St.

Joseph’s Evening College (Autonomous)

#35, Museum Road, Bangalore -560025

BANGALORE

MBA-Twinning Program

PONDICHERRY UNIVERSITY

FINANCIAL MANAGEMENT

(WORKS BOOK)

SECOND SEMESTER

Dr. Prof. S. Kanthimathinathan, M. Com, MBA, [Link]. (C)., [Link].(M)., PhD

2022

1
Financial Management – (Key Notes)
QUESTION COVERAGE – (Problem 40% and theory-60%)

Units:

1. Introduction -Financial Management

2. Capital Budgeting

3. Operating and Financial Leverages

4. Dividend Policy

5. Working Capital management

Problems: ( For 40 Marks)

[Link] Budgeting Page 13 to 27 = 15 Problems

[Link] and Financial Leverages- Page 34 to 48 = 15 Problems

[Link] Capital Management Page 57 to 67 = 10 Problems

2
 UNIT-1-. FINANCIAL MANAGEMENT

1. Meaning of Financial Management:

Financial management is concerned with the efficient use of an important economic resource,
namely, capital funds. Financial management is that managerial activity which is concerned with
the planning and controlling of the firm’s financial resources. Financial management is
concerned with the managerial decisions that result is the acquisition and financing of long term
and short-term assets for the firm.

2. Importance of Financial Management

1. In the words of Collins Brooks, “Bad Production management and bad sales management
have slain in hundreds but faulty finance has slain in thousands”.
2. Finance is the” lifeblood of business”. Every business unit needs money to make more
money. But money will get more money, only when it is managed properly.
3. Financial Management helps in Profit Planning capital budgeting, controlling inventories
and accounts receivables etc.
4. Financial Management helps a firm in optimizing the output from a given input of funds.
(i.e. a given amount of money).
5. Financial Management helps a firm in monitoring the effective employment of funds in
fixed assets (i.e. Fixed capital) as well as in current assets (i.e. working capital).
6. Financial management is important even for non-profit-making organizations.

3. Objective of Financial Management

The objectives of Financial Management can be broadly classified into two categories
1. Basic objectives
2. Other objectives

1. Basic Objectives:
a) Maintenance of adequate liquid assets in the firm.
b) Profit Maximization
c) Wealth Maximizations

2. Other objectives:

a) Ensuring maximum operational efficiency through planning, directing and

controlling of the utilization of the funds. i.e. through the effective employment of
funds.
b) Enforcing financial discipline in the organization in the use of financial resources
through the co-ordination of the operations of the various divisions in the
organization.
c) Building up of adequate resources for financing growth and expansion.
d) Ensuring a fair return to the shareholders on their investments.

3
SCOPE OF FINANCIAL MANAGEMENT:

I Scope of Financial Management under the old or Traditional Approach:

1. Arrangement of funds through financial instruments. (i.e. raising of funds by the issue of
shares and debentures)
2. Arrangement of funds from financial institutions. (i.e. raising of loans from financial
institutions.)
3. Looking after the legal and accounting relationship between the company and the
supplies of the various sources of funds.

It is true that, under the traditional approach financial management included within its scope
the study of the entire gamut of raising funds by a company externally. However, the
traditional approach came in for severe criticisms and was given up in 1949.

The various civisms of the traditional approach were:

1. The traditional approach was an outsider looking is approach, and not an insider looking
out approach.
2. The traditional approach focused on the problems of only long-term financing. It ignored
the problems of short term or working capital financing.
3. Under the traditional approach, the Finance function was limited to the mere raising of
funds and the administering of the funds raised.
4. The traditional approach laid undue emphasis on the financial problems arising from
episodic happenings like incorporation, merger, re-organization etc. It did not give any
importance to the routine day-to-day financial problems of a concern.
5. The traditional approach gave attention to the financial problems of only the corporate
bodies. It completely ignored the financial problems of non-corporate undertakings like
sole trading concern.

Scope of Financial Management under the Modern Approach:

As stated earlier, the traditional approach was popular till 1949. Since 1950, it lasts its popularity
under the modern or new approach, financial management has a vast scope or coverage under the
modern or new approach, financial management is concerned not only with the raining of funds,
but also with the wise application of the funds raised. It covers the following aspects;

1. What is the total volume of funds an enterprise should raise?

2. How should the funds required be financed?
3. What specific assets should the enterprise acquire?

The above questions or aspects relate to four broad decisions areas or functions of financial
management.

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Management Finance Functions:

1. Financing decision
2. Funds requirement decision
3. Investment decision
4. Dividend decision
5. Current asset management

The modern approach to financial management covers not only the four broad decision areas or
managerial finance functions, but also certain routine functions. The routing functions of
financial managements are:

1. Record keeping
2. Custody and safeguarding of securities and other valuable papers
3. Ensuring the supply or provision of funds to all the divisions in the organization.
4. Evaluation of the financial performances of various division in the organization
5. Supervision of cash receipts and cash payment and safeguarding of the cash balance.
6. Preparation and submission of financial reports.
7. Keeping tracer of stock exchange quotations and behavior of stock market price.

Basic principles of Financial Decisions:

1. Striking a balance between liquidity and profitability

2. Suitability.
3. Risk return trade off
4. Maximization of wealth
5. Time value of money
6. Diversification.
7. Financial beverage or trading on equity.

Financial Tools or Methods:

1. Financial leverage or trading on equity

2. Inventory control techniques
3. Cost of capital.
4. Ratio analysis
5. Capital budgeting appraisal methods.
6. Techniques for management of accounts receivables.
7. Funds flow analysis and cash flow analysis
8. Cash management models
9. Investment decision

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Functions of the finance manager:

1. Administrative the financial activities.

2. He should anticipate the finance requirement.
3. Analysis of the financial performance
4. Selection of right source, at right time and at right cost.
5. Allocation of Funds.
6. Protection of interacts of investors and creditors.

Functional Area of Financial Management:

1. Profit Planning and control

2. Working capital management
3. Estimating the financial requirement.
4. Selection of the sources of funds and allocation of funds.
5. Analysis and interpretation of the results.
6. Usage of CVP and BEP techniques.
7. Capital budgeting.
8. Fair returns to the investors.
9. Maintaining liquidity.
10. Wealth Maximization.

Financial Plan:
Basic consideration to be kept in mind in formulating financial plan.

1. Flexibility
2. Simplicity.
3. Long-term view.
4. Fore sight
5. Optimum use
6. Contingencies
7. Liquidity
8. Economy
9. Investors’ preference or temperament.

Techniques of Financial Analysis:

Steps involved in the analysis of financial statement.

1. Analysis
2. Comparison
3. Interpretation.
Objective of Analysis and Interpretation of financial statement:
1. To determine the progress of a concern.
2. To measure the operational efficiency of the concern.
3. To judge the Financial position of the concern
4. To ascertain the future prospects of the concern.

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Profit Maximization;

Earnings profits by a corporate or a company is a social obligation; profit is the only means
through which an efficiency of organization can be measured. As the business units are
exploiting the resources of the country namely, Land, labour, capital and resources has an
obligation to make use of these resources to achieve profits. Through the profit Maximization
has many features different people expressed different optimum to consider this as a main goal
of a company.

Wealth Maximization;

The concept of wealth Maximization refers to the gradual growth of the value of assets of the
firm in terms of benefiter it can produce. Any financial action can be judged in terms of the
benefits it produces less cost of action. The wealth maximization attained by a accompany is
reflected in the market value of shares. It is nothing but the process of creating wealth of an
organization. This maximizes the Wealth of shareholders. Wealth maximization is the net present
value of a financial decision. Any financial action results in position NPV creates wealth to the
organization.

Significance of Wealth Maximization;

1. Creditors
2. Workers
3. Society / Public
4. Management

Advantages;

1. Wealth maximization is a clear term. Here, the present value of cash flows is taken in to
consideration.
2. It considers the concepts of time value of money. The present values of cash inflows and out
flows help the management to achieve the overall objective of the company.
3. The concept of wealth maximization is universally accepted, because it takes care of interest
of financial institution, owner’s employs and society at large.
4. Wealth Maximization guide the management in framing consistent strong dividend policy to
reach maximum return to the equity holders.
5. The concept of Wealth Maximization considers the impact of risk factor, while calculating the
NPV at a particular discount rate; adjustment is being made to cover the risk that is associated
with the investment

Other objectives;
1. Balanced Asset structure.
2. Liquidity.
3. Judicious planning of funds
4. Efficiency
5. Financial discipline.

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Profit Maximization:

Points in favour of Profit Maximization Points against Profit Maximization

1 Profit is a barometer through which the Profit is not a clear term, Is it accounting profit?
performance of business units can be Economic Profit? Profit before tax? After tax? Net
measured. profit? Gross profit or earning per share.

2 Profit ensures maximum welfare to the In encourages corrupt practices to increase the
shareholders, employees, and prompts profits.
payment to creditors of a company.

3 Profit Maximization increases the Profit maximization does not consider the element
confidence of management in expansion of risks.
and diversification program me of a
accompany.
4 Profit maximization attracts the investors It does not consider the impact of time value of
to invest their savings in securities. money.

5 Profit indicates the efficient use of funds The true and fair picture of the organization is not
for different requirements. reflected through Profit maximization.

2. Cost of Capital

The cost of capital is an important concept in formulating firm’s capital structure. The cost of
capital is still largely an academic term, and the problem of measuring it in operational terms is a
recent phenomenon. Prior to this development, the problem was either ignored or by passed. The
term cost of capital is often defined as the rate of return-on-investment projects necessary to
leave unchanged the market price of firm’s stocks. It is the rate of return required by those who
supply the capital. The cost of capital of the firm is a weighted average of the cost of each type
of capital. If a firm cost of capital is the rate of return on an investment, the latter must increase
the value of a firm. From this point of view, it may be said that the cost of capital is not a cost as
such. It is merely a hurdle rate and represents a minimum rate of return, which depends upon
whether a firm operates at a zero-risk level or at some business or financial risk. Where risk is
involved the minimum rate of return is higher. The cost of capital is clearly related to BEP,
which relates to operating cost, while the optimum cost of capital is the financial BEP. It is a
technical term which can be defined in one of the following several ways.

1. The minimum required ROI for proposals for using capital funds.
2. The cut- off rate for capital expenses.
3. The target ROI which must be serviced if the capital used is to be justified and
4. The financial standards.

8
Types of cost;

1 Job process or Product

2. Direct
3. Indirect
4. Fixed
5. Variable
6. Out of packet
7. Sunk
8. Avoidable
9. Un-avoidable
10. Common
11. Relevant
12. Irrelevant
13. Marginal
14. Committed
15. Controllable
16. Uncontrollable
17. Program me
18. Historical
19. Specific
20. Explicit
21. Implicit cost

Types of Capital;

1. Real
2. Financial
3. Fluid
4. Sunk
5. Fixed
6. Circulating
7. Loan

Methods of computing cost of capital;

1. Cost of Equity capital
2. Cost of preferred capital
3. Cost of Debt capital.
4 Cost of internally generated funds
5. Overall cost of capital
6. Weighted average cost of capital
7. Marginal cost of capital.

Organizational structure of Financial System.

1. Financial Market,2. Products and,3. Market participants

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 UNIT-2. CAPITAL BUDGETING

Meaning:

“Capital budgeting is long term planning for making and financing proposed capital out lays”.
“Capital budgeting consists in planning development of available capital for the purpose of
maximizing the long-term profitability of the concern”.

FACTORS INFLUENCING THE INVESTMENT DECISIONS:

(FACTORS INFLUENCING THE CAPITAL BUDGETING)

1. Government policy
2. Taxation policy
3. Availability of funds
4. Structure of capital
5. Lending policies of financial institutions
6. Immediate need of the project
7. Earnings
8. Capital return
9. Economic value of the project
10. Working capital
11. Accounting practice
12. Trend of earnings

FEATURE OF CAPITAL BUDGETING:

1. Exchange of funds for future benefits.

2. Long term investment activities
3. Associated with risks and uncertainty
4. Irreversible is nature
5. Life time decisions.

PROCESES OR STEPS INVOLVED IN CAPITAL BUDGET

1. Project generation
2. Project evaluation
3. Project selection
4. Project execution

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ADVANTAGES OF CAPITAL BUDGETING:

1. It is helpful for having proper decisions on capital expenditure.

2. It facilitates proper adjustment of production facilities with the sales budget.
3. It provides the basis for long term financial planning.
4. It avoids over investment and under investment iN fixed assets.
5. It indicates proper timings for purchase of fixed assets.
6. It serves as a means of controlling capital expenditure.
7. It furnished essential information for cash budget.

LIMITATION OF CAPITAL BUDGETING

1. It is a very difficult task.

2. It is subject to all the limitation of budgeting.
3. None of the various capital appraisal methods available is free from draw backs

BASIC PRINCIPLES OF CAPITAL EXPENDITURE PROPOSALS:

1. Principle of cash flow

2. Investment principle
3. Long term funds principle
4. Interest exclusion principle
5. Post-tax principle.

METHODS OF APPRAISAL OF CAPITAL BUDGETING OR METHODS OF

INVESTMENT EVALUATION:

1. TRADITIONAL METHODS

a) Payback period method.

b) Accounting rate of return method.

2. Discounted cash flow methods

a) The net present value method.

b) Internal rate of return
c) Profitability index method or benefit cost ratio method.

11
CAPITAL BUDGETIN FORMULAS

1. Pay Back Period = Original Investment of the Project

Annual Cash In-Flow of the project

2. Pay Back Profitability = Total cash flow generated during the economic life of a
Machine or Project = xxx
Less; Original Investment = xxxx
Post Pay Back Profitability xxxx

3. a) A R R = Average Annual income after tax and depreciation x100

Initial Investment

b) A R R = Average Annual income (after tax and depreciation) x 100

Average Investment

Average Investment = Original Invest ment + scrap

2

c) ARR = Annual Average Net earnings x 100

Average Investment

Annual Average Net earnings = Total Income after Depreciation and Tax
Estimated life of Machine

i
4. Net Present Value = ---------------------
(1+i)n Where = I = Discount Rate
N = No. of year after which
the Rupee is received.

5. IRR = A + (C – O) X (B – A)
(C-D)
A = Discount factor of lower trial rate
B = Discount factor of higher trial rate
C = Present value of cash inflow at lower trial rate
D = Present value of cash inflow at higher trial rate
O= Original out lay / Initial cash out lay

Calculation of factor = original investment

A/V cash flows per year

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6. Profitability index = PV of cash inflows
Initial cash outlay

7. Net present value method

Total present value of cash inflow = xxx
Less: original investment = xxx
---------
NPV = XXX

CAPITAL BUDGETING-PROBLEMS

1. As a Finance Manager, which of the two following alternative investments will you advice
and why under the Pay Back period and Payoff profitability methods?
Investment-A
Capital Investment; Rs 10000
Estimated annual cash income; Rs 3200
Life of Project 5 years
No scrap or terminal value at the end.
Investment –B
Investment; Rs 8000
Cash income;
1- Year-Rs 3600
2- Year-Rs 3000
3- Year-Rs 2800
4- Year-Rs 2000
5- Year-Rs 1000
Life of Project -5 Years
No scrap or terminal value

SOLUTION; -

13
2.A company has up to Rs 200000 to invest. The following proposals are under consideration
Project Initial outlay; Annual cash Flow Life in years
A 100000 25000 5
B 80000 26000 7
C 40000 10000 15
D 100000 24000 20
E 50000 11250 15
F 60000 24000 6
G 20000 10000 2
Rank these projects in order of their desirability under the Pay –Scale method and post pay off
profitability method.

SOLUTION;-

14
3 Sufi Ltd is producing articles mostly by manual lab our and is considering to replace it by a
new machine. There are two alternative models M and N of the new machine. Prepare a
statement Of profitability showing the Pay Back period from the following information.

Machine “M” Machine “N”

Estimated life of Machine; 4-Years - 5-Years
Cost of Machine; 9000 - 18000
Estimated Saving s in scrap ; 500 - 800
Estimated Savings in Direct Wages; 6000 - 8000
Additional cost of Maintenance ; 800 - 1000
Additional cost of Supervision; 1200 - 1800
Ignore Taxation

SOLUTION;-

15
4. Jawahar ltd is considering the purchase of a new Machine. There are two alternative modules
‘X’ and ‘Y’ of the new Machine. Prepare a statement of profitability showing the Pay Back
Period from the following.
“X” - “Y”
Cost of Machine 180000 - 300000
Estimated life (in Years) 10 15
Estimated Savings in scrap p.a 12000 - 18000
Additional cost of Supervision P.a 14400 - 19200
Additional cost of Maintenance ; P.a 8400 - 13200
Cost of Indirect Material P.a 7200 - 9600
Estimated Savings in Wages;
Workers not required 150 - 200
Wages per workers p.a 720 - 720
Assume taxation at 50% of profit
Which model would you recommend?

SOLUTION;-

16
5.”X” Ltd is considering the purchase of a machine ‘Two machine are available’ and ‘F’.The
cost of each machine is Rs 60000. Each Machine has an expected life of 5 Years. N/P before
tax during the expected life of the Machine are given below;
Year Machine ‘E’ - Machine ‘F’
1 15000 - 5000
2 20000 - 15000
3 25000 - 20000
4 15000 - 30000
5 10000 - 20000
85000 - 90000
Following the method of return on investment ascertain which of the alternatives will be more
profitable. The average rate of tax may be taken at 50%.

SOLUTION;-

17
6. Bharath Electronic co ltd is considering the Purchase of a Machine .Two Machine ‘A’ and ‘B’
Are available, each costing Rs 50000. In comparing the profitability of these Machines a
discount rate of 10% is to be used. Earnings after tax expected to be as follows;
Year Machine ‘A” Machine ‘B’
Cash-inflow Cash-inflow
1 15000 5000
2 20000 15000
3 25000 20000
4 15000 30000
5 10000 20000
You are also given the following date;
Year Present Value of Rs 1
At 10% discount
1 0.909
2 0.826
3 0.751
4 0.683
5 0.621
Evaluate the proposals using;
1The Pay Back period
2 The Accounting Rate of Return
3 The Net present Value and Profitability index.

SOLUTION;-

18
 7, which Project will be selected under pay back method and Accounting Rate of return
method,

PROJECT-A PROJECT -B
Cash Out Flow Rs 500000 Rs 500000

Cash Inflow
1- Year 300000 100000
2- Year 200000 200000
3- Year 100000 300000
4- Year
50000 400000

SOLUTION;-

19
 8. The Working results of two Machines are as follows

Machine -1 Machine-2
Cost of the Machine 45000 45000
Sales per Year 100000 80000
Cost Per Year 36000 30000
Expected Life 2 Year 3 Year
Tax Rate 50 % 50 %
;

Which of the two should be preferred under the average rate of return method?

SOLUTION; -

20
 9.A Company proposing to expand its production can go in either for an automatic Machine
Costing Rs 224000 with an estimated life of 5 ½ Years or an ordinary Machine costing Rs
60000 having an estimated life of 8 Years. The annual sales and costs are estimated as
follows;

AUTOMATIC MACHINE ORDINARY MACHINE

Sales 150000 150000
Cost;
Materials 50000 50000
Labour 12000 60000
Variable Overhead 24000 20000

Compute the comparative profitability of the proposal under the payback period and return
on investment method

SOLUTION; -

21
 10. Using the information given below, Compute the payback period under
A) Traditional pay back method
b) Discounted pay back method

Initial Out lay = Rs 80000

Estimated Life = 5 Years

Profit after Tax;

End of the year; 1 6000

2. 14000
3 24000
4, 16000
5. nil
Depreciation has been calculated under straight line method. The cost of capital may be taken
at 20 % and the Present value of Rs 1 at 20 % per annum is given below.
Year ; 1 2 3 4 5

P.V Factor ; 0.83 0.69 0.58 0.48 0.40

SOLUTION;-

22
 [Link] Alpha co ltd is considering the purchase of a new Machine. Two alternative Machine
( A and B ) have been suggested .Each costing Rs 400000 , Earning after taxation and
expected to be as follows

Cash Flow Cash Flow

years MACHINE -A MACHINE-B
1 40000 120000
2 120000 160000
3 160000 200000
4 240000 120000
5 160000 80000

The company has a target return on capital of 10% and on this basis .You are required to
compare the profitability of the Machine and state which alternative You consider financially
preferable. The present value of Rs 1 at 10 % due in.
YEAR ; 1 2 3 4 5

PV ; 0.91 0.83 0.75 0.68 0.62

SOLUTION;-

23
 12. The Mopeds ltd is considering the purchase of a new Machine. Two alternative Machine
A and B have been suggested each having an initial cost of Rs 400000 and requiring an
additional working capital of Rs 20000 at the end of the 1 –st Year, Earning after taxation are
expected to be as follows; -

Cash Inflows
YEAR Machine-A Machine-B
1 40000 120000
2 120000 160000
3 160000 200000
4 240000 120000
5 160000 80000

The company has a target return on capital of 10 % and on this basis, you are required to
compare the profitability of the Machines and state which Machine is preferable.
Present value of Rs 1 is given as ; 1-year; 0.91, 2- nd year;0.83, 3-rd year; 0.75, 4- th year;
0.68, 5-th year; 0.62

SOLUTION;-

24
 13. A company has opportunity to invest in any of the following. How will you evaluate the
proposals on the following criteria?

1. Payback period
2. Return on investment
3. Present value method

The cost of the capital to the company is 10 %

Investment Cash Outflow Cash Inflow

Year- 1 Year -2
10000 -
A 10000 10000 1100
B 10000 3762 7762
C 10000 5762 5762
D 10000

Additional particulars;

Discount Value of Rs 1 at 10 %

Years ; 1 2
P.V ; 0.909 0.826

SOLUTION;-

25
 [Link] following two Project A and B require an investment of Rs 200000 each. The income
returns after taxes for these projects are as follows;

Year PROJECT -A PROJECT -B

1 80000 20000
2 80000 40000
3 40000 40000
4 20000 40000
5 --------- 60000
6 --------- 60000

Using the following criteria, determine which of the projects is preferable.

1) 3 years pay back

2) Average rate of return
3) Present value approach, if the company cost of capital is a) 10 % and b) 6 %

SOLUTION;-

26
15. Consider the following proposal investment with the indicated cash inflows; -

Investment Initial outlay Year-end Cash Inflows

Year 1 Year 2 Year 3
A 200000 200000 NIL NIL
B 200000 100000 100000 100000
C 200000 20000 100000 300000
D 200000 200000 20000 20000
E 200000 140000 60000 100000
F 200000 160000 160000 80000

Rank the investment deriving NPV using the discount rate of 10 % and state your views.

Note; Present value of Rs 1 due at the end of the year.

Year ; 1 2 3

P.V ; 0.909 0.826 0.751

SOLUTION;-

27
 CAPITAL STRUCTURE

Meaning:

“Capital structure means the makeup form, composition or mix of the capitalization of a
business.

The capital structure of a business can be measured by the ratios of the various kinds of
permanent loan and equity capital to total capital.

It means the form or composition of long term funds of a concern, it mean the different sources
of long term funds, such as equity shares, preference shares, retained earnings, debentures and
others long term loans in the total capitalization of a company.

Significance of capital structure:

1. It affects the cost of capital or financing.

2. It affects also te earnings per share for the equity share holders.
3. It even affects the control of the promoters and / or the existing management of the
company over the affairs of the company.

Basic patterns of capital structure:

1. Only equity shares.

2. Equity shares and preference shares.
3. Equity shares and long term borrowings like debenture and term loan from financial
institution.
4. Equity shares, pref shares, debentures and term loans from financial institutions.

Sources of capital- various sources of long term capital (more than 7 years):

1. Equity shares
2. Preference shares
3. Retained earnings
4. Debentures
5. Long term loans
6. Long term deposits
7. Installment credit (hire purchasing)
8. Leasing finance

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1. Equity shares:
According to the Company Act of 1956, equity shares are those which are not preference
shares. In other words, these are shares which do not enjoy any preferential right either in
respect of the payment of dividend or in respect of the repayment of capital at the time of
the winding up of the company. They are the ownership shares conferring the ownership
of the company on the holders of these shares.

Methods of issue of shares

1. Issue of share at par

2. Issue of shares at a premium
3. Issue of shares at a discount.

2. Preference shares:
Preference shares are shares which have preferential rights (i.e. first priority or
preferences over other kinds of shares) in respect of payment of dividend during the
existence of the company, and also in respect of repayment or refund of share capital in
the event of the winding up of the company.

Types of preference shares:

1. Cumulative preference shares.
2. Non- cumulative preference shares.
3. Participating preference shares.
4. Non-participating preference shares
5. Convertible preference shares
6. Non-convertible preference shares
7. Redeemable preference shares
8. Irredeemable preference shares.

3. Retained earnings: (Ploughing back of profits) Ploughing back of profits refers to the
creation of reserves out of profits and the utilization of the accumulated profits or
reserves for meeting the financial requirements of the business. In short, it means re-
investment of a part of the profits in the business.

4. Debentures: Debenture means a document acknowledging a debit. Debenture is an

instrument issued by a company under its common seal, acknowledging a debit after a
specified date or on a particular date or at the option of the company and in the meantime,
to pay interest at a fixed rate and at regular intervals.

29
 Kind of debentures

1. Registered debenture
2. Unregistered debenture
3. Secured debentures
4. Un-secured debentures
5. Redeemable debentures
6. Irredeemable debentures
7. Convertible debentures
8. Non-convertible debentures.

5. Long terms loans from industrial finance corporation:

Long-term loan from specialized industrial finance corporations are one of the important
sources of long term finance for industrial companies. In India industrial companies can
raise long term loans for period over 7 years from IFCI, IDBI, and ICICI etc.

6. Long term public deposits:

Of late, long term, public deposits also have become an important source of long term
finance. It may be noted that as per the guide lines issues by RBI, public deposits cannot
be accepted for a period exceeding 36 months.

7. Installment credit:
Installment credit refers to the purchase of machinery, equipment’s etc. by a concern
either on hire purchase system or installment system. It is one of the sources of long term
finance in the sense that the acquisition of a fixed asset is financed by this source.

8. Leasing:
Leasing is an arrangement under which a concern acquires some machinery equipment’s
etc., on lease from a leasing company for the consideration of rent. The machinery,
equipment’s etc. obtained on lease remains the property of the leasing company. The
company, which has acquired the machinery, equipment’s etc. can only use them during
the lease period by paying the agreed rent.

Factors affecting capital structure:

Internal factors:

1. Financial leverage
2. Risk
3. Growth and stability
4. Retaining control

30
 5. Cost of capital
6. Cash flows
7. Flexibility
8. Purpose of finance
9. Asset structure
External factors:

1. Size of the company

2. Nature of the industry
3. Investors
4. Cost of floatation
5. Legal requirement
6. Period of finance
7. Level of interest rate
8. Level of business activity
9. Availability of funds
10. Taxation policy
11. Level of stock prices
12. Condition of the capital market.

31
 UNIT-3. Financial leverages

Earnings per share are the most important index of financial performance. Earnings per share are
influenced by changes in sales revenues. So, it becomes necessary to know how earning per
share is influenced by changes in sales revenues. To know how earning per share is influenced
by changes in sales revenues, the technique of leverage has been introduced in financial analysis.

Meaning of leverage: The term leverage means the influence of one financial variable (i.e.
financial factor or financial figure) over some other related financial variable. It is used to
describe the ability of a company to use fixed cost assets or fixed cost funds to magnify (i.e. to
increase) the returns to its shareholders.

Type of leverages: There are 5 main types of leverages

1. Return on investment leverage (ROI leverage)
2. Assets leverage
3. Operating leverage
4. Financial leverage
5. Total or combined leverage.

FINANCING DECISIONS (Formulas)

1. ROE =NP (after tax) - Preference share Dividend x 100

Equity share capital

2. ROE =NP - Preference Share Dividend

Total No. of equity shares

3. EPS = Earnings available to equity share

No. of equity shares

4. Return on net worth = N.P after tax – Pref. dividend

Net worth

5. Return on gross capital employed = Adjusted NP x 100

Gross cap employed
6. Return on net capital employed = Adjusted NP x 100
Net capital employed
7. Return on Capital employed = N.P + Interest + Tax x 100
A/V capital employed
8. Price earnings ratio = Market price per equity share x 100
Earnings per share
9. Dividend yield ratio = Dividend per share x 100
Market value per share
10. Dividend payout ratio = Dividend per equity share x 100
Earnings per share

32
 11. Earnings yield ratio = Earnings per share x 100
Market price per share
12. Cover for preference dividend = Profit after tax
Preference share. Dividend.

MARGINAL COSTING

Sales = Rs xxxxx

Less; Variable Cost = Rs xxxxx

Contribution = Rs xxxxx

Less; Fixed Cost = Rs xxxxx

Operating profit EBIT = Rs xxxxx

Less; Interest = Rs xxxxx

EBT = Rs xxxxx

Less; Tax = Rs xxxxx

Earnings after tax = Rs xxxxx

Less; Preference share Dividend= Rs xxxxx

Earnings available to Equity S. H =Rs xxxxx

33
 FINANCIAL LEVERAGE-PROBLEMS

1. From the following data calculate

a) Financial Leverages
b) Operating Leverage
c) Combined Leverage

Sales 10000 units Rs 25 per unit as the selling price

Variable cost Rs 5 per unit
Fixed cost Rs 30000
Interest cost Rs 15000

Solution;

34
2. Evaluate two companies in term of its Financial Leverages and Operating Leverages.

Firm –A Firm- B
Sales Rs 2000000 Rs 3000000
Variable cost 40% of sales 30% of sales
Fixed cost Rs 500000 700000
Interest Rs 100000 Rs 125000

Solution

35
[Link] the following data of X Y Z Ltd

Selling Price per unit Rs 60

Variable cost per unit Rs 40
Fixed Cost Rs 300000
Interest burden Rs 100000
Tax rate -50%
Preference Dividend Rs 50000
Calculate three types of leverages if the number
Of units sold are 10000

Solution;-

36
4 . From the following particulars calculate;-

a) Dividend Yield on Equity shares

b) Earnings per share
c) The Price Earnings ratio
Equity capital of a company is Rs 700000 ( Rs 10 each)
10% 20000 Preference share 10 each Rs 200000
Profit after tax at 50% Rs 320000
Depreciation Rs 80000
Equity Dividend paid 25%
Market Price of equity shares Rs 60.

Solution;-

37
5. From the following information calculate;-

a) Earnings per share.

b) Earning Yield Ratio
c) Price Earnings Ratio
d) Dividend Payout Ratio.
Profit before tax Rs 2500000
Tax Rate 50%
Proposed Dividend 30%
Equity capital 50000 shares Rs 100 each 5000000
10% Prefer share Rs 800000
Reserve and surplus Rs 2000000
Market Price of Equity shares Rs 300

Solution

38
6. From the following data, calculate operating, Financial and Combined Leverages.

Interest = Rs 10000
Sales = Rs 15000 units @ Rs 10 per unit
Variable cost = Rs 4 per unit
Fixed Cost = Rs 20000

Solution

39
7. The following data are available for X ltd

Selling price per unit = Rs 120

Variable cost per unit = RS 70
Total fixed cost = 200000
1) What is the operating leverages When X ltd produces and sells 6000 units?
2) What is the percentages change that will occur in the EBIT of X ltd if output increase by 5 %

Solution

40
8.. An analytical statement of X ltd is shown below. It is based on an output ( Sales ) level of 80000 units.
Sales = Rs 960000
Less; Variable cost = Rs 560000
Contribution 400000

Less; Fixed cost = Rs240000

EBIT = 160000
Less ; Interest = 60000

EBT = 100000

Less; Income tax = 50000

Net Income = 50000

Calculate; a) Operational leverages

b) Financial leverages
c) Combined leverages

Solution

41
9. The installed capacity of a factory is 700 units .The actual exploited capacity is 500 units. Selling price
is Rs 10 and variable cost is Rs 6 per unit. Calculate the operating leverages in each of the following
situation.
a) When fixed costs are Rs 500
b) When fixed costs are Rs 1100
c) When fixed cost are Rs 1500.

Solution

42
 10. Calculate Financial leverages and Operating leverages under situation A and B Financial plan
1 and 11 respectively from the following relating to the operation and capital structure of ABC
ltd,

Installed capacity = 1000 units

Actual Production and Sales = 800 units
Selling price per unit = Rs 20
Variable Cost per unit = Rs 15
Fixed Costs ; Situation A; =Rs 800
Situation B = Rs 1500

Capital Structure; Financial plan

1 11

Equity capital Rs 5000 Rs 7000

Debt Rs 5000 Rs 2000
Cost of Debt @ 10 %

Solution

43
11. From the following Financial data , for companies A, B, and C, Prepare their income statements.

A B C
Variable cost as a percentage of sales 66 2/3 75 50
Interest expense Rs200 Rs 300 Rs1000
Degree of operating leverages 5-1 6-1 2-1
Degree of financial leverages 3-1 4-1 2-1
Income tax rate 50% 50% 50%

Solution

44
12. Balance sheet of X ltd as on 31.03.2010

Liabilities assets
Equity share capital(Rs 10 each) 60000 Net Fixed Asset 150000
10% Debentures 80000 Current Assets 50000
Retained Earnings 20000
Current liability 40000

200000 200000

The company total turnover ratio is 3. Its Fixed operating cost are Rs 100000 and variable costs ratio is
40 % The income tax rate is 50 %
a) Calculate for the company all the three type of leverages
b) Determine the likely level of EBIT if EPS is Rs 5

Solution

45
13. Jawahar ltd balance Sheet as on 31.03.2010

LIABILITIES ASSETS
Equity share capital 1500000 Fixed Assets 2000000
Pref share capital ( 5% ) 300000 Current assets 500000
10 % Debentures 200000
Reserve & Surplus;
P& L 200000
General Reserve 100000
Current liability 200000
2500000 2500000

The Net Profit before interest and taxes amount Rs 125000. Firm has the tax liability of 50 % .calculate
Return on capital employed and Return on Net worth Ratio.

Solution

46
14. Calculate return on Gross capital employed Net capital employed and On Average capital employed
from the following information by making a provision of Rs 20000 for tax out of current years profit.

X ltd Balance sheet as on 31.03.2010

LIABILITIES ASETS
Equity Share capital 400000 Fixed Assets;-
10 %Debentures 200000 Land building 320000
Reserve fund 50000 Plant & Machinery 200000
Sundry crs 70000 Current assets;-
P&l ; Sundry debtors 70000
Previous year 30000 B/R 50000
Current year 70000 Bank balance 140000
Prelim exp 40000
820000 820000

Solution

47
15. The following is the Balance sheet of Bharath ltd for the year for the year ending 31.03.2010

LIABILITIES ASSETS
Equity share capital 300000 Good will 40000
Pref share capital 200000 Plant & Machinery 300000
P&L ( Including Rs 30000 P/Y ) 70000 Land & Building 200000
Debentures 200000 Furniture 30000
Creditors 50000 Stock 80000
B/P 50000 Debtors 50000
Cash 150000
Prelims exp 20000
870000 870000

Calculate;-

1. Gross Capital Employed

2. Net Capital Employed
3. Average Capital Employed

Solution

48
 4. DIVIDEND DECISIONS

Dividend is the distribution made by a company to its shareholders on their shareholdings out of
the profits or reserves available for the purpose. In other words, dividend refers to the divisible
profits of a company distributed or divided among its shareholders in proportion to their
shareholdings, as specified in the memorandum of association and articles of association.

SIGNIFICANCE OF DIVIDEND:

1. Dividend has a great impact on the current wealth and welfare of the shareholders, in the
sense that the dividend income increases their current wealth and welfare.
2. Dividend has impact on the value or wealth of the company.
3. It affects the funds left at the disposal of the company for future expansion and
modernization.
4. It affects the liquidity position of the company, as dividend distribution involves payment
of cash.
5. It affects the interest of the creditors and debenture holders.
6. It affects the market value or market price of the shares of the company, as the stock
market is likely to react to the declaration of dividend.
LEGAL AND PROCEDURAL ASPECTS RELATING TO DECLARATION OF

DIVIDEND:

1. There is no legal obligation on the part of a company to declare dividends its

shareholders.
2. Under the provisions of the Company Act of 1956, dividends can be paid by a company
out of the profits earned during current financial year or out of the undistributed profits of
the previous financial year.
3. Dividend cannot be paid out of capital.
4. As per the legal judgment in the case of Lubbock Vs. The British Bank of South America
dividends cannot be paid out of capital profits.
5. No dividends can be declared for the past years for which accounts have been closed.
6. U/s 205 of the Company Act, dividend can be paid out of the profits of the current
financial year only after providing for depreciation and after transferring to reserve such
percentage of profits as specified by the company law.
7. The rights of the creditor must be protected before dividends are declared.
8. The right to declare dividend is the prerogative of the board of directors. As such the
board of directors must in a formal board meeting, pass a resolution to pay the dividends.
9. The resolution of the board of directors to pay the dividend has to be approved by the
shareholders in the annual general meeting.
10. The dividend is payable only those shareholders whose names appear in the register of
members as on the date of declaration of dividend.
11. Once the dividend is declared dividend warrant must be posted to the shareholders within
42 days from the date of declaration of dividend, with in a period of 7 days after the
expiry of the 42 days, the unpaid dividend should be transferred to a special A/c opened
with scheduled banks.
49
 FORMS OF DIVIDEND:
1. Cash dividend.
2. Stock dividend.
3. Scrip dividend.
4. Bond dividend.
5. Optional dividend.

1. CASH DIVIDEND: Cash dividend is the dividend, which is distributed to the shareholder in
cash out of the earnings of the business.

2. STOCK DIVIDEND: Stock dividend is the dividend, which is paid to the shareholders in
kind when stock dividends are paid, a portion of the surplus is transferred to the capital account
and shareholders are issued additional share certificates. Such shares are known as bonus shares
and this process is known as capitalization of profit. This dividend is declared to only equity
shareholders and it may take two forms. Making the partly paid equity shares fully paid up
without asking for cash form the shareholders. Issuing or allotting equity shares to existing
shareholders in a definite proportion out of profit (or surplus).

3. SCRIP DIVIDEND: When earnings of the company justify dividend, but company’s cash
position is temporarily weak and does not permit cash dividend, it may declare dividend in the
form of scrips. In this method of dividend, the shareholders are issued transferable promissory
notes which may or not be interest bearing scrip dividend are justified only when the company
has really earned profit and has only to wait for the conversion of other current assets into cash is
the course of operations.

4. BOND DIVIDENDS: Sometimes, the dividends are paid in bonds or notes than have a long
enough term to fall beyond the current liability group. Effect of both scrap dividend and bond
dividend is the same except that the payment is postponed in the bond dividends.

FACTOR’S INFLUENCING DIVIDEND POLICY:

1. Stability of earnings.
2. Financing policy of the company
3. Liquidity of funds.
4. Dividend policy of competitive concerns.
5. Past dividend rates.
6. Debt obligation
7. Ability to borrow
8. Growth needs of the company
9. Profit rates
10. Legal requirements
11. Policy of control
12. Corporate Taxation Policy
13. Tax position of shareholders
14. Effect of trade policy
15. Attitude of interested group

50
 OBJECTIVES OF STOCK DIVIDEND:

1. Conservation of cash
2. Lowering rate of dividend
3. Financing expansion programmer
4. Transferring the formal surplus and reserves to the shareholders
5. Enhanced prestige
6. Widening share market
7. True presentation of earning capacity.

ADVANTAGES OF STOCK DIVIDEND:

FOR THE COMPANY:

1. Maintenance of liquidity position

2. Satisfaction of shareholders
3. Economical of issue of capitalization
4. Remedy for under capitalizations
5. Enhanced prestige
6. Widening the share for market
7. Finance for expansion programmer
8. Conservation of control.

TO THE INVESTORS:

1. Increase in their equity

2. Marketability of shares is increased
3. Increased income
4. Increased demand for shares

THEORY OF RELEVANCE

According to this theory, the dividend decisions directly influence the value of the firm. If a
firm has higher returns that the cost of equity if it has the opportunities of investing finance
for expansion and diversification, can keep certain amount of profits in the form of retained
earnings. This method of financing increases the value of the firm or increases earnings per
share.

WALTER’S MODEL: Prof. Walter in his theoretical work established the relationship
between IRR (r) internal, rate of return and cost of capital (k) and its influence on the
dividend decisions to achieve wealth maximization his observations are presented below:
ASSUMPTIONS:

1. The form uses only retained earnings for financing investment opportunities. It does not
use debit or fresh equity issues.
2. The IRR (r) and the cost of capital (k) remain constant.

51
 3. Earnings and dividends do not change while determining the market value of shares (p)
4. The firm has a long lige

Walters formula for calculating the market value of shares:

D R(E-D)K
P= ----- + --------------
K K

Where P= Market price per share

D= Dividend per share
R= Internal rate of return
E= Earnings per share
K= Cost of Capital

GORDON’S MODEL: Gordon has also developed a model, which is based on the same
lines of Prof. Walter. He too stresses that the dividend policy of the company has a direct
bearing on the market value of shares. The only difference one can find the Gordon’s model
is, “The market value of a share is equal to the present value of infinite steam of dividends to
be received by the share”.

ASSUMPTIONS:

1. Like Walter model, Gordon model has also the relevance of investment decisions on the
dividend decisions.
2. The rate of return on this firm’s investment is constant.
3. The firm operates its investment activities only through equity.
4. Gordon’s model ignores risk involved in investments and assumes the discount rate of
firm remain constant.
5. The corporate taxes does not exist.
6. The retention ratio, once decided in constant forever.
7. The firm has perpetual life

FORMULA

E (1-b) D
P = -------------- or P = ---------
Ke – br Ke-g

P = Market price per share

E = Earning per share
B = Retained earnings
Ke = Cost of equity capital
Br, g = Growth rate

52
STABILITY OF DIVIDEND: Stability or regularity of dividend is regarded as a desirable
policy by the management of most business concerns. Most of the shareholders also prefer stable
dividends because all other things being the same stable dividends have a positive impact on the
market price of the share.

DIVIDEND PRACTICE:

1. Constant dividend per share.

2. Constant percentage of net earnings
3. Small constant dividend per share plus extra dividend.
4. Dividend as a fixed percentage of market value

SIGNIFICANCE OF STABILITY OF DIVIDEND:

1. Confidence among shareholders

2. Investors desire for current income
3. Institutional investors requirements
4. Stability in market price of shares
5. Raising additional finance.
6. Spreading of ownership of outstanding share
7. Reduce the chances of loss of control
8. Market for debentures and preferences shares

53
 5. WORKING CAPITAL MANAGEMENT

Working capital refers to that part of total capital which is used for carrying out of the routing or
regular business operations. In other words, it is the amount of funds used for financing the day
to day operations. In short it is the capital with which the business is worked over. Working
capital may be regarded as the life blood of a business. Its effective provision can do much to
ensure the success of a business.

CONCEPTS OF WORKING CAPITAL: (TYPES OF WORKING CAPITAL)

1. Gross working capital

2. Net working capital
3. Negative working capital
4. Permanent working capital
5. Variable working capital
6. Reserve working capital

FACTORS AFFECTING THE WORKING CAPITAL (DETERMINANTS OF W/C)

1. Nature Of Industry
2. Size of business
3. Manufacturing cycle
4. Production policy
5. Volume of sales
6. Term of purchaser and sales
7. Business cycle
8. Growth and expansion
9. Fluctuation in the supply of raw materials.
10. Price level changes
11. Operating efficiency
12. Profit margins
13. Profit appropriations
14. Credit policies of RBI
15. Capital structure of the company
16. Dividend policy
17. Taxes
18. Depreciation policy

54
SORUCES OF WORKING CAPITAL:

1. LONG TERM FINANCING

i. Loan from financial institutions, IFC, IDBI,SFC
ii. Floating debentures
iii. Accepting public deposits
iv. Issue of shares(equity – preference)
v. Raising funds by internal financing

2. SHORT TERM FINANCING:

i. Trade credit
ii. Bank credit
iii. Customer advances
iv. Short term public deposit

3. SPONTANEOUS FINANCING: Spontaneous financing refers to the automatic sources

of short term funds. The major sources of such financing are trade credit (creditors and
B/P) and o/s expenses. Spontaneous sources of finances are cost free.

DANGERS OF EXCESS WORKING CAPITAL:

1. It results in excess idle investments on inventory.
2. It indicates the defective credit policy.
3. It leads to managerial inefficiency.
4. It leads to unnecessary expenditure.

DANGERS OF INADEQUATE WORKING CAPITAL:

1. It stagnates the growth of the company
2. It becomes difficult to implement the management policies.
3. It leads to operational in efficiency
4. It becomes very difficult to exploit the fixed assets.
5. Market share for the products reduces
6. It directly affects the liquidity position of the company
7. Paucity of funds reduces the firms reputation.
ROLE OF FINANCE MANAGER IN WORKING CAPITAL MANAGEMENT
1. Knowledge of current assets.
2. Exploitation of available sources
3. Selection of the instruments
4. Current assets to fixed assets ratio
5. Selection of the approaches
6. General consideration

55
PROCESS OR STEPS INVOLVED IN WORKING CAPITAL MANAGEMENT:

Working capital management involves two processes. They are

1. Forecasting the amount of working capital
2. Determining the sources of working capital

CRITERIA FOR JUDGING THE EFFECIENCY OF WORKING CAPITAL

MANAGEMENT.

1. Current ratio
2. Quick ratio
3. Cash to current assets ratio
4. Sales to cash ratio
5. Average collection period
6. Average payment period
7. Inventory turnover ratio
8. Working capital turnover ratio
9. Working capital to net worth ratio

MEASURES TO BE ADOPTED FOR A SOUND WORKING CAPITAL

MANAGEMENT:

1. It should budget its cash flow.

2. It should control its debtors
3. It should control its creditors
4. It should control its stock
5. It should avoid over borrowing
6. It should avoid over investment in fixed assets.

Different aspects of working capital Management

Working capital management has different aspects. They are
1. Management of cash
2. Management of accounts receivables
3. Management of inventory.

Goals of Financial Management

1. Specific objectives
2. General objectives

Specific Objectives
1. Profit Maximization
2. Wealth Maximization

56
 WORKING CAPITAL MANAGEMENT -PROBLEMS

1. Prepare an estimate of Working capital requirement from the following information’s of a

Trading concern; -

a) Project annual Sales 100000 units

b) Selling Price Rs 8 per unit
c) Percentage net profit as Sales 25
d) Average credit period allowed to customers 8 weeks
e) Average credit period allowed by suppliers 4 weeks
f) Average stock holding in terms of sales requirements 12 weeks
g) Allow 10% for contingencies.

SOLUTION; -

57
2. X and company is desirous to purchase and has consulted you and one point as which you are
asked to advise them is the average amount of working capital which will be required is the first
years working. You are given the following estimates and are instructed to add 10% to your
computed figure to allow for contingencies
1. Amount Blocked up in stocks; -
Stock of finished goods - Rs 5000
Stock of material stores – Rs 8000
2. Average credit sales; -
Inland sales – 6 weeks credit =312000
Exports sales – 1-1/2 weeks =78000
3. Log in payment of wages and other out going
Wages -1-1/2 weeks = 260000
Stock of raw materials -1-1/2 months =48000
Rent royalties -6 months =10000
Clerical staff -1/2 months =62400
Managers -1/2 months =4800
Mice expenses -1-1/2 months = 48000
4. Indrawn profit on the Average throughout the year =11000
5. Payment in advance; -
Sundry expenses (paid quarterly in advance) = 8000

SOLUTION

58
3. A proforma cost sheet of a company provides the following particulars; -

Elements of cost - Amount in Rs per unit

Raw materials - 80
Direct lab our - 30
Overhead exp - 60
Total cost - 170
Profit - 30
Selling price - 200
The following particulars are available; -
a) Raw material is in stock on an average for one month.
b) Raw materials are in process on an average for half a month.
c) Finished goods are in stock on average for one month
d) Credit allowed by supplier is one month
e) Log in payments of wages is 1-1/2 weeks
f) Log in payment of O.H exp 1 month
g) 1/4 th of output is sold against cash
h) Cash in hand and Bank is expected to be Rs 25000
i) Credit allowed to customer 2 months
You are required to prepare a statement showing the working capital needed to finance a
level of activity of 104000 units of production. You may assume that the production is
carried on evenly throughout the year, wages and overhead accrue similarly and a time
period of 4 weeks is equivalent to a month.

SOLUTION

59
4. A proforma cost sheet of a company provides the following particulars; -

Elements of costs;-
Materials - 50%
Direct Lab our – 15%
Overhead - 15%
The following further particulars are available; -
1. It is proposed to maintain a level of activity of 300000 units.
2. Selling price Rs 20 per unit
3. Raw materials are expected to remain in stores for an average period of 2 months.
4. Materials will be in process as an average of one month.
5. Finished goods are required to be in stock for an average period of 2 months.
6. Credit allowed to debtors is 2 months.
7. Credit allowed by suppliers is 2 months
You may assume that sales and production follow a consistent pattern.

SOLUTION

60
5.X ltd sells its products on a gross profit of 20% on sales. .The following information is
extracted from its annual accounts for the year ending 31.12.2010

Sales 3 months credit = Rs 4000000

Raw materials = Rs 1200000
Wages paid-15 days in arrears = Rs 960000
Manufactures Expenses - 1 month arrear = Rs 1200000
Administrative expenses -1-month arrear = Rs 480000
Sales promotion exp payable ½ year advance = Rs 200000
Income Tax (Payable quarterly last installment falls due on Dec 2010 ) =Rs
400000
The company enjoys one month credit from supplier of Raw Material and maintain 2
months stock of Raw material and 1 ½ months stock of finished goods. Cash balance is
maintained at Rs 100000 as a precautionary balance. Assuming 10 % margin. Find out
Net Working Capital requirement of the company

SOLUTION

61
6. Prepare an estimate of working capital requirement from the following information of
a trading concern; -

A) Projected annual sales = 120000 units

B) Selling Price Rs 10 per unit
C) Percentage of net profit on sales =30
D) Average credit period allowed to Debtors = 10 weeks
E) Average credit period allowed by supplier = 5 weeks
F) Average stock holding in terms of sales requirement – 5 weeks
G) Allow 15 % for contingency

SOLUTION

62
7. Prepare an estimate of working capital requirement from the following data of a trading
concern; -

A) Projected annual sales = 80000 units

B) Selling price = Rs 8 per unit
C) Percentage of profit = 20 %
D) A/V Credit period allowed to Debtors =10 weeks
E) A/V Credit period allowed by supplier = 8 weeks
F) Average stock holding in terms of sales requirement = 10 weeks
G) Allow 20 % for contingencies.

SOLUTION

63
8. Proforma Cost sheet of a company provides the following particulars; -

Elements of cost;

Materials = 40 %

Direct Labour = 20 %

Overhead = 20 %

The following further particulars are available;

A) It is proposed to maintain a level of activity of 200000 units

B) Raw materials are expected to remains in stores for an average period of one month
C) Materials will be in process an averages of half month
D) Selling price is Rs 12 per unit
E) Finished goods are required to be in stock for an average period of one month
F) Credit allowed to Debtors in two months
G) Credit allowed by supplier is one month.

You may assume that sales and production follow a consistent pattern.

SOLUTION

64
9.A Proforma cost sheet of a company provides the following particulars.

Elements of cost - Amount per unit

Raw materials - 50 %
Direct labour - 10 %
Overheads - 10 %

The following particulars are available;

A) It is proposed to maintain a level of activity of 100000 units

B) Selling price is Rs 10 per unit
C) Raw materials are expected to be in the stores for an A/V of 2 months
D) Materials will be in the process an average of one month
E) Finished are required to be in stock for an A/V of 2 months
F) Credit allowed to debtors is 3 months
G) Credit allowed by supplier is 2 months

SOLUTION

65
10, Estimate the working capital requirement from the following information; -

You are given the following estimates and are instructed to add 20 % as contingencies; -
1, Amount blocked up for stocks;

a) Stock of finished product – 6000

b) Stock of stores of materials -10000

2, Average credit given; -

Inland sales - 8 weeks credit Rs 300000

Export sales - 2 weeks credit Rs 80000

3, log in payment of wages and other out goings; -

Wages - 2 weeks = 250000

Stock of materials – 2 months = 50000
Rent, Royalties - 6 months = 10000
Clerical staff - 1 months = 5000
Mis expenses - 2 months = 50000
Payment in advance - sundry expenses – (period quartley) =10000

SOLUTION

66