Definitions [2]
Answer in one sentence.
Define working capital.
Gerstenbergh defines it as “The excess of current assets over current liabilities.”
Answer in one sentence.
Define capital structure.
According to R. H. Wessel, “The long term sources of funds employed in a business enterprise.”
Formulae [3]
Formula: Debt-Equity Ratio
\[\frac{\mathrm{Debt}}{\mathrm{Equity}}\] (D/E)
Formula: Proportion of Debt in Total Capital
\[\frac{\mathrm{Debt}}{\mathrm{Debt}+\mathrm{Equity}}\] \[\left(\frac{D}{D+E}\right)\]
Formula: Return on Investment (RoI)
\[\frac{\mathrm{EBIT}}{\text{Total Investment}}\times100\]
Key Points
Key Points: Importance of Financial Planning
- Financial planning tackles uncertainty of funds and supports smooth functioning and survival of business.
- It forecasts future conditions and enables preparation of alternative financial plans.
- It helps avoid business shocks and surprises by preparing the company for the future.
- It coordinates sales and production through clear policies, procedures and budgets.
- Detailed action plans reduce waste, duplication of efforts and planning gaps.
- It links present decisions with future requirements and connects investment and financing decisions.
- It sets detailed objectives that make evaluation and comparison of actual performance with planned results easier.
Key Points: Capital Structure
- Capital structure = Mix of owners' funds and borrowed funds.
- Debt is cheaper but riskier than equity.
- Financial risk increases with higher debt.
- Financial leverage is measured by D/E or D/(D+E).
- Optimal capital structure maximizes shareholders' wealth.
- Favourable Financial Leverage: RoI > Cost of Debt → EPS increases.
- Unfavourable Financial Leverage: RoI < Cost of Debt → EPS decreases.
- Trading on Equity should be used only when RoI exceeds the Cost of Debt.
Key Points: Fixed Capital
- Fixed capital is the investment in long-term assets, while current assets are converted into cash within one year.
- Fixed capital decisions (capital budgeting) involve acquiring, expanding, replacing, or modernising fixed assets.
- Fixed assets should be financed through long-term sources, not short-term funds.
- Capital budgeting is important because it involves large investments, long-term growth, risk, and irreversible decisions.
- Fixed capital requirements depend on the nature and scale of business, technology, growth prospects, and diversification.
- Leasing and collaboration can reduce the need for fixed capital investment.
Important Questions [16]
- Normally _________ Gives Advice to the Board of Directors in Respect of Financial Matters.
- Match the Pairs
- Financial Management is Essential for All Types of Organisations.
- Advice to Board of Directors in Respect of Financial Matter is Given by _______.
- State, with Reason, Whether the Following Statement is True Or False.
- Match the Correct Pairs :
- Write Short Notes On Importance of Financial Planning
- Working capital stays in the business almost permanently.
- Write a word or a term or a phrase which can substitute the following statement. The ratio of different sources of funds in the total capital.
- Write a word or a term or a phrase which can substitute the following statement. The internal source of financing.
- State, with Reason, Whether the Following Statement Are True Or False.Requirement of Working Capital Does Not Depend Upon Any Factor.
- Select the Proper Option from the Options Given Below and Rewrite the Sentence: the _________ Capital Remains in Business Almost Permanently.
- Write a Word Or a Term Or a Phrase Which Can Substitute the Following Statement :
- Match the Pairs
- Big Retail Stores Requires Large Amount of ............................. Capital.
- What are the factors affecting requirement of fixed capital?
