344 Best In Business Studies-XII

Overview
Finance is an essential and îndispensable part of an organisation. It is difficult for organisations, whether
otherwise, to sustain themselves for long without proper finances. Financial Management is the process of profit-making or
Controlling and monitoring fnancial resources with a viewto achieve organisational objectives..It is an ideal planning,for,
the financial activities of an organisation such as procurement of funds, utillisation of funds,,and conserving practiceforr r
funds o
cr
ogna
tnroislining,
g
of business. Not just that, the efficient management of these financial resources is essential to be
sustainable and viablefuteuiinrethecouse
run. Financial management helps organisations to do so. Financial management and financial managers play |a
making inancial decisions and exercising control over finances in the organisation. They make use of techniques like crucial role in
long
financial forecasting, profñt and loss analysis, etc. The finance managers are responsible for the planning of financial Iratio
resources in the organisation. To this end, they use available datato understand the needs and prioitiess of the and activiandltiesysis,
asthe overall economic situation and make blueprints, plans and budgets for the same.
Proper use and allocation of funds leads to improvement of the operational efficiency of the business Concern. When thefinanca
organisation
as wel

manager uses thefunds properly, it can reduce the cost of capital and increase the value of the firm. Financial I management helps
to take sound fnancial decisions in the business concern. Financial decisions will affect the entire business onerntips
concern because there is a direct relationship between financial decisions and various departmental functions such as marteti
production, personnel management, etc.

9.1 INTRODUCTION
for everyone
Money makes the Mare go', an English proverb points out the immense significance of moneyestablishment,
Finance is required for the
It is rightly said that money is the life blood of every enterprise.
purposes of liquidation of the firm. The aim of
sustenance, growth, modernisation, expansion and even for
and effectively for profit and wealth
every organisation is to procure optimum finance and use it efficiently concern, should be propen
maximisation. It can be concluded that finance, a significant factor in any businessand in operating activities anu
assets
managed. Success of a business depends on how well finance is invested in
the business.
how timely and cheaply the finances are arranged, from outside or from within
Meaning of Financial Management typicaltermslike
share
The
The term Financial management, is usually used for corporate financial management. used in financial
managemet
etc.
capital, debentures, capitalisation, securities, capital market, stock market,
are, therefore, valid only in the context of companies.
Financial management refers to the efficient acquisition and utilisation of finance.

Definitions of Financial Management efectively utilisingthe

-Joseph&Massie
"Financial management is the operational activity of abusiness that is responsible for obtaining and.
funds necessary for efficient operations." motives and
enterprise& Brigham
-Weston
"Financial management is an area offinancial decision-making, harmonising individual procuremnl
financil
concerned withy
includes
Fromthe above definitions, itis clear that Financial management i18a managerial activity
enterprise. Iti
and efectioe utilisation offinance for the attainment of common objectives of the business
planning, financial administration and financial control.
 Chapter 9 FinancialManagernent

OBJECTIVESOE FINANCIAL MANAGEMENT

E
oOLEAND
92
Meaning every.rganisation depends on the proper administration of finance. Without efficient managernent
success utilisation of
of finance, no business can think of its growth and expansion. The role of financial
1he
ettective over-emphasised since it has a direct bearing on the financial health of abusiness. The
cannot be
Istatements,such as Balance Sheet and Statement of Profit and Loss, reflect a firm's financial position
ohagemernt
pnd

inancial
st health. Almost allthe items in the financial statements of a business are affected directly or
gnd
its
tinancial
financial management decisions.
throughsome
Financial Management
mportanceof
the following points explains the importance of financial management in every organisation-
analy'sis of
The Estimating capital
requirement-The basic function of financial management is to estimate the capital
This will depend upon expected cost, profit and future programs of business.
RJUirementofa business.
and the composition of fixed assets of the business The size and composition of fixed assets
2 The
size
on the capital budgeting decision. For example, a capital budgetíng decision to invest a
business depends amount.
of fixed assets which will be bought by this
a crorein fixed
assets would raise the size
quantumof current assets and its break-up into cash, inventory
and receivables -With an increase
The
3investmentin fixed assets, there is also a commensurate increase in
the working capital requirement. The
nthe ofcurrent assets is also influenced by financial management
decisions. In addition, decisions about
the total
quantum
inventory management affect the amount of debtors and inventory which in tun affects
aitand
assets well as their composition.
management, among others,
amount of long-term and short-termn funds to be used-Financialorganisation wanting to have
UTent
4 The and short-term funds. An
es decision about the proportion of long-term long-term basis. There is a choice between liquidity
iauid assets would raise relatively more amount on a liabilities cost less than long-term liabilities.
dofitability. The underlying assumption here is that current
5 Break-up of long-term financing into debt, equity,management etc. -Of the total long-term finance, the proportion
a financial decision. The amounts of debt, equity
phe raised by way of debt and equity is also affected by the financing decisions, which are a part of financial
kate capital, preference share capital are
Tagement.
Interest, Expense, Depreciation, etc. -Higher amount
6. All items in the Statement of Profit and Loss, e.g.,
higher interest expense in future. Similarly, use of higher equity may entail higher payment of
TGebt means
expansion of business which is a result of capital budgeting decision is likely to
OS, In the same way, an the business.
dit virtually various items in the Statement of Profit and Loss of
financial
statements of a business are largely determinedor affected by
CONCLUSION It can, thus, be stated that the financial current financial
statements would depend upon past as well as Good financial
Tenagernent decisions ttaken earlier.. Similarly, the future financial the quality of its financial management.
teisions. Thus, the overallfinancial lhealth of a business is determined byand deployment of these in the most lucrative
activities.
tandgement resources at alower cost
aims at mobilisation of financial

:SYNOPS\
FinancialS Management
"
the firm. iis the process of planning, organising, controlling and monitoring the financial
resources of

" It is
" concerned with
Procurement of funds
Effective utilisation of funds
Distribution of earnings.
 Best In
Business Studies-XI
346
Management broadly grouped under two categories
Financial
Objectivesof financial managementcan be
Objectives.
of Secondary
The objectives Objectives 2. 500
1. Primary divided )(in 400
Primary Objectives can be
management
financial Price 300
objectives of primary Share200
Primary
into two categories one of the
utilisation of
Maximisation- It is Effective 100
Company
1, Profit financial management.maximisation. A expenses,
objectives of resultsin profit present
availableresources its maximisation
formeetingProfit
profits
shouldearn
future
sufficient
expansion and
modernisation.
or by reducing cost of
increasing sales expressed in terms of
2017 2018 2019 2020 2021
Year ONIOENOA
achieved bymaximisation is
can be Profit or earning per share.
production. investment
sales or return on be derived from the
profit on could
support of this objectiveof economicefficiency'.
The test Value
philosophy that Profitis a also known as
Maximnisation -It is Maximisation. Since S H A
H O LDERRE
2. Wealth Present value shares, Wealth Maximisation Concept,ie.
Maximisation or Net of
the market value market
is reflected in
wealth of owners means the maximisation of the
value of investment in shares
of the the maximisicompay
rng
wealth maximisation
price of shares.
financial management is to maximise the shareholders'
tealth
The primary (main) aim of maximisation of shareholdere
concept. Wealth
referred to as the wealth maximisation increases when benefits from a decision exceed e
market price of equityshare increases and it
Shareholders' Wealth = No. of shares held x Market price per share
Wealth can be maximised
by avoiding high-risk projects.
by paying dividends to shareholders regularly.
by maintaining growth in sales.
" by adopting sound investment policies, etc.
Secondary or Other Objectives
Secondary or other objectives of financial management can be divided into three
1. Operational- Timely availability of required finance, categories
etc., effective utilisation of finances, satety ori
2.
Social-Timely
3. Research- payment of interest, wages, taxes, and
Researching into new and better projects fordividends.
investment.
CASE STUDY 9.1 | |
For optinal procurement of
identifies different available funds,
a
sources finance
of manager
finance and Compares those in term of cost andassociated
ri
and define the highlighted intheabove
concept
 B3FINANCIAL DECISIONS
management is concerned with the
INaWLSA Chapter 9 Financial Management 347

Ainancial major issues relating to the Capital Working Debt Equity

three Budgeting
eraton
operations of a firm corresponding
of Capital
CAPITAL STRUCTURE
inancial questions
ofinvestment, financing ASSETS

othedividernd decisions.
three Thus, financial

DECISON
ATS0Ons
d include:
LInvestmentdecisions
2Financingdecisions
Dividenddecisions
decisions are taken simultaneously
continuously in normal course of the
These
Npsiness.
nd Financial decision-making is
concerned with choosing the best
imarily
option or best investment options
jnancing
RSpeeduptheorowth of the enterprise. Theeo e a t t DIVIDEND
DECISIONS
these decisions is to maximise
cobjectof wealth.
heshareholders'
LInvestment Decisions
of
instment decisions refer to the determinationt h e e
stl amount of assets to be held in the firm,
PROFIT
MmnSsition of these assets and the business riskokotoke
amTlevities ofthe firmas perceived by its inves tors. Retained
Dividends
This decision relates to careful selectiono f h Earnings
sets in which funds will be invested by the
finance manager. The manager has to select
etslong-term as well as short-term in
hich funds will be invested.
Investrment Decisions may be classified as
'Capital Budgeting Decision (Long-term Investment Decision)
Working Capital Decision (Short-term Investment Decision)
ptal Budgeting Decision (Long-term Investment Decision)
assets (i.e., fixed assets) is referred to as capital budgeting decision, which normally involves
iuge amount of tolong-term
shng
investment.
term investment will generate return for more than one year and provide profitability to the business.
Ihese decisions are very crucial for any business since they affect its earning capacity in the long run.
Theesize of assets, profitability and competitiveness are all affected by capital budgeting decisions.
"
Moreover,
ahuge cost. these decisions normally involve huge amnounts of investment and are irreversible except at
Once made, it is often almost impossible for abusiness to wriggle out of such decisions. Therefore. they
Teed to be taken with
utmost care.
"
These decisions must be taken by those who understand themn comprehensively.
Capital budgeting8 decisions are affected by the cash-flows from the project, rate of return and the
investment criteria involved.
 protPayment
of ofnumber techniques
profitability For 10% with because trom or it
Thus,source.
each
with
] enterprises. properly
some whereas. the
provides
Capital the of alongto
techniques
budgeting
of return a
different catego raised
in involves to
and:
for
modernisationfundsi
analysed returnThese SOurces
relates aearned funds.
the Working assets years
selected. of two
be j
from rate also
decision.
affect existing of of
project etc. decision
into to fdefault
insufficient
current amount 4 a rate Period, long-term fundshas is the
as be for be expected with classifiedearnings. cost associated
also known firm in
making
capital (i.e., for shouldlakhshould and
particular 4 in
raising
no floating
involved) Back of of
they in huge Financing
under
proportion
as expansion
investment decisions
budgeting
capital 10 inflows
capital from
various
a risk have involve
to hand,
working return be retained whether
also
business, well a flows A Pay The riskequity
and
financial
the
investingof project a can this,involved
are as inflowsof risk in cash Return,
different likely
time.
as cash funds
management, from earnings.
Decision) rate of
known assets) The enterprises years, same invest
B.
Project
and decide
the
to regardless
fixed
a
at
of are
taken
enterprises, rate, firm
a
cash the
is Such other cost both debt
working return. comnpany of project. raisedor shares Apart
current business. 4 compare the to are
interest Rate finance
is theandcapitalretained
assets
Investment project. of
annual (withdecision considered
by on
thecapital,
new decisions
immediate investment end prefer There Interest to
be
particular capital preference paid
repaid
is of
Decisions of mix
day-to-day
current a the should B investment, has cost
forup project-Whenever
the estimated anddefinitely etc.,
involved-The finance Funds.
Sources funds, and
assets affecting firm
A be be of
set from atlakh
Value, working funds
to
have to of ajudicious
Floating
repaymentoverall
cost capital,
(Short-term
among
critical A labour, a characteristics.
give to company projects selecting shares,
Borrowed funds
have
be shareholders
Budgeting finance.
affect short-term required factorsinflows 25 of Present quantum
of
debts. to
may is yields
proposal. will the sources, share
different
Studies-XI| funds technologies,
amount haspayments. have
of equity the
investments decision
investments The two company of long-term
the cash A inflows Net before
criteria (ii) which the preference
of are sOurces the
borrowed
Interests
on
borrowed or to
Decision
allocation to Capital the investment are basic
relating assets of Project
return. the e.g., Decisions
Financing
2. the andinclude
studied
ie.,returns needs
decisions
determine
Business to
the
enterprise.
investment some fromregular
cash
there investment proposal Risk
fixed
then regardingproposals, about
is Funds their funds,
input, various other therefore,
equity,
Affecting
enterprises,
existing flows if
to Short-term Short-term if funds as
Financial
Capital are estimated
example,of respectively, theseof evaluating
In
Decisions
relatedbusiness. some example, are Owners' on Likewise, payment
and
of each decision
following the rate Owners
Best of based debt,
Cash sources make
The For in The Thecalculations
investment
availability
to proportion
Owners
debentures firm,
A
Working
Decision Factors expectsinvesting
Foryieldsprojects. applied sOurces,
1. For i) be
348 2. 3.
The 12% Thísterm may
it B
 Chapter 9 Financial Management 349

Affecting Financing Decisions

facwing are some of the factors affecting financing decisions -
position of the company-
1. Cash-flow
the business concern is having a strong cash-flow position, it would be beneficial for it to opt for
" If
debt financing instead of equity.
Before raising debt, a company is required to consider its cash-flow position. A company must have
enoughcash at its disposal to carry out its daily operations, and for the payment of interest and
repayment of the principal. Companies expecting alarger and stable cash inflow in future can employ
a large amountof debt in their capital structure,
2.Cost
The cost of obtaining funds through debt or equity is different. Normally a financial manager
considers the cheapest source.
The company can employ more debt in its capital structure if it is available at low rate so that cost of
securing thedebt may not become a problem.
3. Fixedoperating costs -
. Fixed operating costs involve payment of property insurance premium, salaries, office rent, etc.
lf in abusiness, such cost is very high, it is better that the business should opt for lower debt financing
and vice-versa.
4.Risk
. The total risk associated with every business consists of operating risk or business risk as well as fnancial
risk.
Financial risk refers to the failure of acompany to pay its fixed financial charges, e.g., interest on debt,
repayment of principal anmount and preference dividend while operating risk depends upon fxed
operating cost.
" An increase in fixed operating cost increases the business risk and vice-versa.
" Thus, the capacity of a business to use debt is higher if the business risk is lower and vice-versa.
5. Control consideration -
" A public issue of equity results in reduction of management control in the business whereas, debt
choice
does not have any concern with management control; therefore, this factor also affects the
between debt and equity.
However, excessive debt can cause serious liquidity problem which may result into complete loss of
control.
" Fear of reduction of management control over business results in preference to debt financing rather
than equity.
6.
Flotation cost -
Flotation cost, ie., the cost involved in the process of raising resources has a great effect on the
choice between debt and egquity. Considerable expenditure is involved in public issue of shares and
debentures while raising aloan froma bank or a financial institution, does not involve so much cost
Higher flotation cost makes the source of funds less attractive and vice-versa.
Keturn on inyestment[Rol]
When the return on investment of the company is higher than the interest on debt, its ability to use
debt is greater, This is known as Trading on Equity'.
Higher Rol enables acompany to go for trading on equity to increase its Earning Per Share (EPS)
structure. However, increase in use of
Hence, Company can increase debt component in its capital
debt has decreased EPS.
Ihus, in anutshell we cansay the return on investment isan important factor in determining capital
structure.
 decision. Residual called shareholders is equity decisionto
the are These future. investmentin opportunities of there
less areshareholders if equity
dividend dividend the whyreasons dividend. preference
Higher paying after profitsurplus there
is when only shareholders
paid is
paidDividend
is appropriation
profit. ofi an dividend
is it as their cdaim cannot shareholders.
They equity to wel
as l
equityto to preference to
paid dividend
can
be liability,
no tax
meeting after profit no governmernt.
there
is If the
reholders burden
on interest meeting after only shareholders operating
as the paid is Dividend profit.
liability
to tax and debts expenses
and al ofwriting
f aftercompany the by
made profittopartof means Residual
incomes analysingall
the in Decision ResidualDecision-A Dividend
wealth.
shareholders' maximising objective
of overall the view keeping
in
taken should
be dividend regarding decision earnings,
the retained
reinvested/ extent
of the funds
to require not does firm the Since firm.
thdecision
e of financing influences
the alearnings
so retained extent
of
capacity.
The earning future firm's increases
the earning retained as
reinvestment income, current constitutes
the dividend the While
shareholders. to
dividend distribution
of the relating
to decision important very takea
tomanager
has finance the Thus,dividend. aspay tomuch how and
reinvestment foretain
r totax)paying (aftercompany the earned
by
profit much
of how decide manager to finance important for very isIt
dividends. formofshareholders
the in thamong
e distributed betohas
then profit the of rest earnings.
The 'Retained called is
business
and
retained
in profit
is ofpart This
activities. business expansion of and
reinvestmentob business
for the recycled
in be tohasprofit amount
of
Somepurposes. number
of required
afor arshareholders.
eProfits
thamong
e distributed which
is profit portion
of that Dividend
is
Decisions Dividend 3.
liquidation. force
to malenders
y towards
commitments default
in Any
equity. than risky more debt make amount principal repayment
of and debt interest
on Paymentof
riskier Debt
is
proft. tax after of
out paid dividends
are whereas expense
tax-deductible debt
is Interest
on
equity thancheaper financing
is Debt
SYNOPSIS
gh funds raising debt. equity
or
structure
inappropriate the adopt companies
to force
therestrictions These
conditions. certain equity
in
ts/ raiscompanies
e to
restricts
the LawCompany SEBI, provided
by franmework Regulatory "
uity framework Regulatory 9.
hrough iofs tuherough market. capitaldepressed shares
in
the funds raise to
succeed,
i.e., company
to difficult
afor bemay However,
it
funds raise wito l ing rising. iswhenit market stock
s arePeople funds. source of choice
afor the affects greatly also This
betwequieThnutys, through debt. fcompanies
or opt Therefore,
d debt the Whi
inle phase. sucha equity in use prefer
to
the case,former the equity.
In
prices. higherfunds raisingeasily case,sold latter becanshares equity
choice th e at
affects alsobearish bullish
or whether conditions, ie. market stock The "
Markets
Capital State
of 8.
Studies-XIl Business Best
In 350
 Chapter9 Financial Management 351

atorsAffectingDividend
affecting
| Decisions
factors
the payment of dividend to shareholders are as follows-
the of earnings-Dividends are paid out of current and previous earnings. Thus,
Amount earning is a major
erminant,
1, of dividend decision. Managers have to take care of the financial needs of the enterprise, prior to
ofdividends to
shareholders.
paymment
carnings-A company having higher and stable earnings can decare and pay higher
e Stability of dividends.
2 s hareholders. Aconpany with lower and unstable earnings may be likelyto pay
its
lower
companies try to stabilise the payment of dividend to shareholders
to
ridends
Stabilityof dividends-Generally,
Pmaintain,
3 andimprove their reputation in the market. A steady rate of dividend is given every year. Dividend
is1not
alteredif the change in earnings is small or seen to be temporary in nature.
r
share
Growth opportunitiess-Companies having good growth opportunities retain more or a higher part of
outof their
earnings so as to invest in the required projects. Therefore, the dividend declared in such
maneypaniesislower than that in the companies with lesser growth opportunities.
Cash-flow position-Dividendinvolves an outflow of cash. ACompany may be earning profit but may
cash. Availability of enough cash is necessary for payment of dividends.
shorton
FSekaneholders' preferenceShareholders are owners of the company. Their preferences should be given
consideration while declaring dividends. There may be some shareholders who want at least a certain
e be paid as dividend. The companies must consider the preferences of such shareholders. There are
ssome shareholders who depend upon a regular income from their investments.
Tation policy -The choice between the payment of dividend and retaining the earnings is, to some
fested by the difference in the tax treatment of dividends and capital gains. If tax on dividend is higher,
shetter to pay less by way of dividends. As compared to this, higher dividends may be declared if tax rates
eTelatively lower.
AStock market reaction-Generally,an increase in dividend has a positive impact on stock market and
-ersz. Thus, while declaring dividends, this should be kept in mind.
8. Acess to capital market -Large and reputed companies generally, have easy access to the capital
iet and therefore, may depend less on retained earnings to finance their growth. These companies tend to
P higher dividends as compared to the smaller companies.
LLegal constraints- Certain provisions of the Companies Act place restrictions on payouts as dividend.
Nh provisions must be adhered to while declaring dividend.
ir example, one of the restrictions is "No company shall declare dividend unless carried over previous
s and depreciation not provided in previous year are set off againstprofit of the company of the current
Ihe loss or depreciation, whichever is less, in previous years is set off against the profit of the company for
wich dividend is declared or
paid".
Ontractual constraints-- While granting loans to a company,sometimes, the lender may impose certain
Son the payment of dividends in future. The borrowing companies are required to ensure that the
payout does not violate terms of loan agreement in this regard.

YNOPSIS
Dividend Decisioninvolves answering the questions--
. w much of the profit earned bythe company (after tax) is to be distributed among shareholders?
How mnuch of the profit should be retained in business?
A
.
3.
Company
Armount
can pay more or higher dividendin the following cases-
of earnings are
high. 2. Company has stable earnings.
Company Wants stabilise the payment of dividend.
to
There availability of enough cash.
7. f
is
4. Ithas lesser growth opportunities.
6. Shareholders prefer regular income.
tax rates are relatively lower. 8. Higher dividends have positive imnpact on stock
market.
9. The 10. Legal constraints are less.
11. Therecompany has easy accessto the share
are strict contractual constraints.
no
market.
t
 Studies-XII
Business
Best In
352

CASESTUDY9.2 | I is relatively less.

paper
business in theMysore. Considering
decides to venture into this linethe
of various
running a
successful
1. Arun is He is on a visit to his
friend's place in incense amanufacturing unit in Mysore. businessSbfayctors, Aun
industry.
He is
fascinated by
there.
the
His
exclusive variety of Mysore
that
friend tells him Agarbathi
sticks available a pioneerin the activity of
In context of above case
financial decision being taken bydentify
2. Sadhna Ltd. is a manufacturer of
Arun. setingp
and explain tho
haveLaptops. It madae aprcft
known as reserve of forest of 1,000 crore. The directors
region is it has a natural for the base of prthe
oposed
because
manufacturing sandalwood to provide the of 38%. As a finance manager
products especiallyincense production. Moreover, factors would you consider while
Corniparyd,ividewhant
material used in types of raw materials needed
suppliers of other sticks follow a liberalcredit
production of incense
required to manufacture incense sticks
for
policy policy for the company? (Any four)
formulating divúden a

and the time

9.4 FINANCIAL PLANNING

specifying the sources of funds, is called

Meaning of a business and
operations.Financia.
the funds requirement print of an organisation's;future
The process of estimating the preparation of a financial blue
the totallquantum of funds that are Thts,
Planning. It is essentially involves two aspects. Firstly, what is
necessar ingor
financial planning, in practice needs? Secondly, what are the various sources from
for business enterprise to
meet its present and future
enterprise?
nwhich FTTarnc
raised by an
the required funds should be pertains only to the function of finance and incius ke
Baughn, "Financial planning
In the words of Walker &
and promulgating financial policies and develovingfr
determination of thefirms' financial objectives, formulating and the
pprocedure.
Features of Financial Planning
The salient features of financial planning are listed below
estimating the funds required by the business enterprie manc

1. Financial planning is the process that involves they will be raised.

epres

and also determining the sources from where 3

2. Financíalplanning is done for both, i.e., short-term and long-term basis. like growth, perfomance Dlans
3. Financial planning is done by taking into consideration various aspects DIOVIS
investments and requirement of funds for a given period. growthoftheorganisatin
4. Along-termfinancial planningrelates to capital lexpenditure and facilitates thee tbrine
through sound investments. oneyear.
period upto
5. Ashort-term financial plan is called budget. It is a detailed plan of action fora anticipate situations Day ta
6. ldeally financial planning is done for three to five years as it may be difficult to
beyond a certain period.
Objectives of Financial Planning kunis
Financial planning strives to achieve the following twin objectives - estimation of the
expenses
d
1 To ensure availability of funds whenever required-This includes toproper meet day-to-daymadeavailable
required for different purposes, viz,, for the purchase of long-term assets or vest
busines5, etc. Apart from this, there is a need to estimate the time for which thesefunds are to be avaiabe

Financial planning also tries to specify the possible sources of these funds. ensured that the see thl
2. To ensure that the firm does not Sgive
has to
waykr
funds should neither be in excess nor short.raise funds unnecessarily-It is always
Both the situations are harmful. The
financemanager ha
the company does not raise resources wellas
financeas
unnecessarily as idle funds raise the cost of
 h

Bvestnert
and
financal
Tesources.
itiveBetter
inanial
Facilitates
better 1. place.take a Povision Pies lression. gniational
a ithe tining mpany ancal portance
Ads . rational
6 .Ensures L to -tnsures
shortage sor Minimises Helps light Objectives Twin tisa
the to meet planning timings.Ensures 1 planning to PlFiannniancinalg rthne dietfuilre
S of nes af To ToPreparing Estimating
Determining
as tackle process SYNOPSIS Short-term pLteroatrnismme,ge-term fanciapll ans ITime expeto
a particular.Thisa to funds ifferent as objectives. an of ensureensure Frame best
decisions
enterprise
financial link avoid adequate
Hence,
liquidity organisation. Financial ns are
of
inancial
budgets
control. cost
available
Surplus
funds
for a
provides
tool that
the is availability the the that
plplaansThey
funds.between arises an the made for planning nd
pos ible
business of Wwastage meeting
situations. to uncertainty
it the financial funds involves They
financial utilisation of ensures important
funds-Financial
-Liquidity firm sources Financifor al 1se
misuse
financing-Cost due face funds Planning of of are focus both
so
investment utilisation theto of the The doesfundsblueprint. a also a that
operation, optimum of
business long-term
and
finance-In uncertainties
organisation,
An importance in
part not funds on
not known | funds. of
Such contingencies
control-Financial
na means whenever long-term Plans the
policies, funds respect raise
contínuous ofcomplex only of financial
financialand funds overall funds as Even
of expansion.for ability funds
estimates
planning
procedures financing keptis the
-Good when of required Budgets
- of growth
short-term-- if
further typenature availability
requiredfinancial unnecessarily
absence whichFinancial of planning resourcesthere
basis. financial wi
thte
h it and
plans of of is an and is
decisions reduces wastages likelyare running are
Thus, and business planning organisation to
in
investplanning investment some
of and of are
importantare to financialplanning help made
a funds the any not
surplus
the can timing for
business minimum operations, financial
proper
to of under
left
cost arise
develops canbusiness
Financial are be to a
planning, ensures funds
that various period matters. idle Chapter
of
avoided in profit, money,
helpful
financing.
because possible the
honourrequirement beof
explained the and
enterprise. of They
planning viz., future. in but activities funds one 9
in through wastage advance its don'tgood
year are Financial
they limit over or also
current
canfinancial planning asand financial
unnecessarily would
a judicious orderalong
with
in its generally
or
providestacilitate
avoid through
planning. properly
of are during follows aims It
helps less
under
financialfinancial Management
resources variousobligations.
control., thar
the adequate makes in at made
link estimation the achievetheto enabling that.
problemmaintaining
of alternative period the
between for add
utilised. quantity smooth
Good 3-o to 353
mix of the the
of
 nf furke fnd par Se
sourceso fixed
Financial
Planning
iestirmaing
and
of
part
of
availability
enterprises
performanca
of
requirement
be
profitwanted
to abovethe
to trying
internal the by
capital onreturned
ofbusinessfunds.only
funds
a
the
is
he in achieved and and aatInterest total
process
o ensure growth, about he the funds, discussed shares, optimum
issued toreferred
the
at
theof of
of is
it
as that
t thetime. this,
from
outside.
from capital be
sources
sources financial
management.
to datadoing remainingbe identified. of
with
requirement sCope is ensure resources fulhill
needlessly.
consider of funds concept to equity
-
funds
long-term
be etc. to out
alsobe
objective
andperiod relevant objectives
the
to
an securities share
structure. deposit, shalldebt
Planningconcerned the the narrow By of sources
alternative
out
fund
specifying
specifies
main
to
and toinvestment
is given
availability
years. the financial
Identify
the so
concept,
viz, ensure preference has These of
a funds role
the For funds, financial amountproportion
has coming
collected of loans,
public
is the
It It Its Its aat business. to ype ownersDebtEquity
funds.
borrowed
FinancialIt the state
Alsofinancial order t
shareholders' theabout of of "The capital, principal
or share the
cost, also sources
types structure
as
procurement financial effective in the in as, or =
as structure
Capital
reduce proportion debentures,
and Management two defined The
Financial finance. machinery.
long-term capital andratio,
achieve of company
latest amount decisions
company theHe company.
equity funds.
Management includesmaximise to is export
are debt-equity
withyears. be
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rightcanas
usage and the began known includes
borrowed
the four includes
finance. it
as
to control of thewithits estimated financing
help next
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Basically,
in between
structure
Capital
with with scope isobjective of upgrade
business composition
ofmoney.
utilisation
line therefore Borrowed of as
concerned financial
under
performance will to iscapitalisation
position
(Equity)-It
(Debt)--It calculated
Financialconcerned
Studies-XIl
of
usage wider In Dalmia
to Thisthe the STRUCTURE
CAPITAL
9.5 loans. havecapital
on the
mix
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planning.
main decided and
ahas wealth. risk timings. Dalmia
forecast 2. finance
be to
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be
is well is The Rolekeep 9.3 engaged investment long-term Gerstenberg, funds to refers
the company
the
technology, refers Capital thefunds
BusinessbetweenIt It It
STUDY past, the basis. Owners'
and sales of up has It
the Finance structure types theBorrowed text.
is the upto required continuous
a andOwners make strengthens intervals
In CASE Ltd. the of subsequent
Best Difference
1.Meaning 4.0bjective In the linkingpreparation Meaning theof that
debentures
2.Finance been
garments.
Somnath words
Basis
3.Scope S.Role this,funds Capital1. Both amount 1. 2. regular
a
354 had For of
in on the the
It
 ys
sample Troding, ancal As yetVe, Case| l mezseAcapital d shoulrdeyquire
practice a
like, the proportion ge ZSare L 1 RTUTe tzsse
woul d eher any SuK Risk,Analyastsisnd
Financial
Financial
the ethe ement gotal Y
sisk decrease
e rate is the it dbe y's of of of
interest. onfinancíal on or siareamount
increases. 1s l increased
ofthe increasing bestructure the
in otherearns band, paid share the e y
1.Equity ciareturn
holders. The imum efna cialrisk businbuses ines wher as wenders prainsdkis equiy
Calculate called leverage Leverage profitable in of
Hi g her to firm ea dif e r
the business leverage edprofit to a
debtanadCapital interest dividends lower
of
value fixcompany
the equi the ty | goand
Financialrefers leverage return
debt on by cost.
variable
incurs or Structure company. use in to provided
the lower than
Trading arranging is
shareholders stock significantly
Case Case Case
3 Debts 1 Interest Used
Total
RateTaxRate FaceFunds EPS Companies is the or the of said liguidation. oflic
retu rn are rate
2Earnings
to enterprises or to th e Capital debt th at
leverage th increases,
e intended
in on total Trading
shareholders' whi ch Fin anci a l fixeduse ot pai d equiofty
the trading raise necessary
has that
market. of increases
value (Earning owners equity to loss. cormmítments the because ofcost return.
shareholders in
increase on be dividend ís n overallout their
Before overall capital cheaper to principal
per AB Equity. Financial Leverage = out optimal structure pay minimises risktoisIThere of of
& can often to on on Therefore, every Return equity
Additionally,
after-tax andcost
share the are shares.
of
Interest
Company Per in equity. earn Equity nterest th e is is
favourable
beemploy cost capitalemployed.equity-It
profit always debts. the may no
unaffected.
remains
Share). wealth. onthe chanceobligatory business. the lenders risk;
earn risk
more two. when of year average such profits.
& of In a fallor financial
charges
Tax Ltd. earned declines funds other company regularly.
raises owners interest for
is interested The 2. company, on compulsion
that a
(EBIT) more called on Capital
is Now, The Increased the
fixed
the borrowed
rise for
orby sole a words,
proportion firm.
debt
Cost
unfavourable. the of practice question capital cost would
firm paid
cheaper Equity of we from
Debt + thecharges objective anyGearing thus, Ina an
equity financial in study of cheaper
in Debt use on
Debt all of
case assured
because of arranging followed
capital year capital
particular
tw o is a debt of
decisions
before affects paid fail
business. is of
5,00,000 NIL
20,00,000 5,00,000 30% {45,00,000
p.10
a. %10 shareholders debt funds
their
than the of ofAny debt, is
types of to equity, return
following
debt regularly. and
to leverage. both year. by meet default therefore,
deductible
expense
alower is Chapter9
enhance debts by the As
increased
cheaper debt business relating and year,maxímíses the also
obligatíons.
paymentits whícha but and
a finance t he result, in than
due company under capitalthe Moreover,
company
theymay ít repayment
is
whose equity
to ElthSe two profítability Company meetingbusiness
iís more ís cost Financial
is increased
therefore, of lower
likely
the use costs. manager to risky
to factors capital is of
presence of interest earn ín these to equiíty
such the the for of
(Earning Surplus/ one has anynotget
for capítal Management
achieve
profit.To related structure and not considered computatíon a for
is that
carryíng formmarket value
offixed is
earning
which to the and,
less what th e debt firm a
Deficit it pay of
Per to results dívídend. íncreases therefore,
financial than financíal dívídend rísk-less because
Share). but type
capitalshould interest
of 355
will may cost tax
the the of in of
a
 356 Best In Business Studies-XII

Solution -EBIT- EPS Analysis

Case 2 Case 2
AB &Company Ltd. Case 3
EBIT 5,00,000 5,00,000
Less: Interest NIL 72,00,000 5,00,000
EBT (Earnings Before Tax) 5,00,000 73,00,000 72,50,000
Less: Tax @ 30% 1,50,000 Z90,000 72,50,000
EAT (Earnings After Tax) 3,50,000 72,10,000 775,000
4,50,000 2,50,000
1,75,000
No. of shares of 10 each.
EPS (EAT/No. of Shares) 0.78 0.84 2,00,000
0.88
In the given example, there is no debt in case 1, i.e., (unlevered business) while in cases 2 and 3, thhere is a
of 20,00,000 and25,00,000 respectively. The Earning Per Share (EPS) is 0.78 where it is unlevered. debt
with debts of 20,00,000 and 25,00,000, the EPS is T0.84 and T0.88 respectively.
Now, the question here arises; why did EPS increase with higher debts? This is because the cost of debt is
However,
less than the returns which the company is earning on its funds employed.
Overall Return on Total Investment (ROI)
ROI = EBIT/Total Investment x 100
= 5,00,000/45, 00,000 x 100
=11.19%
Financial leverage is favourable because ROI is 11.1% which is higher than interest rate, i.e. 10%. In such
cases, company should use more debts to increase the EPS. This practice is known as Trading on Equity,
Financial leverage would be unfavourable if RoI is less than interest rate.
If we take another example where EBIT is reduced to 3,00,000, the EPS will keep reducing from
Case 1to Case 3.The result wil be increase in financial risks. More trading on equity is not recommended.
cONCLUSION The above three cases show that the return on capital employed is 11.19% in every case which is more than
interest on debt and indicates that when the company is yielding higher return on the capital employed than the prevailing
interest rate on debts, the company should prefer to create debts as a part of capital employed to earn more on equity share
capital by achieving higher earning per share.

2. Capital Gearing-The term capital gearing is used tocapital)

represent the proportion of equity shangs
in the capital structure. Capital gearuig
and fixed cost capital (borrowed capital and preference share
of two kinds
() High Gearing (i) Low Gearing
Example 2.Both the kinds are explained in the following example
'X Co. Ltd. Y'Co. Ltd.
Liabilities
76,00,000
Equity Share Capital (4,00,000
12% Preference Share Capital 2,00,000
73,00,000
2,00,000
10% Debentures 73,00,000
Total
10,00,000
710,00,000 more
capitalis
proportion of fixed cost
() High Gearing-When in the capital structure of a company, less
than equity share capital, then such a situation is called, High Gearing.(X Co. Lta)
fixed cost
capitalis
(ii) Low Gearing-When in the capital structure of a company, proportion of
than the equity share capital, then such asituation is called, Low Gearing. (Y Co. L
 publicrequires
debentures Comnensurate
cannot
tompany
share
Thuch. deotcanprice ndfaced by e,15% tpie us, Tading bincrease nincrease omed ngrest,
he
example For- Flotation 8. holders
equity t 7. e tcreases 5 MOre e A to ta l The 2 () 1.
These 1 S D.
more 4 higher interest hnds. ai
fd
oi
rng tn ot
) thCash-tlow
at
deposits, c Costeample-If only on Return cash repayment toDebt r
Affect ing/Dete rmi
and meetinfogr the nipan
tors g c
be 0reduced - its given lax debt Costequity debt its debt in this
hi g her aonly
Kate-Since
4.5% attractíon DSCR
Interest normal.
taxes
used of 7% of required the
Service
Thisabout
COnsiderations to
EPS, on
DSCR
component =
ratio the
investmentcompany cover the
ththe
WiEquity (30% (i.e., in debt- can increase Interest Coverage business position
equity may topic and
Investment i.e., is of
-Raising
Costs-Process onlyincreases, use fixed
dependscapital
be
the
indicates obligations ratio, a
of t ax 10% not company
covers the in
considerable decrease vis-a-vis thus, its fo
Coverager has on
debentures.
shares or to
upa debt owners, -Stock15%)] liability interest used firm' s A Coverage debt fixed
they
risk
interest Financial
- its
ability the an th e operations;Ratio cash various
structure I
3% the Profit in service paymernt cash
-Size
loans beyond if better adequate
in debt
EPS. (RoI) its service paymernt
are lower assets;payment
may certain Consequently, due equity.
rate (30% determinant ability
is Preference
Dividend + Ratio (ICR)-The
banks
from also spite It to aftercapital ICR= of
factors.
expenditure of a are
Leverage', acan use albility Ratio also commitments, projected
to ondeductible of shows of measure. is and ofthe
raisinglevel, point. to
- Tax
If (DSCR)Debt a
affect of
assuming. the loan 10%) be he relevant. the
company
increased i.e, borrow
debt the structure. t(CR).
Earnings obligations for-
obligations
amount are raised that Rol + to debt risk interest The Choice
the If
their which is is = of is Interest meet interest
resources shareholeders debt Charges
InterestFixed cash-flows important
or
whereas
getting
15%borrowing expense,
7%]. thegreater.
Rol of The A of
financialchoice desired ofand
at at
capital the cash and firm obligation. i.e., involves of
EPS; used is When a is cash company before This
may
+ the coverage but Capital
interest higher A lowerlower a company
th e
an Non-cash
Repayment WeInterest commitments
+ may paymernt of
betweenconsequently,also for rate a cost important preference profits Service alsomust factors
institutionsmay t ax structure.toti @
rate have Interest determining
beyondcompanyexpect a
10%. of rate have there
involves of
paid. rate tax failing ratio
debtloan a debt of already Expense is generated
Coverage be Structure
return increases higher, a interest which
that Thus, is rate,Sinceinterest. determinant high and refers considered
and from increases rate 30%o, is and share to must
sonme
cost. point, thus, affected Tax
equity increase.may the the the EBIT meet beto determine the Management Chapter9
Financial
a of of
observed itconsequently, (e.g., capital. by
Ratio and be
be maximisation
financial actual makes tax its can calculated
follows- asthe sufficient relative
cost of return company capacity
Obligation th e but its
cheaper and debt, rate by choose
pDepreciation)
of repayment
number of before
the operations takes interest
lo w the
hence, Public interest debt is the in
th e Example proportion
institution
as equity lt from will 30%, tax company's to care cash issuing
buffer. It choice
financial is relatively rate. to the of
compared shareholders the issuewealth, for employ use times
the rate save
th e company's ar e balance.
of
capital
may this
The trading principal. of
equity after 1 the debt.
may of go risk
would 30%
that compared earníngs must capital of
reason cheaper and firms, higher ability various
to shares
not and up deficiencies Apart
obligations. Cash-flows
structure. of t ax a
interest
be firm on potential be
structure
issue cost sharply cost in equity
that a 10.5% debt. to before kept
our can with from types 357
so
use
of of in
 industry normsconditions
arerisk.planning phase, a beand e.g.,further lower side. the vice-versa.
choiceflexibility, businessfixed payment, has 358
higher Financial
:SYNOPSIS 14. 13. met For
12.managemene's 11. 10.
following It other
public some 9.
a between operating
When: Trading
Interest.
charges
(í.e,)
should whichCapital Stock RegulatoryorexampleA dilute Control-Debt Flexibility Risk
Financial
How:The
Why: norms companyprice; risk Best
14. 13. 12. 11. 10. 9. 8. 7. 6. 5. 4. 3. Factors 2. 1. is often financial th e it operating preference risk
IfFlotation Higher Higher If
Higher Higher If the issue must
Other
BearishSEBI Business If Cost In
Company
Company Debt Company ReturnDebt them go may procedures
market the and consideration refers
affecting on blindly. structure use debt costs Business
guidelines of Leverage use in debt affect of
control.
panies income
equity is
ROI, th e the is
Equity-Refers may maintain -If the
phase cheaper orfor help. institutions
offramework-
risk cost available on shares company holding and to
greater DSCR, ICR is of deviating equity conditions
the equity normally financiala result risk
dividend
does
maintains is Investment low find firm
of sure debt However, For aStudies-XIl
are lower to istax ratio,Capital is choice
of completed Comparny equity, position
stock not raise low favourable & debt. and (also
of rate atthe
better that component
example, in some uses -As
favourable
the when lower lower ta x ratioother raising is
the in
want require already
market some equity Structure-Company
makes ability the theredeductible to fromThus, between often debentures does higher and
same exceeds companies of -If Every especially
company borrowing its risk. business discussed
to debt rate will increase it debt when
flexibility is ability is other of may
th e with not If
industry dilute debt of tosufficient be along them the must if preferred
equity fulfilment repayment
makes for high is
use th e company having business
raising used interest the rate stock also low cause potential firm's a a
the expense in
management the risk).
company
cheaper debt to with profit and companies be have in earlier,
difficult meet risk of business and power
follow control
to upto capital
intwo. have managementcompanies
funds its cash interest taken markets a
of equity adequate the to large make a business
Business
debt & cash
company earned
by operates of dilution to obligation. risk
the to a flow can a be
certain more same companies other tothe
raise
throuc over
potenti commitmen on
increases take isuse
s raise
risk into in more bearing made number it and
its attract to debt by must are vulnerable full, unable
ran failingcover justification
the consideration of industrythe difficult norms. within in of care vice-versa. risk risk of
more a bullish, holding which control. it
Earning equity know firm same upon under debt
tt he in of loses
of is Apart to
depends
debt
fi such Theshareholders a lower,
shareholders is
industry. -A and equity regulatory unforeseen
the increasesmeet
Per what the SEBI may flexibility
to A
in must higher, relative public from
following Share a
it choice takeover.
current its
ment
oblic the
that useful situation. guidelines. opt
oblic
rest may shares its Theupon
be capacitytotal
(EPS) industry it the
There
guideline of
ease for circumstances. issue
thefixed the
due there cannot opt framework mayholding to
case company the debt This issue financial
fixedfinancial
to for are with
of risk financial
the in are However, source not
norms
both debt. more Raising as factor to
afford equity further depends operating
presence usually in which aopt of use
does th e provided
of
source
management risk,
charges,
the Thus, for also
shares debt risk
are, the capital duringeasily finance. funds debt.
cases. these equity
of whether high notsome of influences upon every of
fixed stock sold iscosts.
follow norms from finance.
by may To higher viz., a
financial financialindustry structure a as maintain business
both business.
bearish even
market the is reduce Higherinterest
they banks it
the can law, wil onthe and the
at a
 incurring
afterheavy
heavyVerytakenfinancial Complexities 25 blocked aptal sets
tisiness.
ong-term
Management 1,
plant involve hay incorrect Foed perimanently.
decisions assetcontinue
Decision iesd nerating ed Capital Fyed Fixed organisation ixed Erery
apital business FIXED,96 imthe
heavy 4.whole
a 3. Inese iore capital assets capital 1. introduction star t a tis
only and Risk tinvestment Long-term
arge
decision can Budgeting. with for Fixedhence, assets sources CASE 9.4
Irreversible in than once the
different the the new of
estimated growetnhjoyinSgunflag STUDY
long- decisions Management loans are and
machinery
after involved in long-term is to a
represernts Capital ntoew plant that plant tothe Iron
of
decisions,
the amount one invested of
takeninvest longbusiness land can WORKING CAPITAL
AND sources an d itc Ltd.
vestment is the -term from current pl a
be nt . increased country
avai l issI
Carefully year Fixed be about wil
firm. long growth-The are The time. and used To th e
manufacturing
financial are in broadly had collectrequire is
decisions
and projects. of and
implications in and 2.assets. and benefits demand
important capital of Capital
irreversiblefixed building, Fixed the Working to 600 about
Investment
Therefore, run.Fixed like funds the about
evaluating madetheir may to should fixed not
amount bethe the crore
is loss where business assets classified needs 8%. is It
assets fo r Based considered. above of for
-Capital capital involved
Therefore, budgeting institutions, quantity increased
R4,000 steel
conversion otherto funds due capital Capital funds for its
toendanger never plantresale
quite marketthe there exceptmust on mentioned other planning steel at
involves procure to for
permanently. are invested into to setting
crore
for its
eachcompany. the to plant
invested the be involves
the be also and as expenses
be demand. economic as
costly investment decisions
involving is -These
these decisions at organisation,
investment finance
assets
by its
aspect the financed
following retained taken machinery, they collected to in
high
a funds from business. a in funds, setupIndia.
in investment huge known It
decisions survivalvery of arefixed to is
andtermsBecause, there risk investments in allocation
include very
usesmay long-termthrough earnings, It loss. required
decisions, reasons is as assets.
made
detailwasteof in These raised carefully furniture, 'Block 2.
and at involved in of of The (b) (a)
investment makingan of result purchase activities. and
or large short-term of in
Fixed debt-equity issuing
their lakh 20
identified in
notbe fixed should assets -
decisions etc.from
the directors Explain ldentify
else t he company's Capital' th e
once what in Fixed as production
amounts. It motor it?in
Therefore,
adverse funds.
the business.a long-term the business assets business Chapter 9
influence
capital substantial are of any the
financially be interest.
rate ofbe of
made planned fixed capital investment because ratio above. two
a (a)concept
profitableno likely sources are car, Investment manufacturing
are capacity.This additional factors
assets. capital
called permanently. from
are affects sources, etc.
purchased
to provides discussed Management
Financial
financial feasible. policy. not portion
after a yield of the The 2:1 that
funds.These into is debentures to
these easily the Investment usually amount is
the viz., benefits required 3:1. company affect and
returns detailed returns different the wil
Abandoning
equences overall
of long-term
for the What lead
capital shares, Main the give
decisions reversible foundation quite is requirements of
second-handfor th e tofor
blocked of to are an are concept its
of in Decisions examples
fixed expansion
business analysis. the funds future. debentures,
projects large. purpose be increase the thinking meaning.
should assets
business made risks 359
a of assets
up
mayproject without being Such
risk This An last the in of of in
or or
be be
 level fixed lease
Monthly meansinvestment
orproducts choose in logical
amount capital. of etc.machinery, fixedplant
organisation. Factors
The most paucity
funds.amounts.
ofbut 360
operations use Companies fixed
hire the also
another's
ofcapital. rentals 8. 7. 6. 5. 4.
intensive 3.
and assets. requirement profitable
2. and 1. Hence, 5.
SYNOPSIS Diversification-Companies basis.
Financing more upgradation use Loss
cases "Refers Fixedinvestment Level to Technology operations-A
assets
Growth of Choice therefore,Scalelarge Nature Affecting deprive Best
7. 5. 3. Factors 1., Installmnent require create Financial
Growth
Financing Capital Blocked of in fixed of As the
Nature Decisions
They and using Afixed heavy of th e In directions of In
Capital each ATM of company fixed and significance
affecting capital of result, a of of the
alternative Business
Intensive of to collaboration uses
financing capital.more prospects-A
alternatives-Fixed higher technique-Companies
prospectsbusiness in inone can consequently
assets is requires business-The fixed the resources
and once fxed the or (EMI) upgradation-Industries plant manufacturing enterprise
amount fixed it. slow, building,
other On Fixed of
leasing thtaken some
ofshare By which fixed capacity to trading Studies-XI
technique
e assets
them and capitalinvestment.
are is fixed assets doing instead and require buy and higher
capital of
areinvested plant,of
capital. Capital investment of
alternativeshigher
manufacturing permanently --Companies purchases
leasing consequently company new concerns et
th e
c . to
irreversible
capital
is
them in machinery in every
for not so, of higher investment a earn
is space, order less
plants need budgeting
with used in each paying it Theywhich organisation, organisations,
operating
higher company
Requirement
fixed sufficient ma y avoids facilities assets business
profit
requirements--A
are new having fixed
fixed require for
excpt assets one jointly towers, on have have to to whereas,using opportunities-Capital
unavailable
venture huge cash can largermneet capital. replace in fixed helpis to from
of which huge capital. fixedin is
at the to require to higher trading
lesserhand, affected are
ATM cash which capital
a establish basis beinvestplans fixed the
either the
capital other
limited.
huge participating make giveneedsums
les They oldcompanies assetsas
Business loss needs arnticipated
to Even
capital. growthtechnological amount the needfor management investment to
fullpreferencewithrequired atless a
purchased more
diversify obsolete by
time. fixed can
8. 6. 4. 2. use a heavy when
requirements the
on Wrong
particular their in prospects manage
Collaboration.
Technology
Diversification Organisation
Scale compared
using of
a fixed following
Whencapital purchasing machines techniques capital.
fixed
organisations. offellow
the to their higher such concerns investmentbudgeting
of purchase to amount on assets propOsals,
channel thlie
n
operations facility. an labour-intensive
with capital
facility.
collaboration/joint as cash growth
generally, scale,
upgradation companies. asset
activitiesdemand to factors
/ needs
more
fixed assets of become needdepends
Joint of basis new whereas,
old require small is
activities is it. is fixed needs limited decisions
Such This machines.
1s more
not which.
decisions
venture higher taken can or plant by organisations,
is capital. expected,
quicker. requires obsolete to on
is
faster be can including companies more bigger the financial could
techniques invest as
on
collaboration isFor purchased
arebeing
eranpi
easible be and
they usually
lease, fixed nature
not
not capifoltoawil ngin On Thi s higher SOoner, not
a
venture, acquired machinery a plant, large have resources only
if the more company capital invote be
the entails where to taken
vailpalbalne ed other amountS mean
reducesscalethe investment etechno- need require more invest of
business into \oSSeS
due
itmpa Equaon on range
which beause space, huge
naru lease larger may more
the of les On on the to
of
 working Mxe
adts WUKing warisation.
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S.
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inAn ary
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Credit colours
anount SCTOT, Nature
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products, The Affecting short-term pavment cour s e
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allowed- of
near of fbusiness
case
amount will
recaepiviatblers,fers liquidity Ihus, arTange ne ds
Circulating of
working manufacturing need business the the sources, capita l . goods funds
and funds for
cycle-Production
that Company will cycle be holi, capital
as of Public obligations tomust "
and Gerstenberg, cash to
lower very
workingWorking Thus, as discharge the
the boom for
enterprise profitability.
Different
of a be required the advances
maintaina from investment in However, are -
debtors, firm capital is
woollen Most sales is utility - i.e . Capital produced,
procurement short-term
required. A required. theto little The NWC=
excess one hand, also
for the isduringbusinesses period, capital current which needs
faces as anworking nature Capital day-to-day blocked
these
firms the phases organisations,
organisations of received "Circulating form cash
th may
clothes in wellorganisations generally is of because in
creasing as simple period, required. the thorganisation,
e requirement a CA satisfactory are
company current
liabilities. toworking current at not of
purpOses
ship-building
allow lean against
as As
sales of
Requirement - another, assets materials, raw
well have business of capital due bank, be
the production business CL from
liabilities it wi th
as reason season.
means the winters, As for flows
uirementthedifferent as have assets (i.e., capital capital to assets, provide sold
ofthe more against some high. or are customers, The level as etc. debtors. too,
that the wel l which which due
service are payment for
credit to Current for and These
will seasonality is
affected over rest and of viz., cash; 1.e.,
requiremernt
etc. as
affect
cycle Such invest to an as example, means
credit company, the time this, wil little payment
be production operate operates cash follows isprovide working constantlycarry stock These current
In be important
sector, current assets
worthiness former involved the therefore, finarnced within
Assets etc. current orsome
terms the peak less. organisations, in
basis by
from w
lofunds
level
on of
for time in oninventories
on - a Some capital. its can operations
working takes smaller viz., liabilities. liquidity ofof
to example, for
season,their of are
the nature number - one changes materials, return. themwages,
their
of
a determinant Currentthrough cashassets
day-to-day be involved
in of working capital larger railways, part Management
Chapter9
Financial
their longerconverting which activity operations. requirement likely year, to converted
customers.
capital. needs because
higher of scale. of of ofAdequate andinventories, of may
scale and currernt from
Hence, meeting
of
clientele. time the to these long-term such
factors. Liabilities). work-in-progress, a be
as profitability. company in the
capital
more increase electricity
as operations.
as the of such
transactions. of as one into inventories a sold
well For
of
require
larger working balance business.
daily
These working the wil be operations, the Some assets bills form on
A raw as
example, working require inventories that cash
liberal former's remains the and amount sOurces expenses,
routine
credit
supply Thus, payable, is to
depend material lesser
larger of usuallyCurrent capital arWorking
e capitalwithin is needs
requirementforlevel therefore, another. finished debtors, for A
credit capital capital the more On the net and changed mnanufacturing
Sweets companies, of to
productionblocked of during amount of important needs a to a
upon into activity. quantum th e
working workingfinanced creditors,
liabilities
is receivables, period be
particular
policy than working
an
of other called in goods, struck etc. 361
the and the near the to
a be the ar e etc.
of
 problem change
requirement. working
requirementsnecessitate also to required. so continuously,lead
between not thereby at the 362
It 12.force meet 11. that minimum extent
must
10. time, have 9. 8. 7.
SYNOPSIS it
Factors Working
Capital regarding capital of Inflation urgentLevel Growth
the may Availability
the reducingOperating Credit Best
A Refers different be the the a it
inflation is
ThereLevel
Growth RawThereCredit IfTheThereThere business If If WorkingRequiredEasilyRequired placement record
it it it of concern of be larger cost. avails In
follows
production operates is However, noted use orders then availed
materials
of is is affecting
a get to a prospects-The able Business
is is manufacturing
organisation
willbusiness-Changes
competition-Higher
prospects lower not
competition a a capital investment
to for components,th e of ofefficiency-The
th e
the A the
higher boom converted the of concern
of
availed a maintain day
increase that more to toun-interrupted need
liberal on working from meet order
requirement raw credit-JustStudies-XIl
operatingdo th e if extend quantity
period
cycle level a = to rising
are not larger working Current the
day
becomefunds in andmaterial-If for
credit
to into in customers. higher on as
is have
higher the of
isorganisation needs liquidity current
company by the working wi th
higher operations capital. liberal concern the purchases, firm a
efficiency policylonger activity scaleassets-current cash (i.e. prices
th e price of
a firm high
operating
record more
capital higher to production actual of
and assets labour same maintain material
availability, allows
in Working (say, levelcreditThus,level working capital. operating
raw
of
can with receipt
peakrequirements- and profitability proportion. with the
uninterrupted increase cost an also
policy. of to
season not the higher materials efficiency working credit
Capitalliabilities inflation an
highercompetitiveness and be of
capital
a and affect the
trading existing working stored higher efficiency to
its raw sales
growth materials
in rate the and refers its
availability the The wi l capital
customers,
organisation prices
material, rate targets and stock
following requirement of
level other
be
actual capitalprospects, can to
inflation. of the(alsolevels less requirement the
proportionately, 5%) requirement of whenever may required
replacement etc.) production
largercalled and minimise optimum it
cases
or does necessitate
service also
as of needs shall vice-versa, lead may
well not working be wastage
sector required. time) materialsutilisation ismay
higher required. be
depends asmean and larger
will the reduCed get
is If,
thentheir
capital. also and credit
sales. increase. amount amount however, can
there that stocks
proportion on relevant. In generate be the of
every The
Rising addition. eavallableresoutte
procured from
of of raw a its
will the workingCompetition; of i w internal
component
rates finished working working Thematerials suppiers
bein prices easliy
no larger
the of and. unds,
serios taprit: canital woula gods caita caçpta te ts I
 selliny
requirementof
ldentifyreasonthein working
Yogesh giving purchasing and solutions for scientific storage and preservation services
ofcapital
answer.
storage
company
Solution Ltd. is a
operating large
support your to the market participants dealing in
products including farmers, traders, etc. agricultural
t locations through war
ofehousing network
a In context of the
different
across lndia. chain above case:
to
undertake
computerisation of
seeksto provide
The
better value added
owned
warehouses at 40
its company now
intendsas
(a) How is the decision to
of owned warehouses undertake
likely to computerisation
affect the fixed
and warehouses
t
capital requirements of the business?
cost effective (b) Name any two sources that
finance the implementation ofcompany
this plan.
may use to

REVISE WHAT
NANCIALMANAGEMENT
management is a
oancial
YOU'VE LEARNT
procurement and managerial activity
effective Working capital decision (Short-term
ah
finmentofcommon utilisation of financeconcerned
objectives of the for the ment in current assets
provides liquidityinvestment) The invest
IIMPORTANCE OF business
FINANCIAL MANAGEMENT enterprise. Factors Affecting lnvestment to the
enterprise.
Etimating capital requirement 1. Cash
flows
2. The rate of from Decisions
the project
)The eand the composition of return
size
fixed assets of the 3. The
investment
Thequantum of current assets and its business B. Financing Decisionscriteria involved
inventory and receivables
amount of long-term and
break-up into cash, Thisdecision is about the
LThe
Break-up of long-term financingshort-term various long-term sources,Guantum of finance to be
into debt,funds to be used proportion of various
This decision relates
raised from
to the relative
6Allitems in the statement of profit and equity, etc. A firm has to
sources finance.
of
DiectivesoffFinancial loss. decide the proportion of funds to be raised
inaryObjectives
Management trom owners funds and borrowed funds, based
1Profit Maximisation- Effective
characteristics.
Factors
on their basic
SOUrces results in profit utilisation of
available re- 1. Affecting Financing Decisions
eam sufficient profit for maximisation. A
company should 2.
Cash-flow position of the
company
ture expansion and
1Wealth
meeting its present expenses,
modernisation. fu 3. Costniov
Fixed operating costs
3u4. Risk
Maximisation-The
cial management is to primary
maximise the
(main) aim of finan 5. Control consideration
which is referred to as the
wealth shareholders' wealth 6. Flotation cost
dary Objectives maximisation concept. 7. Return on
investment
Operational-Timely
fective utilisation of availability of required finance,
8. State of capital
markets
9. Regulatory framework
finances, safety of
1
Social-Timely payment of interest, wages,investment. C. Dividend Decisions
dividends.
i fesearch-Researching
taxes, and Decision relating to the distribution of
into new and better Dividend is that portion of profit whichdividend to sharehoiders.
is distributed
ivestrment. projects for shareholders. Part of profit is retained in business andamong the
ANCIAL DECISIONS Retained earnings. is called
estment
n
DDecisions Factors Affecting Dividend Decisions
stapitrelal ating to long- term assets (i.e., fixed assets) is
1, Amount of earnings
2. Stability of earnings
budget
Sieasrme,rt. decision ing, which normally involves huge referred
a amount 3. Stability of dividends

budpgreoifnitgabdecisions.
abudgeting
ility and (Long-term investment). The size
4.
5.
Growth opportunities
Cash-flow position
competitiveness are all
affected by 6. Shareholders' preference
7. Taxation policy
8. Stock market reaction
 364 Best In Business Studies-XIl

9. Access to capital market 7. Facilitates better financial

10. Legal constraints important because they facilitatecontrol-Financial plans are
11, Contractual constraints financial control. FinancialIpolicies,
are helpful in financial control. maintaining
procedures:and effective
FINANCIAL PLANNING
The process of estimating the funds requirement of a business 8. Acts as alink between
investment and
Financial planning provides a link financial \
budgets
and specifying the sources of funds, is called Financial planning.
Features of Financial Planning
1. Financial planning is the process that involves estimating
financial decisions on continuous between
enterprise is saved from the problembasis.
of funds.
investdecimentsionsand
Thus, a
of surplus or business
the funds required by the business enterprise and also
determining the sources from where they will be raised.
CAPITAL STRUCTURE shortage
2. Financial planning is done for both, ie., short-term and Capital structure refers to composition of
long-term basis. funds, viz., equity shares, preference shares, long-term sources of
3. Financial planning is done by taking into consideration long-term loans.
Both the types of finance have to be in
debentures and
various aspects like growth, performance, investments and right proportion in order
requirement of funds fora given period. to ensure an optimum capital structure.
1. Owners' funds
4. Along-term financial planning relates to capital expendi
ture and facilitates the growth of the organisation through 2. Borrowed funds
Sound investments. Capital structure refers to the mix between owners and
5. Ashort-term financial plan is called budget. It is adetailed borrowed funds. It can be calculated as debt-equity ratio, or as
plan of action for a period up to one year. the proportion of debt out of the total capital.
6. ldeally financial planning is done for three to five years as Capital structure =
Debt
it may be difficult to anticipate situations beyond a certain Equity
period.
Factors Affecting/Determining the Choice of Capital Structure
Objectives of Financial Planning 1. Cash-flow position
1. To ensure availability of funds whenever required 2. Interest Coverage Ratio (ICR)
2. To ensure that the firm does not raise funds unnecessarily 3. Debt Service Coverage Ratio (DSCR)
Importance of Financial Planning 4. Return on Investment (Rol)
1. Ensures adequate funds-Financial planning estimates the 5. Cost of debt
funds requirement along with its quantity and the timings. 6. Tax Rate
Hence, it ensures optimum funds required to invest in 7. Cost of Equity
various activities in order to achieve the organisational 8. Flotation costs
objectives. 9. Risk consideration
2. Ensures liquidity-Liquidity means ability of an organisation
to honour its current obligations. Good financial planning 10. Flexibility
11. Control
provides funds not only when it is running under profit, but
also during the period of depression. 12. Regulatory framework
13. Stock market conditions
3. Serves as a tool to face uncertainties-Financial planning
develops in advance various alternative plans to meet 14. Capitalstructure of other companies
different situations. An organisation, with the help of proper FIXED AND WORKING CAPITAL
financial planning makes adequate provision of funds for Fixed Capital
meeting the contingencies which are likely to arise in the Management of fixed capital involves allocation of company
implica-
with long-term
future. capital into different projects or assets Investment De-
4, Ensures rational utilisation of funds-Good financial tions for the business. These decisions are called
planning ensures that funds are properly utilised, It brings cisions or Capital Budgeting.
tolight the surplus funds available for expansion. Factors Affecting the Fixed Capital Requirement organisations.
5. Helps to avoid wastage of finance-n the absence of 1. Nature of business-In the manufacturing concerns
trading
financial planning, wastage of financial resources may take the needfor fixed capital is more whereas,
place. This arises due to the complex nature of business require lesser amount of fixed capital. operatingon
operations, viz., over or under estimation of finance for a organisation, therefore,
2. Scale of operations-A large space to
particular business operation. Such type of wastages can be more compared
a higher scale, needs bigger plant, assets as
avoided through financial planning. fixed
requires higher investment in intensive
6. Minimises cost of financing-Cost of financing is kept small organisations. capital
companies
to minimum possible through judicious mix of financial 3. Choice of technique--Companies using
whereas,
resources. Better utilisation of funds further reduces the techniques require more fixed capital
require less
capital.
cost of financing. using labour-intensive techniques
 Chapter 9 Financial Management 365

Technologyupgradationn-Industriesin which technological

assets
lbecome obsoletee sooner, need more amount of fixed 3. Business cycle-In case of boom period, sales likely to
capital, whereas, where technological upgradation is slow, increase, therefore, larger amount of working capital is
capital, required as against lesser during the period of depression.
reguirelessfixed
prospects- 4. Seasonal factors-In peak season, because of higher level
Growth -Higher growth prospects generally,
t
requires higher investmentt in fixed assets. of activity, larger amount of working capital s required as
Diversification--Companies which have plans to diversify against the lean season.
6 activities require more fixed capital. 5. Production cycle--The longer is the period, the more will
their be the time for which the capital remains blocked and more
Financing alternatives-A company which purchases assets
working capital will be required.
basis needs heavy amount of fixed capital. On the
on cash financing and leasing facilities 6. Credit allowed-A liberal credit policy results in higher
otherhand, companies using amount of debtors, increasing the requirement of working
require lessfixed capital as assets can be purchased on EMI. capital.
elof collaboration--Companies, which give preference 7. Credit availed--To the extent a firm avails the credit on
capital,
to collaboration, need less fixed purchases, the working capital requirement is reduced.
WorkingCapital 8. Operating efficiency-Operating efficiency can minimise
These
Wring capital refers to investment in current assets. wastage and generate internal funds thereby can reduce
year.
sEets can be converted into cash within a period of one the need for working capital.
9. Availability of raw material-The larger the lead time, the
Retors Affecting the Working Capital Requirements
larger the quantity of raw material to be stored and the
quty 1 Nature of business-Service sector needs very little
larger shall be the amount of working capital required.
working capital due to cash nature of these transactions.
Trading and manufacturing organisations have to invest in 10. Growth prospects-Higher growth prospects need higher
amount of working capital.
inventories and as such require more working capital.
11. Level of competition--Higher level of competitiveness
2 Scale of operations-An organisation, operates on a larger may necessitate larger stocks of finished goods
therefore,
Scale of operations, required larger amount of working working capital requirement will increase.
capital as compared to the organisations which operate on 12. Inflation-The working capital requirements
of a business
smaler scale. become higher with higher rate of inflation.