1. What is Financial Management? Explain its importance. Ans.

Financial Management means planning, organizing, directing and controlling the financial activities such as procurement and utilization of funds of the enterprise. It means applying general management principles to financial resources of the enterp Scope/Elements 1. Investment decisions includes investment in fixed assets (called as capital budgeting). Investment in current assets are also a part of investment decision called as working capital decisions. 2. Financial decisions - They relate to the raising of finance from various resourc which will depend upon decision on type of source, period of financing, cost of financing and the returns thereby. 3. Dividend decision - The finance manager has to take decision with regards to net profit distribution. Net profits are generally divided into two: a. Dividend for shareholders- Dividend and the rate of it has to be decided. b. Retained profits- Amount of retained profits has to be finalized which will depend upon expansion and diversification plans of the enterprise. Objectives of Financial Management The financial management is generally concerned with procurement, allocation and control of financial resources of a concern. The objectives can be1. To ensure regular and adequate supply of funds to the concern. 2. To ensure adequate returns to the shareholders which will depend upon the earning capacity, market price of the share, expectations of the shareholders. 3. To ensure optimum funds utilization. Once the funds are procured, they should be utilized in maximum possible way at least cost. 4. To ensure safety on investment, i.e, funds should be invested in safe ventures so that adequate rate of return can be achieved. 5. To plan a sound capital structure-There should be sound and fair composition of capital so that a balance is maintained between debt and equity capital. Functions of Financial Management 1. Estimation of capital requirements: A finance manager has to make estimation with regards to capital requirements of the company. This will depend upon expected costs and profits and future programmes and policies of a concern. Estimations have to be made in an adequate manner which increases earning capacity of enterprise.
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2. Determination of capital composition: Once the estimation have been made, the capital structure have to be decided. This involves short- term and long- term debt equity analysis. This will depend upon the proportion of equity capital a company is possessing and additional funds which have to be raised from outside parties. 3. Choice of sources of funds: For additional funds to be procured, a company has many choices likea. Issue of shares and debentures b. Loans to be taken from banks and financial institutions c. Public deposits to be drawn like in form of bonds. Choice of factor will depend on relative merits and demerits of each source and period of financing. 4. Investment of funds: The finance manager has to decide to allocate funds into profitable ventures so that there is safety on investment and regular returns is possible. 5. Disposal of surplus: The net profits decision have to be made by the finance manager. This can be done in two ways: a. Dividend declaration - It includes identifying the rate of dividends and other benefits like bonus. b. Retained profits - The volume has to be decided which will depend upon expansional, innovational, diversification plans of the company. 6. Management of cash: Finance manager has to make decisions with regards to cash management. Cash is required for many purposes like payment of wages and salaries, payment of electricity and water bills, payment to creditors, meeting current liabilities, maintainance of enough stock, purchase of raw materials, etc. 7. Financial controls: The finance manager has not only to plan, procure and utilize the funds but he also has to exercise control over finances. This can be done through many techniques like ratio analysis, financial forecasting, cost and profit control, etc. 2. What is meant by Capital budgeting? Explain the importance of capital budgeting. Ans. Capital expenditure budget or capital budgeting is a process of making decisions regarding investments in fixed assets which are not meant for sale such as land, building, machinery or furniture. The word investment refers to the expenditure which is required to be made in connection with the acquisition and the development of
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long-term facilities including fixed assets. It refers to process by which management selects those investment proposals which are worthwhile for investing available funds. For this purpose, management is to decide whether or not to acquire, or add to or replace fixed assets in the light of overall objectives of the firm. What is capital expenditure, is a very difficult question to answer. The terms capital expenditure are associated with accounting. Normally capital expenditure is one which is intended to benefit future period i.e., in more than one year as opposed to revenue expenditure, the benefit of which is supposed to be exhausted within the year concerned. Nature of Capital Budgeting Nature of capital budgeting can be explained in brief as under Capital expenditure plans involve a huge investment in fixed assets. Capital expenditure once approved represents long-term investment that cannot be reserved or withdrawn without sustaining a loss. Preparation of coital budget plans involve forecasting of several years profits in advance in order to judge the profitability of projects. It may be asserted here that decision regarding capital investment should be taken very carefully so that the future plans of the company are not affected adversely. Procedure of Capital Budgeting Capital investment decision of the firm have a pervasive influence on the entire spectrum of entrepreneurial activities so the careful consideration should be regarded to all aspects of financial management. In capital budgeting process, main points to be borne in mind how much money will be needed of implementing immediate plans, how much money is available for its completion and how are the available funds going to be assigned tote various capital projects under consideration. The financial policy and risk policy of the management should be clear in mind before proceeding to the capital budgeting process. The following procedure may be adopted in preparing capital budget :- (1) Organisation of Investment Proposal. The first step in capital budgeting process is the conception of a profit making idea. The proposals may come from rank and file worker of any department or from any line officer. The department head collects all the investment proposals and reviews them in the light of financial and risk policies of the organisation in order to send them to the capital expenditure planning committee for consideration. (2) Screening the Proposals. In large organisations, a capital
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expenditure planning committee is established for the screening of various proposals received by it from the heads of various departments and the line officers of the company. The committee screens the various proposals within the long-range policy-frame work of the organisation. It is to be ascertained by the committee whether the proposals are within the selection criterion of the firm, or they do no lead to department imbalances or they are profitable. (3) Evaluation of Projects. The next step in capital budgeting process is to evaluate the different proposals in term of the cost of capital, the expected returns from alternative investment opportunities and the life of the assets with any of the following evaluation techniques:- Degree of Urgency Method (Accounting Rate of return Method) Pay-back Method Return on investment Method Discounted Cash Flow Method. (4) Establishing Priorities. After proper screening of the proposals, uneconomic or unprofitable proposals are dropped. The profitable projects or in other words accepted projects are then put in priority. It facilitates their acquisition or construction according to the sources available and avoids unnecessary and costly delays and serious cot-overruns. Generally, priority is fixed in the following order. Current and incomplete projects are given first priority. Safety projects ad projects necessary to carry on the legislative requirements. Projects of maintaining the present efficiency of the firm. Projects for supplementing the income Projects for the expansion of new product. (5) Final Approval. Proposals finally recommended by the committee are sent to the top management along with the detailed report, both o the capital expenditure and of sources of funds to meet them. The management affirms its final seal to proposals taking in view the urgency, profitability of the projects and the available financial resources. Projects are then sent to the budget committee for incorporating them in the capital budget. (6) Evaluation. Last but not the least important step in the capital budgeting process is an evaluation of the programme after it has been fully implemented. Budget proposals and the net investment in the projects are compared periodically and on the basis of such evaluation, the budget figures may be reviewer and presented in a more realistic way. Significance of capital budgeting The key function of the financial management is the selection of the most profitable
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assortment of capital investment and it is the most important area of decision-making of the financial manger because any action taken by the manger in this area affects the working and the profitability of the firm for many years to come. The need of capital budgeting can be emphasised taking into consideration the very nature of the capital expenditure such as heavy investment in capital projects, long-term implications for the firm, irreversible decisions and complicates of the decision making. Its importance can be illustrated well on the following other grounds:- (1) Indirect Forecast of Sales. The investment in fixed assets is related to future sales of the firm during the life time of the assets purchased. It shows the possibility of expanding the production facilities to cover additional sales shown in the sales budget. Any failure to make the sales forecast accurately would result in over investment or under investment in fixed assets and any erroneous forecast of asset needs may lead the firm to serious economic results. (2) Comparative Study of Alternative Projects Capital budgeting makes a comparative study of the alternative projects for the replacement of assets which are wearing out or are in danger of becoming obsolete so as to make the best possible investment in the replacement of assets. For this purpose, the profitability of each projects is estimated. (3) Timing of AssetsAcquisition. Proper capital budgeting leads to proper timing of assets-acquisition and improvement in quality of assets purchased. It is due to ht nature of demand and supply of capital goods. The demand of capital goods does not arise until sales impinge on productive capacity and such situation occur only intermittently. On the other hand, supply of capital goods with their availability is one of the functions of capital budgeting. (4) Cash Forecast. Capital investment requires substantial funds which can only be arranged by making determined efforts to ensure their availability at the right time. Thus it facilitates cash forecast. (5) Worth-Maximization of Shareholders. The impact of long-term capital investment decisions is far reaching. It protects the interests of the shareholders and of the enterprise because it avoids over-investment and underinvestment in fixed assets. By selecting the most profitable projects, the management facilitates the wealth maximization of equity shareholders. (6) Other Factors. The following other factors can also be considered for its significance:- It assist in formulating a sound
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depreciation and assets replacement policy. It may be useful n considering methods of coast reduction. A reduction campaign may necessitate the consideration of purchasing most up-todate and modern equipment. The feasibility of replacing manual work by machinery may be seen from the capital forecast be comparing the manual cost an the capital cost. The capital cost of improving working conditions or safety can be obtained through capital expenditure forecasting. It facilitates the management in making of the long-term plans an assists in the formulation of general policy. It studies the impact of capital investment on the revenue expenditure of the firm such as depreciation, insure and there fixed assets.

3. Describe the concept of working capital. Ans. Working capital (abbreviated WC) is a financial metric which represents liquidity available to a business, organization or other entity, including governmental entity. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. Net working capital is calculated as current assets minus current liabilities. It is a derivation of working capital, that is commonly used in valuation techniques such as DCFs (Discounted cash flows). If current assets are less than current liabilities, an entity has aworking capital deficiency, also called a working capital deficit. A company can be endowed with assets and profitability but short of liquidity if its assets cannot readily be converted into cash. Positive working capital is required to ensure that a firm is able to continue its operations and that it has sufficient funds to satisfy both maturingshort-term debt and upcoming operational expenses. The management of working capital involves managing inventories, accounts receivable and payable, and cash. management will use a combination of policies and techniques for the management of working capital. The policies aim at managing the current assets (generally cash andcash equivalents, inventories and debtors) and the short term financing, such that cash flows and returns are acceptable.

Cash management. Identify the cash balance which allows for the business to meet day to day expenses, but reduces cash holding costs. Inventory management. Identify the level of inventory which allows for

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uninterrupted production but reduces the investment in raw materials - and minimizes reordering costs - and hence increases cash flow. Besides this, the lead times in production should be lowered to reduce Work in Process (WIP) and similarly, the Finished Goods should be kept on as low level as possible to avoid over production - see Supply chain management; Just In Time (JIT); Economic order quantity (EOQ); Economic quantity Debtors management. Identify the appropriate credit policy, i.e. credit terms which will attract customers, such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and hence Return on Capital (or vice versa);. Short term financing. Identify the appropriate source of financing, given the cash conversion cycle: the inventory is ideally financed by credit granted by the supplier; however, it may be necessary to utilize a bank loan (or overdraft), or to "convert debtors to cash" through "factoring". There are two important concepts of Working Capital gross and net Gross Working Capital: Gross Working Capital refers to the amounts invested in the various components of current assets. This concept has the following practical relevance. a. Management of current assets is the crucial aspect of Working Capital Management. b. It is an important component of operating capital. Therefore, for improving the profitability on its investment a finance manager of a company must give top priority to efficient management of current assets. c. The need to plan and monitor the utilization of funds of a firm demands working capital management as applied to current assets. d. It helps in the fixation of various areas of financial responsibility. Net Working Capital Net Working Capital is the excess of current assets over current liabilities and provisions. Net Working Capital is positive. when current assets exceed current liabilities and negative when current liabilitiesexceed current assets. This concept has the following practical relevance. 1. It indicates the ability of the firm to effectively use the spontaneous finance in managing the firms Working Capital requirements. 2. A firms short term solvency is measured through the net Working Capital position it commands.
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Permanent Working Capital Permanent Working Capital is the minimum amount of investment required to be made in current assets at all times to carry on the day to day operation of firms business. This minimum level of current asset has been given the name of core current assets by the Tandon Committee. It is also known as fixed Working Capital. Temporary Working Capital It is also known as Variable Working Capital or fluctuating Working Capital. The firms working capital requirements vary depending upon the seasonal and cyclical changes in demands for a firms products. The extra Working Capital required as per the changing production and sales levels of a firm is known as Temporary Working Capital. 4. What are the types of leverages? What is the implication of operating leverage for a firm? Ans. Operating leverage is the extent to which a firm uses fixed costs inproducing its goods or offering its services. Fixed costs includeadvertisingexpenses,administrative costs, equipment and technology, depreciation, and taxes, but not interest on debt,which is part of financial leverage. By using fixed production costs, a company can increase itsprofits. If a company has a large percentage of fixed costs, it has a high degree of operatingleverage. Automated and high-tech companies, utility companies, and airlines generally havehigh degrees of operating leverage.As an illustration of operating leverage, assume two firms, A and B, produce and sell widgets.Firm A uses a highly automated production process with robotic machines, whereas firm B assembles the widgets using primarily semiskilled labour. Table 1 shows both firms operating cost structures.Highly automated firm A has fixed costs of $35,000 per year and variable costs of only $1.00 perunit, whereas labour-intensive firm B has fixed costs of only $15,000 per year, but its variablecost per unit is much higher at $3.00 per unit. Both firms produce and sell 10,000 widgets peryear at a price of $5.00 per widget.Firm A has a higher amount of operating leverage because of its higher fixed costs, but firm Aalso has a higher breakeven point the point at which total costs equal total sales. Nevertheless,a change of Ipercent in sales causes more than a I percent change in operating profits for firm A,
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but not for firm B. The degree of operating leverage measures this effect. Th e following simplified equation demonstrates the type of equation used to compute the degree of operatingleverage, although to calculate this figure the equation would require several additional factorssuch as the quantity produced, variable cost per unit, and the price per unit, which are used todetermine changes in profits and sales: Operating leverage is a double-edged sword, however. If firm As sales decrease by I percent, its profits will decrease by more than I percent, too. Hence, the degree of operating leverage showsthe responsiveness of profits to a given change in sales. Implications: Total risk can be divided into two parts: business risk and financial risk. Business risk refers to the stability of a companys assets if it uses no debt or preferred stock financing. Business risk stems from the unpredictable nature of doing business, i.e., the unpredictability of consumer demand for products and services. As a result, it also involves the uncertainty of long-term profitability. When a company uses debt or preferred stock financing, additional risk financial risk is placed on the companys common shareholders. They demand a higher expected return for assuming this additional risk, which in turn, raises a companys costs. Consequently, companies with high degrees of business risk tend to be financed with relativelylow amounts of debt. The opposite also holds: companies with low amounts of business risk canafford to use more debt financing while keeping total risk at tolerable levels. Moreover, usingdebt as leverage is a successful tool during periods of inflation. Debt fails, however, to provideleverage during periods of deflation, such as the period during the late 1990s brought on by theAsian financial crisis 5. Explain the factors affecting Financial Plan. Ans. To help your organization succeed, you should develop a plan that needs to be followed.This applies to starting the company, developing new product, creating a new department or anyundertaking that affects the companys future. There are several factorsthat affect planning in anorganization. To
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create an efficient plan, you need to understand the factors involved in theplanning process. Priorities In most companies, the priority is generating revenue, and this priority can sometimes interferewith the planning process of any project. For example, if you are in the process of planning alarge expansion project and your largest customer suddenly threatens to take their business toyour competitor, then you might have to shelve the expansion planning until the customer issueis resolved. When you start the planning process for any project, you need to assign each of theissues facing the company a priority rating. That priority rating will determine what issues willsidetrack you from the planning of your project, and which issues can wait until the process iscomplete. Company Resources Having an idea and developing a plan for your company can help your company to grow andsucceed, but if the company does not have the resources to make the plan come together, it canstall progress. One of the first steps to any planning process should be an evaluation of theresources necessary to complete the project, compared to the resources the company hasavailable. Some of the resources to consider are finances, personnel, space requirements, accessto materials and vendor relationships Forecasting A company constantly should be forecasting to help prepare for changes in the marketplace.Forecasting sales revenues, materials costs, personnel costs and overhead costs can help acompany plan for upcoming projects. Without accurate forecasting, it can be difficult to tell if the plan has any chance of success, if the company has the capabilities to pull off the plan and if the plan will help to strengthen the companys standing within the industry. For example, if your forecasting for the cost of goods has changed due to a sudden increase in material costs, then thatcan affect elements of your product roll-out plan, including projected profit and the long-termcommitment you might need to make to a supplier to try to get the lowest price possible. Contingency Planning To successfully plan, an organization needs to have a contingency plan in place. If the companyhas decided to pursue a new product line, there needs to be a part of the plan that addresses thepossibility that the product line will fail. The reallocation of company resources, the acceptablefinancial losses and the potential public relations problems that a failed product can cause allneed to be part of the organizational planning process from the beginning .
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6. Mr. X purchases a bond whose face value is Rs.1000, and which has a nominal interest rate of 8%. The maturity period is 5 years. The required rate of return is 10%. What is the price he should be willing to pay now to purchase the bond? Ans. Interest payable=1000*8%=Rs. 80 Principal repayment is Rs. 1000 Required rate of return is 10% V0=I*PVIFA(kd, n) + F*PVIF(kd, n) Value of the bond=80*PVIFA(10%, 5y) + 1000*PVIF(10%, 5y) = 80*3.791 + 1000*0.621 = 303.28 + 621 =Rs. 924.28

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