Revision: Business Finance and Marketing >> Financial Management Business Studies Commerce (English Medium) Class 12 CBSE

Financial management refers to the efficient acquisition, allocation, and usage of funds by the company. It is carried out with the primary aim of reducing the cost of the funds that are procured, minimizing the risk, and effective distribution of funds to different opportunities.

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

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

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

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

• 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.

• 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.

• 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.

• 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.

• 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.

• 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.

• 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).

• 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.