FINANCIAL MANAGEMENT FULL NOTES

SEM BANGALORE UNIVERSITY

SESHADRIPURAM EVENING DEGREE COLLEGE
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 serway publicity, 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.
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.

Principles/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.

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:-
v It is a barometer through which the performance of a business
unit can be measured.
v It attracts he investors to invest their saving in securities.
v It indicates that the fund is efficiently used for different
requirements.
v It increases the confidence of management in expansion and
diversification programmers of a company.
v 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 inflow cash 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.
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
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 health of 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
planning
It 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
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. Technological improvement,
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. Adequate liquidity
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)

1) 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
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

2) 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:-
1. Equity share.
2. Preference share.
3. Debentures.
4. Retained Earnings.
5. Bonds.
6. Own funds
7. Venture capital.
8. Leasing.
9. Hire-purchase.
2) Short term financial plan:-
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)
1. He should anticipate and estimate the total financial
requirements of the firms.
2. He has to select the right sources of funds at right time and at
right cost.
3. He has to allocate the available funds in the profitable
avenues.
4. He has to maintain liquidity position of the firm at the peak.
5. He has to administrate the activities of working capital
Management.
6. He has to analyze financial performance and plan for it
growth.
7. He has to protect the interest of creditors, shareholders and the
employees.
8. He has to concentrate more on fulfilling the social obligation
of a business unit.
9. Estimation of capitalization requirement of organization.
10. To make a appropriate decision with regard to invest or
utilize funds.
11. Decision with regard to Dividend policy.
12. Financial manager helps to maintain co-ordination
relationship between the employer and employee.
13. Financial manager helps in optimum utilization of Death
and equity ratio of capital of business.
14. Maximization wealth of increasing the value of firm
15. It helps to maximize the value of share holders.
16. Financial manager helps in Making prompt payment to the
creditors.
17. Financial manager helps in effective Administration of the
financial plan.
18. Financial manager to reduces the cost of production and
maximize it the profit.
19. Financial manager Advise the Management to maintain
reserves or retained earnings in the firm for meeting or future
needs of the firm.
20. Financial manager helps in comparing the earning per
share of the compotators with their firms.
21. Financial manager avoid unnecessary utilization of funds.
22. Financial manager helps the firm to maintain flexibility as
well as simplicity of the firm.
23. It ensure prom payment of tax to the government.
24. Financial manager refers to review of financial plan.
25. Ensure prompt payment to the government.
26. Financial manager helps the firm to know about the value
of money, financial risk of the firm.
27. It ensure more credit worthiness of the business.
28. 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 while
preparation 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.
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 intensive business.
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 case future
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 to choose
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.
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:-
v 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.
v Capital structure:- It includes long term debt, preference shares
and equity share capital. In equity capital we include ordinary
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.
v 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:-
1) Nature of Business
2) Regularity and certainty of income.
3) Desire to control the business.
4) Future plans.
5) Attitude of management
6) Freedom of working.
7) Operating ratio.
8) Trading on equity.
B) External factors:-
1) Conditions of capital Market.
2) Nature and type of investors.
3) Cost of capital.
4) Legal requirements.
Optimum or balances capital structure:- (2marks)
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 decision making 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.
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 x Financial 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 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 a certain 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 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 pay higher
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.
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 in
investing 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.
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 of dividends 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 diluted and 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.
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 liabilities current assets.
4. PERMANENT WORKING CAPITAL:-
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:-
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 dangers associated
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.
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. Ploughing back 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.
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 credit depends 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:-
1. Invoice discounting
2. Advance factoring
3. Full factoring
4. Outright purchase of accounts receivables
5. With resource factoring
6. Without resource factoring
7. Maturity factoring
8. 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:-
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 are It 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, 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:-
1. The working capital needs of a firm should be financed out of
short-term borrowings.
2. The permanent working capital should be financed out of
long-term sources.
3. Flexibility in the financial programmes for the raising of
working capital is required.
4. The cost of securing working capital should be as minimum as
possible.
5. Judicious use of different sources of short-term funds is
necessary.
6. Sufficient liquidity in working capital to meet day to day
obligations is required.
7. Avoid over borrowing of working capital.
8. 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 and when 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.
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 not
yet, been presented for payment. The period between the issue
of cheque and its actual presentation for payments is called float
period.
The technique of taking advantage of the float period issuing
cheques without having sufficient cash balance during the float
period is called the technique of playing float.
IV) INVESTMENT OF SURPLUS CASH:-
The two basic problems involved in regard to investment of
surplus cash are:-
1. Determination of the amount of surplus cash
2. Determination of the channels of investments.
But, while investing the surplus cash the firm should take
into account the liquidity, safety, maturity and yield.
MANAGEMENT OF ACCOUNTS (DEBTORS)
RECEIVABLES:-
It refers to the amount receivable by a firm from its customers
for the goods or services provided on credit.
The main costs involved are:-
1. COSTS OF FINANCING:- Cost of funds locked up in
accounts receivable.
2. ADMINISTRATIVE COSTS:- Cost of maintenance of
records with regard to credit sales and payments from the
customers.
3. COLLECTION COSTS:- Cost of collection of debts like legal
charges, cost of sending reminders.
4. DEFAULITNG COSTS:- Bad debts.
The two facts which influence the size of accounts
receivables are volume of credit sales, credit policy and terms of
trade.
Posted by Shetty Dinith at 00:39