Business Finance = Money or cash accessible for an enterprise for its operations (that is, for some unique purpose) is known as finance.
It is integral for survival and increase of business, for manufacturing and distribution of items and assembly day to day prices etc.
It entails obtaining money to purchase Fixed property (tangible and intangible) and Raw substances and keep working capital.
Financial Management consists of these enterprise things to do that are involved with acquisition and conservation of capital cash in assembly the monetary wants and standard goals of a commercial enterprise.
2 Aims of Financial Management
The pursuits of monetary administration need to be beneficial to the firm’s proprietors, managers, personnel and consumers.
For this reason, the solely way is maximization of firm’s value.
The following elements have region in maximizing firm’s value:
A. Rise in profits: If the company needs to maximize its value, it should’ enlarge its income and revenues.
For this motive amplify of income extent or different things to do can be taken up. It is the prevalent characteristic of any association to extend income via acceptable utilization of all possibilities and plans.
Theoretically, company receives most earnings if it is below equilibrium. At that stage the common fee is minimal and the marginal fee and the marginal revenues are equal.
Here, we can’t say the income due to the fact there ought to be appropriate market for the elevated sales.
Further, the above charges need to additionally be controlled.
B. Reduction in cost: Capital and fairness dollars are utilized for production.
So, all kinds of steps need to be taken to decrease firm’s price of capital.
C. Sources of funds: It must be determined by way of maintaining in view the cost of the association to gather money thru problem of shares or debentures.
D. Reduce risks: There won’t be earnings besides risk.
But for this motive if greater danger is taken, it may also grow to be hazard to the existence of the firm.
Hence hazard ought to be decreased to minimal level.
E. Long run value: It has to be the function of economic administration to extend the long-run cost of the firm.
To earn greater income in quick time, some corporations may additionally do the things to do like releasing of low best goods, neglecting the hobbies of customers and employees.
These trials might also provide true consequences in the quick run.
But for growing the cost of the company in the lengthy run, avoiding; such things to do are extra essential.
3 Objectives of Financial Management
The goals of monetary administration are given below:
A. Profit maximization: Main intention of any form of monetary exercise is incomes profit.
A commercial enterprise challenge is additionally functioning in the main for the reason of incomes profit.
Profit is the measuring strategies to recognize the commercial enterprise effectivity of the concern.
The finance supervisor tries to earn most income for the corporation in the momentary and the long-term.
He can’t assurance earnings in the lengthy time period due to the fact of enterprise uncertainties.
However, a employer can earn most income even in the long-term, if:
The Finance supervisor takes suitable monetary decisions
He makes use of the finance of the organisation properly
B. Wealth maximization: Wealth maximization (shareholders’ cost maximization) is additionally a principal goal of monetary management.
Wealth maximization capacity to earn most wealth for the shareholders.
So, the finance supervisor tries to supply a most dividend to the shareholders.
He additionally tries to enlarge the market fee of the shares. The market price of the shares is immediately associated to the overall performance of the company.
Better the performance, greater is the market fee of shares and vice-versa.
So, the finance supervisor should attempt to maximize shareholder’s value
C. Proper estimation of whole economic requirements: Proper estimation of complete economic necessities is a very necessary goal of economic management.
The finance supervisor should estimate the complete monetary necessities of the company.
He needs to discover out how lots finance is required to begin and run the company.
He should discover out the constant capital and working capital necessities of the company.
His estimation ought to be correct. If not, there will be scarcity or surplus of finance. Estimating the economic necessities is a very challenging job.
The finance supervisor needs to reflect on consideration on many factors, such as the kind of technological know-how used with the aid of company, quantity of personnel employed, scale of operations, criminal requirements, etc.
D. Proper mobilization: Mobilization (collection) of finance is a vital goal of economic management.
After estimating the monetary requirements, the finance supervisor ought to figure out about the sources of finance. He can gather finance from many sources such as shares, debentures, financial institution loans, etc.
There ought to be a acceptable stability between owned finance and borrowed finance.
The corporation should borrow cash at a low fee of interest.
E. Proper utilization of finance: Proper utilization of finance is a vital goal of monetary management.
The finance supervisor should make most effective utilization of finance.
He should use the finance profitable. He has to now not waste the finance of the company.
He should no longer make investments the company’s finance in unprofitable projects.
He ought to now not block the company’s finance in inventories. He needs to have a brief deposit period.
F. Maintaining appropriate money flow: Maintaining acceptable money drift is a momentary goal of economic management.
The corporation need to have a suited money drift to pay the everyday prices such as buy of uncooked materials, fee of wages and salaries, rent, electrical energy bills, etc.
If the agency has an accurate money flow, it can take benefit of many possibilities such as getting money reductions on purchases, large-scale purchasing, giving savings to customers, etc.
A healthful money waft improves the probabilities of survival and success of the company.
G. Survival of company: Survival is the most necessary goal of economic management.
The business enterprise ought to live to tell the tale in this aggressive enterprise world.
The finance supervisor needs to be very cautious whilst making economic decisions.
One incorrect choice can make the employer sick, and it will shut down.
H. Creating reserves: One of the goals of monetary administration is to create reserves.
The agency needs to now not distribute the full income as a dividend to the shareholders.
It has to maintain a section of its income as reserves. Reserves can be used for future boom and expansion.
It can additionally be used to face contingencies in the future.
I. Proper coordination: Financial administration should attempt to have ideal coordination between the finance branch and different departments of the company.
J. Create goodwill: Financial administration ought to attempt to create goodwill for the company.
It has to enhance the photo and recognition of the company.
Goodwill helps the business enterprise to live to tell the tale in the momentary and be triumphant in the long-term.
It additionally helps the corporation for the duration of terrible times.
K. Increase efficiency: Financial administration additionally tries to expand the effectivity of all the departments of the company.
Proper distribution of finance to all the departments will extend the effectivity of the complete company.
L. Financial discipline: Financial administration additionally tries to create an economic discipline.
Financial self-discipline means to make investments finance solely in productive areas.
This will deliver excessive returns (profits) to the company.
To keep away from wastage and misuse of finance.
M. Reduce price of capital: Financial administration tries to limit the value of capital.
That is, it tries to borrow cash at a low fee of interest. The finance supervisor needs to graph the capital shape in such a way that the fee of capital it minimized.
N. Reduce running risks: Financial administration additionally tries to limit the running risks.
There are many dangers and uncertainties in a business.
The finance supervisor should take steps to limit these risks.
He should keep away from high-risk projects. He ought to additionally take ideal insurance.
O. Prepare capital structure: Financial administration additionally prepares the capital structure.
It decides the ratio between borrowed finance and owned finance. It brings a suitable stability between the exclusive sources of capital.
This stability is quintessential for liquidity, economy, flexibility and stability.
4 Every organization is required to take three important monetary selections
A. Investment Decision: Resources are scarce and can be put to alternate use.
An association have to pick out the place to make investments so as to earn the absolute best feasible profits.
Investment choice relates to selections about how the firm ‘s cash are invested in exceptional belongings that is, one of a kind funding proposal
# It has two components:
• Working Capital Decisions – Short Term funding decisions.
• Capital Budgeting choices – Long Term investment decisions
Factors affecting Investment Decisions/Capital Budgeting decisions
a) Cash flows of the project: The collection of money receipts and repayments over the existence of a funding thought need to be regarded and analyzed for choosing the excellent proposal.
b) Rate of Return: The anticipated returns from every thought and threat worried in them must be taken into account to choose the satisfactory proposal.
c) Investment Criteria Involved: A variety of funding proposals are evaluated on the foundation of capital budgeting techniques.
These contain calculation involving funding amount, hobby rate, money flows, charge of return etc.
B. Financing Decision
• These are selections w.r.t quantum of finance or composition of dollars from more than a few long-term sources.
(short time period = working capital Financial Management)
• Financing selections involve: a) Decision whether or not or now not to use an aggregate of possession and borrowed funds. b) Determining their specific ratio.
• Firm desires a sensible combine of debt and fairness as:
• Debt entails ‘Financial Risk ‘= hazard of default on charge of hobby on borrowed cash and the compensation of the precept quantity whereas
• Shareholders ‘money contain no constant dedication w.r.t charge of returns or reimbursement of capital.
• Ownership fund vs. Debt fund: They can be in contrast on the groundwork of elements such as examples, interest/dividend payout and compensation of principle, tax deductibility, and hazard and floatation costs.
Factors Affecting Financing Decision
A. Cost: The value of elevating dollars from specific sources are different.
The most inexpensive supply has to be selected.
B. Risk: The chance related with distinct sources is different.
More threat is related with borrowed dollars as in contrast to owner’s fund as activity is paid on it and it is repaid also, after a constant duration of time or on expiry of its; tenure.
C. Flotation Cost: The expenses concerned in issuing securities such as brokers commission, underwriters’ fees, charges on prospectus etc. are referred to as flotation costs.
Higher the flotation cost, much less captivating is the supply of finance.
D. Cash go with the flow function of the business: In case the money float function of an enterprise is suitable adequate then it can without problems use borrowed cash and pay pastime on time.
E. Control Considerations: In case the present shareholders choose to keep the whole manage of commercial enterprise then finance can be raised via borrowed money however when they are equipped for dilution of manipulate over business, fairness can be used for elevating finance.
F. State of Capital Markets: During boom, finance can without problems be raised through issuing shares however all through melancholy period, elevating finance by way of skill of debt is easy.
G. Period of Finance: For everlasting capital requirement, Equity shares ought to be issued as they are now not to be paid lower back and for lengthy and medium time period requirement, choice shares or debentures can be issued.
C. Dividend Decision
• Dividend is that element of divisible income that is dispensed to the proprietors i.e. the shareholders. Its outcomes in modern-day earnings for the shareholders.
• Retained earnings= share of income stored in, that is, reinvested in the enterprise for the business.
• Dividend decision= whether to distribute salary to shareholder as dividends or hold salary to finance long-term income of the firm. Must be executed maintaining in idea the corporation’s standard goal of maximizing the shareholders wealth.
Factors affecting Dividend Decision
A. Earnings: Companies having excessive and secure incomes should declare excessive price of dividends as dividends are paid out of contemporary and paste earnings.
B. Stability of Dividends: Companies usually comply with the coverage of steady dividend.
The dividend per share is no longer altered and modified in case salary trade by way of small percentage or extend in profits is transient in nature.
C. Growth Prospects: In case there are boom potentialities for the organization in the close to future them it will keep its incomes and thus, no or much less dividend will be declared.
D. Cash Flow Positions: Dividends contain an outflow of money and thus, availability of sufficient money is for most requirement for assertion of dividends.
E. Preference of Shareholders: While finding out about dividend the desire of shareholders is additionally taken into account.
In case shareholders wish for dividend then organization may additionally go for declaring the same.
F. Taxation Policy: A enterprise is required to pay tax on dividend declared via it.
If tax on dividend is higher, organization will decide upon to pay much less by way of way of dividends whereas if tax prices are decrease then extra dividends can be declared via the company.
G. Issue of bonus shares: Companies with massive reserves can also additionally distribute bonus shares to extend their capital base as it signifies increase of the organization and enhances its recognition also.
H. Legal constraints: Under provisions of Companies Act, all profits can’t be dispensed and the organization has to furnish for a number reserve. This limits the ability of agency to declare dividend.
5 Financial Planning
It includes practice of a monetary blueprint of an organization.
It is the technique of estimating the fund requirement of a commercial enterprise and deciding the feasible sources from which it can be raised.
6 Objectives of Financial Planning
Financial planning is accomplished to gain the following two objectives:
A. To make certain availability of money every time these are required: The principal goal of monetary planning is that adequate fund ought to be accessible in the business enterprise for exclusive functions such as for buy of lengthy time period assets, to meet day-to- day expenses, etc.
It ensures well timed availability of finance. Along with availability economic planning additionally tries to specify the sources of finance.
B. To see that association does no longer elevate assets unnecessarily: Excess funding is as awful as insufficient or scarcity of funds.
If there is surplus money, monetary planning should make investments it in the first-rate feasible manner as preserving monetary assets idle is an incredible loss for an organization.
Financial Planning consists of each quick time period as nicely as the lengthy time period planning.
Long time period planning focuses on capital expenditure layout whereas quick time period economic plans are known as budgets.
Budgets consist of designated graph of motion for a duration of one years or less.
7 Importance of Financial Planning
Sound monetary planning is quintessential for success of any enterprise.
It’s wanted is felt due to the fact of the following reasons:
A. It Facilitates Collection of Optimum Funds:
The economic planning estimates the specific requirement of money which skill to keep away from wastage and over-capitalization situation.
B. Financial planning helps in creating Appropriate Capital Structure:
Funds can be organized from a range of sources and are used for lengthy term, medium time period and brief term.
Financial planning is crucial for tapping terrific sources at fantastic time as lengthy time period money are typically contributed through shareholders and debenture holders, medium time period via economic establishments and quick time period with the aid of industrial banks.
C. Helps in Investing Finance in Right Projects: Financial graph suggests how the cash are to be allotted for a number functions through evaluating a variety of funding proposals.
D. Helps in Operational Activities: The success or failure of manufacturing and distribution feature of enterprise relies upon the monetary selections as proper choice ensures easy float of finance and easy operation of manufacturing and distribution.
E. Base for Financial Control: Financial planning acts as groundwork for checking the monetary things to do through evaluating the authentic income with estimated income and true price with estimated cost.
F. Helps in Proper Utilization of Finance: Finance is the existence blood of business.
So monetary planning is a necessary phase of the company planning of business.
All enterprise plans rely upon the soundness of monetary planning.
G. Helps in Avoiding Business Shocks and Surprises: By looking forward to the monetary necessities monetary planning helps to keep away from shock or surprises which in any other case companies have to face in unsure situations.
H. Link between Investment and Financing Decisions: Financial planning helps in figuring out debt/equity ratio and by way of identifying the place to make investments this fund.
It creates a hyperlink between each the decisions.
I. Helps in Coordination: It helps in coordinating a number enterprise features such as production, income feature etc.
J. It Links Present with Future: Financial planning relates existing monetary requirement with future requirement via awaiting the income and boom plans of the company.
8 Capital Structure
The term ‘structure’ signifies the game plan of the different parts.
So capital structure implies the plan of capital from various sources with the goal that the drawn-out assets required for the business are raised.
In this way, capital structure alludes to the extents or mixes of value share capital, inclination share capital, debentures, long haul credits, held profit and other long-haul wellsprings of assets in the aggregate sum of capital which a firm should raise to maintain its business
9 Factors Affecting Capital Structure
(A) Cash Flow Position: While making a desire of the capital shape the future money drift role need to be saved in mind.
Debt capital need to be used solely if the money glide function is truly excellent due to the fact a lot of money is wanted in order to make price of activity and refund of capital.
(B) Interest Coverage Ratio-ICR: With the assist of this ratio an effort is made to locate out how many instances the EBIT is accessible to the price of interest.
The capability of the organization to use debt capital will be in direct percentage to this ratio.
It is viable that in spite of higher ICR the money waft function of the enterprise may additionally be weak.
Therefore, this ratio is no longer an appropriate or suitable measure of the ability of the enterprise to pay interest.
It is equally necessary to take into consideration the money glide position.
(C) Debt Service Coverage Ratio-DSCR: This ratio gets rid of the weak spot of ICR.
This suggests the money drift role of the company.
This ratio tells us about the money repayments to be made (e.g., choice dividend, hobby and debt capital repayment) and the quantity of money available.
Better ratio capacity the higher potential of the agency for debt payment. Consequently, extra debt can be utilized in the capital structure.
(D) Return on Investment-ROI: The higher return on funding of an agency will increase its ability to utilize extra debt capital.
(E) Cost of Debt: The capability of an agency to take debt relies upon on the fee of debt.
In case the price of hobby on the debt capital is less, greater debt capital can be utilized and vice versa.
(F) Tax Rate: The fee of tax impacts the value of debt. If the charge of tax is high, the value of debt decreases.
The cause is the deduction of activity on the debt capital from the income thinking about it a section of costs and a saving in taxes.
For example, feel an enterprise takes a mortgage of 0ppp a hundred and the charge of hobby on this debt is 10% and the fee of tax is 30%.
By deducting 10/- from the EBIT a saving of in tax will take region (If 10 on account of hobby are no longer deducted, a tax of @ 30% shall have to be paid).
(G) Cost of Equity Capital: Cost of fairness capital (its capacity the expectations of the fairness shareholders from the company) is affected by way of the use of debt capital.
If the debt capital is utilized more, it will make bigger the fee of the fairness capital.
The easy motive for this is that the increased use of debt capital will increase the hazard of the fairness shareholders.
Therefore, the use of the debt capital can be made solely to a restrained level.
If even after this degree the debt capital is used further, the price of fairness capital begins growing rapidly.
It adversely impacts the market price of the shares. This is now not an excellent situation.
Efforts need to be made to keep away from it.
(H) Floatation Costs: Floatation expenses are these prices which are incurred whilst issuing securities (e.g., fairness shares, desire shares, debentures, etc.).
These encompass fee of underwriters, brokerage, stationery expenses, etc.
Generally, the value of issuing debt capital is much less than the share capital. This attracts the enterprise toward debt capital.
(I) Risk Consideration: There are two kinds of dangers in business:
(i) Operating Risk or Business Risk:
This refers to the chance of lack of ability to discharge everlasting running prices (e.g., lease of the building, price of salary, insurance plan installment, etc.),
(ii) Financial Risk:This refers to the danger of incapacity to pay constant economic repayments (e.g., charge of interest, desire dividend, return of the debt capital, etc.) as promised through the company.
The whole threat of enterprise relies upon on each these sorts of risks.
If the working danger in enterprise is less, the monetary danger can be confronted which ability that extra debt capital can be utilized.
On the contrary, if the working hazard is high, the monetary danger possibly happening after the increased use of debt capital must be avoided.
(J) Flexibility: According to this principle, capital shape needs to be pretty flexible.
Flexibility capability that, if want be, quantity of capital in the commercial enterprise ought to be elevated or diminished easily.
Reducing the quantity of capital in commercial enterprise is feasible solely in case of debt capital or choice share capital.
If at any given time corporation has extra capital than as fundamental then each the above-mentioned capitals can be repaid.
On the different hand, reimbursement of fairness share capital is now not feasible via the business enterprise at some stage in its lifetime.
Thus, from the perspective of flexibility to problem debt capital and desire share capital is the best.
(K) Control: According to this factor, at the time of making ready capital structure, it needs to be ensured that the manipulate of the present shareholders (owners) over the affairs of the organization is no longer adversely affected.
If cash are raised by using issuing fairness shares, then the wide variety of company’s shareholders will enlarge and it immediately influences the manipulate of current shareholders.
In different words, now the quantity of proprietors (shareholders) controlling the agency increases.
This state of affairs will no longer be desirable to the current shareholders.
On the contrary, when dollars are raised via debt capital, there is no impact on the manipulate of the employer due to the fact the debenture holders have no manipulate over the affairs of the company.
Thus, for these who guide this precept debt capital is the best.
(L) Regulatory Framework: Capital shape is additionally influenced by way of authority’s regulations.
For instance, banking corporations can elevate dollars with the aid of issuing share capital alone, now not any different sort of security.
Similarly, it is obligatory for different corporations to preserve a given debt-equity ratio whilst elevating funds.
Different perfect debt-equity ratios such as 2:1; 4:1; 6:1 have been decided for extraordinary industries.
The public trouble of shares and debentures has to be made underneath SEBI guidelines.
(M) Stock Market Conditions: Stock market prerequisites refer to upward or downward developments in capital market.
Both these stipulations have their have an impact on the resolution of sources of finance.
When the market is dull, buyers are commonly afraid of investing in the share capital due to excessive risk.
On the contrary, when prerequisites in the capital market are cheerful, they deal with funding in the share capital as the fantastic preference to reap profits.
Companies should, therefore, make resolution of capital sources retaining in view the prerequisites prevailing in the capital market.
(N) Capital Structure of Other Companies: Capital shape is influenced by using the enterprise to which an organization is related.
All organizations associated to a given enterprise produce nearly comparable products, their charges of manufacturing are similar, they rely on same technology, they have comparable profitability, and for this reason the sample of their capital shape is nearly similar.
Because of this fact, there are exceptional debt- fairness ratios widely wide-spread in one-of-a-kind industries.
Hence, at the time of elevating dollars an agency should take into consideration debt-equity ratio typical in the associated industry.
10 Fixed Capital
Fixed capital refers to funding in long-term assets.
Investment in constant property is for longer period and they ought to be financed via long-term sources of capital.
Decisions bearing on to constant capital contain massive capital money and are now not reversible except incurring heavy losses.
11 Factors Affecting Requirement of Fixed Capital
A. Nature of Business: Manufacturing worries require big funding in constant property & accordingly,
massive constant capital is required for them however buying and selling issues want much less constant capital as they are no longer required to buy plant and equipment etc.
B. Scale of Operations: A corporation working on giant scale requires greater constant capital as in contrast to an enterprise working on small scale.
For Example – A massive scale metal corporation like TISCO requires massive funding as in contrast to a mini metal plant.
C. Choice of Technique: An agency the use of capital-intensive methods requires extra funding in plant & equipment as in contrast to a corporation the use of labor-intensive techniques.
D. Technology upgradation: Organizations the use of belongings which come to be out of date quicker require greater constant capital as in contrast to different organizations.
E. Growth Prospects: Companies having extra boom plans require extra constant capital. In order to increase manufacturing ability greater plant & equipment is required.
F. Diversification: In case an employer goes for diversification then it will require greater constant capital to make investments in constant property like plant and machinery.
G. Distribution Channels: The company which sells its product thru wholesalers and outlets requires much less constant capital.
H. Collaboration: If corporations are underneath collaboration, Joint venture, then they want much less constant capital as they share plant; equipment with their collaborators.
I)Working Capital: Working Capital refers to the capital required for day to day working of an organization.
Apart from the funding in constant property each and every enterprise company desires to make investments in modern assets, which can be transformed into money or money equivalents inside a length of one year.
They furnish liquidity to the business. Working capital is of two sorts – Gross working capital and Net working capital.
Investment in all the modern property is known as Gross Working Capital whereas the extra of contemporary belongings over present day liabilities is known as Net Working Capital.
Following are the elements which have an effect on working capital necessities of an organization:
i. Nature of Business: A buying and selling business enterprise desires a decrease quantity of working capital as in contrast to a manufacturing organization, as buying and selling corporation undertakes no processing work.
ii. Scale of Operations: A business enterprise running on giant scale will require greater stock and thus, its working capital requirement will be extra as in contrast to small organization.
iii. Business Cycle: In the time of increase extra manufacturing will be undertaken and so extra working capital will be required at some stage in that time as in contrast to depression.
iv. Seasonal Factors: During top season demand of a product will be excessive and for this reason excessive working capital will be required as in contrast to lean season.
v. Credit Allowed: If credit score is allowed via a situation to its clients than it will require extra working capital however if items are offered on money foundation than much less working capital is required.
Vi. Credit Availed: If an association is capable to buy uncooked substances on savings from its suppliers than much less working capital will be required.
vii. Inflation: Working capital requirement is additionally decided by way of charge degree changes. For example, all through inflation fees of uncooked material, wages additionally upward jab ensuing in amplify in working capital requirements.
viii. Operating Cycle/Turnover of Working Capital: Turnover skill pace with which the working capital is transformed into money via sale of goods. If it is speedier, the quantity of working capital required will be less.
Short Answer Type
Q1. What is intended by using capital structure?
Ans- Capital shape refers to the mixture of borrowed money and owners’ fund that an association makes use of for financing its fund requirements.
Herein, borrowed money incorporate of loans, public deposits, debentures, etc. and owners’ fund incorporate of choice share capital, fairness share capital, retained incomes etc. Generally, capital shape is sincerely referred as the mixture of debt and fairness that an association makes use of for financing its funds.
It is calculated as the ratio of debt and fairness or the share of debt in the complete capital used through the firm.
The share of the debt and fairness used via the association impacts its economic hazard and profitability.
While on one hand, debt is a more cost-effective source of finance than fairness and lowers the average value of capital however on the different hand, greater use of debt, will increase the monetary hazard for the firm.
Thus, the selection involving the capital shape need to be taken with utmost care.
Capital shape is stated to be most efficient when the share of debt and fairness used is such that the income per share increases.
Q2. Discuss the two goal of Financial Planning.
Ans- Financial Planning entails designing the blueprint of the monetary operations of a firm.
It ensures that simply the proper quantity of dollars is accessible for the organizational operations at the proper time. Thereby, it ensures easy functioning.
Taking into consideration the increase and performance, via economic planning, corporations have a tendency to forecast what quantity of fund would be required at what time.
The following are the two highlighted goals of economic planning.
(i) Ensure Availability of Funds: Ensuring that the proper quantity of cash is accessible at the proper time is one of the fundamental goals of monetary planning.
It includes estimating the proper quantity of money that are required for quite a number enterprise operations in the lengthy time period as properly for day to day operations.
In addition, it additionally entails estimating the time at which the cash would be required.
Thus, monetary planning ensures that proper quantity of cash is on hand at the proper time.
Financial planning additionally factors out the possibly sources of funds.
(ii) Proper Utilization of Funds: Financial Planning goals at full utilization of funds.
It ensures that each insufficient money as nicely as extra cash is avoided. Inadequate money hinders the clean operations and the firm is unable to raise its commitments.
On the different hand, extra dollars add to the price of enterprise and motivate pointless wasteful expenditure.
Thus, economic planning ensures that the dollars are appropriate and optimally utilized.
Q3. What is economic risk? Why does it arise?
Ans- Financial danger refers to a scenario when an employer is now not in a position to meet its constant economic fees such as activity payment, desire dividend and compensation obligations.
In different words, it refers to the chance that the business enterprise would no longer be capable to meet its constant monetary obligations.
It arises when the percentage of debt in the capital shape increases.
This is due to the fact it is compulsory for the employer to pay the hobby fees on debt alongside with the precept amount.
Thus, greater the debt, greater will be its price responsibilities and thereby greater would be the probabilities of default on payment. Hence, greater use of debt leads to greater economic hazard for the company.
Q4. Define a ‘current asset’. Give 4 examples of such assets.
Ans- Current asset of a company refers to these properties which can be transformed into money or money equivalents in a quick length of time, i.e. less than one year.
Such property is used to facilitate the day to day commercial enterprise operations.
As they can be without difficulty transformed into money or money equivalents, these properties furnish liquidity to the company.
Firms gather such property to meet its a number of fee obligations.
However, such property furnishes very little return and are thereby, much less profitable.
Current property can be financed thru non-permanent as nicely as lengthy time period sources.
Some of the examples of contemporary belongings are brief time period investment, debtors, shares and money equivalents.
Q5. Financial administration is primarily based on three vast monetary decisions. What are these?
Ans- Financial administration refers to the environment friendly acquisition, allocation and utilization of dollars of the company.
It offers in three major dimensions of economic selections namely, Investment decisions, Financial selections and Dividend decisions.
a) Investment Decisions: Investment selections refer to the selections related to the place to make investments so as to earn the very best viable returns on investment.
Investment selections can be taken for each lengthy time period as nicely as quick term.
Long time period funding choices additionally recognized as Capital Budgeting selections have an effect on a business’ lengthy time period incomes ability and profitability.
For example, funding in a new machine, buy of a new building, etc. are lengthy time period funding decisions.
Short time period funding choices additionally acknowledged as working capital selections affect a business’ day to day working operations.
For example, choices related to money or consignment receivables are quick time period funding decisions.
b) Financial Decisions: Such selections contain figuring out a range of sources of money and figuring out the first-class aggregate for elevating the funds.
The predominant sources for elevating money are shareholders’ cash (referred as equity) and borrowed money (referred as debt). Based on the fee involved, threat and profitability an employer have to judiciously figure out the aggregate of debt and fairness to be used.
For example, whilst debt is viewed to be the most inexpensive supply of finance, greater debt will increase the economic risk.
Financial choices taken by using a business enterprise impacts its universal value of capital and the monetary risk.
c)Dividend Decisions: The choice includes the choice involving the distribution of earnings or surplus of the company.
An organization can distribute its income to the fairness shareholders in the structure of dividends or maintain it with itself.
Under dividend decision, an organization decides what percentage of the surplus to distribute as dividends and what share to maintain as retained earnings.
It is aimed at maximizing the shareholders’ wealth whilst maintaining in view the requirement of retained profits that are wanted for re-investment.
Q6. What are the principal targets of monetary management? Briefly explain?
Ans- The paramount goal of the economic administration is maximizing the shareholders’ wealth.
That is, the fundamental goal of economic administration for an organization is to choose for these monetary selections that show gainful from the factor of view of the shareholders.
The shareholders are stated to acquire when the market price of their shares rise.
The market fee of shares extends when the advantages from an economic choice exceed the value worried in taking them.
In different words, a monetary selection raises the market cost of share if its outcomes in some cost addition.
Thus, economic choices have to be taken such that some cost addition takes region and subsequently the rate of the fairness share increases.
When an economic choice is capable to fulfil the foremost goal of wealth maximization, different targets such as desirable utilization of funds, upkeep of liquidity etc. are robotically fulfilled.
Q7. How does working capital have an effect on each the liquidity as properly as profitability of a business?
Ans- Working capital of an enterprise refers to the extra of modern property (such as cash in hand, debtors, stock, etc.) over contemporary liabilities.
Working capital influences each the liquidity as properly as profitability of a business.
As the quantity of working capital increases, the liquidity of the commercial enterprise increases.
However, given that contemporary property provides low return, with the make bigger in working capital the profitability of the commercial enterprise falls.
For example, an expand in the stock of the commercial enterprise will increase its liquidity however due to the fact that the inventory is stored idle, the profitability falls.
On the different hand, low working capital, hinders the day to day operations of the business.
Thus, the working capital ought to be such that a stability is maintained between the profitability and liquidity.
Long Answer Type
Q1. What is working capital? How is it calculated? Discuss 5 necessary determinants of working capital requirement.
Ans- Every enterprise wants to take the choice involving the funding in contemporary belongings i.e. the working capital.
Current property refers to the property that are transformed into money or money equivalents in a brief length of time (less than or equal to one year).
There are two wide standards of working capital namely, Gross working capital and Net working capital.
Gross working capital (or, surely working capital) refers to the funding achieved in the present-day assets.
Net working capital, on the different hand, refers to the quantity of modern-day property that is in extra of modern liabilities.
Herein, modern-day liabilities are these compulsory repayments which are due for fee such as payments payable, extremely good expenses, creditors, etc. Net Working Capital is calculated as the distinction of modern belongings over present day liabilities. i.e.
NWC = Current Assets – Current Liabilities
The following are 5 determinants of working capital requirement:
(i) Type of Business: Working capital requirement of a company relies upon on its nature of business.
A business enterprise that offers in offerings or buying and selling will no longer require a whole lot of working capital.
This is due to the fact such enterprises contain small running cycle and there is no processing done.
Herein, the uncooked substances are the equal as the outputs and the income transaction takes vicinity immediately.
In distinction to this, a manufacturing association includes giant working cycle and the uncooked substances want to be transformed into completed items earlier than the ultimate sale transaction takes place.
Thereby, such corporations require massive working capital.
(ii) Scale of Operations: Another aspect figuring out the working capital requirement is the scale of operations in which the association deals.
If a company operates on a massive scale, the requirement of the working capital increases.
This is due to the fact such corporations would want to keep excessive inventory of stock and debtors.
In distinction to this, if the scale of operation is small, the requirement of the working capital will be less.
(iii) Fluctuations in Business Cycle: Different phases of enterprise cycle alter the working capital necessities by means of a firm.
During growth period, the market prospers and thereby, there is greater sale, greater production, greater inventory and debtors.
Thus, at some point of this length the want for working capital increases.
As towards this, in a duration of despair there is low demand, lesser manufacturing and sale, etc.
Thus, the working capital requirement reduces.
(iv) Production Cycle: The time length between the conversion of uncooked substances into completed items is referred as manufacturing cycle.
The span of manufacturing cycle is exceptional for extraordinary companies relying on which the requirement of working capital is determined.
If a company has a longer span of manufacturing cycle, i.e. if there is a lengthy time hole between the receipt of uncooked substances and their conversion into closing completed goods, then there will be an excessive requirement of working capital due to inventories and associated expenses.
On the different hand, if the manufacturing cycle is quick then requirement of working capital will be low.
(v) Growth Prospects: Higher boom and enlargement is associated to greater production, extra sales, extra inputs, etc. Thus, organizations with greater increase possibilities require greater quantity of working capital and vice versa.
Q2.” Do you agree? Why or why not? Capital budgeting selection is good for changing the monetary fortunes of a business”.
Ans- Yes, capital budgeting selection is a very quintessential selection which wishes to be taken carefully. It has the functionality of altering the economic fortunes of a business.
Capital budgeting selection refers to the selections involving the allocation of constant capital to specific projects.
Such selections contain funding selections involving attainment of new assets, expansion, modernization and replacement.
Such lengthy time period investments consist of buying plant and machinery, furniture, land, building, etc.
and additionally expenditure as on launch of a new product, modernization and advertising, etc.
They have lengthy time period implications on the enterprise and are irrevocable besides at a massive cost.
They have an effect on a business’ lengthy time period growth, profitability and risk.
The following are the elements that spotlight the significance of capital budgeting decisions:
(i) Long Term Implications: Investment on capital property (long time period assets) yield return in the future.
Thereby, they have an effect on the future potentialities of a company.
A company’s lengthy time period increase potentialities rely on the capital budgeting selections taken by way of it.
(ii) Huge Amount of Funds: Investing in constant capital includes a giant quantity of funds.
This makes the capital budgeting choices all the extra essential as massive quantity of dollars continues to be blocked for a longer length of time.
These selections as soon as made are challenging to change.
Thus, capital budgeting choices want to be taken cautiously after a distinct find out about of the complete requirement of money and the sources from which they are to be raised.
(iii) High Risk: Fixed belongings contain massive quantity of cash and thereby, contain massive hazard as well.
Such choices are volatile as they have an effect on the lengthy time period existence of the company.
For example, choice about the buy of new equipment includes a chance in phrases of whether or not the return from the equipment would be higher than the value incurred on it.
(iv) Irreversible Decisions: These selections as soon as made are irrevocable.
Reversing a capital budgeting choice entails large cost. This is due to the fact as soon as large funding is made on a project, withdrawing it would imply massive losses.
Q3. Explain the elements affecting the dividend decision.
Ans- Dividend selection of a corporation deals with what element of the income is to be disbursed as dividends between the shareholders and what component is to be saved as retained earnings.
The following are the elements that have an effect on the dividend decision.
(i) Amount of Earning: A company will pay dividend out of its cutting-edge and the previous earnings.
This implies that income play a key function in the dividend decision.
An enterprise having greater salary will be in a role to pay a greater quantity of dividend to its shareholders.
In distinction to this, an agency having low or restrained profits would distribute low dividends.
(ii) Stable Earnings: When an employer has a steady and an easy earning, they are in a role to distribute greater dividend as in contrast to the agencies who have an unstable earning.
In different words, an organization having steady and steady income can distribute greater quantity of dividends.
(iii) Stable Dividends: Companies typically comply with the exercise of stabilizing their dividends.
They strive to avoid normal fluctuations in dividend per share and decide for growing (or decreasing) the cost solely when there is a steady upward thrust (or fall) in the profits of the company.
(iv) Growth Prospects: Companies aiming for a greater boom stage or enlargement of operations keep a greater element of the income with itself for re-investment.
Thus, dividend of such a business enterprise is smaller as in contrast to the businesses with decrease boom opportunities.
(v) Cash Flow Position: Dividend repayments require money outflow.
If a business enterprise is low on money then the dividend will be decrease as in contrast to the business enterprise which has extra liquidity.
Even if an organization has greater profits, it will no longer be in a position to distribute excessive dividends if it does now not have sufficient cash.
(vi) Preference of the Shareholders: A corporation need to maintain in idea the preferences of the shareholders whilst distributing the dividends.
For instance, if the shareholders decide upon at least a sure quantity of dividend, then the employer is probably to declare the same.
(vii) Taxation Policy: Taxation coverage performs a necessary function in determining the dividends.
If the taxation coverage is such that an excessive price of tax is levied on dividend distribution, then the corporations are probable to distribute decrease dividends.
On the other, it may pick to distribute greater dividends if the tax fee is low.
(viii) Stock Market Reactions: The quantity of dividend that an organization distributes influences its inventory market prices.
An expand in dividend with the aid of an organization is seen as an exact signal by way of the traders and the inventory charge of the organization goes up.
On the different hand, a fall in the dividends adversely influences the inventory prices.
Thus, whilst taking the dividend decision, an employer should think about the likely inventory market reactions.
(ix) Contractual Constraints: Sometimes, whilst giving out loans to a company, the lender may additionally impose some restrictions in the structure of agreement.
These restrictions might also be associated to the dividend paid in the future.
In such cases, the enterprise has to hold such agreements in thinking when distributing the dividends.
x) Access to Capital Market:
The organizations that have a larger get right of entry to the capital market have a tendency to pay greater dividends.
This is due to the fact they can remember much less on retained salary and extra on different sources due to the market access.
The smaller organizations who have decrease get admission to capital markets have a tendency to pay decrease dividends.
(xi) Legal Constraints: Companies have to adhere to the policies and insurance policies laid out via the Companies Act.
Thus, any agency wants to take care of such restrictions and insurance policies earlier than declaring the dividends.