Notes of Ch 9 Financial Management| Class 12th Business Studies

Summary and Notes of Ch 9 Financial Management| Class 12th Business Studies 

Meaning of Business Finance

Money required for carrying out business activities smoothly is called Business finance. Finance also helps to run day to day business expenses and purchase assets (Tangible and Intangible).

Financial Management

Financial management is concerned with optimal utilisation of finance.

Aims of Financial Management

• Financial management aims at reducing the cost of funds procured, keeping such fund under control and achieving effective expansion of such funds.

• Financial management also ensure that availability of adequate funds whenever required.

Importance of Financial Management

The financial statements such as Balance Sheet and Profit and Loss Account, reflect a firm’s financial position and its financial health. Some examples of the aspects being affected could be as under:

• The size and the composition of fixed assets of the business.

• The quantum of current assets and its break-up into cash, inventory and receivables.

• The amount of long-term and short-term funds to be used.

• Break-up of long-term financing into debt, equity etc.

• All items in the profit and loss account Example interest, Expense, Depreciation.

• The overall financial health of a business is determined by the quality of its financial management.

Objective of a financial Management

The main objective of the financial management is to maximise shareholder’s wealth. All financial decisions aim at ensuring that each decision is efficient and adds some value. Those decisions which result in increasing the share value known as healthy financial decision and those decisions which result in decline in the share price are poor financial decision.

Financial Decision

Financial decisions depend on three major issues relating to the financial operations of a firm.

• Investment Decision

• Financing Decision

• Dividend Decision

Investment Decision: The investment decision relates to how the firm’s funds invested in different assets. Investment decision can be long term or short term, a decision is long term when managers invest in a new machine to replace old ones this decision is very crucial for any business since they affect its earning capacity of a business. Short-term investment decisions are concerned with the decisions about the level of cash, inventory and receivables.

Factors affecting Capital Budgeting Decision

• Cash flows of the projects: When company takes an investment decision involving huge amount it expects to generate some cash flow.

• The rate of return: During investment time calculations are based on the expected returns from each proposal and the assessment of the risk involved.

• The investment criteria involved: It involved calculations regarding the amount of investment, Interest rate, cash flows and rate of return these terms are considered which investment decisions are taken.

Financing Decision

It refers to the determination as to how the total funds required by the business will be obtained from various long-term sources. Long –term financial sources chiefly include equity share capital, preference share capital, retained earning, debenture, long-term loan, etc.

Factors Affecting Financing Decisions

• Cost: The cost of raising fund in different sources are different, a good financial manager would normally opt for a source which is cheapest.

• Risk: The risk associated with each of the sources is different.

• Floatation Costs: If the floatation cost is higher the sources are less attractive.

• Cash Flow Position of the Company: If the cash flow position of the company is good, the payment of interest on the debt and the refund of capital can be easily made.

• Fixed Operating Costs: There are two types of costs which affect financial decision, fixed operating costs and fixed financial costs.

• Control considerations: When company issues more equity share, the more control of company goes on equity shareholders which are not good situation.

• State of Capital Market: It depends totally on choice of source of fund.

Dividend decision

The decision is that how much of the profit earned by the companies should be retained in the business and how much of the profit distributed to the shareholder.

Factors Affecting Dividend Decision:

• Amount of Earnings: The dividend is paid out of the present and reserved profits. Therefore, greater amount of total profit will ensure greater dividend.

• Stability Earnings: If company having a stable earning is in a better position to declare more Dividends.

• Stability of Dividends: Every companies follow policy of maintaining a dividend. In this condition a little change in profit should not be allowed any increase or decrease in the dividend.

• Growth Opportunities: If the companies have good growth opportunities they pay small amount as a dividend and retain more money for investment.

• Cash Flow Position: The payment of dividend involves an outflow of cash. Availability of enough cash in the company is necessary for declaration of dividend.

• Shareholders’ Preference: While declaring dividends, managements must keep in mind the preferences of the shareholders in this regard.

• Taxation policy: Generally taxation policy is depends on whether company paid less dividend and more if the company has less tax on dividend they paid more and if less tax on dividend they paid more dividend.

• Stock Market Reaction: It means that if the dividend is declared at a higher rate, it is considered to be good news so the price of share increases and market condition related to finance is also good.

• Access to capital Market: In case of need if a company can easily collect finance in the capital market, it should declare dividend at a higher rate otherwise not.

Financial Planning

It refers to the preparation of a financial blueprint of an organisation’s future operations.

Financial planning strives to achieve the following twin objectives:

• To ensure availability of funds whenever required.

• To see that the firm does not raise resources unnecessarily.

Capital Structure

Capital structure refers to the mix between owners and borrowed funds. Capital structure of a company affects both the profitability and the financial risk.

Factors affecting the choice of Capital Structure

• Cash Flow Position

• Interest Coverage Ratio (ICR)

• Debt Service Coverage Ratio

• Return on Investment

• Cost of debt

• Tax Rate

• Cost of Equity

• Floatation costs

• Risk Consideration

• Flexibility

• Control

• Regulatory Framework

• Stock Market Conditions

• Capital Structure of other companies

Fixed Capital

Fixed assets are those which remain in the business for more than one year Example: Plant and Machinery, Furniture and Fixture, Land and building etc., it also helps in to run business.

Management of Fixed Capital

Fixed capital refers to investment in long-term assets. It affects the growth, Profitability and risk of the business in the long-run. It must be financed through long-term source of capital. Investment in these assets would also include expenditure on acquisition expansion, modernisation and their replacement. These decisions include purchase of land, building, plant and machinery.

The management of fixed capital or investment or capital budgeting decisions are important for following reasons:

• These decisions have wearing on the long- term growth.

• When decide to invest in a fixed capital it involves huge amount.

• Investment decision in fixed capital involved a huge amount so, it influence the overall business risk complexion of the firm.

•These decision once taken, are not reversible without incurring heavy losses.

Working capital

• Current assets: A current asset is either cash or an asset that can be converted into cash within a year is often used to pay off current liabilities.

• Current Liabilities: Current liabilities are those payment obligations which are due for payment within one year such as bills payable, creditors, outstanding expenses and advances received from customers.

Factors affecting the Working Capital Requirements

• The requirement of working capital depends on the nature of the business whether it is manufacturing business and trading business.

• There is direct link between the working capital and the scale of operations. More working capital is required in case of big organisation while less working capital is needed in case of small organisation.

• Different phases of business cycles affect the requirement of working capital by a firm.

• Working capital also affect in case of seasonal business.

• Where period of production cycle is more than more working capital needed on the contrary where period of production is little, less working capital will be needed.

• Those enterprises which sell goods on cash payment basis need less working capital but those who provide credit facilities to the customer needs more working capital.

• Firms manage their operations with varied degrees of efficiency.

NCERT Solutions of Chapter 9 Financial Management (MCQ and Short Questions)

NCERT Solutions of Chapter 9 Financial Management (Long Answer Questions)

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