financial management full notes by gajendra malla

8/10/2019 Financial Management Full Notes by Gajendra Malla

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FINANCIAL MANAGEMENT FULL NOTESSEM BANGALORE UNIVERSITY

SESHADRIPURAM EVENING DEGREE COLLEGEFINANCIAL 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 moneyor 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 legbusiness activities.

Finance can be classified into two types:-1. Private finance.2. Public finance.

1. Private finance:-

It deals with requirements receipts and dispersment offunds to an1. Individual2. Business finance and3. Non-profit organization or corporation firms finance


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Business finance sub classified into three types:-1. Sole proprietors finance2. Partnership firm finance and

3. Joint stock company2. Public finance:-It deals with requirement receipts distributions of fund to

the government institutions by1. Local Self Government2. State Government and3. Central GovernmentImportance of finance:-

1. Finance is helpful for modernization, diversificationexpansion 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 tobalance regional development in the country.5. Finance if essential for undertaking research activities,

market serwaypublicity, 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


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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 enterpriseand 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


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1. Anticipation of funds Needed:-

The main aim of finance function is to forecast expected

events in business and not financial implication, selection ofassets 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 projector 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 variousinvestment 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


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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 anyorganization 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 likeshare 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

Financea. Specific objectives b. General objectives.

1. Profit Maximization.2. Wealth Maximization.

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.


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Advantages of Profit Maximization:-v It is a barometer through which the performance of a business

unit can be measured.

v It attracts he investors to invest their saving in securities.v It indicates that the fund is efficiently used for differentrequirements.

v It increases the confidence of management in expansion and

diversification programmers of a company.v 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


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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 thewealth 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 inflowcash outfiowa. 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 valueof 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.


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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 bypractical 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, betterpayment 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=NpoWo=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


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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 theirliquidity.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 goodreputation 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] themovement 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.


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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 strongdividend 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 operationsof 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 DecisionFinancial 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 and3. Dividend decisions.


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All three decisions directly contribute to the corporate goals of

wealth Maximizations.1. Investment decisions:-

It refers to the activity of deciding the pattern ofinvestment. 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 timeexceeding 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 costsand 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.


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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 concernmost 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 thefinancial 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 byMarket 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. orIt 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.


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b) The proportion of debt equity.c) policies for effective administrative financial planFinancial planning results in the formulation the financial plan.

It is primarily a statement of estimating the capital anddetermining 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 and3) The policies to pursued for the flotation of various corporate

securities particularly regarding the time of their floatation.Need for financial planning1) 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 inraising 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


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types of securities should be minimum which can be managed

easily.2) Foresight:-

Financial plan should be prepared only after taking intoconsideration 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 ofthe 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 fundsnot 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:-


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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 theready 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 debt-equity.Steps / factors affecting financial planning:- (5marks)

1) 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


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2) 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 theproductivity 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:-


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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 thelight 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 funds7. 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


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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 atright 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 itgrowth.

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 orutilize 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 firm15. 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.


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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 futureneeds 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


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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 thebusiness 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 shouldensure 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


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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 tocarry out the expansion and diversification programmers.

If it is not flexible then it is difficult to achieve it.

CAPITAL STURCUTRECapital structure:-

Capital structure is the permanent long term financing thatis 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.


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Capital structure with equity shares, preference shares and

debentures.Factors affecting capital structure:- (5 marks)

Success of any business mainly depends upon thefinancial 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 Business2) Regularity and certainty of income.3) Desire to control the business.4) Future plans.5) Attitude of management6) Freedom of working.7) Operating ratio.

8) Trading on equity.B) External factors:-

1) Conditions of capital Market.2) Nature and type of investors.3) Cost of capital.4) 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:-


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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 decisionmaking 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:-


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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 includes1) 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 ofreturns.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.

CAPITALISATIONMeaning:-Capitalization refers to the combination of different types of

securities of a business of a business concern.Definition of Capitalization:-


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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 thebonds.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 anew 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 thecapital raised but, the earning made out of the productive

harnessing of the capital.Formula = Average annual future earning*100

Capitalization rate

CHAPTER-2LEVERAGE:-

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.


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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/EBITDegree 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

EBTDegree 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 shareTherefore, Degree of Financial leverage = % Change in EPS

% Change in EBIT.


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3) Combiner leverage / Composite leverage:-It is the Combination of operating and financial leverage.

It called as combiner leverage.

Combined leverage = Operating leverage xFinancial leverage

CHAPTER 3DIVIDENT DECISIONS

The term dividend refers to that portion of net profits which isdistributed 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


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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 wasdeclared 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 theshareholder, 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 wouldtake 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.


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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 isthe 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 ofthe 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 POLICY1. 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.


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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 paymentof 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 thedirectors 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.


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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 requiresfinance 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 COMPETITIVECONCERN:- 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 decisionsbut 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 firm15. ATITUDE OF INTERESTED GROUP:- A concern may

have certain group of interested and powered shareholders who


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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:- Thisrefers 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 toraise 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.


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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 asfollows:-1) Uncertainty of earnings2) Unsuccessful business operations3) 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 orlack 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 retaintheir 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:-


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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 theissue 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 issuesBonus 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 dividendswithout 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.


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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 issuingbonus 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 dividend1. 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.


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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 inthe 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 dilutedand 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.


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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-upcapital.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.ImpWhat is a dividend decision?A dividend decision refers to the formulation of divided policy

which determines the division of earnings between payments to


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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 rawmaterials, prepaid expenses, etcGross working capital = total of current assets2. 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 liabilitiescurrent 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 bythe 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 concern1. 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


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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 scalerequires 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 manufacturingprocess. 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:-


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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 thefull 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:-


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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 morefor 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 heartbecomes 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 throughsufficient 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


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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 capitalenhances 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 themarket.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


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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 day-to-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.


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THE IMPORTANT SOURCES OF LONG-TERMS

WORKING CAPITAL ARE:-1. Issue of debentures

2. Sale of fixed assets3. Public deposits4. Redeemable preference shares5. Ploughingback of profits6. Term finance from industrial finance corporationsSHORT-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 grantedwithout 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 creditto 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.


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2. The duration of credit is very short.3. This type of credit is meant for only good credit4. No cash discount is provided.

2) BANK CREDIT:- It refers to the credit, financialaccommodation 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

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 thegoods. 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 acceptedwithout 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 funds2. High rate of interest3. Secrecy in maintain their accounts and


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4. Mal practices6) 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 financingunder 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:-

1. Invoice discounting2. Advance factoring3. Full factoring4. Outright purchase of accounts receivables5. With resource factoring6. Without resource factoring7. Maturity factoring

8. Undisclosed factoringTHE 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


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rates fixed interest, interest chargeable to profits for the purpose

of income-tax and so on.The main disadvantages areIt can be issued only by

public limited companies and the company has pay interest ondebentures 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 isfixed 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.


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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 periodvarying 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 capitalmanagement is

concerned with the problems that arise in attempting to manage

the current assets, the current liabilities and the inter relationshipthat exists between them.There are two objectives of working capital management:-1. Maintenance of working capital2. Availability of sufficient funds at the time of need.COMPONENTS OF THE MANAGEMENT OF

WORKING CAPITAL:-

1. Estimation of working capital2. 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 CAPITAL1. 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


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capital such as inventories, accounts receivables accounts

payables, etc.3. OPERATING CYCLE METHOD:- Under this method,

working capital is calculated taking into consideration theoperating cycle of the business.PRINCIPLES OF WORKING CAPITAL

MANAGEMENT:-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-termborrowings 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:-1. The working capital needs of a firm should be financed out of

short-term borrowings.2. The permanent working capital should be financed out of

long-term sources.3. Flexibility in the financial programmes for the raising of

working capital is required.


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4. The cost of securing working capital should be as minimum as

possible.5. Judicious use of different sources of short-term funds is

necessary.6. Sufficient liquidity in working capital to meet day to dayobligations is required.

7. Avoid over borrowing of working capital.8. Exercise proper control on inventories, receivables and

creditors.DIFFERENT ASPECTS OF WORKING CAPITAL

MANGEMENT:-

1. Management of cash2. 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 currencynotes, 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:-


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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:- Thismotive 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 theorganization 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 considerations2. The right quantity whether owned or borrowed.3. The right time to preserve solvency.4. The right source and5. The right cost of capital, the organization can afford to pay.OBJECTIVES OF CASH MANAGEMENT:-1. To make cash payments2. To maintain minimum cash reserveBASIC PROBLEMS OF CAHS MANAGEMENT:-


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1. Controlling the level of cash balance2. Controlling the inflows of cash3. Controlling the outflows of cash

4. Investment of surplus cashI) 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 UNPREDICTABLEDISCREPANCIES:-

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 resultof 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 check2. By increasing cash sales


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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 hireslock 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 thedisbursements.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 issueof 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 cash2. Determination of the channels of investments.

But, while investing the surplus cash the firm should take

into account the liquidity, safety, maturity and yield.


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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.Posted by Shetty Dinith at00:39
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financial management full notes by gajendra malla

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