5 Marks Each

Question 15 Marks

Distinguish between : $(i)$ Gross working capital and net working capital. $(ii)$ Fixed capital and working capital.

Answer

$(i)$ Gross working capital and net working capital.

Points of differences	Gross working capital	Net working capital
$1.$ Meaning	It is the sum total of current assets such as bill receivables, debtors, short term marketable securities, bank balance, cash, etc.	It is current assets minus current liabilities.
$2.$ Liquidity position	This concept does not give an idea about the liquidity position of the company.	This concept gives an idea how much liquidity the company has.
$3.$ Finacial position and measurement	Does not give a true idea of the financial position of the company.	Gives the true idea of financial position of the company.
$4.$ Increase in current liabilities	Increase in current liabilities does not increase the gross working capital. $($Reason: Gross working capital is only concerned with current assets and not liabilities.$)$	Increase in current liabilities decreases net working capital.

$(ii)$ Fixed capital and working capital.

Points of differences	Working Capital	Fixed Capital
$1.$ Meaning	Capital invested in current assets such as stock of raw materials and finished goods, debtors, bills receivable etc. is called working capital.	Capital invested in fixed assets such as land, building, machinery, furniture is called fixed capital.
$2.$ Period	Blocked up for a short period in business.	Blocked up for a long period in business.
$3.$ Liquidity	Ratio of liquidity is high because working capital can be easily converted into cash.	Ratio of liquidity is less because fixed capital is invested for a long period in fixed assets.
$4.$ Risk	Ratio of risk is low.	Ratio of risk is high.
$5.$ Requirement	It is required for day-to-day expenses like wages, salary, purchasing raw materials, etc.	It is required to purchase fixed assets such as land, building, plant and machinery.
$6.$ Sources	Sources of raising working capital include trade credit, bank overdraft, indigenous bankers, etc.	Sources of raising fixed capital include issue of shares and debentures, financial institutions, etc.
$7.$ Depreciation	Depreciation is not calculated on working capital	Depreciation is calculated on fixed assets

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Question 25 Marks

Giving the definition, explain the concepts of working capital.

Answer

Introduction :

Fixed capital is required to establish business and to maintain the business and for day-to-day expenses working payment of salary to employees, to purchase raw material, to make payment o creditors and business activity may stuck.
So it is necessary to consider working capital carefully.

Definition of working capital :

As per simple definition, “the capital which is required for making payment of day-to-day expenses and which is occupied in current assists and continuously moving in circulation is called working capital.”
According to Lincoln’ Doris and Stevens, “Working capital is the excess of current assists over current liability.”
According to J.S. Mill, “the sum current assists means the working capital.”
“Working capital is required in business to make payment of day-to-day expenses, such as salary, labour, stationary, telephone and electricity bill, retail instrument, raw material etc. Working capital is constantly circulating in business so it is called life blood.”

Concept o working capital : There are two concepts of working capital.

Gross working capital :

Sum of total investment in current assists of business such as raw material, finished goods, debtors, bill receivable, short term securities, cash bank balance etc.
Formula : Gross working capital = Total current assists.

Net working capital :

Net working = Current assists – Current liabilities.
Net working capital can be obtains by deducting total current liabilities from gross current assists.

Current liabilities :

Current liabilities include creditors, bills, payable, expenses to be paid, short term bank loan, bank over draft, proposed dividend, provision for taxation etc.
When assists exceed current liabilities it is called positive working capital.
When current liabilities exceed assists it is called negative working capital.

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Question 35 Marks

Discuss the factores affecting the capital structure.

Answer

External factors that affect the capital structure of the company:
$1.$ Condition of boom-depression in capital market:

When the market is low i.e. depressed, the investors prefer to invest safely in debentures rather than in risky equity. This earns them reasonable returns. On the other hand, when market is in boom, the investors invest in equity shares so as to earn higher dividends and profits.
Thus, how the capital structure will be formed is also decided by the trends prevailing outside the company in the capital market.

$2.$ Current rate of interest in capital market:

If the current rate of interest is high in capital market, companies prefer to raise capital by issuing equity shares rather than borrowing capital since borrowing at high interest proves costly for the company.
If the interest rate is less, companies also prefer debentures.

$3.$ Cost of capital expenses of issuing securities:

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

$4.$ Legal restrictions:

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

$5.$ Taxation policy:

When the taxation is high, the companies prefer to issue debentures for acquiring capital. By doing so, the income tax gives deduction of interest paid on the debentures to the company.
Naturally, equity shares become more popular if the income of dividend is tax free or the rate is lower on the dividend income.

$6.$ Institutional investors:

Insurance companies, banks, financial institutions of state and central government, etc. invest in shares and debentures of the companies as per their established rules and conditions.
Trends and conditions of all these institutions are considered at the time of formulating capital structure or at the time of alteration of capital structure.

$7.$ Foreign institutional investor:

A financial institution established and registered outside India and whose objective is to invest in prescribed securities in India in primary and secondary markets is known as foreign institutional investor $(Fll).$
Foreign institutional investors have to get registered with $SEBI.$ Then, such institutions are permitted to purchase shares and debentures of Indian company.
Involvement of these institutions in the capital market of India affects the capital structure of the companies.

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Question 45 Marks

Explain the Importance of Financial Management.

Answer

Introduction :

Human life depends on blood.
In the same way existence of business unit depends on finance.
That is why finance in business activity is possible without money.
Money matter is related right from establishment of business to its expansion and end.
After 1950 due to noteworthy changes is business environment and current economic trends at global level important of financial management has increased.
Big industrial units appoint financial advisors today.

Importance of financial management :

Estimation of financial needs :

Continuity business activity is maintained because financial management estimates the requirement of long term and short term capital in business.

Acquiring Finance :

After having the estimate of required amount, financial management acquires finance at the lowest cost and selects the sources economically.

Planning and controlling :

Financial management plan for financial resources and controls them so that it is utilization economically.

Distribution of Finance :

Financial management distributes money to each department each department is given sufficient finance.

Maintaining liquidity :

Financial management determines the part of the profit to be reinvested in business and the amount to be distributed as dividend among shareholders.

Management of current assists :

Current assists include cash, bank balance, debtors marketable securities etc Financial management formulate, policies for these current assists.

Financial decisions :

Financial management maintains co-ordination among capital budget, dividend policy, poloughing back of profit, etc and takes decisions.
If large amount is re-invested, cash for dividend distribution decrease.
Co-ordination between the two is necessary.

Increase in credit of business :

Through efficient financial management with utilization of adequate financial resources, timely payment of the employees and timely repayment to creditors become possible.

Conclusion :

The importance of financial management is noted logically from every related party.
Growth in economic welfare of shareholders or the owner’s of the company, development fund or goods to customers etc. Depend on efficient financial management.

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Question 55 Marks

Distinguish between :
$(i)$ Gross working capital and net working capital.
$(ii)$ Fixed capital and working capital.

Answer

No.	Points of difference	Gross Working Capital	Net Working Capital
$1.$	Meaning	Gross working capital means sum total assists such as bills receivable, debtors, short term securities, bank balance, cash etc.	Net working capital means current assists minus current liabilities.
$2.$	Liquidity condition	Gross working capital does not show liquidity position of the company.	Net working capital shows liquidity position of the company.
$3.$	Financial position and criteria	It does not indicate true financial position of the company.	It gives clear and true idea of company’s financial position.
$4.$	Increase in current liabilities	Increases current liabilities increases the gross capital.	Increase in current liabilities reduces the net working capital.

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Question 65 Marks

Discuss factors affecting capital structure.

Answer

The internal factors affecting capital structure include the following:i. Nature of the Business:
Capital Structure of a firm largely depends on the nature of the business a firm undertakes. Firms that operate in monopoly or oligopoly markets generally have stable income and low business risk as compared to perfectly competitive firms.
As a result, they may employ a higher proportion of Debt Capital in their Capital Structure. On the other hand, perfectly competitive firms face high risk and hence rely more on Equity Capital.
ii. Size of the Business:
Small scale firms generally have lower capital requirements and hence rely mostly on their own capital. Moreover, many times, financial institutions impose strict lending conditions on such firms, as a result of which they are forced to avoid Debt Capital.
On the other hand, large firms get easy access to institutional credit and hence can depend on Debt Capital. Moreover, they also have higher capital requirements which can hardly be met by new issues always. For this reason, they also depend equally on Debt Capital.

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iii. Stability of Income:
The Capital Structure of a firm also depends on the stability of its income. Firms which can maintain stable income can easily bear the fixed charges like interest on debt and preference share dividend. Hence, they may depend more on Debt Capital or Preference Share Capital.
However, firms with fluctuating income can hardly manage the burden of fixed charge capital and hence should try to avoid them.
iv. Cost of Capital:

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Generally, Debt Capital is associated with lower cost as compared to Equity Capital. Hence, an increase in Debt Capital can significantly reduce the overall or average Cost of Capital. Hence, a firm that intends to minimise their Cost of Capital has to increase the share of Debt Capital in the total capital of the firm.
v. Objective of Financing:
Capital Structure also depends on the objective of financing. In order to finance the normal operating activities, a firm may rely on Debt Capital or Preference Share Capital as the fixed charges can easily be funded from the regular income.
On the other hand, expansion projects which will take time to materialise should preferably be financed by equity share capital or from retained earnings.

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vi. Duration of the Project:
This is another important factor determining the Capital Structure of a firm. A firm should finance the projects with fixed completion period through sources like Debt Capital or Preference Share Capital (which are compulsorily redeemable) by properly aligning the maturity profile of the instruments with the period of the projects.
On the other hand, projects, which do not have any fixed completion period, should preferably be financed by equity share capital which is not associated with compulsory redemption.
vii. Control over the Firm:
Since preference shareholders and debt providers do not have any voting right, procurement of additional capital through these sources does not hamper the controlling interest of the existing shareholders.
But if additional capital is financed by issuing new shares to investors other than the existing shareholders, it may dilute the proportionate shareholding and accordingly the controlling interest of existing shareholders, especially the promoter group.

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As a result, firms with high promoter shareholding may prefer Debt Capital to Equity Capital. However, at times, large borrowings come with strict debt covenants which may invite unnecessary interference by the debt providers. Hence, this aspect also needs to be taken care of.
viii. Flexibility:
Capital Structure of a firm should be flexible. Flexibility means the ease of changing the components of Capital Structure as and when needed.
In order to ensure flexibility, a firm may prefer structured debt instruments or preference shares to traditional equity shares, because convertibility, call ability, etc., can be attached only with these structured instruments and not with equity shares.
ix. Structure of Assets:
Capital Structure decisions are closely associated with the structure of assets of any firm. A firm should avoid financing Current Assets by long-term capital sources. Moreover, a part of the fixed assets may be financed by long-term Debt Capital with matching maturity.

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x. Trading on Equity:
Capital Structure of a firm also depends on the possibility and intention of undertaking Trading on Equity. When a firm has its Rate of Return higher than the cost of fixed charge capital, it can increase the return to shareholders by increasing the share of fixed charge capital in the total capital. Hence, in such cases, Capital Structure comprises more Debt Capital and less Equity Capital.
xi. Attitude of the Management:
Capital Structure of a firm also depends on the attitude and outlook of management towards financial risk. Firms with aggressive management are found to rely more on debt than those with conservative management.
xii. Age of the Company:
Newer companies with uncertain futures generally face hardship in getting institutional finance. As a result, they rely more on unconventional funding like private equities, venture capital funds, etc., mostly in the form of equity investments. Thus, their Capital Structure includes a higher share of owned capital than Debt Capital.

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Question 75 Marks

A business cannot afford to form capital structure ignoring the capital market.

Answer

Boom and depression are the two faces of capital market.
When the market is in boom, the company earns good profit. Investors become positive and invest in the shares of the company. This enhances the capital structure of the company.
When the market is in depression, the investors tend to invest in debt market so that they can safeguard their returns.
Thus, how the market behaves plays a very important role in the formation of capital structure of the company and hence it cannot be ignored.

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Question 85 Marks

Credit policy affects capital requirement. Explain.

Answer

If the business sells its goods on cash, it will require less on hand capital. But, if sold on credit, the business will be cash deficient.
In the same way, if the business can acquire raw material on credit and sell the goods on credit or cash, it will affect the capital available with the business.
Naturally, the availability of capital with the business will decide its credit requirements and policy.

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Question 95 Marks

The manager not only has to acquire finance but also optimize its utilization. Explain.

Answer

The financial manager studies the position of working capital and fixed capital thoroughly. He also studies the factors that affect these capitals.
After studying the requirement the manager has to study the various sources of finance such as equity shares, preference shares, debentures, bank loan, etc. and prepare the right mix of finance sourcing.
The task does not get over at just acquiring finance. The manager also needs to see that it is utilized and allocated properly. Failure to do so can lead to disaster or losing important capital raised for the business.

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Question 105 Marks

What role government assistance and taxation policy plays in deciding the fixed capital?

Answer

Government assistance and taxation policy:

To encourage industries and for balanced growth of various regions, government provides help in form of grant or subsidy to people.
The help can be in the form of cheap or free land, industrial shades at reasonable rates, machinery at subsidized rates, etc. All this reduces the need of fixed capital.
Taxation policy of the government also affects the need of fixed capital. For example, when the government gives tax benefits or adopts liberal policy towards sale of some new machineries then it helps the entrepreneurs because their need for fixed capital reduces.

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Question 115 Marks

Which factors affect the need of fixed capital? Discuss in detail.

Answer

$1.$ Type and nature of business:

Industrial units involved in heavy industrial activities such as shipping industry, iron and steel industry, mining industry, etc. require huge sum of fixed capital.
Units providing services comparatively require less fixed capital.

$2.$ Size of unit:
Small sized units require less fixed capital than large size industrial units. Cottage industry requires less fixed capital than sugar industry or textile industry. Similarly, the units engaged in manufacturing vehicles require huge fixed capital owing to their large scale production.
$3.$ Use of ownership/lease:
Whether the fixed assets are to be purchased or leased affects the need and risk of fixed capital. For example, if fixed assets like land, building, machinery are to be obtained on lease instead of purchasing, the investment as well as risk of fixed capital decreases.
$4.$ Research expense:

In order to remain steady in the ever competitive market, industrial units engage in research of their products and services.
Research makes the product better, more useful, helps in reducing cost of production, improves shape, form, stability and attractiveness. Activities under research increase the need of fixed capital.

$5.$ Modern technology:
As technology becomes advanced, the industrial units have to upgrade their machinery, plant, manufacturing processes, etc, This raises the need of fixed capital.
$6.$ Government assistance and taxation policy:

To encourage industries and for balanced growth of various regions, government provides help in form of grant or subsidy to people.
The help can be in the form of cheap or free land, industrial shades at reasonable rates, machinery at subsidized rates, etc. All this reduces the need of fixed capital.
Taxation policy of the government also affects the need of fixed capital. For example, when the government gives tax benefits or adopts liberal policy towards sale of some new machineries then it helps the entrepreneurs because their need for fixed capital reduces.

$7.$ Establishment expenses:

The establishment expense of sole proprietorship, partnership firm and co-operative society is less as compared to that of the formation of a company.
Company has to bear expenses on preparing documents such as registration fees, fees of experts, legal expenses, etc. These expenses are quite less in other form of firms. So, the form of business enterprise also affects the fixed capital needed.

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Question 125 Marks

What are the various sources through which fixed capital can be raised?

Answer

Sources:
There are several sources from which fixed capital can be raised. These include promoters of the business, owners of the business, various types of securities, financial institutions, ploughing back of profit, etc.

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Question 135 Marks

Discuss the risk associated with fixed capital.

Answer

Fixed capital remains blocked up in fixed assets for a longer period. So, there arises a risk of return on investment in case changes occur in technology, preference of consumers, etc. because the machinery or plant may become obsolete as compared to these changes.
Apart from this, changes in political, social and economic factors also tend to raise the rate of risk.

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Question 145 Marks

Explain the characteristics of fixed capital.

Answer

$1. $Long period:
Fixed capital is invested in business for a long period of $5$ years or above.
$2.$ Different ratio in different types of business:

The ratio of fixed capital is quite high in large industries such as those producing machinery, chemical industries, petrochemical industries, etc.
The ratio of fixed capital is relatively low in trading units.

$3.$ Components:
Fixed capital includes components such as land, building, plant, machinery, vehicles, furniture, etc.
$4.$ Less liquidity:
Fixed capital is invested for a long period in the business. Hence, its liquidity remains low. $($For example: One cannot immediately and easily sell machinery and plant set-up worth crores of rupees.$)$
$5.$ Risk:

Fixed capital remains blocked up in fixed assets for a longer period. So, there arises a risk of return on investment in case changes occur in technology, preference of consumers, etc. because the machinery or plant may become obsolete as compared to these changes.
Apart from this, changes in political, social and economic factors also tend to raise the rate of risk.

$6.$ Depreciation:
As per the taxation laws, depreciation is charged on the fixed assets in which fixed capital is invested. As a result, the book value of fixed assets decreases with time.
$7.$ Sources:
There are several sources from which fixed capital can be raised. These include promoters of the business, owners of the business, various types of securities, financial institutions, ploughing back of profit, etc.

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Question 155 Marks

Discuss the characteristics of working capital.

Answer

Characteristics of working capital:

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

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Question 165 Marks

Explain: Net working capital.

Answer

Net working capital:
Net working capital means current assets minus current liabilities.

Therefore, Net working capital = Current assets – Current liabilities

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

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Question 175 Marks

State important definitions of working capital.

Answer

According to Lincoln, Doris and Stevens, “Working capital is the excess of current assets over current liabilities.”
According to J. S. Mill, “The sum of the current assets means the working capital.”

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Question 185 Marks

What is working and fixed capital?

Answer

Working capital:

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

Fixed capital:

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

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Question 195 Marks

Which legal restrictions does the company face while setting-up its capital structure?

Answer

Legal restrictions:

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

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Question 205 Marks

What is the cost of issuing securities?

Answer

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

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Question 215 Marks

State the impact of booming and depressive market on the capital structure.
OR
Capital structure depends upon the current behavior of the capital market.

Answer

Condition of boom-depression in capital market:
When the market is low i.e. depressed, the investors prefer to invest safely in debentures rather than in risky equity. This earns them reasonable returns. On the other hand, when market is in boom, the investors invest in equity shares so as to earn higher dividends and profits.

Thus, how the capital structure will be formed is also decided by the trends prevailing outside the company in the capital market.

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Question 225 Marks

Discuss the external factors that affect the capital structure of the company.

Answer

External factors that affect the capital structure of the company:
$1.$ Condition of boom-depression in capital market:
When the market is low i.e. depressed, the investors prefer to invest safely in debentures rather than in risky equity. This earns them reasonable returns. On the other hand, when market is in boom, the investors invest in equity shares so as to earn higher dividends and profits.Thus, how the capital structure will be formed is also decided by the trends prevailing outside the company in the capital market.
$2.$ Current rate of interest in capital market:

If the current rate of interest is high in capital market, companies prefer to raise capital by issuing equity shares rather than borrowing capital since borrowing at high interest proves costly for the company.
If the interest rate is less, companies also prefer debentures.

$3.$ Cost of capital expenses of issuing securities:

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

$4.$ Legal restrictions:

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

$5.$ Taxation policy:

When the taxation is high, the companies prefer to issue debentures for acquiring capital. By doing so, the income tax gives deduction of interest paid on the debentures to the company.
Naturally, equity shares become more popular if the income of dividend is tax free or the rate is lower on the dividend income.

$6.$ Institutional investors:

Insurance companies, banks, financial institutions of state and central government, etc. invest in shares and debentures of the companies as per their established rules and conditions.
Trends and conditions of all these institutions are considered at the time of formulating capital structure or at the time of alteration of capital structure.

$7.$ Foreign institutional investor:

A financial institution established and registered outside India and whose objective is to invest in prescribed securities in India in primary and secondary markets is known as foreign institutional investor $($Fll$).$
Foreign institutional investors have to get registered with $SEBI.$ Then, such institutions are permitted to purchase shares and debentures of Indian company.
Involvement of these institutions in the capital market of India affects the capital structure of the companies.

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Question 235 Marks

How will a company prefer to raise capital considering its short term and long term capital requirements?

Answer

Duration of capital requirement:
If capital is required on a permanent basis, the company will prefer to issue equity shares. On the other hand, if capital is required for a short period, company will procure capital through debentures and preference shares.

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Question 245 Marks

Discuss the impact of assets on capital structure.

Answer

No business can be done without raising assets. Assets can be big, small, purchased or leased.
If the business requires fixed assets on large scale, then the ratio of equity share will be high in capital structure of that business.
Similarly, if the company needs high value assets then whether it procures them by purchasing or leasing affects the form of capital structure.

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Question 255 Marks

Discuss the internal factors that affect capital structure.

Answer

Internal factors that affect the capital structure:
$1.$ Type of business:

The type of business affects its capital structure. For example, manufacturing units require huge capital whereas normal trading units require less fixed capital
The fixed capital investment of a firm providing service depends on the type of service it provides. For example, a five star hotel requires huge capital as compared to a standard courier company.

$2.$ Size of business:
A large scale business unit will require large fixed capital as compared to a small scale industrial unit. Moreover, a trading firm will require even lesser fixed capital.
$3.$ Estimation of business income:
In business, although estimation of how much profit will be earned is done, still the estimation may go wrong. In such situation, the company has to depend on borrowed capital. In other words, the capital structure gets affected by estimation of business income.
$4.$ Nature and requirement of assets:

If the business requires fixed assets on large scale, then the ratio of equity/share will be high in capital structure of that business.
Another key decision that affects capital structure is whether these high value fixed assets are to be purchased or are to be taken on lease.

$5.$ Attitude of directors:
If the directors of the company desire to retain the managerial control on company they do not issue equity shares in greater proportion and depend more on preference shares and debentures.
$6.$ Financial requirements:

If the need of capital is less, it can be raised only by issuing equity shares. However, if the need of capital is large, various types of securities need to be issued for raising the fund.
How much finance will be required in future for long term objectives and plans and possibility of future growth is also to be considered while formulating capital structure.

$7.$ Duration of capita! requirement:
If capital is required on a permanent basis, the company will prefer to issue equity shares. On the other hand, if capital is required for a short period, company will procure capital through debentures and preference shares.

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Question 265 Marks

Enlist the external factors affecting capital structure.

Answer

External Factors

Condition of boom-depression in capital market
Present rate of interest in capital market
Cost of capital expenses of issuing securities
Legal restrictions
Taxation policy
Institutional investors
Foreign institutional investors

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Question 275 Marks

Enlist the internal factors affecting capital structure.

Answer

Internal Factors

Type of business
Size of business
Estimation of business income
Nature and requirement of assets
Attitude of directors
Financial requirements
Duration of capital requirement

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Question 285 Marks

Enlist the types of capital structure.

Answer

Types of Capital Structure:
$(A)$ Capital structure of only equity of shares
$(B)$ Capital structure of preference shares with equity shares
$(C)$ Capital structure of debentures with equity shares
$(D)$ Capital structure of preference shares and debentures with equity shares

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Question 295 Marks

What are the characteristics of ideal capital structure?

Answer

An ideal capital structure should have the following characteristics:

Simplicity: It becomes easy to administer capital structure, if lesser varieties of securities are issued.
Profitability: The capital structure should be planned in such a way that profit remains optimum.
Adequate finance: Various sources should be combined properly so that adequate finance can be obtained.
Flexibility: Capital structure of the company should be flexible so that it can be changed as per the requirements and circumstances.
Economy: Various sources should be combined in a manner that optimizes the cost of capital.
Balancing: There should be a proper equilibrium between owner’s capital and borrowed capital.
Liquidity: The capital structure should be so designed that few sources can be liquidated when needed so as to set-off the liability and debts of the company in time.
Attractiveness $($Impressive$):$ Capital structure should be designed in such a manner that investors find it impressive. An impressed investor will stay loyal to the company and even invest more.
Solvency: The proportion of borrowed capital should not be so large that burden of interest cannot be borne by the company and risk of insolvency increases.

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Question 305 Marks

What is capital structure? Explain.

Answer

The combination of different sources utilized by the company to raise necessary capital for running the company is called the capital structure.
According to Hogland, “Capital structure means the proportion and magnitude of different securities issued and sources utilized by a company to raise its finance.”
Company can obtain necessary capital funds from various sources. It can raise capital by issuing various types of securities such as equity share, preference share, debenture, etc.
In this context, Gesternberg says that “Decisions regarding type of securities are reflected in the capital structure of the company.”
It is the responsibility of the finance manager to determine the proportion of various types of securities to be issued.

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Question 315 Marks

State the important aspects of a financial plan.

Answer

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

To estimate need of capital $($Problem of capitalization$)$
To determine sources of capital $($Problem of capital structure$)$

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Question 325 Marks

What is dividend? For a finance manager what decisions are involved with respected to dividend? State the factors that affect the decision regarding dividend.

Answer

Dividend is a part of profit of a company which is distributed among its shareholders. Dividend is a return to shareholders on their investment.
As per the Companies Act, dividends can be paid in cash or cheque on paid-up capital of share. The finance manager has to tactfully decide what part of profit should be distributed as dividend and what part of profit should be retained in business. Retained earnings in business are an important internal source of finance.
Payment of dividend affects the market value of share of the company. If a major portion of profit is distributed as dividend, it decreases the ploughing back of profit. On the other hand, if a major portion of profit is reinvested then less amount is left for distributing dividend.

Factors affecting dividend:

Divisible profit of the company during the current financial year
Estimation of income in future
Rate of dividend paid by the company in the past years
Need of ploughing back of profit in business
Financial condition and financial needs of company at present
Ratio of reserves with company
Future planning of profitable investment
Attitude of directors of company
Taxation policy
Legal restrictions
Expectation of shareholders of the company
Condition of capital market
Growth rate of company
Liquidity position of the company

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Question 335 Marks

Enlist internal and external factors affecting financing.

Answer

$1.$ Internal factors:
Type or nature of business, size of business, growth of business, financial requirement, nature of assets and requirement, attitude of directors are internal factors that affect financing decisions.
$2.$ External factors:
Condition of capital market, expenses of issuing securities, attitude of investors, rate of interest prevailing in market, legal restrictions, institutional investors, etc. are external factors that affect financing decisions.

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Question 345 Marks

Write a note on decisions related to financing and factors affecting it.

Answer

Decisions related to financing:
Investment decisions are connected with the assets of the company while financing decisions are related to the capital structure.Capital structure of the company consists of:
$(a)$ equity shares
$(b)$ equity shares and preference shares
$(c)$ equity shares and debentures
$(d)$ equity shares, preference shares and debentures

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

Factors affecting financing:
The factors affecting financing can be classified as

Internal factors and
External factors.

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Question 355 Marks

Write a note on decisions related to investment that the financial management needs to take.

Answer

Decisions related to investment:

Business requires capital investment in various assets that too for a long and fixed term. This includes investment in machinery, land, etc.
It is always a risky and tricky task for the financial manager to identify the best asset in which investment should be made. Hence it is very crucial that decision of investment is evaluated in terms of expected return and risk.
Investment decision is called capital budgeting. There are several methods of capital budgeting brought in use by the finance manager for deciding the investment decision to be taken for the company. Few of these methods are pay-back method, rate of return method, discounted cash flow method, etc.

Factors affecting investment decision:

Need of total capital
Estimated rate of return and profitability from investment
Estimated net cash receivable from investment
Element of risk involved in investment
Requirement of working capital after investment
Useful economic life of investment and its estimated life
Significance of investment
Capital rationing
Certainty or uncertainty of earning in future

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Question 365 Marks

For which major problems does the financial management make decision? Explain them very briefly.

Answer

Financial management has to take important decisions with respect to the following three problems:
$(A)$ Decisions related to investment
$(B)$ Decisions related to financing
$(C)$ Decisions related to dividend

$(A)$ Decisions related to investment:

Business requires capital investment in various assets that too for a long and fixed term. This includes investment in machinery, land, etc.
It is always a risk to identify the best asset in which investment should be made. Hence it is very crucial that decision of investment is evaluated in terms of expected return and risk.

$(B)$ Decisions related to financing:
Investment decisions are connected with the assets of the company while financing decisions are related to the capital structure.
Capital structure of the company consists of
$(a)$ equity shares
$(b)$ equity shares and preference shares
$(c)$ equity shares and debentures
$(d)$ equity shares, preference shares and debentures.
Financial manager has to take decision regarding the portion to be maintained between equity and debt in capital structure. A fine balance between equity capital and debt is necessary so as to maximize the returns of the company.
$(C)$ Decisions related to dividend:

Dividend is a part of profit of a company which is distributed among its shareholders. Dividend is a return to shareholders on their investment.
The financial manager has to tactfully decide what part of profit should be distributed as dividend and what part of profit should be retained in business.

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Question 375 Marks

How does financial management help in increasing the creditworthiness of the business?

Answer

Financial decisions:
Financial management takes important decisions regarding capital budget, dividend policy, reinvestment of profit, etc. It also co-ordinates various financial decisions such as co-ordination between dividend policy and reinvestment of profit, etc.

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Question 385 Marks

Differentiate between profit maximization and wealth maximization.

Answer

Point of difference	Profit maximization	Wealth maximization
$1.$ Objective	To earn a larger amount of profit	To improve the market value of its shares
$2.$ Emphasizes on	Achieving short term objectives	Achieving long term objectives
$3.$ Risk and uncertainty	It ignores risk and uncertainty	It recognizes risks and uncertainties
$4.$ Advantage	Acts as a yardstick for computing the operational efficiency of the entity	Gaining a large market share

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Question 395 Marks

Explain in detail objective of wealth maximization as an objective of financial management.

Answer

The concept of increasing the value of the business in order to increase the value of the shares held by the shareholders is called wealth maximization.

A term called Net Present Value $(NPV)$ is used to measure the profit of the company. Profit under $NPV$ is obtained by subtracting the present value of wealth from investment required over a period of time.
Wealth maximization focuses on building a profitable $NPV.$ The net present value creates wealth for the shareholders.
Owing to this calculation, the organization should take up only such decisions which increase the net present value and hence the wealth.
A drawback of wealth maximization approach is that it is based only on the concept of cash flow. It does not consider actual profit booked by the business.
Only cash flow is considered as a measurement and the accounting profit is ignored.
The net present value of wealth is the difference between present value of wealth and investment required.

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Question 405 Marks

Write a note on profit maximization.

Answer

The objective of maximizing income of the company is called profit maximization.

In market, investors purchase the shares of company with a hope of earning maximum dividend. As a result, company should earn maximum profit out of its available resources. Moreover, its dividend policy should be based on maximization of profit.
In addition, this approach suggests that company should take up only those business projects which can earn good profits i.e. which aims at profit maximization.
This approach increases the share price of the company. This in turn increases company’s per-share earning.

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Question 415 Marks

State the scope of financial management.

Answer

Wide scope:

The scope of financial management is extremely wide. Its scope includes estimating the need of finance, acquiring finance, maximum utilization, proper allocation and its planning and controlling.
It covers all financial operations, right from the inception of business.

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Question 425 Marks

Enlist the characteristics of financial management and explain them briefly.

Answer

Characteristics of financial management:
$1.$ Branch of management:
Financial management is a branch of management. It includes the function of planning and control for the use of finance.
$2.$ Wide scope:

The scope of financial management is extremely wide. Its scope includes estimating the need of finance, acquiring finance, maximum utilization, proper allocation and its planning and controlling.
It covers all financial operations, right from the inception of business.

$3.$ Base of the managerial decisions:

Financial management is the base for managerial decisions.
All major decisions regarding production, sales, research, development, etc. are based on financial management.

$4.$ Relation with financial decisions:

Financial management is also related with taking financial decisions.
Financial decisions such as new investment, capital structure, dividend policy, etc. are all associated with financial management.
Financial management makes use of modern mathematical techniques for taking financial decisions.

$5.$ Goal of maximization of owner’s economic welfare:
Financial management aims at maximizing economic welfare of the business owner. For this, it works with two approaches: (i) Profit maximization and (ii) Wealth maximization.
$6.$ Key position:
Financial management holds key position in organizational structure of business unit.
$7.$ Relation with other areas of management:

If there is sufficient finance and proper financial management then the financial management will be more flexible in formulating policies related to production, sales, incentives, etc.
On this basis we can say that financial management is related with different areas of management such as production management, marketing management, personnel management, etc.

$8.$ Division into two parts:

Financial management can be divided mainly into two parts namely
1. Management of long term fixed capital and
2. Management of working capital.
Fixed capital management includes planning for expansion of fixed assets such as building, machines, land, etc., while working capital management takes care of day-to-day expenses.

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Question 435 Marks

State important definitions of financial management.

Answer

Finance:

In layman language, management of finance is called financial management.
Finance is the blood of business.
Business can neither be started without finance nor can it sustain without it. Thus, finance is the foundation stone of business.

Financial management:

The activity done at managerial level for planning and controlling financial resources for the business enterprise is called financial management.
Under financial management, the managers try to optimally manage the financial resources so that the business earns a satisfactory return.

Various definitions of financial management:

According to F. W. Paish, “In the modern economy, based on utilization of funds, financial management means acquiring of required funds at the required time.”
According to Raymond J. Chambers, “Financial management means to take decisions about financial matters to implement then smoothly and to review, them.”
According to Prof. M. Kimbal, “Financial management means acquisition of fund, its optimum utilization and its appropriate allocation.”
From all these definitions we can conclude that the scope of financial management is so wide that it covers all the financial decisions of business, right from the inception.

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Question 445 Marks

Indicate the various types of capital structure.

Answer

Types of Capital Structure
The meaning of Capital" structure can be described as the arrangement of capital by using different sources of long term funds which consists of two broad types, equity and debt. The different types of funds that are raised by a firm include preference shares, equity shares, retained earnings, long-term loans etc. These funds are raised for running the business.
Equity Capital
Equity capital is the money owned by the shareholders or owners. It consists of two different typesa) Retained" earnings: Retained earnings are part of the profit that has been kept separately by the organisation and which will help in strengthening the business.b) Contributed Capital: Contributed capital is the amount of money which the company owners have invested at the time of opening the company or received from shareholders as a price for ownership of the company.
Debt Capital
Debt capital is referred to as the borrowed money that is utilised in business. There are different forms of debt capital.

Long Term Bonds: These types of bonds are considered the safest of the debts as they have an extended repayment period, and only interest needs to be repaid while the principal needs to be paid at maturity.
Short Term Commercial Paper: This is a type of short term debt instrument that is used by companies to raise capital for a short period of time.

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Question 455 Marks

Explain the meaning of capital structure and show its characteristics.

Answer

Introduction :

Capital structure of company reflects the sources of fund raised by the company.
As per company act issuing equity shares is compulsory to obtain fund by issuing shares.
Financial management determined capital structure considering the size of business unit, its form, needs, internal and external factors’ company issues various types of securities such as equity shares, preference shares, debentures etc. and acquire capital.

Meaning of capital structure :

In simple words, “Capital structure means combination of various sources utilized by the company to raise required capital.”
According to Hogland, “Capital structure means proportion and magnitude of different securities of the company.”
According to Gestenberg, “Decision regarding types of securities are reflected in capital structure of the company.”
In short, capital structure suggests securities such as equity share, preference share, debt etc. Issued by the company to acquire capital.

Characteristics of ideal capital structure :

Simplicity :

From administrative view point it is quite easy when lesser type of securities are issued.

Profitability :

It is an ideal structure in which the profit remains optimum.

Sufficient finance :

It is an ideal structure in which required finance can be acquired with combination of various sources.

Flexibility :

Structure should be dynamic co that changes can be made according to the circumstances.

Economy :

Capital structure should be dynamic so that changes can be made according to the circumstances.

Balancing :

In capital structure there should be balance between owner’s capital and borrowed capital.

Liquidity :

Provision should be made in capital structure to pay liability and debt in time.

Attractiveness :

Capital structure should be attractive enough to attract various types of investors to invest in the company.

Solvency :

Capital structure should be such as there is no risk of insolvency and borrowed capital should not be too high to feel the burden of interest.

Conclusion :

All characteristics of ideal capital structure is not possible in single company.
E.g. capital structure with less securities is considered simple.
But it cannot be attract various investors and it become a bit difficult to acquire adequate finance.

Financial management should access as per requirement of the company the external factors and bring changes in capital structure.

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Question 465 Marks

Discuss financial decisions taken in financial management.

Answer

Financial Decisions :

Financial management is related to the function of finance, so it is called financial activity.
Financial management has to take decisions regarding the following three matters.
Investment related decisions.
Financing related decisions.
Dividend related decisions.

Decisions related to investment :

For any business unit first of all fixed capital for long term is invested.
Financial management has to determine the selection of assists in which future investment is to be made.
Decisions regarding investment is assists is known as “capital budgeting.”
When financial management has more that in option to invest finance it has to select the assists to invest.
It select from the capital budgeting methods such as pay back method, rate of return method, discounted cash flow method.
Assessment of the investment should be done on the basis of expected return and probable risk.
Factors affecting decision related to investment :
Requirement of total capital.
Estimated rate of return and profitability from investment.
Estimated net cash liquidity from investment.
Risk factor in investment.
Requirement of working capital after investment..
Economic utility of investment and its life.
Importance if investment.
Significance of importance.
Certainty or uncertainty of earning in future.

Decisions related to financing :

Fixed capital investment related finance are connected to company’s fixed assists.
Decisions related to financing are connected with the capital structure of the company.
There are four types of capital structure of the company.
Capital structure of equity share and preference share.
Capital structure of only equity share.
Capital structure of equity share and debenture.
Capital structure of equity share, preference share and debt.
Normally capital structure is a mixture of owner’s capital and has to deter =mine the proportion of equity share capital and debt in capital structure.
Optimum structure in less risky and yields maximum return.

Factors affecting financing related decisions :

Internal factors :

It includes the type of business , its form, size of business, development of business, need of finance, form assists and its need attitude of management etc.

External factors :

It includes market situation, expense of issuing securities, attitude of investors, interest rate prevailing in the market, legal restrictions, institutional investors etc.

Decisions related to dividend :

Company distributes its profit to shareholders as dividend.
As per companies act dividend can be distributed in cash only.
Dividend is a financial return to the shareholder on the investment they have made in the company.
Dividend payment depends on availability of company’s cash.
It is paid to shareholders at fixed rate on fully paid up share capital.
Financial management has to determine the portion of profit to be distributed as dividend and the portion to be kept in business.
For financial management retained earning is important internal source of finance for the company.
Dividend payment affect market price of the share of the company.
Market value of the share increases if high dividend is paid.
On the other hand reinvestment of profit decreases.
If large share profit is re-investment then less amount remains for payment of dividend.
So the rate of dividend decreases market price of share decreases.

Factors affecting decisions related to dividend :

After proper study of different alternatives and after evaluation of that alternative from different view point, best plan should be selected.
As this stage, time, expense, profitability, like of plan etc.
Matters should be considered.
Divisible profit of the company during the current financial year.
Estimation of earning in future.
Rate of dividend paid by the company in the previous years.
Need of re-investment (plugging back) in business.
Financial status of the company at present and financial need.
Reserve with the company.
Future planning of profitable investment.
Attitude of the management of the company.
Taxation policy
Legal restrictions.
Expectations of company’s shareholders..
Condition of capital market.
Growth rate of the company.
Liquidity – position of the company.

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Question 475 Marks

Explain the Objectives of Financial Management.

Answer

Introduction :

Equity shareholder are the original owner of business unit.
They invest money in the company as share capital.
Their objective is to obtain maximum economic return.
Considering the view point the aim of financial management should be “Maximum economic welfare of the owner. “For this maximum utilization of company’s money is needed.

Objectives of Financial Management :

Consider two objectives for maximum economic welfare of the owner
Objective of maximization of profit.
Objective of maximization of wealth.

Objective of Profit Maximization :

Maximization of profit means to maximize company’s income.
Shareholder hope for the maximum dividend buy shares of the company and invest money.
So company should earn maximum profit throughout its financial resource.
Dividend policy should be based on profit maximization.
This concept suggests that company should accept only profit making projects.
Through the objective of maximization of profit company can raise earning per share.
As a result the aim of owner’s welfare is maintained.

Objectives of wealth maximization :

This objective is recognized as net present value.
Present value creates shareholders wealth.
Management should take decisions which increase not present value of wealth.
In this concept only cash only cash liquidity is the criteria and accounting profit is ignored.
This difference between present value of wealth and required capital investment means net present value of wealth.
In short, Net present value of wealth = present value of wealth – required capital investment for wealth.
Company’s wealth increases due to right decisions taken by financial management.
As a result the price of the share of the company increases and wealth of the shareholder maximizes.
Decisions taken for maximization of wealth have become universally accepted.
Prof. Solomon too favors the objective of maximization of wealth.
The objective of wealth maximization is superior to the objective of maximization of profit.

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Question 485 Marks

Explain the Meaning and Characteristics of Financial Management.

Answer

Introduction :

Finance is like foundation brick of each business.
It is as important as blood in human body.
Financial management is related to the planning of control of financial instrument (resource).
Through it only maximum utilization of financial resource is possible and satisfactory return can be obtained on investment.
Finance is needed for each economic activity of business unit.
That is why the to obtain finance at lowest expense from various source and its proper utilization is considered important function of financial management.

Meaning or concept of Financial Management :

In simple language financial management takes finance related decisions and implement them.
In practical life financial management means to manage financial activities.
According to Prof. Kimbal, “Financial management means acquisition of fund, its optimum utilization and its appropriate allocation.”
According to F. W. Paish, “In the modern economy, based on utilization of funds, financial management means acquiring of required funds at the required time.”
According to Raymond J. Chambers, “Financial management means to take decisions above financial matters to implement then smoothly and to review them.”
On the basis of the above definitions it is understood that the scope of financial management is quite vast.
It covers all financial decisions right from inception of business unit to its expansion and its end.

Characteristics of Financial Management :

Branch of Management :

Like other branches of management financial management is one of the branches of management.
It covers the planning for utilization of finance and the function of its control.

Wide scope :

Financial management includes estimated required fund for business, its resource, its maximum utilization, proper allocation, its planning and control.

Base of the managerial decisions :

Financial management provides base for managerial decision such as regarding production, sales, research, development etc.

Relation with financial decisions :

Financial management is related to capital structure of business unit, investment and dividend paying policy decisions.
In the process of decisions making, financial management uses modern mathematical techniques.

Goal of maximization of owner’s economical welfare :

Financial management adopts.
Maximization of profit.
Maximization of wealth and attempts for the maximum economic welfare of the owner.

Key position :

Financial management activity holds key position in managerial structure of a business unit.

Relations with other areas of management :

When financial management has adequate funds it shows more flexibility towards production policy, sales policy and its formulation.
From this point of view financial management is related to various areas of management such as marketing, personal management, production management.

Division into two parts :

Financial management can be divided into two parts.
E.g. management of long term fixed capital and management of working capital.
Fixed capital management includes all fixed assists such as land, building, plant and machinery and planning for expansion of this work.
Working capital is required for day to day expenses.

Conclusion : Financial management is related to decision regarding all activities of business production, sales, personnel activities and their efficiency and continuity depend on financial management.

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Question 495 Marks

Explain the Characteristics of Working Capital.

Answer

Introduction :

After business came into existence to keep it running working capital is required.
It is required for purchase, for production, sale, advertisement, distribution and for day-to-day administrative expenses.
Working capital is found in various forms so it is known with different names.
E.g. it is called current capital as it is invested in current assists.
When it is in production process it is called moving capital.
It increases and decreases so it is called flexible capital.
It is required for short term so it is called short term capital.

Characteristics of working capital :

Short term capital:

Working capital is required less than $5$ years so it is called short term capital.

Investment in current assists :

Working capital is invested in short term securities of business such as debtors, bills receivable etc.

Liquidity :

All current assists in which working capital is invested and is converted into cash. So it has the attribute of cash liquidity.

Less risk :

Working capital in business is for short term and is easily converted into cash. So the risk factor is less.

Changing form :

The form of working capital changes when it is employees in current assists e.g. raw material is converted into semi finished goods, semi finished goods is converted into finished goods.
Finished goods is converted into debtors and if such goods sold in cash or credit it is converted in to cash.

To pay day-to-day expenses :

Working capital is required to pay day-to-day expenses.

No depreciation :

Working capital is circulating in business so depreciation is not calculated on it.

Requirement according to type and form of business :

Working capital is required in all types of business. Its requirement differs according to nature and form of business.

Conclusion :

Chief characteristic of working capital is its liquidity. Company purchases raw material through working capital then process is carried on it.
After the goods ready for sale once again it is converted into cash and after sale once again raw material is purchased from cash.
Thus, working capital is circulating in business.

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Question 505 Marks

Distinguish between: Fixed Capital and Working Capital.

Answer

No.	Points of Difference	Fixed Capital	Working Capital
$1.$	Meaning	Capital invested in assists of business such as land, building, machinery, furniture etc is called fixed capital.	Capital employee in current assists such as raw material, stock of finished goods, debtors, bills receivable etc is called working capital.
$2.$	Time duration	This capital is invested in business for 5 and or more years.	This capital is invested in business for short term.
$3.$	Liquidity	This capital is blocked for long term so the ratio of liquidity is normal.	This capital is employee in current assists so it is quickly converted into cash so the level of cash liquidity is high.
$4.$	Risk	This capital is employee in fixed assists so the risk of obsolete is high.	The ratio of risk is low.
$5.$	Requirement	It is requires to purchase fixed assists in business such as land, labour, salary etc.	Working capital is required to purchase raw material and for day-to-day expense of building, plant, machinery etc.
$6.$	Depreciation	This capital is employee in fixed assists so depreciation is calculated on it.	This capital is employee in current assists so depreciation is not calculated on it.
$7.$	Sources	This capital is obtained through of shares, debenture of financial institutions.	The source of this capital are trade credit bank over draft, indigenous bankers, public deposits etc.
$8.$	Other names	Fixed capital is known as long term capital or steady capital.	Working capital is known as short term capital, unsteady capital, moving capital, changeable capital, current capital, flexible capital etc.

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