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FINANCIAL MANAGEMENT FULL NOTES - IV SEM B.

COM 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.

v
v
v
v
v

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:It is a barometer through which the performance of a business unit can be measured.
It attracts he investors to invest their saving in securities.
It indicates that the fund is efficiently used for different requirements.
It increases the confidence of management in expansion and diversification
programmers of a company.
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 debtequity.
Steps / factors affecting financial planning:- (5marks)
1)

2)

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
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.

1)
2)
3)
4)

B) External factors:Conditions of capital Market.


Nature and type of investors.
Cost of capital.
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 dayto-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

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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:Invoice discounting
Advance factoring
Full factoring
Outright purchase of accounts receivables
With resource factoring
Without resource factoring
Maturity factoring
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:-

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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:The working capital needs of a firm should be financed out of short-term
borrowings.
The permanent working capital should be financed out of long-term sources.
Flexibility in the financial programmes for the raising of working capital is required.
The cost of securing working capital should be as minimum as possible.
Judicious use of different sources of short-term funds is necessary.
Sufficient liquidity in working capital to meet day to day obligations is required.
Avoid over borrowing of working capital.
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.