Financial Management

Introduction

Financial Management is the specialized function of general management which is related to the procurement of finance and its effective utilization for the achievement of the organizational objectives.

"Financial Management is the operational activity of a business that is responsible for obtaining and
effectively utilizing the funds necessary for efficient operations." - Massie

Objectives of Financial Management

1. Profit Maximization

Traditional objective. Implies that all decisions should increase profit.

Pros: Simple, measures efficiency.
Cons: Ignores time value of money, ignores risk factor, vague term 'profit'.

2. Wealth Maximization (Shareholder Value Maximization)

Modern and universally accepted objective. Maximizing the market value of shares.

Pros: Considers time value of money, considers risk, objective and clear.

Three Major Financial Decisions

1. Investment Decision (Capital Budgeting)

Relates to careful selection of assets in which funds will be invested by the firms.

Long-term: Buying Machinery, Land (Capital Budgeting).
Short-term: Inventory, Cash (Working Capital Management).

2. Financing Decision (Capital Structure)

Relates to the proportion of Debt and Equity in the capital structure.

Debt: Cheaper but risky (Fixed Interest).
Equity: No fixed burden but dilution of control.
Goal: Optimal Capital Structure (Lowest Cost of Capital).

3. Dividend Decision

Relates to how much of the profit is to be distributed to shareholders as dividend and how much to be retained in the business (Retained Earnings).

Financial Planning

The process of estimating the fund requirements of a business and specifying the sources of funds.

Objectives: To ensure availability of funds whenever required and to see that the firm does not raise resources unnecessarily.

Capital Structure

The mix of long-term sources of funds (Equity, Preference Shares, Debentures, Loans).

Financial Leverage: The proportion of debt in the overall capital. High debt = High
Financial Risk.

Working Capital

The capital required for day-to-day operations.

Gross Working Capital: Total Current Assets.
Net Working Capital: Current Assets - Current Liabilities.

Numericals & PYQs - FM

Part A: Practical Concepts/Numericals (10 Questions)

Q1. Calculate Net Working Capital: Cash ₹10k, Inventory ₹20k, Debtors ₹15k, Creditors ₹10k, Bills Payable ₹5k.

Current Assets = 10 + 20 + 15 = 45k.

Current Liabilities = 10 + 5 = 15k.

NWC = CA - CL = 45k - 15k = ₹30,000.

Q2. Company earns ₹10,000 profit. Capital Employed is ₹1,00,000. Calculate ROI.

ROI = (Net Profit / Capital Employed) x 100

ROI = (10,000 / 1,00,000) x 100 = 10%.

Q3. Financial Leverage calculation: EBIT ₹1,00,000. Interest ₹20,000.

Financial Leverage = EBIT / EBT

EBT = EBIT - Interest = 1,00,000 - 20,000 = 80,000.

FL = 1,00,000 / 80,000 = 1.25.

Q4. Present Value of ₹1,100 received after 1 year at 10% discount rate.

PV = FV / (1+r)^n

PV = 1,100 / (1+0.10)^1 = 1,100 / 1.1 = ₹1,000.

Q5. Cost of Equity concept: Dividend ₹5, Market Price ₹50. Growth 0%.

Ke = (D1 / P0)

Ke = 5 / 50 = 0.10 or 10%.

Q6. Payback Period: Initial Investment ₹50,000. Annual Cash Inflow ₹10,000.

Payback Period = Investment / Annual Inflow

PP = 50,000 / 10,000 = 5 Years.

Q7. Gross Working Capital refers to:

Total Current Assets.

Q8. Capital Structure Debt-Equity Ratio 2:1. Equity is ₹5,00,000. Debt?

Debt / Equity = 2/1.

Debt = 2 * Equity = 2 * 5,00,000 = ₹10,00,000.

Q9. EPS Calculation: Net Income ₹2,00,000. Number of Shares 50,000.

EPS = Net Income / No of Shares.

EPS = 2,00,000 / 50,000 = ₹4 per share.

Q10. Rule of 72: Interest rate 12%. Doubling period?

Years = 72 / Rate.

Years = 72 / 12 = 6 Years.

Part B: Previous Year Questions (PYQs) (10 Questions)

Q11. The primary goal of financial management is: (JKSSB FAA)

Wealth Maximization.

Q12. Working Capital Management involves management of:

Current Assets and Current Liabilities.

Q13. Capital Budgeting is related to:

Long-term Investment Decisions.

Q14. Which is the cheapest source of finance?

Debt (Due to tax deductibility of interest).

Q15. Dividend is paid on:

Paid-up Capital.

Q16. Financial Leverage involves the use of:

Fixed Cost bearing securities (Debt).

Q17. Time Value of Money implies:

A rupee today is worth more than a rupee tomorrow.

Q18. Cost of Capital is:

Minimum Rate of Return expected by investors.

Q19. Net Working Capital is positive when:

Current Assets > Current Liabilities.

Q20. Retained Earnings are:

Undistributed Profits (Ploughing back of profits).

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