Q.1.

(E) Comparison Chart

Basis for
Operating Leverage Financial Leverage
Comparison
Use of such assets in the Use of debt in a company's
company's operations for capital structure for which it
Meaning which it has to pay fixed has to pay interest expenses
costs is known as Operating is known as Financial
Leverage. Leverage.
Effect of Fixed operating
Measures Effect of Interest expenses
costs.
Relates Sales and EBIT EBIT and EPS
Ascertained by Company's Cost Structure Company's Capital Structure
High, only when ROCE is
Preferable Low
higher
Formula DOL = Contribution / EBIT DFL = EBIT / EBT
Risk It give rise to business risk. It give rise to financial risk.

OR

COMPARISON TABLE

OPERATING LEVERAGE FINANCIAL LEVERAGE

Operating leverage is related to the
Financial leverage is related to the
firm’s operating cost structure.
firm’s capital structure.
Measures
Operating Leverage is helpful in Financial Leverage is helpful in
measuring the business risk of the measuring the financial risk of the
firm. firm.
calculates
Operating Leverage calculates the Financial Leverage calculates the
operating risk associated with the mix financial risk associated with the
of variable and fixed operating choice of sources of funds for
expenses. financing the business.
Relationship
Operating Leverage is determined by Financial Leverage is determined
the relationship between Sales by the relationship between EBIT
revenue and EBIT (Operating Income) (Operating Income) and EPS
 OPERATING LEVERAGE
of the firm.
Nature
Operating Leverage may be favorable
or unfavorable to the organization.
Business risk to the firm.
FINANCIAL LEVERAGE
(Earning Per Share) of the firm.
Financial Leverage may be
positive or negative to the earnings
of the organization.
Financial risk of the firm.

Meaning of Risk
Operating Risk is the risk of the
company not being able to meet the
fixed operating cost requirements.
Concerned With
There is a direct relation between
operating profit and Break Even Point
(BEP). The Degree of Operating
Leverage is usually higher near BEP.
Financial Risk is the risk of the
company not being able to meet
the fixed financial cost
requirements.
The financial leverage is concerned
with the liabilities side of the
balance sheet where different
sources of capital is shown.

Q.1. (f) What Is Dividend Policy?

Dividend policy is the policy a company uses to structure its dividend

payout to shareholders. Some researchers suggest that dividend policy
may be irrelevant, in theory, because investors can sell a portion of their
shares or portfolio if they need funds.

Stable Dividend Policy

Stable dividend policy is the easiest and most commonly used. The goal
of the policy is steady and predictable dividend payouts each year, which
is what most investors seek. Whether earnings are up or down, investors
receive a dividend. The goal is to align the dividend policy with the long-
term growth of the company rather than with quarterly earnings volatility.
This approach gives the shareholder more certainty concerning the
amount and timing of the dividend.

Q.1.(G)
Cash Management refers to the collection, handling, control and
investment of the organizational cash and cash equivalents, to ensure
optimum utilization of the firm’s liquid resources.

Objectives of Cash Management

Why do we need to manage cash flow in the organization? What is the

use of cash management in the business?

 Fulfil Working Capital Requirement: The organization needs to

maintain ample liquid cash to meet its routine expenses which
possible only through effective cash management.
 Planning Capital Expenditure: It helps in planning the capital
expenditure and determining the ratio of debt and equity to acquire
finance for this purpose.
 Handling Unorganized Costs: There are times when the company
encounters unexpected circumstances like the breakdown of
machinery. These are unforeseen expenses to cope up with; cash
surplus is a lifesaver in such conditions.
 Initiates Investment: The other aim of cash management is to
invest the idle funds in the right opportunity and the correct
proportion.
 Better Utilization of Funds: It ensures the optimum utilization of
the available funds by creating a proper balance between the cash
in hand and investment.
 Avoiding Insolvency: If the business does not plan for efficient
cash management, the situation of insolvency may arise. It is either
due to lack of liquid cash or not making a profit out of the money
available.

Q1.(H)
Operating cycle refers to number of days a company takes in converting
its inventories to cash. It equals the time taken in selling inventories (days
inventories outstanding) plus the time taken in recovering cash from trade
receivables (days sales outstanding).

Length of a company's operating cycle is an indicator of the company's

liquidity and asset-utilization. Generally, companies with longer
operating cycles must require higher return on their sales to compensate
for the higher opportunity cost of the funds blocked in inventories and
receivables.

Q.2. Functions of Finance Manager

Finances are the cornerstone of every business. The prime goal of any
organization would be to garner huge profits and this is only possible
with proper management of the finances. Therefore, effectual finance
management is imperative for every organization as it leads to enhanced
profits and reduction in the operational cost. A finance manager plays an
important role in the management of a business organization as he
manages all the activities related to finance. There are many functions
that a financial manager is expected to perform. These include:
 1. Estimating the amount of capital required for the proper
functioning of the business

The most basic function of a finance manager is the estimation of the

capital because funds are required for both long term and short term. The
firm requires capital so that it can meet its liability with no delay, benefit
from early business opportunities, pay for resources, operational cost etc.
Sufficient capital is also required so that the firm can face any crisis like
recession and bottleneck.

2. Devising a capital structure

For the determination of the capital structure, the financial manager

must ensure that the earning rate is higher than the rate of interest on the
borrowed amount. A fine capital structure is required to minimize
operational cost and to maximize the shareholder’s profits.

3. Sources to raise funds

For proper financial management, it is imperative to find the various

sources from where the firm can raise funds. The organisation can raise
funds through different sources including equity and preference shares,
debentures, banks, financial institutions and other sources. The funds can
be raised for short as well as long period.

4. Acquisition of funds

While acquiring funds, the financial manager needs to follow some

basic steps such as legal formalities and documentation required. He
might also need to negotiate with the financial institutions. The factors
affecting procurement are the market conditions, the policy of the
government, investor’s choice, and many more.

5. Utilising funds

It is the task of the finance manager to ensure that the funds are invested
wisely so as to garner maximum ROI. While investing, the firm must take
care of safety, profitability, and liquidity of the funds. The funds must be
utilized in such a way that the firm does not face its shortage in near
future.

6. Disposing of profits
Effectual finance management involves analyzing the funds that can be
invested for proper working of the organization and distributing the rest
among the shareholders. The firm’s earning must be in such a way that a
large proportion can be distributed among the investors.

7. Managing the available cash

A financial manager needs to manage the cash in such a way that there
is neither shortage nor surplus and daily expenses can be met without any
hassles. This can be done by forecasting cash inflows and outflows and
balancing them. The manager must ensure that sufficient funds are
always available to purchase material and meet daily expenses.

8. Control of Finance

Finance management involves evaluation and control of the financial

performance of an organization. This involves employing finance control
techniques, auditing, break-even analysis and analysis of cost. Finally,
ROI is measured which deciphers whether the company has incurred
profits or loss.

Role and Responsibilities of a Modern Finance Manager

In the modern enterprise, a finance manager occupies a key position, he

being one of the dynamic member of corporate managerial team. His role,
is becoming more and more pervasive and significant in solving complex
managerial problems.

1. Estimating the Requirements of Funds: A business requires funds

for long term purposes i.e. investment in fixed assets and so on. A careful
estimate of such funds is required to be made.  An assessment has to be
made regarding requirements of working capital involving, estimation of
amount of funds blocked in current assets and that likely to be generated
for short periods through current liabilities. Forecasting the requirements
of funds is done by use of techniques of budgetary control and long range
planning.

2. Decision Regarding Capital Structure: Once the requirements of

funds is estimated, a decision regarding various sources from where the
funds would be raised is to be taken. A proper mix of the various sources
is to be worked out, each source of funds involves different issues for
consideration. The finance manager has to carefully look into the existing
capital structure and see how the various proposals of raising funds will
affect it. He is to maintain a proper balance between long and short term
funds. 

3. Investment Decision: Funds procured from different sources have to

be invested in various kinds of assets. Long term funds are used in a
project for fixed and also current assets. The investment of funds in a
project is to be made after careful assessment of various projects through
capital budgeting. A part of long term funds is also to be kept for
financing working capital requirements. Asset management policies are
to be laid down regarding various items of current assets, inventory
policy is to be determined by the production and finance manager, while
keeping in mind the requirement of production and future price estimates
of raw materials and availability of funds.

4. Dividend Decision: The finance manager is concerned with the

decision to pay or declare dividend. He is to assist the top management in
deciding as to what amount of dividend should be paid to the
shareholders and what amount be retained by the company, it involves a
large number of considerations. The principal function of a finance
manager relates to decisions regarding procurement, investment and
dividends. 

5. Supply of Funds to all Parts of the Organisation or Cash

Management: The finance manager has to ensure that all sections i.e.
branches, factories, units or departments of the organisation are supplied
with adequate funds. An adequate supply of cash at all points of time is
absolutely essential for the smooth flow of business operations. Even if
one of the many branches is short of funds, the  whole business may be in
danger. 

6. Evaluating Financial Performance: Management control systems are

usually based on financial analysis, e.g. ROI (return on investment)
system of divisional control. A finance manager has to constantly review
the financial performance of various units of the organisation. Analysis of
the financial performance helps the management for assessing how the
funds are utilised in various divisions and what can be done to improve it.

7. Financial Negotiations: Finance manager's major time is utilised in

carrying out negotiations with financial institutions, banks and public
depositors. He has to furnish a lot of information to these institutions and
persons in order to ensure that raising of funds is within the statutes.
Negotiations for outside financing often requires specialised skills.

8. Keeping in Touch with Stock Exchange Quotations and Behavior

of Share Prices: It involves analysis of major trends in the stock market
and judging their impact on share prices of the company's shares.
Q.8.

Meaning:

In an ordinary sense, working capital denotes the amount of funds needed

for meeting day-to-day operations of a concern.

This is related to short-term assets and short-term sources of financing.

Hence it deals with both, assets and liabilities—in the sense of managing
working capital it is the excess of current assets over current liabilities. In
this article we will discuss about the various aspects of working capital.

Concept of Working Capital:

The funds invested in current assets are termed as working capital. It is

the fund that is needed to run the day-to-day operations. It circulates in
the business like the blood circulates in a living body. Generally, working
capital refers to the current assets of a company that are changed from
one form to another in the ordinary course of business, i.e. from cash to
inventory, inventory to work in progress (WIP), WIP to finished goods,
finished goods to receivables and from receivables to cash.

Definitions of Working Capital, as per various management experts

are as under:

“Working Capital is the excess of C.A. over current liabilities.”

-H.G, Guthmann

“Working Capital is descriptive of that capital which is not fixed. But

the more common use of the Working Capital is to consider it as the
difference between the book value of the C.A. and current liabilities.

- Hoglend.J. Bierman and A. K. Mc Adams

“Working Capital represents the excess of C.A. over current

liabilities”

-J.L. Brown and L.R. Housard

There are two concepts in respect of working capital:

(i) Gross working capital and

(ii) Net working capital.

Gross Working Capital

The sum total of all current assets of a business concern is termed as gross working
capital. So,

Gross working capital = Stock + Debtors + Receivables + Cash.

Net Working Capital:

The difference between current assets and current liabilities of a business concern is
termed as the Net working capital.

Hence,

Net Working Capital = Stock + Debtors + Receivables + Cash – Creditors – Payables.

Nature of Working Capital:

The nature of working capital is as discussed below:

i. It is used for purchase of raw materials, payment of wages and expenses.

ii. It changes form constantly to keep the wheels of business moving.

iii. Working capital enhances liquidity, solvency, creditworthiness and reputation of
the enterprise.

iv. It generates the elements of cost namely: Materials, wages and expenses.

v. It enables the enterprise to avail the cash discount facilities offered by its suppliers.

vi. It helps improve the morale of business executives and their efficiency reaches at
the highest climax.

vii. It facilitates expansion programmes of the enterprise and helps in maintaining

operational efficiency of fixed assets.

Need for Working Capital:

Working capital plays a vital role in business. This capital remains blocked in raw
materials, work in progress, finished products and with customers.

The needs for working capital are as given below:

i. Adequate working capital is needed to maintain a regular supply of raw materials,

which in turn facilitates smoother running of production process.

ii. Working capital ensures the regular and timely payment of wages and salaries,
thereby improving the morale and efficiency of employees.

iii. Working capital is needed for the efficient use of fixed assets.
iv. In order to enhance goodwill a healthy level of working capital is needed. It is
necessary to build a good reputation and to make payments to creditors in time.

v. Working capital helps avoid the possibility of under-capitalization.

vi. It is needed to pick up stock of raw materials even during economic depression.

vii. Working capital is needed in order to pay fair rate of dividend and interest in time,
which increases the confidence of the investors in the firm.

Importance of Working Capital:

It is said that working capital is the lifeblood of a business. Every business needs
funds in order to run its day-to-day activities.

The importance of working capital can be better understood by the following:

i. It helps measure profitability of an enterprise. In its absence, there would be neither

production nor profit.

ii. Without adequate working capital an entity cannot meet its short-term liabilities in
time.

iii. A firm having a healthy working capital position can get loans easily from the
market due to its high reputation or goodwill.

iv. Sufficient working capital helps maintain an uninterrupted flow of production by

supplying raw materials and payment of wages.

v. Sound working capital helps maintain optimum level of investment in current

assets.
ADVERTISEMENTS:

vi. It enhances liquidity, solvency, credit worthiness and reputation of enterprise.

vii. It provides necessary funds to meet unforeseen contingencies and thus helps the
enterprise run successfully during periods of crisis.

Classification of Working Capital:

Working capital may be of different types as follows:

(a) Gross Working Capital:

Gross working capital refers to the amount of funds invested in various components
of current assets. It consists of raw materials, work in progress, debtors, finished
goods, etc.

(b) Net Working Capital:

The excess of current assets over current liabilities is known as Net working capital.
The principal objective here is to learn the composition and magnitude of current
assets required to meet current liabilities.

(c) Positive Working Capital:

This refers to the surplus of current assets over current liabilities.

(d) Negative Working Capital:

Negative working capital refers to the excess of current liabilities over current assets.

(e) Permanent Working Capital:

The minimum amount of working capital which even required during the dullest
season of the year is known as Permanent working capital.

(f) Temporary or Variable Working Capital:

It represents the additional current assets required at different times during the
operating year to meet additional inventory, extra cash, etc.

It can be said that Permanent working capital represents minimum amount of the
current assets required throughout the year for normal production whereas Temporary
working capital is the additional capital required at different time of the year to
finance the fluctuations in production due to seasonal change.

Main factors affecting the working capital are as follows:

(1) Nature of Business:

The requirement of working capital depends on the nature of business. The nature of
business is usually of two types: Manufacturing Business and Trading Business. In
the case of manufacturing business it takes a lot of time in converting raw material
into finished goods. Therefore, capital remains invested for a long time in raw
material, semi-finished goods and the stocking of the finished goods.

Consequently, more working capital is required. On the contrary, in case of trading

business the goods are sold immediately after purchasing or sometimes the sale is
affected even before the purchase itself. Therefore, very little working capital is
required. Moreover, in case of service businesses, the working capital is almost nil
since there is nothing in stock.

(2) Scale of Operations:

ADVERTISEMENTS:

There is a direct link between the working capital and the scale of operations. In other
words, more working capital is required in case of big organisations while less
working capital is needed in case of small organisations.
(3) Business Cycle:

The need for the working capital is affected by various stages of the business cycle.
During the boom period, the demand of 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.

(4) Seasonal Factors

Some goods are demanded throughout the year while others have seasonal demand.
Goods which have uniform demand the whole year their production and sale are
continuous. Consequently, such enterprises need little working capital.

On the other hand, some goods have seasonal demand but the same are produced
almost the whole year so that their supply is available readily when demanded.

Such enterprises have to maintain large stocks of raw material and finished products
and so they need large amount of working capital for this purpose. Woolen mills are a
good example of it.

(5) 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.
6) Credit Allowed:

Those enterprises which sell goods on cash payment basis need little working capital
but those who provide credit facilities to the customers need more working capital.

ADVERTISEMENTS:

(7) Credit Availed:

If raw material and other inputs are easily available on credit, less working capital is
needed. On the contrary, if these things are not available on credit then to make cash
payment quickly large amount of working capital will be needed.

(8) 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.

(9) Availability of Raw Material:

Availability of raw material also influences the amount of working capital. If the
enterprise makes use of such raw material which is available easily throughout the
year, then less working capital will be required, because there will be no need to stock
it in large quantity.

On the contrary, if the enterprise makes use of such raw material which is available
only in some particular months of the year whereas for continuous production it is
needed all the year round, then large quantity of it will be stocked. Under the
circumstances, more working capital will be required.

(10) Growth Prospects:

Growth means the development of the scale of business operations (production, sales,
etc.). The organisations which have sufficient possibilities of growth require more
working capital, while the case is different in respect of companies with less growth
prospects.

(11) Level of Competition:

High level of competition increases the need for more working capital. In order to
face competition, more stock is required for quick delivery and credit facility for a
long period has to be made available.

(12) Inflation:

Inflation means 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 the working capital.