1.what are the different types of leverage?

Leverage refers to borrowing funds for a particular purpose with an obligation to repay
these funds, with interest, at an agreed-to schedule. The idea behind leverage is to help
borrowers achieve a higher return with a smaller investment.
There are three main types of leverage:

 Financial
 Operating
 Combined
 Financial leverage
 Financial leverage refers to the amount of debt a business has acquired. On a
balance sheet, financial leverage is represented by the liabilities listed on the right-hand
side of the sheet.
 Financial leverage lets your business continue to make investments even if you're
short on cash. It’s usually preferred to equity financing, as it lets you raise funds without
diluting your ownership.

Operating leverage
Operating leverage accounts for the fixed operating costs and variable costs of providing
goods and services. As fixed assets don’t change with the level of output produced, their
costs are constant and must be paid regardless of whether your business is making a profit
or experiencing losses. On the other hand, variable costs change depending on the output
produced.

You can determine operating leverage by finding the ratio of fixed costs to variable costs.
If your business has more fixed expenses than variable expenses, it has high operating
leverage. You can use a high degree of operating leverage to magnify your returns, but too
much of it can increase your financial risk.

Combined leverage
Combined leverage accounts for your organization’s total business risks. As the name
suggests, combined leverage aggregates the effects of operating and financial leverages to
present a complete picture of your company’s financial health.

Combined leverage can be used by capital-intensive businesses with expansion potential

but insufficient levels of cash or equity. To effectively use combined leverage though, be
sure of your business’s future expenses and the market conditions. High levels of combined
risk can make returns susceptible to inputs, such as sales volumes.

2. Explain the functions of financial management

Functions of Financial Management

1. Estimation of capital requirements: A finance manager has to make estimation with
regards to capital requirements of the company. This will depend upon expected costs and profits
and future programmes and policies of a concern. Estimations have to be made in an adequate
manner which increases earning capacity of enterprise.
2. Determination of capital composition: Once the estimation have been made, the capital
structure have to be decided. This involves short- term and long- term debt equity analysis. This
will depend upon the proportion of equity capital a company is possessing and additional funds
which have to be raised from outside parties.
3. Choice of sources of funds: For additional funds to be procured, a company has many
choices like-
a. Issue of shares and debentures
b. Loans to be taken from banks and financial institutions
c. Public deposits to be drawn like in form of bonds.
Choice of factor will depend on relative merits and demerits of each source and period of
financing.
4. Investment of funds: The finance manager has to decide to allocate funds into profitable
ventures so that there is safety on investment and regular returns is possible.
5. Disposal of surplus: The net profits decision have to be made by the finance manager.
This can be done in two ways:
a. Dividend declaration - It includes identifying the rate of dividends and other
benefits like bonus.
b. Retained profits - The volume has to be decided which will depend upon
expansional, innovational, diversification plans of the company.
6. Management of cash: Finance manager has to make decisions with regards to cash
management. Cash is required for many purposes like payment of wages and salaries, payment
of electricity and water bills, payment to creditors, meeting current liabilities, maintainance of
enough stock, purchase of raw materials, etc.
7. Financial controls: The finance manager has not only to plan, procure and utilize the
funds but he also has to exercise control over finances. This can be done through many
techniques like ratio analysis, financial forecasting, cost and profit control, etc.

3. Explain the various techniques of capital budgeting?

Payback Period Method

It refers to the time taken by a proposed project to generate enough income to cover the initial
investment. The project with the quickest payback is chosen by the company.

Net Present Value Method (NPV)

Evaluating capital investment projects is what the NPV method helps the companies with. There may
be inconsistencies in the cash flows created over time. The cost of capital is used to discount it. An
evaluation is done based on the investment made. Whether a project is accepted or rejected depends on
the value of inflows over current outflows.

This method considers the time value of money and attributes it to the company's objective, which is to
maximize profits for its owners. The capital cost factors in the cash flow during the entire lifespan of
the product and the risks associated with such a cash flow. Then, the capital cost is calculated with the
help of an estimate.

Internal Rate of Return (IRR)

IRR refers to the method where the NPV is zero. In such as condition, the cash inflow rate equals the
cash outflow rate. Although it considers the time value of money, it is one of the complicated methods.

It follows the rule that if the IRR is more than the average cost of the capital, then the company accepts
the project, or else it rejects the project. If the company faces a situation with multiple projects, then the
project offering the highest IRR is selected by them.

Profitability Index

This method provides the ratio of the present value of future cash inflows to the initial investment. A
Profitability Index that presents a value lower than 1.0 is indicative of lower cash inflows than the
initial cost of investment. Aligned with this, a profitability index great than 1.0 presents better cash
inflows and therefore, the project will be accepted.

4. Elucidate the importance of financial management?

Financial management provides pathways to attain goals and objectives in an organisation. The
main duty of a financial manager is to measure organisational efficiency through proper
allocation, acquisition and management.
The importance of financial management is explained below −
 It provides guidance in financial planning.
 It assists in acquiring funds from different sources.
 It helps in investing an appropriate amount of funds.
 It increases organisational efficiency.
 It reduces delay production.
 It cut down financial costs.
 It reduces cost of fund.
 It ensures proper use of fund.
 It helps business firm to take financial decisions.
 It prepares guideline for earning maximum profits with minimum cost.
 It increases shareholders’ wealth.
 It can control the financial aspects of the business.
 It provides information through financial reporting

5. Mention the factors responsible for the success of financial planning?

Financial goals

You can’t make a plan until you know what you want to accomplish with your money—so
whether you’re creating it yourself or working with a professional, your plan should start with a
list of your goals, both big and small. It can help to organize them by how soon you’ll need the
money:

 Short-term goals are those you hope to achieve in the next five years—such as paying off
debt or buying a new car.
 Medium-term goals are those you hope to achieve in the next five to 10 years—such as
the down payment on a home or starting your own business.
 Long-term goals are those that are 10 or more years away—including college and, of
course, retirement.

Net worth statement

Every plan needs a baseline, so next you should determine your net worth. Make a list of all your
assets (bank and investment accounts, real estate, valuable personal property) and another one of
all your debts (credit cards, mortgages, student loans). Your assets minus your liabilities equals
your net worth.

“Don’t be discouraged if your liabilities outweigh your assets,” Rob says. “That’s not uncommon
when you’re just starting out—especially if you have a mortgage and student loans.”
Debt management plan

Debt is sometimes treated like a four-letter word, but not all debt is bad debt. A mortgage, for
example, can help build equity—and boost your credit score in the bargain. High-interest
consumer debt like credit cards, on the other hand, weighs heavily on your credit score. Plus,
every dollar you pay in finance charges and interest is one you can’t put toward other goals.

Budget and cash flow planning

Your budget is really where the rubber meets the road, planning-wise. It can help you determine
where your money is going and where you can cut back in order to meet your goals.

A budget calculator can help ensure you don’t overlook irregular but important expenses, such as
car repairs, out-of-pocket health care costs, and real estate taxes. As you’re compiling your list,
separate your expenses into two buckets: must-have items such as groceries and rent, and nice-
to-haves such as eating out and gym memberships.

Emergency funds

When something unexpected happens—you lose your job, for example, or get hit with an
unexpected medical bill—an emergency fund can help you avoid tapping your long-term savings
to make ends meet.

It’s generally a good idea to save enough to cover at least three months’—but ideally six
months’—worth of essential living expenses (e.g., groceries, housing, transportation, and
utilities). Save this money in a highly liquid checking or savings account so you can access it in a
hurry should the need arise.

Insurance coverage

Insurance is an important part of protecting your financial downside—but neither should you
overpay for coverage you don’t need. In general:

 Health insurance: Without it, even routine care can cost a pretty penny, while a serious
injury or hospital stay could set you back tens of thousands of dollars. As you get older, you may
want to consider long-term care insurance, as well.
 Disability insurance: This coverage protects you and your family in the event you’re
unable to work. Employer-provided disability insurance typically replaces about 60% of your
salary.
 Auto and homeowners’/renters’ insurance: If you own a car or home—or rent and
can’t afford to replace possessions out of pocket—make sure you’re adequately protected.
 Life insurance: This is generally a good idea for those with dependents. Work with an
insurance agent to understand what type of—and how much—coverage makes the most sense for
you.
6. Expound the characteristics of working capital?

These are three main characteristics associated with working capital management:

1. Accounts Receivable
Accounts receivable are revenues due—what customers and debtors owe to a company for past
sales. A company must collect its receivables in a timely manner so that it can use those funds
to meet its own debts and operational costs. Accounts receivable appear as assets on a
company's balance sheet, but they do not become assets until they are collected. Days sales
outstanding is a metric used by analysts to assess a company's handling of accounts receivables.
The metric reveals the average number of days a company takes to collect sales revenues.

Accounts Payable
Accounts payable is the amount that a company must pay out over the short term and is a key
component of working capital management. Companies endeavor to balance payments with
receivables to maintain maximum cash flow. Companies may delay payments as long as is
reasonably possible with the goal of maintaining positive credit ratings while sustaining good
relationships with suppliers and creditors. Ideally, a company's average time to collect
receivables is significantly shorter than its average time to settle payables.

Inventory
Inventory is a company's primary asset that it converts into sales revenues. The rate at which a
company sells and replenishes its inventory is a measure of its success. Investors also consider
the inventory turnover rate to be an indication of the strength of sales and how efficient the
company is in its purchasing and manufacturing. Low inventory means that the company is in
danger of losing out on sales, but excessively high inventory levels could be a sign of wasteful
use of working capital.

7.Discuss the objectives of financial management?

Objectives of Financial Management
The financial management is generally concerned with procurement, allocation and control of
financial resources of a concern. The objectives can be-

1. To ensure regular and adequate supply of funds to the concern.

2. To ensure adequate returns to the shareholders which will depend upon the earning
capacity, market price of the share, expectations of the shareholders.
3. To ensure optimum funds utilization. Once the funds are procured, they should be
utilized in maximum possible way at least cost.
4. To ensure safety on investment, i.e, funds should be invested in safe ventures so that
adequate rate of return can be achieved.
5. 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.

8.Essential of a sound financial plan?

Sound financial planning is necessary for the success of any business enterprise. It entails
policies and procedures for proper co-ordination between the various functional areas of
business. This involves proper allocation of resources among various departments and thus
leads to minimisation of waste of resources.
Simplicity:A sound financial structure should provide simple financial structure which could be
managed easily and understandable even to a layman. “Simplicity’ is an essential sine qua non
which helps the promoters and the management in acquiring the required amount of capital. It is
also easy to work out a simple financial plan.
Foresight:
Foresight must be used in planning the scope of operation in order that the needs for capital may
be estimated as accurately as possible. A plan visualised without foresight spells disaster for the
company, if it fails to meet the needs for both fixed and working capital. In simple words, the
canon of foresight means that besides the needs of ‘today’ the requirements of ‘tomorrow’
should also be kept in view.

(3) Flexibility: Financial readjustments become necessary often. The financial plan must be
easily adaptable to them. There should be a degree of flexibility so that financial plan can be
adopted with a minimum of delay to meet changing conditions in the future.

(4) Optimum use of funds:

Capital should not only be adequate but should also be productively employed. Financial plan
should prevent wasteful use of capital, avoid idle capacity and ensure proper utilisation of funds
to build up earning capacity of the enterprise.
Liquidity:
It means that a reasonable percentage of the current assets must be kept in the form of liquid
cash. Cash is required to finance purchases, to pay salaries, wages and other incidental expenses.
The degree of liquidity to be maintained is determined by the size of the company, its age, its
credit status, the nature of its operations, the rate of turnover etc.

9.Features of an appropriate capital structure?

Flexibility:
The consideration of flexibility gives the finance manager the ability to alter the firm’s capital
structure with a minimum cost and delay, if warranted by the changed environment. It should
also be possible for the company to provide funds whenever needed to finance its profitable
activities.

2. Profitability:
A sound capital structure should permit the maximum use of leverage at a minimum cost so as to
provide better profitability and thus maximizing earnings per share.

3. Solvency:
Extensive debt threatens the solvency and credit rating of the company. The debt financing
should be only to the extent that it can be serviced fully and also be paid back (if required).

4. Conservatism:
No company should exceed its debt capacity. As already explained that the interest is to be paid
on debt and the principal sum is also to be paid. These payments depend on future cash flows. If
future cash flows are not sufficient then the cash insolvency can lead to legal insolvency.

5. Control:
The capital structure should not lead to loss of control in the company.

10.Discuss the importance of cost of capital?

Designing the capital structure: The cost of capital is the significant factor in designing a
balanced and optimal capital structure of a firm. While designing it, the management has to
consider the objective of maximizing the value of the firm and minimizing cost of capital.
Comparing the various specific costs of different sources of capital, the financial manager can
select the best and the most economical source of finance and can designed a sound and balanced
capital structure.

Capital budgeting decisions: The cost of capital sources as a very useful tool in the process of
making capital budgeting decisions. Acceptance or rejection of any investment proposal depends
upon the cost of capital. A proposal shall not be accepted till its rate of return is greater than the
cost of capital. In various methods of discounted cash flows of capital budgeting, cost of capital
measured the financial performance and determines acceptability of all investment proposals
by discounting the cash flows.

Comparative study of sources of financing: There are various sources of financing a project.
Out of these, which source should be used at a particular point of time is to be decided
by comparing costs of different sources of financing. The source which bears the minimum cost
of capital would be selected. Although cost of capital is an important factor in such decisions, but
equally important are the considerations of retaining control and of avoiding risks.

Evaluations of financial performance: Cost of capital can be used to evaluate the financial
performance of the capital projects. Such as evaluations can be done by comparing actual
profitability of the project undertaken with the actual cost of capital of funds raise to finance the
project. If the actual profitability of the project is more than the actual cost of capital, the
performance can be evaluated as satisfactory.

Knowledge of firms expected income and inherent risks: Investors can know the firms
expected income and risks inherent there in by cost of capital. If a firms cost of capital is high, it
means the firms present rate of earnings is less, risk is more and capital structure is imbalanced,
in such situations, investors expect higher rate of return.

Financing and Dividend Decisions: The concept of capital can be conveniently employed as a
tool in making other important financial decisions. On the basis, decisions can be taken
regarding dividend policy, capitalization of profits and selections of sources of working capital.

11. Discuss the role of financial manager?

1. Raising of Funds
In order to meet the obligation of the business it is important to have enough cash and liquidity.
A firm can raise funds by the way of equity and debt. It is the responsibility of a financial
manager to decide the ratio between debt and equity. It is important to maintain a good balance
between equity and debt.
2. Allocation of Funds
Once the funds are raised through different channels the next important function is to allocate the
funds. The funds should be allocated in such a manner that they are optimally used. In order to
allocate funds in the best possible manner the following point must be considered

o The size of the firm and its growth capability

o Status of assets whether they are long-term or short-term
 o Mode by which the funds are raised

These financial decisions directly and indirectly influence other managerial activities. Hence
formation of a good asset mix and proper allocation of funds is one of the most important
activity
3. Profit Planning
4. Profit earning is one of the prime functions of any business organization. Profit earning is
important for survival and sustenance of any organization. Profit planning refers to proper usage
of the profit generated by the firm.
Profit arises due to many factors such as pricing, industry competition, state of the economy,
mechanism of demand and supply, cost and output. A healthy mix of variable and fixed factors
of production can lead to an increase in the profitability of the firm.
Fixed costs are incurred by the use of fixed factors of production such as land and machinery. In
order to maintain a tandem it is important to continuously value the depreciation cost of fixed
cost of production. An opportunity cost must be calculated in order to replace those factors of
production which has gone thrown wear and tear. If this is not noted then these fixed cost can
cause huge fluctuations in profit.
5. Understanding Capital Markets
Shares of a company are traded on stock exchange and there is a continuous sale and purchase of
securities. Hence a clear understanding of capital market is an important function of a financial
manager. When securities are traded on stock market there involves a huge amount of risk
involved. Therefore a financial manger understands and calculates the risk involved in this
trading of shares and debentures.
Its on the discretion of a financial manager as to how to distribute the profits. Many
investors do not like the firm to distribute the profits amongst share holders as dividend instead
invest in the business itself to enhance growth. The practices of a financial manager directly
impact the operation in capital market.

12. Discuss the scope of financial management?

1. Planning
The financial manager projects how much money the company will need in order to maintain
positive cash flow, allocate funds to grow or add new products or services and cope with
unexpected events, and shares that information with business colleagues.

Planning may be broken down into categories including capital expenses, T&E and workforce
and indirect and operational expenses.
2. Budgeting
The financial manager allocates the company’s available funds to meet costs, such as mortgages
or rents, salaries, raw materials, employee T&E and other obligations. Ideally there will be some
left to put aside for emergencies and to fund new business opportunities.

Companies generally have a master budget and may have separate sub documents covering, for
example, cash flow and operations; budgets may be static or flexible.

Managing and assessing risk

Line-of-business executives look to their financial managers to assess and provide compensating
controls for a variety of risks, including:

 Market risk
Affects the business’ investments as well as, for public companies, reporting and stock
performance. May also reflect financial risk particular to the industry, such as a pandemic
affecting restaurants or the shift of retail to a direct-to-consumer model.

 Credit risk
The effects of, for example, customers not paying their invoices on time and thus the business
not having funds to meet obligations, which may adversely affect creditworthiness and valuation,
which dictates ability to borrow at favorable rates.

 Liquidity risk
Finance teams must track current cash flow, estimate future cash needs and be prepared to free
up working capital as needed.

 Operational risk
This is a catch-all category, and one new to some finance teams. It may include, for example, the
risk of a cyber-attack and whether to purchase cybersecurity insurance, what disaster recovery
and business continuity plans are in place and what crisis management practices are triggered if a
senior executive is accused of fraud or misconduct.

13. state briefly the methods and tools of financial management.

Tools of Financial Management for Financing
a)Financial Leverage

In this tool, finance manager fixes his need of financing. Over and low financing estimation may
be harmful for company. Optimum loan requirement is fixed with financial leverage tool. Learn
about it at here.
B) Selection Best Source of Finance

In this tool, finance manager analyze different source of financing. He check their rates,
repayment terms and other conditions and then choose best option.
Tools of Financial Management for Investing Decision

These tools are used to know which is best alternative of investment. Will this alternative give us
best return at minimum risk. Capital budgeting, internal rate of return, net present value. In the
area of investment in current assets, we use working capital management for knowing best
investment in current author.
14. state the limitations of financial planning.
An Expensive Process
Planning is actually the top process so it is extremely time-consuming and funds consuming. It
may delay certain cases that expenses regarding planning is directly proportional to your time
invested during planning stage. It’s a major limitations of financial planning for small business
owners. In case you reserve and maintain your finances according, then consequences might vary
in many matters.
No Availability of Data
It’s a leading limitations of financial planning in every organization. Where you’ll not see the
genuine data what a person desire. planning loses considering those values in their absence.
Secondly, you can perhaps not effort too-much of cost expenditure to get correct and sufficient
insight information.

Lack of Communication
If there is an insufficient communication and improper co-ordination anywhere between different
officers, departments associated with a company, even the excellent financial strategy will never
exercise effectively and is assured in order to fail. This type of limitations of financial planning
most observed in large companies.

Change in Environment, Rules, Policies

Abrupt changes in the government guidelines or the economic environment may adversely
impact your finance plan. In the event that financial strategy cannot adjust for corrections based
on the changing government rules, policies as well as financial environment, an efficient
financial plan probably also be inefficient for the insufficient required adjustments.

Lack of Financial Forecasting

As financial methods depend on presumptions, which, financial forecasting, truth be told there
continues to be a scope for the mistaken predictions. Therefore, the program must be evaluated
from time for you time and some must adjustments must be created with respect to the business
environment.

Failure to Plan
Planning is a always a forward looking process. If a founder, owner or management possesses to
follow instead of leading then he can never make a good financial plans. Therefore, this
limitations of financial planning can be avoided by hiring a best financial planner.
Over Ambitious Projection
Sometimes professionals and business owners put through over ambitious projections then the
realistic once. Always describe the best clear vision. Business planning should-be based on
realistic vision and mission.

Rigid Planning
It involves your determination of the course of action ahead of time. It may lead to inflexibility,
internal as well as procedural rigidity. For example: utilizing at the planning a business may
succeed some objectives. Then again this way planning may build rigidity or even locks business
into some goals. To overcome this disadvantages of financial planning you should have dynamic
planning with involvement of others.

15.state the objectives of capital budgeting

1.Selecting profitable projects: An organization comes across various profitable projects

frequently. But due to capital restrictions, an organization needs to select the right mix of
profitable projects that will increase its shareholders’ wealth.

2. Capital expenditure control: Selecting the most profitable investment is the main objective of
capital budgeting. However, controlling capital costs is also an important objective. Forecasting
capital expenditure requirements and budgeting for it, and ensuring no investment opportunities
are lost is the crux of budgeting.

3. Finding the right sources for funds: Determining the quantum of funds and the sources for
procuring them is another important objective of capital budgeting. Finding the balance between
the cost of borrowing and returns on investment is an important.

16. Discuss the features of capital structure?

Maximum Return:
The financial structure of a company should be guided by clear- cut objective. Its objective can
be maximisation of the wealth of the shareholders or maximisation of return to the shareholders.
Less Risky:
The capital structure should represent a balance between different types of ownership and debt
securities. This is essential to reduce risk on the use of debt capital.

Safety:
A sound capital structure should ensure safety of investment. It should be so determined that
fluctuations in the earnings of the company do not have heavy strain on its financial structure.

Flexibility:
A sound capital structure should facilitate expansion and contraction of funds. The company
should be able to procure more capital in times of need and should be able to pay all its debts
when it does not require funds.

Economy:
The capital structure should ensure the minimum costs of capital which in turn would increase its
ability to generate more wealth for the company.

Control:
The capital structure of a company should not dilute the control of equity shareholders of the
company. That is why, convertible debentures should be issued with great caution.

17.Explain the importance of working capital?

Working capital is a daily necessity for businesses, as they require a regular amount of cash to
make routine payments, cover unexpected costs, and purchase basic materials used in the
production of goods.

Efficient working capital management helps maintain smooth operations and can also help to
improve the company's earnings and profitability. Management of working capital includes
inventory management and management of accounts receivables and accounts payables. The
main objectives of working capital management include maintaining the working capital
operating cycle and ensuring its ordered operation, minimizing the cost of capital spent on the
working capital, and maximizing the return on current asset investments.

Working capital is an easily understandable concept, as it is linked to an individual’s cost of

living and, therefore can be understood in a more personal way. Individuals need to collect the
money that they are owed and maintain a certain amount on a daily basis to cover day-to-day
expenses, bills, and other regular expenditures.

Working capital is a prevalent metric for the efficiency, liquidity and overall health of a
company. It is a reflection of the results of various company activities, including revenue
collection, debt management, inventory management and payments to suppliers. This is because
it includes inventory, accounts payable and receivable, cash, portions of debt due within the
period of a year and other short-term accounts.

18. explain the meaning and importance of valuation concept/

Valuation is the analytical process of determining the current (or projected) worth of an asset or
a company. There are many techniques used for doing a valuation. An analyst placing a value
on a company looks at the business's management, the composition of its capital structure, the
prospect of future earnings, and the market value of its assets, among other metrics.

Fundamental analysis is often employed in valuation, although several other methods may be
employed such as the capital asset pricing model (CAPM) or the dividend discount
model (DDM).

19.Explain the difference bases of determining the capitalization of a firm?

Cost Theory of Capitalisation:

According to this theory, capitalisation of a firm is determined on the basis of cost of different
assets. A firm needs funds to acquire fixed assets, to meet promotional and organisation expenses
and to meet current assets requirements of the enterprise. Sum of the cost requirements of the
above assets gives the amount of capitalisation.

Thus, if a company requires Rs. 1,00,000 to pay for promotional expenses, cost of selling
securities, acquiring fixed assets and to provide it with necessary working capital and to cover
possible initial losses, it will capitalize at Rs. 1,00,000 and sell securities of this amount.

Earning Theory of Capitalisation:

According to earnings theory, a firm should be capitalized on the basis of expected earnings of
the firm. A firm is a profit seeking entity and hence, its real value should be determined
according to what it earns. It should, however, not mean that if a firm’s annual earning is about
Rs. 50,000, it is worth that amount, for the firm will continue to earn for a number of years.

Since company is a going concern, it is customary to assume that the Stream of net earnings will
continue for an indefinite period. Accordingly, value obtained by multiplying annual net income
of a firm by appropriate multiplier would be the real value of the firm. The multiplier here would
mean capitalisation rate.

20. write a short note on capital rationing

Businesses typically face many different investment opportunities but lack the resources to
pursue them all. Capital rationing is a way of allocating their available funds in a logical
manner.1 A company will typically attempt to devote its resources to the combination of
projects that offers the highest total net present value (NPV).2

Companies may also use capital rationing strategically, forgoing immediate profit to invest in
projects that hold out greater long-term potential for the business as it positions itself for the
future.

Two Types of Capital Rationing

There are two primary types of capital rationing, referred to as hard and soft:

1. Hard capital rationing. This type of capital rationing occurs based on external factors.
For example, the company may be finding it difficult to raise additional capital, either through
equity or debt. Or, its lenders may impose rules on how it can use its capital. These situations
will limit the company's ability to invest in future projects and may even mean it must reduce
spending on current ones.
2. Soft capital rationing. This second type of rationing is also known as internal rationing.
It is based on the internal policies of the company. A fiscally conservative company, for
example, may require a particularly high projected return on its capital before it will get
involved in a project—in effect, self-imposing capital rationing.

21. discuss the qualities which a sound capital structure should possess.

Maximum Return:
The financial structure of a company should be guided by clear- cut objective. Its objective can
be maximisation of the wealth of the shareholders or maximisation of return to the shareholders.

Less Risky:
The capital structure should represent a balance between different types of ownership and debt
securities. This is essential to reduce risk on the use of debt capital.

Safety:
A sound capital structure should ensure safety of investment. It should be so determined that
fluctuations in the earnings of the company do not have heavy strain on its financial structure.

Flexibility:
A sound capital structure should facilitate expansion and contraction of funds. The company
should be able to procure more capital in times of need and should be able to pay all its debts
when it does not require funds.
 Economy:
The capital structure should ensure the minimum costs of capital which in turn would increase its
ability to generate more wealth for the company.

22. what is meant by operating cycle concept in management of working capital.

The cash operating cycle (also known as the working capital cycle or the cash conversion cycle)
is the number of days between paying suppliers and receiving cash from sales.

Cash operating cycle = Inventory days + Receivables days – Payables days.

In the manufacturing sector inventory days has three components:

(i) raw materials days

(ii) work-in-progress days (the length of the production process), and
(iii) finished goods days.

However, exam questions tend to be based in the retail sector where no such sub-analysis is
required.

The longer the operating cycle the greater the level of resources ‘tied up’ in working capital.
Although it is desirable to have as short a cycle as possible, there may be external factors which
restrict management’s ability to achieve this:

 Nature of the business – a supermarket chain may have low inventory days (fresh food),
low receivables days (perhaps just one to two days to receive settlement from credit card
companies) and significant payables days (taking credit from farmers). In this case the operating
cycle could be negative (ie cash is received from sales before suppliers are paid). On the other
hand a construction company may have a very long operating cycle due to the high levels of
work-in-progress.
 Industry norms – if key competitors offer long periods of credit to their customers it may
be difficult to reduce receivables days without losing business.

 Power of suppliers – an attempt to delay payments could lead to the supplier demanding
‘cash on delivery’ in future (ie causing payables days to actually fall to zero rather than rising).

23. explain the various types of dividend.

Cash Dividend
Cash dividends are the most commonly used dividend type. In this type of dividend, the dividend
amount is paid by transferring a sum of money. The money can be transferred electronically or
through cash and check. When the company declares the dividend, then all the shareholders
existing on the date specified by the company are eligible to receive the payment of dividend
before the company makes a payment; the company must arrange enough cash to pay off the
dividends.

Stock Dividend
Stock dividends refer to the dividend which is paid by allotting a certain number of shares to the
existing shareholders without taking any kind of consideration. The stock dividend is treated
differently in two different cases where; the first case is when the company issues less than 25 %
of the outstanding shares, then it is treated as a stock dividend, but if the issue is more than 25%
of the outstanding number of share, then the same is treated as stock split and nit stock dividend.

Scrip Dividend
A scrip dividend is the type of dividend issued by the company in which the company gives
transferrable promissory notes which promise to pay the shareholders the amount of dividend on
some later date. The notice issued may or may not be interest-bearing.

24. explain the objectives of financial management

Profit Maximization

A business is set up with the main aim of earning huge profits. Hence, it is the most important
objective of financial management. The finance manager is responsible to achieve optimal profit
in the short run and long run of the business. The manager must be focused on earning more
and more profit. For this purpose, he/she should properly use various methods and tools
available.

Wealth Maximization

Shareholders are the actual owners of the company. Hence, the company must focus on
maximizing the value or wealth of shareholders. The finance manager should try to distribute
maximum dividends among the shareholders to keep them happy and to improve the goodwill of
the company in the financial market. The declaration of dividend and payout policy is decided
with the help of financial management. A proper dividend policy related to the declaration of
dividends or retaining the company's profit for future growth and development is part of
dividend decisions. But this is based on the performance of the company and the amount of
profit earned. Better performance means a higher value of shares in the financial market. In
nutshell, the finance manager focuses on maximizing the value of shareholders.

Maintenance of Liquidity

With the help of proper financial management, the manager can easily monitor the regular
supply of liquidity in the company. But it is not as easy as it sounds. To maintain the proper
cash flow, the manager must keep an eye over all the inflows and outflows of money to reduce
the risk of underflow and overflow of cash. The finance manager is responsible to maintain an
optimal level of liquidity in the organization. Healthy cash flow means a higher possibility of
survival and success of the business. Because it helps the business to deal with uncertainty,
timely payment of dues, getting cash discounts, making day-to-day payments without delays, etc.

Proper Mobilization

Financial management helps in the effective utilization of sources of finance. It means without
wasting them and getting the maximum benefit from the available resources. The finance
manager is responsible for managing the different sources of funds such as shares, debentures,
bonds, loans, etc. So, after estimating the financial requirements, the manager must decide
which source of the funds he/she should use to avail the maximum benefit.

Improved Efficiency

Financial management is also beneficial in increasing the efficiency of all sections and
departments of the organization. If the finance is effectively distributed to all the departments
then they will work efficiently. It will support the company to achieve its targets easily which
will be further helpful for the growth of the entire company.

Creating Reserves

The business environment is full of uncertainty such as sudden changes in customers'

preferences, climate change, natural calamity, change in technology, etc. To overcome such
unplanned issues, the company should have a sufficient amount in the form of reserves. The
company can create reserves over the year by having an optimal dividend payout policy. The
company should also keep some part of profits in the form of reserves. The reserves are not only
helpful in dealing with unwanted situations but also to expand the business and face
contingencies in the future. This benefit can only be taken if the company has effective
management of finance.
Decreases the Cost of Capital

This objective includes measuring the cost of capital, risk evaluation, and calculating the
approximate profits out of a particular project. Financial managers are responsible for the
effective investments of available funds in the current or fixed assets to get the maximum
benefits or ROI.

Balanced Structure

Financial management also provides a balanced capital structure to the company. In other words,
it brings a proper balance between the various sources of capital such as loans, equity, bonds,
retained earnings, etc. This balance is required for flexibility, liquidity, and stability in the
organization as well as the economy.

Developing Financial Scenarios

With the help of financial management, financial scenarios can be developed. It can be done by
forecasts and the current state of the company. But for this purpose, the financial manager has to
assume a wide range of possible outcomes as per the current and future market conditions.

25. explain the factors determining capital structure

 Cost of Capital

In a nutshell, the cost of capital can be defined by predicting the return that a firm needs to the
cost spent on projects before considering it. This factor can save the firm from choosing such a
capital structure which depicts the limit which shouldn’t be crossed while investing in the
project, cutting the project costs. The cost of capital is the factor that determines the need of the
type of capital structure, i.e., equity or capital. A firm needs to adapt.

 Size and Nature of Business

The size and nature of the business are two crucial factors that shouldn’t be ignored while
making capital structure. A small business faces difficulties in raising funds. This happens as
they aren’t yet scaled enough and have less credibility for significant and long-term borrowings.
Even if they remain successful in growing, they are bound to some disadvantages of poor debt-
to-equity ratio higher interest rates, which harms the capital structure.

Similarly, the nature of business specifies the need for capital. Bottom-level businesses such as
manufacturers, producers, and farmers demand high and more flexible capital structures.
 Flexibility of Capital Structure

A structure should be flexible enough to cope with different market and business situations. The
rigid structure can lead to a financial crisis or a shortage of funds in a business in emergencies.

 Control on Business

Business ownership also affects the capital structure of a firm. Sole proprietorship or partnership
firms have fewer owners, which advances to adjust the capital structure more easily as per the
situations. On the other hand, public companies have the stakes of innumerable individuals,
which can be the restriction point, making it inflexible.

 Capital Market Conditions

Capital market conditions are also essential factors that should be taken into consideration.
Capital market conditions can determine the cost of capital at the present time alongside risk
issuing any new projects. On several conditions, people don’t want to invest in a firm owing to
market volatility or the firm’s aspects. Similarly, in above normal market conditions, a firm
shouldn’t raise funds at an increased cost of capital.

 Debt to Equity Ratio of Firm

The debt to equity ratio is the financial tool that gives an accurate overview and need of the type
of capital structure. Maintaining an optimal capital or equity structure is essential, and an
increased inflow of debt capital can affect the capital structure. A poor debt-to-equity ratio also
decreases stakeholder investments and credibility. Similarly, a good-performing debt-to-equity
ratio increases the availability of a firm’s financial leverage, which in turn can be used on
development or in an emergency.

26. explain the various types of working capital and its characteristics

 Gross Working Capital

Gross working capital is the total value of the company’s current assets. Current assets include
cash, receivables, short-term investments, and especially market securities.
The Gross working capital does not showcase the current liabilities. Gross working capital can
be executed by calculating the difference between the existing assets and current liabilities.
The difference remaining is the actual working capital that the company has to meet its
obligations.
 Net Working Capital
Networking capital is the difference between the current assets and current liabilities of the
company. If the company’s assets are more than current liabilities, it indicates a positive
working capital, and the company is in a financial position to meet its obligations.
However, if the company’s assets are less than current liabilities, it indicates a negative
working capital, and the company is facing financial distress.
The key difference between gross and net working capital is that gross working capital will
always be a positive value. In contrast, networking capital can either be a negative or positive
value.
 Permanent Working Capital
Permanent working capital is the minimum amount of capital required to carry on the
operations without interruption or difficulty.
For example, a company will need minimum cash to keep the operations smooth and running;
here, the minimum amount of money required will act as permanent working capital.
 Regular Working Capital
Regular working capital is the amount of funds businesses require to fund its day to day
operations. For example, cash needed for making payment of wages, raw materials, salaries
comes under regular working capital.
 Reserve Margin Working Capital
Apart from conducting day-to-day activities, a business may need some amount of capital to
face unforeseen circumstances. Reserve margin working capital is nothing, but the money kept
aside apart from the regul ar working capital. These funds are held separately against
unexpected events like floods, natural calamities, storms, etc.
 Variable Working Capital
Variable working capital can be defined as the capital invested for a temporary period in the
business. Variable working capital is also called fluctuating working capital.
Such capital differs with respect to changes in the business assets or the size of the business.
Furthermore, variable capital is subdivided into two parts:
1)Seasonable Variable Working Capital
Seasonable variable working capital is the amount of capital kept aside to meet the seasonal
demand if the business is running seasonally.
2) Special Variable Working Capital
Special variable working capital is the temporary rise in the working capital due to any
unforeseen or occurrence of a special event.
28. what is time value of money?
The time value of money (TVM) is the concept that a sum of money is worth more now than
the same sum will be at a future date due to its earnings potential in the interim. The time
value of money is a core principle of finance. A sum of money in the hand has greater value
than the same sum to be paid in the future. The time value of money is also referred to as the
present discounted value.
Why Is the Time Value of Money Important?

The concept of the time value of money can help guide investment decisions. For instance,
suppose an investor can choose between two projects: Project A and Project B. They are
identical except that Project A promises a $1 million cash payout in year one, whereas Project B
offers a $1 million cash payout in year five. The payouts are not equal. The $1 million payout
received after one year has a higher present value than the $1 million payout after five years.

How Is the Time Value of Money Used in Finance?

It would be hard to find a single area of finance where the time value of money does not
influence the decision-making process. The time value of money is the central concept
in discounted cash flow (DCF) analysis, which is one of the most popular and influential
methods for valuing investment opportunities. It is also an integral part of financial planning
and risk management activities. Pension fund managers, for instance, consider the time value of
money to ensure that their account holders will receive adequate funds in retirement.

29. distinguish between liquidity and profitability

Liquidity

The liquidity and profitability of a company are directly related to the working capital. When a
company maintains high temporary working capital in current assets, it is known to be more
liquid. The companies that maintain a lower level of working capital are known as less liquid.
Companies that maintain higher liquidity and considered to be at lower risk. They are able to
meet the needs of the company and their reservoir of current assets lets them have the freedom to
stay solvent.
However, more liquid companies have lower profitability because their funds are tied up in
operations and these funds cannot be used for the production and expansion of the company.

Profitability

Profitability is different from liquidity. In fact, the terms profitability and liquidity are opposite
in sense when they are used for a company’s operations. Profitability is the amount of profit the
company earns from the sales of its products.
 Some of the outcomes of profitability are related to liquidity as well. For example, when
a company uses its current assets for liquidity, it is going in the direction of less profitability.
Doing so will make the company more liquid but as the return from the activity leads to less
income, the activity will generate less profit.
 Profitability is the ultimate aim of all companies. In order to earn profits, the companies
should manage their working capital in the best way possible.
For example, the company utilizing its temporary working capital more efficiently will be able
to use its current assets more favorably. Therefore, it will earn more profit than its competitors
that do not follow an efficient working capital management policy.
 When a company is highly liquid and solvent, it will become less profitable. As the funds
needed for growth and profitability or the current assets of the company are tied up and idle, it
cannot be profitable. Therefore, a company aiming to be profitable must take some risks and be
less liquid in nature.

30. write a short note on optimum capital structure

The optimal capital structure of a firm is the best mix of debt and equity financing that
maximizes a company’s market value while minimizing its cost of capital. In theory, debt
financing offers the lowest cost of capital due to its tax deductibility. However, too much debt
increases the financial risk to shareholders and the return on equity that they require. Thus,
companies have to find the optimal point at which the marginal benefit of debt equals the
marginal cost.

Understanding Optimal Capital Structure

The optimal capital structure is estimated by calculating the mix of debt and equity that
minimizes the weighted average cost of capital (WACC) of a company while maximizing its
market value. The lower the cost of capital, the greater the present value of the firm’s future
cash flows, discounted by the WACC. Thus, the chief goal of any corporate finance department
should be to find the optimal capital structure that will result in the lowest WACC and the
maximum value of the company (shareholder wealth).

According to economists Franco Modigliani and Merton Miller, in the absence of

taxes, bankruptcy costs, agency costs, and asymmetric information, in an efficient market, the
value of a firm is unaffected by its capital structure.

31. discuss the capital structure practices in india

Capital structure refers to the specific mix of debt and equity used to finance a company’s assets
and operations. From a corporate perspective, equity represents a more expensive, permanent
source of capital with greater financial flexibility. Financial flexibility allows a company to raise
capital on reasonable terms when capital is needed. Conversely, debt represents a cheaper, finite-
to-maturity capital source that legally obligates a company to make promised cash outflows on a
fixed schedule with the need to refinance at some future date at an unknown cost.
business characteristics: features associated with a company’s business model, operations, or
maturity;
capital structure policies and leverage targets: guidelines set by management and the board that
seek to establish sensible borrowing limits for the company based on the company’s risk appetite
and ability to support debt; and
market conditions: current share price levels and market interest rates for a company’s debt. The
prevalence of low interest rates increases the debt-carrying capacity of businesses and the use of
debt by companies.
32. explain the principal motives for holding cash.
The Motives for Holding Cash is simple, the cash inflows and outflows are not well
synchronized, i.e. sometimes the cash inflows are more than the cash outflows while at other
times the cash outflows could be more. Hence, the cash is held by the firms to meet the certain as
well as uncertain situations.

1. Transaction Motive: The transaction motive refers to the cash required by a firm to meet
the day to day needs of its business operations. In an ordinary course of business, the firm
requires cash to make the payments in the form of salaries, wages, interests, dividends, goods
purchased, etc.
Likewise, it also receives cash from its sales, debtors, investments. Often the firm’s cash inflows
and outflows do not match, and hence, the cash is held up to meet its routine commitments.

2. Precautionary Motive: The precautionary motive refers to the tendency of a firm to hold
cash, to meet the contingencies or unforeseen circumstances arising in the course of business.
Since the future is uncertain, a firm may have to face contingencies such as an increase in the
price of raw materials, labor strike, lockouts, change in the demand, etc. Thus, in order to meet
with these uncertainties, the cash is held by the firms to have an uninterrupted business
operations.

3.Speculative Motive: The firms hold cash for the speculative purposes to avail the benefit of
bargain purchases that may arise in the future. For example, if the firm feels the prices of raw
material are likely to fall in the future, it will hold cash and wait till the prices actually fall.
Thus, a firm holds cash to exploit the possible opportunities that are out of the normal course of
business. These opportunities could be in the form of the low-interest rate charged on the
borrowed funds, expected fall in the raw material prices or favorable change in the government
policies.

Thus, the cash is the most significant and liquid asset that the firm holds. It is significant as it is
used to pay off the firm’s obligations and helps in the expansion of business operations.

33. how would you, involve finance manager in the process of financial decision?
 Financial planning: Preparing the financial plan, which projects revenues, expenditures,
and financing needs over a given period.
 Investment (spending money): Investing the firm’s funds in projects and securities that
provide high returns in relation to their risks.
 Financing (raising money): Obtaining funding for the firm’s operations and investments
and seeking the best balance between debt (borrowed funds) and equity (funds raised through the
sale of ownership in the business).

34. define financial planning. state its objectives

Financial planning is nothing but the process of:

a. Determining your future needs in terms of investment, resources, funds

b. Determining the sources of funds
c. Managing or utilizing these funds efficiently
d. Identifying risks and issues in the plan

The objectives of a financial plan are as follows:

 Estimating the capital requirement

Determining the investment or capital required for a business is the commencing step of a
financial plan. The capital requirement is divided into two categories:

1. Short-term capital
2. Long-term capital

Capital requirements are affected by multiple businesses needs such as the ratio of the
requirement for current and fixed assets, operation expenses, etc.

 Estimation of sources, availability, and timing of funds

 This particular activity is time-consuming and requires precision in terms of execution.
The required funds should be made available at the appropriate times in alignment with the
business needs. It also includes estimating fund requirements for different purposes in the
business. Financial planning aids primarily by determining the cheapest sources of funds and
ensuring availability at the right time.

 Determining the Capital structure for the business

The capital structure of a business refers to the composition of total internal and external debt
towards the shareholder’s capital. Financial planning includes determining an effective debt-
equity ratio of the business both short-term and long-term.

 Avoiding unnecessary generation of funds

One may imagine that having an excess of funds can never be a bad thing. But that’s a
misconception. An unnecessary excess and shortage of funds, both, are expensive affairs. An
important function of financial planning is to ensure that the business does not raise unnecessary
resources. Excess funds are idle assets. They don’t earn revenues for the business, moreover,
incur their own cost.

 Tackling financial risks:

Financial planning helps identify beforehand the operational and financial risks of a business. As
a result, effective strategies can be prepared to counter such identified risks and issues. This way,
the business can operate smoothly while also saving money and time.

35. explain the meaning and objectives of cash management?

The skill of controlling cash inflows and cash outflows is known as cash management. It is an
essential step in making sure that any business can survive.

For this particular reason, banks and businesses frequently collaborate where banks are given
custody of cash assets. However, banks can assist companies with more than just holding cash;
they can help them receive money from receivables and pay it forward under payables and other
business expenditures.

objectives of cash management

Controls Cash Flow

The most vital objective of a cash management system is limiting your cash outflow as well as
accelerating cash inflow. A business owner might always want to increase the amount of cash
flowing into the business. However, minimising the cash outflow will result in reduced
operational expenses.
An efficient cash management system that is integrated with cash management software will
increase your real-time cash visibility which will give you greater control of your cash flow.

2. Efficient Cash Planning

The right cash management system will help you to optimise cash and plan effectively. It helps
in planning the capital expenditure and determining the ratio of equity and debt to acquire
finances. With the right planning, you will have the right amount of liquid cash so that you do
not fall short of it.

3. Meet Unforeseen Expenses

The company might have to face certain unexpected circumstances like breakdown of
machinery. Having surplus cash will help in coping with this situation in the best manner.

4. Ease of Investment
Cash management helps in optimum utilisation of available funds by creating an adequate
balance between cash in hand and investments. It will help you to invest the idle funds in the
right proportion at the right opportunity as it is one of the aims of cash management.

5. Avoiding Insolvency
If companies do not have proper planning for cash management, a situation might arise when the
business will be unable to pay their bills. This situation may occur due to lack of liquid cash or
not being able to make profit from the money available.