CHAPTER-9
Financial
Management
Concept, Objective and Role of Financial Management
Ø Financial Management : It is concerned with decisions related to
procurement and utilisation of fund.
Ø Objectives of Financial Management : The
primary objective of financial management is to maximise shareholders’ wealth. It means maximisation of the market value of
equity shares. It can happen through appropriate decision making. The secondary
objectives include profit maximization, ensuring effective utilisation of
funds, availability of funds at reasonable costs, liquidity, avoidance of idle
finance, etc.
Ø Role of Financial Management : The role
of financial management cannot be overemphasised, since it has a direct bearing on the financial health of a business. The
importance of financial management can be judged by the fact, that almost all
items in the financial statements of a business are affected directly or
indirectly through some financial management decisions. Some of the examples
are :
(i)
Size and composition of fixed assets by the business.
(ii)
Quantum of current assets.
(iii)
Amount of long term and short term funds to be used
(iv)
Breakup of long term financing into debt, equity, etc.
(v)
All items in the Profit and Loss Account.
Financial Decisions
Ø Types of Financial Decisions :
(i)
Investment Decision : It is concerned with investment
of firm’s funds in different assets.
(a) A long-term investment decision
in fixed assets is called as capital budgeting decision.
(b)
A short-term investment decision in cash,
inventory, and debtors is called as working capital decision. Factors affecting
capital budgeting decision are :
(a)
Cash flows of the project.
(b)
Rate of return.
(c)
Investment criteria.
(ii)
Financing
Decision : It deals with the quantum of finance to be raised
from various long-term sources viz.
debt and equity.
Factors affecting Financing
Decision are :
(a)
Cost of funds.
(b)
Cost of floatation.
(c)
Cash flow position of business.
(d)
Control consideration.
(e)
Capital market situation.
(f)
Fixed operating cost.
(g)
Risk.
(h)
Return on investment.
(i)
Tax rate.
(j)
Flexibility.
(k)
Regulatory frame work.
III. Dividend Decision : It
determines how much of the profits are to be distributed as dividends and how
much to be retained for the
investment requirement.
Factors affecting dividend
decisions are :
(a)
Amount of earnings.
(b)
Stability of earnings.
(c)
Stability of dividends.
(d)
Growth opportunities.
(e)
Cash flow position.
(f)
Shareholders’ preference.
(g)
Taxation policy.
(h)
Stock market reaction.
(i)
Access to capital market.
(j)
Legal constraint.
(k)
Contractual constraints.
Fixed and Working Capital - Concept and Factors
Affecting their Requirements
Ø Features of Fixed Capital/Investment decision/Capital budgeting decision
:
(i)
Long-term growth and impact.
(ii)
Large amount of funds involved.
(iii)
Risk involved.
(iv)
Irreversible decision.
Ø Factors affecting the requirement of fixed capital :
(i)
Nature of business.
(ii)
Scale of operation.
(iii)
Choice of technique.
(iv)
Technology upgradation.
(v)
Growth prospects.
(vi)
Diversification.
(vii) Financing alternatives.
(viii)
Level of Collaboration.
Ø Working Capital = Current Assets – Current Liabilities
Ø Factors affecting the working capital requirements :
(i)
Nature of business.
(ii)
Scale of operations.
(iii)
Business cycle.
(iv)
Seasonal factors.
(v)
Production cycle.
(vi)
Credit availed.
(vii) Credit allowed.
(viii)
Operating efficiency.
(ix)
Availability of raw material
(x)
Growth prospects.
(xi)
Level of competition.
(xii) Inflation.
Ø Financial Planning : It is the
process of estimating the fund requirement of a business and specifying the sources of funds.
Ø Objectives of Financial Planning :
(i)
To ensure the availability of funds whenever required.
(ii)
To ensure that the firm does not raise resources unnecessarily.
Ø Importance of Financial Planning :
(i)
Prepares for future challenges.
(ii)
Avoids business shocks and surprises.
(iii)
Co-ordinates various business functions.
(iv)
Eliminates wasteful efforts.
(v)
Links present with future.
(vi) Links investment with financing
decision.
(vii) Facilitates financial control.
Capital Structure-Concept
Ø Capital Structure : It refers
to the mix between owners funds i.e., equity and borrowed funds raised by a company i.e.,
Debt/Equity Capital.
Ø Trading on Equity : It refers
to an increase in profit earned by the equity shareholders due to the presence of fixed financial charges
like interest.
Ø Factors determining the capital structure :
(i)
Cash flow position
(ii)
Interest Coverage Ratio (ICR)
(iii)
Debt Service Coverage Ratio (DSCR)
(iv)
Return on Investment (ROI)
(v) Cost of debt
(vi)
Tax rate
(vii)
Cost of equity
(viii) Floatation costs
(ix)
Risk consideration
(x)
Flexibility
(xi) Control
(xii)
Regulatory framework
(xiii) Stock market condition
(xiv) Capital structure of other
companies
Know the
Terms
Ø Financial Management : It is concerned with the optimum procurement as
well as the usage of finance.
Ø Financial decision : These are
decisions which are concerned with three aspects – viz. investment, financing and dividend.
Ø Fixed capital : It is the money invested in fixed
assets like land, machinery, etc., which is to be used over a long period of time.
Ø Management of Fixed Capital : It
involves allocation of firm’s capital to different projects or assets with
long-term implications for the business. These are called investment decisions
or capital budgeting decision.
Ø Working Capital : It is the
money invested in current assets like stock, debtors, etc. to facilitate smooth
day-to-day operations of the business. It is the excess of current assets over
current liabilities.
Ø Financial Planning : It is the
process of estimating the fund requirement of a business and specifying the sources of funds.
Ø Production cycle : Time span between the receipt of raw material and their conversion into
finished goods.
Ø Floatation cost : Cost involved in the issue of securities.
Ø Financial risk : Risk of inability to meet fixed financial charges.
Ø Business risk : Risk of inability to meet fixed operating costs as well as fixed
financial charges.
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