9.12 Financial Management

This chapter is not as easy as the others. You are going to see new terms. However, there is no need to worry about a little bit of mathematics. It is such cool!

Business finance

  • Money required for carrying out business activities is called business finance.
  • Almost all business activities require some finance.
  • Finance is needed to establish a business, to run it, to modernise it, to expand, or diversify it
  • Financial Management: Financial Management is concerned with optimal procurement as well as usage of finance. For optimal procurement, different available sources of finance are identified and compared in terms of their costs and associated risks.

Objectives and Financial Decisions

  • Primary aim of financial management is to maximise shareholder’s wealth, which is referred to as the wealth maximisation concept.
  • The market price of a company’s shares are linked to the three basic financial decisions.
    • Investment Decision,
    • Financing Decision,
    • Dividend Decision

Investment Decision

Financing Decision

Dividend Decision

  1. The part of profit to be distributed among the shareholders.
    1. PBIT – Profit Before Interest and Tax
    2. PBT – Profit Before Tax
    3. PAT – Profit After Tax
      1. PBIT = 2,00,000
      2. PBT = 2,00,000 – 10,000 = 190000
      3. PAT = 1,90,000 – 5000 = 1,85,000
        1. EPS = PAT/Number of Shares
        2. EPS = 1,85,000/10 = 18,500

Financial Planning and Importance

  • Financial planning is essentially preparation of a financial blueprint of an organisation’s future operations.
  • The objective of financial planning is to ensure that enough funds are available at right time.
  • Financial planning strives to achieve the following twin objectives.
    • To ensure availability of funds whenever these are required:
    • To see that the firm does not raise resources unnecessarily:
  • Financial planning is an important part of overall planning of any business enterprise.
  • It aims at enabling the company to tackle the uncertainty in respect of the availability and timing of the funds and helps in smooth functioning of an organisation.

Capital Structure

  1. Risk Consideration
  2. Cost of Debt
  3. Cost of Equity
  4. Flotation Cost
  5. Cash Flow Position
  6. Control
  7. Tax Rate
  8. Return on Investment
  9. Flexibility
  10. Interest Coverage Ratio
  11. Debt Service Coverage Ratio
  12. Stock Market Conditions
  13. Regulatory Framework
  14. Capital Structure of other Companies.

Fixed and Working Capital

  1. Fixed capital refers to investment in long-term assets.
  2. Management of fixed capital involves around allocation of firm’s capital to different projects or assets with long-term implications for the business.
  3. These decisions are called investment decisions or capital budgeting decisions and affect the growth, profitability and risk of the business in the long run.
  4. Factors affecting the Requirement of Fixed Capital are:
    1. Nature of Business,
    2. Scale of Operations,
    3. Choice of Technique,
    4. Technology Upgradation,
    5. Growth Prospects,
    6. Diversification,
    7. Financing Alternatives,
    8. Level of Collaboration.
  5. Apart from the investment in fixed assets every business organisation needs to invest in current assets.
  6. This investment facilitates smooth day-to-day operations of the business. Current assets are usually more liquid but contribute less to the profits than fixed assets.
  7. Factors affecting the working capital requirements are:
    1. Nature of Business,
    2. Scale of Operations,
    3. Business Cycle,
    4. Seasonal Factor,
    5. Production Cycle,
    6. Credit Allowed,
    7. Credit Availed,
    8. Operating Efficiency,
    9. Availability of Raw Material,
    10. Growth Prospects,
    11. Level of competition,
    12. Inflation.

Written by Biju John

Biju John is an educational writer, educator and the author of OM - The Otherwise Men. He gives live classes on Skype and Facebook. You can attend his 3 Day Classes (English & Business Studies) in Delhi, Bangalore, Qatar and Dubai. His Contact number is 91 9810740061.

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