FINANCIAL

MANAGEMENT

CLASS 12
BUSINESS
 NOTES
FINANCIAL MANAGEMENT
Money required for carring out business activities is called Business
finance.
Availability of efficient finance is very crucial. for the survival and
growth of a business and hence it is known as "life blood of the
business".

Financial management
It is concerned with efficient acquisition and utilisation
(distribution) allocation of funds.
or, the proper and efficient use or management of business finance.

Objectives of financial management

main objective is to maximise the wealth of equity shareholder ie...
gainful for the owner/ Shareholder.
ie. ....the value of share increases.

The above objective automatically fulfills many of the objectives, the

value of share increases when the shareholder get more amt. of
dividend and this can be possible when company is gaining more amt of
profit.
So, it will fulfill many objectives that are

CLASS 12 BUSINESS
 NOTES
FINANCIAL MANAGEMENT

Profit Maintance
maximisation of liquidity

Max. of wealth of Equity

shareholder

Meeting of financial proper utilisation of

commitments funds

Financial functions or financial decisions:-

(i) investment decision
(ii) Financing decision
(iii) Divident decision

(i) investment Decision [Capital Budgeting decision]

It is related to careful selection of assets in which funds will is invested
to bring max benefit.
Firm invest it's funds in acquiring

Fixed assets Current assets

when fund is invested for fixed assets known as Capital budgeting

decision

CLASS 12 BUSINESS
 NOTES
FINANCIAL MANAGEMENT
Factors affecting investment decision
Cash flow of the project.
Return on investment. It is most important criteria
Ex Project A is bringing 10 % return
Project B is bringing 15 % return
Firm will prefer project B
Risk involved
investment criteria availability of labour, machinery etc.
Importance of investment decision
Long term growth
Large amount of funds involved.
Risk involved
Irreversible decision = ie.. they can't be reversed or changed overnight

(ii) Financial decision

It is concerned with deciding source of finance"
Generally there are 2 sources

Equity Taking loan & advances

issue of shares issue of Debentures

The financial manager prefer a mix of both types

he/she fixes a ratio of both kind of fund in capital structure of
company.
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CLASS 12 BUSINESS
 NOTES
FINANCIAL MANAGEMENT
Factors affecting financial decisions
Cost
Risk More risk in loan & advanced [Borrowed fund]
as compared to equity [owner’s fund]
Cash flow position smooth and steady cash flow companies can
easily afford borrowed fund.
Control consideration [control over the fund]
Floatation cost ie.... cost involved in issue of securities such as
broker 's commission underwriters fee etc.
Fixed operating cost a company having high fixed operating cost
prefer owner's fund as it is difficult to pay high amount of interest
on borrowed fund [debt securities]
State of capital market During boom period it is easy to sell
equity shares, but during depression period there is more demand of
debt securities.

(iii) Dividend decision

This decision is concerned with the distribution of surplus fund.
The profit of the company is distributed among various parties ie..
creditors, employee, shareholder etc.
The surplus profit is either distributed as dividend to shareholder
or kept aside as retained earning.
The manager makes decision about the amount to kept as reserve
and the amount that is to be distributed
This decision is also knows as residual decision as it is concerned
with distribution of residual or left over income.
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CLASS 12 BUSINESS
 NOTES
FINANCIAL MANAGEMENT
Factors affecting dividend decision
Earning dividends are paid out of current and previous year. earning,
ie... more earning more amount of dividend.
Cash flow position
Growth opportunities
Stability of dividend Some companies follow a stable dividend policy
as it has better impact on market.

There are 3 types of stable divided policy

1. Constant dividend per share = ie..... 10% dividend
2. Constant payout ratio= ie......10%of profit
3. Constant divided per share, and external dividend [ if any.]

Preference of shareholder [expectations of shareholder]

Taxation policy today dividend is tax free for Shareholder, but
company has to pay.
Tax on dividend so high tax rate less amount of dividend.
Low tax rate more amount of dividend.
Legal restrictions / law in order
Reputation of company in market
Contractual constraints/ restrictions when companies take long
term loan then financier may put some restrictions on distribution of
dividend .
Stock market reaction the amount of dividend paid has impact on
stock market as increase in divided will result to increase in price of
security [a good news in stock market] where as less amount of
dividend paid will reduce the price of shares / securities in share
market.

CLASS 12 BUSINESS
 NOTES
FINANCIAL MANAGEMENT
Financial planning
It means deciding in advance how much to spend , on what to spend
according to the funds at disposal.

The financial planning begins with determination of total capital

requirement.
The next step is deciding how to raise this finance.
It also includes long term investment decision

Objectives of financial planning

It ensures timely availability of finance.
To see that firm does not raise resources unnecessarily
Financial planning includes both short term as well as the long
term planning.

Importance of financial planning

It facilitates collection of optimum funds = ie......avoid wastage
and over capitalisation situations
Helps in fixing the most appropriate capital structure.
Helps in investing finance in right projects
Base for financial control.
Helps in proper utilisation of finance.
Avoiding business shocks and surprise
Links present with future.
Helps in co-ordination b/w various business function.

CLASS 12 BUSINESS
 NOTES
FINANCIAL MANAGEMENT
Capital structure
It means the proportion of debt and equity used for financing the
operations of business

capital structure = Debt / equity

It represents the proportion of deb capital and equity capital in the

capital structure.
It affects the profitability and financial risk
The best capital structure is the one which results in maximising the
value of equity shares.

Financial leverage / Trading on equity

It refers to proportion of debt in the overall capital.

Financial leverage = D/E

where, D = Debt E = Equity

with debt fund , companies funds and earnings. increase because debt
is a cheaper source of finance but is very risky..
when,
Rate of intrest on debt > return on investment
more debt means loss for company

1 lack loan 10% ⇒10,000

1 lack Investment 8% ⇒
8,000

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CLASS 12 BUSINESS
 NOTES
FINANCIAL MANAGEMENT
Factors determining the capital structure
Cash flow position before inducing the debt in capital structure
company must analyse properly the liquidity of its working capital.
company employs more of debt if company is sure of generating
enough cash inflow where as if there is shortage of cash then it
must employ more of equity in capital structure.
Intrest coverage ratios

1CR = EBIT / intrest

[EBIT - earning before intrest and tax]
high ICR = company can have more of borrowed fund .
low ICR = less borrowed fund securities

Return on investment
cost of Debt
Tax rate = high tax rate promotes debt. as interest paid on deb. is
subtracted from income before calculating tax
Cost of equity
Floatation costs [explained earlier].
Control
Capital structure of other company.
Stock market condition.

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CLASS 12 BUSINESS
 NOTES
FINANCIAL MANAGEMENT
Fixed and working capital
1.Fixed capital
It involves allocation of firm's capital to long- term assets or
projects
Managing fixed capital is related to investment decision and is also
called capital budgeting.

Factors affecting requirement of fixed capital

Nature of business.
Scale of operation.
Technique of production

capital intensive Technology labour intensive Technology

Technology upgradation.
level of collaboration / Joint ventures.
Diversification [range types to products]

2.Working capital

Current Assets - Current Liabilities

Gross working capital =It refers to the investment in all the current
assets

CLASS 12 BUSINESS
 NOTES
FINANCIAL MANAGEMENT
Net working capital / working of capital It refers to excess of current
assets over current liabilities.
It can be negative also
It indicates the liquidity position of the company

Factors affecting the working capital

Lenght of operating cycle [ it refers to the time period involved in
production ]
Nature of business
Scale of operation
Business cycle fluctuation during boom period more amount of
working capital is required, whereas during depression period to
less amount of working capital is needed.
Seasonal factors
Technology and production cycle
Credit allowed
Credit avail/recieved.
operating efficiency
Level of competition.
inflation when there is rise in price then the price of raw materials
and cost of labour will rise, result in an increase in working.
capital requirement
Growth planning

CLASS 12 BUSINESS
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