FINANCIAL MANAGEMENT NOTES

CHAPTER 1: INTRODUCTION & CAPITAL BUDGETING:

MEANING: financial management refers to the management of flow of funds in the firm. It deals with
the financial decision making of the firm. It is mainly concerned with timely procurement of adequate
finance from various sources and its utmost efficient utilization for the attainment of organizational
objectives.

DEFINITION OF FINANCIAL MANAGEMENT:

Financial management deals with procurement of funds and their effective utilisation in the business. –
S.C. Kuchhal.

OBJECTIVES OF FINANCIAL MANAGEMENT:

ROLE OF FINANCE MANAGER:

1. Forecasting financial requirement 6. Supply of funds to all parts of the organisation

2. Financing decision 7. Evaluation of financial performance
3. Investment decision 8. Keep an eye on stock exchange and company’s
4. Dividend decision share performance
5. Deciding overall objectives
SIGNIFICANCE / IMPORTANCE OF FINANCIAL MANAGEMENT:

1. Helps in financial planning

2. Helps in acquisition of funds
3. Helps in proper utilization of funds
4. Helps in taking proper finance decision
5. Helps in improving profitability
6. Helps in increasing the value of the firm
7. Promotes savings.

MEANING OF CAPITAL BUDGETING:

Capital budgeting means planning the capital expenditure in acquisition of fixed (capital) assets such as
land, building, plant or new projects as a whole.

DEFINITION OF CAPITAL BUDGETING:

Capital budgeting is the long term planning for making and financing proposed capital outlays – Charles
T. Horngren

FEATURES OF CAPITAL BUDGETING:

1. Investment: capital expenditure plans involve a huge investment in fixed assets.

2. Long term: capital expenditure once approved, represents long term investment that cannot be
reversed or withdrawn without sustaining a loss.
3. Forecasting: preparation of capital budget plans involve forecasting of several years profits in
advance in order to judge the profitability of the project.
4. Serious Consequences: in the view of the investment of large amount for a fairly long period of
time, any error in the evaluation of investment projects may lead to serious consequences,
financially and otherwise may adversely affect the other future plans of the organisation.

OBJECTIVES OF CAPITAL BUDGETING:

1. Capital budget aims at choosing the most profitable project among the numerous investment
proposals that are available.
2. It helps in deciding the most suitable among the different sources of finance on the basis of
capital market constraints.
3. The growth and expansion of the firm and modernisation can be taken care by proper planning
and execution of capital budgeting decision.
NEED/ SIGNIFICANCE / IMPORTANCE OF CAPITAL BUDGETING:

CAPITAL BUDGETING PROCESS:

ADVANTAGES OF CAPITAL BUDGETING:

TYPES OF CAPITAL BUDGETING DECISIONS:

1. Replacing and Modernisation decision

2. Expansion decision
3. Diversification decision
4. Accept – Reject decision
5. Mutual exclusive decisions: decisions are said to be mutually exclusive if two or more alternative
proposals are such that the acceptance of one proposal will exclude acceptance of the other
alternative proposals. For ex: a firm may be considering proposal to buy either a low cost
economy model asset or a high cost super model asset. If the economy model is purchased it
means that the super model need not be purchased and vice versa.

FACTORS INFLUENCING CAPITAL BUDGETING DECISION:

VARIOUS METHODS TO CALCULATE CAPITAL BUDGETING DECISIONS:

1. PAYBACK PERIOD METHOD: this method is also called as the pay out or pay off method or
replacement price method, determines the length of time required to recover the initial cost
being invested in the project.
2. ACCOUNTING OR AVERAGE RATE OF RETURN: ARR is the annualised net income earned on
the average funds invested in a project. it is measured based on the accounting profit (profit after
depreciation and tax) rather than cash flows.
3. NET PRESENT VALUE METHOD: in this method both future cash inflows and outflows from a
projects are discounted at a cost of capital rate. This gives present value of cash inflows and
outflows. The different between present value of cash inflows and outflows is called Net Present
Value (NPV)
4. INTERNAL RATE OF RETURN: IRR is the rate of return at which the sum of discounted cash
inflows equal the sum of discounted cash outflows. This method is also known as the marginal
rate of return method or time adjusted rate of return method.
5. PROFITABILITY INDEX: this method is a variant of the NPV Method. It is also known as benefit
cost ratio or present value index. It is also based on the basic concept of discounting the future
cash flows and is ascertained by comparing the present value of cash inflows with the present
value of cash outflows.

FORMULAE’S RELATED TO CAPITAL BUDGETING:

CHAPTER 2: COST OF CAPITAL:

MEANING: for financing its operations, a firm can raise long term funds through a combination of (i)
debt, (ii) preference share capital, (iii) equity share capital. The firm has to service these funds by paying
interest, preference dividend and equity dividend respectively.

DEFINITION OF COST OF CAPITAL:

Milton H. Spencer – cost of capital is the minimum rate of return which a firm requires as a condition
for undertaking an investment.

IMPORTANCE OF COST OF CAPITAL:

1. Helps in capital budgeting decision

2. Helps in proper Designing of the capital structure
3. Helps in taking decision regarding the method of financing
4. Helps in evaluating the performance of top management
5. Helps the top level management in assisting them in important decision.
6. Also assist the top management in other areas of decisions.

FACTORS DETERMINING THE COST OF CAPITAL:

1. General economic conditions

2. Market conditions
3. Operating and financial position of the company
4. Amount the amount required for the project
5. Risk nature of the project.

TYPES OF COST OF CAPITAL:

1. Historical cost: it means the cost which had already been incurred in order to finance a
particular job.
2. Future cost: it is the expected cost of funds for financing a particular project.
3. Explicit cost: cost that are measurable in nature is called as explicit cost.
4. Implicit cost: cost that are not measurable in nature is called as implicit cost ex: human energy
5. Specific cost: cost incurred to accomplish one specific job or task is called as specific cost.
6. Composite cost: it can also explained as the combined cost of procurement of various types of
funds required for business.
7. Average cost: it is the weighted average cost of each component of funds invested by the firm
for a particular project.
8. Marginal cost: it is the processes of calculating additional fund being invested for the additional
investment made in the additional project.
FORMULA’S FOR COMPUTATION OF COST OF CAPITAL:

1. COST OF DEBT:
2. COST OF PREFERENCE:
3. COST OF EQUITY: 4. COST OF RETAINED EARNINGS:
CHAPTER 3: FINANCIAL PLANNING:

MEANING: financial planning refers to the planning function related to financial requirement of a firm.
A financial plan implies financial needs of a firm. Shortage of funds as well as excess funds prove costly
for a firm.

DEFINITION: J.H. Bouneville – defines financial planning as a process consisting of determining the
amount of capital required and the capital structure and laying down the financial policies.

SCOPE OR ASPECTS OF FINANCIAL PLANNING:

1. Determining financial objectives

2. Determining the capital requirement
3. Deciding upon the capital mix
4. Formulating policies and procedures

OBJECTIVES / CHARACTERISTICS OF FINANCIAL PLANNING:

FACTORS AFFECTING FINANCIAL PLANNING:

1. Nature of the industry

2. Status of the company in the industry
3. Evaluation of alternative source of finance
4. Attitude of management towards control
5. Magnitude of external capital requirement
6. Capital structure
7. Flexibility
8. Government policy
9. Taxation policy
10. Economic condition
11. Buying attitude of buyer’s
12. Income level of target audience

ESSENTIALS OF SOUND FINANCIAL PLAN:

1. Simplicity
2. Flexibility
3. Long term perspective
4. Economy
5. Optimum use of funds
6. Liquidity
7. Solvency

SIGNIFICANCE AND MERITS OF FINANCIAL PLANNIG:

1. Successful promotion
2. Effective direction
3. Conservation of capital
4. Expansion and development
5. Adequate liquidity
6. Sufficient return on capital employed
7. Optimum capital structure
8. Unity and coordination in operative function
9. Helps in tackling changing price level.

LIMITATIONS OF FINANCIAL PLANNING:

1. Forecasting may go wrong 3. Problem of coordination

2. Highly rigid in nature 4. Market is highly volatile in nature (plans may not work)
DIFFERENCE BETWEEN FIXED CAPITAL AND WORKING CAPITAL:

CHAPTER 4: CAPITAL STRUCTURE:

Meaning: capital structure refers to the mix of sources from where the long term funds required in a
firm may be raised. Ie what should be the proportion of equity share capital, preference share capital,
internal sources, debentures and other sources of funds in the total amount of capital which a firm may
raise for establishing its business.

DEFINITION:

Capital structure is the combination of debt and equity securities that comprise a firm’s financing of its
assets. – John J. Hampton.

PATTERNS OF CAPITAL STRUCUTRE:

1. Fully equity
2. Equity and preference
3. Equity, preference and debenture combination
4. Equity, preference, debentures, bonds and loan from financial institutions
5. Equity and long term debt (long term debentures).
DIFFERENCE BETWEEN CAPITAL STRUCTURE AND FINANCIAL STRUCTURE:

S.NO CAPITAL STRUCTURE FINANCIAL STRUCTURE

It includes only the long term sources of It includes both long term and short term
1.
funds. sources of funds.
It means only the long term liabilities of It means the entire liabilities side of the
2.
the company. balance sheet.
It consist of equity, preference and Financial structure consist of all sources of
3.
retained earnings capital. capital.
It is one of the major determinations of It will not be more important while
4.
the value of the firm determining the value of the firm.

MEANING OF OPTIMUM CAPTIAL STRUCUTRE:

The capital structure is said to be optimum capital structure when the firm has selected such a
combination of equity and debt so that the wealth of firm is maximum. At this capital structure, the cost
of capital is minimum and market price per share is maximum.

FEATURES OF AN APPROPRIATE CAPITAL STRUCTURE:

1. Minimum cost 5. Flexibility

2. Maximum return 6. Easy liquidity
3. Minimum risk 7. Full utilisation
4. Maximum control 8. Simplicity

THEORIES OF CAPITAL STRUCTURE:

1. Net income approach 4. Modigliani and miller approach

2. Net operation income approach 5. EBIT – EPS Analysis
3. Traditional approach 6. Point of Indifference.
CHAPTER 5: LEVERAGES, DIVIDEND POLICY AND WORKING CAPITAL MANAGEMENT:

MEANING: leverage refers to meeting a fixed cost or paying a fixed return for employing resources or
funds.

TYPES OF LEVERAGE:

1. Operating Leverage
2. Financing Leverage
3. Combined Leverage

MEANING OF DIVIDEND: dividend is a part of profit being share with the shareholders of the company.
The dividend is being allotted form the profit which had been derived after payment of all the expenses
of the company.

TYPES OF DIVIDEND:

1. Regular dividend: it is being given to all the equity and preference shareholders at regular
interval ie. Every year at the end of accounting year etc..
2. Interim dividend: it is paid to the shareholder any time as per the decision from the top level
management. There is no fixed date for a company to declare divided such kind is called as
interim dividend.
 3. Stock dividend: when there is no cash is available for company to dividend to its shareholders
the company can allot additional shares to its shareholders this situation is called as stock
dividend.
4. Bond dividend: it means dividend are paid in the form of long term period. The firm generally
pays interest on these bonds and repay the bonds on maturity.
5. Property dividend: It happens in some rare situations. When the dividend volume is huge and
the company doesn’t have money to pay the company may transfer some of its assets in the name
of the shareholder. This kind of act is described as property dividend.

DEFINITION OF DIVIDEND POLICY:

Dividend policy determines the division of earnings between payments to shareholders and retained
earnings. – Weston and Brigham.

NATURE OF DIVIDEND POLICY:

1. It is Tied up with retained earnings

2. It has its influence on companies financing decision
3. It has its effect on companies share price
4. Dividend policy of the company must be optimal in nature.

OBJECTIVES OF DIVIDEND POLICY:

1. Providing sufficient financing

2. Return to shareholders
3. Wealth maximization

FACTORS DETERMINING DIVIDEND POLICY:

1. Earning capacity of the firm 6. Legal requirements

2. Age of the firm 7. Trade cycle
3. Time for payment of dividend policy 8. Taxation policy
4. Availability of liquid funds 9. Past dividend rates
5. Government policies 10. Extent of share distribution
6. Companies overall sale performance and its market share.

TYPES OF DIVIDEND POLICY:

1. Generous dividend policy

2. Erratic dividend policy
3. Stable divided policy
IMPORTANT FORMULAE’S:

DEFINITION OF WORKING CAPITAL MANAGEMENT:

ICAI – working capital means the fund that is available for day to day operations of the enterprise.

ADVANTAGES OF ADEQUATE WORKING CAPITAL:

1. Helps in providing attractive cash discounts

2. Provides Sense of security and confidence
3. Helps in maintaining credit worthiness of the company
4. Helps in ensuring continuous supply of raw materials.
5. Helps in increasing productivity
6. Helps in announcement of attractive dividend
7. Helps in facing unforeseen contingencies.
FACTORS DETERMINING WORKING CAPITAL REQUIREMENT OF THE COMPANY:

1. Nature of business 9. Dividend policy of the firm

2. Length of production cycle 10. Operating efficiency
3. Nature of product 11. Growth and expansion plans of the business
4. Business cycle 12. Price level of the raw materials
5. Earning capacity of the firm 13. Capital structure of the firm
6. Size of the business
7. Profit margin
8. Capacity to repay

OPERATING CYCLE OF MANUFACTURING FIRM:

OPERATING CYCLE OF TRADING FIRM:

VARIOUS SOURCES OF WORKING CAPITAL:

CHAPTER 6: SOURCES OF FINANCE:

TYPES OF SOURCES OF FINANCE:

1. Short term source: having maturity period less than 1 year

2. Long term source: having maturity period more than 1 year.

TYPES OF SHORT TERM SOURCE OF FINANCE:

1. Trade credit: it is the credit extended by the supplier of goods to the purchaser in the normal
course of business.
2. Bank credit: short term loans, cash credit, overdraft facilities are some examples of bank credit.
3. Customer’s advances: it happens mostly in construction sector were people pay a certain amount
in advance by which the company raises money which need not be repaid to customers.
4. Cash credit: it is a separate arrangement of credit given by the bank to the business based on the
value of goods that are ready for immediate sale.
5. Instalment credit: payments are made in small number and in a regular interval after receiving
the product.
6. Depreciation fund: it is created out of firms profit and acts as a reliable source when needed.
7. Provisions for taxation: it is also created out of firms profit and can be used at the time needed.
8. Outstanding expenses: expenses have to be paid and cannot be avoided.
TYPES OF LONG TERM FINANCE SOURCES:

1. Shares
2. Retained earnings
3. Debentures
4. Public deposits
5. Loan from financial institutions
6. Lease financing
7. Venture capital financing
8. Hire purchase financing
9. International financing

DIFFERENCE BETWEEN EQUTIY AND PREFERENCE SHARES:

DIFFERENCE BETWEEN SHARES AND DEBENTURES:

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