CHAPTER.

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FINANCIAL Management

It is concerned with efficient acquisition and allocation of funds while smooth working of business.

Objective of Financial Management:

1.) To maximise the wealth of stakeholders..

Wealth of Shareholder = No. Of shares × Market value

2.) Maintenance of Liquidity for the smooth conduct of the activities

3) Proper utilization of funds so that it becomes gain full.

4) Meeting financial commitments with the creditors, Paying back the liabilities on time.

.Role of Financial Management:

1) It determines the size and composition of fixed assets 2). It determines the quantum of current assets
with its composition.

3.) It determines the amount of long term and short term debts on the basis of the requirements in the
organisation

4) It also determines the elements of long term funds like debt equity

5.) It determines and influences all the items of profit & loss account .

Financial Decisions: →→

1) Financing Decisions ~ source of finance / acquisition

2) Investing Decisions → utilisation of funds,

3) Dividend Decisions ~ Disposal of Surplus

Financing Decisions:
Decision relates with acquiring funds from various sources. It also determines the proportion in which
fund are acquired from different sources.

Determinants / Factor Affecting

1. Cost : Finance manager has to determine the cost of raising finance from different sources. the
source with minimum cost is preferred.
2. Risk:
Borrowed funds = more risky
Owners fund = Less risky
Security with moderate risk factors are preferred.
3. Cash flow:
 * Good CF Position (Inflow > outflow and Regular in flow)-- Debt preferred.
*Bad C/F position (Irregular Inflow, inflow < outflow) -- Equity preferred.
4. Control Consideration:
*Retaining Full Control – Debts preferred
*Dilution of Control – Equity preferred
5. Floatation Cost: Issuing expenses
*Cheap - Debt
*Expensive - Shares
6. Fixed operating Cost::
Fixed Cost = fixed operating cost + Fixed financial Cost
*High operating cost→ Low financial cost = Equity preferred
*Low operating expenses = high financial cost = Debt preferred
7. State of Capital Market:
*Boom (Profitable) → easy to attract investors = Equity preferred
*Depression ( loss full) → difficult to attract investors = Debt preferred

Investing Decision ::
Long term (Capital budgeting)
Capital budgeting is the process of making investment decisions in long term assets. It is
the process of deciding whether or not to invest in a particular project as all the
investment possibilities may not be rewarding.

Importance or scope of Capital Budgeting Decision:

1. It affects the growth of the business in Long run.
2. large amount of fund involved therefore a wrong decision can waste huge amount of
funds.
3. Risk Involved because risk increase with amount of investment and time taken until
returns starts coming.
4. Irreversible decision - can not be changed overnight

Factors affecting Capital budgeting decision::

1. ROI (Return on Investment) →
*Higher rate of return will be preferred to bring back the funds for the company in terms of
income.
ROI = EBIT /Total Investment X 100
Rule is ROI > Interest rate
2. Investment Criteria Involved –
Along with ROI rest cash flow, interest rate, availability of labour, technology, inputs and
machinery should also be consider.
3. Cash flow of the project →
A regular amount of cash flow is require to meet day to day expenses. Therefore the
amount of cash flow of the investment proposal must be estimated before investing the
scarce funds .
Short term (Working Cap. Management)
1. Profitability: Low amount of Working Capital can reduces the liquidity.
2. Liquidity: More amount of working Capital increases the liquidity but reduces the
profit earning capacity.

Dividend Decision →
1. Earning :
Higher the earnings = higher dividend
2. Stability of Earning:
More Stability is the earning= More is the value of dividend
3. Growth Prospects:
*High Growth Prospects = more funds Required = More Retained = Less
Dividend

*Low Growth Prospects = less funds Required = less Retained = More Dividend
4. Cash Flow position:
*Good cash flow: (inflow > outflow and regularity) = More capacity to pay higher
dividend
*Bad cash flow:( inflow < outflow and regularity) = less capacity to pay higher
dividend

5. Stability of Dividend:
*Stable dividend — Positive impact on investors > more Goodwill > more
Investors *Unstable dividend > Negative impact on investors > loss of Goodwill >
Discourages Investors.
6. Legal Constraints:
The provision of the Company Act must be followed:
a) Dividend can't be distributed out of the Capital.
b) Dividend can not be distributed out of borrowing
c) Can be distributed only out of the profits which includes current year & past
year profit.
7. Contractual Constraints:
Any agreements sighed with the long term creditors may put restrictions on
distribution of dividend which the company has to follow.
8. Stock Market reaction:
* High Dividend > Positive Impact > market Value Rises
*Low Dividend > Negative Impact > Market Value Reduces
9. Access to Capital Market:
• Large scale business -- Easy Access = High Dividend
• Small scale business – less or No Access → No Demand → No Div.
10.Taxation policy:
*Higher taxes = Less dividend
 *Lower taxes = More dividend
Dividend in the hands of share holders is tax free.
11.Shareholder’s preference:
*Regular income = stable and regular dividend
*Capital gains = Dividend do not affect directly

Fixed Capital →
"Fixed capital is that part of the total capital which is invested in fixed asset such
as land building furniture etc. . It involves allocation of funds to long term assets
of project. It affects the Growth and profitability of a business. Eg..land, building
etc.
Determinants/ factors affecting Fixed Capital requirements:
1. Nature of Business :
*Manufacturing = More Machinery = More (FA) = More Fixed Capital
*Trading = less Fixed Assets = less Fixed Capital
2. Scale of operations:
*Large scale= More production= More Fixed Capital
*Small scale= Less Production= Less Fixed Capital
3. Mode of acquiring Fixed Assets / financing alternative:
*Purchase = More FC
*Lease financing = Less FC
4. Techniques of production :
*Labour intensive Technique: Less machines = More Manual Work → Less
Fixed Capital
*Capital Intensive technique: More Machinery = Less Manual work = More
Fixed Capital
5. Growth prospects:
*Higher Growth Prospects > Increase Production capacity > More fixed
assets are required → More Fixed Capital
*Less growth prospects > Not required to increase the production capacity >
Less fixed assets are required > Less fixed capital
6. Diversification:
*More diversification > require more variety of fixed assets > More fixed
capital required
*Less diversification > requires less variety of fixed assets > Less fixed capital
required
7. Level of collaboration:
*Greater degree of collaboration > More sharing of infrastructure > Less
fixed capital required
*Low degree of collaboration > Less sharing of infrastructure > More fixed
capital required
8. Technological upgradation:
*Required frequently > new fixed assets required more frequently > More
fixed capital required
 *Required occasionally > New fixed assets are not required frequently > Less
fixed capital required

WORKING CAPITAL:
It is the money available to a business enterprise for daily operation.
It refers to the current assets of the company that are changed from
one form to another during the operating cycle.
Determinants/ factors affecting Working Capital requirements:
1. Nature of Business :
*Manufacturing – More working Capital
*Trading – Less working Capital
2. Scale of operations :
*Large scale – More working Capital
*Small scale – Less working Capital
3. Business cycle :
*Boom period – Huge demand – More working Capital
*Depression period – low demand – low sales – low working Capital
4. Production cycle : Time required to in Production
*Longer cycle – more time – capital is blocked – more working Capital
*Shorter cycle – less time – capital is recycled – less working Capital

5. Seasonal factors :
*Peak season – more demand – more stock required - more working Capital
*Lean season – low demand – less stock required – less working Capital
6. Credit allowed : credit sales
*More credit allowed – less cash received – more working Capital
*Less credit allowed – more cash received – less working Capital
7. Credit availed: credit purchase
*More credit availed – less cash required – less working Capital
*Less credit availed – more cash required – more working Capital
8. Operating efficiency :
*Higher efficiency – less raw material stock required – less working Capital
*Lower efficiency – more raw material stock required – more working Capital
9. Availability of raw material :
*Seasonally available – huge stock required – more working Capital
*Regularly available – less stock required – less working Capital
10. Growth prospects :
*Higher – more funds required to increase production – more working Capital
*Lower – less funds required to increase production – less working Capital
11. Level of competition :
*Higher degree of competition – more stock required and more expenses on – more working
Capital
*Lower degree of competition – less stock required – less working Capital
12. Inflation :
More working capital is required to maintain the same level of production.

CAPITAL STRUCTURE::
It is the proportion of
the use of different sources in raising funds.

Factors affecting Capital structure::

1. Cash flow position :
*Good cash flow – easy to repay on time – More debt
2. Interest coverage ratio :
ICR = EBIT÷ Interest
*Higher ICR – less risk of liability – More debt
*Lower ICR – more risk of liability – less debt
3. Debt service coverage ratio:
DSCR = (Profit after tax+ interest+ dep.+ Non cash expenses written
off) ÷ ( preference dividend+ interest+ repayment obligation)
*Higher DSCR – less risk of liability – More debt
*Lower DSCR – more risk of liability – less debt

4. ROI: Return on investment= EBIT / Total Investment

*Higher ROI – high credit worthiness – more debts
*Lower ROI – lower credit worthiness – less debts
5. Cost of debt: expected returns of the investor
*Lower rate of interest – more debts
*Higher rate of interest – less debts
6. Cost of equity : expected returns of the investor
*High debts – high financial risk – high expectations of returns –
high cost of equity
Therefore, debts should be used only upto a limit.
7. Tax rate :
*High tax rate – high tax liability – more debts to reduce the tax
liability
*Lower tax rate – lower tax liability – less debts
8. Floatation cost : Issuing expenses
*High expenses for share capital
*Low expenses for debt capital
• Cheaper is preferred
9. Risk consideration :
Risk = operating risk + financial risk
*High risk – less debts
*Low risk – more debts
10. Control consideration :
*Complete control over management – debts preferred
*Dilution of control – Equity preferred
 11. Flexibility:
Debts bring flexibility as they can be raised and repaid as and when
required.
12. Regulatory framework :
SEBI guidelines and provisions of the Company Act must be followed
13. Stock market condition :
*Bearish ( loss full) – No attraction of equity – debts preferred
*Bullish (profitable) – Investors are attracted – equity preferred
14. Capital structure of other companies:
To understand the industry norms and taken as guideline.

FINANCIAL PLANNING ::
Financial planning is the process of estimating the financial requirements of an organisation specifying
the sources of funds and ensuring that enough funds are available at the right time. It is necessary to
enable the business enterprise to have the right amount of capital to continue its operations efficiently.

Importance of financial planning::

(ii) Helps in forecasting what may happen in future under different

business situations. By doing so, it helps the firms to face the eventual
situation in a better way. In other words, it makes the firm better
prepared to face the future.

(ii) It helps in avoiding business shocks and surprises and helps the company in preparing for the future.

(iii) If helps in co-ordinating various business functions, e.g., sales and production functions, by providing
clear policies and procedures.

(iv) Detailed plans of action prepared under financial planning reduce waste, duplication of efforts, and
gaps in planning.

(v) It tries to link the present with the future.

(vi) It provides a link between investment and financing decisions on a continuous basis.

(vii) By spelling out detailed objectives for various business segments, it makes the evaluation of actual
performance easier.