Business

Financial management
The money required for carrying out business activities is called Business finance.

F.M. is concerned with the optimal procurement as well as usage of finance/ funds.
In other words, it can be defined as planning, organising, directing and
controlling the financial activities of an organisation.

Need for business finance

1. To start and establish a business
2.To run day to day activities of business like payment of for raw material
salaries etc
3.To modernize, expand and diversify the business.
4.To purchase assets like land, building, trademarks, parents etc.

Role of Financial Management

Financial management influences the financial health of a business. Almost all

items in the financial statements are affected directly or indirectly through some
financial management decisions.
Some prominent examples of the aspects being affected by financial management are:

1. Size and the composition of fixed assets of the business: financial management
plays an important role in determining the size and composition of fixed assets of
business. For example, if we decide to invest a sum of Rupees 100 crores in fixed
assets,then this will change our total fixed assets block by this amount.
2. The Quantum of current assets and its breakup into cash inventory and
receivables: current assets are required for day to day transactions of business.
On the basis of investment in fixed assets, the amount of investment in current
assets is decided and then it is determined how much should be invested in cash,
stock, debtors etc
3. The amount of long term and short term funds to be used: every business needs
both long term and short term funds the cost and liquidity of long term sources is
higher than the cost and liquidity of short term sources does if more liquidity is
required in business then more cost will have to be borne. Long term debts
adversely affects the profitability because they are costly as compared to short
term debts.
4. Breakup of long term financing into debt- equity etc: Firm can raise long term
funds by issue of equity shares as well as issue of debentures and other borrowed
funds. Financial management helps in fixing the ratio between these sources.
5. All items in profit and loss account: all items in profit and loss account get
affected due to financial management decisions. For example more debt or equity
raised will lead to more interest or dividend payment, depreciation on fixed assets
etc.

Objectives of financial management

1.Ensure enough funds at reasonable cost.
2. Ensure safety of funds.
3. Ensure efficient effective and profitable use of funds.
4. Ensure that finance does not remain idle.
5. select the best and least costly source of finance,

Financial decisions
Financial decisions also called as finance function is concerned with three major
decisions which every finance manager has to take that is investment decisions,
financing decisions, and dividend decisions.
Investment decision : It relates to how the funds are invested in different assets
so that they are able to earn the highest possible returns for their investors.
Investment decision can be short term investment decision (also called as working
capital decisions) and long term investment decision ( called as capital budgeting
decisions).
*For example investment in new machines or opening a new branch.
*These decisions are very crucial for any business since they affect it's earning
capacity in the long run.
*The size of assets profitability and competitiveness are all affected by capital
budgeting decisions.

Importance of capital budgeting decisions:

1. Large amount of funds involved: investing long term projects involve amount of
funds and if wrong proposal is selected it may result in wastage of huge amount of
funds.
2. Long term growth: the capital budgeting decisions affect the long term growth of
the company. As the funds invested in long term assets brings returns in future and
enhances it's earning capacity in the long run.
3. Irreversible decisions: these decisions cannot be easily changed as they involve
huge funds and risk. These decisions must be taken with great care as reversing
them would mean huge loss to the firm.
4. Risk involved :The fixed capital decisions involve huge funds and also big risk
because the return comes in long run.

Factors affecting investment or capital budgeting decisions,:

1. Cash flows of the project whenever a company is investing use amount of funds in
some project it expect some regular cash inflows to meet the day today requirement.
Such cash flows should be analysed properly before investing in a particular
project.
2. Rate of return: The company should compare the rate of return expected from
different investment projects and select the one with higher return. For example,
if return on project A is 10% and on project B 12% then, obviously the company will
prefer project B.
3. Investment criteria involved: there are various criteria or calculations
involved while selecting an investment project, such as the rate of return, risk
involved, cash flows, interest rate etc. There are different capital budgeting
techniques to evaluate investment proposals example net present value internal rate
of return payback period etc. These techniques are applied to each proposal before
selecting a particular project.

What is meant by financing decision?

Explain different factors affecting the financing decision.

Financing decision relates to the quantum of funds to be raised from various long
term sources that is debt and equity. It is concerned with the decision about how
much funds are to be raised from debt and how much funds from equity. Financing
decision determines the overall cost of capital and the financial risk of the
enterprise. Debt and equity differ in terms of their cost and risk for the firm.
Cost of equity means the expected rate of return on equity capital for assuming
risk.
Cost of debt means the expected rate of return of lenders on debt capital for
assuming risk.
Depth is cheaper but it is more risky for a business firm because the payment of
interest and the return of capital is compulsory for the business where as equity
is less risky but more costly.
Financial risk is the chance that a firm would fail to meet its payment obligation
that is interest and principal amount. Thus, overall financial risk depends upon
proportion of debt in the total capital employed. If more debt is there in capital
employed, the firm is said to be in high financial leverage and if more equity is
there we say the firm is in low financial gear.
Factors affecting the financing decision,:
1. Cost: A wise manager generally prefers the cheapest source of finance and in
this sense, the debt capital is the cheapest source.
2. Risk: debt is cheaper but is more risky because interest payment is compulsory.
But in case of equity shares the payment of interest or the principal amount is not
compulsory so if a firm wants to take less risk it should go in for equity shares.
3. Flotation cost: Refers to the cost involved in issue of security for example
underwriting commission, brokerage, stamp duty, listing charges etc . Firms prefer
security with least floatation cost. for example bank loan.
4. Cash flow position: debt financing is better than financing through equity If
the cash flow position is strong.
5. Fixed operating cost: lower debt financing is better in case of high level of
fixed operating cost (example building rent salary etc).
6. Control consideration: Issue of equity shares may lead to dilution of management
control over the business. Companies which are upgrade of a takeover bed wood
prefer debt financing.
7. State of capital market: During the period when the stock market is rising
equity shares can be easily issued however during depressed capital market a
company may find it difficult to make equity issue and hence it may opt for debt.

Financial planning is essentially the preparation of a financial blueprint of an

organisation's future operations. It ensures that enough funds are available at the
right time. Financial Planning taked into consideration the growth, performance,
investment and requirement of funds for a given period of time.
Financial planning includes the following:
1. determination of amount of funds needed by enterprise for carrying out business
operations smoothly.
2. determination of sources of funds that is debt or equity.
3. determination of suitable policies for proper utilisation and administration of
funds.

That twin objectives of financial planning:

1. to ensure availability of funds whenever required:
which involves estimation of funds needed, the time at which these funds are to be
made available and the source of these funds.
2.To see that the firm does not raise resources unnecessarily:
As excess s funding is almost as bad as in adequate funding. So financial planning
ensures that enough funds are available at the right time.

Importance of Financial Planning:

1. It helps in avoiding business shocks and surprises:
By preparing the blueprint of various possible situations, the firm can avoid
business shocks and surprises and can be better prepared to face the different
types of situations in future.
2. The to face future eventualities: financial planning helps in forecasting what
may happen in future under different business situations and does prepares the form
to faces it.
For ex. If a company is expecting 20% growth in sales there are chances that it may
be 10% or maybe 30% .The planners prepare the blueprint for all the three
situations, so that the firm can well adjust to any of the situation which may
arise.
3. Helps in coordination: it helps in coordinating various functions like
production, sales, finance, purchase etc by providing clear cut policies and
procedures.
4. Helps in avoiding wastage of finance: detailed plan of action prepared under
financial planning helps in reducing waste, duplication of efforts and gaps in
planning.
5. Help to link present with the future: It helps to link present with future by
anticipating sale, growth etc.
6. Helps in creating link between investment and financing decisions: it helps in
deciding from where to raise the funds and in which project to make the investment
so that's the return on investment is highest.

Capital structure
It means the proportion of debt and equity used for financing the operations of
business.
Capital structure is equal to debt/equity. An ideal capital structure is one which
increases the wealth of equity shareholders and involves less risk.
Both Debt and Equity differ in their cost and risk.Debt is less costly but more
risky because regular interest payment is legal obligation for the business. If
company fails to pay interest then the security holders can claim over the assets
of the company.
2. Equity shares are expensive security but these are less risky from the companies
point of view.
If the company does not earn profits in a particular year then the payment of
dividend is not binding on the company.

Factors Affecting Capital Structure of a Company:

1. Cost of debt: if debt is available at a low rate of interest then the firms will
prefer the use of debt instead of equity because interest is a text detective
expense.
2. Risk consideration: financial risk refers to a position when a company is
unable to meet its fixed financial charges such as interest, payment to creditors
and preference dividend etc. If firms business risk is lower, than it can raise
more capit al by issue of debt security whereas at the time of high business risk
it should depend upon equities.
3. Cost of equity : Use of more debt increases the financial risk faced by the
shareholders. So their desired rate of return (cost of equity) also increases. So,
this point should be kept in mind while raising funds through debt.
3.Cost of equity: owners or equity shareholders expect a good rate of return on
their investment that is earning per share. As far as debt is increasing the EPS
then we can include it in capital structure but when EPS starts decreasing with
increase of debt, then we must depend upon equity share capital only.
4.Interest coverage ratio:
ICR =EBIT/Interest.
More death can be raised if ICR is high.
5. Tax rate: A higher tax rate makes debt relatively cheaper. So more debt can be
used. Interest is tax deductible item, where as dividend on equity is not tax
deductable.
6. Flexibility: if a firm uses its debt potential to the full, it loses flexibility
to issue further debt.
7. Cash flow position:
A company can use more debt if it can generate enough cash inflows to pay interest
on debt. company there for should study liquidity of its working capital before
including debt in the capital structure.
8. Control :
Equity shareholders are the owners of the company and they have full control over
the company. If existing shareholders want complete control on management then they
should prefer debt or the loans. But if they don't mind sharing their control then
they may go for equity shares.
9. Stock market condition:
If the stock markets are bullish, equity shares can be easily issued, even at a
higher price. However, during a bearish phase a company may find it difficult to
raise equity capital and hence it may opt for debt.
10. Capital structure of other companies:
Sometime the company follows capital structure of other successful company. But
proper care should be taken while following the capital structure of other company.
For example, if a firm cannot afford high risk it should not raise more debt only
because other firms are raising.
11. Debt service coverage ratio (DSCR)= profit after tax + interest+ non cash
expense/ preference dividend + interest + repayment obligation
A higher DSCR indicates better ability of the firm to meet the cash commitments, so
the companies potential to increase debt rises.
12. Floatation cost:
The source of finance with less floatation cost (example, cost of advertising)
should be preferred, example bank loan.
13.Return On Investment (ROI):
When the ROI of the company is greater than the rate of interest on debt then, firm
can use more debt to increase the profit earned by the shareholders. But if return
on investment is less than the rate of interest to be paid on the borrowing then,
the company should avoid debt and rely on equity capital.

Factors affecting the working capital requirements of a business

1. Nature of business it influences the working capital required example are
trading firm requires less working capital as compared to a manufacturing form
which has to invest in raw material labour charges etc
2. Scale of operation an organisation operating at large scale needs more working
capital and small scale business needs small amount of working capital.
3. Business cycle different faces of Business cycle affect the requirement of
working capital by a firm in case of boom period larger amount of working capital
is required as compared to depression.
4. Seasonal factors during peak season larger amount of working capital is required
for carrying on business activity as compared to lean season.
5. Production cycle:
Production cycle is the time span between receipt of raw materials and its
conversion into finish goods. The firms with longer processing cycles need more
working capital where is forms with short production cycle can manage with less
working capital.
6. Credit allowed
A firm following liberal credit policy needs more working capital due to higher
amount of debtors. Where as in case of strict credit policy less working capital is
needed.
7. Credit availed:
Accompany enjoying liberal credit facilities from its supplier will need less
working capital.
8. Availability of Raw Material:
If the raw materials and other required materials are available freely and
continuously, then less working capital will be needed as less inventory has to be
maintained.
9. Level of competition:
If the market is highly competitive more working capital will be required.
10. Growth prospects:
If the growth potential of a firm is higher, it will require higher amount of
working capital so that it is able to meet higher production and sales target.
11. Inflation:
With rising prices larger amounts are required to maintain a constant volume of
production and sales. It will result in an increase in the working capital
requirements.
12. Operating efficiency:
It may reduce the level of raw materials, debtors and finished goods respectively,
resulting in lower requirement of working capital.