@ Financial Management Que. What is business finance? ‘Ans. Business Finance means money or funds available for a business for operations. It is indispensable for the survival and || growth of the business, for the production and distribution of goods and meeting day-to-day expenses etc. Finance is needed to establish a business, to run it, to ||-modernise and expand, or diversify it. Que. What is financial management? Ans "Financial management involves the application of general management principles tovparticular financial operation” Financial Management is concerned with optimalprocurement as well as the usage of finance. Que. What is role of financial management? Ans, Role of financial management are as follo 1, Size and the composition of fixed assets:- Size and || composition of fixed assets is depent upon the decision of finance in business. How much proportion is needed to spend on a fixed asstes.2, Size and composition of current asstes:-The size and composition of fixed assets are dependent upon the decision oF finance in business. How much proportion is needed to spend on a fixed asset. 3. The amount of long-term and short-term funds:- The amount of long-term and short-term funds is dependent upon the financial management of an organization. 4.Break-up of long-term financing into debt, equity etc:- Rising of fund is also dependent upon the financial ‘management of an organisation. How much debt equity ratio organisation wants to maintain. SAll items in the Profit and Loss:-A bigger amount of debt indicates a larger future interest expense. Similarly, the use of ‘more equity may result in bigger dividend payments. Similarly, a business expansion as a result of a capital budgeting choice is likely to effect almost all items in the company's profit and loss statement. Que.Explain the objective of financial management. Ans. The objective of financial management are as follows: Profit maximization:- Profit maximisation is a financial management goal that focuses on enhancing a company's net || income or profitability. It includes set up plans and making decisions that will generate profit for the organisation.2. Maintenance of liquidity:- The maintenance of liquidity is an important goal of financial management. It refers to a || company’s capacity to satisfy its short-term obligations by || having enough cash or easily convertible assets. || B. Proper Utilisation of Funds:- The proper use of funds is an important goal of financial management. It refers to the efficient use of a company's financial resources in order to maximize value and achieve the organization's objectives. 4.Meeting of financial commitment to the creditor:- Meeting || the financial commitments to creditors is an important goal oF financial management. It refers to repaying borrowed money on |_time and meeting commitments to creditors. Que.Explain the three financial decisions and the factors || affecting them. |_Ans.Three financial decisions and the factors affecting them | are as follows:- Llnvestment Decision:- As a result, the investment decision is |_related to how the firm's finances are invested in various |_assets. Long-term or short-term investment decisions might be made, & Capital Budgeting is another name investment decision, These decisions have significance for any firm since they determine its long-term earning capacity. Capital budgeting decisions have an impact on asset size, proftability, and competitiveness. Also, such decisions generally involve large sums of money and are unchangeable except at a high cost.Importance of Investment decision or Capital Budgeting:- The importance of Investment decision or Capital Budgeting are as follows:- 1. Long-term growth:- Long-term growth is an important factor in financial management investment decisions, It involves making strategic decisions about how to allocate resources to ideas, assets, and opportunities that will provide long-term and profitable growth for the organization. 2.Large amount of fund involved:- The involvement of o huge amount of capital is a important factor in investing decisions. It highlights the value of careful investigation, evaluation, and decision-making when allocating large sums of money. Risk Involve:- Investment obviously involves some degree of risk, Financial managers must evaluate and understand the uncertainties and risks connected with different investment possibilities, This allows individuals to make sound decisions while taking into account the possible influence of unknown incidents. 4.lrreveasable decision:- An irreversible decision is one that, ‘once made, cannot be reversed or undone without significant expenses or implications. It highlights the significance of complete study, evaluation, and consideration of long-term implications in the context of investment decisions.Factors affecting an investment decision or Capital budgeting:- 1. Cash flow of the project:-The cash flow of a project is an important factor that influences investment decisions. The ‘movement of cash in and out of a project during a specified time period is referred to as cash How. Financial managers must determine if the project's estimated cash inflows are sufficient to cover the initial investment and create enough returm on investment. 2.Return on investment:- Return on investment (ROI) is a important factor that influences investment decisions. Financial managers evaluate an investment opportunity that gives expected return on investment. It must be evaluated by estimating profits over time and compare them to the initial investment cost. Higher projected RO! investments are often attractive and favorable for decision-making. B.lnvestment Criteria:- Investment criteria are specific benchmarks or guidelines that are used to rate and evaluate opportunities for investment. There are various factors involves in investment criteria such as CashHow, ROI, Risks, etc. 2.Finaneing decision:- Financing decision means from which source organisation has to rise funds. Whether from owner's fund or borrowed fund, or from both. This is one of the important decision for an organisation as it will directly impact on our organisation's value,Fi Hocting nancial dactainen 1. Costi= The price of raising money from various sources varies. A responsible financial manager would usually choose the cheapest source. 2. Risk:- The risk that is connected to each of the sources varies. Borrowed funds are riskier than owner's funds. So the finance manger evaluate which one he/she has to choose for the organisation. 3.Cash flow position:- A greater cash How situation may make debt financing easier than equity funding.Understanding the cash How of an organisation is essential when considering financing choices since it immediately impacts its ability to ‘meet financial obligations and make strategic decisions. 4.Control consideration:- More equity issues may result in a loss of management control over the organization. Debt financing does not have such an effect. Companies who are afraid of having their businesses taken over would choose debt over equity. S.Floating cost:- It refers to the costs related to the issue of securities, such as the broker's commission, underwriters fees, prospectus charges, and so on. The firm supports securities with the lowest flotation cost.$. Fixed Operating Costs:- 4 company with huge fixed operating costs must decrease fixed financing costs. As a result, lesser debt financing is preferable. Similarly, if the fixed operational costs are low, debt financing may be chosen. 2. State of Capital Markets:- The financial market conditions also influence the source of funds, If the capital market is rising, finance can be easily raised by issuing shares; however, during a downturn, issuing equity shares is difficult. B.Dividend Decision:-Dividends ore the portions of profits that are distributed to shareholders. The decision here is how much of the company's profit after taxes) should be paid to shareholders and how much should be maintained in the firm. Factors affecting the dividend decision:- LEarnings:-Dividends are paid from profits, therefore a company's earnings are an important factor in determining dividend decisions. Companies with high and accurate earnings ‘may announce high dividend rates. 2.Stabili 3=An organization with regular profits is in a stronger position to issue greater dividends.In contrast, an organization with uncertain earnings is more likely to pay a lower dividend.3.Cash Flow Positions:- The payment of dividends involves an outHow of cash. A company may be earning profit but may be short on cash. The availability of enough cash in the company is necessary for the declaration of dividends. 4. Growth Opportunities:-Companies with high growth potential keep more money from their earnings to finance the necessary investment. As a result, the dividend in growth business organizations is lower than in non-growing organizations S.. Stability of Dividends:- Companies often use a policy of dividend-per-share stabilization. Dividends are often increased when there is confidence that their earning potential has increased, rather than just the earnings for the current yeor. In other words, if the change in earnings is small or considered to be temporary, the dividend per share remains unchanged. 4 Preference shareholder: Management must take the preferences of the shareholders carefully when issuing dividends. Companies are likely to declare the same dividend if the shareholders as a group want at least a particular amount paid out. There will always be stockholders who depend on their investments for a regular income. ZTaxation Policy:-The difference between the tax treatment of dividends and capital gains influences the decision between paying a dividend and keeping the earnings to some extent. It is better to pay less in dividends if the tox rate is greater. Higher dividends may be declared in contrast to this if tax rates are comparatively lower. Although dividends are tax-free in the hands of shareholders, firms are subject to a dividenddistribution tax. As a result, shareholders are likely to choose greater payouts under the current tax regime. 8 Access to Capital Markets-Large and reputed companies generally have easy access to the capital market and, therefore, may depend less on retained earnings to finance their growth, These companies tend to pay higher dividends “than the smaller companies which have relatively low access to the market. 9.Legal constraints:-Under provisions of Companies Act, all earnings can’t be distributed and the company has to provide for various reserves. This limits the capacity of company to declare dividend. 10. Contractual Constraints:-Sometimes the lender may impose certain restrictions on the payment of dividends in Future while granting loans to a company. IStock Market Reaction:-An increase in dividend is usually seen favourably by investors, and this favourably impacts stock prices Similar to this, @ reduction in dividend may have a negative effect on stock market share prices.Therefore, when making a decision, management takes into account a number of important factors, one of which is the potential impact of the dividend policy on the price of equity shares.Que. What is financial planning? ‘Ans. It involves the preparation of a financial blueprint for an organization. It is the process of estimating the fund requirement of a business and determining the possible sources from which it can be raised. The objective of financial planning is to ensure that enough Funds are available at the right time. The objective of financial planning is to ensure that enough funds are available at the right time. Que.ldhat are the objectives of financial planning? Ans.Objectives of financial planning are as follows:- To ensure availability of funds whenever reguired:- This includes a proper estimation of the funds required for various purposes such as the purchase of long-term assets or meeting day-to-day business expenses, among others. Other than that, an estimate of the time when these funds will be available is required. Financial planning also attempts to identify the possible sources of these funds. 2.To see that the firm does not raise resources unnecessarily:- Excess funding is almost as bad as inadequate funding. Even if there is some surplus money, good financial planning would put it to the best possible use so that the financial resources are not left idle and don’t unnecessarily add to the cost.Que, What is the importance of financial planning? ‘Ans._The importance of financial planning are as follows:- 1. Makes the firm better prepared to face Futures-Jt helps in forecasting and preparing for the future under different business situations. It helps businesses set goals, allocate resources effectively, manage risks, make informed decisions, monitor performance, and communicate with stakeholders. 2Help in avoiding business shocks and surprises: Financial || planning helps businesses avoid shocks and surprises by fostering a proactive and strategic approach to financial ‘management. By maintaining emergency funds, managing cash flow, assessing and mitigating risks, conducting sensitivity analysis, and developing contingency plans, businesses can be better prepared to handle unexpected events and reduce their impact on financial stability. 3.Coordinates various functions:- It helps in co-ordinating various business functions, e.g., sales and production functions, by providing clear policies and procedures. 4.Proper utilisation of finance:-Detailed plans of action prepared under financial planning reduce waste, duplication of efforts so it helps in proper utilisation of finance. ‘S.Link present with future:- We makes a financial planning in present for the future task by keeping in mind the different aspects of a function so financial planning link present with future.6, Link between investment and financing decisions:-. lt provides a link between investment and financing decisions on a continuous basis as in financial planning we how we need to and on what to spend. | 2. Makes evaluation of actual performance earlier:- It || facilitates the evaluation of actual performance by explaining detailed objectives for various business factors. Que.What is capital structure? || Ans.Finding the right combination of debt and equity financing for a company's long-term success and sustainability is known as capital structure. Capital structure refers to the mix between owners and borrowed funds.lt gives the ratio of debt capital and equity capital in the capital structure. a SS Que, What is Financial leverage or trading on equity? ‘Ans.The proportion of debt in the overall capital is also called | financial leverage. a | Where D= Debt | And E= EquityQue. Explain factors determining the capital structure. Ans. Factors determining the capital structure are as follows:- 1. Cash Flow Position:-Before borrowing, the size of estimated cash Hows must be examined. Cash Hows must include not only cover fixed cash payment requirements but there must | also be an adequate reserve. It should be remembered that a firm has cash payment requirements for (i) normal business operations, (ii) investment in fixed assets, and Cili) meeting debt service commitments, such as interest payment and || principal payback. 2. Interest Coverage Ratio (ICR):-The interest coverage ratio refers tothe number of times earnings beforeinterest and taxes of a company covers the interest obligation. |The higher the ratio, lower shall be the risk of company failing to meet its interest payment obligations. 3. Debt Service Coverage Ratio(DSCR):- Debt Service Coverage Ratio takes care of the deficiencies referred to in the Interest || Coverage Ratio (ICR).The cash profits generated by the operations are compared with the total cash required for the service of the debt and the preference share capital. DSCR || take care of return of interest as well as principal repayment.A higher DSCR indicates a better ability to meet cash commitments and consequently, the company’s potential to increase the debt component in its capital structure. 4. Return on Investment (Rol):- Return on investment is an important factor that helps in deciding the capital structure. IF the Return on Investment is more than the Rate of Interest then the company must prefer debt in its capital structure whereas if the Return on Investment is less than the Rate of Interest to be paid on debt, then the company should avoid debt. S. Cost of debt:-A firm’s ability to borrow at a lower rate increases its capacity to employ higher debt. Thus, more debt can be used if debt can be raised at a lower rate. $. Tax Rate:- Higher tax rate makes debt cheaper as interest paid to debt security holders is subtracted from income before calculating tax whereas companies have to pay tax on dividend to be paid to shareholders, So high end tox rate means prefer debt whereas at low rate can prefer equity in capital structure. 2. Cost of Equity:- Another factor which helps indeciding capital structure is cost of equity. Owner or equity shareholder expect a return on their investment that is earning per share. As far as debt is increasing earning per share, then we can include it in capital structure but when ESP starts decreasing with inclusion of debt then we must depend upon equity share copital only.8. Floatation Costs:- Floatation cost is the cost involved in the issue of shares or debentures. These costs include the cost of advertisement, underwriting statutory fees, etc. Issue of share, debenture requires more formalities as well as more Hoatation cost. Whereas there is less cost involved in raising capital through loans or advances. 4, Risk Consideration;-The use of debt increases the financial risk of a business. Apart from the financial risk, every business has some operating risk (also called business risk). The business risk depends upon fixed operating costs. Higher fixed operating costs result in higher business risk and vice-versa. The total risk depends upon both the business risk and the financial risk, If a firm’s business risk is lower, its capacity to use debt is higher and vice-versa, 10, Flexibility:- Excess of bebt may restict the firms capacity to borrow further. To maintain flexibility it must maintain some borrowing power to take care of unforeseen circumstances. Hl, Control:-if the existing shareholder wants complete control then should prefer debt, loans of small amount. If they don't ‘mind sharing the control then they may go for equity share also.12, Regulatory Framework:- Every company operates within a regulatory framework provided by the law under SEB] guidelines. Companies have to follow the regulation of monetary policies, If SEBI guidelines are easy then companies ‘may prefer the issue of securities for additional capital whereas if monetary policies are more Hexible then they may go for more debt. 13, Stock Market Conditions:- If the stock market is in a boom period, equity shares are more easily sold even at a higher price. The use of equity is often preferred by companies in such @ situation. However, during a recession phase, a company, may find raising of equity capital more difficult and it may opt for debt. 14, Capital Structure of other Companies:- Some companies frame their capital structure according to industrial norms, But proper care must be taken as blindly following industrial norms may lead to financial risk. If firm cannot afford high risk it should not raise more debt only because other firms are raising. Que.lohat is Fixed copital? Ans.Fixed capital refers to investment in long-term assets. Investment in fixed assets is for longer duration and must be financed through long-term sources of capital. Decisions relating to fixed capital involve huge capital investments and are irreversible without incurring heavy losses. It is also called capital budgeting.Que, What are the factors affecting the requirement of fixed capital? Ans. Factors affecting the requirement of fixed capital are as follows:- 1. Nature of Business:- The type of business affects the fixed capital requirements. A trading company, for example, requires less investment in fixed assets than a manufacturing company because it does not need to purchase plant and machinery, etc. 2. Scale of Operations:-A larger organisation operating on a larger scale requires larger plant, more space, and so on, and thus requires a higher investment in fixed assets than a small organisation. 3. Choice of Technigue:-Some businesses are capital intensive, while others are labour intensive.A capital-intensive organisation must invest more in plant and machinery because it relies less on manual labour. Such organisations would have a greater need For fixed capital. Labor-intensive businesses, on the other hand, require less capital investment.As a result, their fixed capital requirement is lower. 4, Technology Upgradation:- An organization using obsolete |_ assets require more fixed capital as compared to other organizations. Growth Prospects:- Companies having higher growth prospects require more fixed capital investments, in order to expand their production capacity.5. Diversification:- 4 company may decide to diversify its operations for a variety of reasons. Fixed capital requirements increase as an outcome of diversification. 7. Avoilability of finance and leasing Facility:- Companies that can easily arrange financial and leasing facilities require less fixed capital because they can acquire assets in easy installments rather than paying a large sum all at once. If, on the other hand, easy loans and leasing facilities are not available, then more fixed capital is required because companies will have to buy plants and machinery in one payment. B.Level of Collaboration/joint venture:-Componies that prefer collaborations or joint ventures will require less fixed capital because they can share plant and machinery with their collaborations, whereas companies that prefer to operate as independent units will require more fixed capital. Que. What is working capital? ‘Ans.Working Capital refers to the funds required for the day to day operations of an organization. Apart from the investment in fixed assets every business organization needs to invest in the current assets, which can be converted into cash or cash equivalents within a period of one year. Working capital is of two types:- () Gross working capital: Investment in all the current assets is called as Gross Working Capital.(b) Net working capital:- The excess of current assets over current liabilities is called Net Working Capital. Que. Explain factors affecting the working capital requirement. Ans. Factors affecting the working capital requirement are as follows:- 1. Nature of Business:- The basic nature of a business enterprise influences the amount of working capital required by it. For example:-A trading organization needs a lower amount of working capital as compared to @ manufacturing organization, 2, Scale of Operations:-The quantity of inventory and debtors required by organisations operating on a larger scale is required a large amount of working capital when compared to smaller organisations. 3. Business Cycle:- When there is a boom in the economy, more production will be undertaken and so more working capital will be required during that time as compared to depression in the economy. 4.Seasonal Factors:- In peak season, demand for a product will be high and thus high working capital requirements will be |_more as compared to lean season.S$. Technology Production Cycle: When a company is using a labor-intensive technique then it needs more working capital as compared to a labor-intensive technique. The production cycle is the period between the receipt of raw materials and their conversion into finished goods. working capital requirements will be higher in firms with longer processing cycles and lower in firms with shorter processing cycles, $. Credit Alloweds- Different companies offer different credit terms to their customers. These are determined by the firm's level of competition as well as the creditworthiness of its customers. 4 liberal credit policy increases the number of debtors, increasing the need for working capital. 2. Credit Availed:-A firm allows credit to its customers it also may get credit from its suppliers. To the extent it avails the credit on purchases, the working capital requirement is reduced. 38. Operating Efficiency:- Different enterprises manage their operations with varied degrees of efficiency. Such efficiencies ‘may reduce the level of raw materials, finished goods and debtors resulting in lower requirement of working capital. 9. Availability of Raw Material: If the raw materials and other required materials are available freely and continuously, enterprise can maintain adequate stock of materials. If the lead time is more, larger the quantity of material to be stored and larger shall be the amount of working capital required.10, Level of Competition:- higher level of competitiveness, necessitate larger stocks of finished goods to meet urgent orders from prospective customers. I Inflation;-With rising prices, larger amounts are required even to maintain a constant volume of production and sales. The working capital requirement of a business thus, becomes higher with a higher rate of inflation. 12. Growth Prospects:- If the growth potential of concern is perceived to be higher, it will require a larger amount of working capital.