PROBABLE QUESTION (FFM)

✅ UNIT – 1 — SHORT QUESTIONS (3 Marks Each)

1. What is Finance?

Meaning:

Finance refers to the management of money and funds required for carrying out business or
personal activities.

Points:

1. It deals with raising, managing and using funds.

2. It focuses on investment and financing decisions.
3. Its objective is to maximize wealth and ensure smooth functioning of business.

2. What is Financial Management?

Meaning:

Financial management refers to planning, organizing and controlling financial resources to achieve
business goals.

Points:

• Ensures efficient procurement and utilization of funds.

• Aims to maximize shareholders’ wealth.
• Involves investment, financing and dividend decisions.

Mr Durga, you can make payment on 7853802279.

 3. Financial Decisions – Investment, Finance, Dividend

Meaning:

Financial decisions refer to the decisions taken by a firm regarding how money should be raised,
used and distributed.

Points:

1. Investment decision: Where and how much to invest.

2. Financing decision: How to raise funds (debt or equity).

3. Dividend decision: How much profit to distribute and retain.

4. Explain Time Value of Money (TVM).

Meaning:

Time value of money states that the value of money today is greater than its value in the future due
to earning capacity.

Points:

1. Money can earn interest over time.

2. Present value ≠ Future value.
3. Concept is used in investment and borrowing decisions.

2
 5. Write any three reasons of TVM.

Meaning:

Time value of money arises because value of money changes over time.

Points:

1. Interest earning capacity.

2. Inflation reduces purchasing power.
3. Risk and uncertainty of future cash flows.

6. What is Compounding in TVM?

Meaning:

Compounding refers to finding the future value of current money by applying interest over multiple
periods.

Points:

1. Converts present value into future value.

2. Involves earning interest on interest.
3. Used for long-term investment calculation.

3
 7. What is Discounting in TVM?

Meaning:

Discounting refers to finding the present value of future money by reversing the compounding
process.

Points:

1. Converts future value into present value.

2. Uses discount rate instead of interest rate.
3. Helps evaluate investment proposals.

8. What is Annuity?

Meaning:

Annuity is a series of equal payments made at regular intervals for a certain period.

Points:

1. Payments are equal.

2. Frequency is fixed (monthly/ yearly).
3. Examples: pensions, insurance installments.

4
 9. What is Perpetuity?

Meaning:

Perpetuity is a type of annuity where equal payments are made forever without any end.

Points:

1. Infinite duration of payments.

2. No maturity date.
3. Example: preference dividend.

10. Explain Rule 72 and Rule 69.

Meaning:

These are shortcut formulas to estimate the time required for money to double at a given rate of
return.

Points:

1. Rule 72: Time to double = 72 ÷ interest rate.

2. Rule 69: More accurate for continuous compounding.
3. Used for quick financial estimation.

Great 👍

5
 ✅ UNIT – 1 — LONG QUESTIONS

1. What is Financial Management? Explain the

objectives of it.

Meaning / Definition:
Financial management refers to the process of planning, organizing, directing and controlling
the financial resources of an organization for achieving its goals.

Explanation:
It involves estimating the financial requirements of the business, acquiring funds, allocating
funds efficiently and ensuring optimal utilization to maximize wealth.

Objectives of Financial Management:

1. Profit Maximization – To earn maximum profit for business survival and growth.

2. Wealth Maximization – To increase the market value of shareholders’ investment.

4. Efficient Utilization of Funds – To use available resources in the most productive way.

5. Maintain Liquidity – To ensure the business has enough cash to meet short-term obligations.

6. Ensure Safety of Investment – To maintain a balance between risk and return.

7. Sound Capital Structure – To maintain a balance between debt and equity.

6
 2. Briefly explain the functions of Financial
Management.

Meaning:
Functions of financial management refer to the activities performed to manage the financial
affairs of a business effectively.

Explanation with Functions:

1. Estimation of Financial Requirements

Forecasting how much finance is required for fixed and working capital.
2. Financial Planning
Preparing financial plans and budgets to achieve organizational goals.
3. Acquisition of Funds
Raising funds through equity, debt, loans, retained earnings etc.
4. Investment / Allocation of Funds
Allocating funds in profitable and safe projects to maximize return.
5. Dividend Decision
Deciding how much profit should be distributed and how much retained.
6. Working Capital Management
Managing current assets and current liabilities for smooth business operations.
8. Financial Control
Controlling financial activities through auditing, cost control, and performance evaluation.

7
 3. Explain the role of Chief Financial Officer (CFO).

Meaning:
A Chief Financial Officer (CFO) is the senior executive responsible for managing the financial
activities of an organization.

Explanation — Roles of CFO:

1. Financial Planning & Strategy

Prepares long-term and short-term financial strategies.
2. Capital Structure Decision
Decides the mix of debt and equity to minimize cost of capital.
3. Budgeting & Forecasting
Supervises preparation of budgets and financial projections.
4. Management of Cash & Working Capital
Ensures sufficient liquidity and smooth business operations.
5. Risk Management
Identifies and controls financial risks.
6. Financial Reporting & Compliance
Ensures accurate financial statements and compliance with law.
7. Investor Relations
Maintains communication with shareholders, analysts and regulatory authorities.

4. What is Risk? Explain the different types of risks.

Meaning / Definition:
Risk refers to the possibility of deviation between expected return and actual return on
investment.
Explanation:
In business and finance, risk indicates uncertainty regarding future outcomes and the
probability of financial loss.

8
 Types of Risks:

1. Business Risk
Risk due to change in operating conditions such as demand, competition and cost.
2. Financial Risk
Risk arising due to the use of debt in capital structure.
4. Market Risk
Uncertainty caused by market fluctuations such as price change and interest rate movement.
5. Operational Risk
Risk caused by human errors, system failures and inefficiencies in internal operations.
6. Credit Risk
Risk of loss due to default in payment by customers or borrowers.
7. Liquidity Risk
Risk of not having sufficient cash to meet short-term obligations.

9
✅ UNIT – 2 — SHORT QUESTIONS (3 Marks
Each)

1. Short-term sources of finance – Trade credit,

factoring, commercial paper etc.

Meaning:
Short-term sources of finance provide funds for a period of less than one year to meet
working capital needs.

Points:

1. Trade credit: Credit allowed by suppliers for purchasing goods.

2. Factoring: Selling accounts receivable to a financial institution for quick cash.
3. Commercial paper: Short-term unsecured promissory notes issued by large companies.

2. Medium-term sources – Preference shares, public

deposits, bank loans etc.

Meaning:
Medium-term sources of finance provide funds for a period of one to five years for business
expansion.

Points:

1. Preference shares: Capital raised by issuing shares with fixed dividend.

2. Public deposits: Money collected from the public for a fixed period.
3. Bank loans: Loans taken from banks for fixed instalment repayment.

10
 4. Long-term sources – Equity, debenture, retained
earnings etc.

Meaning:
Long-term sources of finance provide funds for more than five years for long-term
investment.

Points:

1. Equity shares: Funds raised by issuing ownership shares to shareholders.

2. Debentures: Borrowed funds raised through issue of debt instruments.
3. Retained earnings: Profits kept aside instead of distributing dividends.

5. What is Cost of Capital?

Meaning:
Cost of capital is the minimum rate of return a company must earn to maintain the market
value of its securities.

Points:

1. It is the cost of raising funds from various sources.

2. It acts as a benchmark for investment decisions.
3. It influences capital structure of a firm.

11
 6. What is Explicit Cost and Implicit Cost?

Meaning:
These are two types of costs related to raising capital.

Points:

1. Explicit cost: Actual cash outflow, e.g., interest and dividend payment.
2. Implicit cost: Opportunity cost of funds, e.g., sacrifice of alternative earnings.
3. Explicit cost is measurable, implicit cost is non-cash but real.

7. What are Specific Costs – cost of equity, cost of

preference, cost of debt?

Meaning:
Specific costs are the individual costs of each source of capital.

Points:

1. Cost of equity: Return expected by equity shareholders.

2. Cost of preference: Fixed dividend to preference shareholders.
3. Cost of debt: Interest payable on borrowed money.

8. Explain WACC – Weighted Average Cost of Capital.

Meaning:
WACC is the average cost of different sources of capital, weighted according to their
proportion in capital structure.

12
 Points:

1. Combines cost of equity, preference, and debt.

2. Used in investment appraisal and valuation.
3. Lower WACC helps maximize firm value.

9. What is Marginal Cost of Capital?

Meaning:
Marginal cost of capital is the cost of raising one additional rupee of new capital.
Points:

1. Refers to incremental cost of extra funds.

2. Increases when more capital is raised.
3. Used in capital budgeting decisions.

10. What is Cost of Retained Earnings?

Meaning:
Cost of retained earnings is the return that shareholders could have earned if profits were
distributed instead of retained.

Points:

1. It is an opportunity cost to shareholders.

2. Reinvested profits must earn expected return of shareholders.
3. Helps decide how much profit should be retained vs. Distributed.

13
 ✅ UNIT – 2 — LONG QUESTIONS

1. What is Finance? Explain about its sources.

Meaning / Definition:
Finance refers to the process of raising, managing and allocating funds to carry out business
activities effectively.

Explanation:
Every business needs finance for starting, operating and expanding its activities. Finance may
come from internal or external sources depending on requirement.

Sources of Finance:

(A) Short-term Sources (Below 1 year)

1. Trade Credit
2. Bank Overdraft
3. Commercial Paper
4. Factoring
5. Bill Discounting

(B) Medium-term Sources (1 to 5 years)

1. Bank Loans
2. Public Deposits
3. Hire Purchase

14
 4. Lease Finance
5. Preference Share Capital

(C) Long-term Sources (More than 5 years)

1. Equity Share Capital

2. Debentures / Bonds
3. Term Loans
4. Retained Earnings
5. Venture Capital

2. What is Cost of Capital? State its significance.

Meaning / Definition:
Cost of capital is the minimum rate of return that a firm must earn on its investments to
maintain the market value of its shares.

Explanation:
It represents the cost of obtaining funds from various sources such as equity, preference, debt
and retained earnings. It is used as a benchmark to evaluate investment proposals.

Significance of Cost of Capital:

1. Investments Decisions – Helps select profitable projects by comparing return with cost of
capital.
2. Capital Structure Decision – Helps decide proportion of debt and equity to reduce cost of
funds.
3. Dividend Policy – Guides the company whether to distribute or retain profits.
4. Performance Evaluation – Helps evaluate managerial decisions regarding financial
planning.
5. Valuation of Firm – Lower cost of capital increases firm value and shareholder wealth.

15
 3. Practical Problem on Short Term and Long Term Cost
of Capital.

📌 Note: For 10-mark and 3-mark exam, this question is solved when values are given.
Since no numerical is provided in the image, I will include the general formula sheet used in
solving.

(A) Cost of Debt (Kd):

Before Tax = Interest / Net Proceeds × 100

After Tax = Interest (1 – Tax Rate) / Net Proceeds × 100
(B) Cost of Preference Share (Kp):
Dividend / Net Proceeds × 100
(C) Cost of Equity (Ke):
Dividend / Market Price × 100
OR D1 / (P0 – F) + g (Dividend Growth Model)
(D) Cost of Retained Earnings (Kr):
Ke (1 – Flotation Cost)
(E) Cost of Debenture (Kd) with discount or premium:
Interest ± (Discount or Premium / Number of Years) / Net Proceeds × 100

4. State how would you determine Weighted Average Cost

of Capital (WACC) of a firm.

Meaning / Definition:
WACC is the average cost of various sources of capital (equity, preference, debt, retained
earnings) weighted according to their proportion in total capital.

16
 Formula:

{WACC} = \sum (W_i \times K_i)

= Weight of each source
= Cost of each source

Steps to calculate WACC:

1. Identify each source of capital — equity, debt, preference, retained earnings.

2. Find the cost of each source (Ke, Kp, Kd, Kr).
3. Calculate proportion (weights) of each source in total capital.
4. Multiply weight × cost for each source.
5. Add the weighted costs to get WACC.

Importance of WACC:

1. Used as discount rate in capital budgeting.

2. Helps in valuation of business.
3. Determines risk and return trade-off.
4. Helps in deciding capital structure.

Great 👍

17
 ✅ UNIT – 3 — SHORT QUESTIONS (3 Marks
Each)

1. What is Capital Expenditure?

Meaning:
Capital expenditure refers to the spending done by a business for acquiring fixed assets or
improving them for long-term use.

Points:

1. It provides benefits for more than one accounting year.

2. Includes purchase of machinery, land, building etc.
3. It improves earning capacity of the business.

2. What is Capital Budgeting?

Meaning:
Capital budgeting is the process of evaluating and selecting long-term investment projects
that involve large capital expenditure.

Points:

1. Helps decide whether to accept or reject investment proposals.

2. Based on estimated cash inflows and outflows.
3. Supports long-term financial planning.

18
 3. What is Payback Period?
Meaning:
Payback period is the time required to recover the original investment from the net cash
inflows.

Points:

1. Measures liquidity and risk of investment.

2. Shorter payback = safer project.
3. Ignores time value of money.

4. Explain NPV method of Capital Budgeting.

Meaning:
Net Present Value (NPV) is the difference between the present value of cash inflows and the
present value of cash outflows.

Points:

1. Positive NPV → accept project.

2. Negative NPV → reject project.
3. Considers time value of money.

19
 5. What is Accounting Rate of Return (ARR)?
Meaning:
ARR measures the profitability of an investment as a percentage of average annual
accounting profit to initial or average investment.

Points:

1. Based on accounting profit (not cash flows).

2. Higher ARR is preferred.
3. Ignores time value of money.

6. Merits and Demerits of NPV Method (any three).

Meaning:
NPV evaluates present value of future cash flows using discounting technique.

Points:

1. Considers time value of money (merit).

2. Measures profitability accurately (merit).
3. Difficult to calculate and understand (demerit).

7. Merits and Demerits of ARR Method (any three).

Meaning:
ARR evaluates profitability based on accounting profit.

Points:
1. Easy to calculate and understand (merit).
2. Uses readily available accounting data (merit).
3. Ignores time value of money (demerit).

20
 8. How to get Net Present Value?

Meaning:
NPV is calculated by discounting future cash inflows and subtracting the present value of
cash outflows.

Points:

1. NPV = PV of Inflows – PV of Outflows.

2. Uses discount rate to determine present value.
3. Helps accept or reject project.

9. What is Profitability Index? Formula to find it.

Meaning:
Profitability Index measures the relationship between present value of inflows and present
value of outflows.

Points:

1. PI = PV of inflows / PV of outflows.
2. PI > 1 → Accept, PI < 1 → Reject.
3. Used for ranking investment proposals.

21
 10. Explain IRR method of Capital Budgeting.
Meaning:
IRR is the discount rate which makes NPV of a project equal to zero.

Points:

1. Measures rate of return earned from project.

2. Higher IRR than required rate → Accept.
3. Considers time value of money.

11. What is Dividend?

Meaning:
Dividend is the portion of profit distributed by a company to its shareholders.

Points:

1. Paid in cash or stock.

2. Reward to shareholders for investment.
3. Declared by the Board of Directors.

12. What is Stock Dividend?

Meaning:
Stock dividend is the distribution of additional shares to shareholders instead of cash.

Points:
1. No cash outflow for company.
2. Increases number of shares held by investors.
3. Retains cash for business growth.

22
 13. What is Cash Dividend?

Meaning:
Cash dividend is the distribution of profit to shareholders in the form of cash.

Points:

1. Involves immediate cash payment.

2. Reduces retained earnings.
3. Most common type of dividend.

14. What is Dividend Policy?

Meaning:
Dividend policy refers to the decision regarding how much profit should be distributed as
dividend and how much should be retained.

Points:

1. Balances dividend payout and retained earnings.

2. Influences investor satisfaction.
3. Affects share price and firm value.

23
 15. Write any three assumptions of Walter’s Model.
Meaning:
Walter’s model explains the relationship between dividend policy and the value of the firm.

Points:

1. Firm finances only through retained earnings.

2. Rate of return and cost of capital remain constant.
3. Earnings and dividends remain constant.

16. What is Gordon’s Model?

Meaning:
Gordon’s model states that value of a firm is affected by dividend policy and assumes
constant growth of dividends.

Points:

1. Based on dividend capitalization approach.

2. Uses growth rate formula g = br.
3. Dividend policy influences share price.

24
 17. What is Gordon’s Revised Model?
Meaning:
Gordon’s revised model is the improved version of original model, considering corporate
taxes.

Points:

1. Assumes dividend is taxed at shareholder level.

2. Incorporates tax effect on expected return.
3. Provides more realistic valuation.

18. Read all types of dividend.

Meaning:
Types of dividend represent different ways of distributing profit to shareholders.

Points:

1. Cash dividend.
2. Stock/Scrip dividend.
3. Bonus share dividend / Property dividend / Interim dividend etc. (any three accepted)

25
 ✅ Long Answers for Unit – 3

____________________________________________________________________________________

1. What is Capital Budgeting? Explain in brief the process

of Capital Budgeting.

Meaning / Definition

Capital Budgeting refers to the process of planning and evaluating long-term investment
projects that involve large capital expenditure, such as purchase of machinery, construction
of buildings, or starting new business ventures.

Explanation

Capital Budgeting helps a business decide whether an investment project is profitable and
worth undertaking. It aims to maximize the wealth of shareholders by investing funds in the
most productive projects.

Process of Capital Budgeting (Steps)

1. Identification of Investment Opportunities

The company identifies various investment proposals such as expansion, replacement of
assets, or starting new products.
2. Screening / Evaluation of Proposals
Each proposal is analyzed using financial tools (NPV, IRR, Payback etc.) to check feasibility
and profitability.
3. Selection of the Best Proposal
The project that provides highest return and matches organizational objectives is selected.

26
 4. Capital Budgeting Approval and Financing
Management approves the selected project and arranges required funds from internal or
external sources.
5. Implementation of the Project
The project is executed by purchasing assets, installing equipment and starting operations.
6. Review / Post-Audit
After implementation, performance is monitored and results are compared with expected
outcomes to ensure improvement in future decisions.

2. Elaborate the methods of long-term

investment decision or Capital Budgeting.

Meaning

Methods of Capital Budgeting refer to financial techniques used to evaluate and select long-
term investment proposals.

Capital Budgeting Methods

A. Traditional / Non-Discounting Methods

1. Payback Period Method

Calculates the time required to recover the initial investment from cash inflows.
2. Accounting Rate of Return (ARR)
Measures profitability by dividing average annual profit by average investment.

27
 B. Modern / Discounting Methods
1. Net Present Value (NPV)
Present value of cash inflows minus present value of cash outflows.
If NPV is positive → Accept the project.
2. Internal Rate of Return (IRR)
The discount rate which equals present value of cash inflow and outflow.
If IRR > Cost of capital → Accept the project.
3. Profitability Index (PI)
Ratio of present value of cash inflows to present value of cash outflows.
If PI > 1 → Project is profitable.

3. Explain the relevance theory of dividend – Walter’s

Model, Gordon’s Model.

Meaning

Relevance theory states that dividend policy affects the value of the firm and wealth of
shareholders.

(A) Walter’s Model

Developed by Prof. James E. Walter.

According to the model, the market price of share depends on:
Rate of Return (r)
Cost of Equity (Ke)
Dividend Payout Ratio
• Key Idea:-
If r > Ke → Firm should distribute low dividend
If r < Ke → Firm should distribute high dividend
If r = Ke → Firm may follow any dividend policy

28
 (B) Gordon’s Model
Developed by Myron Gordon also known as Dividend Growth Model.
Suggests that dividend policy has direct impact on the market value of shares.
• Key Idea
Share price is influenced by:
Expected dividend
Growth rate of dividend (g)
Market capitalization rate (Ke)
Higher dividend + stable growth → increases market value.u

4. What is Dividend Policy? Explain its determinants.

Meaning / Definition

Dividend Policy refers to the decision of management regarding the proportion of profit to be
distributed to shareholders as dividend and the portion to be retained in the business.

Determinants of Dividend Policy

1. Profitability of the Company

Higher profits allow higher dividends; low profits lead to lower dividends.
2. Stability of Earnings
Firms with regular earnings pay stable dividends.
3. Liquidity Position
A company must have sufficient cash to distribute dividends.
4. Growth Opportunities
Fast-growing companies retain more earnings for expansion and pay less dividend.
5. Tax Considerations
Tax laws for company and shareholders influence dividend decisions.

29
 6. Shareholders’ Preference
Investors seeking regular income influence the company to pay stable dividends.
7. Legal Restrictions
Companies must follow legal rules such as paying dividends only from profits.
8. Inflation
During inflation companies retain more funds to maintain assets.

5. Practical Problems – Capital Budgeting & Dividend

Policy.

(Here you will get numerical questions in exam.

Examples of types of sums:)
Capital Budgeting Problems
Calculate Payback Period
Compute NPV
Compute IRRCompute PI
Dividend Policy Problems
Calculate Walter’s Model value
Calculate Gordon’s Model value
Calculate Dividend Payout Ratio / Retention Ratio
(If you want, send numerical questions. I will solve step-by-step with formulas.)

30
 6. Explain the different types of dividend.

Meaning

Types of dividend represent various forms in which a company distributes profits to its
shareholders.

Types of Dividend
1. Cash Dividend
Dividend paid in cash to shareholders. Most common form.
2. Stock / Bonus Dividend
Dividend paid in the form of additional shares instead of cash.
3. Property Dividend
Dividend paid in the form of assets like inventory or equipment.
4. Scrip Dividend
Dividend paid with a promissory note promising cash payment at a later date.
5. Liquidating Dividend
Dividend paid from capital instead of profits, usually during winding-up of company.
6. Interim Dividend
Dividend declared and paid between two annual general meetings.

31
 ✅ UNIT – 4 — SHORT QUESTIONS (3 Marks
Each)

1. Explain Working Capital.

Meaning

Working Capital refers to the capital used to finance day-to-day operations of a business.

Working Capital = Current Assets – Current Liabilities}

1. Used for purchasing raw materials and paying wages & bills.
2. Ensures smooth business operations.
3. Required for maintaining stock and meeting short-term expenses.

2. Explain Gross & Net Working Capital.

Gross Working Capital

Total investment in current assets such as cash, inventory, receivables.
Measures liquidity strength.
Focuses only on current assets.
Net Working Capital
Excess of current assets over current liabilities.
{NWC = CA – CL}
High NWC = better liquidity.

32
 3. What is W.C. (Working Capital) Cycle?

Meaning

Working Capital Cycle is the time gap between the outflow of cash for purchase of raw
materials and the inflow of cash from sales.

Points

1. Longer cycle → higher working capital requirement.

2. Shorter cycle → efficient business operations.
3. Represents conversion: Cash → Inventory → Sales → Cash.

4. Conservative Policy relating to Current Assets.

Meaning

A conservative working capital policy maintains high level of current assets to reduce risk.

Points

1. Low risk but low profitability.

2. High investment in cash and inventory.
3. Ensures high liquidity and safety.

33
 4. Aggressive Policy relating to Current Assets.

Meaning

Aggressive working capital policy maintains low level of current assets to increase
profitability.

Points

1. High risk but high return.

2. Low cash, low inventory, strict credit terms.
3. Suitable for firms willing to take risk.

5. Balance Policy relating to Current Assets.

Meaning

Balanced policy maintains optimum level of current assets — neither too high nor too low.

Points

1. Moderate risk and moderate return.

2. Balances liquidity and profitability.
3. Preferred by most stable companies.

34
 6. Cash Forecasting Method.

Meaning

This method estimates working capital by forecasting cash inflows and outflows during a
period.

Points

1. Used for short-term cash planning.

2. Helps avoid cash surplus or deficit.
3. Suitable for seasonal businesses.

7. Projected Balance Sheet Method.

Meaning

Working capital is estimated by preparing a projected balance sheet showing expected assets
and liabilities.

Points

1. Working capital = Total CA – Total CL.

2. Suitable for long-term working capital planning.
3. Helps assess financial health in advance.

35
 8. Working Capital vs. Capital Budgeting.

Meaning

Working Capital deals with day-to-day operations; Capital Budgeting deals with long-term
investments.

Points

1. WC = short-term; CB = long-term.
2. WC manages liquidity; CB manages fixed assets.
3. WC affects current profitability; CB affects future growth.

9. Sources of Working Capital – read in detail.

Meaning

Sources of working capital are ways through which business arranges funds for daily
operations.

Points

1. Internal – Retained earnings, depreciation funds.

2. External – Bank loans, trade credit, commercial paper.
3. Short-term financial institutions and bill discounting.

36
 10. Operating Cycle or Circular Flow Concept.

Meaning

Operating Cycle refers to the repeated cycle of converting cash to raw materials →
production → finished goods → sales → receivables → cash.

Points

1. Shorter cycle → low working capital required.

2. Longer cycle → high working capital required.
3. Indicates efficiency of working capital management.

✅ UNIT – 4 — LONG QUESTIONS (8 Marks

Each)

1. What is Working Capital? Explain the various sources

to meet Working Capital.

Meaning / Definition

Working Capital refers to the capital required to finance day-to-day business operations such
as purchasing raw materials, paying wages, rent, electricity, and other operating expenses.

{Working Capital = Current Assets – Current Liabilities}

37
 Sources to Meet Working Capital

1. Trade Credit
Credit received from suppliers for purchasing goods without immediate payment.
2. Bank Credit
Short-term bank loans, cash credit, overdraft and working capital limits are provided by
banks.
3. Commercial Paper
Short-term unsecured promissory notes issued by large companies to raise funds.
4. Public Deposits
Money collected from the public for short duration to finance working capital.
5. Factoring Services
Sale of accounts receivables to a factor to get immediate cash.
6. Discounting of Bills
Banks provide funds by discounting bills of exchange before maturity.
7. Short-term Loans from Financial Institutions
Industrial Finance Corporation and others provide temporary working capital loans.
8. Internal Sources / Retained Earnings
Part of profits retained in the business can be used for day-to-day working needs.

38
 2. Explain the factors determining working capital
requirements.

Meaning

Working capital requirement refers to the amount of working capital a business needs to
operate efficiently. This requirement depends on several factors.

Factors Determining Working Capital Requirement

1. Nature of Business
Trading firms need more working capital than service firms.
2. Size of Business
Larger organizations need higher working capital to manage daily transactions.
3. Production Cycle
Longer production cycle requires more working capital.
4. Credit Policy
Liberal credit to customers increases working capital need; strict credit reduces it.
5. Seasonal Variations
Seasonal businesses (like wool, sugar) need more working capital during peak seasons.
6. Business Growth and Expansion
Growing firms require more funds to meet increasing operational activities.
7. Operating Efficiency
Efficient inventory and cash management reduce working capital need.
8. Availability of Raw Material
Easily available raw materials reduce inventory storage and lower working capital need.

39
 3. Broadly explain the concepts of Working Capital.

Meaning

Concepts of working capital express how working capital is measured and viewed in financial
management.

Types / Concepts of Working Capital

1. Gross Working Capital

Total investment in current assets such as cash, inventory, receivables etc.
2. Net Working Capital
Excess of current assets over current liabilities.
NWC = CA – CL}
3. Permanent / Fixed Working Capital
Minimum level of working capital required at all times to run business operations.
4. Temporary / Variable Working Capital
Working capital needed for seasonal or unexpected business demand.
5. Regular Working Capital
Working capital required for normal manufacturing and selling activities.
6. Reserve Working Capital
Additional funds kept aside for emergencies or contingencies.
7. Special Working Capital
Working capital required for special events such as promotional campaigns or bulk orders.
8. Initial Working Capital
Working capital required when a business is newly established.

40
 4. Methods of estimating Working Capital.

Meaning

Methods of estimating working capital help determine the required amount of current assets
and current liabilities for smooth operation.

Methods

1. Percentage of Sales Method

Working capital estimated as a certain percentage of projected sales.
2. Operating Cycle Method
Based on the time taken to convert cash into inventory → finished goods → receivables →
cash.
3. Cash Forecasting Method
Working capital requirement estimated by preparing cash inflow and outflow forecasts.
4. Adjusted Net Income Method
Portion of net income added back for working capital needs.
5. Ratio Method
Current assets and liabilities are estimated using financial ratios.
6. Projected Balance Sheet Method
A balance sheet is prepared showing projected assets & liabilities; difference gives required
working capital.

41
 5. Explain the needs or importance of Working Capital.
Meaning

Working capital is crucial for day-to-day functioning of a business. Adequate working capital
ensures smooth operations and financial stability.

Importance / Need
1. Smooth Business Operations
Ensures uninterrupted production and sales.
2. Timely Payment of Expenses
Helps in paying salaries, wages, bills and suppliers on time.
3. Maintaining Goodwill
Timely payments to creditors enhance business creditworthiness.
4. Ability to Face Crises
Adequate working capital protects the business during recession / emergencies.
5. Increases Profitability
Proper stock and cash management reduces costs and increases profitability.
6. Facilitates Credit Sales
Provides funds for offering credit to customers, increasing sales.
7. Supports Expansion and Growth
Adequate working capital enables business to grow without financial stress.
8. Improves Operational Efficiency
Efficient utilization of resources leads to better productivity and performance.

42