Page 1
chapter
9
When TaTa STeel a cquired c oruS
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. This makes Tata Steel the fifth
largest steel producer in the world. 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. This SPV
received funds from Tata Steel routed
through a Singapore subsidiary.
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 Tata Steel.
? Needless to emphasise, decisions
like this affect the future of the
organisation. These decisions are
almost irrevocable after they have been
formalised.
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 ManageMenT
Ch_9.indd 215 10-08-2022 09:09:51
Rationalised 2023-24
Page 2
chapter
9
When TaTa STeel a cquired c oruS
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. This makes Tata Steel the fifth
largest steel producer in the world. 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. This SPV
received funds from Tata Steel routed
through a Singapore subsidiary.
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 Tata Steel.
? Needless to emphasise, decisions
like this affect the future of the
organisation. These decisions are
almost irrevocable after they have been
formalised.
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 ManageMenT
Ch_9.indd 215 10-08-2022 09:09:51
Rationalised 2023-24
FINANCIAL MANAgeMeNTS
217
BUSINe SS STUDIe S
216
thus, very crucial for the survival and
growth of a business.
Financial ManageMenT
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 nTroducTion 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 oF BuSineSS 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
Rationalised 2023-24
Page 3
chapter
9
When TaTa STeel a cquired c oruS
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. This makes Tata Steel the fifth
largest steel producer in the world. 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. This SPV
received funds from Tata Steel routed
through a Singapore subsidiary.
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 Tata Steel.
? Needless to emphasise, decisions
like this affect the future of the
organisation. These decisions are
almost irrevocable after they have been
formalised.
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 ManageMenT
Ch_9.indd 215 10-08-2022 09:09:51
Rationalised 2023-24
FINANCIAL MANAgeMeNTS
217
BUSINe SS STUDIe S
216
thus, very crucial for the survival and
growth of a business.
Financial ManageMenT
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 nTroducTion 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 oF BuSineSS 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
Rationalised 2023-24
FINANCIAL MANAge Me NTS
217
BUSINeSS STUDIeS
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 BjecTiveS
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
Rationalised 2023-24
Page 4
chapter
9
When TaTa STeel a cquired c oruS
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. This makes Tata Steel the fifth
largest steel producer in the world. 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. This SPV
received funds from Tata Steel routed
through a Singapore subsidiary.
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 Tata Steel.
? Needless to emphasise, decisions
like this affect the future of the
organisation. These decisions are
almost irrevocable after they have been
formalised.
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 ManageMenT
Ch_9.indd 215 10-08-2022 09:09:51
Rationalised 2023-24
FINANCIAL MANAgeMeNTS
217
BUSINe SS STUDIe S
216
thus, very crucial for the survival and
growth of a business.
Financial ManageMenT
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 nTroducTion 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 oF BuSineSS 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
Rationalised 2023-24
FINANCIAL MANAge Me NTS
217
BUSINeSS STUDIeS
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 BjecTiveS
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
Rationalised 2023-24
FINANCIAL MANAgeMeNTS
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 eciSionS
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
Rationalised 2023-24
Page 5
chapter
9
When TaTa STeel a cquired c oruS
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. This makes Tata Steel the fifth
largest steel producer in the world. 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. This SPV
received funds from Tata Steel routed
through a Singapore subsidiary.
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 Tata Steel.
? Needless to emphasise, decisions
like this affect the future of the
organisation. These decisions are
almost irrevocable after they have been
formalised.
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 ManageMenT
Ch_9.indd 215 10-08-2022 09:09:51
Rationalised 2023-24
FINANCIAL MANAgeMeNTS
217
BUSINe SS STUDIe S
216
thus, very crucial for the survival and
growth of a business.
Financial ManageMenT
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 nTroducTion 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 oF BuSineSS 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
Rationalised 2023-24
FINANCIAL MANAge Me NTS
217
BUSINeSS STUDIeS
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 BjecTiveS
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
Rationalised 2023-24
FINANCIAL MANAgeMeNTS
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 eciSionS
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
Rationalised 2023-24
FINANCIAL MANAge Me NTS
219
BUSINeSS STUDIeS
218
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
Ch_9.indd 219 10-08-2022 09:09:51
Rationalised 2023-24
Read More