CBSE Class 12 Business Studies Financial Management Worksheet Set C

1 Financial Management
Financial Management is concerned with optimal procurement as well as the usage of finance. For optimal procurement, different available sources of finance.

2 Meaning of Business Finance
Money required for carrying out business activities is called business finance.

3 Objective of Financial Management
To maximise shareholders‘ wealth.

4 Financial Decision
It means the selection of best financing alternative or best investment alternative.

5 Investment Decision
The investment decision, therefore, relates to how the firm‘s funds are invested in different assets.

6 Financing Decision
This decision is about the quantum of finance to be raised from various long-term sources. Short-term sources are studied under the ‗working capital management‘.

7 Dividend Decision
The decision involved here is how much of the profit earned by company (after paying tax) is to be distributed to the shareholders and how much of it should be retained in the business.

8 Financial Planning
The objective of financial planning is to ensure that enough funds are available at right time. If adequate funds are not available the firm will not be able to honour its commitments and carry out its plans.

9 Capital Structure
On the basis of ownership, the sources of business finance can be broadly classified into two categories viz., ‗owners‘ funds‘ and
‗borrowed funds‘.

10 Interest Coverage Ratio (ICR)
The interest coverage ratio refers to the number of times earnings before interest and taxes of a company covers the interest obligation.

11 Fixed and Working Capital Meaning
Every company needs funds to finance its assets and activities. Investment is required to be made in fixed assets and current assets. Fixed assets are those which remains in the business for more than one year, usually for much longer, e.g., plant and machinery, furniture and fixture, land and building, vehicles, etc.

12 Working Capital
Apart from the investment in fixed assets every business organization needs to invest in current assets. This investment facilitates smooth day-today operations of the business. Current assets are usually more liquid but contribute less to the profits than fixed assets.

Business Finance:- It refers to funds required for carrying out business activities.
Financial Management:- It includes decisions relating to procurement of funds, investment of funds in long term and short term assets and distribution of earning to the owner.

Role of Financial Management:-
1. Size and Composition of Fixed Assets.
2. Amount and Composition of Current Assets.
3. The Amount of Long-term and Short-term Funds.
4. Break up of Long Term Financing into Debt, Equity etc.
5. All Items in Profit and Loss Account.

Objective of Financial Management:- Maximize wealth of equity shareholders which means maximizing the market price of Equity shares.

Financial Decisions:-
The finance functions relate to three major decisions which every finance manager has to take:
A) Investment decision,
B) Financing decision and,
C) Dividend decision

Importance or Scope of Capital Budgeting Decision/ Investment Decision:-
1. Long term growth
2. Large amount of funds involved
3. Risk involved
4. Irreversible decision.

A. Investment decision (Capital Budgeting Decision):- This decision relates to careful selection of assets in which funds will be invested by the firms.

Factors Affecting Investment/ Capital budgeting decision:–
1. Cash flows of the project:- Before considering an investment option, business must carefully analyse the net cash flow expected from the investment during the life of the investment. Investment should be made if net cash flow is more.
2. The rate of return:- Investment should be done in the projects which earn the higher rate of return. It should be calculated on the basis of expected return of the projects.
3. Investment criteria involved:- Before taking decision, each investment opportunity must be compared by using the various capital budgeting techniques. These techniques involve calculation of rate of return, cash flow during the life of investment, cost of capital etc.

B. Financing decision:- It deals with determination of sources of finance i.e. amount to be raised from each source.

Factors Affecting Financing decision:-
1. Cost of raising finance: - The cost of raising finance from various sources is different and finance managers always prefer the source with minimum cost.
2. Risk involved:-The risk associated with each of the sources is different.
3. Flotation costs:- Higher the floatation cost, less attractive the source.
4. Cash flow position of the company: - A strong cash flow position may make debt financing more viable than funding through equity.
5. Fixed Operating Costs: - If a company is having high fixed operating cost then they must prefer owner‘s fund because due to high fixed operational cost, the company may not be able to pay interest on debt securities.
6. Control consideration: - If existing shareholders want to retain the complete control of business then they prefer borrowed fund securities to raise further fund.

C. Dividend decisions:- It refers decisions related to amount of profit/surplus to be distributed among shareholders and how much amount of profit/surplus keep aside as retained earnings.

Factors Affecting Dividend decisions:-
1. Amount of Earning: - Dividends are paid out of current and past earning.
2. Stability of earning: - Companies having stable or smooth earning prefer to give high rate of dividend.
3. Stability of dividend: - Some companies follow a stable dividend policy as it has better impact on shareholder and improves the reputation of company in the share market.
4. Growth opportunities: - If companies have no investment or growth plans then it would be better to distribute more in the form of dividend. Generally mature companies declare more dividends whereas growing companies keep aside more retained earnings.
5. Cash Flow Position:-Paying dividend means outflow of cash. Companies declare high rate of dividend only when they have surplus cash.
6. Taxation Policy: - If tax rate is higher, then company prefers to pay less in the form of dividend whereas if tax rate is low then company may declare higher dividend.

Financial planning- It is the process of estimating the funds requirement, specifying the sources of fund and utilizing them in an optimum manner.

Objective of financial Planning-
a. To ensure availability of funds whenever these are required.
b. To see that firm does not raise resources unnecessarily.

Importance of financial Planning-
a. Makes the firm better prepared to face the future
b. Helps in avoiding Business Shocks and Surprises
c. Coordinate various functions
d. Proper utilization of finance
e. Link present with future
f. Link between Investment and Financing Decisions

Capital Structure:- – Refers to proportion of debt and equity used for financing the operations of business.

Factors Affecting Capital Structure: –
1. Cash flow positions: - A company employs more of debt securities in its capital structure if company is sure generating enough cash inflow whereas if there is shortage of cash then it must employ more of equity in its capital structure.
2. Interest coverage ratio (ICR):- High ICR means companies can have more of borrowed fund securities whereas lower ICR means less borrowed fund securities.
3. Return on investment: - If return on investment is more than rate of interest then company must prefer debt in its capital structure otherwise equity.
4. Tax rate: - High tax rate makes debt cheaper as interest paid to debt security holders is subtracted from income before calculating tax.
5. Cost of Debts: - If firm can arrange borrowed fund at low rate of interest then it will prefer more of debt as compared to equity.
6. Risk consideration: - If firm‘s business risk is low then it can raise more capital by issue of debt securities whereas at the time of high business risk it should depend upon equity.

Fixed Capital:– It refers to money invested in the fixed assets, which is to be used over a long period of time.

Factors Affecting Fixed Capital: –
1. Nature of business: - A manufacturing company needs more fixed capital as compared to a trading company.
2. Scale of operations:- A large scale company require more fixed capital as they need more machineries and other assets.
3. Techniques of production:-Companies using capital-intensive technique require more fixed capital whereas companies using labour intensive technique require les capital.
4. Technology upgradation:-Industries in which technology upgradation is fast need more amount of fixed capital as when new technology is invented old machines become obsolete.
5. Growth prospectus: - Companies which are expanding and have higher growth plan require more fixed capital as to expand their production capacity.
6. Diversification: - Companies which have plan to diversify their activities by including more range of products require more fixed capital as to produce more products.

Working Capital:- refers to the amount which is invested in current assets. This fund also needed for payment of daily expenses, payment of current liabilities etc. this investment facilitate smooth business operation.

Factors affecting the requirement of working capital:-
1. Nature of business:-the requirement of working capital depends on the nature of business. Manufacturing business requires more amount of working capital because it takes lot of time in converting raw material into finished goods while trading business requires less amount of working capital.
2. Scale of operation:-Business operating on larger scale requires more funds to maintain the high quantum of inventory, debtors or meet day to day expenses as compared to small scale business.
3. Business Cycle fluctuation:-Different phases of business cycle affect the requirement of working capital by a firm. In case of boom, there is increase in production and scales leading to the increased requirement for working capital whereas the requirements for working capital reduce during depression.
4. Seasonal factors: - Many businesses may have high level of activity during specific period of time which may be referred as season time. Therefore, during peak season the level of activity is high, leading to increased need of working capital as compared tothe capital during lean period.
5. Technology and production cycle:- If a company is using labour intensive technique of production then more working capital is required because company needs to maintain enough cash flow for making payments to labour.
6. Inflation: - If there is increase or rise in price then the price of raw material and cost of labour will rise, it will result in an increase in working capital requirement.

Important Questions for NCERT Class 12 Business Studies Financial Management

Question. A fixed asset should be financed through:
(a) Long-term liability
(b) A short-term liability
(c) A mix of long and short-term liabilities

Answer : A

Question. Current assets of a business firm should be financed through:
(a) Current liability only
(b) Long-term liability only
(c) Both types (i.e. long and short-term liabilities)

Answer : C

Question. The main objective of financial management is
(a) Profit Maximisation
(b) Wealth Maximisation
(c) Ensuring availability of finance
(d) None of the above

Answer : B

Question. A company is attracted to what capital out of the following with reference to floatation costs?
(a) Equity Share Capital
(b) Preference Share Capital
(c) Debt Capital
(d) None of these

Answer : C

Question. What capital out of the following is better with reference to control?
(a) Equity Share Capital
(b) Preference Share Capital
(c) Debt Capital
(d) None of these

Answer : C

Question. If fixed operating cost is high, a firm should prefer
(a) Debt
(b) Equity
(c) Both (a) and (b)
(d) None of the above

Answer : B

Question. Fixed capital means that capital which is used in purchasing ________ assets.
(a) Current assets
(b) Fixed assets
(c) Material
(d) All the above

Answer : B

Question. Use of machines makes the use of fixed capital ________ .
(a) More
(b) Nil
(c) Less
(d) Very little

Answer : A

Question. The decision related to acquiring funds from debt or equity is called
(a) Investment decision
(b) Financing decision
(c) Dividend decision
(d) All of the above

Answer : B

Question. If large number of shareholders of the firm are from middle income group and old age group who prefer regular income, then the firm should prefer giving
(a) Low dividend
(b) High dividend
(c) No dividend
(d) None of the above

Answer : B

Question. If ICR is high, firm prefers
(a) Debt
(b) Equity
(c) Both (a) and (b)
(d) None of the above

Answer : A

Question. working capital decisions are concerned with the decision of
(a) control
(b) debt
(c) inventory
(d) Equity

Answer :  C

Question. Companies with stable earnings are likely to :
(a) Pay higher dividend
(b) Not pay any dividend
(c) pay lesser dividend
(d) Dividend are not affected by stable earning

Answer :  A

Question. Companies with a higher growth pattern are likely to: 
(a) pay lower dividends
(b) pay higher dividends
(c) dividends are not affected by growth considerations
(d) none of the above

Answer :    A

Question. Higher working capital usually results in: 
(a) higher current ratio, higher risk and higher profits
(b) lower current ratio, higher risk and lower profits
(c) higher equity, lower risk and lower profits
(d) lower equity, lower risk and higher profits

Answer :  A

Question. Current assets are those assets which get converted into cash: 
(a) within six months
(b) within one year
(c) between one and three years
(d) between three and five years

Answer :   B

Question. Higher dividend per share is associated with: 
(a) high earnings, high cash flows, unstable earnings and higher growth opportunities
(b) high earnings, high cash flows, stable earnings and high growth opportunities
(c) high earnings, high cash flows, stable earnings and lower growth opportunities
(d) high earnings, low cash flows, stable earnings and lower growth opportunities

Answer :   C

Question. Factors affecting financing decisions are:
(a) Stability of earning
(b) Investment criteria
(c) Cash flow of the project
(d) Control consideration

Answer :  D

Question. Factors affecting dividend decisions are
(a) return on investment
(b) flotation cost
(c) legal constraints
(d) Control consideration

Answer :  C

Question. ROI of a company is 12%. To finance its project, it has two borrowing options.
(a) Rate of interest 9%
(b) Rate of interest 13%
Which option is better. Give reason.

Answer :  A

Question. Higher debt equity ratio results in
(a) Lower financial risk
(b) higher operating risk
(c) higher financial risk
(d) higher EPS

Answer :  C

True/False :

Question. Trading on equity takes place when ROI is less than the rate of interest.

Answer :  False

Question. Companies with higher growth potential pay lower dividends.

Answer : True

Question. If cash flow position of a company is weak more debt financing is not recommended.

Answer : True

Question. An ‘Advertising agency’ needs to have large fixed capital.

Answer : False

Question. Capital budgeting decisions are very crucial for any business.

Answer : True

Fill in the blanks :

Question. Objective of financial management is ..........

Answer : maximisation of shareholders wealth

Question. Current assets get converted into cash within a period of .......... .

Answer : 1 year

Question. Inflation will result in an increase in ........ capital requirements.

Answer : Working

Very short questions 

Question. A company wants to establish a new unit in which a machinery of worth Rs.10 lacs is involved. Identify the type of decision involved in financial management?
Answer : Capital Budgeting decision or investment decision.

Question. Ankit adopted a new policy in his business: Purchase computer on credit and sell them for cash. Will it affects the requirement of working capital?
Answer : Yes, it will reduce the need of working capital as the debtors due to cash sales and there is less investment in inventory due to credit availed.

Question. What kind of decisions involves distributions of profit to share holders?
Answer : Dividend Decisions.

Question. How do ‘Growth Opportunities’ as a factor affect dividend decision? State.
Answer : Companies having growing opportunities in near future declare lesser dividend as compared to companies, which do not have any growth plans.

Question. What is meant by ‘Financial Risk’?
Answer : Financial risk refers to inability to meet fixed financial charges like interest payment, preference dividend and repayment obligations.

Question Which type of dividend policy should be followed by a company having growth opportunities?
Answer : Conservative dividend policy, i.e. such company should pay less dividend.

Question. Identify, why the requirement of Fixed Capital for a trading concern are different from that of a manufacturing organization.
Answer : Trading concern requires less fixed capital as compared to manufacturing organization because trading concern requires relatively much less investment in fixed assets.

Question. Management has to decide whether a new and modern plant should be replaced with the old one. Which type the financial decision is it.
Answer : Investment Decision.

Question. For optimal procurement of funds, a finance manager identifies different available sources and compares those in term of cost and associated risks. Identify and define the concept highlighted in the above lines.
Answer : The concept is financial management and is concerned with management of flow of funds and involves decisions relating to procurement and investment of funds, in long term and short term assets and distribution of earning to the owner.

Question. A decision is taken to raise money for long-term capital needs of the business from certain sources. What is this decision called?
Answer : Financing decision.

Question. State how ‘Growth Prospects’ affect the working capital requirements of a company?
Answer : The firms which have sufficient possibilities of growth prospects in future require more working capital. However, for companies with lesser prospects, less working capital is needed.

Short Answer Type Questions 

Question. Financial decision is concerned with selection of fixed assets in which funds will be invested by the business? Identify the decision and explain any three factors affecting the decision.
Answer : Long term Investment decision/Capital Budgeting Decision-It is concerned with investment of firm’s fund in different fixed assets like buying of machinery.
Factors Affecting –
1. Cash flow position of the company-Before considering an investment option, business must carefully analyse the net cash flow expected from the investment during the life of the investment. Investment should be made if net cash flow is more.
2. Return on investment-Investment should be done in the projects which earn the higher rate of return. It should be calculated on the basis of expected return of the projects.
3. Investment criteria-Before taking decision, each investment opportunity must be compared by using the various capital budgeting techniques. These techniques involve calculation of rate of return, cash flow during the life of investment, cost of capital etc.

Question. What are the objectives of financial management for an organization? Give any three reasons in support of your answer.
Answer : 1. Financial management helps in determination of total funds required.
2. Helps in allocation of fund for fixed assets and current assets.
3. Helps in determination of sources to raise fund for the organization.
4. Wealth maximization

Question. ‘Sarah Ltd.’ is a company manufacturing cotton yarn. It has been consistently earning good profits for many years. This year too, it has been able to generate enough profits.
There is availability of enough cash in the company and good prospects for growth in future. It is a well managed organization and believes in quality, equal employment opportunities and good remuneration practices. It has many shareholders who prefer to receive a regular income from their investments. It has taken a loan of Rs.40 lakhs from IDBI and is bound by certain restrictions on the payment of dividend according to the terms of loan in agreement.
The above discussion about the company leads to various factors which decide how much of the profits should be retained and how much has to be distributed by the company.
Quoting the lines from the above discussion identity and explain any four such factor.
Answer : Dividend Decision-It refers decisions related to the amount of profit to be distributed among shareholders and amount of profit to be retained in the business for further growth
of the business..
Factors affecting dividend decision:
(i) Stability of Earnings: It affects dividend decision as a company having stable earnings is in a position to declare higher dividends.
(ii) Cash Flow Position: A good cash flow position is necessary for declaration of dividend. ‘There is availability of enough cash in the company’.
(iii) Growth prospects: If a company has good growth opportunities, it pays out fewer dividends. ‘Good prospects for the growth in the future’.
(iv) Shareholders’ Preferences: Shareholders ’preference is kept in mind by the management before declaring dividends. ‘It may have shareholders who prefer to receive regular income from their investments’.

Question What do you mean by Financial planning? Explain its two importance.
Answer : Financial planning is the process of estimating the funds requirement, specifying the sources of fund and utilizing them in an optimum manner.
Importance of financial Planning-
1. To ensure availability of funds whenever required–financial needs are anticipated and then the sources of availability of finance are allocated.
2. It helps the company to prepare for the future-It forecasts what may happen infuture under different business situations and decide what must be done in each situation.

Long Answer Type Questions

Question. What is the Capital structure? Explain any five factors affecting the choice of capital structure?
Answer : Capital structure refers to mix sources of long term finance. Sources of finance include Share capital, Borrowed fund and Retained earnings. The appropriate proportion of funds
is made in such a manner that it can give more benefit or return to the shareholders.
Factors affecting the choice of capital structure
1. Cash Flow Position: Size of projected cash flows must be considered before issuing debt, to ensure that it has sufficient cash buffer after meeting its fixed cash obligations.
2. Interest Coverage Ratio (ICR): The interest coverage ratio refers to the number of times earnings before interest and taxes of a company covers the interest obligation.
3. Debt Service Coverage Ratio (DSCR):Debt Service Coverage Ratio takes care of the deficiencies referred to in the Interest Coverage Ratio(ICR).
4. Return on Investment(RoI):If the RoI of the company is higher, it can choose to use trading on equity to increase it EPS, i.e., its ability to use debt is greater.
5. Cost of debt: A firm’s ability to borrow at a lower rate increases its capacity to employ higher debt. Thus, more debt can be used if debt can be raised at a lower rate.

Question. Which decision is concerned with rising of finance using shareholders’ funds or borrowed Funds ? Identify and describe the financial decision involve in this decision. Explain any four factors affecting that decision.
Answer : Financing decision:- This decision concerned with raising of finance using shareholders fund or borrowed fund. It involves identification of various sources of finance and the quantum of finance to be raised from long term and short term sources.
Factors affecting the financing decision.
1. Cost: - cost of raising fund influences the financing decisions. A prudent financial manager selects the cheapest source of finance.
2. Risk: - Debt capital is most risky and from the point of view of risk it should not be used.
3. Floatation cost: - From the point of view of floating costs, retained profit is the mostappropriate source. Therefore, it should be made.
4. Cash Flow position:-If the cash flow position of the company is good, the payment of interest on the debt and the refund of capital can be easily made. Therefore, in order to advantage of cheap finance, debt can be given priority.

Question. What do you mean by fixed capital? Explain any four factors affecting the requirement of fixed capital.
Answer : Fixed capital refers to the amount which is invested in fixed assets of the business enterprise.
This capital is used to acquire Land & Building, Plant and Machinery, Furniture etc. This capital is raised from the long term sources of finance. 
Factors affecting the requirement of fixed capital .
1. Nature of business:-The requirement of fixed capital depends on the nature of business. Manufacturing business requires heavy amount of fixed capital to invest in the fixed assets like-Land & Building, Plant and Machinery, Furniture etc, where as trading concern business require less capital.
2. Scale of operation:-Business operating on larger scale requires larger amount of fixed capital as they need heavy and bigger machinery and equipments. However, firms operating at small scale need relatively lesser fixed capital.
3. Choice of Technique- Production technique adopted by business also influences the requirement of fixed capital. Companies using capital-intensive technique require more fixed capital as larger investment is needed in the plant and machinery as it relies less on manual labour.
4. Growth prospects-Companies with growth plans in future need more fixed capital as more investment in the plant and machinery is needed to increase the production capacity. In other situation requires less fixed capital.

Question. What do you mean by Working capital? Explain any four factors affecting the requirement of working capital.
Answer : Working capital refers to the amount which is invested in current assets. This fund also needed for payment of daily expenses, payment of current liabilities etc. this investment facilitate smooth business operation.
Factors affecting the requirement of working capital .
1. Nature of business:-the requirement of working capital depends on the nature of business. Manufacturing business requires more amount of working capital because it takes lot of time in converting raw material into finished goods while trading business requires less amount of working capital.
2. Scale of operation:-Business operating on larger scale requires more funds to maintain the high quantum of inventory, debtors or meet day to day expenses as compared to small scale business.
3. Business Cycle:-Different phases of business cycle affect the requirement of working capital by a firm. In case of boom, there is increase in production and scales leading to the increased requirement for working capital whereas the requirements for working capital reduce during depression.
4. Seasonal factors: - many businesses may have high level of activity during specific period of time which may be referred as season time. Therefore, during peak season
the level of activity is high , leading to increased need of working capital as compared to the capital during lean period.

Question Explain briefly the Investment Decisions.
Answer : Investment Decision: It refers to the selection of assets in which funds will be invested by the business. Assets which are obtained by the business are of two types, i.e., long-term assets and Short-term assets. On this basis, investment decision is also divided into two parts:
(i) Long-term Investment Decision: This is referred to as the Capital Budgeting Decision. It relates to the investment in long-term assets. For example, buying a new machine.
(iil) Short-term Investment Decision: This is referred to as the Working Capital Management It relates to the investment in short-term assets, such as, cash, stock, debtors, etc

Question  What is meant by financial management State any two financial decisions taken by a financial manager?
Answer : Financial management refers to that part of management which concerned with the efficient planning and controlling of financial affairs of an enterprise.
Following are the main decisions which are involved in financial management Investment Decision:
(i)Investing Decision: It refers to deciding about how the funds are invested in different assets so that they are able to earn the highest possible return for the investors.
(ii) Financing Decision: It refers to the determination as to how the total funds required by the lines will be obtained from various long-term sources.

Question. Explain the term Financial Planning.
Answer : To predetermine what is to be done in future is called planning. A financial manager has to formulate plans regarding future financial requirement, its procurement and utilization.
Financial planning, therefore refers to predetermining of financial activities so that the objectives of the organisation could be achieved. In short, it includes financial objectives, financial policies and financial procedures.

Question. What is meant by Financial Planning? State any two points of its importance.
Answer : Meaning: It refers to the preparation of a financial blueprint of an organization’s future operations.
(i)Helps to Face the Eventualities: it tries to forecast various business situations. On this basis alternative financial plans are prepared. By doing so, it helps to face the eventual situations in a better way.
(ii)Helps in Avoiding Business Shocks and Surprises: Proper provision regarding shortage or surplus of funds is made by anticipating future receipts and payments. Hence. It helps in avoiding business shocks and surprises.

Question. Explain the objectives of financial planning.
Answer : Following are the objectives of financial planning.
(1) To Ensure Timely Availability of Finance: The first objective of financial planning is make finance available in time. Under it, the long-term and short-term financial needs are anticipated and then the sources of availability of finance are located.
(2) To Ensure Proper Balance of Finance: It is always ensured that the balance of cash should neither be in excess nor short. The balance of cash in both these situations is harmful.

Question. Give the meaning of Financial Management. State its main Objective.
Answer : Meaning of Financial Management: refers that branch management activity which concerned with the efficient acquisition and use of money.
Objective of Financial Management: The objective financial management maximize wealth the owners of the business the maximum extent.

Question. State the primary objective of financial management.
Answer : Wealth maximization is the primary objective of financial management which means maximizing the market value of investment in the shares of the company.