Financial Mgmt Notes

8/11/2019 Financial Mgmt Notes

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FINANCIAL MANAGEMENT

Finance:-

It is a flow of money.

Management:-

Control or Managing of money

Financial Management:-

It is the process of managing or controlling flow of money or fund.

In the technique word: Financial Management it is a process of acquitting of funds from various sources to meet the

business needs in order to accomplish overall objectives of the firm.

1. Maximization of wealth.

2. Maximization of profit.

Financial Management it is consider as a life blood of all business enterprises and it also consider as arms and leg

business activities.

Finance can be classified into two types:-

1. Private finance.

2. Public finance.

1. Private finance:-

It deals with requirements receipts and dispersment of funds to an

1. Individual

2. Business finance and

3. Non-profit organization or corporation firms finance

Business finance sub classified into three types:-

1. Sole proprietors finance

2. Partnership firm finance and

3. Joint stock company

2. Public finance:-

It deals with requirement receipts distributions of fund to the government institutions by

1. Local Self Government

2. State Government and

3. Central Government

Importance of finance:-

1. Finance is helpful for modernization, diversification expansion and development of a enterprises.

2. Availability of adequate finance increase the credit worthiness (repayment of loan. of the concern in the high of

the supplies, traders and general public.

3. The issue of a large number of securities as provided wide investment opportunities to the investors.

4. By insuring wide distribution of funds finance contribute to balance regional development in the country.

5. Finance if essential for undertaking research activities, market serwaypublicity, transportation, communication

and for efficient marketing of a product.

6. By contributing to the renovation and modernization of industry finance contribute to the production and supplies

goods at fair prices to the society.

Business finance/finance function

It is a process of raising, providing and managing of funds or money used in the business. In short it is the

process of acquisition of funds and the effective utilization.

Importance of finance

In the words of Henry ford,

Money is an arm or a leg. You either we it or loose it. This statement is very simple and meaningful which

shows the significance of finance or money.


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In modern money oriented economy,Finance is one of the basic foundations of all kinds of economic activities. It

is the master key which provides access to all the sources for being employed in manufacturing and merchandising

activities.

Business finance use to make more money, only when it is properly managed. Hence, efficient management

of its finance, Thus, Finance is regarded as the life blood of business enterprise and finance is the back bone of every

business.

The following are the points which shows the importance of finance in the economy:-

Finance is helpful for modernization, diversification, expansion and development of an enterprise.

It is essential for undertaking research, Market Survey, paragraph, publicity and for efficient Marketing of product.

Availability of sufficient Finance increases the credit worthiness of concern in the eye of the supplier, traders and in

the general public.

The issue of a large number of securities has provided wide investment opportunities to the investors.

By ensuring wide distribution of funds, finance contribute to balanced regional development in the country.

By contributing to the renovation and modernization of industries, finance contributes to the production and supply

of goods at fair prices to the society.

rinciples/Aims/Functions/Steps of Finance Function

1. Anticipation of funds Needed:-

The main aim of finance function is to forecast expected events in business and not financial implication,

selection of assets or projects takes place only after proper evaluation which is helpful to anticipation of funds is the

first aim of fianc function.

2. Allocation or utilization of funds:-

The main aim of finance function is to assess the required needs of course the prime objective or traditional

finance function. Efficient allocation of Investment avenues meant investment of funds on profitable projects which

means a project or an asset that provides return which is higher than the cost of funds.

Apart from this assets are balanced by weigh their profitability [refers to earning of profit] and liquidisation [means

closeness to money].

3. Administrating the allocation of funds:-

Ones the funds are allocated or utilized, on various investment opportunities. It is a basic aim of the financial

management watch the performance of each rupee i.e., as been invested.

4. Increase profitability:-

Proper planning, managing and controlling of finance function aims at increasing profitability of the firms.

Proper planning of anticipation of funds, selection of investment of avenues and allocation of funds helps to increase

the profit. Financial management has to arrange sufficient funds at least at the right time and investing on the right

asset. So that they can control the operations like cash receipts and payments also helps to increase profits. Hence

financial functions need to match the cost and returns from the funds.

5. Maximizing Wealth of the firms:-

The prime objective of any finance function in any organization is to maximizing the firms value by taking

right decision. But maximization of share holders wealth is possible only when the firm is able to increase profit,

hence finance managers what ever, decision he takes, it should be the objectives of maximization of owners wealth.

6. Acquiring sufficient funds:-

The firm has to acquire sufficient funds by raising from suitable sources of finance which may be long term

sources like share capital bonds or debentures, long term loans from financial institution or short term sources like

short term loans from banks, retainer earning etc.

Objectives of Financial Management or goals of Business Finance

a. Specific objectives b. General objectives.

1. Profit Maximization.

2. Wealth Maximization.


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1. Profit Maximization:-

Earning profits by a corporate or a company is a social obligation. Profit means is the only means through

which an efficiency of organization can be measures profits also serve as a protection against risks which cannot be

ensure it is an Economic obligation to cover cost of funds and provide funds to expansion and growth.

Profit maximization ensures maximum welfare to the share-holders, employee and prompt payment to creditors of a

company.

Advantages of Profit Maximization:-

It is a barometer through which the performance of a business unit can be measured.

It attracts he investors to invest their saving in securities.

It indicates that the fund is efficiently used for different requirements.

It increases the confidence of management in expansion and diversification programmers of a company.

It ensures maximum welfare to the share-holders. Employees and prompt payment to creditors of a company.

Disadvantages of profit maximization:-

Profit is not a clear term. It is accounting profit?, Economic profit?, Profit before tax?, After Tax?, Net profit?,

Gross profit or Earning per share?.

Profit maximization does not consider the Element of risks.

Huge profit attracts Government intervention.

Huge profit invites problems from workers. They demand high salary and fringe benefits.

Profit Maximization attracts Cut-throat competition.

Profit Maximization is a narrow concept, later if affects the long-term liquidity of a company.

It does not consider the impact of time value of money.

It encourages corrupt practices to increase the profits.

Modern concept of marketing does not encourage profit maximization.

The true and fair picture of the organization is not reflected through profit maximization.

2. Wealth Maximization:-

It refers to gradual growth of the value of assets of the firms in terms of benefits it can produce. Any financial

action an be judged in terms of the benefits it produces less cost of action. The wealth maximization attained by a

company is reflected in the market value of share. In short term, it is the process of creating wealth of an

organization. This will maximizes the wealth of share-holders.

1. Wealth maximization is the net present value of a financial decision [Investment decision]:-

Net present value will be equal to the gross present value of the benefit of that mines the amount invested to

receive such benefits.

Npv = Gpv of benefits-Investment or

Npv= present cash inflowcash outfiow

a. Any financial results in positive Npv, creates wealth to organization.

b. If the Npv is Negative, it reduces the existing wealth of the share holders.

The total cash inflow of the organization must always be more than the cash outflows. The surplus inflow of

cash indicates the size of wealth, which was added to the total value of the assets.

2. When Earning per share (Eps. and profit after tax are considered as indicator of welfare of share holders [Equity

share holders]

Eg:- The Company has 50,000 shares of Rs:10 each has an earning per share of Rs:0.40 with a profit of Rs:20,000.

Assume that, the company has issues an additional capital of Rs:50,000 shares of Rs:10 each for its financial

requirement. Now profit will increase upon Rs:30,000 After taxes, resulting in a net increase of Rs:10,000. Though

the additional profit of Rs:10,000 is increased, the earning per share has come down Rs:0.30.

This does not add to the wealth, and Hence does not serve the interest of owners, due to this reason, the

finance manager always concentrates on wealth maximization, cash flows and time value of money.

3. Wealth maximization has been explainer differently by practical financial executive.

When the companys profits are more, he advises the management to keep certain amount of profit for future

requirements i.e., for expansion, through which he increases the production and market share.


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The benefits gainer will be passed on not only to the equity share holders but also passed to the creditors,

better payment of wages to workers, develop infrastructure, create more facilities to the society, pay prompt taxes to

the Government and attain self sufficiently and earn good reputation in the market, which will be reflected by

market value of shares in the stock exchange. This is the situation where investors can maximize their value of

investment.

Symbolically, it is expressed as Wo=Npo

Wo=Wealth of the firm,

N =Number of share owner and,

Po =price per share in the market.

Significance of wealth Maximization.

The company cares more for economic welfare of the share holders, it cannot forget the other who directly or

indirectly contribute efficiency for the overall development of the company, namely,

1. Creditors/lenders:-

It refers to financial institution, commercial banks, private money lenders, debentures and trade creditors. The

company has to meet their obligation of paying interest and principal on dues dates. The earning of the company

assures prompt recovery of their investment, so that the lenders can increase their confidence level by financing

more to the company. This would help the company to earn good reputation and can increase their liquidity.

2. Workers/Employees:-

They are the back bone of the industry. They are the main contributors to the growth and success of one industry. It

is the basic obligation of the company to keep the workers in good humour and harmony. This can be achieved only

by providing fairs wages, good working conditions with appropriate welfare measures. This would help the

company to earn good reputation and can increase their liquidity.

3. Society/public:-

4. Management:-

The success of the business mainly depends on the decisions taken by the Management. The finance manger

has to make and guide the management in taking right decision at the right time and also control over [Maximum

control over] the movement of funds and invest the funds in the profitable avenues to reach maximum profit. This

will increase the confidence in the minds of equity share holders.

Advantages of wealth Maximization:-

1. Wealth Maximization is a clear term. Here, the present value of cash flows is taken in to consideration. The net

effect of investment and benefits can be measured Cleary.

2. It considered the concept of time value of money present cash inflow and cash out flows help the management to

achieve the overall objective of company.

3. It considered as a universal accepted concept, because it takes care of interest of financial instructions owners,

employees, management and society at large.

4. It guides the Management in formulating a consistent strong dividend policy to reach Maximum returns to equity

share holders.

5. It considers/studies the impact of risk factor, while calculating the Npv at a particular discount rate adjustment is

being made to cover the risk that is associated with the investment.

Disadvantage or criticisms of wealth Maximization.

1. It is a prescriptive idea. The object is not descriptive of what the firms actually do.

2. The objective of wealth maximization is not necessarily socially desirable.

General objectives:-

1. Ensuring maximum operational efficiency through planning directing and controlling of the utilization of funds.

2. Enforcing financial discipline in the organization in the use of financial resources through the co-ordination of the

operations of the various decision in the organization.

3. Building up of adequate reserve for Financial Growth and Expansion.

4. Ensuring a fair return to the share-holders on their investments.

Financial Decision


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Financial decision refers to the decision concerning financial matters of a business concern. The functions of finance

involves three important decision i.e.,

1. Investment decisions.

2. Financing decisions and

3. Dividend decisions.

All three decisions directly contribute to the corporate goals of wealth Maximizations.

1. Investment decisions:-

It refers to the activity of deciding the pattern of investment. It covers both short term investment decision and long

term investment decisions.

The long term investment decision is referred to as the capital budgeting and short term investment decision as

working capital Management.

Capital budgeting is the process of making investment decisions in capital expenditure. These are the expenditures,

the benefits of which are expected to be received over a long period of time exceeding one year. The finance

manager has to assess the profitability of various project before investing of the funds.

The investment proposals should be examined in terms of expected profitability, costs involved and risks associated

with the project. Investment decision not only concentrate on setting up of new units but also for expansion of

present units, replacement of assets, research and development project costs and reallocation of funds.

Short term investment decision is one which ensures higher profitability, proper liquidity and sound structural healthof the organization.

2) Financing decisions:-

It is another important decision where a business concern to maximum care in financing to different proposals. The

combination of debt to equity directly contributes to profitability of a business unit and reduces/financial risk. The

instrument that are to be selected must aim of maximizing the returns to the investors and to protect the interest of

creditors. Suppose, if a finance manager would like to have more debt and less equity. This bring more dividends to

share holders and results in increased price of the shares in the market and may lead to wealth maximization but the

cost of borrowed funds [i.e Interest on debentures] may increase the risk of the business concern most of the earned

funds will be used on the payment of interest on the borrowed funds which is also called as financial risk. Hence

he should be intelligent and tactful in deciding the ration between debt of equity.

3) Dividend decision:-

This relates to dividend policy. Dividend is a part of profits, which are available for distribution to equity share

holders payment of dividends should be analyzed in relation to the financial decision of a firm.

There are two options available in dealing with net profits of a firm, i.e, distribution of profits as dividends to the

ordinary shareholders where there is no need of retain earning in the firms itself if they require for financing of any

business activity.

Financial manager should determine optimum dividend policy, which maximizes market value of Shares and there

by Market value of the firm.

Financial planningIt is the process of estimating the total financial requirements of the firm and determining the sources of in its capital

structure (D: E)is called financial planning. or

It is the primary function of the management financial plan is a statement estimating the amount of capital required,

determination of finance mix and formulating of policies for effective administration of financial plan.

Financial planning states,

a) The amount of capital required to be raised.

b) The proportion of debt equity.

c) policies for effective administrative financial plan

Financial planning results in the formulation the financial plan. It is primarily a statement of estimating the capital

and determining its composition [contents]

1) The quantum of finance i.e., the amount needed for implementing the business plans.

2) The pattern of financing, i.e., the form and proportion of various corporate securities to be issued to raise the

required amount and


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3) The policies to pursued for the flotation of various corporate securities particularly regarding the time of their

floatation.

Need for financial planning

1) To maintain the liquidity throughout the year.

2) To indicate the surplus resources [Reserves] available for expansion or external investments.

3) To minimize the cost of fund raising procuring the funds under the most favourable terms.

4) To maintain proper balancing of costs and risks involved in raising funds to protect the interest of the investors.

5) To ensures simplicity of financial structure.

6) To ensures proper utilization of funds raises.

7) To see to it that the share holders get proper return on their investment.

8) It ensure flexibility so as to adjust as per requirements.

Characteristics / principles of sound financial plan:- (5marks)

1) Simplicity:-

The financial plan should a simple financial structure so that, it can be easily understood even by a laymen [common

man]. The types of securities should be minimum which can be managed easily.

2) Foresight:-

Financial plan should be prepared only after taking into consideration of today and future needs for funds. It is a

difficult task as it requires an accurate forecast of the future scale of operations of the company. Technologicalimprovement, demand forecast, resource availability and other secular changes should be kept in view while drafting

the financial plan.

3) Long term view/needs.

The financial plan should be formulated and conceived by the promotes / management keeping in view the long-

terms needs of the company rather than the easiest way of obtaining the original capital. This is because the original

financial plan would continue to operate for a long period even after the formulation of the company.

4) optimum use:-

The financial plan should provide for meeting the genuine needs of the company. The business should neither be

starved of funds not should it have unnecessary spare funds, waste full use of capital it as bad as in adequate capital.

A proper balance should be maintained between long-term and short-term funds since the surplus of one would not

be able to offset the shortage of the other.

5) Contingencies:-

It should keep in view the requirements of funds for contingencies. It does not, however, mean that capital should be

kept unnecessarily idle for meeting contingencies. Management is foresight will considerably reduce this risk.

6) Flexibility:-

The financial plan should have a degree of flexibil.ity also. It is helpful in making changes or revising the plan

according to pressure of circumstances with minimum possible delay.

7) Liquidity:-

Liquidity is the ability of the enterprise to make available the ready cash whenever to make disbursement. Adequateliquidity also flexibility to the financial plan. Liquidity ensures the credit worthinees and goodwill of the firm.

8) Economy.

Economy means funds should be raised at minimum cost. Cost minimization depends on the selection of various

sources of finance and optimum mix of debt-equity.

Steps / factors affecting financial planning:- (5marks)

) Estimating the capital requirements :-

Fixed cost- cost incurred on fixed assets eg:-plant and machinery, land and building,

furniture etc

Cost of intangible assets:- cost incurred on patent ,copy rights, technology collaboration, goodwill trademark

etc.

Amount invested on current assets like cash at bank , cash in hand, debtors, bills receivables, stocks, materials

etc


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Cost of promotion:-registration charges, stamp duty,legal charges, promoters remuneration, etc

Cost of financing:- cost incurred for printing of prospectus MOA, AOA, share holders application forms,

underwriters commission, brokerage etc

) Determining the sources of funds:-

Setting of objectives:-

The financial objectives any business enterprises is to employ the capital in whatever proportion necessary to

increase the productivity of the remaining factor of production over the long run. The use of capital varies from firm

to firm, the objective is identical in all the firms, the objective is identical in all the firm. Business enterprises

operate in a dynamic society and, in order to take advantage of changing economic conditions. Financial planners

should establish both short-run and long run objectives.

Policy formulation:-

The financial policies of a concern deal with procurement, administration and disbursement of fund in a best

possible way. The current and future needs of funds should be considered and future needs for funds should be

considered while formulating financial policies.

The financial policies may be of the following types:-

1) Policies regarding the size of capitalization. [amount of capital to be raised]

2) Policy governing the capital structure [debt-equity mix].

3) Policy regarding collection and credit.

4) Dividend policy.

5) Policy regarding Management of working capital or current assets.

3) Laying down the financial procedures:-

For the proper execution of the financial policies, detailed procedures incorporating rules and regulations are

required to be laid down. The financial procedures are very helpful to the middle level executives to know their

responsibilities.

4) Financial forecasting:-

Forecasting or Estimating the future variability of factors. Forecasting is done in regards to output, sales, costs,

profits etc.

5) Review of financial plan:-

The financial plan should be reviewed from time to time in the light of changing economic, social, political and

business Environment.

Long term and short term financial plans:-

Financial plans may be dividend in to two types :-

They are,

1) Long-term financial plan.

3) Short term financial plan.

1) Long-term financial plan:-

It is a plan which covers a period of 5 years or more. It is concerned with the formulating of long term financial

goals of the enterprises.

The following financial instruments are utilized to develop a long term financial plan. They are:-

. Equity share.

. Preference share.

. Debentures.

. Retained Earnings.

. Bonds.

. Own funds

. Venture capital.

. Leasing.

. Hire-purchase.

2) Short term financial plan:-


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It is the financial plan which cover a period of one year or less.

It is concerned with the planning or determination of short-term financial activities to accomplish long term financial

objectives.

Finance Manager

Finance manager is person who heads the department of finance.

Role or Functions of Finance Manager (15marks)

. He should anticipate and estimate the total financial requirements of the firms.

. He has to select the right sources of funds at right time and at right cost.

. He has to allocate the available funds in the profitable avenues.

. He has to maintain liquidity position of the firm at the peak.

. He has to administrate the activities of working capital Management.

. He has to analyze financial performance and plan for it growth.

. He has to protect the interest of creditors, shareholders and the employees.

. He has to concentrate more on fulfilling the social obligation of a business unit.

. Estimation of capitalization requirement of organization.

0. To make a appropriate decision with regard to invest or utilize funds.

1. Decision with regard to Dividend policy.

2. Financial manager helps to maintain co-ordination relationship between the employer and employee.

3. Financial manager helps in optimum utilization of Death and equity ratio of capital of business.

4. Maximization wealth of increasing the value of firm

5. It helps to maximize the value of share holders.

6. Financial manager helps in Making prompt payment to the creditors.

7. Financial manager helps in effective Administration of the financial plan.

8. Financial manager to reduces the cost of production and maximize it the profit.

9. Financial manager Advise the Management to maintain reserves or retained earnings in the firm for meeting or

future needs of the firm.

0. Financial manager helps in comparing the earning per share of the compotators with their firms.

1. Financial manager avoid unnecessary utilization of funds.

2. Financial manager helps the firm to maintain flexibility as well as simplicity of the firm.

3. It ensure prom payment of tax to the government.

4. Financial manager refers to review of financial plan.

5. Ensure prompt payment to the government.

6. Financial manager helps the firm to know about the value of money, financial risk of the firm.

7. It ensure more credit worthiness of the business.

8. Financial manager helps the firm to know about the consignees events.

15marks:-

Characteristic of a sound financial plan or principles of sound financial plan or steps be considered whilepreparation of financial plan:

1) Simplicity:- The financial plan should simple so that the investors are attracted towards investment. There should

not be many types of securities otherwise the business capital structure will become complicated. The financial plan

of the business should be such that not only in present, but also in the future finance is available.

2) Flexibility:- The financial plan of the business should be flexible so that adjustments can be made in to business

requirements. The financial plan should not be expensive for the enterprise.

3) Foresightedness:- The financial plan not only over the present requirement but also the future requirements can be

fulfilled.

4) Liquidity:- For the Effective running of a business the business should have adequate liquidity. The shortage of

liquidity has adverse effect on goodwill and sometimes it lead to liquidation of a business.

5) Useful:- The financial plan should use the financial sources fully and gainfully.

6) Completeness:- The financial plan should be complete and it should cover every future contingency.


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7) Economical:- The financial plan should be economical both in raising and utilization of funds. Issue expenses

should be less.

8) Communication:- A sound financial plan should b e a good source of information to the inventors and finance

providers.

9) Implementation:- The financial plan should be implemented without difficulty and its benefits should go to the

enterprise.

10) Control:- The capital structure and financial plan should ensure continuation of the control of the enterprise in

the present hands.

11) Less risks:- The financial plan should be prepared in such a way that are less risk in the enterprise.

12) Provision for contingencies:- A good financial plan has adequate provisions for business oscillation and

anticipated contingencies.

13) Intensive use of capital:- Effective utilization of capital is as much important as the procurement of adequate

funds. This is possible by maintaining equilibrium in fixed and working capital. Surplus of fixed and working capital

should not be used as substitution to shortages of another. Such practices should not be encouraged as they would

drag the company use of capital for a fair capitalization.

Factors affecting financial planning:-

1) Nature of a Business:-

More Finance is required for capital intensive business and less finance is required for labour intensivebusiness.

2) Flow of income of business:-

If regular flow of income in a business it can run with less capital.

If flow of income fluctuating, more capital is needed.

3) Risk in a business:-

If the business is involves in high risk then it require more owner capital because the available of debt capital

is less.

More debt capital is available only when the firm involves in less risk.

4) Plans of expansion:-

The financial plan is not prepared on the basis of present prepared on the basis of present requirement but in

casefuture requirements are also considered.

5) Status and size of a business:-

If a business has good reputations can easily obtain finance.

In case if a firm does not have a good fame or size of a business of the firm then it is quite difficult to achieve

finance for the business.

6) Government control:-

The financial plans should be prepared on the basis of Government policies, control and legal requirements.

7) Alternative sources of finance:-

Financial plan depends upon the availability of the alternative finance for the business that help the firm tochoose the profitable finance to the business.

8) Flexibility:-

The financial planning is flexible than it is very easy to carry out the expansion and diversification

programmers.

If it is not flexible then it is difficult to achieve it.

CAPITAL STURCUTRE

Capital structure:-

Capital structure is the permanent long term financing that is represented by

Long term debt.

Preference share capital.

Equity share capital and

Retained earnings.


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If a firm uses only equity capital in its capital structure and does not use debt capital, in such a situation the firm

cannot get the benefits of trading on equity and the owners of the firm cannot be successful in achieving the

objective of maximization of their wealth.

Definition:- (2marks)

According to John J.Hampton.

Capital structure is the combination of debt and equity securities that comprise a firms financing of its

assets.

According to I.M.Panday.

Capital structure is the permanent financing of the firm, represented by long-term debt, preferred stock and

net worth.

According to Rebort H.Wersel.

The term capital structure of frequently user to indicate the long term sources of funds employed in a business

Enterprises.

One should know the concept of financial structure, capital structure and assets structure:-

Financial structure:- It refers to the way the firms assets are financed, it is the entire left hand side of the balance sheet.

It included all long term and short term obligations of the firm.

Financial structure = Long term funds +current liabilities.

Capital structure:- It includes long term debt, preference shares and equity share capital. In equity capital we includeordinary share capital, surplus and reserves and retained earnings.

Capital structure = Long term funds or

Capital structure = Ordinary share capital +Preference share capital+ reserves and

surplus +Long term debt.

Assets structure:- This means total assets of the firm. This is the total of fixed assets and current assets.

Assets structure = Foxed Asset +current assets +other assets [if any].

Patter of capital structure [2marks]

Capital structure with equity shares only.

Capital structure with both equity shares and preference shares.

Capital structure with equity shares and debentures.

Capital structure with equity shares, preference shares and debentures.

Factors affecting capital structure:- (5 marks)

Success of any business mainly depends upon the financial plan and capital structure.

A company or firm should try to construct an optimum capital structure.

A firm should consider all those factors which affect its capital structure.

Generally factors affecting capital structure are:-

A) Internal factors:-

) Nature of Business

) Regularity and certainty of income.

) Desire to control the business.

) Future plans.

) Attitude of management

) Freedom of working.

) Operating ratio.

) Trading on equity.

B) External factors:-

) Conditions of capital Market.

) Nature and type of investors.

) Cost of capital.

) Legal requirements.

Optimum or balances capital structure:- (2marks)


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Means an ideal combination of borrower and owner capital that may attain the marginal goal i.e., maxim of market

value will be maximized or the cost of capital will be minimize when the real cost of each source of funds is the

same.

Internal factors:-It includes.

1) Regularity and certainty of income:-

Regularity and certainty of income affects capital structure. Debentures are issued if there is certainty of

income in future. If funds are needed for some time, then redeemable preference share may issued.

2) Desire to control the business:-

If the promotes and founders want to control the business the equity shares are issued large part is kept in the

control of a group of some people and rest of the equity capital is difficult in the hands of small investors. When

company needs, more funds in future, those are obtained through debentures of preference shares.

3) Future plans:-

Future plans should also be kept in view and for this purpose authorized capital should be kept more. Preference

shares and debentures should also be part of future.

4) Attitude of Management:-

Attitude of Management affects capital structure in form of skills, Judgments, experience, temperament and

motivation, ambition, confidence and conservativeness of the management.

5) Freedom of working:-

If the founders do not want interference in policy formation and decisionmaking of the firm than further

equity share will not be issuer and debentures will be floater.

6) Operating ratio:-

If operating ratio is very high than there is less income, then the firm have more burden of payment of

interest and dividend. If the firm achieve more income with less operative ration then the firm easily distributed

interest and dividend to the share holders.

8) Trading on equity:-

If the promoter wants to increase the income then they have to slove the problems of debt financing then they

can easily increase the profit of the firm.

External factors:- It includes

1) Conditions of capital market:-

Capital Market conditions have significance influence over capital structure. During depression interest rates

are low and profit potentiality is uncertain and irregular, so in such a situation debentures are more popular. During

inflation profit potentiality is high, therefore demand for ordinary share rise and in such conditions equity shares are

issued.

2) Nature and type of investors:-

Nature and type of investors affects the capital structure. If investors are ready to take more risk, equity issue is

betters and if they take more risk, then debentures are more suited.

3) Cost of capital:-

Each source of capital involves cost capital structure combine various sources of optimum capital mix, involving

the least average cost of capital and in this way helping in maximizing of returns.

4) Legal requirements:-

The SEBI has issued guidelines for the issues of shares and debentures. According to the companies act, they

have to perform it.

CAPITALISATION

Meaning:-

Capitalization refers to the combination of different types of securities of a business of a business concern.

Definition of Capitalization:-

According to Husband and Dockeray,

Capitalization is the computation, appraisal or estimation of the present values. [or]

The sum of the par value of the outstanding stocks and the bonds.


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Bases of capitalization:-

There are two recognized theories of capitalization for new companies.

a) Cost theory.

b) Earning theory.

a) Cost theory:-

According to this theory the total amount of capitalization for a new company is arrived at, by adding up the cost of

fixed assets, the amount of working capital and the cost of establishing the business.

b) Earning theory:-

According to this theory, the true value of an enterprise depends upon its earning capacity.

In other words, the worth of a company is not measured by the capital raised but, the earning made out of the

productive harnessing of the capital.

Formula = Average annual future earning*100

Capitalization rate

CHAPTER-2

LEVERAGE:-

In financial Management the term leverage is user to describe the firms ability to use fixed assets or funds to

increase the returns to its owners; i.e, equity shareholders.

It must noted that higher is the degree of leverage higher is the risk as well as return to the owners.

There are basically types of leverages. They are:-

1) Operating leverage.

2) Financial leverage.

3) Combined leverage.

1) Operating leverage:-

It may be defined as the ability of a concern to use fixed operating costs to magnify (to increase) the effect of

change in sales on its operating profits.

Operating leverage=Contribution

Operating profit/EBIT

Degree of operating leverage:-

It refers to the percentage change in operating profit, resulting from a percentage change in sales. It can be

expresser with following formula:-

Therefore, Degree of operating leverage=% Change in EBIT

% Change in Sales.

2) Financial leverage or Trading on Equity:-

The use of long term fixed interest bearing debt and preference share term fixed interest bearing debt and

preference share capital along with equity share capital is called as financial leverage or trading on equity.

Financial leverage = EBIT

EBT

Degree of financial leverage:-

The degree of financial leverage measures the impact of a change in EBIT measures the impact of a change in

EBIT on change in Earning on equity per share

Therefore, Degree of Financial leverage = % Change in EPS

% Change in EBIT.

3) Combiner leverage / Composite leverage:-

It is the Combination of operating and financial leverage. It called as combiner leverage.

Combined leverage = Operating leverage xFinancial leverage

CHAPTER 3

DIVIDENT DECISIONS

The term dividend refers to that portion of net profits which is distributed among the shareholders. It is the reward of

the shareholders for investments made by them in the shares of the company. If a company pays out as dividend


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most of what it earn then for business requirement and for the expansion, it will have to depend upon outside source

such as issue of debt or new shares. Dividend policy of a firm thus effects both the long-term financing and the

wealth of the shareholders.

DIVIDEND POLICY:-

The term dividend policy refers to the policy concerning the amount of profit to be distributed as dividends It refers

to the decisions whether to retain earnings in the firm for capital investment and other purposes or to pay out the

earnings in the form of cash dividend to shareholders.

FORMS OF DIVIDEND:-

Generally, the dividend is paid in cash. But, it can be paid in other forms also these are as follows. On the basis of

medium in which they are paid.

1. CASH DIVIDEND:- Cash dividend is the dividend which is distributed to the shareholders in cash out of the

earnings of the business. It is the most commonly used term for the payment of dividend. Generally, the company

which has enough cash balance is likely to pay dividend in cash but payment of dividend in cash results in outflows

of funds the firm was declared the dividend in cash only when it financial position is strong and have adequate cash

balance at, its at its disposal without effect ting its liquidity position.

2. SCRIP DIVIDEND:- Such form of dividend is not practices in India during the storage of cash and the

companys cash position is temporarily weak and does not permit cash dividend in that case the company may

declare dividend in the form of scrip or promissory note. This ensures or promises the shareholder, the dividend at acertain date in near future. The strong reason behind the issue of scrip dividend is to postpone due payment of cash

for short time and the company is waiting for the conversion of current assets into cash in the course of operations.

3. BOND DIVIDEND:- Sometimes, during shortage of cash and the company also has no idea about now much time

it would take to generate cash. The company may issue the bonds to its shareholders for long period. The issue of

bond dividends increases the long-term ability of the company. This form of dividends is also not prevalent in India.

4. PROPERTY DIVIDEND:- This involves a payment with assets other than cash. This form of dividend may be

followed wherever there are assets that are no longer necessary in the operation of the business. Under exceptional

circumstances property dividend is paid to its shareholders in some kind rather than this form of dividend the

company may also give its own products in place of cash dividend.

For ex:- A biscuit manufacturing company may give biscuit of its shareholders as property dividend Again, this form

of dividend is not prevalent in India.

STOCK DIVIDEND OR BONDS SHARES:- Stock dividend is the dividend which is paid to shareholders in kind

when stock dividend are paid. A portion of surplus is transferred to the capital account and shareholders are issued

additional share certificates. This dividend is declared to only equity shareholders and such issue of bonds shares

increases the total number of share of the existing shareholding.

INTERIM DIVIDEND:- It is dividend which is declared by the director of the company between two annual general

meetings of the company.

COMPOSITE DIVIDEND:- It means a part of dividend that is paid in cash and another part is paid in the form of

property.

EXTRA DIVIDEND:- In any year if the company earns a handsome profits, it may decide to give some extra

dividends to its shareholder along with the regular dividends.

FACTORS INFLUENCING THE DIVIDEND POLICY

1. STABILITY OF DIVIDENDS:- It refers to the payment of dividend regularly and shareholders generally prefer

such stable dividend payment which will increase over the years. This is the most important factor influencing the

dividend policy. Generally, the concerns which deal in necessities suffer less from fluctuating incomes rather than

those concerns which deal with luxurious goods.

2. FINANACIAL POLICY OF THE COMPANY:- Dividend policy may be effected and influenced by financing

policy of the company. If the company decides to meet its expenses from its earnings then it will have to pay less

dividends to its shareholders.

3. LIQUIDITY OF FUNDS:- Liquidity is the continuous ability of a company to meet the maturing obligations as

and when they become due. The dividend policy of a firm is largely influenced by the availability of liquid assets or

resources. For the payment of dividend, a company requires cash and it is not compulsory that highly profitable


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company will have large amount of cash at its disposal. So, a firm may have adequate earning but it may not be in a

position to pay dividend due to liquidity problem.

4. DESIRE OF THE SHAREHOLDER:- Even if the Directors have considerable liberty regarding the disposal of

firms earnings. The shareholders are technically the owners of the company and therefore their desire cannot be

overlooked by the directors while taking the dividend decisions.

5. FINANCIAL NEEDS OF THE COMPANY:- This may be indirect conflict with the desire of the shareholders to

receive large dividends. However, a prudent (wise) management should give proper weight age to the financial

needs of the company. So, growth firms are likely to follow low pay-out ratio and declining companies are likely to

follow high payout ratio.

6. DESIRE FOR CONTORL:- If a growth of company requires additional funds it has to issue additional equity

shares and if the existing equity shareholders are enable to buy the additional shares there voting power is diluted so,

the management cannot pay more dividend in the fear of losing control over the company.

7. LEGAL RESTRICITIONS:- While declaring dividend the Board of Directors also have to consider the legal

restrictions and provisions which is specified in sec 93, 205 A, 206 and 207 of the company act, 1956.

8. DEBT OBLIGATIONS:- A firm which has incurred heavy indebtedness is not in a position to pay higher

dividend to shareholders.

9. ABILITY TO BORROW:- Every company requires finance both for expansion and for meeting unanticipated

expenses. The new company generally, find it difficult, to borrow from the market and hence cannot offer to payhigher rate of dividend.

10. PAST DIVIDEND RATE:- The company while declaring dividend also have to take into consideration, the

dividend declared in previous years.

11. DIVIDNED POLICY OF THE COMPETITIVE CONCERN:- This is one more factor which have to be

considered while declaring dividend.

12. CORPORATE TAXATION POLICY:- Corporate taxes affects the rate of dividend of the concern high rate of

taxation reduces the profits available for distribution to the shareholders.

13. TAXATION POSITION OF THE SHAREHOLDERS:- This is another influencing factor influencing the

dividend decisions but it should be noted here that capital gain tax will be less when compared to the income tax

they should have paid when each dividend was declared and added to the personal income of the shareholders.

14. EFFECT OF TRADECYCLE: - This is also one of the important factor which influences the dividend policy of

the concern. For example:- during the period of inflection funds generated from depreciation may not be adequate to

replace the assets, consequently there is a need for retain carriage in enter to preserve the earning power of the firm

15. ATITUDE OF INTERESTED GROUP:- A concern may have certain group of interested and powered

shareholders who have certain attitude towards the payment of dividend and have a definite say in policy

formulation regarding dividend payments. If they are not interested in higher rate of dividend shareholders are not in

higher rate of dividend. On the other hand, if they are interested in higher rate of dues they will manage to make

company declare higher rate of dividend even in the force of many odds.

TYPES OF DIVIDEND POLICY:-

1. REGULAR DIVIDEND POLICY:- The payment of dividend at the usual rate is termed as regular dividend. The

investors such as retired persons, widows and other economically weaker persons prefer to get regular dividend.

The following are some of the advantages of this type of policy.

a) It creates confidence among the shareholders.

b) The shareholders views dividends as a source of funds to meet their day-to-day expenses.

c) It stabilities the market value of the shares.

d) It establishes the profitable record of the company.

2. STABLE DIVIDEND POLICY:- This means consistency in the stream of dividend payments. It means payments

of certain amount of dividend regularly. A Stable dividend policy may take any one of the following forms:-

1) CONSTANT DIVIDEND PER SHARE:- This means stream of dividend payments. If means payments of certain

amount of dividend regularly a stable dividend.


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If refers to a policy where the companies pay fixed dividend per share irrespective of the level of earnings year after

year. For this purpose dividend equalization fund will be created to pay fixed dividend in the year when the earnings

are not good to pay such fixed dividends.

2) CONSTANT PAY OUT RATIO:- It refers to payment of a fixed percentage of net earnings as dividends every

year Here, the amount of dividend fluctuates directly with the earnings of the company.

3) STABLE RUPEE DIVIDEND + EXTRA DIVIDEND:- This refers to policy where the company declares low

constant dividend and in the year of high profits pay extra dividends.

A STABLE DIVIDEND POLICY PROVIDE ADVANTAGES BOTH TO THE INVESTORS AND THE

COMPANY WHICH ARE AS FOLLOWS:-

1) It creates confidence among the investors, and conveys then that the company has a bright future. This helps the

company to raise additional funds through the issue of equity shares.

2) It provides the source of livelihood to those investors who view dividends as a source of funds to meet day-to-day

expenses. Therefore, these people desire stable dividend policy.

3) A stable dividend policy assures the investors certain payment of dividend which is an indication of the bright

future of the company.

4) Stability of dividend helps the company to raise additional funds easily through the issue of debenture and

preference shares.

5) The stability of dividend seems the interest needs of the institutional investors as these investors are interested ininvesting in those companies which follow a stable dividend policy.

6) Stable Dividend policy results in the raise in the share value of the company.

7) It results in a continuous flow to the national income stream and thus helps in the stabilization of the national

economy.

8) State dividend policy is the sign of continued and normal operations of the economy.

3. IRREGULAR DIVIDEND POLICY:- The reason behind the adopting of irregular dividend policy by the

companys are as follows:-

1) Uncertainty of earnings

2) Unsuccessful business operations

3) Lack of liquid resources.

4) Fear of adverse effects of regular dividends on the financial standing of the company.

4. NO DIVIDEND POLICY:- A company will follow this policy when there is unfavourable working capital

position or lack of funds for future expansion and growth.

STOCK DIVIDEND OR BONDS SHARES:-

Stock dividend is the dividend which is paid to the shareholders in kind. It is also known as bonus shares which are

the fire share allotted by the company to the existing shareholders by capitalizing the reserve of the company. It has

a effect of increasing the number of shares. But the shareholders retain their proportionate ownership in the

company. Issue of bonus shares increases the paid-up capital and decreases the reserves of the company. Bonus

shares does not result in the cash inflow or outflow.

This dividend is declared to only equity shareholders and it may take two forms:-

1. Making the partly paid equity share fully paid without asking for cash from the shareholders.

2. Issuing or allotting equity shares to existing shareholders in a definite proportion out of profits.

OBJECTS OF ISSUING BONUS SHARES:-

A company may issue stock dividends for any one of the following reasons:-

1. TO CONSERVE CASH:- The issue of bonus shares does not involve the payment of cash.

2. FINANCING EXPANSION PROGRAMMES:- Through the issue of Bonus shares corporate savings become the

permanent capital of the company.

3. TO LOWER THE RATE OF DIVIDEND: The rate of dividend may be reduced after the issue of bonus shares

because the increase in the number of shares reduces the rate of dividend per share.

4. TO ENHANCE PRESTAGE:- The company which issues Bonus shares will have increased credit standing in the

market.


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5. WIDEN THE MARKET:- A company interested in widening the ownership of its shares may issue bonus shares

where income of the old shareholders may sell their new shares.

ADVANTAGES OF BONUS SHARES:-

1) FROM THE COMPANY POINT OF VIEW:

1. RETAINED CASH:- It permits the company to pay dividends without outflow of cash. Retained cash can be

invested in future profitable project and the company need not to have additional funds from external sources.

2. SATISFACTION OF THE SHAREHOLDERS:- By the issue of bonus shares the equity of shareholders in the

company increases.

3. ECONOMICAL ISSUE OF CAPITALISATION:- The issue of bonus shares involve minimum cost and hence, it

is the most economical issue of securities.

4. ENHANCE PRESTIGE:- By issuing Bonus shares the company increases its credit standing and its borrowing

capacity is gone high in the eyes of lending institution.

5. WIDENING THE SHARES OF MARKET:- A company which is interested in widening of the ownership of the

shares may issue bonus shares.

6. FINANCE FOR EXPANSION PROGRAMMES:- By issuing bonus shares the expansion and modernization of a

company can be easily financed.

7. CONSERVATION OF CONTROL:- Maintenance of existing control is possible by issuing bonus shares.

8. This is best remedy for companies which has earned sufficient profits but lacks sufficient cash for the payment ofdividends as this type of dividend is not paid in the form of cash.

ADVANTAGES OF INVESTORS:-

1. IT INCREASES THE FUTURE DIVIDEND:-

Stock dividend increases the total number of shares of existing shareholders. The company can declare more

dividends in future by investing the available cash in the business with regular dividend

1. BONUS SHARES INCREASES THE MARKET VALUE OF SHARES:-

Stock dividend is also an indicator of growth of the company and results in increase demand for the shares of

the company and hence increases the market value of shares.

3. RETAINED PROPORTIONAL OWNERSHIP FOR THE SHAREHOLDERS:-

By issuing the stock dividend the shareholders retains their proportional ownership of the company as the

bonus shares are issued to the existing shareholders.

4. TAX BENEFITS:- Dividend income is to be included in the income of the shareholders and they will be liable to

payment of tax. But in case of bonus shares they do not have to pay any tax. Further, the capital gain tax what they

have to pay on the sale of bonus shares in low when compared to income tax.

DISADVANTAGES OF BONUS SHARES / STOCK DIVIDEND:-

1. For the company issue of bonus shares leads to an increase in the capitalization of the company. But this is

justified only if there is a proportionate increase in the earning capacity of the company.

2. Issue of bonus shares results in more liability on the company in respect of future dividends.

3. It prevents new investors from becoming the shareholders of the company.

4. Control over the management of the company is not dilutedand the present management may misuse its position.

FOR THE INVESTORS:

1. Some shareholders prefer cash dividends instead of bonus shares and such shareholders may be disappointed.

2. Issue of bonus shares lowers the market value of the existing shares too.

CONDITIONS FOR THE ISSUE OF BONUS SHARES:-

1. It can be issued by a company only when there are sufficient accumulated reserves or profits.

2. It can be issued by a company only if it is empowered by its articles.

3. The issue of bonus shares must be recommended by the BOD by resolutions.

4. The approval of the shareholders must be obtained for the issue of Bonus share through a resolutions pass at the

general body meeting.

5. Bonus shares must be issued only to the existing equity shareholders and that to on the equity shares which is

fully paid. If there are mans any partly paid equity shares that must be made fully paid shares before the issue of

bonus shares.


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6. Bonus shares are issued in addition to cash dividend and not in lieu of cash dividends.

7. The amount of bonus shares should not exceed the paid-up capital.

8. A company can declare bonus shares once in a year.

9. The maximum bonus shares ration is 1:1 i.e, one bonus share for one fully paid share held by the existing

shareholdings.

10. A company issuing bonus shares should not be in default of the payment of statutory dues to the employees and

term loans to financial institution.

11. The issue of bonus shares should be made as per the guidelines given buy the security exchange board of India

(SEBI).

DISADVANTAGES OF STABLE DIVIDEND POLICY:-

1. It is not easy for a company to change once a stable dividend policy is followed. Any change may adversely affect

the attitude of the inventors towards the financial stability of the company.

Any company which follows stable dividend policy if fails to pay the dividend in any year due to insufficient

earnings it has to face the wrath of the investors. To avoid this company may resort to pay dividend out of capital

which results in weakening of results in the liquidation of the company and ultimately results in the liquidation of

the company.

3. This policy is suitable only for well established compares and not for new and young companies.

Imp

What is a dividend decision?

A dividend decision refers to the formulation of divided policy which determines the division of earnings between

payments to shareholders and retrained earnings. Formulation of proper divided policy is one f the major financial

decisions to be taken by financial manger.

CHAPTER-4

WORKING CAPITAL MANAGEMENT

The term working capital in the broad sense refers to investments made in current assets which comprises of cash,

debtors, bills receivable, inventories, etc.

In other words, it is the aggregate of all the currents assets held by a firm as on the given date it is that part of the

capital i.e., retained in liquid form

In accounting working capital is defined as the difference between the inflows. It is defined as the excess of current

assets over current liabilities and provisions.

Working capital also refers to that part of total capital which is used for carrying out the routine or regular business

operations.

TYPES OF WORKING CAPITAL:-

1. Gross working capital

2. Net working capital

3. Negative working capital

4. Permanent working capital

5. Temporary working capital

1. GROSS WORKING CAPITAL:-

This is also known as circulating capital, operating capital or current capital. It refers to the total of

investments on current assets such as cash in hand, cash at bank, accounts receivable, stock of finished goods, work-

in-progress, stock of raw materials, prepaid expenses, etc

Gross working capital = total of current assets

2. NET WORKING CAPITAL:-

This refers to the difference between current assets and current liabilities.

3. NEGATIVE WORKING CAPITAL:-

It is also known as working capital deficit which means the excess of current liabilities over current assets.

Negative working capital = current liabilitiescurrent assets.

4. PERMANENT WORKING CAPITAL:-


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It is also known as fixed working capital which refers to the minimum amount of investments in current assets

required throughout the year for carrying out the business operations.

5. TEMPORARY WORKING CAPITAL:-

It is represents the total working capital which is required by the business over and above the permanent working

capital. It is also known as various or fluctuating working capital, as it goes on fluctuating from time to time with the

change in the volume of business activities.

FACTORS AFFECTING WORKING CAPITAL:-

The following are the factors which has its own effect on the working capital requirements of a concern

1. NATURE OF THE BUSINESS:-

His factors affect the working capital requirements to a great extent. The public utilities like transport

organization services have large fixed assets so that their requirements of current assets will be low whereas,

industrial and manufacturing enterprises need more working capital as they have to invest substantially on

inventories and accounts.

2. SCALE OF OPERATION:-

A concern which carries its activities on a small scale requires less working capital when compared to the

concerns carrying its activities on a large scale.

3. GROWTH AND EXPANSION OF THE BUSINESS:-

When there is a growth and expansion plans such firms require more working capital.

4. LENGTH OF MANUFACTURING PROCESS:-

Longer the manufacturing process higher will be the amount of working capital requirements and shorter the

manufacturing process. Working capital requirement is less.

5. LENGTH OF THE OPERATING CYCLE:-

Requirements of working capital depends upon the operating cycle the longer the operating cycle the greater will

be the requirements of working capital like manufacturing concerns and shorter the operating cycle lesser will be

the operating capital like trading concerns.

6. PRODUCTION POLICIES:-

It has its great impact on the working capital needs. A capital intensive industry require more fixed capital than

working capital but labour intensive industry requires less fixed capital but more working capital.

7. RAPIDITY OF TURNOVER:-

This has the great impact on the working capital requirements because a firm which can affect its sales with great

speed requires less working capital than the firms which cannot effect its sales at a great speed.

8. SEASONAL FLUCTUATIONS:-

This factor effects working capital requirements because seasonal factors create production and shortage

problems.

For ex:-seasonal agricultural production must be purchased in the month of production for smooth running of

business for the full year. Similarly, demand of woolen clothes is in the winter only but has to be manufactured

throughout the year resulting in more working capital.

9. DIVIDEND POLICY:-

A company which follows a liberal dividend policy which require more working capital than a company which

declares stable dividend policy

10. TAXES:-

Higher taxes are a strain on the working capital of the firm.

11. DEPRECIATION POLICY:-

This has an indirect effect on the working capital of the firm because when a company charges higher

depreciation it reduces the profit available for dividend and results in the less outflow of cash in the form of

dividend.

12. PROFIT LEVEL:-

A company which can earn high profits can contribute to the generation of internal funds which results in contribute

to the generation of internal funds which results in contribution to more working capital.

13. GOVERNMENT REGULATIONS:-


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This has a great effect on the working capital requirements because government regulation like tendon committee

has person prescribe norms for holding inventories and debtors which a concern is not expected to exceed which will

certainly effect the working capital requirements of the concern.

14. CREDIT POLICY OF THE CENCERN:-

A concern which follows liberal credit policy requires more working capital than a concern which follows light

credit policy.

15. PRICE LEVEL CHANGES:-

In the periods of raising prices a concern who has to pay more for the purchases it makes but cannot increase the

prices of its products considerably requires more working capital.

ADVANTAGES OR NEED OR IMPORTANCE OF ADEQUATE WORKING CAPITAL:-

Working capital is the art of business. Just as circulation of blood in the body for maintaining the life, a main

spring to a watch for the smooth functioning, working capital is very essential to maintain the smooth running of a

business. If heart becomes weak i.e, if the working capital is weak the business can hardly proper and survive. The

following are the few advantages of adequate working capital in the business.

1. CASH DISCOUNT:- It helps the firm to avail of the cash discount facilities offered by the suppliers for prompt

payment.

2. GOODWILL:- Any company which is prompt in making payment can earn goodwill which is possible only

through sufficient cash balance (working capital in the organization).

3. SOLVENCY OF THE BUSINESS:- Working capital in helps in maintaining the solvency of the business.

4. REGULAR SUPPLY OF RAW-MATERIALS:- It helps in regular supply of raw-materials for continuation of

business as the firm is able to procure raw-materials on time by meeting the payment to the suppliers promptly.

5. ABILITY TO FACE CRISIS:- without adequate capital a firm cannot face any crisis in the business.

6. GOOD BANK RELATION:- If businessmen is having cash in bank in the form of current account deposits, fixed

deposits, etc. The relation of business men and the bank will be good and cordial. Further, with adequate working

capital a firm can pay interest on loans borrowed from bank promptly.

7. HIGH MORALE:- It improves the morale of the executives and he employees of the firm.

8. CREDIT WORTHINESS:- an adequate working capital enhances the credit worthiness of the firm.

9. RESEARCH AND INNOVATION PROGRAMMES:- No research is possible without cash and cash is the part

of working capital.

10. ECONOMY IN PURCHASES:- A businessmen with adequate working capital can enjoy the economy in

purchases by purchasing raw-materials when its prices are low in the market.

11. REGULAR PAYMENT OF BUSINESS EXPENSES:- If company is having sufficient cash and bank balances

then it can make the payments like salaries, wages, etc, promptly.

12. FAVORABLE CREDIT TERMS:- Any company which process adequate working capital can extent favorable

credit terms to its customers.

INADEQUACY OF WORKING CAPITAL:-

Inadequacy refers to the shortage of working capital for meeting the firms regular obligations. The dangersassociated with adequacy of working.

1. CASH DISCOUNT:- Cash discounts are lost if the company suffers from inadequacy of capital as the firm cannot

pay the payments promptly.

2. LOSS OF GOODWILL:- When a concern fails to meet its day-to-day financial commitments due to inadequate

working capital, there is the danger of the firm losing its reputation.

3. UTILISATION OF FIXED ASSETS:- When a firm suffers from the inadequacy of working capital its fixed

assets may not be used efficiently which result in the reduction in the rate of return on investments.

4. DIFFICULTY IN OPERATION:- When there is shortage of working capital it will be difficult for the firm to

meet the day-to-day commitments and as a result operating inefficiency may creep into the day-to-day operations of

the firm.

5. INTERRUPTIONS IN PRODUCTION:- Shortage of working capital interrupts the production process which will

adversely affect the profitability of the enterprise.


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6. STAGNATION IN THE GROWTH:- Inadequate capital makes it difficult for the firm to undertake profitable

activities which will result in the stagnation in the growth of the firm.

7. CREDIT TERMS:- The firm may not be able to enjoy attractive credit terms due to shortage of capital from the

suppliers and creditors.

8. INEFFICIENT DAY-TO-DAY MANAGEMENT:- Due to scarcity of funds the firm may not be able to meet its

day-to-day commitments which will result in inefficient day-to-day management.

9. SCARCITY OF FUNDS:- It results in low liquidity which definitely threatens the solvency of the firm. A

company loses its liquidity when it is not able to pay its debts on maturity.

10. The modernization of equipments and even route repairs and maintenance may be difficult to administer due to

scarcity of working capital.

DISADVANTAGES OR PROBLEMS ASSOCIATED WITH EXCESS WORKING CAPITAL:-

1. Excess working capital results in idle funds which lowers the profitability of business.

2. Excess working capital leads to unnecessary accumulation of inventories which attracts problems like

mishandling, wastage, theft of inventories etc. which may reduce the profits of the firm.

3. Excess working capital leads to huge accounts receivable which is an indication of defective credit policy of the

firm and also inefficient collection of debts, ultimately it may result in bad debts which results in the low profits of

the firm.

4. Excessive working capital results in managerial inefficiency.

5. Excessive working capital may lead to speculative transitions due to which the company may become liberal with

regard to dividend policy.

15marks:-

SOURCES OF WORKING CAPITAL:-

A business concern may procure funds from various sources to meet its working capital requirements.

The sources of working capital can be broadly classified into two:-

1. Short term sources for meeting the variable working capital requirements.

2. Long term sources for meeting the permanent working capital requirements.

THE IMPORTANT SOURCES OF SHORT-TERMS WORKING CAPITAL ARE:-

1. Trade credit

2. Bank credit

3. Advances from customers

4. Short-term public deposits

5. Indigenous bankers

6. Installment credit

7. Factoring

THE IMPORTANT SOURCES OF LONG-TERMS WORKING CAPITAL ARE:-

1. Issue of debentures

2. Sale of fixed assets

3. Public deposits

4. Redeemable preference shares

5. Ploughingback of profits

6. Term finance from industrial finance corporations

SHORT-TERM CREDIT:-

1) TRADE CREDIT:- If refers to the credit obtained from the suppliers of goods in the normal course of trade. This

type of credit is common to all types of business which is granted without any security except the credit standing of

the concern. The duration of the credit is usually 15 days to 90 days. The three types of trade credit are:-

a) OPEN ACCOUNTS OR ACCONTS PAYABLE:- Under which goods are sold to customers without accepting

any document or instrument evidencing the debts due.

b) NOTES PAYABLE:- Under which goods are sold on credit to the customers by executing the promissory notes

as a proof of debt.


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c) TRADE ACCEPTANCES:- Under which goods are sold on credit to the customers by accepting the drafts or bills

of exchange drawn by the suppliers.

THE MAIN ADVANTAGES ARE:-

1. It is easy to obtain trade credit.

2. No security is to be provided for obtaining such debt.

3. It is a cheap source of debt.

4. It increases with the growth of the firm.

THE MAIN DISADVANTAGES ARE:-

1. The price of the goods bought on credit will normally be high.

2. The duration of credit is very short.

3. This type of credit is meant for only good credit

4. No cash discount is provided.

2) BANK CREDIT:- It refers to the credit, financial accommodation or advance provided by commercial banks. It

may be unsecured or against guarantee or against hypothecation, pledge or mortgage of assets. The bank credit may

take various forms like short-term loans, over drafts, cash credit, discounting and purchasing of bills of exchange

and also commercial letter of credit.

3) ADVANCES FROM CUSTOMERS:- If refers to the advances received from the customers before the delivery of

the goods. These advances are generally a part of the price of the good ordered by the customers. The time of creditdepends upon the time of the delivery of goods. No interest is allowed on customer advances.

4) SHORT-TERM PUBLIC DEPOSITS: If refers to the deposits accepted by a concern from the general public

from a short period not exceeding one year. These deposits are accepted without offering any security. Normally,

10% to 12% interest is allowed on such deposits. This type of deposits is meant only for the concerns having high

credit standing.

5) INDIGENOUS BANKERS:- This type of the source of working capital is very popular among small concern in

India. The main reasons b behind the popularity of indigenous bankers are easy accessibility, flexible working hours,

easy accommodation of loans in times of difficulties lending against all types of securities. The main drawbacks

are:-

1. Limited funds

2. High rate of interest

3. Secrecy in maintain their accounts and

4. Mal practices

6) INSTALMENT CREDIT:- It refers to the credit obtained by a concern for the purchase of equipments, vehicles,

etc. It will be normally on hire purchase or on installment basic.

7) FACTORING:- It can be defined as the system of financing under which a factor undertakes to collect the

accounts receivables or book debts of its client and remit the money collected to the client and also advances money

to the client against the security of accounts receivables in case the client needs money in advance.

Different types of factoring are:-

. Invoice discounting

. Advance factoring

. Full factoring

. Outright purchase of accounts receivables

. With resource factoring

. Without resource factoring

. Maturity factoring

. Undisclosed factoring

THE OTHER SOURCES OF SHORT-TERM WORKING CAPITAL ARE:-

1. Accrued expenses (expenses incurred not yet due and also not yet paid).

2. Deferred incomes (Incomes received in advance).

3. Commercial papers (Instrument to raise short-term funds in the money market).

LONG-TERM SOURCES OF WORKING CAPITAL:-


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1) ISSUE OF DEBENTURES:- By the issue of redeemable debentures the company can raise long term finance.

They enjoy a lot of benefits through the issue of debentures like low interest rates fixed interest, interest chargeable

to profits for the purpose of income-tax and so on.

The main disadvantages areIt can be issued only by public limited companies and the company has pay

interest on debentures even if it does not earn any profits.

2) SALE OF FIXED ASSETS:- Any idle fixed assets can be sold and this fund can be utilized for financing the

working capital requirements.

3) PUBLIC DEPOSITS:- Long term public deposit not exceeding 3 years also has become one of the important

sources of long-term working capital requirements.

The main merits are:-

1. Less formalities in the collection of deposits.

2. It does not create any charge on the asset of the borrower.

The main disadvantages are:-

1. Deposits are unreliable and undependable.

2. There is a restriction on the total amount of their deposits.

4) REDEEMABLE PREFERENCE SHARES:- The main merits of this type of source is that the dividend on

preference shares is fixed and it does not create any charge on the assets of the company. Further, the redemption of

preference shares is a remedy to the over capitalization problems.

The demerits are:-

They are costlier than debentures and it involves legal formalities for its issue and so on.

5) PLOUGHING BACK OF PROFITS:- It means the re-investment by a concern of its surplus earnings in its

business. A part of the earned profits may be ploughed back by the concern in meeting their long-term working

capital requirements. It is internal sources of finance and it is the cheapest source of working capital.

The main disadvantage is that there will be a reduction in the rate of dividend to the shareholders.

6) TERM FINANCE FROM INDUSTRIAL FINANCE CORPORTIONS:- There institutions give loans for a period

varying from 3 to 7 years and the financial institutions which provide such loans are LIC, SFC, UTI and ICICI.

WORKING CAPITAL MANAGEMENT:-

It refers to the management of all the aspects of working capital i.e, current assets and current liabilities.

According to Smith.K.V. Working capital management is concerned with the problems that arise in attempting to

manage the current assets, the current liabilities and the inter relationship that exists between them.

There are two objectives of working capital management:-

1. Maintenance of working capital

2. Availability of sufficient funds at the time of need.

COMPONENTS OF THE MANAGEMENT OF WORKING CAPITAL:-

1. Estimation of working capital

2. Determination of the size of the working capital.

3. Decisions regarding the ratio of short-term and long-term capital.

4. To locate the appropriate sources of working capital.

FORCASTING TECHIQUES OF WORKING CAPITAL

1. PERCENTAGE OF SALES METHODS:- Where working capital is determined on the basis of part experience,

but the condition is both sales and working capital should be stable.

2. ESTIMATION OF THE COMPONENTS OF WORKING CAPITAL:- Since working capital is the difference of

current assets and current liabilities, its assessment can be made by estimating the amounts of different constituents

of working capital such as inventories, accounts receivables accounts payables, etc.

3. OPERATING CYCLE METHOD:- Under this method, working capital is calculated taking into consideration the

operating cycle of the business.

PRINCIPLES OF WORKING CAPITAL MANAGEMENT:-

1. PRINCIPLE OF RISK VARIATION:- Larger investments in current assets with less dependence on short-term

borrowings increases liquidity, reduce risk and thereby decrease the opportunity for gain or loss. On the other hand,


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less investments in current assets with greater dependence on short-term borrowings increases risk, reduces liquidity

and the profitability.

2. PRINCIPLE OF COST OF CAPITAL:- All the different sources of working capital have the element of cost and

risk Generally, higher the risk lower is the cost and vice versa.

3. PRINCIPLE OF EQUITY POSITION:- According to this principle the amount invested in current assets should

be planned.

4. PRINCIPLE OF MATURITY OF PAYMENT:- According to this principle a firm should make every effort to

relate maturities of payment to its flow of internally generated funds.

FINANCIAL POLOICIES REGARDING WORKING CPAITAL:-

. The working capital needs of a firm should be financed out of short-term borrowings.

. The permanent working capital should be financed out of long-term sources.

. Flexibility in the financial programmes for the raising of working capital is required.

. The cost of securing working capital should be as minimum as possible.

. Judicious use of different sources of short-term funds is necessary.

. Sufficient liquidity in working capital to meet day to day obligations is required.

. Avoid over borrowing of working capital.

. Exercise proper control on inventories, receivables and creditors.

DIFFERENT ASPECTS OF WORKING CAPITAL MANGEMENT:-

1. Management of cash

2. Management of accounts receivables.

3. Management of inventories.

MANAGEMENT OF CASH:-

Cash is one of the current assets of a business. It is needed at all times to keep the business going. It is

essential that a business concern should have sufficient cash for meeting its obligations. In a narrow sense, cash

includes coins and currency notes, cheques, drafts and balances in bank accounts. But, in a real sense cash also

means near cash assets i.e, those assets which can be immediately converted into cash whenever it is required like

time deposits, marketable securities, etc.

The reason for cash management arises because there is a gap between cash inflows and cash outflows. The firm

also has to meet its obligations promptly therefore, it is essential to manage cash.

What are the different motives of holding cash?

Motives for holding cash:-

1. TRANSACTION MOTIVE:- It refers to the motive of holding cash by a concern for meeting various business

transactions like purchases, expenses, taxes, dividend and so on.

2. PRECAUTIONARY OR CONTINGENCY MOTIVE:- This motive refers to keeping cash for meeting various

contingencies like sharp rise in prices of raw-materials, unexpected delay in the collection of account receivables,

presentment of bills by the creditors for payments earlier than the expected date, strikes, etc.

3. SPECULATIVE MOTIVE:- This motive refers to holding of cash for investing in profitable opportunities as andwhen they arise. It can take a form of sudden fall in prices of raw-materials availing cash discount for prompt

payment of bills, etc.

4. COMPENSATION MOTIVE:- Every concern requires to keep certain minimum cash with the banker to allow

him to use and earn income in return for the services he provides to the concern. This motive holding cash is known

as compensation motive.

MEANING OF CASH MANAGEMENT:-

It means provision of adequate cash to all the sections of the organization and also ensuring the cash in not held idle

in financial management has to adhere to the five Rs of money management. Those are:-

1. The right of quality of money for liquidity considerations

2. The right quantity whether owned or borrowed.

3. The right time to preserve solvency.

4. The right source and

5. The right cost of capital, the organization can afford to pay.


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OBJECTIVES OF CASH MANAGEMENT:-

1. To make cash payments

2. To maintain minimum cash reserve

BASIC PROBLEMS OF CAHS MANAGEMENT:-

1. Controlling the level of cash balance

2. Controlling the inflows of cash

3. Controlling the outflows of cash

4. Investment of surplus cash

I) CONTROLLING THE LEVEL OF CASH BALANCE:-

The level of cash balance can be controlled through:-

1. BY PREPARING CASH BUDGET:-

Cash budget is the most significant device for planning and controlled the cash receipts and payments. It is a

summary statement of the firms expected cash inflows and outflows over a projected time period.

2. BY PROVIDING FOR UNPREDICTABLE DISCREPANCIES:-

It means provision of sufficient cash balance for meeting the discrepancies between the cash inflows and cash

outflows on account of unforeseen circumstances, such as strike, recession, etc. which are not provided by the cash

budget.

3. CONSIDERATION OF THE SHORT COSTS:-

The term short costs refers to the costs incurred as a result of shortage of cash.

It may be the cost incurred with respect to defend the suit filed by the creditors for the recovery of amounts due to

them, loss of cash discounts for non-payments to creditors in time, etc.

4. BY MAKING ARRANGEMENTS FOR FUNDS FROM OTHER SOURCES:-

This can be resorted to in times of emergencies by which a firm can avoid unnecessary large balance of cash.

II) CONTROLLING THE INFLOW OF CASH:-

The main techniques are:-

1. By proper system of internal check

2. By increasing cash sales

3. CONCENTRATION BANKING:- It is a device employed by large business firms having business spread over

wide area for ensuring speedy collections and last movement of funds. And

4. LOCK BOX SYSTEM:- Under this system, the firm hires lock boxes from post offices in various areas and

instructs its customers to mail their remittances to the lock box or post office box in their area. The firms local bank

picks up the mails and deposits the cheques into the firms account. It also transfers the funds to the head office bank

through telegraphic transfers, when this exceeds or specified limit.

III) CONTROLLING THE OUTFLOW OF CASH:-

1. Centralized system of disbursements to slow down the disbursements.

2. Payments only on due date which helps to slow down the payments but also to enjoy cash discount for prompt

payments and to keep up its prestige.

3. TECHNIQUE OF PLAYING FLOAT:- The term float refers to the amount lied up in cheques, but has been

issued, but no

Documents

Financial Mgmt Notes