NCERT Textbook - Financial Management | Business Studies (BST) Class 12 - Commerce PDF Download

 Page 1


chapter 
9
 When Ta Ta STeel a cquired 
c oru S
Tata Steel, the biggest steel producer 
in the Indian private sector has 
acquired Corus, (formerly known as 
British Steel) in a deal worth $8.6 
billion in 2007. A financial decision 
of this magnitude has significant 
implicitness for both Tata Steel and 
Corus as well as their employees 
and shareholders. To mention some 
of them:
?	 Tata Steel raised a debt of over $8 
billion to finance the transaction. 
The deal will be paid for by Tata 
Steel UK, a special purpose vehicle 
(SPV) set up for the purpose. 
Another company of the Tata 
group, Tata Sons Ltd., invested 
$ 1 billion dollars for preference 
shares along with Tata Steel which 
will invest an equal amount. 
?	 Tata Steel, the acquirer company, 
arranged about 36,500 crores of 
rupees to finance the take-over.
?	 Tata Steel raised this amount 
through debt or equity or a 
combination of both. Some amount 
came from internal accruals 
also. This financing decision 
affected the capital structure of 
the acquirer.
 Source: The Economic Times
Learning Objectives
After studying this chapter, you 
should be able to:
 ¾ explain the meaning of 
business finance; 
 ¾ describe financial 
management;
 ¾ explain the role of financial 
management in our 
enterprise;
 ¾ discuss objectives of 
financial management and 
how they could be achieved;
 ¾ explain the meaning and 
importance of financial 
planning;
 ¾ state the meaning of capital 
structure;
 ¾ analyse the factors affecting 
the choice of an appropriate 
capital structure; 
 ¾ state meaning of fixed capital 
and working capital; and
 ¾ analyse the factors affecting 
the requirement of fixed and 
working capital.
Financial Manage Men T
Ch_9.indd   215 2/6/2024   09:51:33 AM
2024-25
Page 2


chapter 
9
 When Ta Ta STeel a cquired 
c oru S
Tata Steel, the biggest steel producer 
in the Indian private sector has 
acquired Corus, (formerly known as 
British Steel) in a deal worth $8.6 
billion in 2007. A financial decision 
of this magnitude has significant 
implicitness for both Tata Steel and 
Corus as well as their employees 
and shareholders. To mention some 
of them:
?	 Tata Steel raised a debt of over $8 
billion to finance the transaction. 
The deal will be paid for by Tata 
Steel UK, a special purpose vehicle 
(SPV) set up for the purpose. 
Another company of the Tata 
group, Tata Sons Ltd., invested 
$ 1 billion dollars for preference 
shares along with Tata Steel which 
will invest an equal amount. 
?	 Tata Steel, the acquirer company, 
arranged about 36,500 crores of 
rupees to finance the take-over.
?	 Tata Steel raised this amount 
through debt or equity or a 
combination of both. Some amount 
came from internal accruals 
also. This financing decision 
affected the capital structure of 
the acquirer.
 Source: The Economic Times
Learning Objectives
After studying this chapter, you 
should be able to:
 ¾ explain the meaning of 
business finance; 
 ¾ describe financial 
management;
 ¾ explain the role of financial 
management in our 
enterprise;
 ¾ discuss objectives of 
financial management and 
how they could be achieved;
 ¾ explain the meaning and 
importance of financial 
planning;
 ¾ state the meaning of capital 
structure;
 ¾ analyse the factors affecting 
the choice of an appropriate 
capital structure; 
 ¾ state meaning of fixed capital 
and working capital; and
 ¾ analyse the factors affecting 
the requirement of fixed and 
working capital.
Financial Manage Men T
Ch_9.indd   215 2/6/2024   09:51:33 AM
2024-25
FINANCIAL MANAge Me NTS
217
BUSINe SS  STUDIe S
216
thus, very crucial for the survival and 
growth of a business.
Financial Manage Men T
All finance comes at some cost. It 
is quite imperative that it needs to 
be carefully managed. Financial 
Management is concerned with optimal 
procurement as well as the usage of 
finance. For optimal procurement, 
different available sources of finance 
are identified and compared in terms 
of their costs and associated risks. 
Similarly, the finance so procured 
needs to be invested in a manner that 
the returns from the investment exceed 
the cost at which procurement has 
taken place. Financial Management 
aims at reducing the cost of funds 
procured, keeping the risk under 
control and achieving effective 
deployment of such funds. It also 
aims at ensuring availability of enough 
funds whenever required as well as 
avoiding idle finance. Needless to 
emphasise, the future of a business 
depends a great deal on the quality of 
its financial management.
Importance: The role of financial 
management cannot be over-
emphasised, since it has a direct 
bearing on the financial health of a 
business. The financial statements, 
such as Balance Sheet and Profit 
and Loss Account, reflect a firm’s 
financial position and its financial 
health. Almost all items in the financial 
statements of a business are affected 
directly or indirectly through some 
financial management decisions. Some 
i n Troduc Tion In the above case, these decisions 
require careful financial planning, 
an understanding of the resultant 
capital structure and the riskiness 
and profitability of the enterprise. All 
these have a bearing on shareholders 
as well as employees. They require 
an understanding of business 
finance, major financial decision 
areas, financial risk, and working 
capital requirements of the business. 
Finance, as we all know, is essential 
for running a business. Success of 
business depends on how well finance 
is invested in assets and operations 
and how timely and cheaply the 
finances are arranged, from outside 
or from within the business.  
Meaning o F Bu Sine SS Finance Money required for carrying out 
business activities is called business 
finance. Almost all business activities 
require some finance. Finance is 
needed to establish a business, to 
run it, to modernise it, to expand, or 
diversify it. It is required for buying 
a variety of assets, which may be 
tangible like machinery, factories, 
buildings, offices; or intangible such 
as trademarks, patents, technical 
expertise, etc. Also, finance is central 
to running the day-to-day operations 
of business, like buying material, 
paying bills, salaries, collecting cash 
from customers, etc. needed at every 
stage in the life of a business entity. 
Availability of adequate finance is, 
Ch_9.indd   216 10-08-2022   09:09:51
2024-25
Page 3


chapter 
9
 When Ta Ta STeel a cquired 
c oru S
Tata Steel, the biggest steel producer 
in the Indian private sector has 
acquired Corus, (formerly known as 
British Steel) in a deal worth $8.6 
billion in 2007. A financial decision 
of this magnitude has significant 
implicitness for both Tata Steel and 
Corus as well as their employees 
and shareholders. To mention some 
of them:
?	 Tata Steel raised a debt of over $8 
billion to finance the transaction. 
The deal will be paid for by Tata 
Steel UK, a special purpose vehicle 
(SPV) set up for the purpose. 
Another company of the Tata 
group, Tata Sons Ltd., invested 
$ 1 billion dollars for preference 
shares along with Tata Steel which 
will invest an equal amount. 
?	 Tata Steel, the acquirer company, 
arranged about 36,500 crores of 
rupees to finance the take-over.
?	 Tata Steel raised this amount 
through debt or equity or a 
combination of both. Some amount 
came from internal accruals 
also. This financing decision 
affected the capital structure of 
the acquirer.
 Source: The Economic Times
Learning Objectives
After studying this chapter, you 
should be able to:
 ¾ explain the meaning of 
business finance; 
 ¾ describe financial 
management;
 ¾ explain the role of financial 
management in our 
enterprise;
 ¾ discuss objectives of 
financial management and 
how they could be achieved;
 ¾ explain the meaning and 
importance of financial 
planning;
 ¾ state the meaning of capital 
structure;
 ¾ analyse the factors affecting 
the choice of an appropriate 
capital structure; 
 ¾ state meaning of fixed capital 
and working capital; and
 ¾ analyse the factors affecting 
the requirement of fixed and 
working capital.
Financial Manage Men T
Ch_9.indd   215 2/6/2024   09:51:33 AM
2024-25
FINANCIAL MANAge Me NTS
217
BUSINe SS  STUDIe S
216
thus, very crucial for the survival and 
growth of a business.
Financial Manage Men T
All finance comes at some cost. It 
is quite imperative that it needs to 
be carefully managed. Financial 
Management is concerned with optimal 
procurement as well as the usage of 
finance. For optimal procurement, 
different available sources of finance 
are identified and compared in terms 
of their costs and associated risks. 
Similarly, the finance so procured 
needs to be invested in a manner that 
the returns from the investment exceed 
the cost at which procurement has 
taken place. Financial Management 
aims at reducing the cost of funds 
procured, keeping the risk under 
control and achieving effective 
deployment of such funds. It also 
aims at ensuring availability of enough 
funds whenever required as well as 
avoiding idle finance. Needless to 
emphasise, the future of a business 
depends a great deal on the quality of 
its financial management.
Importance: The role of financial 
management cannot be over-
emphasised, since it has a direct 
bearing on the financial health of a 
business. The financial statements, 
such as Balance Sheet and Profit 
and Loss Account, reflect a firm’s 
financial position and its financial 
health. Almost all items in the financial 
statements of a business are affected 
directly or indirectly through some 
financial management decisions. Some 
i n Troduc Tion In the above case, these decisions 
require careful financial planning, 
an understanding of the resultant 
capital structure and the riskiness 
and profitability of the enterprise. All 
these have a bearing on shareholders 
as well as employees. They require 
an understanding of business 
finance, major financial decision 
areas, financial risk, and working 
capital requirements of the business. 
Finance, as we all know, is essential 
for running a business. Success of 
business depends on how well finance 
is invested in assets and operations 
and how timely and cheaply the 
finances are arranged, from outside 
or from within the business.  
Meaning o F Bu Sine SS Finance Money required for carrying out 
business activities is called business 
finance. Almost all business activities 
require some finance. Finance is 
needed to establish a business, to 
run it, to modernise it, to expand, or 
diversify it. It is required for buying 
a variety of assets, which may be 
tangible like machinery, factories, 
buildings, offices; or intangible such 
as trademarks, patents, technical 
expertise, etc. Also, finance is central 
to running the day-to-day operations 
of business, like buying material, 
paying bills, salaries, collecting cash 
from customers, etc. needed at every 
stage in the life of a business entity. 
Availability of adequate finance is, 
Ch_9.indd   216 10-08-2022   09:09:51
2024-25
FINANCIAL MANAge Me NTS
217
BUSINe SS  STUDIe S
216
prominent examples of the aspects 
being affected could be as under:
 (i) The size and the composition of 
fixed assets of the business: For 
example, a capital budgeting 
decision to invest a sum of Rs. 100 
crores in fixed assets would raise 
the size of fixed assets block by this 
amount.
( ii) The quantum of current assets and 
its break-up into cash, inventory 
and receivables: With an increase 
in the investment in fixed assets, 
there is a commensurate increase 
in the working capital requirement. 
The quantum of current assets 
is also influenced by financial 
management decisions. In addition, 
decisions about credit and inventory 
management affect the amount of 
debtors and inventory which in 
turn affect the total current assets 
as well as their composition.
( iii) The amount of long-term and 
short- term funds to be used: 
Financial management, among 
others, involves decision about 
the proportion of long-term and 
short-term funds. An organisation 
wanting to have more liquid assets 
would raise relatively more amount 
on a long-term basis. There is 
a choice between liquidity and 
profitability. The underlying 
assumption here is that current 
liabilities cost less than long term 
liabilities.
( iv) Break-up of long-term financing into 
debt, equity etc: Of the total long- 
term finance, the proportions to be 
raised by way of debt and/or equity 
is also a financial management 
decision. The amounts of debt, 
equity share capital, preference 
share capital are affected by the 
financing decision, which is a part 
of financing management.
( v) All items in the Profit and Loss 
Account, e.g., Interest, Expense, 
Depreciation, etc. : Higher amount 
of debt means higher interest 
expense in future. Similarly, use 
of higher equity may entail higher 
payment of dividends. Similarly, an 
expansion of business which is a 
result of capital budgeting decision 
is likely to affect virtually all items 
in the profit and loss account of the 
business.
It can, thus, be stated that the 
financial statements of a business 
are largely determined by financial 
management decisions taken earlier. 
Similarly, the future financial 
statements would depend upon past 
as well as current financial decisions. 
Thus, the overall financial health 
of a business is determined by the 
quality of its financial management. 
Good financial management aims at 
mobilisation of financial resources at 
a lower cost and deployment of these 
in most lucrative activities.
o Bjec Tive S
The primary aim of financial 
management is to maximise 
shareholders’ wealth, which is referred 
to as the wealth-maximisation concept. 
The market price of a company’s shares 
Ch_9.indd   217 10-08-2022   09:09:51
2024-25
Page 4


chapter 
9
 When Ta Ta STeel a cquired 
c oru S
Tata Steel, the biggest steel producer 
in the Indian private sector has 
acquired Corus, (formerly known as 
British Steel) in a deal worth $8.6 
billion in 2007. A financial decision 
of this magnitude has significant 
implicitness for both Tata Steel and 
Corus as well as their employees 
and shareholders. To mention some 
of them:
?	 Tata Steel raised a debt of over $8 
billion to finance the transaction. 
The deal will be paid for by Tata 
Steel UK, a special purpose vehicle 
(SPV) set up for the purpose. 
Another company of the Tata 
group, Tata Sons Ltd., invested 
$ 1 billion dollars for preference 
shares along with Tata Steel which 
will invest an equal amount. 
?	 Tata Steel, the acquirer company, 
arranged about 36,500 crores of 
rupees to finance the take-over.
?	 Tata Steel raised this amount 
through debt or equity or a 
combination of both. Some amount 
came from internal accruals 
also. This financing decision 
affected the capital structure of 
the acquirer.
 Source: The Economic Times
Learning Objectives
After studying this chapter, you 
should be able to:
 ¾ explain the meaning of 
business finance; 
 ¾ describe financial 
management;
 ¾ explain the role of financial 
management in our 
enterprise;
 ¾ discuss objectives of 
financial management and 
how they could be achieved;
 ¾ explain the meaning and 
importance of financial 
planning;
 ¾ state the meaning of capital 
structure;
 ¾ analyse the factors affecting 
the choice of an appropriate 
capital structure; 
 ¾ state meaning of fixed capital 
and working capital; and
 ¾ analyse the factors affecting 
the requirement of fixed and 
working capital.
Financial Manage Men T
Ch_9.indd   215 2/6/2024   09:51:33 AM
2024-25
FINANCIAL MANAge Me NTS
217
BUSINe SS  STUDIe S
216
thus, very crucial for the survival and 
growth of a business.
Financial Manage Men T
All finance comes at some cost. It 
is quite imperative that it needs to 
be carefully managed. Financial 
Management is concerned with optimal 
procurement as well as the usage of 
finance. For optimal procurement, 
different available sources of finance 
are identified and compared in terms 
of their costs and associated risks. 
Similarly, the finance so procured 
needs to be invested in a manner that 
the returns from the investment exceed 
the cost at which procurement has 
taken place. Financial Management 
aims at reducing the cost of funds 
procured, keeping the risk under 
control and achieving effective 
deployment of such funds. It also 
aims at ensuring availability of enough 
funds whenever required as well as 
avoiding idle finance. Needless to 
emphasise, the future of a business 
depends a great deal on the quality of 
its financial management.
Importance: The role of financial 
management cannot be over-
emphasised, since it has a direct 
bearing on the financial health of a 
business. The financial statements, 
such as Balance Sheet and Profit 
and Loss Account, reflect a firm’s 
financial position and its financial 
health. Almost all items in the financial 
statements of a business are affected 
directly or indirectly through some 
financial management decisions. Some 
i n Troduc Tion In the above case, these decisions 
require careful financial planning, 
an understanding of the resultant 
capital structure and the riskiness 
and profitability of the enterprise. All 
these have a bearing on shareholders 
as well as employees. They require 
an understanding of business 
finance, major financial decision 
areas, financial risk, and working 
capital requirements of the business. 
Finance, as we all know, is essential 
for running a business. Success of 
business depends on how well finance 
is invested in assets and operations 
and how timely and cheaply the 
finances are arranged, from outside 
or from within the business.  
Meaning o F Bu Sine SS Finance Money required for carrying out 
business activities is called business 
finance. Almost all business activities 
require some finance. Finance is 
needed to establish a business, to 
run it, to modernise it, to expand, or 
diversify it. It is required for buying 
a variety of assets, which may be 
tangible like machinery, factories, 
buildings, offices; or intangible such 
as trademarks, patents, technical 
expertise, etc. Also, finance is central 
to running the day-to-day operations 
of business, like buying material, 
paying bills, salaries, collecting cash 
from customers, etc. needed at every 
stage in the life of a business entity. 
Availability of adequate finance is, 
Ch_9.indd   216 10-08-2022   09:09:51
2024-25
FINANCIAL MANAge Me NTS
217
BUSINe SS  STUDIe S
216
prominent examples of the aspects 
being affected could be as under:
 (i) The size and the composition of 
fixed assets of the business: For 
example, a capital budgeting 
decision to invest a sum of Rs. 100 
crores in fixed assets would raise 
the size of fixed assets block by this 
amount.
( ii) The quantum of current assets and 
its break-up into cash, inventory 
and receivables: With an increase 
in the investment in fixed assets, 
there is a commensurate increase 
in the working capital requirement. 
The quantum of current assets 
is also influenced by financial 
management decisions. In addition, 
decisions about credit and inventory 
management affect the amount of 
debtors and inventory which in 
turn affect the total current assets 
as well as their composition.
( iii) The amount of long-term and 
short- term funds to be used: 
Financial management, among 
others, involves decision about 
the proportion of long-term and 
short-term funds. An organisation 
wanting to have more liquid assets 
would raise relatively more amount 
on a long-term basis. There is 
a choice between liquidity and 
profitability. The underlying 
assumption here is that current 
liabilities cost less than long term 
liabilities.
( iv) Break-up of long-term financing into 
debt, equity etc: Of the total long- 
term finance, the proportions to be 
raised by way of debt and/or equity 
is also a financial management 
decision. The amounts of debt, 
equity share capital, preference 
share capital are affected by the 
financing decision, which is a part 
of financing management.
( v) All items in the Profit and Loss 
Account, e.g., Interest, Expense, 
Depreciation, etc. : Higher amount 
of debt means higher interest 
expense in future. Similarly, use 
of higher equity may entail higher 
payment of dividends. Similarly, an 
expansion of business which is a 
result of capital budgeting decision 
is likely to affect virtually all items 
in the profit and loss account of the 
business.
It can, thus, be stated that the 
financial statements of a business 
are largely determined by financial 
management decisions taken earlier. 
Similarly, the future financial 
statements would depend upon past 
as well as current financial decisions. 
Thus, the overall financial health 
of a business is determined by the 
quality of its financial management. 
Good financial management aims at 
mobilisation of financial resources at 
a lower cost and deployment of these 
in most lucrative activities.
o Bjec Tive S
The primary aim of financial 
management is to maximise 
shareholders’ wealth, which is referred 
to as the wealth-maximisation concept. 
The market price of a company’s shares 
Ch_9.indd   217 10-08-2022   09:09:51
2024-25
FINANCIAL MANAge Me NTS
219
BUSINe SS  STUDIe S
218
is linked to the three basic financial 
decisions which you will study a little 
later. This is because a company funds 
belong to the shareholders and the 
manner in which they are invested and 
the return earned by them determines 
their market value and price. It means 
maximisation of the market value of 
equity shares. The market price of 
equity share increases, if the benefit 
from a decision exceeds the cost 
involved. All financial decisions aim at 
ensuring that each decision is efficient 
and adds some value. Such value 
additions tend to increase the market 
price of shares. Therefore, those 
financial decisions are taken which 
will ultimately prove gainful from 
the point of view of the shareholders. 
The shareholders gain if the value of 
shares in the market increases. Those 
decisions which result in decline in 
the share price are poor financial 
decisions. Thus, we can say, the 
objective of financial management is 
to maximise the current price of equity 
shares of the company or to maximise 
the wealth of owners of the company, 
that is, the shareholders.
Therefore, when a decision is taken 
about investment in a new machine, 
the aim of financial management 
is to ensure that benefits from the 
investment exceed the cost so that 
some value addition takes place. 
Similarly, when finance is procured, 
the aim is to reduce the cost so that 
the value addition is even higher.
In fact, in all financial decisions, 
major or minor, the ultimate objective 
that guides the decision-maker is that 
some value addition should take place. 
All those avenues of investment, modes 
of financing, ways of handling various 
components of working capital must 
be identified which will ultimately lead 
to an increase in the price of equity 
share. It can happen through efficient 
decision-making. Decision-making is 
efficient if, out of the various available 
alternatives, the best is selected.
Financial d eci Sion S
Financial management is concerned 
with the solution of three major issues 
relating to the financial operations 
of a firm corresponding to the three 
questions of investment, financing 
and divident decision. In a financial 
context, it means the selection of 
best financing alternative or best 
investment alternative. The finance 
function, therefore, is concerned 
with three broad decisions which are 
explained below:
investment Decision
A firm’s resources are scarce in 
comparison to the uses to which 
they can be put. A firm, therefore, 
has to choose where to invest these 
resources, so that they are able to earn 
the highest possible return for their 
investors. The investment decision, 
therefore, relates to how the firm’s 
funds are invested in different assets.
Investment decision can be long-
term or short-term. A long-term 
investment decision is also called a 
Capital Budgeting decision. It involves 
committing the finance on a long-
Ch_9.indd   218 10-08-2022   09:09:51
2024-25
Page 5


chapter 
9
 When Ta Ta STeel a cquired 
c oru S
Tata Steel, the biggest steel producer 
in the Indian private sector has 
acquired Corus, (formerly known as 
British Steel) in a deal worth $8.6 
billion in 2007. A financial decision 
of this magnitude has significant 
implicitness for both Tata Steel and 
Corus as well as their employees 
and shareholders. To mention some 
of them:
?	 Tata Steel raised a debt of over $8 
billion to finance the transaction. 
The deal will be paid for by Tata 
Steel UK, a special purpose vehicle 
(SPV) set up for the purpose. 
Another company of the Tata 
group, Tata Sons Ltd., invested 
$ 1 billion dollars for preference 
shares along with Tata Steel which 
will invest an equal amount. 
?	 Tata Steel, the acquirer company, 
arranged about 36,500 crores of 
rupees to finance the take-over.
?	 Tata Steel raised this amount 
through debt or equity or a 
combination of both. Some amount 
came from internal accruals 
also. This financing decision 
affected the capital structure of 
the acquirer.
 Source: The Economic Times
Learning Objectives
After studying this chapter, you 
should be able to:
 ¾ explain the meaning of 
business finance; 
 ¾ describe financial 
management;
 ¾ explain the role of financial 
management in our 
enterprise;
 ¾ discuss objectives of 
financial management and 
how they could be achieved;
 ¾ explain the meaning and 
importance of financial 
planning;
 ¾ state the meaning of capital 
structure;
 ¾ analyse the factors affecting 
the choice of an appropriate 
capital structure; 
 ¾ state meaning of fixed capital 
and working capital; and
 ¾ analyse the factors affecting 
the requirement of fixed and 
working capital.
Financial Manage Men T
Ch_9.indd   215 2/6/2024   09:51:33 AM
2024-25
FINANCIAL MANAge Me NTS
217
BUSINe SS  STUDIe S
216
thus, very crucial for the survival and 
growth of a business.
Financial Manage Men T
All finance comes at some cost. It 
is quite imperative that it needs to 
be carefully managed. Financial 
Management is concerned with optimal 
procurement as well as the usage of 
finance. For optimal procurement, 
different available sources of finance 
are identified and compared in terms 
of their costs and associated risks. 
Similarly, the finance so procured 
needs to be invested in a manner that 
the returns from the investment exceed 
the cost at which procurement has 
taken place. Financial Management 
aims at reducing the cost of funds 
procured, keeping the risk under 
control and achieving effective 
deployment of such funds. It also 
aims at ensuring availability of enough 
funds whenever required as well as 
avoiding idle finance. Needless to 
emphasise, the future of a business 
depends a great deal on the quality of 
its financial management.
Importance: The role of financial 
management cannot be over-
emphasised, since it has a direct 
bearing on the financial health of a 
business. The financial statements, 
such as Balance Sheet and Profit 
and Loss Account, reflect a firm’s 
financial position and its financial 
health. Almost all items in the financial 
statements of a business are affected 
directly or indirectly through some 
financial management decisions. Some 
i n Troduc Tion In the above case, these decisions 
require careful financial planning, 
an understanding of the resultant 
capital structure and the riskiness 
and profitability of the enterprise. All 
these have a bearing on shareholders 
as well as employees. They require 
an understanding of business 
finance, major financial decision 
areas, financial risk, and working 
capital requirements of the business. 
Finance, as we all know, is essential 
for running a business. Success of 
business depends on how well finance 
is invested in assets and operations 
and how timely and cheaply the 
finances are arranged, from outside 
or from within the business.  
Meaning o F Bu Sine SS Finance Money required for carrying out 
business activities is called business 
finance. Almost all business activities 
require some finance. Finance is 
needed to establish a business, to 
run it, to modernise it, to expand, or 
diversify it. It is required for buying 
a variety of assets, which may be 
tangible like machinery, factories, 
buildings, offices; or intangible such 
as trademarks, patents, technical 
expertise, etc. Also, finance is central 
to running the day-to-day operations 
of business, like buying material, 
paying bills, salaries, collecting cash 
from customers, etc. needed at every 
stage in the life of a business entity. 
Availability of adequate finance is, 
Ch_9.indd   216 10-08-2022   09:09:51
2024-25
FINANCIAL MANAge Me NTS
217
BUSINe SS  STUDIe S
216
prominent examples of the aspects 
being affected could be as under:
 (i) The size and the composition of 
fixed assets of the business: For 
example, a capital budgeting 
decision to invest a sum of Rs. 100 
crores in fixed assets would raise 
the size of fixed assets block by this 
amount.
( ii) The quantum of current assets and 
its break-up into cash, inventory 
and receivables: With an increase 
in the investment in fixed assets, 
there is a commensurate increase 
in the working capital requirement. 
The quantum of current assets 
is also influenced by financial 
management decisions. In addition, 
decisions about credit and inventory 
management affect the amount of 
debtors and inventory which in 
turn affect the total current assets 
as well as their composition.
( iii) The amount of long-term and 
short- term funds to be used: 
Financial management, among 
others, involves decision about 
the proportion of long-term and 
short-term funds. An organisation 
wanting to have more liquid assets 
would raise relatively more amount 
on a long-term basis. There is 
a choice between liquidity and 
profitability. The underlying 
assumption here is that current 
liabilities cost less than long term 
liabilities.
( iv) Break-up of long-term financing into 
debt, equity etc: Of the total long- 
term finance, the proportions to be 
raised by way of debt and/or equity 
is also a financial management 
decision. The amounts of debt, 
equity share capital, preference 
share capital are affected by the 
financing decision, which is a part 
of financing management.
( v) All items in the Profit and Loss 
Account, e.g., Interest, Expense, 
Depreciation, etc. : Higher amount 
of debt means higher interest 
expense in future. Similarly, use 
of higher equity may entail higher 
payment of dividends. Similarly, an 
expansion of business which is a 
result of capital budgeting decision 
is likely to affect virtually all items 
in the profit and loss account of the 
business.
It can, thus, be stated that the 
financial statements of a business 
are largely determined by financial 
management decisions taken earlier. 
Similarly, the future financial 
statements would depend upon past 
as well as current financial decisions. 
Thus, the overall financial health 
of a business is determined by the 
quality of its financial management. 
Good financial management aims at 
mobilisation of financial resources at 
a lower cost and deployment of these 
in most lucrative activities.
o Bjec Tive S
The primary aim of financial 
management is to maximise 
shareholders’ wealth, which is referred 
to as the wealth-maximisation concept. 
The market price of a company’s shares 
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is linked to the three basic financial 
decisions which you will study a little 
later. This is because a company funds 
belong to the shareholders and the 
manner in which they are invested and 
the return earned by them determines 
their market value and price. It means 
maximisation of the market value of 
equity shares. The market price of 
equity share increases, if the benefit 
from a decision exceeds the cost 
involved. All financial decisions aim at 
ensuring that each decision is efficient 
and adds some value. Such value 
additions tend to increase the market 
price of shares. Therefore, those 
financial decisions are taken which 
will ultimately prove gainful from 
the point of view of the shareholders. 
The shareholders gain if the value of 
shares in the market increases. Those 
decisions which result in decline in 
the share price are poor financial 
decisions. Thus, we can say, the 
objective of financial management is 
to maximise the current price of equity 
shares of the company or to maximise 
the wealth of owners of the company, 
that is, the shareholders.
Therefore, when a decision is taken 
about investment in a new machine, 
the aim of financial management 
is to ensure that benefits from the 
investment exceed the cost so that 
some value addition takes place. 
Similarly, when finance is procured, 
the aim is to reduce the cost so that 
the value addition is even higher.
In fact, in all financial decisions, 
major or minor, the ultimate objective 
that guides the decision-maker is that 
some value addition should take place. 
All those avenues of investment, modes 
of financing, ways of handling various 
components of working capital must 
be identified which will ultimately lead 
to an increase in the price of equity 
share. It can happen through efficient 
decision-making. Decision-making is 
efficient if, out of the various available 
alternatives, the best is selected.
Financial d eci Sion S
Financial management is concerned 
with the solution of three major issues 
relating to the financial operations 
of a firm corresponding to the three 
questions of investment, financing 
and divident decision. In a financial 
context, it means the selection of 
best financing alternative or best 
investment alternative. The finance 
function, therefore, is concerned 
with three broad decisions which are 
explained below:
investment Decision
A firm’s resources are scarce in 
comparison to the uses to which 
they can be put. A firm, therefore, 
has to choose where to invest these 
resources, so that they are able to earn 
the highest possible return for their 
investors. The investment decision, 
therefore, relates to how the firm’s 
funds are invested in different assets.
Investment decision can be long-
term or short-term. A long-term 
investment decision is also called a 
Capital Budgeting decision. It involves 
committing the finance on a long-
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term basis. For example, making 
investment in a new machine to 
replace an existing one or acquiring 
a new fixed asset or opening a new 
branch, etc. These decisions are very 
crucial for any business since they 
affect its earning capacity in the long 
run. The size of assets, profitability 
and competitiveness are all affected by 
capital budgeting decisions. Moreover, 
these decisions normally involve 
huge amounts of investment and are 
irreversible except at a huge cost. 
Therefore, once made, it is often almost 
impossible for a business to wriggle out 
of such decisions. Therefore, they need 
to be taken with utmost care. These 
decisions) are concerned with the 
decisions about the levels of cash, 
inventory and receivables. These 
decisions affect the day-to-day 
working of a business. These affect 
the liquidity as well as profitability of a 
business. Efficient cash management, 
inventory management and receivables 
management are essential ingredients 
of sound working capital management.
Factors affecting Capital 
Budgeting Decision
A number of projects are often available 
to a business to invest in. But each 
project has to be evaluated carefully 
and, depending upon the returns, a 
particular project is either selected or 
rejected. If there is only one project, its 
viability in terms of the rate of return, 
viz., investment and its comparability 
with the industry’s average is seen. 
There are certain factors which affect 
capital budgeting decisions.
(a) Cash flows of the project: When 
a company takes an investment 
decision involving huge amount 
it expects to generate some cash 
flows over a period. These cash 
flows are in the form of a series 
of cash receipts and payments 
over the life of an investment. 
The amount of these cash flows 
should be carefully analysed before 
considering a capital budgeting 
decision.
(b) The rate of return: The most 
important criterion is the rate 
of return of the project. These 
calculations are based on the 
Wealth Maximisation Concept
decisions must be taken by those who 
understand them comprehensively. 
A bad capital budgeting decision 
normally has the capacity to severely 
damage the financial fortune of a 
business. Short-term investment 
decisions (also called working capital 
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