Important Questions : Financial Management Class 12 Notes | EduRev

Class 12 : Important Questions : Financial Management Class 12 Notes | EduRev

 Page 1


 
 
FINANCIAL MANAGEMENT    12 MARKS 
CONCEPT MAPPING:  
Key Concepts in nutshell: 
 
Meaning of Business Finance:  Money required for carrying out business activities is called 
business finance. 
Financial Management: It is concerned with optimal procurement as well as usage of 
finance. 
 
Role of Financial Management: It cannot be over-emphasized, since it has a direct bearing 
on the financial health of a business.  The financial statements such as Profit and Loss A/C and 
B/S reflect a firm’s financial position and its financial health. 
i) The size as well as the composition of fixed assets of the business 
ii) The quantum of current assets as well as its break-up into cash, inventories and 
receivables. 
iii) The amount of long-term and short-term financing to be used. 
iv) Break- up of long-term financing into debt, equity etc. 
v) All items in the profit and loss account e.g., interest, expenses, depreciation etc. 
 
Page 2


 
 
FINANCIAL MANAGEMENT    12 MARKS 
CONCEPT MAPPING:  
Key Concepts in nutshell: 
 
Meaning of Business Finance:  Money required for carrying out business activities is called 
business finance. 
Financial Management: It is concerned with optimal procurement as well as usage of 
finance. 
 
Role of Financial Management: It cannot be over-emphasized, since it has a direct bearing 
on the financial health of a business.  The financial statements such as Profit and Loss A/C and 
B/S reflect a firm’s financial position and its financial health. 
i) The size as well as the composition of fixed assets of the business 
ii) The quantum of current assets as well as its break-up into cash, inventories and 
receivables. 
iii) The amount of long-term and short-term financing to be used. 
iv) Break- up of long-term financing into debt, equity etc. 
v) All items in the profit and loss account e.g., interest, expenses, depreciation etc. 
 
 
Objectives of Financial Management: Maximisation of owners’ wealth is sole objective of 
financial management.  It means maximization of the market value of equity shares.  Market 
price of equity share increases if the benefits from a decision exceed the cost involved. 
 
FINANCIAL DECISIONS 
 
 
 
Investment Decision: It 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. 
Page 3


 
 
FINANCIAL MANAGEMENT    12 MARKS 
CONCEPT MAPPING:  
Key Concepts in nutshell: 
 
Meaning of Business Finance:  Money required for carrying out business activities is called 
business finance. 
Financial Management: It is concerned with optimal procurement as well as usage of 
finance. 
 
Role of Financial Management: It cannot be over-emphasized, since it has a direct bearing 
on the financial health of a business.  The financial statements such as Profit and Loss A/C and 
B/S reflect a firm’s financial position and its financial health. 
i) The size as well as the composition of fixed assets of the business 
ii) The quantum of current assets as well as its break-up into cash, inventories and 
receivables. 
iii) The amount of long-term and short-term financing to be used. 
iv) Break- up of long-term financing into debt, equity etc. 
v) All items in the profit and loss account e.g., interest, expenses, depreciation etc. 
 
 
Objectives of Financial Management: Maximisation of owners’ wealth is sole objective of 
financial management.  It means maximization of the market value of equity shares.  Market 
price of equity share increases if the benefits from a decision exceed the cost involved. 
 
FINANCIAL DECISIONS 
 
 
 
Investment Decision: It 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. 
 
Factors affecting Capital Budgeting Decision/Investment Decision: 
1. Cash flows of the project: If anticipated cash flows are more than the cost involved then 
such projects are considered. 
2. The rate of return:  The investment proposal which ensures highest rate of return is  
finally selected.  
3. The investment criteria involved: Through capital budgeting techniques, investment 
proposals are selected. 
 
Financing Decision: - It refers to  the quantum of finance to be raised from various sources of 
long-term of finance.   It involves identification of various available sources.  The main sources 
of funds for a firm are shareholders funds and borrowed funds.  Shareholders funds refer to 
equity capital and retained earnings.  Borrowed funds refer to finance raised as debentures or 
other forms of debt. 
 
Factors Affecting Financing Decision:- 
a) Cost: The cost of raising funds through different sources is different. A prudent financial 
manager would normally opt for a source which is the cheapest. 
(b) Risk: The risk associated with different sources is different. 
(c) Floatation Costs: Higher the floatation cost, less attractive the source. 
(d) Cash Flow Position of the Business: A stronger cash flow position may make debt 
financing more viable than funding through equity. 
(e) Level of Fixed Operating Costs: If a business has high level of fixed operating costs (e.g., 
building rent, Insurance premium, Salaries etc.), It must opt for lower fixed financing costs. 
Hence, lower debt financing is better. Similarly, if fixed operating cost is less, more 
f) Control Considerations: Issues of more equity may lead to dilution of management’s 
control over the business. Debt financing has no such implication. Companies afraid of a 
takeover bid may consequently prefer debt to equity. 
g) State of Capital Markets: Health of the capital market may also affect the choice of source 
of fund. During the period when stock market is rising, more people are ready to invest in 
equity. However, depressed capital market may make issue of equity shares difficult for any 
company. 
DIVIDEND DECISION:-The decision involved here is how much of the profit earned by 
company (after paying tax) is to be distributed to the shareholders and how much of it should 
be retained in the business for meeting the investment requirements. 
Page 4


 
 
FINANCIAL MANAGEMENT    12 MARKS 
CONCEPT MAPPING:  
Key Concepts in nutshell: 
 
Meaning of Business Finance:  Money required for carrying out business activities is called 
business finance. 
Financial Management: It is concerned with optimal procurement as well as usage of 
finance. 
 
Role of Financial Management: It cannot be over-emphasized, since it has a direct bearing 
on the financial health of a business.  The financial statements such as Profit and Loss A/C and 
B/S reflect a firm’s financial position and its financial health. 
i) The size as well as the composition of fixed assets of the business 
ii) The quantum of current assets as well as its break-up into cash, inventories and 
receivables. 
iii) The amount of long-term and short-term financing to be used. 
iv) Break- up of long-term financing into debt, equity etc. 
v) All items in the profit and loss account e.g., interest, expenses, depreciation etc. 
 
 
Objectives of Financial Management: Maximisation of owners’ wealth is sole objective of 
financial management.  It means maximization of the market value of equity shares.  Market 
price of equity share increases if the benefits from a decision exceed the cost involved. 
 
FINANCIAL DECISIONS 
 
 
 
Investment Decision: It 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. 
 
Factors affecting Capital Budgeting Decision/Investment Decision: 
1. Cash flows of the project: If anticipated cash flows are more than the cost involved then 
such projects are considered. 
2. The rate of return:  The investment proposal which ensures highest rate of return is  
finally selected.  
3. The investment criteria involved: Through capital budgeting techniques, investment 
proposals are selected. 
 
Financing Decision: - It refers to  the quantum of finance to be raised from various sources of 
long-term of finance.   It involves identification of various available sources.  The main sources 
of funds for a firm are shareholders funds and borrowed funds.  Shareholders funds refer to 
equity capital and retained earnings.  Borrowed funds refer to finance raised as debentures or 
other forms of debt. 
 
Factors Affecting Financing Decision:- 
a) Cost: The cost of raising funds through different sources is different. A prudent financial 
manager would normally opt for a source which is the cheapest. 
(b) Risk: The risk associated with different sources is different. 
(c) Floatation Costs: Higher the floatation cost, less attractive the source. 
(d) Cash Flow Position of the Business: A stronger cash flow position may make debt 
financing more viable than funding through equity. 
(e) Level of Fixed Operating Costs: If a business has high level of fixed operating costs (e.g., 
building rent, Insurance premium, Salaries etc.), It must opt for lower fixed financing costs. 
Hence, lower debt financing is better. Similarly, if fixed operating cost is less, more 
f) Control Considerations: Issues of more equity may lead to dilution of management’s 
control over the business. Debt financing has no such implication. Companies afraid of a 
takeover bid may consequently prefer debt to equity. 
g) State of Capital Markets: Health of the capital market may also affect the choice of source 
of fund. During the period when stock market is rising, more people are ready to invest in 
equity. However, depressed capital market may make issue of equity shares difficult for any 
company. 
DIVIDEND DECISION:-The decision involved here is how much of the profit earned by 
company (after paying tax) is to be distributed to the shareholders and how much of it should 
be retained in the business for meeting the investment requirements. 
 
FACTORS AFFECTING DIVIDEND DECISION:- 
a) Earnings: Dividends are paid out of current and past earning. Therefore, earnings is a 
major determinant of the decision about dividend. 
(b) Stability of Earnings: Other things remaining the same, a company having stable earning 
is in a position to declare higher dividends. As against this, a company having unstable 
earnings is likely to pay smaller dividend. 
c) Stability of Dividends: It has been found that the companies generally follow a policy of 
stabilising dividend per share. 
(d) Growth Opportunities: Companies having good growth opportunities retain more 
money out of their earnings so as to finance the required investment. 
(e) Cash Flow Position: Dividends involve an outflow of cash. A company may be profitable 
but short on cash. Availability of enough cash in the company is necessary for declaration of 
dividend by it. 
(f) Shareholder Preference: While declaring dividends, managements usually keep in mind 
the preferences of the shareholders in this regard. 
(g) Taxation Policy: The choice between payment of dividends and retaining the earnings is, 
to some extent, affected by difference in the tax treatment of dividends and capital gains. 
(h) Stock Market Reaction: Investors, in general, view an increase in dividend as a good 
news and stock prices react positively to it. Similarly, a decrease in dividend may have a 
negative impact on the share prices in the stock market.  
(i) Access to Capital Market: Large and reputed companies generally have easy access to the 
capital market and therefore may depend less on retained earnings to finance their growth. 
These companies tend to pay higher dividends than the smaller companies which have 
relatively low access to the market. 
(j) Legal Constraints: Certain provisions of the Company’s Act place restrictions on payouts 
as dividend. Such provisions must be adhered to while declaring the dividends.  
(k) Contractual Constraints: While granting loans to a company, sometimes the lender may 
impose certain restrictions on the payment of dividends in future. 
 
FINANCIAL PLANNING 
Financial Planning is essentially preparation of financial blueprint of an organisations’s 
future operations.  The objective of financial planning is to ensure that enough funds are 
available at right time. 
OBJECTIVES 
Page 5


 
 
FINANCIAL MANAGEMENT    12 MARKS 
CONCEPT MAPPING:  
Key Concepts in nutshell: 
 
Meaning of Business Finance:  Money required for carrying out business activities is called 
business finance. 
Financial Management: It is concerned with optimal procurement as well as usage of 
finance. 
 
Role of Financial Management: It cannot be over-emphasized, since it has a direct bearing 
on the financial health of a business.  The financial statements such as Profit and Loss A/C and 
B/S reflect a firm’s financial position and its financial health. 
i) The size as well as the composition of fixed assets of the business 
ii) The quantum of current assets as well as its break-up into cash, inventories and 
receivables. 
iii) The amount of long-term and short-term financing to be used. 
iv) Break- up of long-term financing into debt, equity etc. 
v) All items in the profit and loss account e.g., interest, expenses, depreciation etc. 
 
 
Objectives of Financial Management: Maximisation of owners’ wealth is sole objective of 
financial management.  It means maximization of the market value of equity shares.  Market 
price of equity share increases if the benefits from a decision exceed the cost involved. 
 
FINANCIAL DECISIONS 
 
 
 
Investment Decision: It 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. 
 
Factors affecting Capital Budgeting Decision/Investment Decision: 
1. Cash flows of the project: If anticipated cash flows are more than the cost involved then 
such projects are considered. 
2. The rate of return:  The investment proposal which ensures highest rate of return is  
finally selected.  
3. The investment criteria involved: Through capital budgeting techniques, investment 
proposals are selected. 
 
Financing Decision: - It refers to  the quantum of finance to be raised from various sources of 
long-term of finance.   It involves identification of various available sources.  The main sources 
of funds for a firm are shareholders funds and borrowed funds.  Shareholders funds refer to 
equity capital and retained earnings.  Borrowed funds refer to finance raised as debentures or 
other forms of debt. 
 
Factors Affecting Financing Decision:- 
a) Cost: The cost of raising funds through different sources is different. A prudent financial 
manager would normally opt for a source which is the cheapest. 
(b) Risk: The risk associated with different sources is different. 
(c) Floatation Costs: Higher the floatation cost, less attractive the source. 
(d) Cash Flow Position of the Business: A stronger cash flow position may make debt 
financing more viable than funding through equity. 
(e) Level of Fixed Operating Costs: If a business has high level of fixed operating costs (e.g., 
building rent, Insurance premium, Salaries etc.), It must opt for lower fixed financing costs. 
Hence, lower debt financing is better. Similarly, if fixed operating cost is less, more 
f) Control Considerations: Issues of more equity may lead to dilution of management’s 
control over the business. Debt financing has no such implication. Companies afraid of a 
takeover bid may consequently prefer debt to equity. 
g) State of Capital Markets: Health of the capital market may also affect the choice of source 
of fund. During the period when stock market is rising, more people are ready to invest in 
equity. However, depressed capital market may make issue of equity shares difficult for any 
company. 
DIVIDEND DECISION:-The decision involved here is how much of the profit earned by 
company (after paying tax) is to be distributed to the shareholders and how much of it should 
be retained in the business for meeting the investment requirements. 
 
FACTORS AFFECTING DIVIDEND DECISION:- 
a) Earnings: Dividends are paid out of current and past earning. Therefore, earnings is a 
major determinant of the decision about dividend. 
(b) Stability of Earnings: Other things remaining the same, a company having stable earning 
is in a position to declare higher dividends. As against this, a company having unstable 
earnings is likely to pay smaller dividend. 
c) Stability of Dividends: It has been found that the companies generally follow a policy of 
stabilising dividend per share. 
(d) Growth Opportunities: Companies having good growth opportunities retain more 
money out of their earnings so as to finance the required investment. 
(e) Cash Flow Position: Dividends involve an outflow of cash. A company may be profitable 
but short on cash. Availability of enough cash in the company is necessary for declaration of 
dividend by it. 
(f) Shareholder Preference: While declaring dividends, managements usually keep in mind 
the preferences of the shareholders in this regard. 
(g) Taxation Policy: The choice between payment of dividends and retaining the earnings is, 
to some extent, affected by difference in the tax treatment of dividends and capital gains. 
(h) Stock Market Reaction: Investors, in general, view an increase in dividend as a good 
news and stock prices react positively to it. Similarly, a decrease in dividend may have a 
negative impact on the share prices in the stock market.  
(i) Access to Capital Market: Large and reputed companies generally have easy access to the 
capital market and therefore may depend less on retained earnings to finance their growth. 
These companies tend to pay higher dividends than the smaller companies which have 
relatively low access to the market. 
(j) Legal Constraints: Certain provisions of the Company’s Act place restrictions on payouts 
as dividend. Such provisions must be adhered to while declaring the dividends.  
(k) Contractual Constraints: While granting loans to a company, sometimes the lender may 
impose certain restrictions on the payment of dividends in future. 
 
FINANCIAL PLANNING 
Financial Planning is essentially preparation of financial blueprint of an organisations’s 
future operations.  The objective of financial planning is to ensure that enough funds are 
available at right time. 
OBJECTIVES 
 
(a) To ensure availability of fundswhenever these are required: This include a proper 
estimation of the funds required for different purposes such as for the purchase of long-term 
assets or to meet day- to- day expenses of business etc. 
(b) To see that the firm does not raise resources unnecessarily: Excess funding is almost 
as bad as inadequate funding. 
IMPORTANCE OFFINANCIAL PLANNING 
(i) It tries to forecast what may happen in future under different business situations. By doing 
so, it helps the firms to face the eventual situation in a better way. In other words, it makes the 
firm better prepared to face the future. 
(ii) It helps in avoiding business shocks and surprises and helps the company in preparing for 
the future. 
 (iii) If helps in co-ordinating various business functions e.g., sales and production functions, 
by providing clear policies and procedures. 
(iv)  Detailed plans of action prepared under financial planning reduce waste, duplication of 
efforts, and gaps in planning. 
(v) It tries to link the present with the future. 
(vi) It provides a link between investment and financing decisions on a continuous basis. 
(vii) By spelling out detailed objectives for various business segments, it makes the evaluation 
of actual performance easier. 
CAPITAL STRUCTURE: Capital structure refers to the mix between owners and borrowed 
funds. 
FACTORS AFFECTING THE CHOICE OF CAPITAL STRUCTURE 
1. Cash Flow Position: Size of projected cash flows must be considered before issuing debt. 
2. Interest Coverage Ratio (ICR): The interest coverage ratio refers to the number of times 
earnings before interest and taxes of a company covers the interest obligation. 
3. Debt Service Coverage Ratio(DSCR): Debt Service Coverage Ratio takes care of the 
deficiencies referred to in the Interest Coverage Ratio (ICR). 
4. Return on Investment (RoI): If the RoI of the company is higher, it can choose to use 
trading on equity to increase its EPS, i.e., its ability to use debt is greater. 
5. Cost of debt: A firm’s ability to borrow at a lower rate increases its capacity to employ 
higher debt. Thus, more debt can be used if debt can be raised at a lower rate. 
6. Tax Rate: Since interest is a deductible expense, cost of debt is affected by the tax rate.  
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