FINANCIAL MANAGEMENT - Financial Management means long-term or short-term ▪ Mode by which the funds are result in inefficient operations

esult in inefficient operations like inadequate capacity and,

planning, organizing, directing and controlling the financial raised. 3. Profit Planning: Profit earning is one of the prime increased expenditure, non competitive production and
activities such as procurement and utilization of funds of the functions of any business organization. Profit earning is pricing resulting in poor market share and have serious
enterprise. It means applying general management principles important for survival and sustenance of any organization. financial implications. On the other hand an over investment
to financial resources of the enterprise. “Financial Profit planning refers to proper usage of the profit generated would result in higher depreciation and increased operating
management is an area of financial decision-making by the firm. Profit arises due to many factors such as pricing, costs and result in liquidity crisis. TYPES OF CAPITAL
harmonizing individual motives and enterprise goal. financial industry competition, state of the economy, mechanism of INVESTMENT DECISIONS - A. On the Basis of Firm's
management is the business function that deals with demand and supply, cost and output. A healthy mix of
Existence. 1. Buying New and Replacement of Fixed Asset:
investing the available financial resources in a way that variable and fixed factors of production can lead to an
greater business success and return-on-investment (ROI) is increase in the profitability of the firm. 4. Understanding If company or firm is newly incorporated, it will take which
achieved. Financial management professionals plan, organize, Capital Markets: Shares of a company are traded on stock new fixed asset should be purchased but an existing form will
exchange and there is a continuous sale and purchase of take capital investment decisions relating to replacement of
and control all transactions in a business. The financial any old fixed asset due to modernization. Company will take
securities. Hence a clear understanding of capital market is
management of an organization determines the objectives, an important function of a financial manager. When decision which fixed asset should be replaced and which new
formulates the policies, lays out the procedures, implements securities are traded on stock market there involves a huge fixed asset should be purchased after replacement.
the programmes, and allocates the budgets related to all amount of risk involved. Therefore, a financial manager 2. Expansion of Fixed Asset : In these decision, company may
financial activities of a business. Through a streamlined understands and calculates the risk involved in this trading of take decision to extend fixed asset for improving efficiency.
financial management practice, it is possible to ensure that shares and debentures. TIME VALUE OF MONEY - The time Suppose, we have one plant but due to increase of demand,
there are sufficient funds available for the company at any value of money (TVM) is the concept that money you have we can take decision for expansion it. 3. Diversification
stage of its operations. FINANCIAL MANAGEMENT now is worth more than the identical sum in the future due Decision: For reducing risk of business, company may take
FUNCTIONS - 1. Estimation of capital requirements: A to its potential earning capacity. This core principle of finance decision to diversify its business or market. Suppose, one
finance manager has to make estimation with regards to holds that provided money can earn interest, any amount of company is doing online business of selling laptop, it may
capital requirements of the company. This will depend upon money is worth more the sooner it is received. TVM is also take decision for selling of ipad or mobile. But for this, it need
expected costs and profits and future programmes and sometimes referred to as present discounted value. FUTURE to invest big amount. B. On the Basis of Decision Situation. 1.
policies of a concern. Estimations have to be made in an VALUE OF A SINGLE CASH FLOW - Future value of a single Mutually Exclusive Decision:
adequate manner which increases earning capacity of cash flow refers to how much a single cash flow today would Mutually exclusive decision are those capital decision in
grow to over a period of time if put in an investment that which we accept one proposal and other will not include in it.
enterprise. 2. Determination of capital composition: Once For example, we can buy semi automatic machine or highly
pays compound interest. - The formula for calculating future
the estimation have been made, the capital structure have to automatic machine. If we have taken decision for buying semi
value is:
be decided. This involves short- term and long- term debt automatic, it means, we will not use highly automatic
equity analysis. This will depend upon the proportion of machine. Cost of major factor for taking such decision. Cheap
equity capital a company is possessing and additional funds investment may be our best option. Following example may
explain it more. 2. Accept and Reject Decision :
which have to be raised from outside parties. 3. Choice of
If we take decision of accept and reject of project on its
sources of funds: For additional funds to be procured, - a. return basis, then these type of decision will be accept and
company has many choices likea. Issue of shares and reject decisions.3. Contingent Decision :These are the
debentures. b. Loans to be taken from banks and financial decisions in which one decision requires other decision.
institutions. c. Public deposits to be drawn like in form of Suppose, we have to take decision to make plant, for making
bonds. - Choice of factor will depend on relative merits and plant, we also have to take decision for making building and
demerits of each source and period of financing. 4. buying of machinery. CAPITAL BUDGETING APPRAISAL
Investment of funds: The finance manager has to decide to METHODS – 1. Net Present Value (NPV) – this capital
allocate funds into profitable ventures so that there is safety investment appraisal technique measures the cash in-flow,
on investment and regular returns is possible. 5. Disposal of PRESENT VALUE OF A SINGLE CASH FLOW - Present value of
whether excess or shortfall, after the routine finance
surplus: The net profits decision have to be made by the a single cash flow refers to how much a single cash flow in
commitments are met with. All capital investment appraisals
finance manager. This can be done in two ways : a. Dividend the future will be worth today. The present value is
have a single objective – drive towards a positive NPV. The
declaration - It includes identifying the rate of dividends and calculated by discounting the future cash flow for the given
NPV is a mathematical calculation involving net cash flow at a
other benefits like bonus. b. Retained profits - The volume time period at a specified discount rate. - The formula for
particular present time ‘t’ at discount rate at the same time,
has to be decided which will depend upon expansional, calculating future value is:
i.e. (t – initial capital outlay). Thus there is an inverse
innovation, diversification plans of the company. 6. proportional relation between discount rate and NPV. A high
Management of cash: Finance manager has to make discount rate would reduce the net present value of capital. A
decisions with regards to cash management. Cash is required high interest rate increases discount rates over a period of
for many purposes like payment of wages and salaries, time and most capital investment appraisals are wary of such
payment of electricity and water bills, payment to creditors, an increase. NPV=Cash flow/(1+i)t−initial investment. - where:
meeting current liabilities, maintenance of enough stock, i=Required return or discount rate.
purchase of raw materials, etc. 7. Financial controls: The t=Number of time periods
finance manager has not only to plan, procure and utilize the 2. Internal Rate of Return (IRR) – capital investment
funds but he also has to exercise control over finances. This FV = Future value of money. - r = Annual interest rate. - T =
Number of years . - M = Number of periods based on appraisal techniques define IRR as discount rate that gives a
can be done through many techniques like ratio analysis, value of zero to NPV or net present value. Among all capital
financial forecasting, cost and profit control, etc. OBJECTIVES compounding frequency . CONCEPT OF CAPITAL BUDGETING
- Capital budgeting is the process a business undertakes to investment appraisal techniques, IRR is generally considered
OF FINANCIAL MANAGEMENT – 1. Profit Maximization : evaluate potential major projects or investments. to measure the efficiency of the capital investment. Thus, if
Construction of a new plant or a big investment in an outside cost of capital investment in company works out to be
Main aim of any kind of economic activity is earning profit. A
venture are examples of projects that would require capital greater than the IRR value, the project is highly likely to be
business concern is also functioning mainly for the purpose of
budgeting before they are approved or rejected. As part of rejected. On the other hand, a low cost of capital has more
earning profit. Profit is the measuring techniques to
capital budgeting, a company might assess a prospective chances of being accepted. IRR is calculated by equating NPV
understand the business efficiency of the concern. Profit
project's lifetime cash inflows and outflows to determine to zero and then deriving the discount rate. Even though IRR
maximization is also the traditional and narrow approach,
whether the potential returns that would be generated meet and NPV are related capital investment appraisal techniques
which aims at, maximizes the profit of the concern. Profit
a sufficient target benchmark. The capital budgeting process they are different from each other. IRR considers the time
maximization consists of the following important features. •
is also known as investment appraisal. businesses would value of money over the project life time and derives the
Profit maximization is also called as cashing per share
pursue any and all projects and opportunities that world discount rate. 3. Payback Period – appraising capital
maximization. It leads to maximize the business operation for
enhance shareholder value and profit. However, because the investment on the basis of time that would be taken to get
profit maximization. • Ultimate aim of the business concern is
amount of capital or money any business has available for back your initial investment is called as payback period.
earning profit, hence, it considers all the possible ways to
new projects is limited, management uses capital budgeting Payback period is one of the easiest methods of capital
increase the profitability of the concern. • Profit is the
techniques to determine which projects will yield the best investment appraisal techniques. Projects with a shorter pay
parameter of measuring the efficiency of the business
return over an applicable period. IMPORTANCE OF CAPITAL back period are usually preferred for investment when
concern. So it shows the entire position of the business
INVESTMENT DECISIONS - Investment decision otherwise compared to ones with longer pay back periods.Payback
concern. • Profit maximization objectives help to reduce the
known as capital budgeting decision is perhaps the most Period = Initial investment / Cash flow per year 4. Present
risk of the business. 2. Wealth Maximization: Wealth
important decision taken by a Finance Manager. Whatever is Value Index - (PVI) The ratio of the NPV of a project to the
maximization is one of the modern approaches, which
the objective of the firm, whether profit maximization or initial outlay required for it. The index is an efficiency
involves latest innovations and improvements in the field of
wealth maximization, capital budgeting decision affects measure for investment decisions under capital rationing. PVI
the business concern. The term wealth means shareholder
performance of the firm decisively. These investment = PV of inflows/PV of outflows. MANAGEMENT OF
wealth or the wealth of the persons those who are involved
decisions have the following implications for the firm. - 1. WORKING CAPITAL - Working capital management is a
in the business concern. Wealth maximization is also known
They define the strategic focus and direction of the business. business tool that helps companies effectively make use of c
as value maximization or net present worth maximization.
The capital expenditure made in new investments may result urrent assets, helping companies to maintain sufficient cash
This objective is an universally accepted concept in the field
in entry into new products, services or new markets. 2. flow to meet short term goals and obligations. By effectively
of business. ROLE AND FUNCTIONS OF FINANCE MANAGER. -
Capital budgeting decisions require large funds and generally managing working capital, companies can free up cash that
1. Raising of Funds: In order to meet the obligation of the
have long repayment periods. The results of capital would otherwise be trapped on their balance sheets. As a
business it is important to have enough cash and liquidity. A
budgeting continue to impact the finances of the firm for result, they may be able to reduce the need for external
firm can raise funds by the way of equity and debt. It is the
many years. Due to long project life, assessment involves borrowing, expand their businesses, fund mergers or
responsibility of a financial manager to decide the ratio
number of years of future events leading to difficulty and acquisitions, or invest in R&D. Working capital is essential to
between debt and equity. It is important to maintain a good
uncertainty regarding the accuracy of assessment. 3. Capital the health of every business, but managing it effectively is
balance between equity and debt. 2. Allocation of funds:
budgeting decisions are mostly irreversible. They involve something of a balancing act. Companies need to have
Once the funds are raised through different channels the next
investment in plant and machinery or new soft wares or enough cash available to cover both planned and unexpected
important function is to allocate the funds. The funds should
technology etc. They are normally industry or user specific. If costs, while also making the best use of the funds available.
be allocated in such a manner that they are optimally used. In
the project does not proceed ahead, it may be difficult to This is achieved by the effective management of accounts
order to allocate funds in the best possible manner the
find buyers for the assets and the only alternative would be payable, accounts receivable, inventory and cash. Concept of
following point must be considered. ▪ The size of the firm
scar the assets at a huge loss. 4. An under investment will Working Capital - There are two concepts or senses used for
and its growth capability ▪ Status of assets whether they are
working capital.- 1. Gross Working Capital: The concept of amount of working capital will be needed. (8) Operating company. Hence, consideration of future projects is also one
gross working capital refers to the total value of current Efficiency: Operating efficiency means efficiently completing of the important objectives of dividend policy. 3. The rate of
assets. In other words, gross working capital is the total the various business operations. Operating efficiency of every dividend distribution should be consistent over the years
amount available for financing of current assets. However, it organisation happens to be different. (9) Availability of Raw because large fluctuations in the rate affect the market price
does not reveal the true financial position of an enterprise. Material: Availability of raw material also influences the of the share. Hence the consistency in the rate of distribution
How? A borrowing will increase current assets and, thus, will amount of working capital. If the enterprise makes use of of dividends is also one of the objectives of dividend policy. 4.
increase gross working capital but, at the same time, it will such raw material which is available easily throughout the If the company takes the help of external finances, it puts
increase current liabilities also. - As a result, the net working year, then less. TYPES OF MANAGEMENT OF WORKING doubts on the financial position of the company in the eyes of
capital will remain the same. This concept is usually CAPITAL - 1. Permanent Working Capital: It is that portion of shareholders. Hence, shareholders can move from the
supported by the business community as it raises their assets the working capital that remains permanently tied up in company and it can result in the dilution of existing
(current) and is in their advantage to borrow the funds from current assets to undertake business activity uninterruptedly. shareholders of the company. Hence, the dividend policy
external sources such as banks and the financial institutions. - In other words, permanent working capital is the least should be conservative so that the existing shareholders do
In this sense, the working capital is a financial concept. As per amount of current assets needed to carry out business not get hampered due to the policy.
this concept: - Gross Working Capital = Total Current Assets . effortlessly. Thus, it is also known as fixed working capital. 2.
2. Net Working Capital: The net working capital is an Regular Working Capital: This is defined as the least amount
accounting concept which represents the excess of current of capital required by a business to fund its day-to-day
assets over current liabilities. Current assets consist of items operations of a business. Examples include payment of CAPITAL STRUCTURE DECISIONS - Internal financing - In the
such as cash, bank balance, stock, debtors, bills receivables, salaries and wages and overhead expenses for the processing theory of capital structure, internal financing is the process
etc. and current liabilities include items such as bills payables, of raw materials. 3. Reserve Margin Working Capital : Apart of a firm using its profits or assets as a source of capital to
creditors, etc. Excess of current assets over current liabilities, from day-to-day activities, a business may need some fund a new project or investment. Internal sources of finance
thus, indicates the liquid position of an enterprise. The ratio amount of capital for unforeseen circumstances. Reserve contrast with external sources of finance. The main
of 2:1 between current assets and current liabilities is Margin Working Capital is nothing but the amount of capital difference between the two is that internal financing refers to
considered as optimum or sound. What this ratio implies is kept aside apart from the regular working capital. These pool the business generating funds from activities and assets that
that the firm/ enterprise have sufficient liquidity to meet of funds are kept separately for unforeseen circumstances already exist in the company whereas external financing
operating expenses and current liabilities. It is important to such as strikes, natural calamities, etc. 4. Variable Working requires the involvement of a third party. Internal financing is
mention that net working capital will not increase with every Capital : This can be defined as the working capital invested generally thought to be less expensive for the firm than
increase in gross working capital. NEED AND IMPORTANCE for a temporary period of time in the business. For this external financing because the firm does not have to
OF WORKING CAPITAL - 1. Strengthen The Solvency : reason, it is also called as fluctuating working capital. Such a incur transaction costs to obtain it, nor does it have to pay
Working capital helps to operate the business smoothly capital varies with respect to the change in the size of the the taxes associated with paying dividends. Many economists
without any financial problem for making the payment of business or changes in the assets of the business. 5. Gross debate whether the availability of internal financing is an
short-term liabilities. Purchase of raw materials and payment Working Capital : This refers to the aggregate amount of important determinant of firm investment or not. A
of salary, wages and overhead can be made without any funds invested in the current assets of the business. In other related controversy is whether the fact that internal financing
delay. Adequate working capital helps in maintaining words, Gross Working Capital is the total of the current assets is empirically correlated with investment implies firms
solvency of the business by providing uninterrupted flow of of the business. These include:-Cash-Accounts Receivable- are credit constrained and therefore depend on internal
production. 2. Enhance Goodwill : Sufficient working capital Inventory-Marketable Securities-Short-Term Investments. 6. financing for investment. ALTERNATIVE FORMS OF FINANCE
enables a business concern to make prompt payments and Net Working Capital : Net Working Capital is the amount by – 1. Crowdfunding : Crowdfunding is the most public form of
hence helps in creating and maintaining goodwill. Goodwill is which current assets exceed the current liabilities of a alternative financing. It’s simply an online platform where
enhanced because all current liabilities and operating business. Thus, the working capital equation is defined as the many investors invest small amounts in a company. Popular
expenses are paid on time. 3. Easy Obtaining Loan : A firm difference between current assets and current liabilities. crowdfunding sites include Kickstarter, Indiegogo, and
having adequate working capital, high solvency and good Where current assets refer to the sum of cash, accounts GoFundMe. This is a great option for companies that
credit rating can arrange loans from banks and financial receivable, raw material and finished goods inventory. have customers who want what they have but the bank does
institutions in easy and favorable terms. 4. Regular Supply Of Whereas, current liabilities include accounts payable. not agree. For example, some indie films have
Raw Material : Quick payment of credit purchase of raw DIVIDEND POLICY - A dividend policy is the policy a company raised capital via crowdfunding platforms as both
materials ensures the regular supply of raw materials fro uses to structure its dividend payout to shareholders. Some a marketing effort and capital raising. As a result of investor’s
suppliers. Suppliers are satisfied by the payment on time. It researchers suggest the dividend policy is irrelevant, in donations, they get perks such as rewards, early access, etc.
ensures regular supply of raw materials and continuous theory, because investors can sell a portion of their shares or 2. Grants: Other alternative forms of financing include
production. 5. Smooth Business Operation : Working capital portfolio if they need funds. Dividends are often part of a grants, competitions, and accelerators. Grants do not have to
is really a life blood of any business organization which company's strategy. However, they are under no obligation be paid back, unlike a loan. They are usually disbursed or
maintains the firm in well condition. Any day to day financial to repay shareholders using dividends. Stable, constant, and gifted by one entity. Often, that entity is a government
requirement can be met without any shortage of fund. All residual are the three types of dividend policy. Even though department. It could also be a corporation, trust, or
expenses and current liabilities are paid on time. 6. Ability To investors know companies are not required to pay dividends, foundation. Most grants require an extensive application
Face Crisis : Adequate working capital enables a firm to face many consider it a bellwether of that specific company's process. In addition, most grants are designated for a specific
business crisis in emergencies such as depression. SOURCES financial health. DIVIDEND AND ITS FORMS - 1. Cash purpose – like research and development. 3. Mezzanine
OF WORKING CAPITAL : Sources of working capital can be Dividend : The cash dividend is by far the most common of Lenders : Mezzanine Lenders are organizations that
spontaneous, short term and long term. Spontaneous the dividend types used. On the date of declaration, the provide loans to businesses; however, they are not required
working capital includes mainly trade credit such as the board of directors resolves to pay a certain dividend amount to have all of the guarantees and collateral of a traditional
sundry creditor, bills payable, and notes payable. Short term in cash to those investors holding the company’s stock on a bank. Their loan to you might have some aspects of
sources are tax provisions, dividend provisions, bank specific date. The date of record is the date on which convertible debt to equity. In addition, it will definitely be
overdraft, cash credit, trade deposits, public deposits, bills dividends are assigned to the holders of the company’s stock. more expensive than a traditional commercial loan. It will be
discounting, short-term loans, inter-corporate loans, and On the date of payment, the company issues dividend about as expensive as using a credit card. But
commercial paper. Long-term sources are retained profits, these lenders are great alternative to companies that may
provision for depreciation, share. FACTORS AFFECTING payments. 2. Stock Dividend : A stock dividend is the not be bankable. 4. Private Equity : Private Equity firms are
WORKING CAPITAL - (1) Nature of Business: The requirement issuance by a company of its common stock to its common funds, and team of individuals manages this fund that
of working capital depends on the nature of business. The shareholders without any consideration. If the company provides debt and equity to businesses. Usually, the “hold”
nature of business is usually of two types: Manufacturing issues less than 25 percent of the total number of previously period for the investment can be anywhere from 3-7 years.
Business and Trading Business. In the case of manufacturing outstanding shares, then treat the transaction as a stock The Private Equity (“P.E”) firms bring best practices and find
business it takes a lot of time in converting raw material into dividend. If the transaction is for a greater proportion of the synergies with other portfolio companies to streamline costs.
finished goods. Therefore, capital remains invested for a long previously outstanding shares, then treat the transaction as a P.E. firms sometimes specialize in an industry or market to
time in raw material, semi-finished goods and the stocking of align their interests. Depending on the type of firm, private
stock split. 3. Property Dividend : A company may issue a
the finished goods. (2) Scale of Operations: There is a direct equity investors may take a managing role in a company. 5.
link between the working capital and the scale of operations. non-monetary dividend to investors, rather than making a Sweat Equity : While bootstrapping is not necessarily a form
In other words, more working capital is required in case of big cash or stock payment. Record this distribution at the fair of financing, it does free up cash that is needed elsewhere.
organisations while less working capital is needed in case of market value of the assets distributed. Since the fair market For example, a company can bootstrap
small organisations. (3) Business Cycle: The need for the value is likely to vary somewhat from the book value of the by hiring employees on equity rather than a salary. While this
working capital is affected by various stages of the business assets, the company will likely record the variance as a gain may be a cheap option in the meantime, it can become
cycle. During the boom period, the demand of a product or loss. This accounting rule can sometimes lead a business to expensive in the long run (especially if the company takes
increases and sales also increase. Therefore, more working deliberately issue property dividends in order to alter their
capital is needed. On the contrary, during the period of taxable and/or reported income. 3.Bond Dividend : • Bond
dividend is also known as “script dividend”. • If the company off). 6 . Working Capital Loans : Every business has high
depression, the demand declines and it affects both the
production and sales of goods. Therefore, in such a situation does not have sufficient funds to pay cash dividend, the times and low points—but seasonal businesses in particular*
company promises to pay the shareholder at a future specific *may need a helping hand to cover operating costs (like
less working capital is required. (4) Seasonal Factors: Some date with the help of issue of bond or notes or scrips. • Bonds salaries and rent) in the low season. Banks and other lenders
goods are demanded throughout the year while others have are issued promising to pay in a longer maturity period and will provide short-term working capital loans to carry you
seasonal demand. Goods which have uniform demand the bears interest. While scrips are issued promising to pay in a through the times when cash is going out faster than it’s
whole year their production and sale are continuous. shorter maturity period. OBJECTIVES OF DIVIDEND POLICY – coming in. COST OF CAPITAL - The term cost of capital refers
Consequently, such enterprises need little working capital. (5) 1. The most important objective of dividend policy is the to the minimum rate of return a firm must earn on its
Production Cycle: Production cycle means the time involved improvement of the financial health of the company. This investments. This is in consonance with the firm’s overall
in converting raw material into finished product. The longer objective also takes into consideration shareholder’s wealth object of wealth maximization. Cost of capital is a complex,
this period, the more will be the time for which the capital as the shareholder of the company plays a very important controversial but significant concept in financial
remains blocked in raw material and semi-manufactured role in the company’s growth. 2. The distribution of dividends management. the cast of capital is that minimum rate of
products. (6) Credit Allowed : Those enterprises which sell increases the cash outflow of the company and hence less return which a firm is expected to earn on its investments so
goods on cash payment basis need little working capital but cash is available to the company after the distribution of that the market value of its share is maintained. We can also
those who provide credit facilities to the customers need dividends. If in the future, the company wants to acquire any conclude from the above definitions that there are three
more working capital. (7) Credit Availed : If raw material and new project or if it wants to expand its business, with the basic aspects of the concept of cost of capital: • Not a cost as
other inputs are easily available on credit, less working available little cash, it cannot go for a new acquisition or such: In fact the cost of capital is not a cost as such; it is the
capital is needed. On the contrary, if these things are not expansion. In this case, it has to take the help of external rate of return that a firm requires to earn from its projects. •
available on credit then to make cash payment quickly large financing which will result in the extra cost of interest to the It is the minimum rate of return: A firm’s cost of capital is
that minimum rate of return which will at least maintain the (EBIT). • The dividend payout ratio is 100%, which means Unfavourable financial leverage occurs when the company
market value of the share. SIGNIFICANCES OF COST OF there are no retained earnings. • There are no corporate does not earn as much as the funds cost. Hence, it is also
CAPITAL -• Capital budgeting decisions: The cost of capital is taxes. This assumption has been removed later. CONCEPT OF called as negative financial leverage.- Financial leverage can
used for discounting cash flows under Net Present Value OPTIMUM CAPITAL STRUCTURE - Optimum capital structure be calculated with the help of the following formula: - FL =
method for investment proposals. So, it is very useful in is the capital structure at which the weighted average cost of OP/ PBT - Where, / FL = Financial leverage /OP = Operating
capital budgeting decisions. • Capital structure decisions : An capital is minimum and thereby the value of the firm is profit (EBIT) /PBT = Profit before tax. 3. Combined leverage :
optimal capital structure is that structure at which the value maximum.Optimum capital structure may be defined as the When the company uses both financial and operating
of the firm is maximum and cost of capital is the lowest. So, capital structure or combination of debt and equity, that leverage to magnification of any change in sales into a larger
cost of capital is crucial in designing optimal capital structure. leads to the maximum value of the firm. Capital structure relative changes in earning per share. Combined leverage is
• Evaluation of financial performance: Cost of capital is used refers to the kinds of securities and the proportionate also called as composite leverage or total leverage. Combined
to evaluate the financial performance of top management. amounts that make up capitalization. It is the mix of different leverage express the relationship between the revenue in the
The actual profit is compared to the expected and actual cost sources of long-term sources such as equity shares, account of sales and the taxable income.- Combined leverage
of capital of funds and if profit is greater than the cost of preference shares, debentures, long-term loans and retained can be calculated with the help of the following formulas:- CL
capital the performance nay be said to be satisfactory. • earnings. The term capital structure refers to the relationship = OL × FL
Other financial decisions: Cost of capital is also useful in between the various long-term source financing such as
making such other financial decisions as dividend policy, equity capital, preference share capital and debt capital. CL = C /OP × OP/ PBT = C /PBT - Where,/ CL = Combined
capitalization of profits, making the rights issue, etc. Deciding the suitable capital structure is the important Leverage /OL = Operating Leverage /FL = Financial Leverage/
decision of the financial management because it is closely C = Contribution /OP = Operating Profit (EBIT) /PBT = Profit
related to the value of the firm. Capital structure is the Before Tax.
permanent financing of the company represented primarily
THEORIES OF CAPITAL STRUCTURE - Net Income Approach - by long-term debt and equity.
As suggested by David Durand, this theory states that there is
a relationship between the Capital Structure and the value of FACTORS AFFECTING CAPITAL STRUCTURE – 1. Leverage : It
the firm. Assumptions • Toal Capital requirement of the firm is the basic and important factor, which affect the capital
are given and remain constant • Kd < Ke • Kd and Ke are structure. It uses the fixed cost financing such as debt, equity MANAGEMENT OF CASH AND MARKETABLE SECURITIES -
constant • Ko decreases with the increase in leverage. and preference share capital. It is closely related to the CASH MANAGEMENT - Cash management is the process of
overall cost of capital. 2. Cost of Capital : Cost of capital collecting and managing cash flows. Cash management can
constitutes the major part for deciding the capital structure be important for both individuals and companies. In business,
of a firm. Normally long- term finance such as equity and it is a key component of a company's financial stability. For
Cost of Ke debt consist of fixed cost while mobilization. When the cost individuals, cash is also essential for financial stability while
of capital increases, value of the firm will also decrease. also usually considered as part of a total wealth portfolio.
capital Hence the firm must take careful steps to reduce the cost of Individuals and businesses have a wide range of offerings
capital. 3. Nature of the business: Use of fixed available across the financial marketplace to help with all
(%) KO - Kd interest/dividend bearing finance depends upon the nature types of cash management needs. Banks are typically a
of the business. If the business consists of long period of primary financial service provider for the custody of cash
operation, it will apply for equity than debt, and it will reduce assets. There are also many different cash management
the cost of capital. 4. Size of the company: It also affects the solutions for individuals and businesses seeking to obtain the
0 Degree of leverage capital structure of a firm. If the firm belongs to large scale, it best return on cash assets or the most efficient use of cash
can manage the financial requirements with the help of comprehensively. In corporate cash management, also often
Net Operating Income (NOI) Approach - the total value of internal sources. But if it is small size, they will go for external known as treasury management, business managers,
the firm will not be affected by the composition of capital finance. It consists of high cost of capital. 5. Legal corporate treasurers, and chief financial officers are typically
structure. – Assumptions - d. K0 and Kd are constant. e. Ke requirements: Legal requirements are also one of the the main individuals responsible for overall cash
will change with the degree of leverge. f. There is no tax. considerations while dividing the capital structure of a firm. management strategies, cash-related responsibilities, and
For example, banking companies are restricted to raise funds stability analysis. Many companies may outsource part or all
from some sources. 6. Requirement of investors: In order to of their cash management responsibilities to different service
collect funds from different type of investors, it will be providers. Regardless, there are several key metrics that are
cost of Ke appropriate for the companies to issue different sources of monitored and analyzed by cash management executives on
securities. 7. Government policy : Promoter contribution is a daily, monthly, quarterly, and annual basis. OBJECTIVES OF
capital KO fixed by the company Act. It restricts to mobilize large, long- CASH MANAGEMENT - 1. It Controls Cash Flow : Perhaps the
term funds from external sources. Hence the company must most vital objective of any cash management system is
1 (%) consider government policy regarding the capital structure. f limiting your cash outflow and accelerating cash inflow.This
LEVERAGE, - The term leverage refers to an increased means objective is clear-cut. As a business owner, you want to
Kd of accomplishing some purpose. Leverage is used to lifting increase the amount of money flowing into the business. At
heavy objects, which may not be otherwise possible. In the the same time, if you minimize the cash leaving your store,
0 degree of leverage financial point of view, leverage refers to furnish the ability to you reduce operational expenses and CIT costs. A currency
use fixed cost assets or funds to increase the return to its recycler, for example, recycles the same cash that comes in
shareholders. Financial decision is one of the integral and through transactions to fund your employee floats and cash
Traditional Approach - It takes a mid-way between the NI important parts of financial management in any kind of registers. 2. It Optimizes Cash Levels for the Business :
approach and the NOI approach. - Assumptions - d. The business concern. A sound financial decision must consider Controlling your cash flow is essential to optimizing cash
value of the firm increases with the increase in financial the board coverage of the financial mix (Capital Structure), levels. If your inflow isn’t available for your use – you have
leverage, upto a certain limit only. e. Kd is assumed to be less total amount of capital (capitalization) and cost of capital outstanding unpaid invoices or money is sitting in your cash
than Ke. (Ko ). Capital structure is one of the significant things for the registers – you may not have the liquidity your business
management, since it influences the debt equity mix of the needs. Your cash management system allows you to optimize
business concern, which affects the shareholder’s return and your cash levels, creating better liquidity. 3. It Enables More
risk. TYPES OF LEVERAGES - 1. Operating leverage: The Efficient Cash Planning : The right cash management system
leverage associated with investment activities is called as helps optimize cash, which allows you to plan more
operating leverage. It is caused due to fixed operating effectively. When you determine how often – and how much
expenses in the company. Operating leverage may be defined – to deposit, you control CIT fees and keep the right amount
as the company’s ability to use fixed operating costs to of cash liquid for the business. Automated cash management
magnify the effects of changes in sales on its earnings before systems collect and provide data, which helps you make more
interest and taxes. Operating leverage consists of two informed decisions. With the right system, you will stop
important costs viz., fixed cost and variable cost. When the worrying about cash shortages and multiple deposits running
company is said to have a high degree of operating leverage if up the costs of doing business. 4. It Enables More Effective
Modigliani-Miller Approach - The Modigliani – Miller
it employs a great amount of fixed cost and smaller amount Cash Management : Cash flow is a factor in more than 80
hypothesis is identical with the Net Operating Income
of variable cost. Thus, the degree of operating leverage percent of business failures, so it’s easy to see why business
approach. Modigliani and Miller argued that, in the absence
depends upon the amount of various cost structure. owners put so much emphasis on managing cash flow
of taxes the cost of capital and the value of the firm are not
Operating leverage can be determined with the help of a correctly. Having the right cash management system in place
affected by the changes in capital structure. In other words,
break even analysis. Operating leverage can be calculated is key here. A good management system allows you to see
capital structure decisions are irrelevant and value of the firm
with the help of the following formula: - OL = C/ OP - Where, cash as it flows through your business, giving you a bird’s eye
is independent of debt – equity mix. - M - M Hypothesis can
- /OL = Operating Leverage /C = Contribution/ OP = Operating view of where cash is leaving the business and where it’s
be explained in terms of two propositions of Modigliani and
Profits. 2.Financial leverage : Leverage activities with entering. FACTORS DETERMINING CASH NEEDS – 1. Nature
Miller. They are : - The overall cost of capital (KO) and the
financing activities is called financial leverage. Financial of business: The working capital requirement of a firm is
value of the firm are independent of the capital structure.
leverage represents the relationship between the company’s closely related to the nature of its business. A service firm,
The total market value of the firm is given by capitalising the
earnings before interest and taxes (EBIT) or operating profit like an electricity undertaking or a transport corporation
expected net operating income by the rate appropriate for
and the earning available to equity shareholders. Financial which has a short operating cycle and which sells
that risk class. The financial risk increases with more debt
leverage is defined as “the ability of a firm to use fixed predominantly on cash basis, has a modest working capital
content in the capital structure. As a result cost of equity (Ke)
financial charges to magnify the effects of changes in EBIT on requirement. On the other hand, a manufacturing concern
increases in a manner to offset exactly the low – cost
the earnings per share”. It involves the use of funds obtained likes a machine tools unit, which has a long operating cycle
advantage of debt. Hence, overall cost of capital remains the
at a fixed cost in the hope of increasing the return to the and which sells largely on credit, has a very substantial
same. - Assumptions of the MM Approach . - • There is a
shareholders. “The use of long-term fixed interest bearing working capital requirement. 2. Seasonality of operations:
perfect capital market. Capital markets are perfect when
debt and preference share capital along with share capital is Firms which have marked seasonality in their operations
investors are free to buy and sell securities, they can borrow
called financial leverage or trading on equity”. Financial usually have highly fluctuating working capital requirements.
funds without restriction at the same terms as the firms do,
leverage may be favourable or unfavourable depends upon To illustrate, consider a firm manufacturing ceiling fans. The
they behave rationally, they are well informed, and there are
the use of fixed cost funds. Favourable financial leverage sale of ceiling fans reaches a peak during the summer months
no transaction costs. • Firms can be classified into
occurs when the company earns more on the assets and drops sharply during the winter period. The working
homogeneous risk classes. All the firms in the same risk class
purchased with the funds, then the fixed cost of their use. capital need of such firm is likely to increase considerably in
will have the same degree of financial risk. • All investors
Hence, it is also called as positive financial leverage. summer months and decrease significantly during the winter
have the same expectation of a firm’s net operating income
period. 3. Production policy: A firm marked by pronounced relationship with your customers by giving them discounts of the supply chain in various ways. 4. Material Requirement
seasonal fluctuation in its sales may pursue a production and offers for maintaining a steady payment record. This also Planning (MRP) Technique : Material Requirements Planning
policy which may reduce the sharp variations in working helps increase transparency between your business and your (MRP) is an inventory management technique. Under this
capital requirements. For example, a manufacturer of ceiling customers, thus building a stronger bond with a lasting technique, the manufacturers/producers order the inventory
fans may maintain a steady production throughout the year relationship. 4. Boost up sales volume : Receivable after taking into account the sales forecast. Material
rather than intensify the production activity during the peak management helps increase sales resulting in increased Requirements Planning (MRP) system incorporates data from
business season. Such a production policy may dampen the profitability. Businesses can extend credit facilities to their different areas of the business where inventory is utilized.
fluctuations in working capital requirements. 4. Market customers which will help them boost their sales volume, as After considering the data and the market demand, order for
conditions: The degree of competition prevailing in the more customers would avail this facility by purchasing new inventory is placed. 5. Dropshipping : Dropshipping is a
market has an important bearing on working capital needs. products on a credit basis. CREDIT POLICY - The discharge of business model, it allows to sell and ship commodities
When competition is keen, a larger inventory of finished is the credit function in a company embraces a number of without owning and stocking them. This technique of
required to promptly serve customers who may not be activities for which the policies have to be clearly laid down. inventory management eliminates the cost of inventory
inclined to wait because other manufacturers are ready to Such a step will ensure consistency in credit decisions and holding all together. 6. Economic Order Quantity (EOQ)
meet their needs. 5. Conditions of supply: The inventory of actions. A credit policy thus, establishes guidelines that Model : In this inventory management technique, a company
raw materials, spares, and stores on the conditions of supply. govern grant or reject credit to a customer, what should be focuses on the decision regarding how much quantity of
If the supply is prompt and adequate, the firm can manage the level of credit granted to a customer etc. A credit policy inventory should be ordered and when the order should be
with small inventory. However, if the supply is unpredictable can be said to have a direct effect on the volume of placed. In this technique, the stock of inventory is re-ordered
and scant, then the firm, to ensure continuity of production, investment a company desires to make in receivables. 1. when it reaches the minimum ordering level. This inventory
would have to acquire stocks as and when they are available Credit Terms- Credit terms refer to the stipulations management technique saves the carrying and ordering cost
and carry large inventory on an average. A similar policy may recognized by the firms for making credit sale of the goods to incurred while placing the order.
have to be followed when the raw material is available only its buyers. In other words, credit terms literally mean the
seasonally and production operations are carried out round terms of payments of the receivables. A firm is required to
the year. consider various aspects of credit customers, approval of
credit period, acceptance of sales discounts, provisions
regarding the instruments of security for credit to be
accepted are a few considerations which need due care and
BASIC STRATEGIES OF CASH MANAGEMENT - 1. Conduct a attention like the selection of credit customers can be made
regular cash flow analysis. 2. Cut expenses. 3. Tackle late on the basis of firms, capacity to absorb the bad debt losses
payments with an incentive. 4. Make paying easier for during a given period of time. However, a firm may opt for
customers. 5. Set up automated payment reminders. 6. determining the credit terms in accordance with the
Request a change to payment terms. 7. Use invoice financing established practices in the light of its needs. The amount of
and invoice factoring. 8. Increase profit margins. 9. Use a funds tied up in the receivables is directly related to the limits FINANCIAL MANAGEMENT TOOLS – 1. Financial planning:
business credit card. 10. Build a cash reserve in case of of credit granted to customers. A. Credit period: The credit financial planning involves developing strategic plans,
emergencies. 11. Cash flow forecasting. 12. Hire an period lays its multi-faced effect on many aspects the volume identifying the financial resources, obtaining and developing
accountant. CASH MANAGEMENT TECHNIQUES / PROCESSES of investment in receivables; its indirect influence can be resources to achieve business goals. Generating relevant and
- 1. Create a cash flow statement and analyze it monthly: seen on the net worth of the company. B. Cash Discount realistic budgets is a function of financial planning tools. 2.
The primary objective of a cash flow statement is to help you Terms: The cash discount is granted by the firm to its Cash flow management: the cash flow statement is a very
budget for future periods and identify potential financial debtors, in order to induce them to make the payment earlier important financial statement. Managing cash flow ensures
problems before they get out of hand. This doesn’t have to than the expiry of credit period allowed to them. Granting that the business has enough cash to pay current bills. A cash
be a complicated procedure. Simply prepare a schedule that discount means reduction in prices entitled to the debtors so flow management tool automates the generation of cash
shows the cash balance at the beginning of the month and as to encourage them for early payment before the time flow statements. 3. Budgeting and managing a budget: a
add cash you receive (from things like cash sales, collections stipulated to the i.e. the credit period. 2. Collection Policy - well-planned budget presents what a business expects to
on receivables, and asset dispositions). Then, subtract cash Collection policy refers to the procedures adopted by a firm spend and earn over a specific time period. Creating
you spend to calculate the ending cash balance. If your cash (creditor) collect the amount of from its debtors when such operating budgets, project budgets, and cash budgets can be
balance is decreasing month to month, you have negative amount becomes due after the expiry of credit period. The done easily and accurately using budgeting software. 4.
cash flow and you may need to make adjustments to your requirements of collection policy arises on account of the Expense management: Monitoring employee expenses on
operations. If it’s climbing, your cash flow is positive. 2. defaulters i.e. the customers not making the payments of the go is part of the accounting software. Expense
Create a history of your cash flow: Build a cash flow history receivables in time. As a few turnouts to be slow payers and management software speeds up reimbursement claim
by using historical financial records over the course of the some other non-payers. A collection policy shall be validation, processing, approval, and payment. Using expense
past few of years. This will help you discover if there is a formulated with a whole and sole aim of accelerating management software ensures that businesses don’t spend
particular time of year which needs more attention. 3. collection from bad-debt losses by ensuring prompt and more than they need to. 5. Payroll management: payroll
Forecast your cash flow needs: Use your historic cash flow regular collections. Regular collection on one hand indicates management requires accuracy and consistency, even the
and project the next 12 to 24 months. This process will help collection efficiency through control of bad debts and slightest error may prove costly for the business. Payroll
identify how much excess cash is required in the good collection costs as well as by inducing velocity to working management tools must be able to grow as the business
months to cover payroll costs and other expenses during the capital turnover. On the other hand it keeps debtors alert in evolves and integrate with existing accounting software. 6.
low-cash months. To smooth out cash flow, you might respect of prompt payments of their dues. A credit policy is Inventory tracking: tracking inventory from multiple
consider establishing a line of credit that can be paid back as needed to be framed in context of various considerations like locations requires powerful tools that help save time and
cash becomes available. 4. Implement ideas to improve cash short-term operations, determinations of level of authority, money. Automated inventory management provides real-
flow: Now that you know your cash needs, consider ideas to control procedures etc. INVENTORY MANAGEMENT - time inventory visibility and the ability to track inventory
help improve your cash position. For example:-Reduce the lag Inventory management helps companies identify which and from purchase order to sale. 7. Tax preparation: a business
time between shipping and invoicing.- Re-examine credit and how much stock to order at what time. It tracks inventory tax software imports data from POS systems, downloads data
collection policies.- Consider offering discounts for early from purchase to the sale of goods. The practice identifies from inventory systems, and provides complete data to
payment.- Charge interest on delinquent balances. - Convert and responds to trends to ensure there’s always enough accountants for the purpose of tax preparation. Financial
excess and unsold inventory back into cash. .RECEIVABLE stock to fulfill customer orders and proper warning of a information systems for small businesses must integrate with
MANAGEMENT - Account receivables refer to the shortage. Once sold, inventory becomes revenue. Before it other business systems for getting a complete picture.
outstanding invoices or money which is yet to be paid by your sells, inventory (although reported as an asset on the balance CREDIT RATING - The term credit rating refers to a quantified
customers. Until it is paid, such invoices or money is sheet) ties up cash. Therefore, too much stock costs money assessment of a borrower's creditworthiness in general terms
accounted as accounts receivables. Also known as bills and reduces cash flow. One measurement of good inventory or with respect to a particular debt or financial obligation. A
receivables. You need cash all the time to keep your business management is inventory turnover. An accounting credit rating can be assigned to any entity that seeks to
running smoothly and ensuring the accounts receivables are measurement, inventory turnover reflects how often stock is borrow money—an individual, a corporation, a state or
paid on time is essential to manage cash flow efficiently. And sold in a period. A business does not want more stock than provincial authority, or a sovereign government. - A credit
as the term suggests, management of your accounts sales. Poor inventory turnover can lead to deadstock, or rating is a quantified assessment of the creditworthiness of a
receivable is called receivable management. Basically, the unsold stock. OBJECTIVES OF INVENTORY MANAGEMENT -  borrower in general terms or with respect to a financial
entire process of defining the credit policy, setting payment 1. Material Availability . 2. Better Level of Customer Service. obligation. - Credit ratings determine whether a borrower is
terms, sending payment follow ups and timely collection of 3. Keeping Wastage and Losses to a Minimum . 4. approved for credit as well as the interest rate at which it will
the due payments can be defined as receivables Maintaining Sufficient Stock. 5. Cost-Effective Storage. 6. be repaid. - A credit rating or score is assigned to any entity
management. Management of Receivables is also known as: - Cost Value of Inventories Can Be Reduced. 7. Optimizing that wants to borrow money—an individual, a corporation, a
Payment Collection. - Collection Management. - Accounts Product Sales . TECHNIQUES OF INVENTORY MANAGEMENT state or provincial authority, or a sovereign government. -
Receivables. OBJECTIVES OF RECEIVABLE MANAGEMENT – 1. – 1. ABC Analysis : ABC analysis is a technique of sorting of Credit for individual consumers is rated on a numeric scale
Helps improve cash flow: It is obvious that sound receivable inventories into 3 categories. The categorization of the based on the FICO calculation by credit bureaus. - Bonds
management will help business owners keep their cash inventory under the ABC analysis is done according to how issued by businesses and governments are rated by credit
inflow steady. This process will give you a clear picture of well the inventory can sell and how much it will cost to hold. agencies on a letter-based system ranging from AAA to D.
where your cash is stuck while maintaining a systematic Always Better Control technique (ABC) analysis classifies A loan is a debt—essentially a promise, often contractual. A
record of all sales transactions. It ensures that you have a inventory into three categories namely: A, B, and C. 2. Just-in- credit rating determines the likelihood that the borrower will
sufficient amount of cash to take care of your everyday time (JIT) Method: Just-in-time is a Japanese technique of be willing and able to pay back a loan within the confines of
transactions, and you do not give credit facilities over and inventory management, in this technique the company the agreement without defaulting. A high credit rating
above your credit policies or credit limit. 2. Reduces losses maintains only such quantity of inventory as it requires indicates that a borrower is likely to repay the loan in its
incurred due to bad debts : Blocked cash means lack of funds during the manufacturing/production process. It implies no entirety without any issues, while a poor credit rating
to conduct your everyday activities. No business would want excess inventory in hand and saves the cost of warehousing, suggests that the borrower might struggle to make their
to face any kind of losses. If receivables aren’t managed shipping, insurance and another allied cost. Further inventory payments. Just as an individual credit score is used to
efficiently, they would result in bad debts ultimately resulting is ordered when the old stock is close enough to be evaluate the creditworthiness of a single person, businesses
in losses. Receivable management will let you keep a close replenished. 3. Safety Stock Inventory: This technique also use credit ratings to demonstrate their creditworthiness
track on the payment schedule so that you can regularly emphasis on maintaining a small stock of inventory in hand to to prospective lenders. RISK-RETURN TRADEOFF DEFINITION
follow up with your debtors and maintain optimum levels of protect against any unexpected market demands and the - The risk-return tradeoff states that the potential return rises
cash flow. 3. Improved customer satisfaction: Since timing difference between the initiation and completion of a with an increase in risk. Using this principle, individuals
receivables management also keeps a track of your buyers production process (lead time). This inventory management associate low levels of uncertainty with low potential returns,
and their payment performance, you can improve your technique plays an important part in the smooth operations and high levels of uncertainty or risk with high potential
returns. According to the risk-return tradeoff, invested
money can render higher profits only if the investor
will accept a higher possibility of losses. --- The risk-return
tradeoff is the trading principle that links high risk with high
reward. The appropriate risk-return tradeoff depends on a
variety of factors including an investor’s risk tolerance, the
investor’s years to retirement and the potential to replace
lost funds. Time also plays an essential role in determining a
portfolio with the appropriate levels of risk and reward. For
example, if an investor has the ability to invest in equities
over the long term, that provides the investor with the
potential to recover from the risks of bear markets and
participate in bull markets, while if an investor can only invest
in a short time frame, the same equities have a higher risk
proposition. - The risk-return tradeoff is an investment
principle that indicates that the higher the risk, the higher the
potential reward. - To calculate an appropriate risk-return
tradeoff, investors must consider many factors, including
overall risk tolerance, the potential to replace lost funds and
more. - Investors consider the risk-return tradeoff on
individual investments and across portfolios when making
investment decisions.