9

9 

Chapter – 9

Financial Management

It deals with planning, organizing, directing and controlling financial activities like procurement and utilization of funds and distribution of earnings to owners.

“Financial management deals with procurement of funds and their effective utilization in the business” – S.C. Kuchhal.

Role and Importance of Financial Management

a.    The size and composition of fixed assets – 

b.    The amount of current assets – 

c.    Amount of long term and short term funds – 

d.    Debt – equity ratio – 

e.    All items in the Profit and loss account – 

Objectives of financial management

1.    Profit maximization- 

2.    Wealth maximization – 

the three decisions in financial management 

1.      Investment Decision – It will include the following:

a.    Long term investment decisions (capital budgeting decision)  

b.    Short term investment decision (working capital decision) 

Factors affecting Capital Budgeting (Investment Decision)

a.    Cash flow of the project – 

b.    The rate of return –  

c.    Investment criteria involved – 

2.    Financing Decision – it is concerned with the quantum of finance to be raised from various long term sources. They are shareholders’ fund and borrowed fund such as shares, debentures, loans etc.

Factors affecting financing decision

a.    Cost – 

b.    Risk – 

c.    Flotation coast – 

d.    Cash flow position – 

e.    Fixed cost –

f.     Control – .

g.    Capital market condition –  

3.    Dividend Decision – 

Factors affecting dividend decision

a.    Amount of earnings – 

b.    Stability of earnings – 

c.    Stability of dividend –.

d.    Growth opportunities –  

e.    Cash flow position –  

f.     Shareholders’ preference – 

g.  Taxation Policy –

h.    Stock Market Reaction – 

i.      Access to Capital Market – 

j.      Legal Constraints – 

k.    Contractual Constraints – .

Financial Planning – When the process of planning employed in finance, it is called financial planning. involves the following aspects:

a.    Estimation of quantum of finance

b.    Determining the pattern of financing –.

c.    Proper utilization of finance – 

Types of financial planning

a.    Long term financial planning – 

b.    Short term financial planning – 

Objectives of Financial Planning

1.    To ensure availability of funds whenever required – 

2.    To ensure that the firm does not raise resources unnecessarily – 

Importance of financial planning

1.    Forecasting –

2.    Avoiding uncertainties – 

3.    Coordination – Helps to 

4.    Reduces wastages –  

5.    Easy evaluation – 

Capital Structure

Capital structure refers to the mix or composition , of borrowed funds to owner’s funds. 

Financial Leverage – The proportion of debt in the capital structure is called financial leverage or capital gearing 

Trading on equity – It refers to the use of fixed income securities such as debentures and preference capital in the capital structure so as to increase the return on equity capital. 

Factors Affecting the Choice of Capital Structure

1.    Cash flow ability for servicing the debt – 

2.   Interest coverage ratio – 

  

3.    Debt Service Coverage Ratio (DSCR) – 

4.    Return on Investment (ROI) – 

5.    Cost of debt – 

6.    Tax rate – 

7.  Cost of Equity – 

8.    Floatation cost – 

9.    Risk Consideration – 

10. Flexibility – 

      11. Control – 

12. Regulatory Framework –

13. Stock Market Conditions – 

14. Capital Structure of other Companies – 

Fixed Capital and Working Capital

Fixed Capital

Fixed capital represents a long term investment which needed to acquire fixed assets like land and building, plant and machinery, vehicles etc., benefits of which are expected to be received over a number of years in future.

Importance of management of fixed capital

1.    Long term growth – 

2.    Large amount of funds involved – 

3.    High risk – I

4.    Irreversible decision – 

Factors affecting the requirement of fixed capital

1.    Nature of Business – 

2.    Scale of Operations – 

3.    Choice of technique – 

4.    Technology up gradation – 

5.    Growth prospects – 

6.    Diversification – s.

7.    Method of acquiring fixed assets (financing alternatives) – 

8.    Collaboration – 

Working Capital

Working capital is that part of capital required for investing in short term or current assets like inventory (raw materials, work in progress and finished goods), bills receivables, sundry debtors, cash required for day to day affairs like salaries, wages, rent, etc. There are two concepts of defining working capital as follows:-

i.              Gross working capital = Total investment in current assets

ii.            Net working capital = Current assets – Current Liabilities

Factors affecting Working Capital Requirements

1.    Nature of business – .

2.    Scale of Operations – 

3.    Business Cycle – .

4.    Seasonal Factors – 

5.    Production cycle – 

6.    Credit allowed – 

7.    Credit availed – 

8.    Operating efficiency – 

9.    Availability of raw materials – 

10. Growth prospects – 

11. Level of competition – 

           Inflation –