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Dividend Decision.

(a) Capital structure.

(b) (i) Cash flow position

(ii) Floatation cost

(iii) Risk consideration

(iv) Tax rate

(v) Control

1. (a) (B) Capital Structure

2. (C) Higher degree of financial risk

3. (B) Financial Leverage

4. (D) Trading on Equity

(A) Profit maximization and
(B) Wealth maximization

Share holder's wealth maximisation.

Wealth maximisation objective of financial management is achieved by performing the following financial activities:

(i) Judicious utilisation of funds so that funds find their best place in terms of risk and return.

(ii) Optimum financing mix so that overall cost of fund remains minimum.

(iii) Appropriate proportion of dividend and retained earnings out of profit earned so as to meet long-term and short-term financial needs of shareholders.

Planning can be defined as a process of setting goals and objectives for a given period of time, evaluating alternatives for the course of action and deciding an appropriate action from various alternatives. 

The importance of planning can be explained through the following points: 

i. Renders direction - Planning clearly states the goals and objectives to be achieved. Thus, it acts as a guide for the actions to be taken. Further, it guides the managers on things to be done, routes to taken and objectives to be achieved. It ensures that the path taken for the accomplishment of goals is righteously chosen. 

ii. Subdues risks - By guiding the organisation in the right direction, it accredits its managers to analyse and anticipate changes. This leads to a reduction in the uncertainty of foreseen events. Planning shows how to deal with situations that may arise in the due course of management, though it does not fully eliminate the problems. 

iii. Minimises overlapping - As the managers are well comprehended on the policies and plans of the organisation, 

they can coordinate the activities together to fulfil the objectives. Thus, overlapping of work is reduced. Also, any wastage of resources that may take place due to repetitiveness is reduced. 

iv. Encourages creativity - Planning includes formulation of policies and plans requiring innovation. It is a crucial activity that demands the best of managers with apt thinking and creativity. It calls out for new ideas by the management to attain the goals. 

v. Helps in decision making - Planning serves as the basis for decision making. It involves steps like analysing the future, evaluating various courses of action and choosing the best alternative as per the objective. Thus, a proper planning process helps managers in taking rational decisions. 

vi. Essential for controlling - Planning states the objectives that are to be achieved. Thus, it sets the standards on which the overall performance is to be evaluated. It also helps in determining whether there is any deviation from the said objectives. This further helps in taking corrective measures if required.

The long term finance is required for the development programs such as an expansion of the level of production, modernization of production methods, etc. The long term finance is raised by Joint Stock Companies through the issue of Shares and Debentures. Issue of shares and debentures play an important role in long term credit.

Issue of Shares: The capital of a joint stock company is divided into a small unit called shares. To start a joint stock company, the promoters issue shares. Also whenever they need additional capital for a long term purpose, the companies raise the funds through the issues of shares to the public.

Debentures: The joint stock companies are empowered to borrow finance for meeting long term financial requirements through the issues of debentures. Debentures are the debts or loans borrowed by the companies. A company under its common seal acknowledges a debt to some persons containing an undertaking to repay the debt after a specified period. A fixed rate of interest is paid to the debenture holders at regular intervals.

It refers to the aggregate of current assets.

Gross working capital v/s net working capital.

Correct option is (A) Excess of current assets over current liabilities

Net working capital:

Net working capital means current assets minus current liabilities.

Therefore, Net working capital = Current assets – Current liabilities

• If current assets > current liabilities, it is called positive working capital.
• If current assets < current liabilities, it is called negative working capital.

Characteristics of working capital:

1. Short term capital: Working capital is a short term capital.
2. Investment in current assets: Working capital (Gross) is used in current assets such as bill receivables, debtors, short term marketable securities, bank balance, cash, etc.
3. Liquidity: Liquidity is the basic feature of working capital. All the current assets in which working capital is employed are converted into cash easily.
4. Less risk: Working capital gets circulated for short term and it is easily convertible cash (i.e. it has high liquidity). Hence, there is less risk in working capital.
5. Changing form: The form of working capital keeps on changing constantly. For example, raw material is converted into semi-finished goods and finally into finished goods. Finished goods are converted into debtors if they get sold on credit, and into cash, if sold on cash.
6. To pay day-to-day expenses: Working capital is needed constantly to pay day-to-day expenses.
7. No depreciation: Since the form of working capital keeps on changing, its depreciation is not calculated.
8. Requirement according to type and form of business: Need of working capital depends upon the form and type of business. Thus its ratio is different in each business.

Characteristics of Working Capital:

• Short-Term Capital
• Investment in current assets
• Liquidity
• Less Risk,
• Changing Form
• No Depreciation
• Requirement according to Type and Form of Business and
• To pay Day-to-Day expenses.

(a) (i) Money Market 

(ii) Capital Market 

(b) Primary Market 

(c) Secondary Market 

(d) Economic Growth

Financial planning is concern with the preparation of a financial blueprint of an organization for future operations. Financial planning is the process of determining the objectives, policies, procedure and programs to deal with the financial activities of an organization.

Estimating capital requirement: Financial Management makes the estimation of both short term & long term financial needs to make the smooth running of a business.

• Short Term Financial Needs: Refers to the financial requirement for a period within one year or financially required to meet day to day expenses. 
• Long Term Financial Needs: Refers to the financial requirements for a period exceeding one year.

Capital budgeting: It refers to the long term funds. Capital can be raised in two ways either debts or Equity. Capital budgeting decides the composition of debt & equity in the long term finance of an organization.

Working capital marketing: Excess of current assets over current liabilities represents the working capital of an organization. To ensure the smooth working of an organization it should have sufficient working capital to meet the day to day needs.

Appraisal of financial performance & financial control: Financial Management provides various financial tools such as Ration analysis, Budgeting, Variance analysis. It helps the management to control the financial activities of the organization.

Making financial decisions: Financial Management is concerned with financial decisions relates to the composition of assets. Capital & Investment. Sound financial decisions are made depending on risk & return.

Solution to financial problem: A good financial management helps the top management by providing financial information and also solutions to various financial problems.

Communication of financial performance: It is used to measure profitability & liquidity of the business. The various stakeholders who are keen about the financial performance of the organization are Shareholders, Creditors, Investors, Economists, Employees and Government.

The working and fixed capital requirement of’S’ Limited will be high due to the following reasons.

1. The business is capital intensive and the scale of operation is large. 

2. Heavy investments are required for building up the production base and for technological up-gradation 

3. In case of steel industry, the major input is iron ore and coal. The ratio of cost of raw material to total cost is very high. Hence, higher will be the need for working capital. 

4. The longer the operating cycle, the larger is the amount of working capital required as the funds get locked up in the production process for a long period of time. 

5. Terms of credit for buying and selling of goods, discount allowed to the suppliers and to the customers also determine the quantum of working capital.

• When a company issues securities for raising the capital, it has to incur expenses for doing so.
• The expenses for issuing securities include releasing prospectus, underwriting commission, brokerage, etc. As a result, the cost of capital increases.
• The expense on issuing debenture is lesser then issuing securities.

Working capital:

• Capital needed in the business to run day-to-day expenses is known as working capital.
  Working capital is generally used in current assets of business such as purchasing raw material, making payment to creditors, paying utility bills, etc.
• Working capital continuously circulates in the business.

Fixed capital:

• Capital invested in business for a period of five years or above is called fixed capital.
• Fixed capital is invested in fixed assets such as land, building, machinery, plant, furniture, etc. Thus, fixed capital remains in business for a long period.

Legal restrictions:

• There are various legal restrictions which a company has to follow and hence they affect its capital structure.
• As per Companies Act, the company raising capital fund through securities has to compulsorily issue equity shares. In addition to this, rules of SEBI and RBI and provision of Companies Act are also to be considered while formulating the capital structure.

Factors Affecting Capital Structure:

1. Trading on Equity (Financial Leverage): It refers to the use of fixed income securities such as debentures and preference capital in the capital structure so as to increase the return of equity shareholders. 

2. Stability of Earnings: If the company is earning regular and reasonable income, the management can rely on preference shares or debentures. Otherwise issue of equity shares is recommended. 

3. Cost of Debt: A rm’s ability to borrow at lower rate, increases its capacity to employ higher debt. 

4. Interest Coverage Ratio (ICR): The interest coverage ratio refers to the number of times earnings before interest and taxes of a company covers the interest obligation. Higher the ratio, better is the position of the rm to raise debt.

5. Desire for control: If the management has a desire to control the business, it will prefer preference shares and debentures in capital structure because they have no voting rights.

6. Flexibility: Capital structure should be capable of being adjusted according to the needs of changing conditions. 

7. Capital Market Conditions: In depression, debentures are considered good. In a booming situation, issue of shares will be more preferable. 

8. Period of Finance: If funds are required for short period, borrowing from bank should be preferred. If funds are required for longer period company can issue shares and debentures.

9. Taxation Policy: interest on loan and debentures is deductible item under the Income Tax Act whereas dividend is not deductible. In order to take advantage of this provision, companies may issue debentures. 

10. Legal Requirements: The structure of capital of a company is also influenced by the statutory requirements.

For example, Banking Regulation Act, Indian Companies Act, SEBI, etc.

The working capital requirement of Manish would be more as he is engaged in ‘Manufacturing Industry’. Manish needs more working capital because: In a Manufacturing Firm, requirement of Working Capital is large because operating cycle period is larger since: 

a. They carry large quantity of raw materials 

b. They carry large quantity of work in progress. 

Factors which will affect his Fixed Capital requirement are: 

a. Scale of Operations: A larger organization operating at a higher scale needs bigger plant, more space etc and therefore, requires bigger investment in fixed assets when compared with the small organizations. 

b. Diversification: 

• A firm may choose to diversify its operations for various reasons. 
• With diversification, fixed capital requirements increase, example a textile company is diversifying and starting a cement manufacturing plant. Obviously its investment in fixed capital will increase.

Correct option is (A) Issuing shares; Borrowing capital

Trademark , patents, technical expertise etc.

(b) within one year

Factors affecting capital structure 

(1) Trading on Equity 

(2) Stability of earnings 

(3) Cost of debt 

(4) Interest Cover Ratio 

(5) Desire for control 

(6) Capital market condition 

(7) Taxation policy 

(8) Legal Requirements

(c) Financial Management

Companies having good growth opportunities retain more money out of their earnings so as to finance their required investments and pay less dividend and vice-versa.

(c) Higher dividend per share includes high earnings, high cash flows, stable earning and lower growth opportunities.

Financial Planning:

The process of estimating the fund requirement of a business and specifying the sources of funds is called financial planning. It ensures that enough funds are available at right time.

The twin objectives of financial planning are 

(a) To ensure availability of fund at the right time and its possible sources.

(b) To see that rm does not raise fund unnecessarily.

Amount of fixed capital depends upon the following factors:

i. Nature of Business: Need of fixed capital depends upon the nature of business. Usually, nature of business is of two kinds: Manufacturing Business and Trading Business. In case of manufacturing business, large investment is made in land, building, machinery, etc. Thus, there is need for large amount of fixed capital. On the contrary, in case of trading business in which finished goods are bought and sold, less amount of fixed capital is needed.

ii. Scale of Operations: Larger the spread of business activities greater is the need for fixed capital.

iii. Choice of Technique: Those manufacturing enterprises which make use of modern and automatic machines, need large amount of fixed capital. On the other hand, those enterprises in which production is carried out mainly through labourer, need for fixed capital is very little.

iv. Technology Upgradation: There are some businesses where fixed asset is used and which does require immediate change. These days computer technology is undergoing rapid changes. Therefore, those companies whose business is computer based need more fixed capital.

i. Choice of Technique: Those manufacturing enterprises which make use of modern and automatic machines, need large amount of fixed capital. On the other hand, those enterprises in which production is carried out mainly through labourer, need for fixed capital is very little.

ii. Nature of Business: Need of fixed capital depends upon the nature of business. Usually, nature of business is of two kinds: Manufacturing Business and Trading Business. In case of manufacturing business, large investment is made in land, building, machinery, etc. Thus, there is need for large amount of fixed capital. On the contrary, in case of trading business in which finished goods are bought and sold, less amount of fixed capital is needed.

1. Stability of earning: A company having stable earning is in a position to declare more dividends and vice versa.

2. Growth opportunities: If the company has more opportunities for growth, it will require more finance. In such a situation, a major part of the income should be retained and a small part of it should be paid as dividend.

3. Cash flow position: The payment of dividend results in outflow of cash. It is possible that the company may have enough income but it is equally possible that it may not have sufficient cash to pay dividend. In this way, the cash flow position of the company is a factor that determines the dividend decision. The better the cash flow position of the company, the better will be the capacity of the company to pay dividend.

4. Taxation policy: The dividend decision, to some extent, depends on tax policy. If the tax rate on dividend is higher it would be better to declare less dividend and vice versa. Nowadays in the hands of shareholders the dividend income is tax free. From this angle, shareholders like to get higher dividend.

1. Stability of dividends: Every company adopts the policy of maintaining the stability of dividend per share. (Here the stability of dividend means that the dividend will, in no case, be allowed to fall. It is always good if the dividend remains stable or increases.) From this point of view, a little change in profit should not be allowed any increase or decrease in the dividend.

2. Shareholders’ preference: There are two types of shareholders from the point of view of investment:

(i) those who invest with the purpose of getting some regular income and

(ii) those who invest in the company to gain capital profit. If the majority of the shareholders are of the former type, the company must declare dividend according to their expectation. On the contrary, if the majority of the shareholders are of the latter type the company enjoys freedom about declaring dividend.

3. Access to capital market: In case of need if a company can easily collect finance in the capital market, it should declare dividend at a higher rate otherwise not.

4. Legal constraints: The dividend policy of a company should always remain confined within the limits provided by law. According to the legal provisions, a company cannot make payment of dividend out of paid-up share capital because it will reduce the capital which will adversely affect the security of the debt providers. Therefore, it should be kept in mind that the dividend is not being paid out of the capital. According to Article 205 of the Company Law, dividend can be paid out of the current year’s profit or the profits of the previous years after taking into consideration the provisions made for depreciation.

It refers to the risk of the company not being able to cover its fixed financial costs. The higher levels of risks are attached to higher degrees of financial leverage. With the increase in fixed financial costs, the company is also required to raise its operating profit (EBIT) to meet financial charges. If the company cannot cover these financial charges, it can be forced into liquidation.

Factors affecting the choice of capital structure:

i. Cash flow position: If the cash flow position of the company is good, the payment of interest on the debt and the refund of capital can be easily made. Therefore, in order to take advantage of cheap finance, debt can be given priority.

ii. Cost: The cost of all the sources of finance is different. The rate of interest on debt, fixed rate of dividend to be paid on preference share capital and the expectations of the shareholders on the equity share capital are in the form of costs. If the situations happen to be favourable, the benefit of cheap finance can be availed of by choosing debt capital.

iii. Floatation cost: From the point of view of floating costs, retained profit is the most appropriate source. Therefore, its use should be made.

iv. State of capital market: Bullish time brings more profit. Therefore, the people like to invest more in equity shares. On the contrary, the profits are low when there is a bear market. The people give preference to debt capital in order to earn more profits. Therefore, the source of finance should be chosen keeping in view the position of the market.

Debt. is the component of capital structure determines the overall financial risk.

It refers to the risk of company not being able to cover its fixed financial costs. The higher level of risks are attached to higher degrees of financial leverage. With the increase in fixed financial costs, the company is also required to raise its operating profit (EBIT) to meet financial charges. If the company cannot cover these financial charges, it can be forced into liquidation.

It refers to the risk of not able to cover fixed financial costs by a business.

Any financial plan consists of two important aspects plan. They are:

1. To estimate need of capital (Problem of capitalization)
2. To determine sources of capital (Problem of capital structure)

Financing Decision: It refers to the determination as to how the total funds required by the business will be obtained from various long-term sources. Long-term financial sources chiefly include equity share capital, preference share capital, retained earnings, debentures, long-term loan, etc.

Factors affecting financing decisions are as follows:

(i) Cost of Funds: Different financial sources have different cost like interest on debt, dividend of shares. A company chooses a source which proves to be the cheapest.

(ii) Risk: From companies point of view debt is more risky than equity,. So, company should analyse its financial risk bearing capacity and choose a source accordingly.

(iii) Floatation Cost: Higher the floatation cost of a source, less attractive it appears to the management.

(iv) Cash Flow position: A stronger cash flow position makes debt financing more viable that funding through equity.

(v) Level of Fixed Operating Cost: If a business has high fixed operating costs (For example, rent, insurance premium etc.), it should opt for less fixed financing cost (interest) by using less debt financing. Similarly if fixed operating cost is less, more debt financing can be done.

(vi) Control Consideration: Issue of more equity may lead to dilution of managements control over the business companies which may afraid them of a takeover bid. So it may prefer debt to equity.

(vii) State of capital markets: A depressed capital market makes issue of equity, shares difficult and less attractive source finance in comparison to debt. Similarly a rising capital market makes equity more viable source of finance than debt.

(viii) Return on Investment: lf the ROI for a company is higher, it will use more debt to take advantage of trading on equity.

(ix) Tax Rate: Since interest is a tax deductable expense, a higher tax rate makes debt relatively cheaper and increases its attraction vise-visa equity.

(x) Flexibility: If a firm uses its debt potential to the full capacity, it losses flexibility to issue further debt. To maintain flexibility, it must maintain some borrowing power to take care of unforeseen circumstances.

(xi) Regulatory Framework: Different sources of finance have different regulatory framework provided by the law. The relative ease with which these norms can be met have a good effect on the choice of the source of finance.

Cost:

The cost of raising funds from different sources are different. A wise finance manager opt for the cheapest source of finance.

Cash Flow Position of the Company:

A stronger cash flow position may make debt financing more viable than funding through equity.

Fixed Operating Cost:

If a firm is having a higher fixed operating burden like payment of interests, premiums, salaries, rent, etc, then it should avoid financing through debt. This is because it will further increase the interest payment burden and the firm can reach an unfavourable position. However, if the firm has lower operating cost, then the firm can borrow funds.

Control Considerations:

Issue of more equity may dilute shareholders’ control over the business. Therefore, a company afraid of a takeover bid may prefer debt to equity.

State of Capital Market:

If the stock market is rising, then it is easy to sell equity shares. But in a depressed capital market, the company has to opt for debt financing.

Return on Investment (RQl)

Return on Investment means the earnings of a company on its investments. It is an important criteria for deciding the type of funds to be sourced.

Regulatory Frame Work:

The Companies Act and SEBI guidelines must be observed while raising funds from the public. Government has laid down certain norms for debt equity ratio and ceilings on public deposits. Borrowings from banks and other financial institutions, require fulfillment of certain norms. Thus, the relative ease with which their procedures ’ and norms can be met, has an impact on the choice of the source of finance.

1. Cash flow position: If the cash flow position of the company is good, the payment of interest on the debt and the refund of capital can be easily made. Therefore, in order to take advantage of cheap finance, debt can be given priority.

2. Level of fixed operating costs: In business, there are mainly two types of costs:

i. Fixed operating costs, e.g., rent of the building, payment of salary, insurance premium, etc.

ii. Fixed financial costs, e.g., interest on debt, etc. If the level of fixed operating costs is in excess, it is better to keep the fixed financial costs at their minimum. Therefore, debt capital should not be used. On the contrary, if the level of fixed operating cost is low, the use of debt capital is profitable.

3. Control consideration: The ultimate control of the company is that of the equity shareholders. Greater the number of equity shareholder, the greater will be the control in the hands of more people. This is not a good situation. Therefore, from this point of view the equity share capital should be avoided.

4. State of capital market: Bullish time brings more profit. Therefore, the people like to invest more in equity shares. On the contrary, the profits are low when there is a bear market. The people give preference to debt capital in order to earn more profits. Therefore, the source of finance should be chosen keeping in view the position of the market.

Financing Decision: It refers to the determination as to how the total funds required by the business will be obtained from various long-term sources. Long-term financial sources chiefly include equity share capital, preference share capital, retained earnings, debentures, long-term loan, etc.

Factors affecting financing decisions are as follows:

(i) Cost of Funds: Different financial sources have different cost like interest on debt, dividend of shares. A company chooses a source which proves to be the cheapest.

(ii) Risk: From companies point of view debt is more risky than equity,. So, company should analyse its financial risk bearing capacity and choose a source accordingly.

(iii) Floatation Cost: Higher the floatation cost of a source, less attractive it appears to the management.

(iv) Cash Flow position: A stronger cash flow position makes debt financing more viable that funding through equity.

(v) Level of Fixed Operating Cost: If a business has high fixed operating costs (For example, rent, insurance premium etc.), it should opt for less fixed financing cost (interest) by using less debt financing. Similarly if fixed operating cost is less, more debt financing can be done.

(vi) Control Consideration: Issue of more equity may lead to dilution of managements control over the business companies which may afraid them of a takeover bid. So it may prefer debt to equity.

(vii) State of capital markets: A depressed capital market makes issue of equity, shares difficult and less attractive source finance in comparison to debt. Similarly a rising capital market makes equity more viable source of finance than debt.

(viii) Return on Investment: lf the ROI for a company is higher, it will use more debt to take advantage of trading on equity.

(ix) Tax Rate: Since interest is a tax deductable expense, a higher tax rate makes debt relatively cheaper and increases its attraction vise-visa equity.

(x) Flexibility: If a firm uses its debt potential to the full capacity, it losses flexibility to issue further debt. To maintain flexibility, it must maintain some borrowing power to take care of unforeseen circumstances.

(xi) Regulatory Framework: Different sources of finance have different regulatory framework provided by the law. The relative ease with which these norms can be met have a good effect on the choice of the source of finance.

Financial Risk refers to a position when a company is unable to meet its fixed financial charges namely interest payment, preference dividend and repayment obligations. Financial risk arises due to use of debt and preference shares as source of finance.

Two other broad decisions are:

(i) Investment Decision

(ii) Financing Decision

Financing decisions are concerned with how to raise the funds for business activities from various sources. There are two sources of raising finance. the business they are Debt and Equity. The owner fund or shareholders fund are called equity. The harrowed funds are called debts.

Decisions related to financing:

Investment decisions are connected with the assets of the company while financing decisions are related to the capital structure.

Capital structure of the company consists of:
(a) equity shares
(b) equity shares and preference shares
(c) equity shares and debentures
(d) equity shares, preference shares and debentures

• Capital structure is a mixture of owner’s capital and debt. Finance manager has to take decision regarding the portion to be maintained between equity and debt in capital structure. A fine balance between equity capital and debt is necessary so as to maximize the returns of the company.
• Capital structure having a proper proportion of equity capital and debt is called optimum capital structure. Optimum capital structure is less risky and ensures maximum return.

Factors affecting financing:

The factors affecting financing can be classified as

1. Internal factors and
2. External factors.

1. Internal factors: Type or nature of business, size of business, growth of business, financial requirement, nature of assets and requirement, attitude of directors are internal factors that affect financing decisions.

2. External factors: Condition of capital market, expenses of issuing securities, attitude of investors, rate of interest prevailing in market, legal restrictions, institutional investors, etc. are external factors that affect financing decisions.

Two other broad decisions are:

(i) Investment Decision

(ii) Dividend Decision