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PLUS TWO BUSINESS STUDIES

Chapter 9
FINANCIAL
MANAGEMENT

Prepared by:Sandeep Kumar N V

HSST Commerce,Katukukke HSS Kasaragod
Mob:9496357371,
E mail:sandeepneelian@gmail.com
Residence :PILICODE,KASARAGOD
+2 BUSINESS STUDIES
Chapter 9
Financial Management
Introduction :
Finance refers to money, cash or
fund available to carry out business
operations.
It is the life blood of business. A
business enterprise requires funds at
different stages - to start a business,
to operate and expand it.
 Financial management
deals with planning,
organizing, directing and
controlling financial
activities like procurement
and utilization of funds and
distribution of earnings to
owners.
IMPORTANCE OF
FINANCIAL
MANAGEMENT:
Importance of Financial Management:
All items in the financial statements
of a business are directly or indirectly
affected by the financial management
decisions, some of them are given
below
1.The amount of fixed assets:
Financial management
determine the size and
composition of fixed assets.
2.The amount of current assets:
Current assets are also
affected by the financial
management decisions.
3.Amount of long term and short
term funds:
It is the duty of the financial
management to take appropriate
decision in this regard.
4.Break-up of long-term
financing into debt, equity etc. :
Financial management
determine capital structure.
OBJECTIVES OF FINANCIAL
MANAGEMENT:
Objectives of financial management:
The main objective of financial management
is to maximize the wealth of the owners of the
company.
Other objectives include
1.Ensure safety on investment.
2.Plan a sound capital structure.
3.Distribute dividend to shareholders.
4.Ensure optimum funds utilization.
Objectives of financial management:
The main objective of financial management
is to maximize the wealth of the owners of the
company.
Other objectives include
1.Ensure safety on investment.
2.Plan a sound capital structure.
3.Distribute dividend to shareholders.
4.Ensure optimum funds utilization.
 FINANCE FUNCTION
or
FINANCIAL DECISIONS
 E
RE NS
TH SIO
CI
DE
Finance Function/ Financial Decisions:
Three important decision areas of a finance
manager is known as finance function. The finance
functions relate to three major decisions which
every finance manager has to take. They are
I). Investment decision
II). Financing decision and
III). Dividend decision
 INVESTMENT DECISION
FINANCING DECISION
DIVIDEND DECISION

FINANCE MANAGER
Finance Function/ Financial Decisions:

I
INVESTMENT
DECISION
Finance Function/ Financial Decisions:
I).Investment decision:
Investment decisions are decision
related to the selection of assets in which
funds will be invested by a firm. The
investment decision relates to how the
firm’s funds are invested in different
assets.
Finance Function/ Financial Decisions:
Generally two types of investment
decisions are to be taken by Finance
Manager.
They are decision relating to long term
investment and short term investment. Ie,
1.Long Term Investment decisions
2.Short Term Investment Decisions
 INVESTING FUND IN ASSETS

IN FIXED ASSETS IN CURRENT ASSETS

Long Term Investment decisions Short Term Investment Decisions

(Working capital decisions)
(Capital budgeting)
 Long Term Investment decisions
(Capital budgeting)

INVESTMENT
DECISION

Short Term Investment Decisions

(Working capital decisions)

FOCUS ARES - +2 BUSINESS – CHAPTER 9 - FINANCIAL MANAGEMENT

Finance Function/ Financial Decisions:
1.Long Term Investment decisions:(Capital
expenditure decision or capital budgeting.)
The decision of investing funds in the long
term assets like plant and machinery, land
and building etc. is known as Capital
Budgeting.
These decisions involve huge amount of
investment, affect the earning capacity and
are irreversible.
2.Short Term Investment Decisions: (Working
capital decisions)
Decisions relating to investment of fund in
current asset is known as Short- term
investment decisions or working capital
decisions or liquidity decision. This decision
affect day to day working of business. E.g.,
Level of cash in hand, inventory etc.
 FIXED CAPITAL

CAPITAL Long Term Investment decisions

(Capital budgeting)

INVESTMENT
WORKING CAPITAL
DECISION

Short Term Investment Decisions

(Working capital decisions)
FACTORS AFFECTING
CAPITAL BUDGETING
(Investment decisions)
 FACTORS AFFECTING CAPITAL BUDGETING

a)Cash flow of the project :

The inflow and outflow of cash
in the business should be
considered before making capital
budgeting decisions.
 FACTORS AFFECTING CAPITAL BUDGETING

b)The rate of return:

While selecting a project, the
rate of return must be considered.
The company compares the return
from different investment
proposals.
 FACTORS AFFECTING CAPITAL BUDGETING

c).Investment criteria involved:

A number of calculations are to be
made with respect to amount of
investment, interest rate, cash flows,
rate of return etc. While making
investment decision.
Finance Function/ Financial Decisions:

II
FINANCING
DECISION
II).Financing Decision:
The main sources of funds for a
firm are shareholders’ funds and
borrowed funds.
Owned funds consist of equity share
capital, preference share capital and
retained earnings.
 Borrowed funds include
debentures, Long term loan &
Public deposit
Thus financing decision is
concerned with designing the
capital structure ie, a combination
of different sources of finance.
 OWNERS FUND BORROWED FUND

EQUITY SHARE CAPITAL DEBENTURES

PREFERENCE SHARE CAPITAL LONG TERM LOAN

RETAINED EARNINGS PUBLIC DEPOSIT

 EQUITY PREFERENCE
SHARE SHARE

LONG TERM DEBENTURE

LOAN
FACTORS AFFECTING
FINANCING DECISIONS
 Factors affecting financing decision:
a).Cost:
The costs of raising funds through
different sources are different. The
finance manager always prefers the
source with minimum cost.
 Factors affecting financing decision:
b)Risk:
The risk associated with each
of the sources is different. Risk
involved in each source should
be evaluated.
 Factors affecting financing decision:
c)Floatation Costs:
It is the cost incurred for
floating securities. It is
generally less in the case of
debt, when compared to
equity.
 Factors affecting financing decision:
d)State of Capital market:
During boom period, more people
invest in equity. During depression,
people does not like to take risk and
are not interested in buying equity
shares.
 Factors affecting financing decision:
e)Control Considerations:
Issues of more equity may
lead to dilution of
management’s control over the
business.
Factors affecting financing decision:

f)Cash flow position:

A stronger cash flow
position recommends more
debt financing.
Finance Function/ Financial Decisions:

III
DIVIDEND
DECISION
III).Dividend decision:
Dividend is that portion of profit which is
distributed to shareholders.
A company has to decide how much profit
to distribute as dividend and how much to
retain for investment in the business.
Dividend decision relates to the
appropriation of earned profits.
 DIVIDEND

PROFIT
RESERVE
(RETAINED EARNINGS)
FACTORS AFFECTING
DIVIDEND DECISIONS
DIVIDEND DECISION-Factors affecting dividend decision:
a)Amount of earnings
b)Stability Earnings
c)Growth Opportunities
d)Cash flow position
e)Shareholders’ Preference
f)Taxation Policy
g)Stock Market Reaction
h)Legal Constraints
i)Contractual Constraints
DIVIDEND DECISION-Factors affecting dividend decision:

a).Amount of earnings :
Dividend decision is
always depend on the
amount of profit during
the current period.
DIVIDEND DECISION-Factors affecting dividend decision:

PROFITABILITY POSITION OF A & B COMAPNY

b)Stability Earnings: YEAR A B
If a company has COMPANY COMPANY

2018 25LAC 12 LAC

stable earnings, it
will provide high 2019 26 LAC 50 LAC

dividends to its 2020 25 LAC 2 LAC

shareholders.
DIVIDEND DECISION-Factors affecting dividend decision:

c)Growth Opportunities:
Companies having good growth
opportunities retain more money
out of their earnings so as to
finance the required investment.
DIVIDEND DECISION-Factors affecting dividend decision:

d)Cash flow position :

Payment of dividend involves
outflow of cash, therefore, enough
cash must be available for the
declaration of dividend.
DIVIDEND DECISION-Factors affecting dividend decision:

e)Shareholders’ Preference:
While declaring
dividends, managements
must keep in mind the
preferences of the
shareholders in this regard.
DIVIDEND DECISION-Factors affecting dividend decision:

f)Taxation Policy:
Taxation policy of government also
influences dividend decision. If tax on
dividend is higher, it is better to pay less
dividend.
DIVIDEND DECISION-Factors affecting dividend decision:

g)Stock Market Reaction:

Investors generally evaluate
the companies on the basis of
their dividend declaration
status. Higher the rate of
dividend gives a positive
impact in the market.
DIVIDEND DECISION-Factors affecting dividend decision:

h)Legal Constraints :
While declaring
dividends, the companies
have to follow the
restrictions laid down by
Companies Act.
DIVIDEND DECISION-Factors affecting dividend decision:

i)Contractual Constraints:
The companies are
required to ensure that the
dividend does not violate the
terms of the loan agreement
in this regard.
DIVIDEND DECISION-Factors affecting dividend decision:

a).Amount of earnings
b)Stability Earnings
c)Growth Opportunities
d)Cash flow position
e)Shareholders’ Preference
f)Taxation Policy
g)Stock Market Reaction
h)Legal Constraints
i)Contractual Constraints
FINANCIAL
PLANNING
 When the process of
planning employed in
finance, it is called
financial planning.
 Financial planning is the plan
needed for estimating the fund
requirements of a business and
determining the sources for the same.
Financial planning includes both
short-term as well as long-term
planning.
OBJECTIVES
OF FINANCIAL
PLANNING:
Objectives of Financial Planning:
Financial planning strives to achieve the
following twin objectives.
1.To ensure availability of funds whenever required:
The objective of financial planning is to ensure
that enough funds are available at right time.

2.To ensure that the firm does not raise resources

unnecessarily:
Surplus funds does not earn returns but adds to
costs.
IMPORTANCE
OF FINANCIAL
PLANNING:
Importance of financial planning:
1.It helps in forecasting what may happen in
future under different business situations.
2.It helps the company to prepare for the
future.
3.It helps in co-ordinating various business
functions.
4.Helps to reduce waste, duplication of efforts.
5.It makes the evaluation of actual
performance easier.
 CAPITAL
STRUCTURE
Prepared by: Sandeep Neelian , Kasaragod
CAPITAL STRUCTURE
 OWNERS FUND BORROWED FUND

EQUITY SHARE CAPITAL DEBENTURES

PREFERENCE SHARE CAPITAL LONG TERM LOAN

RETAINED EARNINGS PUBLIC DEPOSIT

 EQUITY PREFERENCE
SHARE SHARE

LONG TERM DEBENTURE

LOAN
 Capital structure refers to the
mix or composition of long term
sources of funds such as equity
share capital, preference share
capital, debentures, long term
loans and reserves and surplus.
 In other words, it refers to the
proportion of borrowed funds to owner’s
funds. (It is a mix between owners’ funds
and borrowed funds).
That proportion of debt and equity,
which results in an increase in the value
of equity share may be called the optimal
capital structure.
FACTORS AFFECTING THE
CHOICE OF CAPITAL
STRUCTURE:
FACTORS AFFECTING THE CHOICE OF CAPITAL STRUCTURE:

1.Trading on equity or Financial leverage

2.Floatation cost
3.Risk consideration
4.Flexibility
5.Capital structure of other companies
6.Legal frame work:(Regulatory Framework)
7.Stock market conditions
8.Cash Inflow of the business
9.Tax Rate:
10.Control:
 FACTORS AFFECTING THE CHOICE OF CAPITAL STRUCTURE:

1.Trading on equity or Financial leverage

or capital gearing:
Trading on equity refers to the use of
the fixed income bearing securities
(debentures, preference shares etc.) in the
capital structure of a company, with a
view to increase return on equity shares.
 NO
OWNERS FUND FIXED
DIVIDEND
BORROWED FUND

EQUITY SHARE CAPITAL 7% DEBENTURES

9% PREFERENCE SHARE CAPITAL

LONG TERM LOAN
Interest @ 8.2%
 FACTORS AFFECTING THE CHOICE OF CAPITAL STRUCTURE:

2.Floatation cost :
It is the cost incurred for
floating (issue) securities
such as brokerage,
underwriting commission
etc. It is generally less in
case of debts.
 FACTORS AFFECTING THE CHOICE OF CAPITAL STRUCTURE:

3.Risk consideration:
Use of debt increases the
financial risk of the business.
Financial risk refers to a position
when a company unable to meet its
fixed financial obligation like
payment of interest, dividend on
preference shares etc.
 FACTORS AFFECTING THE CHOICE OF CAPITAL STRUCTURE:

4.Flexibility:
The capital structure should
be designed in such a way that
the company should be able to
effect changes as and when
required.
 FACTORS AFFECTING THE CHOICE OF CAPITAL STRUCTURE:

5.Capital structure of other

companies:
A useful guidelines in the
capital structure planning is the
debt equity ratios of other
companies in the same industry.
 FACTORS AFFECTING THE CHOICE OF CAPITAL STRUCTURE:

6.Legal frame work:

(Regulatory Framework)
The structure of capital
of a company is also
influenced by the statutory
requirement applicable to
them.
 FACTORS AFFECTING THE CHOICE OF CAPITAL STRUCTURE:

7.Stock market conditions:

In the times of depression
debentures are consider good
while equity shares find a
better market during raising
prices. (Boom period).
 FACTORS AFFECTING THE CHOICE OF CAPITAL STRUCTURE:

8.Cash Inflow of the

business :
Companies which have
regular cash inflow can
issue more debt capital as
they are in a position to
repay the debt regularly.
 FACTORS AFFECTING THE CHOICE OF CAPITAL STRUCTURE:

9.Tax Rate:
Since interest is a
deductible expense, cost
of debt is affected by the
tax rate.
 FACTORS AFFECTING THE CHOICE OF CAPITAL STRUCTURE:

10.Control:
If the control of the
management is to be
retained, debt financing is
recommended for raising
additional fund.
FACTORS AFFECTING THE CHOICE OF CAPITAL STRUCTURE:

1.Trading on equity or Financial leverage

2.Floatation cost
3.Risk consideration
4.Flexibility
5.Capital structure of other companies
6.Legal frame work:(Regulatory Framework)
7.Stock market conditions
8.Cash Inflow of the business
9.Tax Rate:
10.Control:
TYPES OF CAPITAL
FIXED CAPITAL &
WORKING CAPITAL
Fixed Capital:
Fixed capital represents a long
term investment which needed to
acquire fixed assets like land and
building, plant and machinery,
vehicles etc.
 Fixed assets are those assets which are
required for permanent use and are not
meant for resale.
It must be financed through long-term
sources of capital such as equity or
preference shares, debentures, long-term
loans etc.
Importance of
management of fixed capital:
Importance of management of fixed capital:

1.Long term growth:

It will affect the future
prospects of the business.
Importance of management of fixed capital:

2. Large amount of funds involved:

Purchase of fixed assets involve
huge amount of fund. Therefore
detailed analysis should be
undertaken before such decisions.
Importance of management of fixed capital:

3.More risk:
It involve investment of huge
amount. Therefore fixed capital
influence the overall business risk.
Importance of management of fixed capital:

4.Irreversible decisions:
These decisions once taken,
are not reversible without
incurring heavy losses.
FACTORS AFFECTING
FIXED CAPITAL:
FACTORS AFFECTING FIXED CAPITAL:

1.Nature of business
2.Scale of Operations:(Size of the Company)
3.Choice of technique(Use of technology):
4.Technology up gradation:
5.Growth prospects
6.Diversification
7.Method of acquiring fixed assets
8.Collaboration
FACTORS AFFECTING FIXED CAPITAL:
1.Nature of business:
The nature of business
determine how much fixed
capital is required. eg,a
manufacturing concern needs
more fixed capital as compared
to a trading concern
FACTORS AFFECTING FIXED CAPITAL:

2.Scale of Operations:(Size of
the Company)
Large scale business
generally require huge
investments in fixed capital
than a small scale business
organization.
FACTORS AFFECTING FIXED CAPITAL:

3.Choice of technique(Use
of technology):
Highly mechanized and
automated industries
require large amount of
fixed capital.
FACTORS AFFECTING FIXED CAPITAL:
4.Technology up gradation:
In certain industries assets become obsolete
sooner. It requires replacement of old machine.
Higher investments in fixed assets may
therefore require for such business.
FACTORS AFFECTING FIXED CAPITAL:

5.Growth prospects :
Higher investment in
fixed capital is necessary,
if the organization is in
the way of growth and
expansion.
FACTORS AFFECTING FIXED CAPITAL:

6.Diversification:
When a firm diverts its
operations to new
segments, higher fixed
capital requirement
arises.
FACTORS AFFECTING FIXED CAPITAL:

7.Method of acquiring
fixed assets : INSTALMENT
If it is on hire purchase
or lease system, less
amount of investment is
required .
FACTORS AFFECTING FIXED CAPITAL:

8.Collaboration:
By collaborating with AIRTEL
other firms, the VI

requirement of fixed
capital can be reduced,
e.g., establishment of B
S
N
Mobile towers jointly . L
FACTORS AFFECTING FIXED CAPITAL:

1.Nature of business
2.Scale of Operations:(Size of the Company)
3.Choice of technique(Use of technology):
4.Technology up gradation:
5.Growth prospects
6.Diversification
7.Method of acquiring fixed assets
8.Collaboration
WORKING CAPITAL
 Working capital is that part of capital
required for investing in short term or
current assets like inventory , bills
receivables, sundry debtors, cash
required for day to day affairs like
salaries, wages, rent, etc.
Gross working capital:
Gross working capital = Total current assets
Gross working capital is the total value of
current assets.
Net working capital:
On the other hand net working capital is
the excess of current assets over current
liabilities.
Net working Capital=Current Asset – Current Liability
 Gross working capital is the total value of
current assets. On the other hand net working
capital is the excess of current assets over
current liabilities.
Gross working capital = Total current assets
Net working Capital=Current Asset – Current
Liability
Gross working Capital=Total Current Asset

Net working Capital=Current Asset – Current Liability

 FACTORS AFFECTING
THE REQUIREMENT OF
WORKING CAPITAL:
FACTORS AFFECTING WORKING CAPITAL:

1.Nature of business
2.Scale of operations:(Size)
3.Seasonal operations:
4.Business Cycle:
5.Production cycle:
6.Credit allowed:(Terms of sale)
7.Credit availed:(Terms of purchase)
8.Level of competition
9.Availability of raw materials
FACTORS AFFECTING WORKING CAPITAL:

1.Nature of business :
The amount of working
capital depends upon the type
or nature of business. Trading
units require less working
capital than manufacturing
industries.
FACTORS AFFECTING WORKING CAPITAL:

2.Scale of operations:
(Size)
Firms which operate
on a large scale require
more working capital
than small scale firms.
FACTORS AFFECTING WORKING CAPITAL:

3.Seasonal operations:
Industries that produce
and sell seasonal goods
require large amount of
working capital during the
peak season.
FACTORS AFFECTING WORKING CAPITAL:

4.Business Cycle:
In boom period, when the
business is prospering , large
amount of working capital is
required.
FACTORS AFFECTING WORKING CAPITAL:

5.Production cycle:
Duration and the length of production
cycle, affects the amount of funds required for
raw materials and expenses. It is the time
span between the receipt of raw material and
their conversion into finished goods.
FACTORS AFFECTING WORKING CAPITAL:

6.Credit allowed:(Terms of sale)

Those enterprises which sell goods on cash
basis need little working capital but those who
provide credit facilities to the customers need
more working capital.
FACTORS AFFECTING WORKING CAPITAL:

7.Credit availed:(Terms of purchase)

If a business gets credit facility from its
suppliers for goods, lesser would be the
working capital requirement.
FACTORS AFFECTING WORKING CAPITAL:

8.Level of competition :
In case the competition is
high, more shall be the stock
of finished goods, this
increases working capital
requirement.
FACTORS AFFECTING WORKING CAPITAL:

9.Availability of raw materials:

If raw materials are available
regularly without any shortage, less
working capital is needed.
FACTORS AFFECTING WORKING CAPITAL:

1.Nature of business
2.Scale of operations:(Size)
3.Seasonal operations:
4.Business Cycle:
5.Production cycle:
6.Credit allowed:(Terms of sale)
7.Credit availed:(Terms of purchase)
8.Level of competition
9.Availability of raw materials
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Prepared by:Sandeep Kumar N V

HSST Commerce,Katukukke HSS Kasaragod
Mob:9496357371,9961658658
E mail:sandeepneelian@gmail.com
Residence :PILICODE,KASARAGOD
SANDEEP NEELIAN, KASARAGOD