixed capital?

Factors affecting requirement of fixed capital :
(i) Nature of Business - The nature of business plays a vital role in determining fixed capital requirement. The big business enterprises providing public utility services, manufacturer and industrial enterprise need large fixed investments. On the other hand, trading concerns require less fixed capital as they do not need large funds for land, building, plants and machinery.
(ii) Size of Business - Larger the size of business, higher is the need of fixed capital. Hence, size of a firm either in terms of its assets and scale of operations affects the fixed capital requirements.
(iii) Growth and Expansion - In order to manage growing production and turnover, a firm with higher growth prospects will require large amount of fixed capital.
(iv) Stage of Development of Business - The requirement of fixed capital for a new established organisation is more than that of an existing or established organisation.
v) Business Cycle - Where there is boom period in an economy. the organisation needs to invest more in fixed assets so as to increase its production capacity. However, in recession the organisation avoids huge projects. and hence, it may not require more of Fixed Capital.

Explain briefly any four factors affecting the fixed capital requirements of an organisation.

The capital invested in fixed assets like land and buildings, plant and machinery, furnitures and fixtures etc, is known as fixed capital. How much is to be invested in fixed assets is determined by many factors.

The factors affecting the fixed capital requirements are :

(1) Nature of Business:

The type of business has a bearing upon the fixed capital requirement.

(2) Scale of Operations:
A larger organisation operating at a larger scale needs higher investment in fixed assets as compared to a small organisation

(3) Technology Upgradation:
In certain industries assets become obsolete sooner. Consequently, their replacements become due faster. For example, technology becomes obsolete faster than furniture.

(4) Financing Alternatives:

If alternatives of leasing or hire purchase are available, the assets are not to be purchased outrightly, but only rent or installments have to be paid

Avdhesh is the Managing Director of Delta Ltd. The company had established a good name for itself and had been doing well. It was known for timely completion of orders. The Production Manager, Ms. Priyanka was efficiently handling the processing of orders and had a team of ten motivated employees working under her. Everything was going on well. Unfortunately, Priyanka met with an accident. Avdhesh knew that in the absence of Priyanka, the company may not be able to meet the deadlines. He also knew that not meeting the deadlines may lead to customer dissatisfaction with the risk of loss of business and goodwill. So, he had a meeting with his employees in which accurate and speedy processing of orders was planned. Everybody agreed to work as team because the behaviour of Avdhesh was positive towards the employees of the organisation. Everyone put in extra time and efforts and the targets were met on time. Not only this, Avdhesh visited Priyanka and advised her to take adequate rest.
(a) Identify the leadership style of Avdhesh and draw a diagram depicting the style.
(b) Also, identify any two values highlighted by the behaviour of Avdhesh.

(a) Democratic or Participative Leadership style
(b) Values invilved
(i) Positive attitude towards employees
(ii) Considerate towards employees' health and their well-being

Distinguish between:
Fixed capital and Working capital

Sr. No.	Basis	Fixed Capital	Working Capital
1.	Need	It is needed for meeting long term requirements of the enterprise.	It is needed for short term requirements of the enterprise.
2.	Example	It is needed for acquiring fixed assets like land, building, etc.	It is needed for acquiring current assets like wages of workers, power, transportation, etc.
3.	Liquidity	Liquidity is very low.	Comparatively liquidity is high.

Answer the following question:
Explain any four features of a budget.

Any four features of a budget are:

1. Statement of expected results in numerical terms.

2. Highlights revenue and expenditure of an organisation.

3. Quantifies future facts and figures which helps in making other plans.

4. Budgets are prepared by managers at every level so it is pervasive in nature.

Why is there a need for Ratio Analysis?

Ratio analysis is very useful as it facilitates comparison. Financial statements show the performance of the company but they can be useful only when they can be compared. With the help of ratio analysis, performance of a company, in various years can be compared. Similarly, the performance of various companies can be compared with the help of ratios.
We can draw conclusions regarding liquidity position, long term solvency, operating efficiency and overall profitability using ratio analysis.

State the objective of financial management.

Wealth maximization (shareholders' value maximization) is a main objective of financial management. Wealth maximization means to earn maximum wealth for the shareholders. So, the finance manager tries to give a maximum dividend to the shareholders. He also tries to increase the market value of the shares. The market value of the shares is directly related to the performance of the company. Better the performance, higher is the market value of shares and vice-versa. So, the finance manager must try to maximise shareholder's value.

Give two factors affecting dividend decision

(i) Earnings (ii) Stability of learnings

Why is dividend decision called residual decision?

Dividend Decision is considered as residual decision with the distribution of left over surplus profit, ie., how much to be kept aside as retained earning and how much to be distributed in the form of dividend.

A Business who wants to start a manufacturing concern, approaches you to suggest him whether the following manufacturing concern would required large or small working capital:
(a) Bread (b) Coolers (c) Sugar (d) Motor car (e) Furniture manufactured against specific orders
(f) Locomotives

(a) Bread: Requirement of working capital will be less because it has quick cash turnover.
(b) Coolers. Requirement of working capital is more because it is a seasonal product.
(c) Sugar: Working Capital required will be moe because operating cycle is long.
(d) Motor car. Working capital required will be more because of long operating cycle
(e) Furniture: Requirement of working capital will be less because no inventory has to be maintained
(f) Locomotives: Requirement of working capital will be less because of small operating cycle.

Give two factors affecting financing decision.

(i) Risk (ii) Returns

How do growth opportunities affect Dividend Decision?

The amount of growth a firm can sustain and its profitability is related to its dividend decisions, so long as the firm (because of managerial imposed to external market constraints) cannot issue additional equity.

Firms with strong growth prospects maintain low target payout ratios. In fact, all the firms that experience above-average growth rates are expected to have low dividend payout ratios since, in line with the residual theory of dividends, a greater number of profitable investment opportunities should result (other things being equal in a greater need for earnings retention. This interrelationship among the firm’s growth, its profitability, and its investment, financing, and dividend decisions cannot be overemphasized.

There are three important decisions which an organisation has to take in respect of financial management. Enumerate and explain in brief these three decisions.

Every finance manager has to take three important decisions in an organisation, these are:
(i) Investment decision
(ii) Financing decision
(iii) Dividend decision

How does control of existing shareholders affect financing decisions?

If existing shareholders do not want to lose the control then more of borrowed fund securities should be issued.

What is meant by gross working capital and net working capital?

Gross working capital refers to aggregate value of current assets. Net working capital refers to excess of current assets over current liabilities.
Net working capital =C.A - C.L

How is return on investment computed?

$$ROI=\cfrac { EBIT }{ Total\quad investment } $$

Give two factors affecting investment decision.

(i) ROI (ii) Risk

Shalini, after acquiring a degree in Hotel Management and Business Administration took over her family food processing company of manufacturing, pickles, jams and squashes. The business was established by her great grandmother and was doing reasonably well. However the fixed operating costs of the business were high and the cash flow position was weak. She wanted to undertake modernisation of the existing business to introduce the latest manufacturing processes and diversify into the market of chocolates and candies. She was very enthusiastic and approached a finance consultant, who told her that approximately Rs. 50 lakh would be required for undertaking the modernization and expansion programme. He also informed her that the stock market was going through a bullish phase.
(a) Keeping the above considerations in mind, name the source of finance Shalini should not choose for financing the modernisation and expansion of her food processing business. Give one reason in support of your answer.
(b) Explain any two other factors, apart from those stated in the above situation which Shalini should keep in mind while taking this decision.

(a) Debt
Reason:
1. Due to weak cash flow position, the firm may not be able to honour fixed cash payment obligations.
2. Increased fixed operating cost will increase the business risk, therefore debt should not be issued as it further increases the financial risk
3. The stock market condition beingbullish, the investors will prefer to buy equity shares
(b) Other factors
Return on Investment
Tax rate
Cost of Equity
Floatation Costs
Flexibility
Control Consideration
Regulatory Framework
Capital Structure of other companies
Debt Service Coverage Ratio
Cost of Debt

Avik is the finance manager of Mars Ltd. In the current year the company earned high profit. However, Avik thinks that it is better to declare smaller dividend as he is unsure about the earning potential of the company in the coming years.
Avik's choice of dividend decision is based on which of the factor that affects it?

Stability Dividend

'A business that doesn't grow dies', says Mr. Shah, owner of Shah Marble Ltd. with glorious 36 months of tis grand success having a capital base of Rs. 80 crores. Within a short span of time, the company could generate cash flow which not only covered fixed cash payment obligations but also create sufficient buffer. The company is on the growth path and a new breed of consumers is eager to buy the Italian marbe sold by Shah Marble Ltd. To meet the increasing demand. Mr. Shah decided to expand his business by acquiring a mine. This required an investment of Rs. 120 crores. To seek adivice in this matter, he called his financial advisor Mr. Seth who advised him about the judicious mix of equity (40%) and Debt(60%). Mr.Seth also suggested him to take loan from a financial institution as the cost of raising funds from financial institutions is low. Though this will increase the financial risk but will also raise the return to shareholders. He also apprised him that issue of debt will not dilute the control of equity shareholders. At the same time, the interest on loan is a tad deductible expense for computation of tax liability
After due deleberations with Mr. Seth, Mr. Shah decided to raise funds from a financial institution
(a) Identify and explain the concept of Financial Management as advised by Mr. Seth in the above situation
(b) State the four factors affecting the concept as identified in part (a) above which have been discussed between Mr. Shah and Mr. Seth.

The directors of a manufacturing company are thinking of issuing Rs. 20 lacs additional debentures for expansion of their production capacity. This will lead to an increase in debt-equity ratio from $$2:1$$ to $$3:1$$. What are the risks involved in it? What factors other than risk do you think the directors should keep in view before taking the decision?

A debt-to-equity ratio measures the amount of debt a company uses to fund its business for every dollar of equity it has. The ratio equals total liabilities divided by total stockholders’ equity, which are found on the balance sheet. The higher the ratio is, the more debt a business uses compared to equity. A ratio that is too high can potentially cause problems in your small business.

Defining a High Debt-to-Equity Ratio

Acceptable debt-to-equity ratios differ among industries. In general, a ratio that is greater than the industry average is too high. For example, if your small business has Rs-400,000 in total liabilities and Rs 250,000 in total stockholders’ equity, your debt-to-equity ratio is 1.6. This means you use Rs 1.60 in debt for every Rs 1 of equity, or your debt level is 160 percent of your equity. If the industry average is 0.9, you have a high debt-to-equity ratio.

Directors should keep in view before taking the decision-

Reduced Ownership Value

Liabilities and equity represent the respective claims that creditors and owners have on a company’s assets. A high debt-to-equity ratio reduces the value of owners’ stake in a business as a proportion of its assets. If your small business has a high debt-to-equity ratio and you sell or liquidate the company, you would have to distribute a larger portion of the proceeds to creditors than if you had a low debt-to-equity ratio.

Increased Risk

The risk of defaulting on, or being unable to repay, your debt increases as your debt-to-equity ratio rises. A reasonable amount of debt can help you grow your small business, but too much can overburden you with high-interest payments. You have to generate more business just to break even. If you fail to make these interest payments, creditors might take your company’s assets or force you into bankruptcy.

Trouble Obtaining Additional Financing

Banks typically require a low debt-to-equity ratio when they extend new credit. Because a high debt-to-equity ratio reduces a bank’s chances of being repaid, it might refuse to provide additional funding or might give you money only with unfavorable terms. Say your debt-to-equity ratio is 2 and the bank’s cutoff is 1.5; it would likely deny you a loan.

Violating Debt Covenants

Loan agreements often include covenants, which are stipulations that require a business to do or not do certain things, such as maintain adequate financial ratio levels. If your debt-to-equity ratio exceeds that allowed by a covenant with an existing lender, the lender might call your entire loan due. For example, if an existing lender requires you to keep your debt-to-equity ratio below 1.8 and it jumps to 2.1, you would violate the covenant.

Pinnacle Ltd deals in the sale of stationary and office furniture. They source the finished products from reputed brands who give them four to six months credit. Seeing the demand for electronic items,they are also planning to market these items by opening outlets throughout India. For this, they have decided to join hands with a Japanese electronic goods manufacturer.
Identify and state any two factors that would affect the fixed capital requirement of Pinnacle Ltd as discussed above.

Two factors that would affect the fixed capital requirement of Pinnacle Ltd. are:
(i) Diversification: It will increase the fixed capital requirements as the investment in fixed capital will increase.
(ii) Level of Collaboration: Collaboration reduces the level of investment in fixed assets.

Sudha is an enterprising business woman who has been running a poultry farm for the past ten years. She has saved Rs. Four Lakhs for her business. She shared with her family her desire to utilize this money to expand her business. Her family members gave her different suggestions like buying new machinery to replace the existing one, acquiring altogether new equipments with latest technology, opening a new branch of the poultry farm in another city and so on. Since these decisions are crucial for her business, involve a huge amount of money and are irreversible except at a huge cost Sudha wants to analyze all aspects of the decisions, before taking any final decision
(i) Identify and explain the financial decision to be taken by Sudha
(ii) Also,explain briefly the factors that will affect this decision.

(i) Investment decision/Capital budgeting decision: Investment/Capital budgeting decision involves deciding about how the funds are invested in different assets so that they are able to earn the highest possible return for their investors.
(ii) Factors that affect captial budgeting
(a) Cash flows of the project
(b) Rate of return of the project
(c) Investment criteria

You are the finance manager of a company. The board of directors has asked you to determine the working capital requirement for the company.
State the factors that you would take in consideration while determining the requirement of working capital for the company?

The finance manager must keep in mind following factors before estimating the amount of working capital.

1. Length of Operating Cycle:

The amount of working capital directly depends upon the length of operating cycle. Operating cycle refers to the time period involved in production. It starts right from acquisition of raw material and ends till payment is received after sale.The working capital is very important for the smooth flow of operating cycle. If operating cycle is long then more working capital is required whereas for companies having short operating cycle, the working capital requirement is less.

2. Nature of Business:

3. Scale of Operation:

The firms operating at large scale need to maintain more inventory, debtors, etc. So they generally require large working capital whereas firms operating at small scale require less working capital.

4. Business Cycle Fluctuation:

During boom period the market is flourishing so more demand, more production, more stock, and more debtors which mean more amount of working capital is required. Whereas during depression period low demand less inventories to be maintained, less debtors, so less working capital will be required.

5. Seasonal Factors:

The working capital requirement is constant for the companies which are selling goods throughout the season whereas the companies which are selling seasonal goods require huge amount during season as more demand, more stock has to be maintained and fast supply is needed whereas during off season or slack season demand is very low so less working capital is needed.

6. Technology and Production Cycle:

If a company is using labour intensive technique of production then more working capital is required because company needs to maintain enough cash flow for making payments to labour whereas if company is using machine-intensive technique of production then less working capital is required because investment in machinery is fixed capital requirement and there will be less operative expenses.

7. Credit Allowed:

Credit policy refers to average period for collection of sale proceeds. It depends on number of factors such as creditworthiness, of clients, industry norms etc. If company is following liberal credit policy then it will require more working capital whereas if company is following strict or short term credit policy, then it can manage with less working capital also.

8. Credit Avail:

Another factor related to credit policy is how much and for how long period company is getting credit from its suppliers. If suppliers of raw materials are giving long term credit then company can manage with less amount of working capital whereas if suppliers are giving only short period credit then company will require more working capital to make payments to creditors.

9. Operating Efficiency:

The firm having high degree of operating efficiency requires less amount of working capital as compared to firm having low degree of efficiency which requires more working capital.

10. Availability of Raw Materials:

If raw materials are easily available and there is ready supply of raw materials and inputs then firms can manage with less amount of working capital also as they need not maintain any stock of raw materials or they can manage with very less stock.

11. Level of Competition:

If the market is competitive then company will have to adopt liberal credit policy and to supply goods on time. Higher inventories have to be maintained so more working capital is required. A business with less competition or with monopoly position will require less working capital as it can dictate terms according to its own requirements.

12. Inflation:

If there is increase or rise in price then the price of raw materials and cost of labour will rise, it will result in an increase in working capital requirement.

Saqib Ltd, is a large creditworthy company operating in the Kashmir Valley. It is an export-oriented unit, dealing in exclusive embroidered shawls. The floods in the Valley have created many problems for the company. Many craftsmen and workers have been displaced and raw materials have been destroyed. The firm is therefore, unable to get an uninterrupted supply of raw material, and the duration of the production cycle has also increased. To add to the problems of organization, the suppliers of raw material who were earlier selling on credit are asking the company, for advance payment or cash payment on delivery. The company is facing a liquidity crisis. The CEO of the company feels that taking a bank loan is the only option with the company to meet its short term shortage of cash.
As a finance manager of the company, name and explain the alternative to bank borrowing that the company can use to resolve the crisis.

Commercial Paper: It is a short-term unsecured promissory note, negotiable and transferable by endorsement and delivery with a fixed maturity period. It is issued by large and creditworthy companies to raise short term funds at lower rate of interest than market rates. The issuance of commercial paper is an alternative to bank borrowing for large companies that are generally considered to be financially strong.

How do rising prices affect the requirement of working capital of an organization?

With rising prices larger amounts are required to maintain a constant volume of production and sales. Thus working capital requirement of a business will be high.

Terry International Ltd. earned a net profit of Rs. 50 crores. Ankit, the finance manager of Terry International Ltd, wants to decide how to appropriate these profits. Identify the decision that Ankit will have to take and also discuss any five factors which help him in taking this decision.

Dividend decision
Factors affecting dividend decision:
(i) Amount of earnings (ii) Stability of earnings
(iii) Stability of dividend (iv) Growth opportunities
(v) Cash flow position (vi) Shareholders preference
(vii) Taxation policy (viii) Stock market reaction
(ix) Access to capital market (x) Legal constraints
(xi) Contractual constraints

Bharati Ltd. is a leading mobile company. It is planning to acquire Queen Ltd' (its close competitor) business worth Rs. 1000 crore. Which financial decision is involved in it? Explain it.

Investment

"Ranbaxy Ltd. has been earning handsome profits since last 15 years. Company enjoy fair goodwill in the market, so company can easily arrange debt as well as equity from the market, whenever needed. Therefore company decided to declare dividend with a hike of 15 % from last year.
Which two components affecting dividend decision have been highlighted in the above paragraph.

(i) Stability of earning
(ii) Access to capital markets

Dabur India has decided to increase credit limit and duration of credit to its customers to boost its sales. Name the type of decision involved.

Working capital

When is financial leverage favourable?

When ROI is higher than cost of Debt

Jai Bharat Company Ltd is an auto part supplier company in Guru Gram, Haryana. Its business is spread over several cities. The CEO of company wants to open a factory in Gujarat near Tata Motors Ltd. but due to recession for the last two years, its business is facing slow down. Company needs capital. Rakesh Gupta is CA and financial advisor of the company. He opines that during recession profit falls and investors prefer to invest in debentures to earn fixed income. Therefore, the company should issue debentures.
In this paragraph, which factor affecting financing decision has been highlighted?
Explain state of capital market?

State of capital market

HCL Company's finance manager has decided to retain its entire profit to meet financial requirement for its growth. Name the type of decision involved.

Dividend

Canara Bank wants to open a new branch of his bank. What is this decision called?

This decision is considered as investment decision

Tata sons has debt equity ratio of $$4:1$$ and Bajaj has $$1:1$$ debt equity ratio. Name the advantage, Tata sons may have over Bajaj.

Trading on equity

'REI Agro Food Ltd. is a famous multinational company. Mr. S.K Nagi is its finance manager. He is making efforts to increase the market value of capital invested by the equity shareholders. He already kew it could be possible only when price of the share increases and price of shares increase only if financing, investment and dividend decisions are taken optimally. He did the same and achieved success.
Which objective of financial management has been referred here?
Explain?

Interest is an expense while dividend is an appropriation

"Tax benefits is available only in case of payment of interest and not on the payment of preference dividend." Why?

Interest is an expense while dividend is an appropriation

In case of high fixed operating cost, company should prefer debt or equity?

Equity

Amit is running an 'Advertising Agency' and earning a lot by providing this service to bidding industries. State whether the working capital requirement of the firm will be 'less' or 'more'. Give reason in support of your answer.

Less working capital is required as service industries which usually do not have to maintain inventory require less working capital.

'Sarah Ltd' is a company manufacturing cotton yarn. It has been consistently earning good profits for many years. This year too, it has been able to generate enough profits. There is availability of enough cash in the com[any and good prospects for growth in future. It is a well managed organisation and believes in quality, equal employment opportunities and good remuneration practices. It has many shareholders who prefer to receive a regular income from their investments
It has taken a loan of Rs. 40 lakhs from IDBI and is bound by certain restrictions on the payment of dividend according to the terms of loan agreement.
The above discussion about the company leads to various factors which decide how much of the profits should be retained and how much has to be distributed by the company.
Quoting the lines from the above discussion identify and explain any four such factor.

Factors affecting
(i) Stability of earnings: A company having stable earnings is in a position to declare more dividends and vice-versa
"It has been consistently for many years."
(ii) Cash flow position: The better the cash flow position of the company, the will the capacity of the company to pay dividend
"There is availability of enough cash in the company"
(iii) Growth opportunities: If the company has more opportunities for growth, it will require more finance. In such a situation, a major part of the income should be retained and a small part of it should be paid as dividend
"Good prospects for growth in the future"
(iv) Shareholders preference: There are two types of shareholders from the point of view of investment (a) those who invest with the purpose of getting some regular income and (b) those who invest in the company to gain capital profit. If the majority of the shareholders are of the former type, the company must declare dividend according to their expectation. On the contrary, if the majority of the shareholders are of the latter type the company enjoys freedom about declaring dividend
"It many have shareholders from their investments."
(v) Contractual constraints: When a company receives finance in the form of debt, the debt provider can put a ban on the company to give any dividend
"It has taken a loan of Rs. 50 lakhs agreement".

A company's earnings before interest and tax is Rs. 7 lakh. It pays 10% interest on its debt. Total investment of company is Rs. 50 lakh.
(a) Advise company whenever it should include debt or equity to raise its capital.
(b) Name the concept related to this.
(c) Will the company's decision to raise funds from debt or equity will change if company's EBIT becomes 3 lakh.

Company should prefer debt to raise fund as debt is gainful for equity shareholders till ROI > Rate of interest
In the above case $$ROI=\cfrac { EBIT }{ Total\quad income } \quad \times 100=\cfrac { 7 }{ 50 } \times 100=14$$%
Interest$$=10$$%
14> 10 si debt is more suitable
(b) The company is leverage effect or trading on equity
(c) Yes company's decision will change if EBIT becomes 3 lac, because with 3 lac ROI will become less than interest
$$ROI=\cfrac { EBIT }{ Total\quad income } \quad \times 100=\cfrac { 3 }{ 50 } \times 100=6$$%
Interest $$1=$$%
6< 10
So, now company must prefer equity to raise capital

A decision is taken to raise money for long term capital needs of business from certain sources. What is their decision called? Explain the three factors affecting such decision.

Financing decision

What is another name for long term investment decision?

Capital budgeting

'S' Limited is manufacturing steel at its plant in India. It's enjoying a buoyant demand for its product as economic growth is about 7 to 8% and the demand for steel is growing. It is planning to set up a new steel plant to cash on the increased demand it is facing. It is estimated that it will require about Rs.5,000 crores to setup and about Rs. 500 crores working capital to start the new plant.
(a) What is the role and objectives of financial management for this company?
(b) What is the importance of having a financial plan for this company?
Give an imaginary plan to support your answer.
(c) What are the factors which will affect the capital structure of this company?
(d) Keeping in mind that it is highly capital intensive sector. What factors will affect the fixed and working capital.

The role of financial management
(i) Size and composition of fixed assets
(ii) Amount and composition of current assets
(iii) The amount of longterm and short term financing
(iv) Fixing the debt equity ratio in capital
While playing this role the main objective of finance manager will be maximization of wealth of equity share holders
(b) The main importance
(i) To ensure availability of funds whenever these are required
(ii) To see that firm does not raise resources unnecessarily
(iii) Determination of suitable policies for proper utilization and administration of funds
Financial Plan for this Co
Total finance required: Fixed capital Rs.5,000 crores working capital Rs.500 crores
Source of finance 2:! RAtio, ie 50% finance will be collected by issue of shares and 50% by borrowed fund
Investment of this fund in right investment proposals.

What is favourable financial leverage?

Favourable financial leverage means when, ROI> Rate of Interest on debt.

A decision is taken to distribute certain part of profit to shareholders after paying tax. What is this decision called? Explain any three factors affecting such decisions.

Dividend decision

Capital structure decision is essentially optimisation of risk-return relationship. Comment.

Capital structure decision is related to proportion of debt and equity in the capital structure. What proportion is maintained, decides the cost and risks.

This is because both equity and debt differ significantly in their risk and returns.

(i) On one side, equity is a less risky source, but it has no benefit of tax deductibility of dividend, and dividends are paid out of profits after tax.

(ii) On the other hand, debentures are paid fixed rate of interest, the interest paid are deductible from the income for tax calculation purposes. Thus, it creates a higher rate of return for equity shareholders.

However, debt is more rewarding in terms of increase in the wealth of shareholders, but increases the risk too. Thus, reckless use of debt also is unfavorable and sometimes, may even force the company to go into liquidation. Thus, capital structure should be so formed, which optimizes the risk-return relationship.

What is meant by capital structure?

The capital structure is how a firm finances its overall operations and growth by using different sources of funds. Debt comes in the form of bond issues or long-term notes payable, while equity is classified as common stock, preferred stock or retained earnings. Short-term debt such as working capital requirements is also considered to be part of the capital structure.

What are the main objectives of financial management?Briefly explain.

The financial management is generally concerned with procurement, allocation and control of financial resources of a concern. The objectives can be-

To ensure regular and adequate supply of funds to the concern.
To ensure adequate returns to the shareholders which will depend upon the earning capacity, market price of the share, expectations of the shareholders.
To ensure optimum funds utilization. Once the funds are procured, they should be utilized in maximum possible way at least cost.
To ensure safety on investment, i.e, funds should be invested in safe ventures so that adequate rate of return can be achieved.
To plan a sound capital structure-There should be sound and fair composition of capital so that a balance is maintained between debt and equity capital.

Discuss the two objectives of financial planning.

Financial Planning has got many objectives to look forward to:

Determining capital requirements- This will depend upon factors like cost of current and fixed assets, promotional expenses and long- range planning. Capital requirements have to be looked with both aspects: short- term and long- term requirements.
Determining capital structure- The capital structure is the composition of capital, i.e., the relative kind and proportion of capital required in the business. This includes decisions of debt- equity ratio- both short-term and long- term.

Explain the term 'trading or equity'. Why, when and how can it be used by a business organisation?

Trading on Equity- The word “equity” denotes the ownership of the company. Trading on equity means taking advantage of equity share capital to borrowed funds on reasonable basis. It refers to additional profits that equity shareholders earn because of issuance of debentures and preference shares. It is based on the thought that if the rate of dividend on preference capital and the rate of interest on borrowed capital is lower than the general rate of company’s earnings, equity shareholders are at advantage which means a company should go for a judicious blend of preference shares, equity shares as well as debentures. Trading on equity becomes more important when expectations of shareholders are high.

What do you mean by dividend decision?

Dividend Decision:

The financial decision relates to the disbursement of profits back to investors who supplied capital to the firm. The term dividend refers to that part of profits of a company which is distributed by it among its shareholders.

It is the reward of shareholders for investments made by them in the share capital of the company. The dividend decision is concerned with the quantum of profits to be distributed among shareholders.

A decision has to be taken whether all the profits are to be distributed, to retain all the profits in business or to keep a part of profits in the business and distribute others among shareholders. The higher rate of dividend may raise the market price of shares and thus, maximize the wealth of shareholders. The firm should also consider the question of dividend stability, stock dividend (bonus shares) and cash dividend.

What do you mean by management of fixed capital?

Management of fixed capital means the management of fixed assets for the business and financing long-term \ projects. Fixed capital represents long-term investment. It is required for purchasing fixed assets such as land and buildings, plant and machinery, motor vehicles, furniture, etc. These assets enhance the future earning capacity and improve the growth prospects of the business.

Explain the link between operating cycle and working capital.

The working capital is very important for the smooth flow of operating cycle. If operating cycle is long then more working capital is required whereas for companies having short operating cycle, the working capital requirement is less.

What do you mean by negative working capital?

Negative working capital is when a company's current liabilities exceed its current assets. This means that the liabilities that need to be paid within one year exceed the current assets that are monetizable over the same period.

A buyer usually considers negative working capital in a target as detrimental because it signifies additional capital that will be required to run the business after closing.

Explain the concept of wealth maximisation as an objective of financial management.

Wealth maximization: Wealth maximization (shareholders' value maximization) is also a main objective of financial management. Wealth maximization means to earn maximum wealth for the shareholders. So, the finance manager tries to give a maximum dividend to the shareholders. He also tries to increase the market value of the shares. The market value of the shares is directly related to the performance of the company. Better the performance, higher is the market value of shares and vice-versa. So, the finance manager must try to maximize shareholder's value.

What are the various aspects of financial planning?

Determining capital requirements- This will depend upon factors like cost of current and fixed assets, promotional expenses and long- range planning. Capital requirements have to be looked with both aspects: short- term and long- term requirements.
Determining capital structure- The capital structure is the composition of capital, i.e., the relative kind and proportion of capital required in the business. This includes decisions of debt- equity ratio- both short-term and long- term.
Framing financial policies with regards to cash control, lending, borrowings, etc.
A finance manager ensures that the scarce financial resources are maximally utilized in the best possible manner at least cost in order to get maximum returns on investment.

Why is the dividend decision treated as residual decision?

The dividend decision are known a the residual decisions as they are taken only after the payment of the fixed assets by the company and keeping a potion of the profits as retained earnings. That is, dividends are decided only after meeting the financial and other obligations of the company.

What is meant by financial planning?

Explain the important steps of financial planning.

Six Steps in the Financial Planning Process

The following steps make up the financial planning:

Establishing and defining the client-planner relationship - The financial planner explains or documents the services to be provided and defines his or her responsibilities along with the responsibilities of the client. The planner explains how he or she will be paid and by whom. The planner and client should agree on how long the relationship will last and on how decisions will be made.
Gathering client data and determining goals and expectations - The financial planner asks about the client's financial situation, personal and financial goals and attitude about risk. The planner gathers all necessary documents at this stage before giving advice.
Analyzing and evaluating the client's financial status - The financial planner analyzes client information to assess his or her current situation and determine what must be done to achieve the client's goals. Depending on the services requested, this assessment could include analyzing the client's assets, liabilities and cash flow, current insurance coverage, investments or tax strategies.
Developing and presenting the financial planning recommendations and/or alternatives - The financial planner offers financial planning recommendations that address the client's goals, based on the information the client provided. The planner reviews the recommendations with the client to allow the client to make informed decisions. The planner listens to client concerns and revises recommendations as appropriate.
Implementing the financial planning recommendations - The financial planner and client agree on how recommendations will be carried out. The planner may carry out the recommendations for the client or serve as a "coach, " coordinating the process with the client and other professionals such as attorneys or stockbrokers.
Monitoring the financial planning recommendations - The client and financial planner agree upon who will monitor the client's progress toward goals. If the planner is involved, he or she should report to the client periodically to review the situation and adjust recommendations as needed.

Explain briefly any five factors to be considered at the time of determining working capital requirement.

The finance manager must keep in mind following factors before estimating the amount of working capital.

1. Length of Operating Cycle:

2. Nature of Business:

3. Scale of Operation:

The firms operating at large scale need to maintain more inventory, debtors, etc. So they generally require large working capital whereas firms operating at small scale require less working capital.

4. Business Cycle Fluctuation:

5. Seasonal Factors:

State why the working capital needs for a 'Service industry' are different from that of a Manufacturing industry.

Nature of Business:

Likewise, the service industry requires less working capital as there is not much requirement of working capital unike manufacturing industry.

A company wants to establish a new unit in which a machinery of worth Rs.10 lakh is involved. Identify the type of decision involved in financial management.

Investment decision: The investment decision relates to how the firm’s funds are invested in different assets. Investment decision may be long-term or short-term. Long-term investment decision is called capital budgeting decision and short-term investment decision is called working capital decision.

Therefore, it is a capital budgeting decision.

Explain the term trading on equity. Why, when and how can it be used by business organisations?

Trading on equity is the financial process of using debt to produce gain for the residual owners. The practice is known as trading on equity because it is the equity shareholders who have only interest (or equity) in the business income.

The term owes its name also to the fact that the creditors are willing to advance funds on the strength of the equity supplied by the owners. Trading feature here is simply one of taking advantage of the permanent stock investment to borrow funds on reasonable basis.

Trading on equity acts as a lever to magnify the influence of fluctuations in earnings. Any fluctuation in earnings before interest and taxes (EBIT) is magnified on the earnings per share (EPS) by operation of trading on equity larger the magnitude of debt in capital structure, the higher is the variation in EPS given any variation in EBIT.

Name the concept which increases the return on equity shares with a change in the capital structure of a company.

Trading on equity increases the return on equity shares with a change in the capital structure of a company.

Explain briefly factors kept in mind while planning the capital structure of a company.

Various factors to be kept in mind while planning the capital structure of a company:

(ii) Return on Investment (RoI): It refers to the earning expected from the investment. If Rol of a company is high, it can opt for trading on equity to increase the earning per share. Thus, it is an important determinant of the extent of trading on equity.

(iv) Risk Consideration: While deciding the capital structure, risk must be analysed and considered. Total risk consists of two types of risks:

(a)Financial risk: It refers to a position when a company is unable to meet its fixed financial charges namely, interest payment, preference dividend and payment obligations. It arises when a company borrows. Use of debt increases the financial risk of a business.

(b)Business risk: It depends upon fixed operating costs. Higher fixed operating cost means higher business risk and vice-versa. If a firm’s operating risk is lower, its capacity to use debt is higher and vice-versa.

(v)Flexibility: To maintain flexibility, a firm should not use its debt potential in full, So that it can borrow in unforeseen circumstances.

Explain the meaning and nature of financial planning.

Financial planning reflects the needs of the business and is integrated with the overall business planning. Proper financial planning is necessary to enable the business enterprise to have right amount of capital to continue its operations efficiently. Financial planning involves taking certain important decisions so that funds are continuously available to the company and are used efficiently. These decisions highlight the scope of financial planning.

You are the finance manager of a company. The board of directors have asked you to decide the dividend policy. What factors would you keep in mind to perform this function?

Dividend decisions relate to how much of the company’s after tax profit is to be distributed to the share holders and how much of it should be retained in the business for future requirements.

Factors affecting dividend decisions are:

(i) Stability of dividend: Companies generally have a policy of stabilizing dividends, i.e. increase in dividend is only done when the earning potential of the company has gone up and not just the current year’s earnings. Thus, dividend per share is not altered when the change is small or temporary in nature.

(ii)Shareholders’ preference: While declaring dividends, management must keep in mind the preferences of the shareholders in this regard. If the shareholders in general desire that at least a certain amount is paid as dividend, the companies are likely to declare the same. There are always some shareholders who depend upon a regular income from their investments.

(iii)Legal constraints: Certain provisions of The Companies Act place restrictions on payouts as dividend. Such provisions must be adhered while declaring the dividend.

(iv) Access to capital market: Large and reputed companies generally have easy access to the capital market and, therefore, may depend less on retained earning to finance their growth. These companies tend to pay higher dividends than the smaller companies.

Delta Cables Ltd. earned a net profit of 50 crores. Atul, the finance manager of Delta Cables Ltd. wants to decide how to appropriate these profits. Which financial decision will help him in deciding it?

How does working capital affect the liquidity of a company?

Working capital by its definition means the capital employed in day-to-day operation/running of business. To run the business you need capital and if the cycle of the working capital is too long you might face problems in paying your current liabilities which is nothing but liquidity crunch. So if you have a liquidity crunch you go to a lender/bank but they charge interest and this interest would eat up a portion of your profit and hence your overall profitability will get affected.

Explain the factors affecting the dividend policy of a company.

Factors Affecting Dividend Decision:

The finance manager analyses following factors before dividing the net earnings between dividend and retained earnings:

1. Earning:

2. Stability of Earnings:

Companies having stable or smooth earnings prefer to give high rate of dividend whereas companies with unstable earnings prefer to give low rate of earnings.

3. Cash Flow Position:

Paying dividend means outflow of cash. Companies declare high rate of dividend only when they have surplus cash. In situation of shortage of cash companies declare no or very low dividend.

4. Growth Opportunities:

5. Stability of Dividend:

What is meant by 'Financial Planning'? State its objectives

Definition of Financial Planning

Objectives of Financial Planning

Financial Planning has got many objectives to look forward to:

Determining capital requirements- This will depend upon factors like cost of current and fixed assets, promotional expenses and long- range planning. Capital requirements have to be looked with both aspects: short- term and long- term requirements.
Determining capital structure- The capital structure is the composition of capital, i.e., the relative kind and proportion of capital required in the business. This includes decisions of debt- equity ratio- both short-term and long- term.
Framing financial policies with regards to cash control, lending, borrowings, etc.
A finance manager ensures that the scarce financial resources are maximally utilized in the best possible manner at least cost in order to get maximum returns on investment.

How does 'level of competition' affect the working capital requirement of an organisation?

Level of Competition:

How does "Trading on Equity" affect the choice of capital structure of a company? Explain with the help of a suitable example.

Trading on equity refers to the use of fixed cost sources of finance such as debentures and preference share capital in the capital structure so as to increase the return on equity shares. There are two conditions to use trading on equity:

(i) The rate of interest on loan/debentures should be less than the rate of Return on Investment.

(ii) The interest should be deducted from profit before tax.

What is the primary objective of 'Financial Management'?

Financial management is one of the functional areas of business. Therefore, its objectives must be consistent with the overall objectives of business. The overall objective of financial management is to provide maximum return to the owners on their investment in the long- term.

This is known as wealth maximisation. Maximisation of owners’ wealth is possible when the capital invested initially increases over a period of time. Wealth maximisation means maximising the market value of investment in shares of the company.

Wealth of shareholders = Number of shares held ×Market price per share.

State how 'Growth Prospects' affect the working capital requirements of a company?

Growth Prospects:

Firms planning to expand their activities will require more amount of working capital as for expansion they need to increase scale of production which means more raw materials, more inputs etc. so more working capital also.

Which type of companies can declare higher dividend?

A company having higher and stable earnings can declare higher dividends than a company with lower and unstable earnings.

'Financial Planning is a financial blueprint of an organisation's future operations'. Explain the twin objectives of Financial Planning in the light of this statement.

Financial planning strives to achieve the following two objectives

(i) To ensure availability of funds whenever these are required This includes a proper estimation of the funds required for different purpose such as for the purchase of long-term assets or to meet day-to-day expenses of business, etc. Apart from this, there is a need to estimate the time at which these funds are to be made available. Financial planning also tries to specify possible sources of these funds.

(ii) To ensure unneccessary finance is not raised Excess funding is almost as bad as inadequate funding. Even if there is some surplus money, good financial planning would put it to the best possible use so that the financial resources are not left idle and don’t unnecessarily add to the cost.

What is meant by 'Short Term Investment Decisions'?

Short-term investments are those investments that an owner can access quickly, have low risk, and will mature in the form of cash within a year. These are often used as a way to make a safe yet small return. An investment must be liquid to be short term.

Explain why the requirements of fixed capital for a trading concern are different from that of a manufacturing organisation.

Nature of Business:

The wholesalers as compared to retail shop require more working capital as they have to maintain large stock and generally sell goods on credit which increases the length of operating cycle. The manufacturing company requires huge amount of working capital because they have to convert raw material into finished goods, sell on credit, maintain the inventory of raw material as well as finished goods.

Which component of capital structure determines the overall financial risk in an organisation?

Proportion of debt in the total capital determines the overall financial risk.

Explain the impact of Stock Market Conditions and Regulatory frameworks on the capital structure of a company?

Regulatory Framework:

Issues of shares and debentures have to be done within the SEBI guidelines and for taking loans. Companies have to follow the regulations of monetary policies. If SEBI guidelines are easy then companies may prefer issue of securities for additional capital whereas if monetary policies are more flexible then they may go for more of loans.

Stock Market Condition:

There are two main conditions of market, i.e., Boom condition. These conditions affect the capital structure specially when company is planning to raise additional capital. Depending upon the market condition the investors may be more careful in their dealings.

During depression period in the market business is slow and investors also hesitate to take risk so at this time it is advisable to issue borrowed fund securities as these are less risky and ensure fixed

repayment and regular payment of interest but if there is Boom period, business is flourishing and investors also take risk and prefer to invest in equity shares to earn more in the form of dividend.

Explain the following factors which affect the choice of capital structure of a company?

Following are the factors determining the relative proportion of various types of funds, or the capital structure:

(iv) Risk of consideration While deciding the capital structure, risk must be analysed and considered. Total risk consists of two types of risks:

(v) Flexibility To maintain flexibility, a firm should not use its debt potential in full, So that it can borrow in unforeseen circumstances.

'Financial Planning tries to link the present with the future'.
Explain the importance of Financial Planning in the light of this statement?

Financial planning is the preparation of a financial blueprint, which foresees the entire fund requirement in respect to quantum as well as the timing. It is the process of estimating the fund requirements of a business and specifying the sources of funds. It involves the preparation of a financial blueprint of an organization’s future operations. The objective of financial planning is to ensure that enough funds are available at right time.

Financial planning is essential in financial management because:

(i) Helps in avoiding business shocks and surprises: Proper provision regarding shortage or surplus of funds is made by anticipating future receipts and payments. Hence, it helps in avoiding business shocks and surprises.

(ii) Helps in avoiding wastage of finance: In the absence of financial planning, wastage of financial resources may take place. This arises due to the complex nature of business operations such as, excessively over or under estimation of finance for a particular business operation. such types of wastages can be avoided through financial planning.

(iii) Helps in coordination: It helps in coordinating various business activities, such as sales, purchase, – production, finance, etc.

What is meant 'Financial Planning'? State any two points of its importance.

Importance of Financial Planning

Adequate funds have to be ensured.
Financial Planning helps in ensuring a reasonable balance between outflow and inflow of funds so that stability is maintained.

Explain the meaning and the objective of Financial Management.

Objectives of Financial Management

The financial management is generally concerned with procurement, allocation and control of financial resources of a concern. The objectives can be-

To ensure regular and adequate supply of funds to the concern.
To ensure adequate returns to the shareholders which will depend upon the earning capacity, market price of the share, expectations of the shareholders.
To ensure optimum funds utilization. Once the funds are procured, they should be utilized in maximum possible way at least cost.
To ensure safety on investment, i.e, funds should be invested in safe ventures so that adequate rate of return can be achieved.
To plan a sound capital structure-There should be sound and fair composition of capital so that a balance is maintained between debt and equity capital.

'Indian Logistics' has its own warehousing arrangements at key locations across the country. Its warehousing services help business firms to reduce their overheads, increase efficiency and cut down distribution time.
State with reason, whether the working capital requirements of 'Indian Logistics' will be high or low?

The working capital requirement of Indian Logistics will be low because the company has its own warehouses and it is not required to pay the rent required for warehousing services. Few other expenses may also be cut down because of this advantageous position.

Investment decision can be long-term. Explain long term investment decision and state any two factors affecting this decision.

Long-term investment decision is referred to as the capital budgeting decision. It relates to the investment in fixed assets e.g. buying a new machine. Befoje taking the final decision the finance manager makes a comparative study of various alternatives available in the market on the basis of their cost and profitability.

These decisions are very important as they affect the earnings of the business in the long-run.

Factors affecting long-term investment decision are:

(i) Cash flow of the project Cash flow of the project during the life of an investment affects the long-term investment decision.

Series of cash receipts and payments over the life of an investment has to be carefully analysed before taking a capital budgeting decision. .

(ii) Rate of return of the project The most important criterion is the rate of return of the project. Investment yields return in future. Thus, calculation of returns is necessary to analyse the best project.

(iii) Risk involved With every investment proposal, there is some degree of risk involved. The company must try to calculate the risk involved in every proposal and select a proposal with moderate degree of risk only.

Name the process which helps in determining the objectives, policies, procedures, programmes and budgets to deal with the financial activities of an enterprise. Explain its three points of importance.

Financial Planning helps in ensuring a reasonable balance between outflow and inflow of funds so that stability is maintained.
Financial Planning ensures that the suppliers of funds are easily investing in companies which exercise financial planning.

Explain how (i) Risk consideration and (ii) Tax Rate affect the choice of capital structure.

(i) Risk of consideration While deciding the capital structure, risk must be analysed and considered.

Total risk consists of two types of risks:

(ii)Tax rate Interest is a deductible expense. Cost of debt is affected by the tax rate. A higher tax rate

makes debt relatively cheaper and increases its attraction in relation to equity.

To avoid the problem of shortage and surplus of funds, what is required in financial management?
Name the concept and explain why three points of its importance.

Financial Planning is required to avoid shortage or surplus of finance.

Importance of financial planning is:

1- It helps in coordinating the various business activities such as sales,purchases, production, finance etc.

2-It helps in setting up standard and compare with the actual performance.

The deviations, if any are then analysed. Causes found out and corrective measures are taken.

Name the decision a financial manager takes, keeping in view the overall objective of maximizing shareholders' wealth.
Explain any two factors affecting this decision.

Financing decision is concerned with the decisions about how much funds are to be raised from which long-term source, i.e. by means of shareholders’ funds or borrowed funds.

Shareholders’ funds include share capital, reserves and surplus and retained earnings, whereas, borrowed funds include debentures, long-term loans and public deposits.

Factors affecting financing decision :

Cost

The cost of raising funds from different sources are different. A wise finance manager opt for the cheapest source of finance.

Risk

The risk associated to each of the source is different. The source which involves least risk should be preferred.

How do 'Choice of Technique' and 'Nature of Business' affects the 'Fixed Captial' requirements of a company? Explain.

Choice of Technique :

Companies using capital-intensive techniques require more fixed capital whereas companies using labour-intensive techniques require less capital because capital-intensive techniques make use of plant and machinery and company needs more fixed capital to buy plants and machinery.

Nature of Business

The type of business Co. is involved in is the first factor which helps in deciding the requirement of fixed capital. A manufacturing company needs more fixed capital as compared to a trading company, as trading company does not need plant, machinery, etc.

What is meant by 'Investment Decision'?
State and three factors which affect the Investment Decision.

Investment Decisions:

Factors Affecting Investment/Capital Budgeting Decisions

1. Cash Flow of the Project:

Whenever a company is investing huge funds in an investment proposal it expects some regular amount of cash flow to meet day to day requirement. The amount of cash flow an investment proposal will be able to generate must be assessed properly before investing in the proposal.

2. Return on Investment:

The most important criteria to decide the investment proposal is rate of return it will be able to bring back for the company in the form of income for, e.g., if project A is bringing 10% return and project В is bringing 15% return then we should prefer project B.

3. Risk Involved:

With every investment proposal, there is some degree of risk is also involved. The company must try to calculate the risk involved in every proposal and should prefer the investment proposal with moderate degree of risk only.

Explain the following as factors affecting financing decision:-
(i) Cost
(ii) Cash flow position of business
(iii) Level of fixed operating cost and
(iv) Control considerations

Cost- The cost of raising funds from different sources is different. A wise finance manager opts for the cheapest source of finance.

Cash Flow Position of the Company- A stronger cash flow position may make debt financing more viable than funding through equity.

Fixed Operating Cost- If a firm is having a higher fixed operating burden like payment of interests, premiums, salaries, rent, etc, then it should avoid financing through debt. This is because it will further increase the interest payment burden and the firm can reach an unfavorable position. However, if the firm has lower operating costs, then the firm can borrow funds.

Control Considerations- The issue of more equity may dilute shareholders’ control over the business. Therefore, a company afraid of a takeover bid may prefer debt to equity.

Pranav is engaged in 'Transportation-Business'. Identify the working capital requirements of Pranav stating the reason in support of your answer. Pranav also wants to expand and diversify his Trasport-Business.
Explain any two factors that will affect these fixed capital requirements.

(a) As it is a service industry, the working capital requirement would be less. The working capital requirement would be for the payment of salary, fuel charges, maintenance of the vehicle, etc.

(b) Factors effecting Capital Requirement:

The scale of Operations: Larger the spread of business activities, the greater is the need for fixed capital.
Diversification: Diversification means running a business in more products than merely in one product. Those organizations who wish to adopt diversification certainly need more fixed capital.

Explain any four factors which affect the 'Working Capital' requirements of a company.

1. Length of Operating Cycle:

2. Nature of Business:

The type of business, firm is involved in, is the next consideration while deciding the working capital. In case of trading concern or retail shop the requirement of working capital is less because length of operating cycle is small.The wholesalers as compared to retail shop require more working capital as they have to maintain large stock and generally sell goods on credit which increases the length of operating cycle. The manufacturing company requires huge amount of working capital because they have to convert raw material into finished goods, sell on credit, maintain the inventory of raw material as well as finished goods.

3. Scale of Operation:

The firms operating at large scale need to maintain more inventory, debtors, etc. So they generally require large working capital whereas firms operating at small scale require less working capital.

4. Business Cycle Fluctuation:

Give the other name of Long-term Investment Decision and state any three factors which affect this decision?

These decisions are very important as they affect the earnings of the business in the long-run.

Factors affecting long-term investment decision are:

(i) Cash flow of the project Cash flow of the project during the life of an investment affects the long-term investment decision.

Series of cash receipts and payments over the life of an investment has to be carefully analysed before taking a capital budgeting decision. .

What is meant by Financial Planning? State any three points of its importance.

Importance of Financial Planning

Adequate funds have to be ensured.

Financial Planning helps in ensuring a reasonable balance between outflow and inflow of funds so that stability is maintained.

Financial Planning ensures that the suppliers of funds are easily investing in companies which exercise financial planning.

What is meant by 'Long-term Investment Decision'?
State any three factors which affect the long term investment decisions.

Long-term investment decision is referred to as the capital budgeting decision. It relates to the investment in fixed assets e.g. buying a new machine. Before taking the final decision the finance manager makes a comparative study of various alternatives available in the market on the basis of their cost and profitability.

These decisions are very important as they affect the earnings of the business in the long-run.

Factors affecting long-term investment decision are:

(i) Cash flow of the project Cash flow of the project during the life of an investment affects the long-term investment decision.

Series of cash receipts and payments over the life of an investment has to be carefully analysed before taking a capital budgeting decision. .

Explain any four factors which affect the 'Dividend Decision' of a company.

Factors Affecting Dividend Decision:

The finance manager analyses the following factors before dividing the net earnings between dividend and retained earnings:

1. Earning:

Dividends are paid out of current and previous year’s earnings. If there are more earnings then the company declares a high rate of dividend whereas during the low earning period the rate of dividend is also low.

2. Stability of Earnings:

Companies having stable or smooth earnings prefer to give a high rate of dividend whereas companies with unstable earnings prefer to give a low rate of earnings.

3. Cash Flow Position:

Paying dividends means an outflow of cash. Companies declare high rates of dividend only when they have surplus cash. In the situation of shortage of cash, companies declare no or very low dividends.

4. Growth Opportunities:

If a company has a number of investment plans then it should reinvest the earnings of the company. As to investing in investment projects, the company has two options: one to raise additional capital or invest its retained earnings. The retained earnings are a cheaper source as they do not involve floatation costs and any legal formalities.

What is meant by Dividend decision?
State any four factors affecting the Dividend decision.

Dividend Decision:

It is the reward of shareholders for investments made by them in the share capital of the company. The dividend decision is concerned with the quantum of profits to be distributed among shareholders.

Factors Affecting Dividend Decision:

The finance manager analyses following factors before dividing the net earnings between dividend and retained earnings:

1. Earning:

2. Stability of Earnings:

Companies having stable or smooth earnings prefer to give high rate of dividend whereas companies with unstable earnings prefer to give low rate of earnings.

3. Cash Flow Position:

Paying dividend means outflow of cash. Companies declare high rate of dividend only when they have surplus cash. In situation of shortage of cash companies declare no or very low dividend.

4. Growth Opportunities:

"Sound Financial Planning' is essential for the success of any business enterprise."
Explain this statement by giving any six reasons.

Financial Planning pertains to functions of finance and includes the determination of firm financial objectives, financial policies, and financial procedure.

The main six points of importance of sound financial planning for the success of business enterprise are given below

(i) Helps to face the eventualities: It forecasts the future business situations which helps in preparing alternative financial plans to face the eventual situations.

(ii) Helps in avoiding business shocks and surprises: Proper provision regarding shortage or surplus of funds is made by anticipating future receipts and„payments. Hence, it helps in avoiding business shocks and surprises.
(iii) Helps in coordination: It helps in coordinating various business activities, such as sales, purchase, production, finance, etc.
(iv) Helps in avoiding wastage of finance In the absence of financial planning, wastage of financial resources may take place. This arises due to the complex nature of business operations such as, excessively over or underestimation of finance for a particular business operation. Such types of wastages can be avoided through financial planning.
(v) Helps to link the present with the future: It makes efforts to link the present with the future. By doing so, it helps to minimize the risks of future uncertainties.
(vi) Helps in creating a link between investment and financing decisions: It helps in deciding that where to invest and from where the required funds will be made available. Under it, the mix of share capital and debt capital is made in such a manner that the cost of capital is reduced to a minimum.

Neelabh is engaged in 'Transport Business' and transports fruits and vegetables to different states. Staring the reason in support of your answer, identify the working capital requirements of Neelabh. Neelabh also wants to expand and diversify his transport business.
Explain any two factors that will affect his fixed capital requirements.

In the transportation business, lower amount of working capital is required as it is a service industry. Working capital requirement of Neelabh would include, payment of salaries, fuel charges, maintenance of vehicles, etc.

Factors Affecting the Fixed Capital Requirements are:

(i) Growth prospects Businessman wants to expand his business, in such situation company requires higher investment to meet the anticipated demand in future. Thus, the requirement of fixed capital will be higher.

(ii) Diversification If the businessman diversifies his business, this means larger amount of fixed capital is required.

Identify the financial decision which determines the amount of profit earned to be distributed and to be retained in the business.
Explain any four factors affecting this decision.

Dividend Decision:

This financial decision relates to the disbursement of profits back to investors who supplied capital to the firm. The term dividend refers to that part of profits of a company which is distributed by it among its shareholders.

Factors Affecting Dividend Decision:

The finance manager analyses following factors before dividing the net earnings between dividend and retained earnings:

1. Earning:

2. Stability of Earnings:

Companies having stable or smooth earnings prefer to give high rate of dividend whereas companies with unstable earnings prefer to give low rate of earnings.

3. Cash Flow Position:

Paying dividend means outflow of cash. Companies declare high rate of dividend only when they have surplus cash. In situation of shortage of cash companies declare no or very low dividend.

4. Growth Opportunities:

What is mean by 'Capital Structure'?
State any four factors affecting the choice of capital structure.

Factors affecting capital structure are:

Period of financing- When company wants to raise finance for short period, it goes for loans from banks and other institutions; while for long period it goes for issue of shares and debentures.
Cost of financing- In a capital structure, the company has to look to the factor of cost when securities are raised. It is seen that debentures at the time of profit earning of company prove to be a cheaper source of finance as compared to equity shares where equity shareholders demand an extra share in profits.
Stability of sales- An established business which has a growing market and high sales turnover, the company is in position to meet fixed commitments. Interest on debentures has to be paid regardless of profit. Therefore, when sales are high, thereby the profits are high and company is in better position to meet such fixed commitments like interest on debentures and dividends on preference shares. If company is having unstable sales, then the company is not in position to meet fixed obligations. So, equity capital proves to be safe in such cases.
Sizes of a company- Small size business firms capital structure generally consists of loans from banks and retained profits. While on the other hand, big companies having goodwill, stability and an established profit can easily go for issuance of shares and debentures as well as loans and borrowings from financial institutions. The bigger the size, the wider is total capitalization.

What is working capital?
Explain any four factors affecting the working capital requirements.

Working capital, also known as net working capital, is the difference between a company’s current assets, like cash, accounts receivable (customers’ unpaid bills) and inventories of raw materials and finished goods, and its current liabilities, like accounts payable.

Factors affecting working capital requirement:

1. Length of Operating Cycle:

2. Nature of Business:

3. Scale of Operation:

The firms operating at large scale need to maintain more inventory, debtors, etc. So they generally require large working capital whereas firms operating at small scale require less working capital.

4. Business Cycle Fluctuation:

Identify the decision taken in financial management which affects the liquidity as well as the profitability of business.

Short term Investment decision is the decision that is taken in financial management which affects the liquidity as well as the profitability of business.

What is meant by 'Financing decision'?
State any four factors affecting the financing decision.

Financing Decision:

This decision relates to how, when and where funds are to be acquired to meet investment needs. It is related to the capital structure or financial leverage. This is debt-equity ratio. If more recourse is taken to debt capital, shareholders’ risk is lessened and the prospects of their dividend earning are reduced. So, in financing decision, the crucial point is the trade-off between returned risks.

The financing decision— unlike investment decision— relates to the determination of the capital structure — the proper balance between debt and equity.

Factors Affecting Financing Decisions:

While taking financing decisions the finance manager keeps in mind the following factors:

1. Cost:

The cost of raising finance from various sources is different and finance managers always prefer the source with minimum cost.

2. Risk:

More risk is associated with borrowed fund as compared to owner’s fund securities. Finance manager compares the risk with the cost involved and prefers securities with moderate risk factor.

3. Cash Flow Position:

4. Control Considerations:

Explain any four factors which affect the fixed capital requirements of a business?

The requirement of fixed capital depends upon various factors which are explained below:

1. Nature of Business:

The type of business Co. is involved in is the first factor which helps in deciding the requirement of fixed capital. A manufacturing company needs more fixed capital as compared to a trading company, as trading company does not need plant, machinery, etc.

2. Scale of Operation:

The companies which are operating at large scale require more fixed capital as they need more machineries and other assets whereas small scale enterprises need less amount of fixed capital.

3. Technique of Production:

4. Technology Up-gradation:

You are the Financial Manager of a newly established company. The Directors have asked you to determine the amount of working capital requirement for the company.
Explain any four factors that you will consider while determining the working capital requirement for the company.

Factors affecting working capital requirement:

1. Length of Operating Cycle:

2. Nature of Business:

3. Scale of Operation:

The firms operating at large scale need to maintain more inventory, debtors, etc. So they generally require large working capital whereas firms operating at small scale require less working capital.

4. Business Cycle Fluctuation:

How does 'cost of equity' affect the choice of capital structure of a company? Explain.

Capital structure refer to the mix of both owner’s fund and borrower’s fund. It affects both the profitability and financial risk of business. Raising funds through equity is costlier because it involves payment of dividend and also voting rights given to shareholders. This affects the decision making of the organisation.

'Bharat Express' specialises in courier services. Its 'wide range of express package and parcel services' help business firms to make sure that the good are made available to the customer at the right time.
State with reason, whether the working capital requirements of 'Bharat Express' will be high or low

The working capital requirements of Bharat Express will be low as organizations dealing in services have shorter operating cycles, i.e., no processing is done in such organizations. Accordingly, they require low capital.

Explain the following factors affecting working capital requirements:-
(i) Level of competition
(ii) Seasonal factors
(iii) Production cycles.

Level of Competition:

Seasonal Factors:

Production Cycle:

Production cycle means the time involved in converting raw material into finished product. The longer this period, the more will be the time for which the capital remains blocked in raw material and semi-manufactured products.Thus, more working capital will be needed. On the contrary, where period of production cycle is little, less working capital will be needed.

Explain briefly any four factors which affect the choice of capital structure of a company.

Factors that affect the choice of capital structure are:

(1) Cash Flow Position:

While making a choice of the capital structure the future cash flow position should be kept in mind. Debt capital should be used only if the cash flow position is really good because a lot of cash is needed in order to make payment of interest and refund of capital.

(2) Interest Coverage Ratio-ICR:

With the help of this ratio, an effort is made to find out how many times the EBIT is available to the payment of interest. The capacity of the company to use debt capital will be in direct proportion to this ratio.

(3) Debt Service Coverage Ratio-DSCR:

This ratio removes the weakness of ICR. This shows the cash flow position of the company.

This ratio tells us about the cash payments to be made (e.g., preference dividend, interest, and debt capital repayment) and the amount of cash available. A better ratio means the better capacity of the company for debt payment. Consequently, more debt can be utilized in the capital structure.

(4) Return on Investment-ROI:

The greater return on investment of a company increases its capacity to utilize more debt capital.

Abhishek Ltd'. is manufacturing cotton clothes. It has been consistently earning good profits for many years. This year too, it has been able to generate enough profits. There is availability of enough cash in the company and good prospects for growth in future. It is a well managed oranisation and believes in quality, equal employment opportunities and good remuneration practices. It has many shareholders who prefer to receive a regular income from their investments.
It has taken a loan of Rs 50 lakhs from I.C.I.C.I. Bank and is bound by certain restrictions on the payment of dividend according to the terms of the loan agreement.
The above discussion about the company leads to various factors which decide how much of the profits should retained and how much has to be distributed by the company.
Quoting the lines from the above discussion, identify and explain any four such factors.

Factors affecting dividend decision in the above case are as follows:
(i) Stability of earnings: ‘It has been consistently earning good profits for many years.'
Stability of earnings affects dividend decision as a company having stable earning is in a position to declare higher dividends.
(ii) Cash flow position: 'There is availability of enough cash in the company.'
A good cash flow position is necessary for higher declaration of dividend.
(iii) Growth prospects: 'Good prospects for growth in the future.'
If a company has good growth opportunities, it pays out less dividend.
(iv) Shareholder's preference: 'It has many shareholders who prefer to receive regular income from their investments'.
Shareholder's preference is kept in mind by the management before declaring dividends.
(v) Contractual constraints: 'It has taken a loan of Rs.50 lakh from I.C.I.C.I. and...... agreement’.
While taking dividend decision, companies keep in mind the restrictions imposed by the lenders in the loan agreement.

You are the Financial Manager of a newly established company. The Directors have asked you to determine the amount of Fixed capital requirement for the company.
Explain any four factors that you will consider while determining the Fixed capital requirement for the company?

The requirement of fixed capital depends upon various factors which are explained below:

1. Nature of Business:

The type of business Co. is involved in is the first factor which helps in deciding the requirement of fixed capital. A manufacturing company needs more fixed capital as compared to a trading company, as trading company does not need plant, machinery, etc.

2. Scale of Operation:

The companies which are operating at large scale require more fixed capital as they need more machineries and other assets whereas small scale enterprises need less amount of fixed capital.

3. Technique of Production:

4. Technology Up-gradation:

What is meant by 'Dividend Decision'?
Explain any four factors which affect the dividend decision of the company.

Dividend decision relates to how much of the company’s net profit is to be distributed to the shareholders and how much of it should be retained in the business for meeting the investment requirements.

This decision should be taken, keeping in view the overall objective of maximising shareholders’ wealth.

Factors affecting dividend decision :

Amount of Earnings

Dividends are paid out of current and past earnings. Thus, earnings is a major determinant of dividend decision.

Stability in Earnings

A company having higher and stable earnings can declare higher dividends than a company with lower and unstable earnings.

Stability of Dividends

Generally, companies try to stabilise dividends per share. A steady dividend is given each year. A change is only made, if the company’s earning potential has gone up and not just the earnings of the current year.

Growth Opportunities

Companies having good growth opportunities retain more money out of their earnings so as to finance the required investment. The dividend declared in growth companies is, therefore, smaller than that in the non-growth companies. .

Cash Flow Position

Dividend involves an outflow of cash. Availability of enough cash is necessary for payment or declaration of dividends.

Shareholders’Preference

While declaring dividends, management must keep in mind the preferences of the shareholders. Some shareholder& general desire that atleast a certain amount is paid as dividend. The companies should consider the preferences of such shareholders .

Taxation Policy

If the tax on dividends is higher, it is better to pay less by way of dividends. But if the tax rates are lower, higher dividends may be declared. This is because as per the current taxation policy, a dividend distribution tax is levied on companies. However, shareholders prefer higher dividends, as dividends are tax free in the hands of shareholders.

Stock Market Reaction

Generally, an increase in dividends has a positive impact on stock market, whereas, a decrease or no increase may have a negative impact on stock market. Thus, while deciding on dividends, this should be kept in mind.

Access to Capital Market

Large and reputed companies generally have easy access to the capital market and, therefore, may depend less on retained earnings to finance their growth. These companies tend to pay higher dividends than the smaller companies.

Legal Constraints

Certain provisions of the Companies Act, place restrictions on payouts as dividend. Such provisions must be adhered to while declaring the dividend.

Explain the following factors affecting working capital requirements:-
(i) Business cycles
(ii) Operating efficiency
(iii) Inflation.

(i) Business cycles- The need for the working capital is affected by various stages of the business cycle. During the boom period, the demand for a product increases and sales also increase. Therefore, more working capital is needed. On the contrary, during the period of depression, the demand declines and it affects both the production and sales of goods. Therefore, in such a situation less working capital is required.

(ii) Operating efficiency- Operating efficiency means efficiently completing the various business operations. Operating efficiency of every organisation happens to be different.

Some such examples are: (i) converting raw material into finished goods at the earliest, (ii) selling the finished goods quickly, and (iii) quickly getting payments from the debtors. A company which has a better operating efficiency has to invest less in stock and the debtors.

Therefore, it requires less working capital, while the case is different in respect of companies with less operating efficiency.

(iii) Inflation- Inflation means a rise in prices. In such a situation more capital is required than before in order to maintain the previous scale of production and sales. Therefore, with the increasing rate of inflation, there is a corresponding increase in working capital.

Explain briefly any four factors which affect the fixed capital requirement of a company?

The requirement of fixed capital depends upon various factors which are explained below:( any four)

1. Nature of Business:

2. Scale of Operation:

The companies which are operating at a large scale require more fixed capital as they need more machinery and other assets whereas small-scale enterprises need less amount of fixed capital.

3. Technique of Production:

Companies using capital-intensive techniques require more fixed capital whereas companies using labour-intensive techniques require less capital because capital-intensive techniques make use of plant and machinery and the company needs more fixed capital to buy plants and machinery.

4. Technology Up-gradation:

Answer the following question in $$2$$ or $$3$$ sentences.
Write the meaning of dividend decisions.

Dividend decisions, as the very name suggests, refers to the decision-making mechanism of the management to declare dividends. It is crucial for the top management to determine the portion of earnings distributable as the dividend at the end of every reporting period.

Answer the following question in a word or a sentence.
What is business finance?

Business finance refers to money and credit employed in business. It involves procurement and utilization of funds so that business firms may be able to carry out their operations effectively and efficiently.

Answer the following question in $$15$$ to $$20$$ sentences.
Explain any five factors, which may influence the amount of fixed capital requirements in business.

Factors Affecting Requirement of Fixed Capital :

Investment in fixed assets is for longer duration and is called fixed capital. Fixed capital is financed through long term sources of finance such as equity shares, preference shares, debentures, long term loans, etc.

The requirement of fixed capital depends upon various factors which are explained below:

1. Nature of Business:

The type of business Co. is involved in is the first factor which helps in deciding the requirement of fixed capital. A manufacturing company needs more fixed capital as compared to a trading company, as trading company does not need plant, machinery, etc.

2. Scale of Operation:

The companies which are operating at large scale require more fixed capital as they need more machineries and other assets whereas small scale enterprises need less amount of fixed capital.

3. Technique of Production:

4. Technology Up-gradation:

5. Growth Prospects:

Answer the following question in $$15$$ to $$20$$ sentences.
Explain any five objectives of financial management.

Objectives of Financial Management

The financial management is generally concerned with procurement, allocation and control of financial resources of a concern. The objectives can be-

To ensure regular and adequate supply of funds to the concern.

To ensure adequate returns to the shareholders which will depend upon the earning capacity, market price of the share, expectations of the shareholders.

To ensure optimum funds utilization. Once the funds are procured, they should be utilized in maximum possible way at least cost.

To ensure safety on investment, i.e, funds should be invested in safe ventures so that adequate rate of return can be achieved.

To plan a sound capital structure-There should be sound and fair composition of capital so that a balance is maintained between debt and equity capital.

Distinguish between of the Fixed and Working Capital.

Fixed CapitalWorking CapitalMeaning:
Fixed capital refers to any kind of physical
capital. i.e.fixed assets.Working capital refers to current assets minus current liabilites.Nature:
It stays in business almost permanently i.e. for more than one
accounting year.Working capital is circulating capital.Purpose:
It is not used up in production of product but invested in fixed assets such as land,
building, equipment's, etcWorking capital is invested in short term assets such as cash, account receivable,inventory,etc.Source:
Fixed capital fund can come from selling shares,debentures,long term loans, bonds,etcWorking capital can be funded with short term loans, deposits, trade credits,etcObjective of investment:
Investor invests money in fixed capital hoping to make future profit.Investor invests money in working capital for getting immediate return.Risk Involved:
Investment in fixed capital implies a riskInvestment in working capital is less risky.

Write notes on Capital structure and its components.

Meaning: -Capital structure constitutes two words i.e. capital and structure. Capital refers to investment of funds in the business while structure means arrangement of different components in proper proportion. Thus capital structure means' mix-up of various sources of funds in desired proportion'.
Definition: -" The long term sources of funds employed in a business enterprise." (R.H. Wessel)
Components / parts of Capital Structure There are four basic components of capital Structure. They are as follow:

1. Equity Share capital: -It is the basic of financing activities of business. Equity share capital is provided by equity shareholders. They buy equity shares and help a business firm to raise necessary funds. They bear ultimate risk associated with ownership. Equity shares carry dividend at fluctuating rate, depending upon profit.

2. Preference Share Capital: -Preference shares carry preferential right as to payment of dividend and have priority over equity shares for return of capital when the company is liquidated. These shares carry dividend at a fixed rate. They have limited voting rights.

3. Retained earnings: -it is an internal source financing. It is nothing but ploughing back of profit.

4. Borrowed Capital: -
(a) Debentures: -A debenture is an acknowledgement of loan raised by company. Company has to pay interest at an agreed rate.
(b) Term loan: -Term loans are provided by bank and other financial institutions. They carry fixed rate of interest.

Answer the following question in $$2$$ or $$3$$ sentences.
Give the meaning of financing decisions.

The Financing Decision is yet another crucial decision made by the financial manager relating to the financing-mix of an organization. It is concerned with the borrowing and allocation of funds required for the investment decisions.

Answer the following question in $$20$$ to $$30$$ sentences.
Describe objectives of financial management.

Financial Management means planning, organizing, directing and controlling the financial activities such as procurement and utilization of funds of the enterprise. It means applying general management principles to financial resources of the enterprise.

The objectives of financial management are given below:

1. Profit maximization

Main aim of any kind of economic activity is earning profit. A business concern is also functioning mainly for the purpose of earning profit. Profit is the measuring techniques to understand the business efficiency of the concern.

The finance manager tries to earn maximum profits for the company in the short-term and the long-term. He cannot guarantee profits in the long term because of business uncertainties. However, a company can earn maximum profits even in the long-term, if:

The Finance manager takes proper financial decisions

He uses the finance of the company properly

2. Wealth maximization

Wealth maximization (shareholders’ value maximization) is also a main objective of financial management. Wealth maximization means to earn maximum wealth for the shareholders. So, the finance manager tries to give a maximum dividend to the shareholders. He also tries to increase the market value of the shares. The market value of the shares is directly related to the performance of the company. Better the performance, higher is the market value of shares and vice-versa. So, the finance manager must try to maximize shareholder’s value

3. Proper estimation of total financial requirements

Proper estimation of total financial requirements is a very important objective of financial management. The finance manager must estimate the total financial requirements of the company. He must find out how much finance is required to start and run the company. He must find out the fixed capital and working capital requirements of the company. His estimation must be correct. If not, there will be shortage or surplus of finance. Estimating the financial requirements is a very difficult job. The finance manager must consider many factors, such as the type of technology used by company, number of employees employed, scale of operations, legal requirements, etc.

4. Proper mobilization

Mobilization (collection) of finance is an important objective of financial management. After estimating the financial requirements, the finance manager must decide about the sources of finance. He can collect finance from many sources such as shares, debentures, bank loans, etc. There must be a proper balance between owned finance and borrowed finance. The company must borrow money at a low rate of interest.

5. Proper utilization of finance

Proper utilization of finance is an important objective of financial management. The finance manager must make optimum utilization of finance. He must use the finance profitable. He must not waste the finance of the company. He must not invest the company’s finance in unprofitable projects. He must not block the company’s finance in inventories. He must have a short credit period.

6. Maintaining proper cash flow

Maintaining proper cash flow is a short-term objective of financial management. The company must have a proper cash flow to pay the day-to-day expenses such as purchase of raw materials, payment of wages and salaries, rent, electricity bills, etc. If the company has a good cash flow, it can take advantage of many opportunities such as getting cash discounts on purchases, large-scale purchasing, giving credit to customers, etc. A healthy cash flow improves the chances of survival and success of the company.

7. Survival of company

Survival is the most important objective of financial management. The company must survive in this competitive business world. The finance manager must be very careful while making financial decisions. One wrong decision can make the company sick, and it will close down.

8. Creating reserves

One of the objectives of financial management is to create reserves. The company must not distribute the full profit as a dividend to the shareholders. It must keep a part of it profit as reserves. Reserves can be used for future growth and expansion. It can also be used to face contingencies in the future.

Answer the following question in $$2$$ or $$3$$ sentences.
State any two types of financial decisions.

1. Investment Decision:

A financial decision which is concerned with how the firm’s funds are invested in different assets is known as investment decision. Investment decision can be long-term or short-term.

A long term investment decision is called capital budgeting decisions which involve huge amounts of long term investments and are irreversible except at a huge cost. Short-term investment decisions are called working capital decisions, which affect day to day working of a business. It includes the decisions about the levels of cash, inventory and receivables.

2. Financing Decision:

A financial decision which is concerned with the amount of finance to be raised from various long term sources of funds like, equity shares, preference shares, debentures, bank loans etc. Is called financing decision. In other words, it is a decision on the ‘capital structure’ of the company.

List few aspects of business affected by financial management decisions.

The aspects of business affected by financial management decisions are:
1. The size and the composition of fixed assets of the business.
2. The quantum of current assets and its break-up into cash, inventory and receivables.
3. The amount of long-term and short- term funds to be used.
4. All items in the Profit and Loss Account, e.g., Interest, Expense, Depreciation, etc.

Answer the following question in $$10$$ to $$12$$ sentences.
Explain any four factors affecting financial decision.

Factors affecting financing decision :

Cost

The cost of raising funds from different sources are different. A wise finance manager opt for the cheapest source of finance.

Risk

The risk associated to each of the source is different. The source which involves least risk should be preferred.

Floatation Cost

If the floatation cost, i.e. the expenses incurred in issue of debt is higher, the source of finance becomes less attractive.

Cash Flow Position of the Company

A stronger cash flow position may make debt financing more viable than funding through equity.

Answer the following question.
As a financial consultant, give the list of any $$10$$ factors which affect the choice of capital structure.

Under the capital structure, decision the proportion of long-term sources of capital is determined. Most favourable proportion determines the optimum capital structure. That happens to be the need of the company because EPS happens to be the maximum on it. Some of the chief factors affecting the choice of the capital structure are the following:

(1) Cash Flow Position:

(2) Interest Coverage Ratio-ICR:

With the help of this ratio an effort is made to find out how many times the EBIT is available to the payment of interest. The capacity of the company to use debt capital will be in direct proportion to this ratio.

It is possible that in spite of better ICR the cash flow position of the company may be weak. Therefore, this ratio is not a proper or appropriate measure of the capacity of the company to pay interest. It is equally important to take into consideration the cash flow position.

(3) Debt Service Coverage Ratio-DSCR:

This ratio removes the weakness of ICR. This shows the cash flow position of the company.

This ratio tells us about the cash payments to be made (e.g., preference dividend, interest and debt capital repayment) and the amount of cash available. Better ratio means the better capacity of the company for debt payment. Consequently, more debt can be utilised in the capital structure.

(4) Return on Investment-ROI:

The greater return on investment of a company increases its capacity to utilise more debt capital.

(5) Cost of Debt:

The capacity of a company to take debt depends on the cost of debt. In case the rate of interest on the debt capital is less, more debt capital can be utilised and vice versa.

(6) Tax Rate:

The rate of tax affects the cost of debt. If the rate of tax is high, the cost of debt decreases. The reason is the deduction of interest on the debt capital from the profits considering it a part of expenses and a saving in taxes.

For example, suppose a company takes a loan of 0ppp 100 and the rate of interest on this debt is 10% and the rate of tax is 30%. By deducting 10/- from the EBIT a saving of in tax will take place (If 10 on account of interest are not deducted, a tax of @ 30% shall have to be paid).

(7) Cost of Equity Capital:

Cost of equity capital (it means the expectations of the equity shareholders from the company) is affected by the use of debt capital. If the debt capital is utilised more, it will increase the cost of the equity capital. The simple reason for this is that the greater use of debt capital increases the risk of the equity shareholders.

Therefore, the use of the debt capital can be made only to a limited level. If even after this level the debt capital is used further, the cost of equity capital starts increasing rapidly. It adversely affects the market value of the shares. This is not a good situation. Efforts should be made to avoid it.

(8) Floatation Costs:

Floatation costs are those expenses which are incurred while issuing securities (e.g., equity shares, preference shares, debentures, etc.). These include commission of underwriters, brokerage, stationery expenses, etc. Generally, the cost of issuing debt capital is less than the share capital. This attracts the company towards debt capital.

(9) Risk Consideration: There are two types of risks in business:

(i) Operating Risk or Business Risk:

This refers to the risk of inability to discharge permanent operating costs (e.g., rent of the building, payment of salary, insurance installment, etc),

(ii) Financial Risk:

This refers to the risk of inability to pay fixed financial payments (e.g., payment of interest, preference dividend, return of the debt capital, etc.) as promised by the company.

The total risk of business depends on both these types of risks. If the operating risk in business is less, the financial risk can be faced which means that more debt capital can be utilised. On the contrary, if the operating risk is high, the financial risk likely occurring after the greater use of debt capital should be avoided.

(10) Flexibility:

According to this principle, capital structure should be fairly flexible. Flexibility means that, if need be, amount of capital in the business could be increased or decreased easily. Reducing the amount of capital in business is possible only in case of debt capital or preference share capital.

If at any given time company has more capital than as necessary then both the above-mentioned capitals can be repaid. On the other hand, repayment of equity share capital is not possible by the company during its lifetime. Thus, from the viewpoint of flexibility to issue debt capital and preference share capital is the best.

What is the aim of Financial Management?

The primary aim of financial management is to maximise shareholders wealth, which is referred to as the wealth-maximisation concept. All financial decisions aim at ensuring that each decision is efficient and adds some value. Such value additions tend to increase the market price of shares.

Match the correct pairs of words from group 'A' and group 'B':

(A) Financial Management - Management of Business Funds

(B) Overdraft Facility - Current Account

(D) Depository Act - 1996

(E) Debenture holders - Creditors of the company

What is the meaning of Business Finance?

Money required for carrying out business activities is called Business Finance. Finance is needed to establish a business, to run it, to modernise it, to expand, or diversify it.

What is the importance of Financial Management in Business?

The financial statements, such as Balance Sheet and Profit and Loss Account, reflect a firms financial position and its financial health. Almost all items in the financial statements of a business are affected directly or indirectly through some financial management decisions. The importance of financial management cannot be over-emphasized, since it has a direct bearing on the financial health of a business.

'G. Motors is the manufacturer of sophisticated cranes. The Production manager of the company, reported to the Chief Executive Officer, Ashish Jain that one of the machines used in manufacturing sophisticated cranes had to be replaced to compete in the market, as other competitors were using automatic machines for manufacturing cranes. After a detailed analysis, it was decided to purchase a new automatic machine having the latest technology. It was also decided to finance this machine through long term sources of finance. Ashish Jain compared various machines and decided to invest in the machine which would yield the maximum returns to its investors.

(a) Identify the financial decision taken by Ashish Jain.
(b) Explain any three factors affecting the decision identified in (a) above.

(a) Financing Decision: Financing Decision is concerned with the decisions about, how much funds are to be raised from which long-term sources i.e. Owner’s Funds (consisting of equity share capital and retained earnings) or Borrowed Funds (consisting of debenture loans, bonds etc.)

(b) The factors affecting the finance decision are:
Cost: A prudent financial manager would normally opt for a source which is the cheapest. The cost of each type of finance is estimated. Some sources may be cheaper than others. E.g. Debt is considered the cheapest of all sources because Interest on Debt is a tax-deductible expense.
Risk: Associated Risk is also different for each source. E.g. it is necessary to pay Interest on Debt and redeem the principal amount on maturity. There is no such compulsion to pay dividend on equity shares. Thus, there is some amount of financial risk in debt financing. The overall financial risk depends upon the proportion of debt in the total capital.
Control Consideration: If existing shareholders want to retain the complete control of business, then they prefer borrowed fund securities to raise further fund. On the other hand, if they do not mind to lose the control, then they may go for Owner’s Fund Securities.

What is meaning and role of Financial Management?

Financial Management is concerned with optimal procurement as well as the usage of finance. Financial Management aims at reducing the cost of funds procured, keeping the risk under control and achieving effective deployment of such funds. It also aims at ensuring availability of enough funds whenever required as well as avoiding idle finance.

What is dividend?

The dividend is that portion of profit that is distributed to shareholders. It can be of two kinds -
1. Preference Dividend - which is paid to the preference shareholders at a fixed % or amount, and
2. Equity Dividend - which is paid to the equity shareholders.

How do you calculate Capital Structure?

Capital Structure can be calculated as debt-equity ratio i.e. Debt / Equity or as the proportion of debt out of the total capital i.e. Debt / (Debt +Equity). Here, Debt = total outside liabilities of the business, and Equity = total shareholders' funds.

What do you mean by Investment Decision?

The investment decision relates to how the firms funds are invested in different assets to earn highest possible Return on Investment (ROI). Investment decision can be long term or short-term. These are also known as Capital Budgeting decisions.

Write difference between Debt and Equity.

The difference between Debt and Equity can be given on the following basis:
1. Cost - The cost of debt is lower than the cost of equity for a firm because the lender's risk is lower than the equity shareholder's risk.
2. Return - Interest paid on debt is a deductible expense for computation of tax liability whereas dividends are paid out of after-tax profit.

What do you mean by financing decisions?

The financial decision involves the identification of various available sources. The main sources of funds for a firm are shareholders' funds and borrowed funds. The shareholders' funds refer to the equity capital and the retained earnings. Borrowed funds refer to the finance raised through debentures or other forms of debt.

What are the major issues in financial management?

The 3 major issues in financial management are -
1. Investment Decision - These are concerned with application of funds in long-term assets of the business.
2. Financing Decision - These are concerned with sources of funds and capital structure decisions.
3. Dividend Decision - These are concerned with the proportion of net income distributable to shareholders.

Why Investment decision is important?

A firms resources are scarce in comparison to the uses to which they can be put. Therefore, Investment decision enables the firm to choose where to invest these resources, so that they are able to earn the highest possible return for their investors.

Define capital structure.

Capital Structure relates to the financing pattern or the proportion of the use of different sources in raising funds. The financial risk, finance cost, profitability, and solvency of a business entity are dependent on the choice of funds used in the capital structure.

What kinds of financial decisions are taken in financial management?

There are 3 kinds of decisions that are taken in financial management -
1. Investment Decision - These are concerned with application of funds in long-term assets of the business.
2. Financing Decision - These are concerned with sources of funds and capital structure decisions.
3. Dividend Decision - These are concerned with the proportion of net income distributable to shareholders.

What are the factors affecting financing decisions?

The factors affecting financing decisions are:-
1. Cost
2. Risk
3. Floatation Cost
4. Cash Flow Position of the Company
5. Fixed Operating Costs
6. Control Considerations
7. State of Capital Market

Define Financial Leverage.

The proportion of debt in the overall capital is called financial leverage. It is the use of borrowed funds in the business of an entity in the form of long-term assets. It can be calculated as Total Debt/Shareholders' Equity.

Define trading on 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. It aims at achieving the highest possible EPS by the use of debt or leverage in the business.

Define yield.

Yield can be defined as the returns/earnings generated and realized on an investment over a specific period of time. It is expressed as a percentage of the originally invested amount, current market value, or face value of the security. It includes the interest earned or dividends received from holding a particular security.

Define Fixed Capital.

Fixed capital refers to investment in long-term assets. Management of fixed capital involves the allocation of a firm's capital to different projects or assets with long-term implications for the business. These decisions are called investment decisions or capital budgeting decisions.

Name the concept of financial management which increases the return to equity shareholders due to the presence of fixed financial charges.

The concept of financial management which increases the return to equity shareholders due to the presence of fixed financial charges is called Trading on Equity. It refers to the increase in profit earned by the equity shareholders due to the presence of fixed financial charges.

What do you mean by fixed capital requirement?

Funds are required to purchase fixed assets such as land and buildings as well as plants and machinery, in order to start a firm. The capital required for fixed assets are invested in the company for a long time is a fixed capital requirement.

What do you mean by working capital requirement?

A business needs funds for its day-to-day operation. This is known as working capital. Working Capital Requirement is the amount of money required to bridge the gap between disbursements (payments to suppliers) and receipts (payments from customers). The working capital requirement represents the amount necessary to finance this delay.

What does the term business finance mean?

The term finance means money or fund. The requirement of funds by a business to carry out its various activities is called business finance. Finance is needed at every stage in the life of a business. A business cannot function unless adequate funds are made available to it.

Write notes on the following :
Legal provision regarding unclaimed/ unpaid dividend.

Any person entitled to any amount transferred to IEPF is required to make an application for refund to the authority or committee appointed by the Central Government.

On verifying the evidence or documents. If the authority or committee is satisfied that such a person is legally entitled to receive a refund, it makes an order for payment of such amount due.

Once dividend transferred in Dividend Account but not has been claimed by the shareholder within 30 days of declaration of dividend.
The Company shall transfer such unpaid amount within 37 days from the date of declaration in a special account 'Unpaid Dividend Account'

5:the unclaimed dividend has been transferred to the Fund, may claim the shares from the Authority by making an application in Form IEPF 5 online available on website www.iepf.gov.in along with the fee, as decided by the Authority from time to time in consultation with the Central Government

Rizul Bhattacharya after leaving his job wanted to start a Private Limited Company with his son. His son was keen that the company may start manufacturing of Mobile phones with some unique features. Rizul Bhattacharya felt that the mobile phones are prone to quick obsolescence and a heavy fixed capital investment would be required regularly in this business. Therefore he convinced his son to start a furniture business.
Identify the factor affecting fixed capital requirements which made Rizul Bhattacharya to choose furniture business over mobile phones.

In the above case, ‘Technology Upgradation’ is the factor affecting the fixed capital requirements.

Name and state the aspect of financial management that enables to foresee the fund requirements both in terms of 'the quantum' and 'the timings'.

The process of estimating the fund requirements of a business and specifying the source of funds is called financial planning.

The Return on Investment (ROI) of a company ranges between $$10-12\%$$ for the past three years. To finance its future fixed capital needs, it has the following options for borrowing debt:
Option 'A': Rate of interest $$9\%$$
Option 'B': Rate of interest $$13\%$$
Which source of debt, 'Option A' or 'Option B', is better? Give reason in support of your answer. Also state the concept being used in taking the decision.

The general principle of borrowing at an interest rate is "lower the interest rate, lesser the interest paid". This is because a lower interest rate is essentially lowering the cost of your loan. For example if the loan you have taken is Rs 100, with an interest rate of 13% you are paying back Rs 113 to the lender. Whereas, with an interest rate of 9%, you are paying back Rs 109. Hence, lower the interest rate, lower the costs you face. Furthermore, since the return on investment of the company is 10%-12%, borrowing at an interest rate of 13 % will definitely give negative returns.

Financial Management - Class 12 Commerce Business Studies - Extra Questions

What do you mean by capital structure?

State the steps involved in financial planning?

What is the link between operating cycle and working capital?

Name the factor due to which a petro chemical company requires much higher investment in fixed capital than an information technology company. However both may generate same amount of revenue. Explain any two factors affecting fixed capital requirement?

How does 'Trading on Equity' affect the Capital structure of a company? Explain with the help of a suitable example.

Pankaj is engaged in Warehousing-Business. Identify the working capital requirements of Pankaj stating the reason in support of your answer. Pankaj is also planning to start his Transport business.Explain any two factors that will affect his fixed capital requirements.

Enumerate three important decisions taken in financial management?

Chandra Ltd, is a manufacturer of Laptops. It made a profit of 1000 crores. The director have proposed a dividend of 38%. As a finance manager of the company, what factors would you consider while formulating a dividend policy of the company?

Define financial management.

There are three major decisions which an organisation has to take in respect of financial management. Enumerate and explain these decisions in brief.

State the objectives of financial management.

Explain factors affecting the dividend decision.

Describe the two objectives of financial planning.

Explain the role of financial planning in corporate financial management.

Discuss about working capital? How is it calculated? Discuss five important determinants of working capital requirements.

A sound financial plan is the key to Success of sound financial management of the company.Discuss?

Financial management is based on three broad financial decision. What are these?

What is meant by working capital? How is it calculated? Discuss five important determinants of working capital requirements.

What is meant by 'Capital Structure' of a company?State any two factors which affect the capital structure of a company.

Define working capital.

You are the finance manager of a newly established company. The directors of the company have asked you to plan the capital structure of the company. State any five factors that you would consider while planning the capital structure.

Name the major determinant of dividend decision.

Explain how the (i) Cost of debt and (ii) Cost of Equity affect the choice of capital structure.

Explain factors affecting financing decision.

Explain the meaning of Financial Planning. Why is it important? Give any two reasons.

What is meant by 'financial management'?

Name the financial decision which will help a businessman in opening a new branch of its business.

State whether the working capital requirement of business manufacturing the following items are big or small. Justify your answer:-(i) Bread (ii) Coolers(iii) Sugar (iv) Furniture(v) Motor Car (v) Locomotives

Explain the following factors which affect the choice structure of a company:-(a) cash flow position (b) Tax rate.

State any two objective of financial planning.

Explain the term 'Financial Management'. Briefly explain any three of its objectives.

What is meant by 'Financial Management'? Explain any three decisions involved in financial management.

What is meant by an investment decision? Give two examples?

'Determining the overall cost of capital and financial risk of the enterprise is affected by many factors.' Explain any five such factors.

Explain how 'cost of debt' affects the choice of capital structure of a company?

Explain any four factors which affect the fixed capital requirements of company.

'Determining the relative proportion of various types of funds depends upon various factors.' Explain any five such factors.

Manish is engaged in the business of garments manufacturing. Generally, he used to sell his garments in Delhi. Identify the working of your answer. Further Manish wants to expand and diversify has garments business. Explain any two factors that will affect his fixed capital requirements.

What is meant by 'Financial Planning'? Explain any five points which highlights its importance.

Explain briefly any four factors which affect the working capital requirement of a company.

The size of assets, the profitability and competitiveness are affected by one of the financial decisions. Name and state the decision.

What is a Balance Sheet?

What is a Financial Instrument?

What is meant by 'Financial Risk'?

Give the meaning of 'Investment ' and 'Financing' decision of financial management.

What do you mean by Blue Chip Companies?

State the objective of 'Financial Management'.

What is meant by Diversification?

What do you mean by Break-even Point?

What is a Hedge?

What is Return on Investment (ROI)?

Define Price-Earnings Ratio.

Who is a Financial Intermediary?

Which are the two types of finance required by the business concerns? Give examples.

Match the following.List I: (Financial institutions)List II: (Nature of Activity)

Match the items in Column - 1 with the items in Column - II

The Debt-Equity Ratio of a company is 2:In this relation, match the following

Explain briefly any four factors that affect the Working capital requirements of a company.

Attempt the followingWhat are the factors affecting requirement of fixed capital?

Explain briefly any four factors affecting the fixed capital requirements of an organisation.

Distinguish between:Fixed capital and Working capital

Answer the following question:Explain any four features of a budget.

Why is there a need for Ratio Analysis?

State the objective of financial management.

Give two factors affecting dividend decision

Why is dividend decision called residual decision?

A Business who wants to start a manufacturing concern, approaches you to suggest him whether the following manufacturing concern would required large or small working capital:(a) Bread (b) Coolers (c) Sugar (d) Motor car (e) Furniture manufactured against specific orders(f) Locomotives

Give two factors affecting financing decision.

How do growth opportunities affect Dividend Decision?

There are three important decisions which an organisation has to take in respect of financial management. Enumerate and explain in brief these three decisions.

How does control of existing shareholders affect financing decisions?

What is meant by gross working capital and net working capital?

How is return on investment computed?

Give two factors affecting investment decision.

You are the finance manager of a company. The board of directors has asked you to determine the working capital requirement for the company. State the factors that you would take in consideration while determining the requirement of working capital for the company?

How do rising prices affect the requirement of working capital of an organization?

Terry International Ltd. earned a net profit of Rs. 50 crores. Ankit, the finance manager of Terry International Ltd, wants to decide how to appropriate these profits. Identify the decision that Ankit will have to take and also discuss any five factors which help him in taking this decision.

Bharati Ltd. is a leading mobile company. It is planning to acquire Queen Ltd' (its close competitor) business worth Rs. 1000 crore. Which financial decision is involved in it? Explain it.

Dabur India has decided to increase credit limit and duration of credit to its customers to boost its sales. Name the type of decision involved.

Name the factor due to which a petro chemical company requires much higher investment in fixed capital than an information technology company. However both may generate same amount of revenue.
Explain any two factors affecting fixed capital requirement?

Pankaj is engaged in Warehousing-Business. Identify the working capital requirements of Pankaj stating the reason in support of your answer. Pankaj is also planning to start his Transport business.
Explain any two factors that will affect his fixed capital requirements.

A sound financial plan is the key to Success of sound financial management of the company.
Discuss?

What is meant by working capital? How is it calculated?
Discuss five important determinants of working capital requirements.

What is meant by 'Capital Structure' of a company?
State any two factors which affect the capital structure of a company.

State whether the working capital requirement of business manufacturing the following items are big or small. Justify your answer:-
(i) Bread (ii) Coolers
(iii) Sugar (iv) Furniture
(v) Motor Car (v) Locomotives

Explain the following factors which affect the choice structure of a company:-
(a) cash flow position (b) Tax rate.

What is meant by 'Financial Management'?
Explain any three decisions involved in financial management.

What is meant by an investment decision?
Give two examples?

'Determining the relative proportion of various types of funds depends upon various factors.'
Explain any five such factors.

Manish is engaged in the business of garments manufacturing. Generally, he used to sell his garments in Delhi. Identify the working of your answer. Further Manish wants to expand and diversify has garments business.
Explain any two factors that will affect his fixed capital requirements.

What is meant by 'Financial Planning'?
Explain any five points which highlights its importance.

Match the following.
List I: (Financial institutions)
List II: (Nature of Activity)

Attempt the following
What are the factors affecting requirement of fixed capital?

Distinguish between:
Fixed capital and Working capital

Answer the following question:
Explain any four features of a budget.

A Business who wants to start a manufacturing concern, approaches you to suggest him whether the following manufacturing concern would required large or small working capital:
(a) Bread (b) Coolers (c) Sugar (d) Motor car (e) Furniture manufactured against specific orders
(f) Locomotives

You are the finance manager of a company. The board of directors has asked you to determine the working capital requirement for the company.
State the factors that you would take in consideration while determining the requirement of working capital for the company?

'Financial Planning tries to link the present with the future'.
Explain the importance of Financial Planning in the light of this statement?