12th commerce secretarial practice

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Written according to the New Textbook (2013-2014)published by the Maharashtra State Board of

Secondary and Higher Secondary Education, Pune.

Std. XII Commerce

Secretarial Practice

Ms. Toral Juthani(M.Com, PGDFM)

Ms. Urvi Mehta(M.Com, C.S.)

Salient Features

Exhaustive coverage of syllabus in Question Answer Format.

Covers answers to all Textual Questions, Board Questions(Mar 08 Oct 12)Relevant Marking Scheme for Each Question.Includes Additional Important Questions, Intext Questions.

Quick Review at the end of each chapter to facilitate quickrevision.Two Model Question Papers as per the latest paper pattern.

Simple and Lucid language.Self evaluative in nature.

Tar g et Publications PVT. LTD . Mumbai, MaharashtraTel: 022 6551 6551

Website : www.targetpublications.org | email : [email protected]

First Edition: February 2014


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Std. XII CommerceSecretarial Practice

Tar g et Publications PVT. LTD. All rights reserved

First Edition : February 2014

Price : 140/-

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Published by

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No part of this book may be reproduced or transmitted in any form or by any means, C.D. ROM/Audio VideoCassettes or electronic, mechanical including photocopying; recording or by any information storage and

retrieval system without permission in writing from the Publisher.


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Tar g et Publications Pvt. Ltd. Chapter 01: Business Finance

1

1 usiness FinanceContents:

1.1 Introduction

1.2 Meaning of Financial Management

1.3 Financial Planning

1.4 Capital Structure

1.5 Fixed Capital and Working Capital

1.1 Introduction

Q.1. Explain the term Business Finance. [5]Ans: i. The term business finance can be

broadly explained by considering thefactors business and finance.ii. The term business deals with

production and distribution of goods andservices.

iii. The term finance is basically requiredfor consumption as well as investmentin any business.

iv. In simple words, business financeapplies to all financial activities ofagriculture, industry, banking, transport,insurance, etc.

v. Thus, the scope of business financeincludes commercial finance, industrialfinance, property finance, corporatefinance and even agriculture finance.

vi. It mainly deals with raising,administering and disbursing of funds

by a business firm or an organization.vii. In actual practice, business finance

refers to corporation finance.viii. Now-a-days, the term corporation

finance is known as financialmanagement.

1.2 Meaning of Financial Management

*Q.2. What is Financial Management? State itsrole in the organization. [5]

Ans: i. Being a specialized function of generalmanagement, financial management ismainly concerned with raising offinance and its optimum and effectiveutilization for achievement of goals ofthe organization.

ii. It deals with planning, organizing,

directing, co-ordinating and controllingfinancial activities.iii. It is also called as Resource

Management .

Definition:i. Ezra Soloman: Financial Management

is concerned with effective use of animportant economic resource, namelycapital funds.

ii. Kuchal S.C.: Financial Managementdeals with procurement of funds and

their effective utilization in business. Role of financial management:The role of financial management can beexplained with reference to the functions

performed by it:a. Routine functions.

b. Executive functions.

a. Routine functions: i. Record keeping and reporting:

Keeping records of financialtransactions and sending thereports to different departmentalheads.

ii. Preparing various financialstatements: This is done toanalyze the position and

performance of an organization.iii. Cash Planning: Cash planning is

done properly as it allows thecompany to plan its workingcapital.

iv. Credit Management: Creditmanagement means managing thefunds which are due with thecreditors and accordingly decidingthe credit period that is to beoffered to the creditors.

v. Reporting to Directors: Providing accurate information toBoard of Directors on currentfinancial position for makingdecisions of purchases, marketing,

pricing, etc.


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Tar g et Publications Pvt. Ltd. Std. XII(Commerce): Secretarial Practice

2

b. Executive functions:i. Forecasting financial

requirements: Forecasting offinance means projection offinancial needs of business forsome time ahead. Forecasting

simply means budgeting financialneeds of the expected programmes.An organization requires capitali.e. fixed capital (long term) andworking capital (short term) forrunning its business.Forecasting not only includes theamount of funds required but alsothe duration of funds, its timingand the kind of funds i.e. ownedor borrowed, etc.

ii. Deciding sources of funds: Afterdetermining the amount of financerequired, various sources of raisingof funds such as shares, debentures,financial institutions, moneylenders, etc. are considered.An utmost care is to be takenwhile selecting the funds as thereneeds to be a proper balance

between long term funds and shortterm funds.

iii. Investment Decisions:Investment decision ensureseffective utilization of fundsraised by the organization ina. long term assets or fixed

assets such as land, building, machinery,furniture, etc.

b. short term assets or currentassets such as cashrequirement, accountreceivables and inventory.

iv. Dividend policy: A financemanager has to decide the

proportion of profit that it is to beretained in the business for futureexpansion and the proportion thatis to be distributed as dividendamong shareholders. It is the

prime duty of the finance managerto balance the investorsexpectations and use of retainedearnings for future expansion oracquisition of additional assets.

v. Checking and analysis offinancial performance: Anorganization prepares andanalyzes various financialstatements which helps inimproving techniques of financial

control.vi. Advising Board of Directors: A

finance manager brings to thenotice of the Board of Directors

problems related to finance andalso suggests possible solutionsfor the same. He also gives adviceon important matters such as

pricing, expansion, acquisition,dividend policy, etc.

Q.3. *What are the objectives of financialmanagement?

ORState the objectives of financialmanagement. [5]

Ans: The basic objectives of financial managementare stated as follows:i. Profit maximization:

a. It is considered as the basic principle of any business activity.According to this principle, allfunctions of business aim at profit.

b. The concept of profitmaximization is traditional innature and is based on theassumption that profit is a tool ofmeasuring the success of any

business firm.c. Profit maximization is considered

to be the most important businessobjective since,1. it is difficult for any

business firm to survivewithout profit.

2. success can be measuredwith the profit earningcapacity of an organization.

3. high profit results in betterreturns to shareholders.

4. increase in profitability ofan organization allows theuse of surplus funds for thefuture expansion of thefirm.

5. it has to be achieved forsocio-economic welfare.


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ii. Wealth Maximization:a. According to Prof. Soloman

Ezra, the ultimate goal offinancial management should bemaximization of owners wealth.

b. Wealth maximization is also

known as value maximizationi.e. maximizing net present valueof a firm.

c. The focus of financialmanagement is on wealthmaximization of its owners i.e.,equity shareholders. The wealth ofshareholders is reflected in marketvalue of shares. Thus, wealthmaximization means themaximization of market price ofshares.

d. The wealth of equity shareholdersis maximized only when marketvalue of equity shares ismaximized.

iii. Social satisfaction:a. Business firms now-a-days not

only think about investors, butalso consider welfare of people ingeneral.

b. As a business firm operates insociety, hence it is responsible

towards the society.c. They do so by protecting theinterests of suppliers, customers,creditors, employees of thecompany and government.

Q.4. Write short notes on. [5 marks each]*i. Role of Financial Management.Ans: Refer Q.2.

ii. Investment decisions.Ans: a. Investment decision basically

ensures effective utilization of thefunds raised by the organization in1. Long term assets or fixed

assets.2. Short term assets or

current assets . b. Fixed assets i.e. land, building,

machinery, equipment andfurniture, etc. forms a large

portion of funds raised andincludes a major portion ofinvestment decision.

c. It is important to invest in fixedasset wisely as the investment hasto be made for long term basis.

d. On the other hand, Current assetsinclude investment to be made onshort term assets like cash,

account receivable and inventory.e. The aspect of investment decisions

relating to current assets is knownas working capital management.

iii. Social satisfaction objective of abusiness firm.

Ans: a. Business firms now-a-days notonly think about investors, butalso consider welfare of people ingeneral.

b. As a business firm operates insociety, hence it is responsibletowards the society.

c. The interest of suppliers,customers, creditors, employeesof the company and government isto be protected.

d. The shareholders expect high rateof dividend, customers want

products of good quality atreasonable prices, society requireseffective and efficient use ofscarce resources of production andgovernment insists on obeyance ofrules and regulations and regular

payment of taxes. A business firmhas to fulfill all such socialresponsibilities.

e. Thus, along with profitmaximization and wealthmaximization, social satisfactionis an equally important objectiveof any business firm.

Q.5. State with reasons, whether the followingstatements are True or False.

[5 marks each] *i. Financial management is essential for

all types of organizations.Ans: This statement is TRUE.

Reasons: a. All types of organizations, whether

profit making or non profitmaking, need financialmanagement as it plays a crucialrole in making effective andoptimum use of financial resources.


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b. These organizations require fundsfor their development andexpansion.

c. Financial management refers tomanagement of funds and ismainly concerned with raising of

finance and its effectiveutilization.

d. It also deals with planning,organizing, directing, co-ordinating and controllingfinancial activities.

e. Financial management helps inmaximizing profit of the companywhich results in maximization ofthe owners wealth.

Hence, financial management isessential for all types of organizations.

ii. Financial management has becomesubject of considerable importance indeveloped countries.

Ans: This statement is FALSE. Reasons:a. Financial management is a subject

of considerable importance indeveloping countries like India.

b. In such countries, the existence of business entity depends upon thesavings of the people which aremeager in general.

c. These scarce savings should beutilized to the maximumefficiency through well-managedfinancial activities.

d. Routine and executive functionsof financial management help afinance manager to makeoptimum use of financialresources.

Thus, financial management is a matterof great concern in developingcountries.

iii. An utmost care is to be taken whileselecting the sources of funds.

Ans: This statement is TRUE. Reasons:a. A company can raise its capital

from different sources. Funds canalso be borrowed from financialinstitutions as well as lenders.

b. However, there has to be a proper balance between the short termand long term funds.

c. The funds raised from outsidersand owners have to be in a certain

proportion.

d. However, if a firm raises fundsfrom lenders, the terms andconditions of credit should be keptin mind.

Hence, an utmost care is to be takenwhile selecting the sources of funds.

iv. A finance manager distributes all theprofits earned as dividend to theshareholders.

Ans: This statement is FALSE. Reasons:a. A business firm is a profit making

organization. b. Its profit depends upon the

effective utilization of funds.c. A finance manager has to deal

with the decision regardingdeclaration of dividends out of the

profits earned by the organization.d. Shareholders are usually

interested in receiving higher rateof dividends whereas the Board ofDirectors are interested inretaining earnings for futureexpansion.

Thus, the finance manager balances theexpectations of investors and the use ofretained earnings to acquire additionalassets rather than distributing all the

profits earned as dividend to theshareholders.

*v. The proper aim of financialmanagement is wealth maximization.

Ans: This statement is TRUE. Reasons:a. The shareholders invest their

funds in a company or anorganization with a motive toincrease the investment.

b. The wealth of such shareholders isreflected in market value ofshares.

c. If the market value of equityshares increases, wealth ofshareholders also increases.


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d. The share price of a company,quoted in share market index, is areflection of its earning capacity,dividend and retention policy.

Thus, the proper aim of financialmanagement is maximizing market

value of equity shares of the company.

vi. *Maximization of profit is real andcomplete motive.

ORProfit maximization is the onlyobjective of financial management.

Ans: This statement is FALSE. Reasons:a. Profit is a tool of measuring the

success of any business firm i.e.high level profitability results in

better return (dividend) to theshareholders which in turnincreases their earning per share(EPS).

b. In simple terms, the business firmshould undertake only suchactivities that increase profit andthose activities which decrease

profit should be avoided.c. Maximization of profit is

important in regard to various

factors such as: to generate fundsfor future expansion, betterdividend to the shareholders,increase in the creditworthiness ofthe firm, etc.

d. However, it is not the only factorimportant for financialmanagement.

e. The proper aim of financialmanagement is wealthmaximization of its equityshareholders.

f. Moreover, business firms now-a-days aim at social satisfaction andsocial welfare.

g. Therefore, profit maximizationalong with wealth maximizationand social satisfaction are theimportant objectives of financialmanagement.

Thus, Maximization of profit is not thereal and complete motive.

Q.6. Distinguish between the following:[5 marks each]

i. Routine Function and ExecutiveFunction.

Ans: Routine function Executive function

Meaninga. Routine function

is one of theroutine activityunder financialmanagement.

Executive function isan essential elementi.e. a major activityunder financialmanagement.

Nature b. Routine function

includes tasks andfunctionsconducted on

daily basis.

Executive functionincludes, the keyfunctions undertaken

by the financial

management.Sources c. Routine function

includes recordkeeping,reporting, cash

planning andcreditmanagement.

Executive functionincludes a processwhich begins with1.2.

3.

4.5.

6.

ForecastingDeciding sourcesof fundsMakinginvestmentdecisions

Dividend policyAnalysis offinancial

performanceAdvising Boardof Directors.

Objective d. The main aim of

Routine functionis to preparevarious financialstatements and to

provideinformation to theBoard of Directorsas they are the

policy decisionmakers of theorganization.

The main aim ofExecutive function isto carry out financialfunctions smoothly,and to analyze thefinancial

performance of thefirm. It is significantin improving thetechniques offinancial control.


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Finance manager brings about co-ordination among all departmental headsof the organization.

iii. Dynamism:A dynamic finance manager would takeinitiative and face various changing

financial situations as and when theyarise.Proper and effective financial planninghelps the finance manager to forecastthe future trends.Such forecasting helps the organizationto undertake only profitable projects andavoid the unprofitable ones.

iv. Communication:Proper and effective financial planninghelps the finance manager tocommunicate the various aspects of

financial plan to the executives of otherdepartments.This further helps to eliminate thewastage of time and increase thegoodwill and financial resources of thecompany.

v. Decision Making:Financial planning helps a firm to takeappropriate and timely decisions toachieve its objectives. Thus, toimplement any scheme, there must be a

budgetary provision in the financial

planning.vi. Integration:

Financial planning gets completed onlywith consultation and co-operation of alldepartments of the organization whichin turn, promotes team spirit among allthe executives of the company.

vii. Futuristic:Financial planning takes into accountnot only the present but also the futuredevelopments. This futuristic element offinancial planning helps for advance

programming.Q.8. Write short notes on. [5 marks each]

*i. Objectives of Financial Planning.Ans: Objectives of financial planning include:

a. Proper utilization of funds:Maximum usage of the availablefinancial resources is the basicaim of financial planning. It isimportant that adequate fundsshould be raised at no extra cost.

b. Adequate supply of funds:Financial planning includesforecasting the firms financialneeds. It is important to havesufficient supply of funds toensure smooth functioning of the

organization. There must beenough funds so that the firm doesnot face any financial distress.

c. Efficient use of funds:It is important to manage fundswisely. Financial planning aims atsupervising the usage of funds

because the funds so generated isnot only for earning profit but alsofor the survival of the firm.

d. Elimination of wastefulexpenditure:Financial planning ensures that noexcess fund is raised by the firm.It is important that the firmgenerate or procure only thatmuch amount which is needed.Any extra cost must not beincurred while raising the fundsand the funds so raised should be

properly utilized as per therequirement of the firm. Anysurplus so generated needs to bemonitered, so as to avoid itsmisuse.

*ii. Importance of Financial Planning.Ans: Refer Q.7.


[5 marks each]i. *It is not possible to go ahead without

financial plan.OR

#Sound financial planning is the keyto successful business operations.

Ans: This statement is TRUE. Reasons:a. Financial Planning is an important

function of financial management.It predicts the financialrequirement and arranges for thesources of required funds. It is acontinuous process in day to dayadministration of business.


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b. Financial planning is not onlyrequired for profit making buteven for survival of a firm. Thefinancial plan must includeinformation about economicenvironment in which the business

operates. Financial planningserves as a guide for overallactivities of the organization.

c. The information provided in thefinancial plan assists in decisionmaking of a firm. It establishestargets of sales and profits and

promotes co-ordination ofresources and efforts to reachthese targets. It is an advance

programming of all plans offinancial management.

Thus, it is not possible for financemanager to go ahead unless he preparesa sound financial plan.

ii. Modern management lays a greatemphasis on a detailed financialplan.

Ans: This statement is TRUE.Reasons:

Refer Q.9. (i)

iii. Financial planning helps ineliminating wasteful expenditure ofthe firm.

Ans: This statement is TRUE. Reasons:a. Financial planning helps in

forecasting the needs of anorganization whether current orfuturistic.

b. Financial planning is analytical planning as it considers severalfactors such as change ingovernment policy on taxes,fluctuating interest rates, etc.

c. These events can be timelyanticipated and tackled with thehelp of financial planning.

Hence, financial planning assists inavoiding wasteful expenditure whichwould otherwise become a huge lossand cause an irreversible damage to theorganization.

1.4 Capital Structure

Q.10.Define Capital Structure. Explain thecomponents of capital structure.

OR

*Write a short note on: Capital Structureand its components. [5]

Ans: Capital structure:

i. Capital structure constitutes two wordsi.e. Capital and structure. The wordcapital refers to the investment offunds in business while structure meansarrangement of different components in

proper proportion.ii. A company can raise its capital from

different sources i.e. Owned capital, borrowed capital or both.

iii. To decide Capital structure means todecide upon the ratio of owned capitali.e. equity share capital to a borrowedcapital i.e. debt.

iv. According to John H. Hampton, Afirms capital structure is the relation

between the debt and equity securitiesthat makes up the firms financing of itsassets.

v. Thus, the term Capital structure meansfinancing mix. It refers to the

proportion of different securities raised by a firm for long term finance.

Components of Capital structure.i. Equity share capital:

Equity share capital is provided byequity shareholders and it is the basicsource of financing activities of

business. The holders of such shares bear ultimate risk associated with theownership.Equity shares carry dividend at afluctuating rate, depending upon the

profits earned by the company.ii. Preference share capital:

Preference shares carry dividend at afixed rate of interest and enjoy

preferential right over equity shares forreturn of capital in case of winding up ofthe company. Unlike equityshareholders, preference shareholdershave limited voting rights.


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iii. Retained Earnings:The part of the profit retained by thecompany for meeting future financialneeds and for expansion of the firm isknown as retained earnings. In simplewords, it is ploughing back of profits.

iv. Borrowed Capital:It consists of the following:a. Debentures:

A debenture is a certificate of loanevidencing the fact that thecompany is liable to pay aspecified amount with interest atan agreed rate.

b. Term Loans:Term loans are provided by bankand other financial institutions at afixed rate of interest.

*Q.11.What is Capital Structure? What are theinternal and external factors influencingcapital structure? [10]

Ans: Capital Structure: Refer Q.10.

Factors influencing capital structure:The factors which play a vital role in capitalstructure determination are divided into twocategories:i. Internal factors. ii. External factors.

i. Internal factors:a. Requirement of Capital:

1. In the initial stages of business, a company cannotissue varieties of securitiesas there is considerable riskinvolved and hence, it is

preferable to raise capitalthrough equity shares.

2. Later on for expansion ormodernisation, the companymay issue other types ofsecurities such as shares,debentures, etc.

b. Size and nature of business:1. The size of business has

great impact on its capitalstructure.

2. Trading concerns raisecapital by issue of equity aswell as preference shares asthey require more workingcapital.

3. Small companies havelimited capacity to raisefunds from external sources.

4. Large companies possesshuge investments, hencethey can issue debentures by

offering securities of fixedassets such as land,

building, machinery, etc.So, these companies preferto raise funds by issuingequity shares along withdebentures.

c. Growth of business firm:1. Capital requirement of a

firm depends upon the stageof development.

2. At the initial stage, thesource of finance is mostlyequity shares and short termloans.

3. As the stage progresses, therequirement increases andfunds are procured byissuing debentures and

preference shares.d. Adequate earnings and Cash

position:1. Developed companies with

stable earnings (stable cashflow) utilize large amountof debt capital in theircapital structure as they can

pay a fixed rate of interest.2. Whereas companies with

unstable earnings(unpredictable cash flow)should not opt for debt intheir capital structure asthey may face difficulty inmeeting the fixed amount of

interest.e. Period of finance:

1. If funds are required onregular basis, the companyshould raise it through issueof equity shares.

2. For short period, funds can be raised through issue ofdebentures or preferenceshares.


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f. Future plans and development:1. Capital structure is designed

by the management keeping inmind the future developmentand expansion plans.

2. Equity shares can be issued

in the initial stages whereasdebentures and preferenceshares may be issued infuture to financedevelopmental plans.

g. Trading on equity:1. The use of borrowed capital

for financing a firm is knownas Trading on equity.

2. If the rate of interest on debtis lower than the rate ofearnings of the company, the

equity shareholders getadditional dividend. Thisincreases the creditworthinessof the company and thecompany is able to raisefurther loan at a lower rate ofinterest.

3. On the other hand, if thecompany earnings are notsufficient, it may lead tofinancial crisis as the intereston debt has to be paid even

in case of loss. If no dividendis paid on equity shares, itadversely affects thecreditworthiness of thecompany.

h. Capital gearing:1. The ratio between debt capital

(fixed interest) and equitycapital (variable dividend) iscalled capital gearing.

2. It is high gearing when the proportion of debt capital ishigh than the equity sharecapital while it is lowgearing when the proportionof debt capital is low thanthe equity share capital.

3. In order to protect the interestof equity shareholders, thecompany usually uses propermix of various types ofsecurities in its capitalstructure.

i. Attitude of management:1. Capital structure is influenced

by the attitude of the personsin the management.

2. If the management wishesto have exclusive control,

they raise capital through preference shares and debtcapital. Since the holder ofsuch shares do not enjoyany voting rights, therebycannot interfere in themanagement of thecompany.

ii. External Factors:a. Market Conditions:

1. Various methods offinancing should beconsidered depending uponthe prevailing marketconditions.

2. If the share market is in adeclining situation, thecompany should raise funds

by issuing debts.3. On the other hand, during

the period of boom in theshare market, the companyshould raise funds byissuing equity shares.

b. Attitude of investors:1. Attitude of investors also

plays an important role indetermination of capitalstructure.

2. If the investors prefer totake risk and expect higherreturns, they invest in theequity shares.

3. If the investors prefer to earnsafe and assured income andare not ready to take risk,they invest in preferenceshares and debentures.

c. Cost of capital:1. Cost of capital is the

minimum return expected by its supplier.

2. In case of debt holder, rateof interest is fixed and theloan is repaid within the

prescribed period.


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3. In case of shareholders, rateof dividend is not fixed theircapital is repaid only whenthe company is liquidated.

4. Thus, debt is a cheapersource of capital than

equity.5. However, the company

cannot minimize cost ofcapital by employing onlydebt.

d. Government rules andregulations:1. According to SEBI, the

normal debt equity ratio is2 : 1.

2. However, in case of largecapital intensive project, the

permitted ratio is 3 : 1.3. Government provides aid

and some concessions tosmall industrial projects toraise more debt capital.

e. Attitude of financialinstitutions:1. If financial institutions

prescribe high terms oflending, then the companyshould move to other sourceof financing.

2. However, if financialinstitutions prescribe easyterms of lending, thecompany should obtainfunds from such institutions.

f. Rate of interest:1. Capital structure depends

upon the rate of interest prevailing in the market.

2. If the rate of interest ishigher, firms delay debtfinancing.

3. Conversely, if the rate ofinterest is lower, firms optfor debt financing.

g. Taxation:1. Interest paid against debt is

tax deductable expenditurewhereas dividend is notconsidered as taxdeductable expenditure forthe company.

2. Hence, issue of debt capitalis more preferable thanissue of share capital.

h. Competition:1. The company which faces

cut-throat competitionshould raise funds byissuing equity shares astheir earnings are not certainand adequate.

2. Whereas the companywhich has a monopoly inthe market, may issue debtcapital because of certaintyof earnings.

Q.12. Write short notes on. [5 marks each]i. Factors influencing capital structure.

Ans: Refer Q.11.

ii. Sound Capital Structure.Ans: a. Capital structure refers to the

composition of capital and ratio ofdifferent securities in total capital.It comprises of net worth (equity+ reserves) and long termliabilities.

b. A company can raise its capitalfrom different sources i.e ownedcapital or borrowed capital ormixture of both.

c. Different proportion of sourcesare used in capital structure as per

business requirement.

d. The organization is said to have asound capital structure when theratio of securities i.e. debt toequity, is favourable. The idealratio prescribed by SEBI is 2 : 1.

e. Balanced capital structure is anoptimal mixture of debt andequity.

f. There is no ideal pattern of capitalstructure. However, there should

be appropriate mix of securities inthe capital structure so that EPSi.e Earning per share ismaximized.


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Q.13. State with reasons, whether the followingstatements are True or False. [5 marks each]*i. There is hard and fast rule for the

proportion of owned funds andborrowed funds.

Ans: This statement is FALSE.

Reasons: a. The pattern of capital structure of

various firms varies widely. Henceto determine the best possible

pattern of capital structure i.e. proportion of owned funds and borrowed funds, many factors are to be borne in mind viz. internal andexternal factors.

b. Many internal factors influencecapital structure viz. requirement ofcapital, size and nature of business,

growth of business, cash position, period of finance, trading on equity,development of the firm, etc.

c. On the other hand, external factorssuch as market conditions, cost ofcapital, attitude of investors andfinancial institutions, government

policies and regulations, etc.influence capital structure.

d. Also, it is important to maintain a proper mix of various types offinance in capital structure, so that

the interest of equity shareholders is protected.

Thus, the proportion of owned funds and borrowed funds may differ fromorganization to organization dependingupon certain factors viz. internal andexternal factors.

*ii. Trading on equity is a double edgedsword.

Ans: This statement is TRUE. Reasons:a. The use of borrowed capital for

financing a firm is known asTrading on equity.

b. If the rate of interest on debt is lowerthan the rate of earnings of thecompany, the equity shareholders getadditional dividend.

c. Higher rate of dividend to equityshareholders improves goodwill ofthe company and also increases themarket value of shares.

d. Thus, the company is able to raisefurther loans at lower rate ofinterest.

e. If the company earnings are notsufficient, it may lead to financialcrisis as the interest on debt has to

be paid even in case of loss.f. If no dividend is paid on equity

shares, it adversely affects thegoodwill and creditworthiness ofthe company.

g. Thus, it becomes difficult for thecompany to raise further loans.

Thus, trading on equity is a doubleedged sword as it may increase incomeof shareholders if the things go right.However, it also increases the risk of

loss under adverse conditions.

1.5 Fixed capital and Working capital

*Q.14.What is Fixed Capital? State factorsaffecting requirement of fixed capital. [5]

Ans: Meaning:i. Fixed capital is that portion of total

capital which is invested in fixed assetssuch as, land, building, equipments,machinery, etc.

ii. It may be held in business for 5, 10 or

20 years or more, thereafter it may besold or reused.

iii. In National Accounts , it is defined asthe stock of tangible, durable fixedassets owned or used by residententerprises for more than one year.

iv. Investors invest their money in fixedcapital hoping to make future profit.

Factors affecting fixed capital requirement.i. Nature of business:

a. The nature of business plays a

vital role in determining fixedcapital requirement. For eg. Rail,roads and other public utilityservices have large fixedinvestment.

b. Their working capitalrequirements are nominal as theysupply services and not product.

c. They mainly deal in cash salesonly.


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d. On the other hand, tradingorganizations like retailers, requireless of fixed capital as they do notneed large funds for land, building,

plants and machineries.ii. Size of business:

a. Bigger the business higher theneed of fixed capital.

b. Hence, the size of a firm, either interms of its assets or sales affectsthe need of fixed capital.

iii. Growth and expansion:In order to manage growing productionand turnover, a growing firm may needto invest more in fixed assets.

iv. Stage of development of business:The requirement of fixed capital for anewly established organization is more

than that of an established organization.v. Business cycle:When there is a boom period in aneconomy, the organization needs to investmore in fixed assets so as to increase its

production capacity. However, inrecession, the organization avoidundertaking huge projects, and hence, itmay not require more of fixed capital.

*Q.15.What is Working Capital? State factorsaffecting requirement of working capital.

[10]Ans: i. Working capital means current assets or

circulating capital.ii. According to Gerstenbergh , working

capital is the excess of current assetsover current liabilities. It is sometimesreferred to as net working capital orcirculating capital.

iii. According to Western and Brigham ,working capital refers to a firmsinvestment in short term assets such ascash, short term securities, accountreceivable and inventories. It also refersto gross working capital.

Factors affecting working capitalrequirement:i. Nature of business:

a. Industrial and manufacturingenterprises, trading firms, bigretail stores need a large amountof working capital as they have tosatisfy varied and continuousdemand of consumers.

b. Hence, the nature of businesshighly influences the requirementof working capital.

ii. Size of business:a. Large scale firms require large

amount of working capital. b. Hence, the size of business has a

great impact on the requirement ofworking capital.

iii. Volume of sale:a. The volume of sale is directly

proportional to the size ofworking capital.

b. If the volume of sale increases,there is an increase in amount ofworking capital and vice-versa.

iv. Production cycle:a. The process of converting raw

material into finished goods iscalled production cycle.

b. A firm requires more workingcapital when the production cycleis longer and vice-versa.

v. Business cycle:a. When there is boom in economy,

sales will increase, which willlead to increase in investment tostock. Hence more additionalworking capital would berequired.

b. During recession period, saleswould decline and the need ofworking capital would alsodecrease.

vi. Terms of purchase and sales:a. If the credit terms of purchases are

favourable and terms of sales areless liberal then the requirementof working capital is reduced as

the requirement of cash is less. b. On the other hand, if the firm does

not get proper credit for purchaseand adopts liberal credit policy forsales it will require more workingcapital.

vii. Credit Control:a. Volume and terms of credit sales,

collection policy, etc. are theimportant factors of credit control.


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b. Sound credit policy improves cashflow and hence the firms makingcash sales require less workingcapital.

c. Liberal credit policy increases therisk of bad debts and hence the

firms selling on easy credit termsmay require more working capital.

viii. Growth and expansion activities:a. The working capital requirement

will increase with growth of thefirm.

b. It needs funds continuously tosupport large scale operation.

ix. Management ability:a. The requirement of working

capital is reduced if there is properco-ordination between productionand distribution of goods.

b. Lack of co-ordination betweendifferent departments may resultin heavy stocking of finished andsemi-finished goods, whichultimately leads to an increase inthe requirement of workingcapital.

x. External factors:

If the financial institutions and banks provide funds to the firm as and whenrequired the need of working capital isreduced.

xi. Requirement of cash:The requirement of working capitaldepends upon the cash required by theorganization for various purposes.If the requirement of cash is more, thencompany requires more working capitaland vice-versa.

xii. Seasonal fluctuations:The requirement of working capitaldepends upon the seasonal fluctuations.It states that, if the demand for the

product is seasonal, the working capitalrequired in that season will be more.For eg: Before winter season, sweatersmanufacturing companies need moreworking capital to manufacture the sameso that they can put these goods beforewinter starts.


[5 marks each]i. Fixed capital is used in production of

goods.Ans: This statement is FALSE.

Reasons:a. Fixed capital is that portion of

total capital which is invested infixed assets such as land, building,equipments etc.

b. Fixed capital is held in businessfor longer duration.

c. It is used as an investment in longterm assets for better futurereturns.

d. It is generated by issuing shares,debentures, long term loans, etc.

Thus, Fixed capital is not used in production of goods.

*ii. Requirement of working capital doesnot depend upon any factor.

Ans: This statement is FALSE. Reasons:a. Working capital refers to a firms

investment in short term assetssuch as cash, short term securities,account receivables, inventories,etc.

b. The amount of working capitalneeded may vary from business to

business.c. Working capital is affected by

nature of firms activities, theindustrial health of the country,the availability of raw materials,the ease or tightness of moneymarkets, etc.

d. The working capital requirementis also influenced by the cashamount required in the business. Ifthe requirement of cash is morethen company needs higheramount of working capital andvice-versa.

e. Firms credit policy and period ofholding cash also influence cash

balance which indirectly affectsthe requirement of workingcapital.

Thus, working capital of a firm isinfluenced by various factors.


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*Q.17.Distinguish between: Fixed Capital andWorking Capital [5]Ans:

Fixed Capital Working CapitalMeaning

i. Fixed capital is

that portion oftotal capital whichis invested in fixedassets such asland, building,equipments,machinery, etc.

Working capital

refers to a firmsinvestment in shortterm assets such ascash, short termsecurities, accountreceivable andinventories.

Nature ii. It may be held in

business for 5, 10,20 years or more.

It remains in the business for a short period of time andcirculates into the

business.Purpose

iii. Fixed capital isinvested in longterm assets for thegrowth andexpansion of afirm.

It is invested inshort term assets tofulfill workingcapital needs.

Sources iv. It is generated by

issuing shares,debentures,

borrowing ofloans, etc.

It is accumulatedthrough tradecredits, short termloans, publicdeposits, etc.

Objective v. Investors invest

their money infixed capital for

better futurereturns.

Investors invest inworking capital forimmediate returns.

Risks involved vi. Risk involved in

the investment offixed capital ishigh.

Risk involved inthe investment ofworking capital islow as compared tofixed capital.

Authority vii. Generally, Top

level managementdecides on mattersrelated to fixedcapital investment.

Middle level orlower levelmanagers candecide on mattersrelated to workingcapital needs.

Factors affecting viii. Need of fixed

capital dependsupon variousfactors such as:

Need of workingcapital dependsupon variousfactors such as:

a.

b. c.

Size of business Nature ofmachineryExpansion, etc.

a.

b.c.

SeasonalfluctuationsProduction cycleRequirement ofcash, etc.

Objective Type Questions

I. Select the correct answer from the possiblechoices given below and rewrite thestatements. [1 mark each]*1. Business finance deals with _______

activities of business.(A) manufacturing

(B) selling(C) financial 2. _______ refers to management of

business funds.(A) Financial management(B) Strategic management(C) Inventory management

3. _______ is called as ResourceManagement.(A) Inventory management(B) Data management(C) Financial management

4. Financial management has become animportant aspect in the businessenvironment of _______ countries.(A) developed(B) developing(C) under-developed

*5. A business firm is basically _______organization.(A) profit-oriented(B) service-oriented(C) Non-profit

*6. Normally _______ gives advice toBoard of Directors in respect offinancial matters.(A) Auditor(B) Secretary(C) Finance Manager

7. Wealth maximization is also known as _______ maximization.(A) value(B) source(C) man-power


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*8. Wealth maximization of owner meansmaximization of _______ of shares.(A) face value(B) market value(C) issue value

9. The financial plan must includeinformation about _______ environmentin which business operates.(A) economic(B) social(C) cultural

*10. Due to _______ planning it is possibleto eliminate wasteful expenditure.(A) Financial(B) Sales(C) Production

*11. The _______ means mix-up of varioussources of funds in desired proportions.(A) Capital structure (B) Term loan(C) Retained profit

12. Capital structure is the _______financing of firm represented by longterm debt, preferred stock and net worth.(A) temporary(B) permanent(C) balanced

13. The ideal structure for new company isto raise capital through _______.(A) Debentures(B) Preference shares(C) Equity shares

*14. Large manufacturing companies have _______ investments in fixed assets.(A) huge (B) small(C) moderate

*15. The _______ concerns can acquire

funds from various sources.(A) well established(B) newly established(C) small trading

16. If funds are required on regular basis,the company should raise funds throughissue of _______.(A) Equity shares (B) Preference shares(C) Debentures

*17. Trading on equity means use of _______ capital for financing a firm.(A) equity(B) preference(C) borrowed

*18. During the period of boom in sharemarket, _______ are issued to raisecapital.(A) bonds(B) debentures(C) equity shares

*19. The investors who are ready to take risk prefer _______ shares for investment.(A) preference(B) equity (C) bonus

*20. If share market is depressed a companyshould issue _______ capital.(A) debt(B) owned(C) mix

*21. The SEBI has prescribed debt-equityratio norm of _______.(A) 1 : 1(B) 2 : 1(C) 2 : 2

*22. The _______ is considered as taxdeductable expenditure.(A) dividend(B) bonus(C) interest

*23. The _______ capital stay in businessalmost permanently.(A) fixed(B) working(C) debt

*24. The difference between current assetsand current liabilities is _______ capital.(A) debt(B) fixed(C) working

*25. Big retail stores require large amount of _______ capital.(A) fixed(B) working(C) loan


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*26. If the volume of sales increases, there is _______ in amount of working capital.(A) an increase(B) a decrease(C) no change

27. If credit policy is _______, it is possiblefor the company to improve its cashflow.(A) sound(B) liberal(C) just

*28. A firm selling on credit terms requires _______ working capital.(A) more(B) medium(C) less

*29. A firm making cash sales requires _______ working capital.(A) less (B) more(C) no

II. Match the following. [1 mark each]*1.

Group A Group Bi. Financial

managementa. Minimise market value

of equity sharesii. Wealth

maximization b. Investment in fixed

assetsiii. Financial plan c. Ratio of buying and

sellingiv. Capital

structured. Management of

business fundsv. Fixed capital e. Ad hoc programming

of financef. Investment in current

assets

g. Management of business activitiesh. Maximise market

value of equity sharesi. Ratio of different

securities in capital j. Advance programming

of financialmanagement.

Ans: (i d), (ii h), (iii j), (iv i), (v b).

2. Group A Group B

i. FinanceManager

a. Use of equity capitalfor financing

business.ii. Debt

equity ratio b. Tax deductable

expenditureiii. Trading on

equityc. Ratio between income

and expenditure.iv. Interest d. Non tax deductable

expenditurev. Capital

gearinge. Provides advice to

secretary on financialmatters.

f. 2 : 1g. Use of borrowed

capital.h. 1 : 2i. Provides advice to

Board of Directors onfinancial matters.

j. Ratio between debtcapital and equitycapital.

Ans: (i i), (ii f), (iii g), (iv b), (v j).

III. Fill in the blanks and rewrite the sentences.[1 mark each]

1. In actual practice, business finance

refers to _______ finance.2. The term corporation finance is also

known as _______ management.

3. The new economic policy wasintroduced in July _______.

4. _______ is a tool of measuring thesuccess of business firm.

5. The term _______ planning refers toassessment of financial requirementsand arranging the sources of capital.

6. Financing mix is also known as _______.

7. _______ is an acknowledgement of loanraised by a company.

8. Term loans are provided by bank at a _______ rate of interest.

9. _______ shareholders have priority overequity shareholders.


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CAPITAL STRUCTURE

COMPONENTS INFLUENCING FACTORS

Owned fundsOR

Shareholders funds

Owed fundsOR

Borrowed funds

i. Equity share capital

ii. Preference share capital

iii. Retained earnings.

i. Debentures ii. Term loans

InternalFactors

ExternalFactors

i. Requirement ofcapital

ii. Size and natureof business

iii. Growth of business firm

iv. Adequate earning and cash position v. Period of finance vi. Future plan

and development vii. Trading on equity viii. Capital gearing

ix. Attitude ofmanagement

i. Marketconditions

ii. Attitude ofinvestors

iii. Cost of capital

iv. Government rules

and regulationsv. Attitude of

financial institutions vi. Rate of interest

vii. Taxation

viii. Competition

Quick Review

FINANCIAL MANAGEMENT

FUNCTIONSOBJECTIVES

IMPORTANCE

Routine Executive

ProfitMaximization

WealthMaximization

i. Record keepingand reporting

ii. Preparation ofvarious financial

statementsiii. Cash planning

iv. Credit management

v. Providing information to Board of Directors

i. Forecasting financialrequirements

ii. Deciding sources offunds

iii. Investment decisionsiv. Dividend policy

v. Checking and analysisof financial performance

vi. Advising Board of Directors

i. Elimination of waste expenditure

ii. Co-ordination

iii. Dynamism

iv. Communication

v. Decision making

vi. Integration

vii. Futuristic

SocialSatisfaction


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CAPITAL

FIXED CAPITAL WORKING CAPITAL

Factors affecting fixedcapital requirement

Factors affecting workingcapital requirement

i. Nature of business

ii. Size of business

iii. Growth and expansion of business

iv. Stage of developmentof business

v. Business cycle

i. Nature of business

ii. Size of business

iii. Volume of sale

iv. Production cycle

v. Business cycle

vi. Terms of purchaseand sales

vii. Credit controlviii. Growth and expansion activities

ix. Management ability

x. External factors

xi. Requirement of cash

xii. Seasonal fluctuations

12th commerce secretarial practice

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