NCERT Textbook - Financial Management Commerce Notes | EduRev

Business Studies (BST) Class 12

Commerce : NCERT Textbook - Financial Management Commerce Notes | EduRev

 Page 1


LEARNING OBJECTIVES LEARNING OBJECTIVES LEARNING OBJECTIVES LEARNING OBJECTIVES LEARNING OBJECTIVES
After studying this chapter, you
should be able to:
Ø explain the meaning of business
finance;
Ø describe financial management;
Ø explain the role of financial
management in our enterprise;
Ø discuss objectives of financial
management and how they
could be achieved;
Ø explain the meaning and
importance of financial
planning;
Ø state the meaning of capital
structure;
Ø analyse the factors affecting the
choice of an appropriate capital
structure;
Ø state meaning of fixed capital
and working capital; and
Ø analyse the factors affecting the
requirement of fixed and
working capital.
CHAPTER
9
F F F F FINANCIAL INANCIAL INANCIAL INANCIAL INANCIAL M M M M MANAGEMENT ANAGEMENT ANAGEMENT ANAGEMENT ANAGEMENT
T T T T TATA ATA ATA ATA ATA S S S S STEEL TEEL TEEL TEEL TEEL A A A A ACQUIRES CQUIRES CQUIRES CQUIRES CQUIRES C C C C CORUS ORUS ORUS ORUS 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. 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:
l Tata Steel will become the fifth
largest producer of steel in the world.
l Tata Steel will raise 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 will
get funds from Tata Steel routed
through a Singapore subsidiary.
Another company of the Tata group,
Tata Sons Ltd., will invest $ 1 billion
dollars for preference shares along
with Tata Steel which will invest an
equal amount.
l Tata Steel, the acquirer company, shall
have to arrange about 36,500 crores
of rupees to finance the take-over.
l Tata Steel will have to raise this
amount through debt or equity or a
combination of both. Some amount
may come from internal accruals also.
This financing decision will affect the
capital structure of Tata Steel.
l Tata Steel hopes to increase the
production to 40 million tonnes and
revenue to 32 billion US dollars by
2012.
2015-16(21/01/2015)
Page 2


LEARNING OBJECTIVES LEARNING OBJECTIVES LEARNING OBJECTIVES LEARNING OBJECTIVES LEARNING OBJECTIVES
After studying this chapter, you
should be able to:
Ø explain the meaning of business
finance;
Ø describe financial management;
Ø explain the role of financial
management in our enterprise;
Ø discuss objectives of financial
management and how they
could be achieved;
Ø explain the meaning and
importance of financial
planning;
Ø state the meaning of capital
structure;
Ø analyse the factors affecting the
choice of an appropriate capital
structure;
Ø state meaning of fixed capital
and working capital; and
Ø analyse the factors affecting the
requirement of fixed and
working capital.
CHAPTER
9
F F F F FINANCIAL INANCIAL INANCIAL INANCIAL INANCIAL M M M M MANAGEMENT ANAGEMENT ANAGEMENT ANAGEMENT ANAGEMENT
T T T T TATA ATA ATA ATA ATA S S S S STEEL TEEL TEEL TEEL TEEL A A A A ACQUIRES CQUIRES CQUIRES CQUIRES CQUIRES C C C C CORUS ORUS ORUS ORUS 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. 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:
l Tata Steel will become the fifth
largest producer of steel in the world.
l Tata Steel will raise 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 will
get funds from Tata Steel routed
through a Singapore subsidiary.
Another company of the Tata group,
Tata Sons Ltd., will invest $ 1 billion
dollars for preference shares along
with Tata Steel which will invest an
equal amount.
l Tata Steel, the acquirer company, shall
have to arrange about 36,500 crores
of rupees to finance the take-over.
l Tata Steel will have to raise this
amount through debt or equity or a
combination of both. Some amount
may come from internal accruals also.
This financing decision will affect the
capital structure of Tata Steel.
l Tata Steel hopes to increase the
production to 40 million tonnes and
revenue to 32 billion US dollars by
2012.
2015-16(21/01/2015)
BUSINESS STUDIES
238
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,
thus, very crucial for the survival and
growth of a business.
F F F F FINANCIAL INANCIAL INANCIAL INANCIAL INANCIAL M M M M MANAGEMENT ANAGEMENT ANAGEMENT ANAGEMENT ANAGEMENT
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
I I I I INTRODUCTION NTRODUCTION NTRODUCTION NTRODUCTION 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.
M M M M MEANING EANING EANING EANING EANING     OF OF OF OF OF B B B B BUSINESS USINESS USINESS USINESS USINESS F F F F FINANCE INANCE INANCE INANCE INANCE
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
l It may affect the competitiveness of Tata Steel because the cost of production of
steel in all probability, will change.
l The dividend paying capacity of Tata Steel may be affected because of this huge
cash outflow and because of a significantly higher debt which would need to be
serviced before paying any dividends to shareholders.
l The degree of risk shall also be affected. 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 Source: The Economic Times Source: The Economic Times Source: The Economic Times Source: The Economic Times
2015-16(21/01/2015)
Page 3


LEARNING OBJECTIVES LEARNING OBJECTIVES LEARNING OBJECTIVES LEARNING OBJECTIVES LEARNING OBJECTIVES
After studying this chapter, you
should be able to:
Ø explain the meaning of business
finance;
Ø describe financial management;
Ø explain the role of financial
management in our enterprise;
Ø discuss objectives of financial
management and how they
could be achieved;
Ø explain the meaning and
importance of financial
planning;
Ø state the meaning of capital
structure;
Ø analyse the factors affecting the
choice of an appropriate capital
structure;
Ø state meaning of fixed capital
and working capital; and
Ø analyse the factors affecting the
requirement of fixed and
working capital.
CHAPTER
9
F F F F FINANCIAL INANCIAL INANCIAL INANCIAL INANCIAL M M M M MANAGEMENT ANAGEMENT ANAGEMENT ANAGEMENT ANAGEMENT
T T T T TATA ATA ATA ATA ATA S S S S STEEL TEEL TEEL TEEL TEEL A A A A ACQUIRES CQUIRES CQUIRES CQUIRES CQUIRES C C C C CORUS ORUS ORUS ORUS 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. 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:
l Tata Steel will become the fifth
largest producer of steel in the world.
l Tata Steel will raise 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 will
get funds from Tata Steel routed
through a Singapore subsidiary.
Another company of the Tata group,
Tata Sons Ltd., will invest $ 1 billion
dollars for preference shares along
with Tata Steel which will invest an
equal amount.
l Tata Steel, the acquirer company, shall
have to arrange about 36,500 crores
of rupees to finance the take-over.
l Tata Steel will have to raise this
amount through debt or equity or a
combination of both. Some amount
may come from internal accruals also.
This financing decision will affect the
capital structure of Tata Steel.
l Tata Steel hopes to increase the
production to 40 million tonnes and
revenue to 32 billion US dollars by
2012.
2015-16(21/01/2015)
BUSINESS STUDIES
238
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,
thus, very crucial for the survival and
growth of a business.
F F F F FINANCIAL INANCIAL INANCIAL INANCIAL INANCIAL M M M M MANAGEMENT ANAGEMENT ANAGEMENT ANAGEMENT ANAGEMENT
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
I I I I INTRODUCTION NTRODUCTION NTRODUCTION NTRODUCTION 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.
M M M M MEANING EANING EANING EANING EANING     OF OF OF OF OF B B B B BUSINESS USINESS USINESS USINESS USINESS F F F F FINANCE INANCE INANCE INANCE INANCE
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
l It may affect the competitiveness of Tata Steel because the cost of production of
steel in all probability, will change.
l The dividend paying capacity of Tata Steel may be affected because of this huge
cash outflow and because of a significantly higher debt which would need to be
serviced before paying any dividends to shareholders.
l The degree of risk shall also be affected. 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 Source: The Economic Times Source: The Economic Times Source: The Economic Times Source: The Economic Times
2015-16(21/01/2015)
FINANCIAL MANAGEMENT
239
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
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 ass-
umption 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
2015-16(21/01/2015)
Page 4


LEARNING OBJECTIVES LEARNING OBJECTIVES LEARNING OBJECTIVES LEARNING OBJECTIVES LEARNING OBJECTIVES
After studying this chapter, you
should be able to:
Ø explain the meaning of business
finance;
Ø describe financial management;
Ø explain the role of financial
management in our enterprise;
Ø discuss objectives of financial
management and how they
could be achieved;
Ø explain the meaning and
importance of financial
planning;
Ø state the meaning of capital
structure;
Ø analyse the factors affecting the
choice of an appropriate capital
structure;
Ø state meaning of fixed capital
and working capital; and
Ø analyse the factors affecting the
requirement of fixed and
working capital.
CHAPTER
9
F F F F FINANCIAL INANCIAL INANCIAL INANCIAL INANCIAL M M M M MANAGEMENT ANAGEMENT ANAGEMENT ANAGEMENT ANAGEMENT
T T T T TATA ATA ATA ATA ATA S S S S STEEL TEEL TEEL TEEL TEEL A A A A ACQUIRES CQUIRES CQUIRES CQUIRES CQUIRES C C C C CORUS ORUS ORUS ORUS 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. 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:
l Tata Steel will become the fifth
largest producer of steel in the world.
l Tata Steel will raise 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 will
get funds from Tata Steel routed
through a Singapore subsidiary.
Another company of the Tata group,
Tata Sons Ltd., will invest $ 1 billion
dollars for preference shares along
with Tata Steel which will invest an
equal amount.
l Tata Steel, the acquirer company, shall
have to arrange about 36,500 crores
of rupees to finance the take-over.
l Tata Steel will have to raise this
amount through debt or equity or a
combination of both. Some amount
may come from internal accruals also.
This financing decision will affect the
capital structure of Tata Steel.
l Tata Steel hopes to increase the
production to 40 million tonnes and
revenue to 32 billion US dollars by
2012.
2015-16(21/01/2015)
BUSINESS STUDIES
238
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,
thus, very crucial for the survival and
growth of a business.
F F F F FINANCIAL INANCIAL INANCIAL INANCIAL INANCIAL M M M M MANAGEMENT ANAGEMENT ANAGEMENT ANAGEMENT ANAGEMENT
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
I I I I INTRODUCTION NTRODUCTION NTRODUCTION NTRODUCTION 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.
M M M M MEANING EANING EANING EANING EANING     OF OF OF OF OF B B B B BUSINESS USINESS USINESS USINESS USINESS F F F F FINANCE INANCE INANCE INANCE INANCE
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
l It may affect the competitiveness of Tata Steel because the cost of production of
steel in all probability, will change.
l The dividend paying capacity of Tata Steel may be affected because of this huge
cash outflow and because of a significantly higher debt which would need to be
serviced before paying any dividends to shareholders.
l The degree of risk shall also be affected. 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 Source: The Economic Times Source: The Economic Times Source: The Economic Times Source: The Economic Times
2015-16(21/01/2015)
FINANCIAL MANAGEMENT
239
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
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 ass-
umption 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
2015-16(21/01/2015)
BUSINESS STUDIES
240
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 O O O OBJECTIVES BJECTIVES BJECTIVES BJECTIVES 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 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.
F F F F FINANCIAL INANCIAL INANCIAL INANCIAL INANCIAL D D D D DECISIONS ECISIONS ECISIONS ECISIONS 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
2015-16(21/01/2015)
Page 5


LEARNING OBJECTIVES LEARNING OBJECTIVES LEARNING OBJECTIVES LEARNING OBJECTIVES LEARNING OBJECTIVES
After studying this chapter, you
should be able to:
Ø explain the meaning of business
finance;
Ø describe financial management;
Ø explain the role of financial
management in our enterprise;
Ø discuss objectives of financial
management and how they
could be achieved;
Ø explain the meaning and
importance of financial
planning;
Ø state the meaning of capital
structure;
Ø analyse the factors affecting the
choice of an appropriate capital
structure;
Ø state meaning of fixed capital
and working capital; and
Ø analyse the factors affecting the
requirement of fixed and
working capital.
CHAPTER
9
F F F F FINANCIAL INANCIAL INANCIAL INANCIAL INANCIAL M M M M MANAGEMENT ANAGEMENT ANAGEMENT ANAGEMENT ANAGEMENT
T T T T TATA ATA ATA ATA ATA S S S S STEEL TEEL TEEL TEEL TEEL A A A A ACQUIRES CQUIRES CQUIRES CQUIRES CQUIRES C C C C CORUS ORUS ORUS ORUS 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. 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:
l Tata Steel will become the fifth
largest producer of steel in the world.
l Tata Steel will raise 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 will
get funds from Tata Steel routed
through a Singapore subsidiary.
Another company of the Tata group,
Tata Sons Ltd., will invest $ 1 billion
dollars for preference shares along
with Tata Steel which will invest an
equal amount.
l Tata Steel, the acquirer company, shall
have to arrange about 36,500 crores
of rupees to finance the take-over.
l Tata Steel will have to raise this
amount through debt or equity or a
combination of both. Some amount
may come from internal accruals also.
This financing decision will affect the
capital structure of Tata Steel.
l Tata Steel hopes to increase the
production to 40 million tonnes and
revenue to 32 billion US dollars by
2012.
2015-16(21/01/2015)
BUSINESS STUDIES
238
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,
thus, very crucial for the survival and
growth of a business.
F F F F FINANCIAL INANCIAL INANCIAL INANCIAL INANCIAL M M M M MANAGEMENT ANAGEMENT ANAGEMENT ANAGEMENT ANAGEMENT
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
I I I I INTRODUCTION NTRODUCTION NTRODUCTION NTRODUCTION 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.
M M M M MEANING EANING EANING EANING EANING     OF OF OF OF OF B B B B BUSINESS USINESS USINESS USINESS USINESS F F F F FINANCE INANCE INANCE INANCE INANCE
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
l It may affect the competitiveness of Tata Steel because the cost of production of
steel in all probability, will change.
l The dividend paying capacity of Tata Steel may be affected because of this huge
cash outflow and because of a significantly higher debt which would need to be
serviced before paying any dividends to shareholders.
l The degree of risk shall also be affected. 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 Source: The Economic Times Source: The Economic Times Source: The Economic Times Source: The Economic Times
2015-16(21/01/2015)
FINANCIAL MANAGEMENT
239
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
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 ass-
umption 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
2015-16(21/01/2015)
BUSINESS STUDIES
240
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 O O O OBJECTIVES BJECTIVES BJECTIVES BJECTIVES 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 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.
F F F F FINANCIAL INANCIAL INANCIAL INANCIAL INANCIAL D D D D DECISIONS ECISIONS ECISIONS ECISIONS 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
2015-16(21/01/2015)
FINANCIAL MANAGEMENT
241
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 Investment Decision Investment Decision Investment Decision 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-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 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
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 Factors affecting Capital Factors affecting Capital Factors affecting Capital Factors affecting Capital
Budgeting Decision Budgeting Decision Budgeting Decision Budgeting Decision 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
Wealth Maximisation Concept
2015-16(21/01/2015)
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