Please refer to Financial Management Class 12 Business Studies Exam Questions provided below. These questions and answers for Class 12 Business Studies ave been designed based on the past trend of questions and important topics in your class 12 Business Studies books. You should go through all Class 12 Business Studies Exam Questions provided by our teachers which will help you to get more marks in upcoming exams.
Class 12 Business Studies Exam Questions Financial Management
Class 12 Business Studies students should read and understand the important questions and answers provided below for Financial Management to understand all important and difficult topics.
Short Answer Type Questions :
Question. Sana is a young professional employed in a multinational company. Her annual package is of `6 lakh. Since she lives with her parents, therefore she is able to save a major part of her earnings. Her friends are constantly advising her to invest in shares. But, she is not aware about the nitty-gritties regarding the functioning of the stock-exchange. So, she decided to invest in equity through the primary market, assuming that this will help her to earn stable dividends. But her father, who was a retired bank officer told her that even dividends are
not stable as they are affected by several factors.
(i) Is Sana’s father right in his assertion?
(ii) Explain the following as factors affecting ‘dividend decision’.
(a) Stability of dividend
(b) Legal constraints
(c) Access to capital market
Ans. (i) Yes, Sana’s father is correct in his assertion.
(ii) Factors affecting dividend decision are
(a) Stability of Dividend Every company adopts the policy of maintaining the stability of dividend per share. From this point of view, a little change in profit should not be allowed to increase or decrease the dividend.
(b) Legal Constraints Certain provisions of the Companies Act put restrictions on payouts as dividend. Such provisions must be adhered to while declaring the dividend.
(c) Access to Capital Market Large and reputed companies generally have easy access to the capital market and therefore may be depended less on retained earnings to finance their growth. These companies tend to pay higher dividends than the smaller companies.
Question. Financial management is based on three broad decisions. What are these?
Or Every manager has to take three major decisions while performing the finance functions. Explain them.
Ans. Financial management is concerned with optimum procurement as well as usage of finance. It aims at mobilisation of funds at a lower cost and deployment of these funds in the most profitable activities. Three broad decisions are
(i) Investment Decision It relates to how the firm’s funds are invested in different assets, so that the firm is able to earn the highest possible returns on investment. Investment decisions can be long-term or short-term.
(ii) Financing Decision It is concerned with the decisions of how much funds are to be raised from which long-term source, i.e., by means of shareholders’ funds or borrowed funds.
Shareholders’ funds include share capital, reserves and surplus and retained earnings, whereas borrowed funds include debentures, long-term loans and public deposits.
(iii) Dividend Decision It relates to how much of the company’s net profit is to be distributed to the shareholders and how much of it should be retained in the business for meeting the investment requirements. This decision should be taken, keeping in view the overall objective of maximising shareholders’ wealth.
Question. ‘‘Financial planning is a financial blueprint of an organisation’s future operations.’’ Explain the twin objectives of financial planning in the light of this statement.
Ans. Financial planning means estimating the requirements of a business and determining the sources of funds. Financial planning includes both short-term and long-term planning. Objectives of financial planning are
(i) To ensure Availability of Funds whenever Required If adequate funds are not available, the business unit will not be able to honour its commitments and plans.
(ii) To See that the Firm does not Raise Funds Unnecessarily If excess of funds are available with the business unit, it will unnecessarily add to the cost and may encourage wasteful expenditure and misuse of funds.
Question. How does working capital affect both the liquidity as well as profitability of a business?
Ans. Working capital means the portion of capital which is invested in current assets. It should neither be less or more than what is required. If it is more than the required amount, it will increase the liquidity but decrease profitability. On the other hand, if the working capital is less, then there would be a difficulty in meeting the current liabilities. Thus, the amount of working capital should be optimum, so that neither profitability nor liquidity is affected.
Question. Give any four points explaining the role of financial management.
Ans. Role of financial management can be explained as follows
(i) The Size and the Composition of Fixed Assets of the Business Financial management plays a significant role in determining the size and composition of fixed assets of the business. Decision to invest a sum of ` 500 crore in fixed assets would raise the size of fixed assets blocked by this amount.
(ii) Quantum of Current Assets The quantum of current assets is also influenced by financial management decisions. With an increase in the investment in fixed assets, there is a commensurate increase in the working capital requirement.
(iii) Break-up of Long-term Financing into Debt and Equity Financing decision involves decision regarding procurement of finance from debt as well as equity. Thus, it affects the proportion of equity and debt to make up the capital structure.
(iv) All Items of Profit and Loss Account Capital budgeting decisions, i.e., investment in fixed assets affect the profit and loss statement, e.g. more debt requires more interest payment . Thus, we can see the impact of financial decisions on various items of financial statement such as interest, profit, tax, etc.
Question. ‘G Motors’ is the manufacturer of sophisticated cranes. The production manager of the company, reported to the chief executive officer, Ashish Jain that one of the machines used in manufacturing sophisticated cranes had to be replaced to compete in the market, as other competitors were using automatic machines for manufacturing cranes. After a detailed analysis, it was decided to purchase a new automatic machine having the latest technology. It was also decided to finance this machine through long-term sources of finance. Ashish Jain compared various machines and decided to invest in the machine which would yield the maximum returns to its investors.
(i) Identify the financial decision taken by Ashish Jain.
(ii) Explain any three factors affecting the decision identified in (i) above.
Ans. (i) Financial decision taken by Ashish Jain is investment (Long-term/Capital budgeting) decision.
(ii) The factors affecting investment decision are given below
(a) Cash Flow of the Project When a firm takes an investment decision involving huge amount, it expects to generate some cash flows (inflow or outflow) over a period.
Thus, the inflows and outflows of cash in the business should be considered before making capital budgeting decisions.
(b) Rate of Return Each project is selected after comparing expected returns of different projects and the degree of risk involved in them.
(c) The Investment Criteria Involved The decision to invest in a particular project involves a number of calculations regarding the amount of investment, interest rate, cash flows and rate of return.
Question. What do you mean by working capital? Explain any three factors affecting the requirement of working capital.
Ans. The capital invested in current assets such as stock of materials and finished goods, accounts receivable, bills receivable and bank balances for meeting day-to-day expenses is known as working capital.
Factors affecting the working capital requirements are
(i) Nature of Business A trading organisation and a service industry firm usually needs a smaller amount of working capital as compared to a manufacturing organisation.
(ii) Scale of Operations Organisations which operate on a large scale, their quantum of inventory and debtors required is generally high. Such organisations, therefore, require large amount of working capital as compared to the organisations which operate on a lower scale.
(iii) Credit Availed Just as a firm allows credit to its customers, it also may get credit from its suppliers. To the extent, it avails the credit on purchase, the working capital requirements are reduced.
Question. ‘‘Financial management is concerned with inflow and outflow of money.’’ Do you agree? If yes, How?
Ans. Yes, financial management is concerned with inflow and outflow of money as it is concerned with taking decisions regarding optimal procurement and utilisation of funds. For the effective procurement of funds, different available sources of finance are identified and compared in terms of cost and risk associated with them. Procurement of funds is done for both long-term needs as well as short-term needs.
For long-term financing needs, the funds can be sourced through debt and equity. Short-term financing involves management of working capital.
Now, the funds so procured have to be invested in a manner that the returns are higher than the cost of funds. The outflow of money is through purchase of fixed assets, current assets, working capital needs, distribution of dividends, etc.
Question. The Return on Investment (RoI) of a company ranges between 10-12% for the past three years. To finance its future fixed capital needs, it has the following options for borrowing debt. Option ‘A’ Rate of interest 9% Option ‘B’ Rate of interest 13% Which source of debt, ‘Option A’ or ‘Option B’, is better? Give reason in support of your answer. Also state the concept being used in taking the decision.
Ans. The company should use ‘Option A’ as in this case the return on investment (10-12%) will be more than the cost of debt (9%).
The concept being used in the above case is Trading on Equity. The use of debt alongwith equity increases Earnings Per Share (EPS). This use of fixed financial charge, i.e., interest, increases the profit earned by shareholders. This concept is known as trading on equity. If the company opts for Option A, it will lead to favourable trading on equity as in this case RoI > CoD, where
RoI—Return on Investment (10-12%)
CoD—Cost of Debt (9%)
Question. Steelone Enterprises is manufacturing high quality steel utensils. The demand for steel utensils is rising as people are getting aware that plastic is not good for health. This has led to increase in production of steel utensils.
To encourage sales, Steelone Enterprises declared a liberal credit policy which allows three months credit to its wholesale buyers.
In the light of the above, identify the two factors affecting working capital requirements of Steelone Enterprises. State with reason, whether the factors as identified above, will result in high or low working capital requirement.
Ans. Two factor affecting the working capital requirement of Steelone Enterprises are
(i) Credit Allowed Different firms allow different credit terms to their customers. These depend upon the level of competition that a firm faces, as well as the credit worthiness of their clientele.
A liberal credit policy results in higher amount of debtors, increasing the requirement of working capital.
(ii) Business Cycle Different phases of business cycles affect the requirement of working capital by a firm. In case of a boom, the sales as well as production are likely to be larger and, therefore, larger amount of working capital is required. As against this, the requirement for working capital will be lower during the period of dep- ression, since the sales as well as production will be less.
Question. Name the process which helps in estimating the future finance requirements of an organisation. Also, give four importance of that process.
Ans. Financial planning is the process of estimating the future finance requirements of an organisation.
Importance of financial planning are
(i) By forecasting what may happen in future, company prepares plans for future through financial planning.
(ii) It helps in avoiding business shocks and surprises by preparing a blueprint of organisation’s future preparations.
(iii) Financial planning helps in linking the present with the future.
(iv) Through financial planning, wastage of human as well as physical resources is reduced.
Question. Sunflag Iron Ltd. is manufacturing steel at its plant in India. It is enjoying increased demand for its steel as economic growth of the country is about 8%. It is planning to set up a new plant to avail the benefits of increased demand.
It is estimated that it will require about ₹ 4,000 crore for setting up of plant and about ₹ 600 crore for other expenses to start the new plant.
To collect the above mentioned funds, the sources to be used and the quantity to be collected from different sources had to be considered.
(i) Identify the above discussed concept and give its meaning.
(ii) Explain any two factors that affect the concept identified in (i) above.
Ans. (i) The concept discussed above is capital structure. It refers to the mix between owners funds and borrowed funds or it represents the proportion of debt capital and equity capital to make up the total capital of a firm.
(ii) Two factors affecting capital structure of an organisation are
(a) Cost of Debt A firm’s ability to borrow at a lower rate of interest increases its capacity to employ higher debt. Thus, more debt can be used if debt can be raised at a lower rate.
(b) Cost of Equity When a company increases debt, the financial risk faced by equity shareholders increases. Thus, debt can be used upto a limit. Beyond that point, cost of equity
may go up and share prices may decrease.
Question. The finance manager of Aerial Automobiles has made a detailed plan analysing the minutest financial needs of the firm in the coming six months. He also analyses the sources from where such fund requirement will be met.
(i) Name the process the financemanager is involved in.
(ii) Explain any two essential requirements of a sound financial plan.
Ans. (i) The finance manager is involved in financial planning.
(ii) Following are the two essential elements of a sound financial plan
(a) A sound financial plan should help in facilitating the collection of optimum funds.
(b) It should be able to tap appropriate sources at the appropriate time. Thus, it helps in fixing the most appropriate capital structure.
Question. What are the main objectives of financial management? Briefly explain.
Ans. The main objectives of financial management are
(i) Effective utilisation of funds, by ensuring that benefits of an investment exceeds its cost.
(ii) To raise funds at minimum cost and minimum risk, through effective financing decision.
(iii) To ensure safety of funds by creating reserves, reinvesting profits, etc.
(iv) To maintain financial liquidity and profitability through working capital decision.
Question. There are two companies B and D. Total contribution of capital is ₹ 40 lakh each. The ratio of equity to total capital in company B is ₹ 10 lakh and debt is ₹ 30 lakh while in company D, the total equity capital is ₹ 40 lakh, sourced through equity. EBIT is ₹ 8 lakh, the interest rate on debt is @ 10% and the tax rate is 30%.
Which company enjoys favourable financial leverage?
Ans. As per the given details, company enjoying the favourable financial leverage can be identified as below
Company B is in the position of favourable financial leverage as use of debt increases the EPS and thus, the situation is considered as favourable for trading on equity.
Question. Distinguish between fixed capital and working capital.
Ans. Difference between fixed and working capital
| Basis | Fixed Capital | Working Capital |
| Time Period | Required for long-term. | Required for short-term. |
| Purpose | Money needed to buy fixed assets. | Money needed to buy current assets. |
| Nature | Remains sunk in business. | Revolves in business. |
| Source | Raised through shares, debentures and term loans. | Raised through banks, trade credit, shares and debentures. |
Question. Dividends declared by the companies are taken as a positive note by the investors. Stock markets react positively to such decisions and share prices tend to show an upward trend. But, at the same time, it is restricted to certain extent by the Companies Act as well as the financial condition of the concern. Franco, the financial manager of Sunlight Ltd. declared in the Annual General Meeting (AGM) that ‘‘It is costly to reinvest the retained earnings.’’ After considering his statement, what decision is taken by the board?
Ans. Company’s net earnings are divided into two parts, retained earnings and dividend. If the company has profitable investment options then, it would like to retain the earnings and reinvest rather than distribute it as dividend. But in the given case, the condition is not favourable for reinvesting. Thus, the board may take the residual decision which means the company will pay dividends as the reinvestment is not profitable.
Question. ‘Smart Stationery Ltd’. wants to raise funds of ₹ 40,00,000 for its new project. The management is considering the following mix of debt and equity to raise this amount.
(i) Under which of the three alternatives will the company be able to take advantage of trading on equity?
(ii) Does Earning Per Share (EPS) always rise with increase in debt?
Ans. (i) The company will be available to take advantage of trading on fquity in alternative III. This is because of higher earning per share in Alternative III as calculated below
Calculation of Earning Per Share (EPS) Alternative
(ii) No, Earning Per Shares (EPSs) only rises with increase in debt when the rate of interest on debt is
lower than the return on investment.
Question. Neelabh is engaged in ‘transport business’ and transports fruits and vegetables to different states. Stating the reason in support of your answer, identify the working capital requirements of Neelabh. Neelabh also wants to expand and diversify his transport business, explain any two factors that will affect his fixed capital requirements.
Ans. In the transportation business, lower amount of working capital is required as it is a service industry. Working capital requirement of Neelabh would include payment of salaries, fuel charges, maintenance of vehicles, etc. Factors affecting the fixed capital requirements are
(i) Growth Prospects Businessman wants to expand his business, in such situation company requires higher investment tomeet the anticipated demand in future. Thus, the requirement of fixed capital will be higher.
(ii) Diversification If the businessman diversifies his business, this means larger amount of fixed capital is required.
Question. Surya Ltd. is manufacturing steel at its plant in India. It is enjoying a buoyant demand for its products as economic growth is about 7% to 8% and the demand for steel is growing. Therefore, it is planning to set-up a new steel plant to take benefit of such trends in demand. It is estimated that such an expansion will require about ₹ 5,000 crore to set-up and about ₹ 500 crore of working capital. As the finance manager of the company, state any three factors that would be considered while determining the capital structure for the new venture.
Ans. In this case, the various factors that are to be considered in determining the capital structure for the new venture will be
(i) Cost of Debt If the rate of interest on debt is high, the company should use less debt in its capital structure and vice-versa.
(ii) Cost of Equity When a company interest debt, the financial risk faced by equity shareholders increases. Thus, debt can be used upto a limit. Beyond that point, cost of equity may go up and share prices may decrease.
(iii) Interest Coverage Ratio (ICR) It refers to the number of times earnings before interest and tax covers the interest obligation. Higher the ICR, the company can borrow more funds and vice-versa.
Long Answer Type Questions :
Question. Abhishek Ltd. is manufacturing cotton clothes. It has been consistently earning good profits for many years. This year too, it has been able to generate enough profits. There is availability of enough cash in the company and good prospects for growth in future. It is a well managed organisation and believes in quality, equal employment opportunity and good remuneration practices. It has many shareholders who prefer to receive a regular income from their investments. It has taken a loan of ` 50 lakh from ICICI bank and is bound by certain restrictions on the payment of dividend according to the terms of the loan agreement.
The above discussion about the company leads to various factors which decide how much of the profits should be retained and how much has to be distributed by the company. Quoting the lines from the above discussion, identify and explain any four such factors.
Ans. The factors identified in the above lines are given below
(i) Stability in Earnings A company having higher and stable earnings can declare higher dividends than a company with lower and unstable earnings.
The line ‘‘It has been consistently ……….. many years.’’
(ii) Amount of Earnings Dividends are paid out of current and past earnings. Thus, earnings is a major determinant of dividend decision.
The line “This year too ………… enough profits.”
(iii) Growth Opportunities Companies having good growth opportunities retain more money out of their earnings so as to finance the required investment.
Therefore, the dividend declared in growth companies is smaller than that in the non-growth companies.
The line “There is availability ……… in future.”
(iv) Shareholders Preference While declaring dividends, management must keep in mind the preferences of the shareholders.
Some shareholders in general desire that atleast a certain amount is paid as dividend.
The companies should consider the preferences of such shareholders.
The line “It has many share ……… their a investments”.
Question. From last many years, in the monthe of November, due to sudden rise in the pollution level in Delhi and other parts of Northern India, there has been an increase in the demand for air purifiers.
Inderprastha Technologies Ltd. a manufacturer of air purifiers wants to encash this opportunity and wants to raise its investment in stock.
It is expected that this decision would increase the rate of profitability of the business. Due to this many competitors have recently entered in this industry. In order to increase the sales, the company has started selling air purifiers on liberal credit terms. It is not affecting the profits of the company since the production cycle of the product is short.
Identify and state any two factors that Inderprastha Technologies Ltd. will keep in mind before deciding its working capital requirements. Also state four other factors which should be kept in mind while deciding the working capital requirements of a company.
Ans. (i) Factors that Indusprastha Technology Ltd. will keep in mind before deciding its working capital requirements are
(a) Seasonal Factors In peak season, large amount of working capital is required because of higher level of activity. While during lean season, less amount of working capital is required.
(b) Level of Competition High competition may necessitate the company to keep large stock of finished goods to meet urgent orders from customers. Thus, this will increase the working capital requirement.
(ii) Other factors affecting working capital requirement of a company are
(a) Nature of Business A trading business needs less amount of working capital because there is no processing of good. However, working capital requirement of a manufacturing business is more as raw materialneds to be converted into finished goods.
(b) Scale of Operations A large scale organisation require large amount of working capital as its inventory level, debtors, etc are generally high. However, firms operating at small scale need less working capital.
(c) Growth Prospects If the growth potential of an enterprise is higher, then it will require more amount of working capital so that it is able to meet higher production and sales target
whenever required.
(d) Credit Availed Just as a firm allows credit to its customers, it alsomay get credit fromits suppliers. To the extent, it avails the credit on purchase, the working capital requirement is reduced.
Question. India Inc. issues Bonus Shares and Dividends Corporate India has opened its purse strings to shareholders with interim dividends and bonus shares. Atleast 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 away 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.
(i) Identify the financial decision involved in this case. Explain.
(ii) What factors are considered while taking this decision?
Ans. (i) Dividend Decision This decision relates to the amount of profit that the company would retain for future and the amount that would be distributed among the shareholders.
(ii) Factors affecting dividend decision are
(a) Amount of Earnings Dividends are paid out of current and past earnings. Thus, earnings is a major determinant of dividend decision.
(b) Stability in Earnings A company having higher and stable earnings can declare higher dividends than a company with lower and unstable earnings.
(c) Growth Opportunities Companies having good growth opportunities retain more money out of their earnings so as to finance the required investment.
The dividend declared in growth companies is therefore, smaller than that in the non-growth companies.
(d) Cash Flow Position Dividend involves an outflow of cash. Availability of enough cash is necessary for payment or declaration of dividends.
(e) Taxation Policy If the tax on dividends is higher, it is better to pay less by way of dividends. But if the tax rates are lower, higher dividends may be declared. This is because as
per the current taxation policy, a dividend distribution tax is levied on companies. However, shareholders prefer higher dividends as dividends are tax free in the hands of shareholders.
(f) Access to Capital Market Large and reputed companies generally have easy access to the capital market and therefore, may depend less on retained earnings to finance their growth. These companies tend to pay higher dividends than the smaller companies.
Question. Give the meaning of financial management. State its main objective.
Ans. Financial management is concerned with optimal procurement as well as usage of finance. It aims at reducing the cost of funds procured, keeping the risk under control and achieving effective deployment of such funds. Financial management is an area of financial decision-making harmonising individual motives and enterprise goals.
Objectives of Financial Management The primary aim of financial management is to maximise shareholders’ wealth, which is referred to as the wealth-maximisation concept. The market price of equity share increases, if the benefit from a financial management decision exceeds the cost involved. Therefore, those financial decisions are taken which ultimately prove to be gainful and maximise the current price of equity shares of the company.
With the primary objective of wealth maximisation, following objectives are also achieved
(i) Funds should be deployed in such a way that returns from an investment exceeds its cost.
(ii) To raise funds at minimum cost and minimum risk, through effective financing decision.
(iii) To maintain financial liquidity and profitability, through working capital decision.
(iv) To ensure safety of funds by creating reserves, reinvestment of profits, etc.
Question. Discuss the need and importance ofworking capital.
Or
Why is an adequate amount of working capital required in an enterprise?
Ans. Adequate working capital is essential for smooth and efficient working of every business enterprise. Adequate working capital provides the following advantages to a business enterprise
(i) A firm with adequate working capital can meet its liabilities promptly. Prompt payment helps to raise the credit-standing or reputation of the enterprise.
(ii) Adequacy of working capital enables the firm to take advantage of any favourable business opportunity, e.g. to purchase raw materials at a discount or to execute a special order.
(iii) Financial soundness of business boosts the morale of employees.
(iv) Lack of adequate working capital may result in interruptions in operations and underutilisation of plant capacity.
(v) Adequate working capital permits timely and regular payment of cash dividends. This helps to maintain cordial relations with shareholders.
Question. ‘Monisha Consumer Goods’ is a leading consumer goods chain with a network of 46 stores primarily across Mumbai, Delhi and Pune. It was started by Monisha Gupta in 1987. It has a large market share in Mumbai, Delhi and Pune. Looking for an opportunity to expand, it has decided to open a new branch in Kerala. She has to decide on what new resources she will invest in so that it is able to earn the highest possible return for its investors. Once the company believes that it will be able to generate higher revenues and profits, it also has to decide on how this project will get funded. The finance manager, Atul was told to have an optimal capital structure by striking a balance between various sources of getting the project funded so as to increase shareholders’ wealth. Atul, after assessing the cash flow position of the company, evaluated the cost of different sources of finance and compared the risk associated with each source as well as the cost of raising funds.
(i) State the two financial decisions discussed in the above situation.
(ii) Explain any two factors affecting each of the decisions that still have to be considered by the finance manager.
Ans. (i) Two financial decisions being discussed are
(a) Investment Decisions It involves careful selection of assets in which funds are to be invested.
Decisions relating to investment in fixed assets are known as capital budgeting, whereas those concerning investment in current assets are called working capital decisions.
A business needs to invest funds for setting up new business, for expansion and modernisation. Investment decision is taken after careful scrutiny of available alternatives in terms of costs involved and expected return.
(b) Financing Decisions It is concerned with the decisions of how much funds are to be raised from which long-term source, i.e., by means of shareholders funds or borrowed funds.
Shareholders funds include share capital, reserves and surplus and retained earnings, whereas borrowed funds includes debentures, long-term loans and public deposits.
(ii) Two factors which affect capital budgeting/investment decisions and needs to be considered are
(a) Cash Flows of the ProjectWhen a business invests huge amount of money in a certain project, then it expects regular and reasonable cash inflows from such an investment. Cash
generated from operations are analysed in selecting the desired project.
(b) The Rate of Return Each project is selected after comparing expected returns of different projects and the degree of risk involved in them. Two factors affecting financing decisions and needs to be considered are
(a) 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.
(b) Control Considerations Issue of more equity may dilute shareholder’s control over the business. Therefore, a company afraid of a takeover bid may prefer debt to equity.
Question. “Sound financial planning is essential for the success of any enterprise.” Explain this statement by giving any six reasons.
Ans. ‘‘Sound financial planning is essential for the success of any enterprise.’’ The following points explain the importance of financial planning
(i) It helps in forcasting what may happen in future under different business situations. By doing so, it helps the firms to face the eventual situation in a better way. In other words, it makes the firm better prepared to face the future. By preparing a blueprint of these situations, the management may decide what must be done in each of these situations. This
preparation of alternative financial plans to meet different situations is clearly of immense help in running the business smoothly.
(ii) It helps in avoiding business shocks and surprises and helps the company in preparing for the future.
(iii) It helps in coordinating various business functions, e.g. sales and production functions, by providing clear policies and procedures.
(iv) It provides a link between investment and financing decisions on a continuous basis.
(v) Detailed plans of action prepared under financial planning reduce waste duplication of efforts and gaps in planning.
(vi) By spelling out detailed objectives for various business segments, it makes the evaluation of actual performance easier.
