chapter

9
Financial Management
Learning Objectives When Tata Steel Acquired Corus
Tata Steel, the biggest steel producer in
After studying this chapter, you
the Indian private sector has acquired
should be able to: Corus, (formerly known as British
Steel) in a deal worth $8.6 billion in
¾¾ explain the meaning of 2007. This makes Tata Steel the fifth
business finance; largest steel producer in the world. A
financial decision of this magnitude
has significant implicitness for both
¾¾ d e s c r i b e f i n a n c i a l
Tata Steel and Corus as well as their
management; employees and shareholders. To mention
some of them:
¾¾ explain the role of financial � Tata Steel raised a debt of over $8
management in our billion to finance the transaction.
enterprise; The deal will be paid for by Tata Steel
UK, a special purpose vehicle (SPV)
¾¾ d i s c u s s o b j e c t i v e s o f set up for the purpose. This SPV
financial management and received funds from Tata Steel routed
how they could be achieved; through a Singapore subsidiary.
Another company of the Tata group,
Tata Sons Ltd., invested $ 1 billion
¾¾ explain the meaning and dollars for preference shares along
importance of financial with Tata Steel which will invest an
planning; equal amount.
� Tata Steel, the acquirer company,
¾¾ state the meaning of capital arranged about 36,500 crores of
structure; rupees to finance the take-over.
� Tata Steel raised this amount through
¾¾ analyse the factors affecting debt or equity or a combination
the choice of an appropriate of both. Some amount came from
capital structure; internal accruals also. This financing
decision affected the capital structure
¾¾ state meaning of fixed capital of Tata Steel.
and working capital; and � Needless to emphasise, decisions
like this affect the future of the
organisation. These decisions are
¾¾ analyse the factors affecting
almost irrevocable after they have been
the requirement of fixed and formalised.
working capital.
Source: The Economic Times

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Introduction thus, very crucial for the survival and

growth of a business.
In the above case, these decisions
require careful financial planning,
Financial Management
an understanding of the resultant
capital structure and the riskiness All finance comes at some cost. It
and profitability of the enterprise. All is quite imperative that it needs to
these have a bearing on shareholders be carefully managed. Financial
as well as employees. They require Management is concerned with optimal
an understanding of business procurement as well as the usage of
finance, major financial decision finance. For optimal procurement,
areas, financial risk, and working different available sources of finance
capital requirements of the business. are identified and compared in terms
Finance, as we all know, is essential of their costs and associated risks.
for running a business. Success of Similarly, the finance so procured
business depends on how well finance needs to be invested in a manner that
is invested in assets and operations the returns from the investment exceed
and how timely and cheaply the the cost at which procurement has
finances are arranged, from outside taken place. Financial Management
or from within the business. aims at reducing the cost of funds
procured, keeping the risk under
Meaning of Business Finance control and achieving effective
deployment of such funds. It also
Money required for carrying out aims at ensuring availability of enough
business activities is called business funds whenever required as well as
finance. Almost all business activities avoiding idle finance. Needless to
require some finance. Finance is emphasise, the future of a business
needed to establish a business, to depends a great deal on the quality of
run it, to modernise it, to expand, or its financial management.
diversify it. It is required for buying Importance : The role of financial
a variety of assets, which may be management cannot be over-
tangible like machinery, factories, emphasised, since it has a direct
buildings, offices; or intangible such bearing on the financial health of a
as trademarks, patents, technical business. The financial statements,
expertise, etc. Also, finance is central such as Balance Sheet and Profit
to running the day-to-day operations and Loss Account, reflect a firm’s
of business, like buying material, financial position and its financial
paying bills, salaries, collecting cash health. Almost all items in the financial
from customers, etc. needed at every statements of a business are affected
stage in the life of a business entity. directly or indirectly through some
Availability of adequate finance is, financial management decisions. Some

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prominent examples of the aspects raised by way of debt and/or equity

being affected could be as under: is also a financial management
(i) The size and the composition of decision. The amounts of debt,
fixed assets of the business: For equity share capital, preference
example, a capital budgeting share capital are affected by the
financing decision, which is a part
decision to invest a sum of Rs. 100
of financing management.
crores in fixed assets would raise
the size of fixed assets block by this ( v) All items in the Profit and Loss
amount. Account, e.g., Interest, Expense,
Depreciation, etc. : Higher amount
( ii) The quantum of current assets and of debt means higher interest
its break-up into cash, inventory expense in future. Similarly, use
and receivables: With an increase of higher equity may entail higher
in the investment in fixed assets, payment of dividends. Similarly, an
there is a commensurate increase expansion of business which is a
in the working capital requirement. result of capital budgeting decision
The quantum of current assets is likely to affect virtually all items
is also influenced by financial in the profit and loss account of the
management decisions. In addition, business.
decisions about credit and inventory
It can, thus, be stated that the
management affect the amount of
financial statements of a business
debtors and inventory which in
are largely determined by financial
turn affect the total current assets
as well as their composition. management decisions taken earlier.
Similarly, the future financial
( iii) The amount of long-ter m and statements would depend upon past
short- ter m funds to be used: as well as current financial decisions.
Financial management, among
Thus, the overall financial health
others, involves decision about
of a business is determined by the
the proportion of long-term and
quality of its financial management.
short-term funds. An organisation
Good financial management aims at
wanting to have more liquid assets
mobilisation of financial resources at
would raise relatively more amount
a lower cost and deployment of these
on a long-term basis. There is
in most lucrative activities.
a choice between liquidity and
profitability. The underlying
assumption here is that current
Objectives
liabilities cost less than long term The primary aim of financial
liabilities. management is to maximise
( iv) Break-up of long-term financing into shareholders’ wealth, which is referred
debt, equity etc: Of the total long- to as the wealth-maximisation concept.
term finance, the proportions to be The market price of a company’s shares

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is linked to the three basic financial some value addition should take place.
decisions which you will study a little All those avenues of investment, modes
later. This is because a company funds of financing, ways of handling various
belong to the shareholders and the components of working capital must
manner in which they are invested and be identified which will ultimately lead
the return earned by them determines to an increase in the price of equity
their market value and price. It means share. It can happen through efficient
maximisation of the market value of decision-making. Decision-making is
equity shares. The market price of efficient if, out of the various available
equity share increases, if the benefit alternatives, the best is selected.
from a decision exceeds the cost
involved. All financial decisions aim at Financial Decisions
ensuring that each decision is efficient
Financial management is concerned
and adds some value. Such value
with the solution of three major issues
additions tend to increase the market
relating to the financial operations
price of shares. Therefore, those
of a firm corresponding to the three
financial decisions are taken which
questions of investment, financing
will ultimately prove gainful from
and divident decision. In a financial
the point of view of the shareholders.
context, it means the selection of
The shareholders gain if the value of
best financing alternative or best
shares in the market increases. Those
investment alternative. The finance
decisions which result in decline in
function, therefore, is concerned
the share price are poor financial
with three broad decisions which are
decisions. Thus, we can say, the
explained below:
objective of financial management is
to maximise the current price of equity
Investment Decision
shares of the company or to maximise
the wealth of owners of the company, A firm’s resources are scarce in
that is, the shareholders. comparison to the uses to which
Therefore, when a decision is taken they can be put. A firm, therefore,
about investment in a new machine, has to choose where to invest these
the aim of financial management resources, so that they are able to earn
is to ensure that benefits from the the highest possible return for their
investment exceed the cost so that investors. The investment decision,
some value addition takes place. therefore, relates to how the firm’s
Similarly, when finance is procured, funds are invested in different assets.
the aim is to reduce the cost so that Investment decision can be long-
the value addition is even higher. term or short-term. A long-term
In fact, in all financial decisions, investment decision is also called a
major or minor, the ultimate objective Capital Budgeting decision. It involves
that guides the decision-maker is that committing the finance on a long-

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term basis. For example, making decisions) are concerned with the
investment in a new machine to decisions about the levels of cash,
replace an existing one or acquiring inventory and receivables. These
a new fixed asset or opening a new decisions affect the day-to-day
branch, etc. These decisions are very working of a business. These affect
crucial for any business since they the liquidity as well as profitability of a
affect its earning capacity in the long business. Efficient cash management,
run. The size of assets, profitability inventory management and receivables
and competitiveness are all affected by management are essential ingredients
capital budgeting decisions. Moreover, of sound working capital management.
these decisions normally involve
huge amounts of investment and are Factors affecting Capital
irreversible except at a huge cost. Budgeting Decision
Therefore, once made, it is often almost
A number of projects are often available
impossible for a business to wriggle out
to a business to invest in. But each
of such decisions. Therefore, they need
project has to be evaluated carefully
to be taken with utmost care. These
and, depending upon the returns, a
particular project is either selected or
rejected. If there is only one project, its
viability in terms of the rate of return,
viz., investment and its comparability
with the industry’s average is seen.
There are certain factors which affect
capital budgeting decisions.
(a) Cash flows of the project: When
a company takes an investment
decision involving huge amount
it expects to generate some cash
flows over a period. These cash
flows are in the form of a series
Wealth Maximisation Concept
of cash receipts and payments
over the life of an investment.
The amount of these cash flows
decisions must be taken by those who should be carefully analysed before
understand them comprehensively. considering a capital budgeting
A bad capital budgeting decision decision.
normally has the capacity to severely (b) The rate of retur n: The most
damage the financial fortune of a important criterion is the rate
business. Short-ter m investment of return of the project. These
decisions (also called working capital calculations are based on the

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expected returns from each whether or not a firm has earned a

proposal and the assessment of profit. Likewise, the borrowed funds
the risk involved. Suppose, there have to be repaid at a fixed time. The
are two projects, A and B (with the risk of default on payment is known
same risk involved), with a rate as financial risk which has to be
of return of 10 per cent and 12 considered by a firm likely to have
per cent, respectively, then under insufficient shareholders to make
normal circumstance, project B these fixed payments. Shareholders’
should be selected. funds, on the other hand, involve no
(c) The investment criteria involved: commitment regarding the payment
The decision to invest in a particular of returns or the repayment of capital.
project involves a number of A firm, therefore, needs to have a
calculations regarding the amount judicious mix of both debt and equity
of investment, interest rate, cash in making financing decisions, which
flows and rate of return. There are may be debt, equity, preference share
different techniques to evaluate capital, and retained earnings.
inv e s t m ent p ro p o sals which The cost of each type of finance has
are known as capital budgeting to be estimated. Some sources may
techniques. These techniques are be cheaper than others. For example,
applied to each proposal before debt is considered to be the cheapest
selecting a particular project. of all the sources, tax deductibility
of interest makes it still cheaper.
Financing Decision Associated risk is also different for
This decision is about the quantum each source, e.g., it is necessary to
of finance to be raised from various pay interest on debt and redeem the
long-term sources. Short-term sources principal amount on maturity. There
are studied under the ‘working capital is no such compulsion to pay any
management’. dividend on equity shares. Thus, there
It involves identification of various is some amount of financial risk in
available sources. The main sources debt financing. The overall financial
of funds for a firm are shareholders’ risk depends upon the proportion of
funds and borrowed funds. The debt in the total capital. The fund
shareholders’ funds refer to the equity raising exercise also costs something.
capital and the retained earnings. This cost is called floatation cost.
Borrowed funds refer to the finance It also must be considered while
raised through debentures or other evaluating different sources. Financing
forms of debt. A firm has to decide the decision is, thus, concerned with the
proportion of funds to be raised from decisions about how much to be raised
either sources, based on their basic from which source. This decision
characteristics. Interest on borrowed determines the overall cost of capital
funds have to be paid regardless of and the financial risk of the enterprise.

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Financial Decisions

Factors Affecting Financing different. A prudent financial

Decisions manager would normally opt for a
The financing decisions are affected source which is the cheapest.
by various factors. Important among (b) Risk: The risk associated with each
them are as follows: of the sources is different.
(a) Cost: The cost of raising funds (c) Floatation Costs: Higher the floatation
through different sources are cost, less attractive the source.

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(d) Cash Flow Position of the Company: the choice of source of fund. During
A stronger cash flow position may the period when stock market is
make debt financing more viable rising, more people invest in equity.
than funding through equity. However, depressed capital market
(e) Fixed Operating Costs: If a business may make issue of equity shares
has high fixed operating costs (e.g., difficult for any company.
building rent, Insurance premium,
Salaries, etc.), It must reduce fixed Dividend Decision
financing costs. Hence, lower debt
financing is better. Similarly, if The third important decision that
every financial manager has to
fixed operating cost is less, more
take relates to the distribution of
of debt financing may be preferred.
dividend. Dividend is that portion
(f) Control Considerations: Issues of of profit which is distributed to
more equity may lead to dilution shareholders. The decision involved
of management’s control over here is how much of the profit earned
the business. Debt financing has by company (after paying tax) is to be
no such implication. Companies distributed to the shareholders and
afraid of a takeover bid would how much of it should be retained
prefer debt to equity. in the business. While the dividend
(g) State of Capital Market: Health of constitutes the current income
the capital market may also affect re-investment as retained earning

India Inc. Issues Bonus Shares and Dividends

Corporate India has opened its purse strings to shareholders with interim
dividends and bonus shares. At least 60 companies have declared interim dividend
or announced plans to do so in the first three weeks of January. In addition, around
12 companies have announced bonus share issues this month, about three times
more than January 2006.
There are range of things that a company can do for maximising shareholder
value and dividend is the most direct and simple form of it. Ideally companies
need to balance it up between paying cash and building value of the stock for total
shareholder returns.
This trend of dividends and bonuses is in synchronisation with the good profits
being posted by companies. It’s a way of rewarding shareholders.
A number of companies have also announced plans of bonus shares for their
shareholders. Most of the companies who have already declared bonus issues or
announced that they would be taking it up in their next board meeting are small or
mid-sized companies.
Source: The Economic Times

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increases the firm’s future earning the change in earnings is small or

capacity. The extent of retained seen to be temporary in nature.
earnings also influences the financing (d) Growth Opportunities: Companies
decision of the firm. Since the firm having good growth opportunities
does not require funds to the extent retain more money out of their
of re-invested retained earnings, the earnings so as to finance the
decision regarding dividend should required investment. The dividend
be taken keeping in view the overall in growth companies is, therefore,
objective of maximising shareholder’s smaller, than that in the non–
wealth. growth companies.
Factors Affecting Dividend (e) Cash Flow Position: The payment
Decision of dividend involves an outflow of
cash. A company may be earning
How much of the profits earned by a profit but may be short on cash.
company will be distributed as profit Availability of enough cash in
and how much will be retained in the the company is necessary for
business is affected by many factors. declaration of dividend.
Some of the important factors are
(f) Shareholders’ Preference: While
discussed as follows:
declaring dividends, managements
(a) Amount of Earnings: Dividends
must keep in mind the preferences
are paid out of current and past
of the shareholders in this regard. If
earning. Therefore, earnings is a
the shareholders in general desire
major determinant of the decision
that at least a certain amount is
about dividend.
paid as dividend, the companies
(b) Stability Earnings: Other things are likely to declare the same. There
remaining the same, a company are always some shareholders who
having stable earning is in a better depend upon a regular income
position to declare higher dividends. from their investments.
As against this, a company having (g) Taxation Policy: The choice between
unstable earnings is likely to pay the payment of dividend and
smaller dividend. retaining the earnings is, to some
(c) Stability of Dividends: Companies extent, affected by the difference in
generally follow a policy of the tax treatment of dividends and
stabilising dividend per share. The capital gains. If tax on dividend is
increase in dividends is generally higher, it is better to pay less by
made when there is confidence that way of dividends. As compared
their earning potential has gone to this, higher dividends may be
up and not just the earnings of declared if tax rates are relatively
the current year. In other words, lower. Though the dividends are free
dividend per share is not altered if of tax in the hands of shareholders,

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a dividend distribution tax is levied Financial Planning

on companies. Thus, under the
present tax policy, shareholders Financial planning is essentially the
are likely to prefer higher dividends. preparation of a financial blueprint of
an organisation’s future operations.
(h) Stock Market Reaction: Investors,
The objective of financial planning
in general, view an increase in
is to ensure that enough funds are
dividend as a good news and
stock prices react positively to it. available at right time. If adequate
Similarly, a decrease in dividend funds are not available the firm will
may have a negative impact on the not be able to honour its commitments
share prices in the stock market. and carry out its plans. On the other
Thus, the possible impact of hand, if excess funds are available, it
dividend policy on the equity share will unnecessarily add to the cost and
price is one of the important factors may encourage wasteful expenditure.
considered by the management It must be kept in mind that financial
while taking a decision about it. planning is not equivalent to, or a
(i) Access to Capital Market: Large and substitute for, financial management.
reputed companies generally have Financial management aims at
easy access to the capital market choosing the best investment and
and, therefore, may depend less financing alternatives by focusing on
on retained earning to finance their costs and benefits. Its objective
their growth. These companies is to increase the shareholders’ wealth.
tend to pay higher dividends than Financial planning on the other
the smaller companies which have hand aims at smooth operations
relatively low access to the market. by focusing on fund requirements
(j) L e g a l C o n s t r a i n t s : C e r t a i n and their availability in the light of
provisions of the Companies Act financial decisions. For example, if a
place restrictions on payouts as capital budgeting decisions is taken,
dividend. Such provisions must the operations are likely to be at a
be adhered to while declaring the higher scale. The amount of expenses
dividend. and revenues are likely to increase.
(k) Contractual Constraints: While Financial planning process tries to
granting loans to a company, forecast all the items which are likely
sometimes the lender may impose to undergo changes. It enables the
certain restrictions on the payment management to foresee the fund
of dividends in future. The requirements both the quantum as
companies are required to ensure well as the timing. Likely shortage
that the dividend does not violate and surpluses are forecast so that
the terms of the loan agreement in necessary activities are taken in
this regard. advance to meet those situations.

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Thus, financial planning strives to programmes. Short-term planning

achieve the following twin objectives. covers short-term financial plan called
(a) To ensure availability of funds budget.
whenever required: This include Typically, financial planning is
a proper estimation of the funds done for three to five years. For longer
required for different purposes periods it becomes more difficult and
such as for the purchase of long- less useful. Plans made for periods of
term assets or to meet day-to- one year or less are termed as budgets.
day expenses of business etc. Budgets are example of financial
Apart from this, there is a need to planning exercise in greater details.
estimate the time at which these They include detailed plan of action
funds are to be made available. for a period of one year or less.
Financial planning also tries to Financial planning usually begins
specify possible sources of these with the preparation of a sales forecast.
funds. Let us suppose a company is making
(b) To see that the firm does not a financial plan for the next five years.
raise resources unnecessarily: It will start with an estimate of the
Excess funding is almost as bad sales which are likely to happen in
as inadequate funding. Even if the next five years. Based on these,
there is some surplus money, good the financial statements are prepared
financial planning would put it to keeping in mind the requirement
the best possible use so that the of funds for investment in the fixed
financial resources are not left idle capital and working capital. Then the
and don’t unnecessarily add to the expected profits during the period are
cost. estimated so that an idea can be made
of how much of the fund requirements
Thus, a proper matching of funds
can be met internally i.e., through
requirements and their availability
retained earnings (after dividend
is sought to be achieved by financial
payouts). This results in an estimation
planning. This process of estimating
of the requirement for external funds.
the fund requirement of a business
Further, the sources from which the
and specifying the sources of funds
external funds requirement can be
is called financial planning. Financial
met are identified and cash budgets
planning takes into consideration the
are made, incorporating these factors.
growth, performance, investments
and requirement of funds for a given
period. Financial planning includes
Importance
both short-term as well as long-term Financial planning is an important
planning. Long-term planning relates part of overall planning of any business
to long term growth and investment. enterprise. It aims at enabling the
It focuses on capital expenditure company to tackle the uncertainty in

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respect of the availability and timing sales is predicted. However, it

of the funds and helps in smooth may happen that the growth rate
functioning of an organisation. The eventually turns out to be 10%
importance of financial planning can or 30%. Many items of expenses
be explained as follows: shall be different in these three
(i) It helps in forecasting what may situations. By preparing a
happen in future under different
blueprint of these three situations
business situations. By doing
the management may decide what
so, it helps the firms to face the
eventual situation in a better way. must be done in each of these
In other words, it makes the firm situations. This preparation of
better prepared to face the future. alternative financial plans to meet
For example, a growth of 20% in different situations is clearly of

Cutting Back on Debt

Even successful businesses have debt, but how much is too much? Learning how
to manage debt is what can put you ahead.
Taking on the right amount of debt can mean the difference between a business
struggling to survive and one that can respond nimbly to changing economic or
market conditions. A number of circumstances may justify acquiring debt. As a
general rule, borrowing makes the most sense when you need to bolster cash flow
or finance growth or expansion. But while debt can provide the leverage you need
to grow, too much debt can strangle your business. So the question is: How much
debt is too much?
The answer, experts say, lies in a careful analysis of your cash flow as well as
your industry. A business that doesn’t grow dies. You’ve got to grow, but you’ve got
to grow within the financial constraints of your business. What is the ideal capital
structure a business needs in its industry to remain viable? The higher the volatility
(in your industry), the less debt you should have. The smaller the volatility, the more
debt you can afford.
Although banks and other financial institutions look for a satisfactory debt-to-
equity ratio before agreeing to make a loan, don’t assume a creditor’s willingness
to extend funds is evidence that your business is in a strong debt position. Some
financial institutions are overzealous lenders, particularly when trying to lure
or hold on to promising business customers. “The bank may be looking more at
collateral than whether the (business’s) earnings are going to come in to justify the
debt service.
To avoid these and other credit pitfalls, it’s up to you to get the financial facts
on your business and make sound borrowing decisions. Unfortunately, many
entrepreneurs fail to recognise how important financial analysis is to running a
successful business. Even business owners who receive detailed financial statements
from their accountants often do not take advantage of the valuable information
contained in the documents.

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immense help in running the public deposits etc. These may be

business smoothly. borrowed from banks, other financial
(ii) It helps in avoiding business institutions, debentureholders and
shocks and surprises and helps public.
the company in preparing for the Capital structure refers to the mix
future. between owners and borrowed funds.
These shall be referred as equity and
(iii) If helps in co-ordinating various
debt in the subsequent text. It can
business functions, e.g., sales
be calculated as debt-equity ratio
and production functions, by
providing clear policies and  Debt 
i.e.,  or as the proportion
procedures.  Equity 
(iv) Detailed plans of action prepared
of debt out of the total capital i.e.,
under financial planning reduce
waste, duplication of efforts, and  Debt 
gaps in planning.  Debt + Equity 
.
(v) It tries to link the present with the
Debt and equity differ significantly
future.
in their cost and riskiness for the
(vi) It provid es a lin k between firm. The cost of debt is lower than
investment and financing decisions the cost of equity for a firm because
on a continuous basis. the lender’s risk is lower than the
(vii) By spelling out detailed objectives equity shareholder’s risk, since the
for various business segments, it lender earns an assured return and
makes the evaluation of actual repayment of capital and, therefore,
performance easier. they should require a lower rate of
return. Additionally, interest paid
Capital Structure on debt is a deductible expense for
computation of tax liability whereas
One of the important decisions under dividends are paid out of after-tax
financial management relates to the profit. Increased use of debt, therefore,
financing pattern or the proportion of is likely to lower the over-all cost of
the use of different sources in raising capital of the firm provided that the
funds. On the basis of ownership, the cost of equity remains unaffected.
sources of business finance can be Impact of a change in the debt-equity
broadly classified into two categories ratio upon the earning per share
viz., ‘owners’ funds’ and ‘borrowed is dealt with in detail later in this
funds’. Owners’ funds consist of chapter.
equity share capital, preference share Debt is cheaper but is more risky
capital and reserves and surpluses or for a business because the payment of
retained earnings. Borrowed funds can interest and the return of principal is
be in the form of loans, debentures, obligatory for the business. Any default

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in meeting these commitments may Capital structure of a company,

force the business to go into liquidation. thus, affects both the profitability and
There is no such compulsion in case of the financial risk. A capital structure
equity, which is therefore, considered will be said to be optimal when the
riskless for the business. Higher use proportion of debt and equity is
of debt increases the fixed financial such that it results in an increase
charges of a business. As a result, in the value of the equity share. In
increased use of debt increases the other words, all decisions relating to
financial risk of a company. capital structure should emphasise on
Financial risk is the chance that increasing the shareholders’ wealth.
a firm would fail to meet its payment The proportion of debt in the overall
obligations. capital is also called financial leverage.

Example I
Company X Ltd.
Total Funds used Rs. 30 Lakh
Interest rate 10% p.a.
Tax rate 30%
EBIT Rs. 4 Lakh
Debt
Situation I Nil
Situation II Rs. 10 Lakh
Situation III Rs. 20 Lakh

EBIT-EPS Analysis

Situation I Situation II Situation III

EBIT 4,00,000 4,00,000 4,00,000
Interest NIL 1,00,000 2,00,000
EBT 4,00,000 3,00,000 2,00,000
(Earnings before taxes)
Tax 1,20,000 90,000 60,000
EAT 2,80,000 2,10,000 1,40,000
(Earnings after taxes)
No. of shares of Rs.10 3,00,000 2,00,000 1,00,000
EPS 0.93 1.05 1.40
(Earnings per share)

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D that company is earning on funds

Financial leverage is computed as employed. The company is earning a
E
D return on investment (RoI)
or D + E when D is the Debt and E is  EBIT 
of 13.33%  × 100 
the Equity. As the financial leverage  Total Investment ,
increases, the cost of funds declines  4Lakh 
 × 100  . This is higher than
because of increased use of cheaper 30Lakh 
debt but the financial risk increases. the 10% interest it is paying on debt
The impact of financial leverage on the
funds. With higher use of debt, this
profitability of a business can be seen
difference between RoI and cost of debt
through EBIT-EPS (Earning before
Interest and Taxes-Earning per Share) increases the EPS. This is a situation
analysis as in the following example. of favourable financial leverage. In
Three situations are considered. such cases, companies often employ
There is no debt in situation-I i.e. more of cheaper debt to enhance the
(unlevered business). Debt of Rs. 10 EPS. Such practice is called Trading
lakh and 20 lakh are assumed in on Equity.
situations-II and III, respectively. All Trading on Equity refers to the
debt is at 10% p.a. increase in profit earned by the equity
The company earns Rs. 0.93 per shareholders due to the presence of
share if it is unlevered. With debt of fixed financial charges like interest.
Rs. 10 lakh its EPS is Rs. 1.05. With Now consider the following case of
a still higher debt of Rs. 20 lakh, its, Company Y. All details are the same
EPS rises to Rs. 1.40. Why is the EPS except that the company is earning
rising with higher debt? It is because a profit before interest and taxes of
the cost of debt is lower than the return Rs. 2 lakh.

Example II

Company Y Ltd.
Situation I Situation II Situation III
EBIT 2,00,000 2,00,000 2,00,000
Interest NIL 1,00,000 2,00,000
EBT 2,00,000 1,00,000 NIL
Tax 60,000 30,000 NIL
EAT 1,40,000 70,000 NIL
No. of shares of Rs.10 3,00,000 2,00,000 1,00,000
EPS 0.47 0.35 NIL

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In this example, the EPS of the borrowing. Cash flows must not only
company is falling with increased use cover fixed cash payment obligations
of debt. It is because the Company’s but there must be sufficient buffer
rate of return on investment (RoI) is also. It must be kept in mind that a
less than the cost of debt. The RoI company has cash payment obligations
2Lakh for (i) normal business operations;
for company Y is × 100 , i.e.,
30Lakh (ii) for investment in fixed assets;
6.67%, whereas the interest rate on and (iii) for meeting the debt service
debt is 10%. In such cases, the use commitments i.e., payment of interest
of debt reduces the EPS. This is a and repayment of principal.
situation of unfavourable financial 2. Interest Coverage Ratio (ICR):
leverage. Trading on Equity is clearly The interest coverage ratio refers to
unadvisable in such a situation. the number of times earnings before
Even in case of Company X, interest and taxes of a company covers
reckless use of Trading on Equity is the interest obligation. This may be
not recommended. An increase in debt calculated as follows:
may enhance the EPS but as pointed
EBIT
out earlier, it also raises the financial ICR =
Interest
risk. Ideally, a company must choose
that risk-return combination which The higher the ratio, lower shall
maximises shareholders’ wealth. The be the risk of company failing to
debt-equity mix that achieves it, is the meet its interest payment obligations.
optimum capital structure. However, this ratio is not an adequate
measure. A firm may have a high EBIT
Factors affecting the Choice of
but low cash balance. Apart from
Capital Structure
interest, repayment obligations are
Deciding about the capital structure also relevant.
of a firm involves determining the 3. Debt Service Coverage Ratio
relative proportion of various types (DSCR): Debt Service Coverage Ratio
of funds. This depends on various
takes care of the deficiencies referred
factors. For example, debt requires
to in the Interest Coverage Ratio (ICR).
regular servicing. Interest payment
The cash profits generated by the
and repayment of principal are
obligatory on a business. In addition operations are compared with the total
a company planning to raise debt cash required for the service of the
must have sufficient cash to meet the debt and the preference share capital.
increased outflows because of higher It is calculated as follows:
debt. Similarly, important factors Profit after tax + Depreciation + Interest + Non Cash exp.

which determine the choice of capital Pref. Div + Interest + Repayment obligation

structure are as follows: A higher DSCR indicates better

1. Cash Flow Position: Size of projected ability to meet cash commitments
cash flows must be considered before and consequently, the company’s

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potential to increase debt component reason that a company can not use
in its capital structure. debt beyond a point. If debt is used
4. Return on Investment (RoI): If beyond that point, cost of equity may
the RoI of the company is higher, it go up sharply and share price may
can choose to use trading on equity decrease inspite of increased EPS.
to increase its EPS, i.e., its ability to Consequently, for maximisation of
use debt is greater. We have already shareholders’ wealth, debt can be used
observed in Example I that a firm only upto a level.
can use more debt to increase its 8. Floatation Costs: Process of
EPS. However, in Example II, use of raising resources also involves some
higher debt is reducing the EPS. It is cost. Public issue of shares and
because the firm is earning an RoI of debentures requires considerable
only 6.67% which lower than its cost expenditure. Getting a loan from a
of debt. In example I the RoI is 13.33%, financial institution may not cost so
and trading on equity is profitable. much. These considerations may also
It shows that, RoI is an important affect the choice between debt and
determinant of the company’s ability equity and hence the capital structure.
to use Trading on equity and thus the 9. Risk Consideration: As discussed
capital structure. earlier, use of debt increases the
5. Cost of debt: A firm’s ability to financial risk of a business. Financial
borrow at a lower rate increases its risk refers to a position when a
capacity to employ higher debt. Thus, company is unable to meet its fixed
more debt can be used if debt can be financial charges namely interest
raised at a lower rate. payment, preference dividend and
6. Tax Rate: Since interest is a repayment obligations. Apart from
deductible expense, cost of debt is the financial risk, every business
affected by the tax rate. The firms in has some operating risk (also called
our examples are borrowing @ 10%. business risk). Business risk depends
Since the tax rate is 30%, the after upon fixed operating costs. Higher
tax cost of debt is only 7%. A higher fixed operating costs result in higher
tax rate, thus, makes debt relatively business risk and vice-versa. The total
cheaper and increases its attraction risk depends upon both the business
vis-à-vis equity. risk and the financial risk. If a firm’s
7. Cost of Equity: Stock owners business risk is lower, its capacity to
expect a rate of return from the equity use debt is higher and vice-versa.
which is commensurate with the risk 10. Flexibility: If a firm uses its
they are assuming. When a company debt potential to the full, it loses
increases debt, the financial risk flexibility to issue further debt. To
faced by the equity holders, increases. maintain flexibility, it must maintain
Consequently, their desired rate of some borrowing power to take care of
return may increase. It is for this unforeseen circumstances.

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11. Control: Debt normally does business risk of a firm is higher, it can
not cause a dilution of control. A not afford the same financial risk. It
public issue of equity may reduce the should go in for low debt. Thus, the
managements’ holding in the company management must know what the
and make it vulnerable to takeover. industry norms are, whether they are
This factor also influences the choice following them or deviating from them
between debt and equity especially in and adequate justification must be
companies in which the current holding there in both cases.
of management is on a lower side.
12. Regulatory Framework: Every Fixed and Working Capital
company operates within a regulatory Meaning
framework provided by the law e.g.,
Every company needs funds to finance
public issue of shares and debentures
its assets and activities. Investment
have to be made under SEBI
is required to be made in fixed assets
guidelines. Raising funds from banks
and current assets. Fixed assets are
and other financial institutions require
fulfillment of other norms. The relative those which remains in the business
ease with which these norms can, be for more than one year, usually
met or the procedures completed may for much longer, e.g., plant and
also have a bearing upon the choice of machinery, furniture and fixture, land
the source of finance. and building, vehicles, etc.
Decision to invest in fixed assets
13. Stock Market Conditions: If the
must be taken very carefully as the
stock markets are bullish, equity
investment is usually quite large. Such
shares are more easily sold even at
decisions once taken are irrevocable
a higher price. Use of equity is often
except at a huge loss. Such decisions
preferred by companies in such a
are called capital budgeting decisions.
situation. However, during a bearish
Current assets are those assets
phase, a company, may find raising
which, in the normal routine of the
of equity capital more difficult and it
business, get converted into cash or
may opt for debt. Thus, stock market
cash equivalents within one year, e.g.,
conditions often affect the choice
inventories, debtors, bills receivables,
between the two.
etc.
14. Capital Structure of other
Companies: A useful guideline in the Management of Fixed Capital
capital structure planning is the debt- Fixed capital refers to investment in
equity ratios of other companies in long-term assets. Management of fixed
the same industry. There are usually capital involves allocation of firm’s
some industry norms which may help. capital to different projects or assets with
Care however must be taken that the long-term implications for the business.
company does not follow the industry These decisions are called investment
norms blindly. For example, if the decisions or capital budgeting decisions

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and affect the growth, profitability and is undertaken. This may involve
risk of the business in the long run. decisions like where to procure
These long-term assets last for more funds from and at what rate of
than one year. interest.
It must be financed through (iii) Risk involved: Fixed capital involves
long-term sources of capital such investment of huge amounts. It
as equity or preference shares, affects the returns of the firm as a
debentures, long-term loans and whole in the long-term. Therefore,
retained earnings of the business. investment decisions involving
Fixed Assets should never be financed fixed capital influence the overall
through short-term sources. business risk complexion of the
Investment in these assets firm.
would also include expenditure on
acquisition, expansion, modernisation (iv) Irreversible decisions: These
and their replacement. These decisions decisions once taken, are not
include purchase of land, building, reversible without incurring heavy
plant and machinery, launching losses. Abandoning a project after
a new product line or investing in heavy investment is made is quite
advanced techniques of production. costly in terms of waste of funds.
Major expenditures such as those Therefore, these decisions should
on advertising campaign or research be taken only after carefully
and development programme having evaluating each detail or else the
long term implications for the firm adverse financial consequences
are also examples of capital budgeting may be very heavy.
decisions. The management of fixed
Factors affecting the Requirement
capital or investment or capital
of Fixed Capital
budgeting decisions are important for
the following reasons: 1. Nature of Business: The type
(i) Long-term growth: These decisions of business has a bearing upon
have bearing on the long-term the fixed capital requirements. For
growth. The funds invested in example, a trading concern needs
long-term assets are likely to yield lower investment in fixed assets
returns in the future. These will compared with a manufacturing
affect the future prospects of the organisation; since it does not require
business. to purchase plant and machinery, etc.
(ii) Large amount of funds involved: 2. Scale of Operations: A larger
These decisions result in a organisation operating at a higher
substantial portion of capital funds scale needs bigger plant, more space
being blocked in long-term projects. etc. and therefore, requires higher
Therefore, these investments are investment in fixed assets when
planned after a detailed analysis compared with the small organisation.

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3. Choice of Technique: Some textile company is diversifying and

organisations are capital intensive starting a cement manufacturing
whereas others are labour intensive. plant. Obviously, its investment in
A capital-intensive organisation fixed capital will increase.
requires higher investment in plant 7. Financing Alternatives: A developed
and machinery as it relies less on financial market may provide leasing
manual labour. The requirement of facilities as an alternative to outright
fixed capital for such organisations purchase. When an asset is taken on
would be higher. Labour intensive lease, the firm pays lease rentals and
organisations on the other hand uses it. By doing so, it avoids huge sums
require less investment in fixed assets. required to purchase it. Availability of
Hence, their fixed capital requirement leasing facilities, thus, may reduce the
is lower. funds required to be invested in fixed
4. Technology Upgradation: In certain assets, thereby reducing the fixed
industries, assets become obsolete capital requirements. Such a strategy
sooner. Consequently, their replace- is specially suitable in high risk lines
ments become due faster. Higher of business.
investment in fixed assets may, 8. Level of Collaboration: At times,
therefore, be required in such cases. certain business organisations share
For example, computers become each other’s facilities. For example,
obsolete faster and are replaced much a bank may use another’s ATM or
sooner than say, furniture. Thus, such some of them may jointly establish a
organisations which use assets which particular facility. This is feasible if the
are prone to obsolescence require scale of operations of each one of them
higher fixed capital to purchase such is not sufficient to make full use of the
assets. facility. Such collaboration reduces
5. Growth Prospects: Higher growth the level of investment in fixed assets
of an organisation generally requires for each one of the participating
higher investment in fixed assets. organisations.
Even when such growth is expected,
a company may choose to create Working Capital
higher capacity in order to meet the
Apart from the investment in fixed
anticipated higher demand quicker.
assets every business organisation
This entails larger investment in fixed
needs to invest in current assets. This
assets and consequently larger fixed investment facilitates smooth day-to-
capital. day operations of the business. Current
6. Diversification: A firm may choose assets are usually more liquid but
to diversify its operations for various contribute less to the profits than fixed
reasons, With diversification, fixed assets. Examples of current assets, in
capital requirements increase e.g., a order of their liquidity, are as under.

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1. Cash in hand/Cash at Bank if it can be converted into cash quicker

2. Marketable securities and without reduction in value.
Insufficient investment in current
3. Bills receivable
assets may make it more difficult for
4. Debtors an organisation to meet its payment
5. Finished goods inventory obligations. However, these assets
provide little or low return. Hence, a
6. Work in progress
balance needs to be struck between
7. Raw materials liquidity and profitability.
8. Prepaid expenses Current liabilities are those
These assets, as noted earlier, are payment obligations which are due
expected to get converted into cash for payment within one year; such as
or cash equivalents within a period bills payable, creditors, outstanding
of one year. These provide liquidity to expenses and advances received from
the business. An asset is more liquid customers, etc.

Working Capital Position

“Its been a rather glamorous 18 months, with sales just huge,” says, CFO of PT
Astra International, the US $4 billion in sales Indonesian automaker. Indonesia
was on the growth path again, and a new breed of consumer was eager for a first
vehicle – motorcycles – as well as Astra’s more premium brands of Hondas and
Toyotas. And one of the most beautiful parts of the proposition was that working
capital management seems to be taking care of itself. “Depending on the business,
and counting trade receivables only, we had between eight and 19 days working
capital,” which was manageable given the company’s steady growth. One of the
reasons that working capital had not expanded at the rate of the business was
inventory, or rather the dearth of it. “We were in a market that responded very
strongly to new products,” said the manager “and the presales of products were very
high. We had advanced orders form four to six months, with deposits paid, and this
helped our cash position.” Best of all, as soon as a vehicle was off the assembly line,
it was out to the dealer. “We had low inventory costs and the product lines were
very easy to move.” The salutary role of banks in working capital management was
a result reason that cashflow had improved in his business. Better management
was a result of banking competition that had allowed the company to move from
traditional bankers, the state-owned Indian institutions, to more competitive private
institutions and teh foreign banks that partner with them. These banks had invested
in technology, allowing a visibility over cashflow unheard of few years ago.

http://www.cfoasia.com/archives/200503-02.html

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Some part of current assets is to the organisations which operate on a

usually financed through short-term lower scale.
sources, i.e., current liabilities. The 3. Business Cycle: Different phases of
rest is financed through long-term business cycles affect the requirement
sources and is called net working of working capital by a firm. In
capital. Thus, NWC = CA – CL (i.e. case of a boom, the sales as well as
Current Assets - Current Liabilities.) production are likely to be larger and,
Thus, net working capital may be therefore, larger amount of working
defined as the excess of current assets capital is required. As against this,
over current liabilities. the requirement for working capital
will be lower during the period of
Factors Affecting the Working depression as the sales as well as
Capital Requirements production will be small.
1. Nature of Business: The basic 4. Seasonal Factors: Most business
nature of a business influences the have some seasonality in their
amount of working capital required. operations. In peak season, because of
A trading organisation usually higher level of activity, larger amount
needs a smaller amount of working of working capital is required. As
capital compared to a manufacturing against this, the level of activity as well
organisation. This is because there as the requirement for working capital
is usually no processing. Therefore, will be lower during the lean season.
there is no distinction between raw 5. Production Cycle: Production
materials and finished goods. Sales cycle is the time span between the
can be effected immediately upon receipt of raw material and their
the receipt of materials, sometimes conversion into finished goods. Some
even before that. In a manufacturing businesses have a longer production
business, however, raw material needs cycle while some have a shorter
to be converted into finished goods one. Duration and the length of
before any sales become possible. production cycle, affects the amount
Other factors remaining the same, a of funds required for raw materials
trading business requires less working and expenses. Consequently, working
capital. Similarly, service industries capital requirement is higher in firms
which usually do not have to maintain with longer processing cycle and lower
inventory require less working capital. in firms with shorter processing cycle.
2. Scale of Operations: For organisations 6. Credit Allowed: Different firms
which operate on a higher scale of allow different credit terms to their
operation, the quantum of inventory and customers. These depend upon the
debtors required is generally high. Such level of competition that a firm faces
organisations, therefore, require large as well as the credit worthiness of their
amount of working capital as compared clientele. A liberal credit policy results

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in higher amount of debtors, increasing the lead time, larger the quantity of
the requirement of working capital. material to be stored and larger shall
7. Credit Availed: Just as a firm be the amount of working capital
allows credit to its customers it also required.
may get credit from its suppliers. 10. Growth Prospects: If the growth
To the extent it avails the credit potential of a concern is perceived to
on purchases, the working capital be higher, it will require larger amount
requirement is reduced. of working capital so that it is able
8. Operating Efficiency: Firms to meet higher production and sales
manage their operations with varied target whenever required.
degrees of efficiency. For example, 11. Level of Competition: Higher level
a firm managing its raw materials of competitiveness may necessitate
efficiently may be able to manage with larger stocks of finished goods to
a smaller balance. This is reflected
meet urgent orders from customers.
in a higher inventory turnover ratio.
This increases the working capital
Similarly, a better debtors turnover
requirement. Competition may also
ratio may be achieved reducing the
force the firm to extend liberal credit
amount tied up in receivables. Better
terms discussed earlier.
sales effort may reduce the average
time for which finished goods inventory 12. Inflation: With rising prices,
is held. Such efficiencies may reduce larger amounts are required even
the level of raw materials, finished to maintain a constant volume of
goods and debtors resulting in lower production and sales. The working
requirement of working capital. capital requirement of a business
9. Availability of Raw Material: If thus, become higher with higher rate
the raw materials and other required of inflation. It must, however, be noted
materials are available freely and that an inflation rate of 5%, does not
continuously, lower stock levels may mean that every component of working
suffice. If, however, raw materials do capital will change by the same
not have a record of un-interrupted percentage. The actual requirement
availability, higher stock levels may shall depend upon the rates of price
be required. In addition, the time lag change of different components (e.g.,
between the placement of order and raw material, finished goods, labour
the actual receipt of the materials (also cost,) Finished goods as well as their
called lead time) is also relevant. Larger proportion in the total requirement.

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Key Terms
Financial Management Wealth Maximisation Investment Decision
Financing Decision Dividend Decision Capital Budgeting
Working Capital Financial Planning Capital Structure
Trading on Equity

Summary
Business finance: The money required for carrying out business activities is
called business finance. Almost all business activities require some finance.
Finance is needed to establish a business, to run it, to modernise it, to expand,
and diversify it.
Financial Management: Financial Management is concerned with optimal
procurement as well as usage of finance. For optimal procurement, different
available sources of finance are identified and compared in terms of their costs
and associated risks.
Objectives and Financial Decisions The primary aim of financial management
is to maximise shareholders’ wealth which is referred to as the wealth
maximisation concept. The market price of a company’s shares are linked to
the three basic financial decisions
Financial decision-making is concerned with three broad decisions which are
Investment Decision, Financing Decision, Dividend Decision

Financial Planning and Importance Financial planning is essentially

preparation of a financial blueprint of an organisation’s future operations. The
objective of financial planning is to ensure that enough funds are available at
right time.
Financial planning strives to achieve the following twin objectives.
(a) To ensure availability of funds whenever these are required:
(b) To see that the firm does not raise resources unnecessarily:
Financial planning is an important part of overall planning of any business
enterprise. It aims at enabling the company to tackle the uncertainty in respect
of the availability and timing of the funds and helps in smooth functioning of
an organisation.

Capital Structure and Factors One of the important decisions under financial
management relates to the financing pattern or the proportion of the use
of different sources in raising funds. On the basis of ownership, the sources

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of business finance can be broadly classified into two categories viz., ‘owners
funds’ and ‘borrowed funds’. Capital structure refers to the mix between owners
and borrowed funds.
Deciding about the capital structure of a firm involves determining the
relative proportion of various types of funds. This depends on various factors
which are: Cash Flow Position, Interest Coverage Ratio (ICR), Debt Service
Coverage Ratio (DSCR), Return on Investment (RoI), Cost of debt, Tax Rate,
Cost of Equity, Floatation Costs, Risk Consideration, Flexibility, Control,
Regulatory Framework, Stock Market Conditions, and Capital Structure of
other Companies.

Fixed and Working Capital Fixed capital refers to investment in long-term

assets. Management of fixed capital involves around allocation of firm’s capital
to different projects or assets with long-term implications for the business.
These decisions are called investment decisions or capital budgeting decisions.
They affect the growth, profitability and risk of the business in the long run.
Factors affecting the Requirement of Fixed Capital are: Nature of Business,
Scale of Operations, Choice of Technique, Technology Upgradation, Growth
Prospects, Diversification, Financing Alternatives and Level of Collaboration.
Apart from the investment in fixed assets, every business organisation
needs to invest in current assets. This investment facilitates smooth day-to-
day operations of the organisation. Current assets are usually more liquid but
contribute less to the profits than fixed assets.
Factors affecting the working capital requirement are: Nature of Business,
Scale of Operations, Business Cycle, Seasonal Factor, Production Cycle, Credit
Allowed, Credit Availed, Operating Efficiency, Availability of Raw Material,
Growth Prospects, Level of competition, and rate of Inflation.

exercises

Very Short Answer Type

1. What is meant by capital structure?
2. Sate the two objectives of financial planning.
3. Name the concept of financial management which increases the return
to equity shareholders due to the presence of fixed financial charges.
4. Amrit is running a ‘transport service’ and earning good returns by
providing this service to industries. Giving reason, state whether the
working capital requirement of the firm will be ‘less’ or ‘more’.

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5. Ramnath is into the business of assembling and selling of televisions.

Recently he has adopted a new policy of purchasing the components on
three months credit and selling the complete product in cash. Will it affect
the requirement of working capital? Give reason in support of your answer.
Short Answer Type
1. What is financial risk? Why does it arise?
2. Define current assets? Give four examples of such assets.
3. What are the main objectives of financial management? Briefly explain.
4. Financial management is based on three broad financial decisions. What
are these?
5. Sunrises Ltd. dealing in readymade garments, is planning to expand
its business operations in order to cater to international market. For
this purpose the company needs additional `80,00,000 for replacing
machines with modern machinery of higher production capacity. The
company wishes to raise the required funds by issuing debentures. The
debt can be issued at an estimated cost of 10%. The EBIT for the previous
year of the company was `8,00,000 and total capital investment was
`1,00,00,000. Suggest whether issue of debenture would be considered
a rational decision by the company. Give reason to justify your answer.
(Ans. No, Cost of Debt (10%) is more than ROI which is 8%).
6. How does working capital affect both the liquidity as well as profitability
of a business?
7. Aval Ltd. is engaged in the business of export of canvas goods and bags. In
the past, the performance of the company had been upto the expectations.
In line with the latest demand in the market, the company decided to
venture into leather goods for which it required specialised machinery.
For this, the Finance Manager Prabhu prepared a financial blueprint
of the organisation’s future operations to estimate the amount of funds
required and the timings with the objective to ensure that enough funds
are available at right time. He also collected the relevant data about the
profit estimates in the coming years. By doing this, he wanted to be sure
about the availability of funds from the internal sources of the business.
For the remaining funds, he is trying to find out alternative sources from
outside.
a. Identify the financial concept discussed in the above paragraph. Also,
state the objectives to be achieved by the use of financial concept so
identified. ( Financial Planning).
b. ‘There is no restriction on payment of dividend by a company’.
Comment. ( Legal & Contractual Constraints)

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Long Answer Type

1. What is working capital? Discuss five important determinants of working
capital requirement?
2. “Capital structure decision is essentially optimisation of risk-return
relationship.” Comment.
3. “A capital budgeting decision is capable of changing the financial fortunes
of a business.” Do you agree? Give reasons for your answer?
4. Explain the factors affecting dividend decision?
5. Explain the term ‘Trading on Equity’? Why, when and how it can be used
by company.
6. ‘S’ Limited is manufacturing steel at its plant in India. It is enjoying a
buoyant demand for its products as economic growth is about 7–8 per
cent and the demand for steel is growing. It is planning to set up a new
steel plant to cash on the increased demand. It is estimated that it will
require about `5000 crores to set up and about `500 crores of working
capital to start the new plant.
a. Describe the role and objectives of financial management for this
company.
b. Explain the importance of having a financial plan for this company.
Give an imaginary plan to support your answer.
c. What are the factors which will affect the capital structure of this
company?
d. Keeping in mind that it is a highly capital-intensive sector, what factors
will affect the fixed and working capital. Give reasons in support of
your answer.

Rationalised 2023-24

Ch_9.indd 241 10-08-2022 09:09:53