Overview of Financial Management

• Business finance means money required to carry out business activities.
• Finance is needed to start, run, modernise, expand, or diversify a business.
• It is used to purchase tangible assets (machinery, buildings) and intangible assets (patents, trademarks).
• Finance is essential for daily operations like buying materials, paying salaries, and managing expenses.
• Adequate finance is crucial for the survival and growth of a business.

• Financial management deals with proper procurement and effective use of funds.
• It aims to reduce cost of funds, control risk, and ensure optimum utilisation of finance.
• It influences major decisions like investment in fixed assets and management of working capital.
• It decides the proportion of long-term and short-term funds and the mix of debt and equity.
• The financial health and future success of a business depend on sound financial management decisions.

• The main objective of financial management is to maximise shareholders’ wealth.
• It aims to increase the market price of equity shares.
• Financial decisions should ensure that benefits are more than the costs involved.
• Only those investment and financing decisions are taken which add value to the company.
• Efficient decision-making helps in increasing the financial strength and share value of the company.

• Investment decision means deciding how to use the firm’s funds in different assets to earn maximum returns.
• It can be long-term (Capital Budgeting) or short-term (Working Capital) decisions.
• Long-term decisions involve heavy investment in fixed assets and affect future profitability and growth.
• Capital budgeting decisions are risky, irreversible, and must be taken carefully.
• Short-term decisions relate to cash, inventory, and receivables, affecting daily operations, liquidity, and profitability.

• Capital budgeting decisions are taken after carefully evaluating available investment projects.
• Expected cash flows (receipts and payments) of a project must be properly analysed.
• The rate of return is a key factor; projects with higher returns are generally preferred.
• Risk involved in the project should also be considered while making decisions.
• Various capital budgeting techniques are used to compare and select the best project.

• Financing decision means deciding the amount and sources of long-term funds for the business.
• Main sources of finance are shareholders’ funds (equity, retained earnings) and borrowed funds (debt, debentures).
• Debt requires fixed interest payment and repayment of principal, which increases financial risk.
• A proper mix of debt and equity should be maintained to balance cost and risk.
• Financing decision affects the overall cost of capital and financial stability of the firm.

• Cost of Finance – Firms prefer the source of funds that has the lowest cost.
• Risk Involved – Different sources have different levels of financial risk, especially debt.
• Floatation Cost – Higher issue or floatation cost makes a source less attractive.
• Cash Flow Position – Strong cash flow supports debt financing, while weak cash flow may require equity.
• Control and Market Conditions – Equity may reduce management control, and the state of the capital market also affects the choice of financing source.

• Earnings – Higher profits mean higher dividends.
• Stability of Earnings – Stable profits allow regular dividends.
• Growth Opportunities – Growing companies retain more profit, so pay less dividend.
• Cash Position – Dividend needs cash, not just profit.
• Shareholders’ Preference – Companies consider investors’ desire for regular income.
• Tax Policy – Tax on dividends affects dividend decisions.
• Legal & Loan Restrictions – Company must follow legal and contractual rules before paying dividends.

• Financial planning means preparing a financial blueprint for the future operations of a business.
• Its main objective is to ensure that adequate funds are available at the right time.
• It also avoids raising excess funds, which may increase cost and lead to wasteful use of money.
• It is different from financial management, as financial planning focuses on fund requirements and availability, while financial management focuses on investment and financing decisions.
• It estimates the amount and timing of funds required for fixed capital and working capital.
• It includes both long-term planning (for growth and investment) and short-term planning (through budgets).
• The process starts with sales forecasting, estimating profits, calculating internal funds, and identifying external sources of finance.

• Financial planning helps in forecasting future business situations and prepares the firm to handle different outcomes.
• It reduces business shocks and surprises by making the company ready for uncertainties.
• It helps in coordinating different departments like sales and production through clear policies.
• It reduces waste, duplication of work, and planning gaps by preparing detailed action plans.
• It connects present decisions with future goals of the business.
• It creates a continuous link between investment and financing decisions.
• It sets clear objectives, which makes performance evaluation easier.

• Capital structure means the mix of owners’ funds and borrowed funds in a business.
• Owners’ funds include equity and retained earnings; borrowed funds include loans and debentures.
• Debt is cheaper than equity because interest is tax-deductible.
• Debt increases financial risk since interest and repayment are compulsory.
• More debt lowers cost of capital but raises financial risk.
• An optimal capital structure increases shareholders’ wealth.
• If return is higher than cost of debt, using debt increases EPS (trading on equity).

\[\text{Debt-Equity Ratio}=\frac{\text{Debt}}{\text{Equity}}\]

\[\text{Debt~Ratio}=\frac{\text{Debt}}{\text{Debt}+\text{Equity}}\]

\[\text{Interest Coverage Ratio (ICR)}=\frac{\text{EBIT}}{\text{Interest}}\]

\[\text{DSCR}=\frac{\text{Profit after Tax}+\text{Depreciation}+\text{Interest}+\text{Non-Cash Expenses}}{\text{Preference Dividend}+\text{Interest}+\text{Repayment Obligation}}\]

• Every business requires funds to invest in fixed assets and current assets.
• Fixed assets are long-term assets used for more than one year, such as land, buildings, and machinery.
• Investment in fixed assets involves large and long-term decisions called capital budgeting decisions.
• Current assets are short-term assets that are converted into cash within one year, like inventory and debtors.

• Nature of Business – Manufacturing firms need more fixed capital than trading firms.
• Scale of Operations – Larger businesses require more investment in fixed assets.
• Choice of Technique – Capital-intensive firms need more fixed capital than labour-intensive firms.
• Technology Upgradation – Businesses using rapidly outdated technology need higher fixed capital.
• Growth Prospects – Higher expected growth increases the need for fixed capital.
• Diversification – Expanding into new businesses increases fixed capital requirements.
• Financing Alternatives – Leasing assets can reduce the need for large fixed capital investment.
• Level of Collaboration – Sharing facilities with other firms reduces fixed capital requirement.

• Working capital refers to investment in current assets needed for day-to-day business operations.
• Current assets are short-term assets that are converted into cash within one year and provide liquidity.
• Examples of current assets include cash, marketable securities, debtors, inventory, and prepaid expenses.
• Current liabilities are short-term obligations payable within one year, such as creditors and bills payable.
• Net working capital is the excess of current assets over current liabilities and ensures smooth business functioning.