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Published by Sachin Nigudkar

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Published by: Sachin Nigudkar on Jun 28, 2012
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MB0045-Financial Management
Q.1 Write the short notes on1.Financial management2.Financial planning3.Capital structure4.Cost of capital5.Trading on equity.1.Financial Management
Financial Management is planning, directing, monitoring, organizing, and controlling of the monetary resources of an organization. The management of the finances of a business /organization in order to achieve financial objectives. Financial Management is the efficientand effective planning and controlling of financial resources so as to maximize profitabilityand ensuring liquidity for an individual(called personal finance), government(called publicfinance) and for profit and non-profit organization/firm (called corporate or managerialfinance). Generally, it involves balancing risks and profitability.The decision function of financial management can be divided into the following 3 major areas:
Investment Decision
1.Determine the total amount of assets needed by a firm hence closely tied to theallocation of funds2.Two type of investment decisions namely:
Capital Investment decisions re: large sums, non routine, longer term, critical to the business like purchase of plant and machinery or factory
Working Capital Investment decisions re: more routine in nature, short term but arealso very critical decisions like how much and how long to invest in inventories or receivables
Financing Decision
1.After deciding on the amount and type of assets to buy, the financial manager needsto decide on HOW TO FINANCE these assets with the sources of fund2.Financing decisions for example:
Whether to use external borrowings/debts or share capital or retained earnings
Whether to borrow short, medium or long term
What sort of mix – all borrowings or part debts part share capital or 100% share capital
The needs to determine how much dividend to pay out as this will directly affects thefinancial decision.
2.Financial Planning
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MB0045-Financial ManagementFinancial Planning is an exercise aimed to ensure availability of right amount of money atthe right time to meet the individual’s financial goals
Concept of Financial Planning
Financial Goals refer to the dreams of the investor articulated in financial terms. Eachdream implies a purpose, and a schedule of funds requirements for realising the purposeAsset Allocation refers to the distribution of the investor’s wealth between different assetclasses (gold, property, equity, debt etc.)Portfolio Re-balancing is the process of changing the investor’s asset allocationRisk Tolerance / Risk Preference refers to the appetite of the investor for investment risk viz. risk of lossFinancial Plan Is a road map, a blue print that lists the investors’ financial goals andoutlines a strategy for realising themQuality of the Financial Plan is a function of how much information the prospect shares,which in turn depends on comfort that the planner inspires
3.Capital Structure
Capital structure of a firm is a reflection of the overall investment and financing strategy of the firm.Capital structure can be of various kinds as described below:
Horizontal capital structure: the firm has zero debt component in the structure mix.Expansion of the firm takes through equity or retained earnings only.
Vertical capital structure: the base of the structure is formed by a small amount of equity share capital. This base serves as the foundation on which the super structure of  preference share capital and debt is built.
Pyramid shaped capital structure: this has a large proportion consisting of equity capita;and retained earnings.
Inverted pyramid shaped capital structure: this has a small component of equity capital,reasonable level of retained earnings but an ever-increasing component of debt.
Significance Of Capital Structure:
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MB0045-Financial Management
Reflects the firm’s strategy
Indicator of the risk profile of the firm
Acts as a tax management tool
Helps to brighten the image of the firm.
Factors Influencing Capital Structure:
Corporate strategy
 Nature of the industry
Current and past capital structure4.Cost of CapitalCost of capital is the rate of return the firm requires from investment in order to increasethe value of the firm in the market place. In economic sense, it is the cost of raising fundsrequired to finance the proposed project, the borrowing rate of the firm. Thus undeeconomic terms, the cost of capital may be defined as the weighted average cost of eachtype of capital.There are three basic aspects about the concept of cost1. It is not a cost as such: The cost of capital of a firm is the rate of return which it requireson the projects. That is why; it is a ‘hurdle’ rate.2. It is the minimum rate of return: A firm’s cost of capital represents the minimum rate of return which is required to maintain at least the market value of equity shares.3. It consists of three components. A firm’s cost of capital includes three componentsa. Return at Zero Risk Level: It relates to the expected rate of return when a projectinvolves no financial or business risks. b. Business Risk Premium: Business risk relates to the variability in operating profit(earnings before interest and taxes) by virtue of changes in sales. Business risk premium isdetermined by the capital budgeting decisions for investment proposals.c. Financial Risk Premium: Financial risk relates to the pattern of capital structure (i.e.,debt-equity mix) of the firm, In general, a firm which has higher debt content in its capitalstructure should have more risk than a firm which has comparatively low debt content. Thisis because the former should have a greater operating profit with a view to covering the periodic interest payment and repayment of principal at the time of maturity than the latter.
5.Trading on Equity
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