Short Notes Chapter 9

Meaning : Process of acquiring and utilising of funds to achieve organisational objectives.

Importance of financial management

i) The size and the composition of fixed assets of the business:

ii)The quantum of current assets and its break-up

iii) The amount of long-term and short- term funds to be used:

iv) Break-up of long-term financing into debt, equity etc:

v) All items in the Profit and Loss Account:

Objectives of financial management

1. Primary objectives : ------ Wealthmaximization: increase the market value of its share

2. Secondary objectives: i)Operations ii)Social iii) Research

Financial Decisions : i)Investing decision ii) Financing decision iii) Dividend decision

Investing Decision : Investment in fixed asset for long also known as capital budgeting.

Factors affecting investing decision

i) Cash flow from the project: Cash flow regular project selected , cash flow irregular project rejected.

ii) Rate of return: With same risk high rate of return selected and low rate of return is rejected.

iii) Investment criteria: Scientific techniques used to evaluate the project.

Financing Decision : Proportion of owners funds or debt fund in the total capital based on business risk and financial risk

Factors affecting financing decision

i) Cash flow position: cash flow good opt debt fund, cash flow poor opt owners fund.

ii) Cost: Cost of debt fund is Low than cost of equity

iii) Risk: Debt is more risky than equity

iv) Fixed operating cost : Operating cost high opt owners funds, operating cost low opt debt funds.

v) Control consideration: Wants rigid control opt debt fund, dilute control Opt owners fund.

vi) Flotation cost: Cost of raising the funds high in shares and low in bank loan

vii) Return on investment : ROI > interest opt debt funds, ROI < interest opt owners fund.

viii) Stock market : Bullish Market opt Equity, bearish market opt debt funds.

Dividend Decision : Portion of profit distributed to shareholders.

Factors affecting dividend decision

(a) Amount of Earnings: Earnings good, high dividend, earnings poor ,no or less dividend.

(b) Stability Earnings: Stable earning higher dividends, unstable earnings Low dividend.

(c) Stability of Dividends: Regular dividend--low dividend, irregular dividend-- high dividend

(d) GrowthOpportunities: growing company --- Low Dividend, non–growng company----high dividend

(e) Cash Flow Position: Good Cash flow high dividend, poor Cash flow-- no or less dividend

(f) Shareholders’ Preference: regular income---Give dividend, wealth maximization Less dividend

(g) Taxation Policy: high Tax-----less dividends and low tax ----pay high dividend

(h) Stock Market Reaction: High Dividends--- positive Reaction, low dividend----negative impact
(i) Access to Capital Market: Large companies---easy access---high dividend, small company ---retain profit ----pay less dividend

(j) Legal Constraints: provisions of the Companies Act place restrictions on declaring dividend.

(k) Contractual Constraints: the lender impose restriction on dividend payment in agreement

Financial planning : it is a financial blueprint to ensure funds are available at right time.

Objectives of Financial Planning

(a) To ensure availability of funds whenever required

(b) To see that the firm does not raise resources unnecessarily

Importance of Financial Planning

(i) help in running the business smoothly.

(ii) Avoiding business shocks and surprises

(iii) co-ordinating various business functions,

.(iv) Reduce waste, duplication of efforts, and gaps in planning.

(v) Link the present with the future.

(vi) link between investment and financing decisions

(vii) Evaluation of actual performance easier.

Capital structure : It refers to the mix between owners and borrowed funds, calculated as Debt/ Equity. It affects both the profitability and the financial risk.

The proportion of debt in the overall capital is also called financial leverage.

The proportion of equity in the overall capital is also called Capital gearing.

Trading on Equity: Increase in profit earned by the equity shareholders by using fixed financial charges. If ROI > rate of interest, use more of debt fund benefit
Shareholders.

Factors affecting capital structure

(i) Cash flow position :good cash flow -- opt debt fund,and poor Cash flow----opt owners fund.

(ii) Interest Coverage Ratio (ICR): higher ratio --- opt debt fund and Low ratio ----equity funds.

(iii) Debt service coverage ratio (DSCR) : higher Ratio ---debt Funds and low ratio ----equity fund.

(iv) Return on Investment (RoI): ROI > rate of interest---opt Debt fund and ROI < rate of interest opt owners fund.

(v) Cost of debt : rate of interest is low--- debt funds and higher rate of interest---equity fund

(vi) Tax Rate: high tax rate---- debt Funds and low tax rate ---- equity Fund.

(vii) Cost of Equity: Increases debt leads to increase in financial Risk so cannot use debt beyond a point

(viii) Floatation Cost: Shares/debentures---high flotation cost and bank loan---low flotation cost

(ix) Risk Consideration: Business risk lower---use debt Fund and High Business risk---equity fund

.(x) Flexibility: Debt funds ------- flexible and equity funds------- inflexible

(xi) Control: Wants rigid control------ opt debt fund, And dilute control ----Opt Equity fund.

(xii) Regulatory Framework: Company operates within regulatory framework of SEBI and Companies Act.

(xii) Stock market conditions: Bullish Market---opt shares And bearish Market ----opt debt funds.

(xiii) Capital Structure of other Companies: useful guideline from other companies in the same industry.

Fixed Capital: It refers to investment in long-term assets. It involves hugh amount and decision are irreversible without loss.

Factors affecting Fixed Capital

1. Nature of Business: Trading--- low fixed Capital and manufacturing -----high fixed capital
2. Scale of Operations: larger scale ---- higher scale----- high fixed Capital and small Organisation ---- low fixed

3. Choice of Technique: capital-intensive---- high fixed capital and Labour intensive--- lower Fixed capital

4. Technology Upgradation: Quick changes ----high fixed capital and slow changes ---low fixed capital

5. GrowthProspects: Higher growth------ high fixed Capital and no growth prospects ---- low fixed capital

6. Diversification: choose to diversify------ fixed capital and Do not diversify ----low fixed capital

.7. Financing Alternatives: lease available ---low fixed capital and lease not available ---high fixed capital

8. Level of Collaboration: Collaboration Options Available ----low fixed capital and no such options ---- high fixed capital

Working Capital: defined as the excess of current assets over current liabilities.

Factors affecting Working Capital

1. Nature of organisation: Trading--- low W. Capital and manufacturing -----high W. capital

2. Scale of Operations: larger scale ---- higher scale----- high W. Capital and small scale --- low W. Capital

3. Business Cycle: During depression---- low W. Capital and during boom--- high W. Capital

[Link] Factors: season time --- high W. Capital and off season ---- low W. Capital

5. ProductionCycle: long cycle ----high W. Capital and short cycle ----- low W. Capital

6. Credit Allowed: Liberal credit policy---- high W. Capital and short credit policy ----low W. Capital.

7. Credit Availed: Longer time -----less w. capital And short time ----high W. Capital

8. Operating Efficiency: Management efficient ----low W. Capital and Management inefficient ----high W. Capital

9. Availability of raw material : long lead time ----high W. Capital and short lead time ----low W. Capital

10. GrowthProspects: Higher growth------ high W. Capital and no growthprospects ---- low [Link]

11. Level of Competition: High competiton----- high W. Capital and low competition ----low W. Capital

12. Inflation: high chance inflation---high [Link] and low chance of inflation----low W. Capital