Please refer to the Financial Management Class 12 Notes for Business Studies given below. These revision notes and important question answers have been prepared based on the latest NCERT book for Class 12 Business Studies. Our teachers have developed these short notes and Important Questions Class 12 Business Studies as per the latest syllabus for Grade 12 Business Studies issued by CBSE. Read these notes and important questions to get better marks in examinations
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Financial Management Class 12 Notes PDF
Financial Management
Financial Management is concerned with optimal procurement as well as usage of finance
Objective of Financial Management
✓ The prime objective of financial management is to maximize shareholder’s wealth by maximizing the market price of a company’s shares.
✓ To ensure regular and adequate supply of funds to the concern.
✓ To ensure adequate returns to the shareholders which will depend upon the earning capacity, market price of the share, expectations of the shareholders
✓ To ensure optimum funds utilization. Once the funds are procured, they should be utilized in maximum possible way at least cost.
✓ To ensure safety on investment, i.e, funds should be invested in safe ventures so that adequate rate of return can be achieved.
✓ To plan a sound capital structure-There should be sound and fair composition of capital so that a balance is maintained between debt and equity capital.
Scope of Financial Management Financial Decisions Involved in Financial Management
• Investment Decision
• Financing Decision
• Dividend Decision
1. Investment decisions – includes investment in fixed assets (called as capital budgeting). Investment in current assets are also a part of investment decisions called as working capital decisions.
2. Financial decisions – They relate to the raising of finance from various resources which will depend upon decision on type of source, period of financing, cost of financing and the returns thereby.
3. Dividend decision – The finance manager has to take decision with regards to the net profit distribution. Net profits are generally divided into two:
• Dividend for shareholders- Dividend and the rate of it has to be decided.
• Retained profits- Amount of retained profits has to be finalized which will depend upon expansion and diversification plans of the enterprise.
Role of Financial Management
1. To determine the capital requirements of business, both long-term and short-term.
2. To determine the capital structure of the company and determine the sources from where required capital will be raised keeping in view the risk and return matrix.
3. To decide about the allocation of funds into profitable avenues, keeping in view their safety as well.
4. To decide about the appropriation of profits.
5. To ensure efficient management of cash in order to ensure both liquidity and profitability.
6. To exercise overall financial controls in order to promote safety, profitability and conservation of funds.
Investment Decision
➢ It seeks to determine as to how the firm’s funds are invested in different assets
➢ It helps to evaluate new investment proposals and select the best option on the basis of associated risk and return.
➢ Investment decision can be long-term or short-term.
➢ A long-term investment decision is also called a Capital Budgeting decision.
Types of Investment Decision
1. Working Capital/Short-term Investment Decision
• It refers to the amount of capital required to meet day- to-day running of business.
• It relates to decisions about cash, inventory and receivables.
• It affects both liquidity and profitability of business.
2. Capital Budgeting Decision/Fixed Capital /Long-term Investment Decision
• It refers to the amount of capital required for investment in fixed assets or long term projects which will yield return and influence the earning capacity of business over a period of time.
• It affects the amount of assets, competitiveness and profitability of business.
3. Factors Affecting Capital Budgeting Decision/Long- term Investment Decision
• The expected cash flows from the proposed project should be carefully analyzed.
• The expected rate of return should be carefully studied in terms of risk associated from the proposed project.
• Different types of ratio analysis should be done to evaluate the feasibility of the proposed project as compared to similar projects in the same industry.
Financing Decision
Financing decision relates to determining the amount of finance to be raised from different sources of finance. This decision determines the overall cost of capital and the financial risk of the enterprise.
Types of Sources of Raising Finance
Owned Sources
➢ Equity shares
➢ Preference shares
➢ Retained earnings
Borrowed Sources
➢ Debentures
➢ Bonds
➢ Loan from bank or financial institutions
➢ Public deposit
Considerations Involved in the Issue of Debt
• Interest on borrowed funds has to be paid regardless of whether or not a business has made a profit. Likewise, borrowed funds have to be repaid at a fixed time.
• There is some amount of financial risk in debt financing.
• The cost of debt is less than equity as the degree of risk assumed by the investors is less and the amount of interest paid by the company is tax deductible.
Considerations Involved in the Issue of Equity
• Shareholders do not expect any commitment regarding the payment of returns or repayment of capital.
• The floatation cost on raising equity capital is high.
• The shareholders expect higher returns in return for assuming higher risks.
Factors Affecting Financing Decision
• The source of finance which involves the least cost should be chosen.
• The risk involved in raising debt capital is higher than equity.
• The sources involving high flotation cost require special consideration.
• if the cash flow position of a business is good, it should opt for debt else equity.
• if the fixed operating cost of a business is low, it should opt for debt else equity.
• The issue of equity capital dilutes the control of existing shareholders over business whereas financing through debt does not lead to any such effect
• If there is boom in capital market it is easy for the company to raise equity capital, else it may opt for debt.
Dividend Decision
Dividend Decision relates to disposal of profit by deciding the proportion of profit which is to be distributed among shareholders and the proportion of profit which is to be retained in the business for meeting the investment requirements.
Factors Affecting Dividend Decision
• If the earnings of the company are high, dividends are paid at a higher rate.
• If the earnings of a company are stable, it is likely to pay higher dividends.
• A company is more likely to maintain a stable dividend rate over a period of time, unless there is a significant change in its earnings.
• A company planning to pursue a growth opportunity is likely to pay lower dividends.
• The dividends are paid in cash, therefore if the cash flow of the company is good, it is likely to pay higher dividends.
• If the shareholders prefer regular income in form of dividends, the company is likely to maintain a dividend payout rate
• If the tax rate is high, the company is likely to pay less dividend.
• If a company wants positive reactions at stock market, It Is likely to pay higher dividends.
• A large company can access funds easily from capital market as per its requirements, therefore, it is likely to retain lesser profits and is likely to pay higher dividends.
• The legal constraint should be considered at the time of dividend payment by a company.
• The contractual constraints may also affect the dividend payment by a company.
Financial Planning
Financial Planning: Definition
The process of estimating the funds requirement of a business and specifying the sources of funds is called financial planning. It basically involves preparation of a financial blueprint of an organization’s future operations.
Objectives of Financial Planning
• To ensure availability of funds as per the requirements of business.
• To see that the enterprise does not raise resources needlessly.
• Generating capital structure:
• Avoiding unnecessary funds
Importance of Financial Planning
• It ensures smooth running of a business enterprise by ensuring availability of funds at the right time.
• It helps in anticipating future requirements of funds and evading business shocks and surprises.
• It facilitates co-ordination among various departments of an enterprise, like marketing and production functions, through well-defined policies and procedures.
• It increases the efficiency of operations by curbing wastage of funds, duplication of efforts, and gaps in planning.
• It helps to establish a link between the present and the future.
• It provides a continuous link between investment and financing decisions.
• It facilitates easy performance as evaluation standards are set in clear, specific and measurable terms.
Capital Structure
Capital Structure: Definition
Capital Structure refers to the amount of debt and/or equity employed by a firm to fund its operations and finance its assets. The structure is typically expressed as a debt-to-equity or debt-to-capital ratio.
OR
It refers to the mix between owners and borrowed funds.
Some Basic Term
Financial Risk: Definition
It refers to a situation when a company is unable to meet its fixed financial charges like payment of interest on debt capital.
Trading on Equity: Definition
It refers to the increase in the earnings per share by employing the sources of finance carrying fixed financial charges like debentures (interest is paid at a fixed rate) or preference shares (dividend is paid at fixed rate).
Financial Leverage: Definition
The proportion of debt in the overall capital is called financial leverage. It is computed as D/E or D/D+E, where D is the Debt and E is the Equity.
Working Capital: Definition The funds needed to meet the day-today operations of the business is called working capital.
Fixed Capital: Definition
It refers to investment in long-term assets.
Factor Affecting The Choice Of Capital
| S.No | Factors | Use Source Of Debt Capital | Use Source Of Own Capital |
| 1 | Cash flow position | If the cash flow position is good the business may use debt. | If the cash flow position is poor the business may use equity. |
| 2 | Interest coverage ratio | If the interest coverage ratio is high the business may use debt. | If the interest coverage ratio low the business may use equity. |
| 3 | Debt service coverage ratio | If the debt service coverage ratio is high the business may use debt. | If the debt service coverage ratio is low the business may use equity. |
| 4 | Return on investment | If the return on investment is high the business may use debt. | If the return on investment is low the business may use equity. |
| 5 | Cost of debt | If the cost of debt is low the business may use debt. | If the cost of debt is high the business may use equity. |
| 6 | Cost of equity | The company may use debt up to a certain limit so that shareholders do not expect higher returns on equity. | Shareholders expect higher returns when the company uses debt beyond a point due to increase in the financial risk, so the cost of equity increases. |
| 7 | Tax rate | If the tax rate is high the business may use debt | If the tax rate is low the business may use equity |
| 8 | Floatation costs | The floatation cost is lesser on using debt | The floatation cost is higher on using equity. |
| 9 | Financial risk consideration | If the financial risk is low the business may use debt. | If the financial risk is high the business may use equity. |
| 10 | Flexibility | Too much use of debt reduces flexibility to raise more debt. | If the business doesn’t want to restrict its flexibility, it may issue equity. |
| 11 | Control | Issue of debt doesn’t affect control of existing shareholders. | Issue of equity dilutes the control of the existing shareholders |
| 12 | Stock market conditions | If there is recession in the stock market, the business may issue debt capital. | If there is boom in the stock market, the business may issue equity. |
Note : Regulatory framework: The business will choose the option where it can easily fulfill the norms of the concerned regulator like a bank or SEBI.
Note: Capital structure of other companies: The business must know what the industry norms are, whether they are following them or deviating from them and adequate justification must be there
Case Study Financial Management Class 12 Business Studies
Question. Shalini, after acquiring a degree in Hotel Management and Business Administration, took over her family food processing company of manufacturing pickles, jams and squashes. The business had been established by her great grandmother and was doing reasonably well. However, the fixed operating costs of the business were high and the cash flow position was weak. She wanted to undertake modernization of the existing business to introduce the latest manufacturing processes and diversify into the market of chocolates and candies. She was very enthusiastic and approached a finance consultant, who told her that approximately ? 50 lakh would be required for undertaking the modernization and expansion program . He also informed her that the stock market was going through a bullish phase.
• Keeping the above considerations in mind, name the source of finance Shalini should not choose for financing the modernisation and expansion of her food processing business. Give one reason in support of your answer.
• Explain any two other factors, apart from those stated in the above situation, which Shalini should keep in mind while taking this decision.
Ans. • Shalini should not choose debt capital for financing the modernization and expansion of her food processing business because the fixed operating cost of the company is high. It cannot take the additional burden of fixed commitments in terms of payment of interest and repayment of capital by issuing debt.
• The other two factors that Shalini must keep in mind while taking this decision are stated below:
✓ Risk: Financial risk refers to a situation when a company is unable to meet its fixed financial charges. Financial risk of the company increases with the higher use of debt. This is because issue of debt involves fixed commitment in terms of payment of interest and repayment of capital.
✓ Flexibility: Too much dependence on debt reduces the firm’s ability to raise debt during unexpected situations. Therefore, it should maintain flexibility by not using debt to its full potential.
Question. Radhika and Vani who are young fashion designers, left their job vyith a famous fashion designer chain to set-up a company ‘Fashionate Pvt. Ltd.’ They decided to run a boutique during the day and coaching classes for the entrance examination of National Institute of Fashion Designing in the evening. For the coaching centre, they hired the first floor of a nearby building. Their major expense was the money spent on photocopying of notes for their students. They thought of buying a photocopier knowing fully that their scale of operations was not sufficient to make full use of photocopier. In the basement of the building of Fashionate Pvt. Ltd, Praveen and Ramesh were carrying on a printing and stationery business in the name of ‘Neo Prints Pvt. Ltd.’ Radhika approached Praveen with the proposal to buy a photocopier jointly which could be used by both of them without making separate investment. Praveen agreed to this.
• Identify the factor affecting the fixed capital requirements of Fashionate Pvt. Ltd.
Ans. The factor affecting the fixed capital requirement of Fashionable Pvt. Ltd. is the level of collaboration. This kind of arrangement of using the resources jointly helps to reduce the fixed capital requirements of the business firms.
Question. Kay Ltd. is a company manufacturing textiles. It has a share capital of ? 60 lakhs. In the previous year, its earning per share was ? 0.50. For diversification, the company requires an additional capital of ? 40 lakhs. The company raised funds by issuing 10% debentures for the same. During the year, the company earned a profit of ? 8 lakhs on the capital employed. It paid tax @ 40%.
• State whether the shareholders gained or lost, in respect of earning per share on diversification. Show your calculations clearly.
• Also state any three factors that favour the issue of debentures by the company as part of its capital structure.
Ans. ✓ Let us presume that the share capital of Rs. 60 lakh is made up of Rs. 6 lakh equity shares assuming that the face value of each share is Rs.10
*0.50 x 6,00,000 = 3,00,000 Consequently EBT/EBIT in situation 1 = Rs. 5,00,000 Thus, on diversification, the earning per share fell down from Rs. 0.50 to Rs. 0.40.
✓ The three factors that favour the issue of debentures by the company as part of its capital structure are as follows:
✓ Tax deductibility: Debt is considered to be a relatively cheaper source of finance as the amount of interest paid on debt is treated as a tax deductible expense.
✓ Flotation cost: The money spent by the company on raising capital through debentures is less than that spent on equity.
✓ Control: The issue of debentures doesn’t affect the control of the equity shareholders over the business as the debenture holders do not have the right to participate in the management of the business.
Question. Rizul Bhattacharya, after leaving his job, wanted to start a Private Limited Company with his son. His son was keen that the company may start manufacturing mobile-phones with some unique features. Rizul Bhattacharya felt that mobile phones are prone to quick obsolescence and a heavy fixed capital investment would be required regularly in this business. Therefore, he convinced his son to start a furniture business. ✓ Identify the factor affecting fixed capital requirements which made Rizul Bhattacharya choose the furniture business over mobile phones.
Ans. The factor affecting the fixed capital requirements which made Rizul Bhattacharya choose the furniture business over mobile phones is technological up gradation
Question. Tata International Ltd. earned a net profit of Rs. 50 crores. Ankit, the finance manager of Tata International Ltd. wants to decide how to appropriate these profits. Discuss any five factors which will help him in taking this decision.
Ans. The five factors which will help Ankit, in taking the dividend decision are described below:
1. Earnings: Since the dividends are paid out of current and past earnings, there is a direct relationship between the amount of earnings of the company and the rate at which it declares dividend. If the earnings of the company are high, it may declare a higher dividend or vice-versa.
2. Cash flow position: Since the dividends are paid in cash, if the cash flow position of the company is good it may declare higher dividend or vice-versa.
3. Access to capital market: If the company enjoys an easy access to capital market because of its credit worthiness. It does not feel the need to depend entirely on retained earnings to meet its financial needs. Hence, it may declare higher dividend or vice-versa.
4. Growth prospects: If the company has any forthcoming investment opportunities, it may like to retain profits to finance its expansion projects. This is because retained profits is considered to be the cheapest source of finance as it doesn’t involve any explicit costs. Hence, it may declare lower dividend or vice-versa.
5. Preferences of the shareholders: The companies paying stable dividends are always preferred by small investors primarily if they want regular income in the form of ‘stable returns’ from their investments. Large shareholders may be willing to forgo their present dividend in pursuit of higher profits in future. Therefore, the preferences of the shareholders must be taken into consideration.
Question. Yogesh, a businessman, is engaged in the purchase and sale of ice-creams. Identify his working capital requirements by giving reasons to support your answer. Now, he is keen to start his own ice-cream factory. Explain any two factors that will affect his fixed capital requirements.
Ans. 1. The working capital requirements of Yogesh will be less as he is engaged in trading business.
2. The two factors that will affect his fixed capital requirements when he will start his own ice-cream factory are described below:
✓ Level of collaboration: If Yogesh gets an opportunity to set up his factory in collaboration with another enterprise, his fixed capital requirements will reduce considerably else his fixed capital requirements will be more.
✓ Financial alternatives available: If Yogesh is able to get the place to start the factory and machinery on lease, his fixed capital requirements will reduce considerably. Whereas if he decides to purchase them, his fixed capital requirements will be more.
Financial management class 12 notes will assist the student with understanding the chapter in a great way. Besides, these notes will fill in as the best revision materials during the class 12 board exam. Aside from CBSE Class 12 Notes, we have also provided MCQ Questions and sample papers to assist students with ably planning for the board exam.
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