CBSE Class 12 Business Studies Financial Management Notes Set B

ntroduction: –
Money required for carrying out business activities is called business finance. Finance is needed to establish a business, to run it, to modernise it, to expand or diversify it.
Financial management is the activity concerned with the planning, raising controlling and administering of funds used in the business. It is concerned with optimal procurement as well as usage of finance. It aims at ensuring availability of enough funds whenever required as well as avoiding idle finance.
The Main Objective of Financial Management is to maximise shareholder wealth, for which achievement of optimum capital structure and proper utilisation of funds is a must.

Every company is required to take three main financial decisions which are as follow:

1. Investment Decision: –
It relates to how the firm s funds are invested in different assets. Investment decision can be long-term or short term. A long-term investment decision is called capital budgeting decisions which involve huge amounts of investments and are irreversible except at a huge cost while short term investment decisions are called working capital decisions, which affect day to day working of a business.

2. Financing Decision: –
It relates to the amount of finance to be raised from various long-term sources. The main sources of funds are owner s funds i.e. equity / share holder s funds and the borrowed funds i.e. Debts. Borrowed funds have to be repaid at a fixed time and thus some amount of financial risk (i.e. risk of default on payment) is there in debt financing. Moreover, interest on borrowed funds have to be paid regardless of whether or not a firm has made a profit. On the other hand, shareholder funds involve no commitment regarding payment of returns or repayment of capital. A firm mix both debt and equity in making financing decisions.

3. Dividend Decision: –
Dividend refers to that part of the profit which is distributed to shareholders. A company is required to decide how much of the profit earned by it should be distributed among shareholders and how much should be retained. The decision regarding dividend sh ould be taken keeping in view the overall objective of maximising shareholder s wealth.

Financial Planning: –
The process of estimating the fund requirement of a business and specifying the sources of funds is called financial planning. It ensures that enough funds are available at right time so that a firm could honour its commitments and carry out, its plans.

Importance of Financial Planning
1. To ensure availability of adequate funds at right time.
2. To see that the firm does not raise funds unnecessarily.
Factors affecting Investment Decisions / Capital Budgeting decisions

1. Cash flows of the project: The series of cash receipts and payments over the life of an investment proposal should be considered and analysed for selecting the best proposal.
2. Rate of Return: The expected returns from each proposal and risk involved in them should be taken into account to select the best proposal.
3. Investment Criteria Involved: The various investment proposals are evaluated on the basis of capital budgeting techniques. Which involve calculation regarding investment amount, interest rate, cash flows, rate of return etc.
Factors Affecting Financing Decision

1. Cost: – The cost of raising funds from different sources are different. The cheapest source should be selected.
2. Risk: – The risk associated with different sources is different, more risk is associated with borrowed funds as compared to owner s fund as interest is paid on it and it is rapid also, after a fixed period of time or on expiry of its tenure.
3. Flotation Cost: – The cost involved in issuing securities such as broker commission, underwriters’ fees, expenses on prospectus etc are called flotation cost. Higher the flotation ost, less attractive is the source of finance.
4. Cash flow position of the business: – In case the cash flow position of a company is good enough then it can easily use borrowed funds.
5. Control Considerations: In case the existing shareholders want to retain the complete control of business then finance can be raised through borrowed funds but when they are ready for dilution of control over business, equity can be used for raising finance.
6. State of Capital Markets: – During boom, finance can easily be raised by issuing shares but during depression period, raising finance by means of debt is easy.

Factors affecting Dividend Decision:
1. Earnings: – Company having high and stable earning could declare high rate of dividends as dividends are paid out of current and past earnings.
2. Stability of Dividends: Companies generally follow the policy of stable dividend. The dividend per share is not altered/changed in case earning changes by small proportion or increase in earnings is temporary in nature.
3. Growth Prospects: In case there are growth prospects for the company in the near future them, it will retain its earning and thus, no or less dividend will be declared.
4. Cash Flow Positions: Dividends involve an outflow of cash and thus, availability of adequate cash is foremost requirement for declaration of dividends.

Trading on Equity:
It refers to the increase in profit earned by the equity shareholders due to the presence of fixed financial charges like interest. Trading on equity happen when the rate of earning of an organisation is higher than the cost at which funds have been borrowed and as a result equity shareholder get higher rate of dividend per share.