Today we are going to discuss the new chapter of business studies CBSE class 11 that is Financial Management.
Also, we are going to give you study notes, video lectures and also PDF of handly lecture notes. Firstly, I want to share with you what are all the topics which we are going to cover in this article. Also, you can watch all the chapters videos on my YouTube channel by clicking here.
Topics covered in the financial management are as follows:-
- Meaning & Concept of financial management
- Objectives of financial management
- Role of financial management
- Financial management decisions
- Financial decision
- Investment decision
- Dividend decision
- Capital structure
- Case study of financial management
Meaning & Concept of Financial Management
Financial management means how to manage your money in a proper way. Every financial management has to take care that where ever they are investing money gives them huge output back.
But in the business terms we can say that financial management means “It is a process of acquiring funds optimally (at the minimum cost possible keeping the risk factor also very low) and utilizing them in the best possible manner to maximize shareholder’s wealth).
Objectives of Financial Management
The objective of financial management is the maximization of shareholder’s wealth. The is one formula for calculating shareholder’s wealth.
Shareholder’s wealth = Number of shares possessed by shareholder * Market price of a share
Role of Financial Management
The role of financial management is very important as the following activities are influenced by financial management.
1_ Size and composition of fixed assets (Fixed capital decision)
2_ Size and composition of current assets (Working capital management decision)
3_ Financing decision (Amount of debt or equity to be used)
4_ Financing decision (Amount of long-term funds or short-term funds to be used for financing)
5_ All the items in the profit & loss account (sale expenses, depreciation, etc).
Financial Management Decisions
We can manage our business finance properly by taking three decisions they are:-
- Financial decision
- Investment decision
- Dividend decision
In this decision companies need to think deeply about whether to take finance from debt or equity. So factors of finance decision are:-
- If the cost of the business is low and profit is high then the company borrows money from a debt.
- But if the cost of the business is high and the profit is low then the company borrows money from equity.
- If the business is riskier then the company borrows money from equity.
- If the business is less risky then the company borrows money from a debt.
III) State of capital market
- When the stock market is in a bearish/bear period(loss period) then the company borrows money from a debt.
- When the stock market is in a bull/bullish period (profit period) then the company borrows money from the equity.
IV) Floatation cost
- If the company wants to low the floatation cost then it borrows money from a debt.
- If the company wants to increase the floatation cost then it borrows money from equity.
V) Cash flow position
- If the company has a high cash flow position then it borrows money from a debt.
- If the company has a low cash flow position then it borrows money from equity.
VI) Fixed operating cost
- If the fixed operating cost of the business is low and profit is high then the company borrows money from a debt.
- If the fixed operating cost of the business is high and profit is low then the company borrows money from equity.
VII) Control consideration
- If the company does not want to share its power then it borrows money from a debt.
- But if the company wants to share its power then it borrows money from equity.
Investment decision means a decision which involves the choice of how the funds will be invested in the short or long term asset.
So, Investment decision are of two types:-
- Short term investment decision
- Long term investment decision
Short Term Investment Decision
It is also called working capital decision. Those things which are used in business on daily basis.
Working capital decision can be classified as –
A) Credit allowed – If credit is allowed in a business then its working capital requirement is more.
B) Credit avail – If credit is not allowed in a business then its working capital requirement is less.
C) Scale of operation – More work of business require more capital requirement and vice versa.
D) Seasonal factor – Seasonal factor also affects capital requirement. Example – Production of raincoat increases in rainy season.
E) Level of competition – Increase of competition also increases capital requirement.
F) Growth prospects – Growth of business increases the scale of operation, which automatically increases the working capital requirement.
G) Inflation – When inflation increases, the price of products also increases, then the labor cost is also increased which increases working capital requirement.
H) Nature of business – Different types of business require different quantities of working capital requirements. Example – The steel industry requires more working capital requirements (machines) than the fashion industry.
I) Operating efficiency – More the efficiency of the business less is the working capital requirement and vice versa.
J) Business cycle – If the company is in the boom period then the company becomes financially stronger, whereas when the company is in the depression period then the company becomes financially weak.
K) Production Cycle – If the scale of operation of business increases then we need more machines, the requirement of more machines automatically increases working capital requirement.
Long Term Investment Decision – They are also called fixed assets or capital budgeting decisions.
Fixed assets are those assets that can be used by the company for 1 year or more than 1 year. Example – machines are fixed assets for any company.
Fixed assets can be classified as –
A) Nature of business – Different types of business require different quantities of fixed assets. Example – The steel industry requires more fixed assets (machines) than the fashion industry.
B) Level of collaboration – If two or more people collaborate then we can share the price of machine.
C) Choice of techniques – Use of labor decreases capital requirement whereas the use of machines increases capital requirement.
D) Diversification – Diversification of business increases fixed capital requirement.
E) Growth prospects – Growth in business also increases fixed capital requirement.
F) The scale of operation – If the scale of operation of business increases then we need more machines, the requirement of more machines automatically increases fixed capital requirement.
G) Technology upgradation – Growth in technology also increases fixed capital requirement.
H) Financing alternative(Mortgage) – Lease financing(Mortgaging) decreases the fixed capital requirement.
The dividend decision is Appropriate distribution of the profit between different shareholders is called Dividend decision.
Factors affecting Dividend decision are:-
A) Cash flow position – If the cash flow is more in a company then the company gives more money to its shareholders and vice versa.
B) Contractual constants – Financers prohibit the company to not give the money to shareholders if the company is in long term loan or debt.
C) Stability of earning – If the stability of earning is more in a company then it gives more divident(profit to shareholders) and vice versa.
D) Stability of Divident – The company sometimes fixes certain percent which is given as Divident whether the company is in profit or loss.
E) Stock market reaction – If the company gives more Divident to its shareholders then the stock market is in good position and vice versa.
F) Legal restrictions – According to company act if the company is earning profit then only it can give Divident to its shareholders otherwise not.
G) Access to capital market consideration – If the company gets access(entry) to the stock market then it can invest more money and also can give more Dividend to its shareholders.
H) Growth opportunity – If the company knows that it can grow in the future and earning more profit then, the company gives fewer dividends to its shareholders and vice versa.
I) Amount of earning – Any company earning more will also gives more money to its shareholders and vice versa.
J) Taxation policy – If the company is giving more tax to the government then it gives less Dividend to its shareholders and vice versa.
It is the proportion of debt and equity in raising funds for doing business. In other words, it is the mixture of owner’s funds and borrowed funds.
Factors affecting capital structure are:-
1_ Debt service coverage ratio (DSCR)
DSCR indicates ability of a firm to service its debt. It is the better indicator than ICR.
2_ Interest coverage ratio (ICR)
It is the number of times earnings before interest and tax can cover the interest on debt taken by the firm. It indicates the firm’s ability to serve the interest on the debt taken.
3_ Cash flow position
Debt should be taken only if the cash flow position of a company is in a good position or we can say its cash flow sounds good.
4_ Cost of debt
Debt can be taken if it is available at a lower interest rate.
5_ Cost of equity
The cost of equity means the cost of equity becomes high in case debt is taken beyond a level. This happens due to the increased burden of debt on equity shareholders who expect a higher dividend.
So, Guys, we have finally over with this chapter.
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