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COM BANGALORE
UNIVERSITY
SESHADRIPURAM EVENING DEGREE COLLEGE
FINANCIAL MANAGEMENT
Finance:It is a flow of money.
Management:Control or Managing of money
Financial Management:It is the process of managing or controlling flow of money or fund.
In the technique word: Financial Management it is a process of acquitting of funds
from various sources to meet the business needs in order to accomplish overall
objectives of the firm.
1. Maximization of wealth.
2. Maximization of profit.
Financial Management it is consider as a life blood of all business enterprises and it
also consider as arms and leg business activities.
Finance can be classified into two types:1. Private finance.
2. Public finance.
1. Private finance:It deals with requirements receipts and dispersment of funds to an
1. Individual
2. Business finance and
3. Non-profit organization or corporation firms finance
Business finance sub classified into three types:1. Sole proprietors finance
2. Partnership firm finance and
3. Joint stock company
2. Public finance:It deals with requirement receipts distributions of fund to the government
institutions by
1. Local Self Government
2. State Government and
3. Central Government
Importance of finance:1. Finance is helpful for modernization, diversification expansion and development
of a enterprises.
2. Availability of adequate finance increase the credit worthiness (repayment of
loan. of the concern in the high of the supplies, traders and general public.
3. The issue of a large number of securities as provided wide investment
opportunities to the investors.
4. By insuring wide distribution of funds finance contribute to balance regional
development in the country.
5. Finance if essential for undertaking research activities, market serway publicity,
transportation, communication and for efficient marketing of a product.
6. By contributing to the renovation and modernization of industry finance
contribute to the production and supplies goods at fair prices to the society.
v
v
v
v
v
The company cares more for economic welfare of the share holders, it cannot
forget the other who directly or indirectly contribute efficiency for the overall
development of the company, namely,
1. Creditors/lenders:It refers to financial institution, commercial banks, private money lenders,
debentures and trade creditors. The company has to meet their obligation of paying
interest and principal on dues dates. The earning of the company assures prompt
recovery of their investment, so that the lenders can increase their confidence level
by financing more to the company. This would help the company to earn good
reputation and can increase their liquidity.
2. Workers/Employees:They are the back bone of the industry. They are the main contributors to the
growth and success of one industry. It is the basic obligation of the company to keep
the workers in good humour and harmony. This can be achieved only by providing
fairs wages, good working conditions with appropriate welfare measures. This would
help the company to earn good reputation and can increase their liquidity.
3. Society/public:4. Management:The success of the business mainly depends on the decisions taken by the
Management. The finance manger has to make and guide the management in
taking right decision at the right time and also control over [Maximum control
over] the movement of funds and invest the funds in the profitable avenues to
reach maximum profit. This will increase the confidence in the minds of equity share
holders.
Advantages of wealth Maximization:1. Wealth Maximization is a clear term. Here, the present value of cash flows is
taken in to consideration. The net effect of investment and benefits can be
measured Cleary.
2. It considered the concept of time value of money present cash inflow and cash
out flows help the management to achieve the overall objective of company.
3. It considered as a universal accepted concept, because it takes care of interest of
financial instructions owners, employees, management and society at large.
4. It guides the Management in formulating a consistent strong dividend policy to
reach Maximum returns to equity share holders.
5. It considers/studies the impact of risk factor, while calculating the Npv at a
particular discount rate adjustment is being made to cover the risk that is
associated with the investment.
Disadvantage or criticisms of wealth Maximization.
1. It is a prescriptive idea. The object is not descriptive of what the firms actually do.
2. The objective of wealth maximization is not necessarily socially desirable.
General objectives:1. Ensuring maximum operational efficiency through planning directing and
controlling of the utilization of funds.
2. Enforcing financial discipline in the organization in the use of financial resources
through the co-ordination of the operations of the various decision in the
organization.
3. Building up of adequate reserve for Financial Growth and Expansion.
4. Ensuring a fair return to the share-holders on their investments.
Financial Decision
5) Contingencies:It should keep in view the requirements of funds for contingencies. It does not,
however, mean that capital should be kept unnecessarily idle for meeting
contingencies. Management is foresight will considerably reduce this risk.
6) Flexibility:The financial plan should have a degree of flexibil.ity also. It is helpful in making
changes or revising the plan according to pressure of circumstances with minimum
possible delay.
7) Liquidity:Liquidity is the ability of the enterprise to make available the ready cash whenever
to make disbursement. Adequate liquidity also flexibility to the financial plan.
Liquidity ensures the credit worthinees and goodwill of the firm.
8) Economy.
Economy means funds should be raised at minimum cost. Cost minimization
depends on the selection of various sources of finance and optimum mix of debtequity.
Steps / factors affecting financial planning:- (5marks)
1)
2)
Estimating the capital requirements :Fixed cost- cost incurred on fixed assets eg:-plant and machinery, land and
building, furniture etc
Cost of intangible assets:- cost incurred on patent ,copy rights, technology
collaboration, goodwill trademark etc.
Amount invested on current assets like cash at bank , cash in hand, debtors, bills
receivables, stocks, materials etc
Cost of promotion:-registration charges, stamp duty,legal charges, promoters
remuneration, etc
Cost of financing:- cost incurred for printing of prospectus MOA, AOA, share
holders application forms, underwriters commission, brokerage etc
Determining the sources of funds:Setting of objectives:The financial objectives any business enterprises is to employ the capital in
whatever proportion necessary to increase the productivity of the remaining factor
of production over the long run. The use of capital varies from firm to firm, the
objective is identical in all the firms, the objective is identical in all the firm.
Business enterprises operate in a dynamic society and, in order to take advantage
of changing economic conditions. Financial planners should establish both short-run
and long run objectives.
Policy formulation:The financial policies of a concern deal with procurement, administration and
disbursement of fund in a best possible way. The current and future needs of funds
should be considered and future needs for funds should be considered while
formulating financial policies.
The financial policies may be of the following types:1) Policies regarding the size of capitalization. [amount of capital to be raised]
2) Policy governing the capital structure [debt-equity mix].
3) Policy regarding collection and credit.
4) Dividend policy.
5) Policy regarding Management of working capital or current assets.
3) Laying down the financial procedures:For the proper execution of the financial policies, detailed procedures
incorporating rules and regulations are required to be laid down. The financial
procedures are very helpful to the middle level executives to know their
responsibilities.
4) Financial forecasting:Forecasting or Estimating the future variability of factors. Forecasting is done in
regards to output, sales, costs, profits etc.
5) Review of financial plan:The financial plan should be reviewed from time to time in the light of changing
economic, social, political and business Environment.
Long term and short term financial plans:Financial plans may be dividend in to two types :They are,
1) Long-term financial plan.
3) Short term financial plan.
1) Long-term financial plan:It is a plan which covers a period of 5 years or more. It is concerned with the
formulating of long term financial goals of the enterprises.
The following financial instruments are utilized to develop a long term financial plan.
They are:1. Equity share.
2. Preference share.
3. Debentures.
4. Retained Earnings.
5. Bonds.
6. Own funds
7. Venture capital.
8. Leasing.
9. Hire-purchase.
2) Short term financial plan:It is the financial plan which cover a period of one year or less.
It is concerned with the planning or determination of short-term financial activities
to accomplish long term financial objectives.
Finance Manager
Finance manager is person who heads the department of finance.
Role or Functions of Finance Manager (15marks)
1. He should anticipate and estimate the total financial requirements of the firms.
2. He has to select the right sources of funds at right time and at right cost.
3. He has to allocate the available funds in the profitable avenues.
4. He has to maintain liquidity position of the firm at the peak.
5. He has to administrate the activities of working capital Management.
6. He has to analyze financial performance and plan for it growth.
7. He has to protect the interest of creditors, shareholders and the employees.
8. He has to concentrate more on fulfilling the social obligation of a business unit.
9. Estimation of capitalization requirement of organization.
10.
To make a appropriate decision with regard to invest or utilize funds.
11.
Decision with regard to Dividend policy.
12.
Financial manager helps to maintain co-ordination relationship between the
employer and employee.
13.
12) Provision for contingencies:- A good financial plan has adequate provisions for
business oscillation and anticipated contingencies.
13) Intensive use of capital:- Effective utilization of capital is as much important as
the procurement of adequate funds. This is possible by maintaining equilibrium in
fixed and working capital. Surplus of fixed and working capital should not be used as
substitution to shortages of another. Such practices should not be encouraged as
they would drag the company use of capital for a fair capitalization.
Factors affecting financial planning:1) Nature of a Business:More Finance is required for capital intensive business and less finance is
required for labour intensive business.
2) Flow of income of business:If regular flow of income in a business it can run with less capital.
If flow of income fluctuating, more capital is needed.
3) Risk in a business:If the business is involves in high risk then it require more owner capital
because the available of debt capital is less.
More debt capital is available only when the firm involves in less risk.
4) Plans of expansion:The financial plan is not prepared on the basis of present prepared on the basis
of present requirement but in case future requirements are also considered.
5) Status and size of a business:If a business has good reputations can easily obtain finance.
In case if a firm does not have a good fame or size of a business of the firm
then it is quite difficult to achieve finance for the business.
6) Government control:The financial plans should be prepared on the basis of Government policies,
control and legal requirements.
7) Alternative sources of finance:Financial plan depends upon the availability of the alternative finance for the
business that help the firm to choose the profitable finance to the business.
8) Flexibility:The financial planning is flexible than it is very easy to carry out the expansion
and diversification programmers.
If it is not flexible then it is difficult to achieve it.
CAPITAL STURCUTRE
Capital structure:Capital structure is the permanent long term financing that is represented by
Long term debt.
Preference share capital.
Equity share capital and
Retained earnings.
If a firm uses only equity capital in its capital structure and does not use debt
capital, in such a situation the firm cannot get the benefits of trading on equity and
the owners of the firm cannot be successful in achieving the objective of
maximization of their wealth.
Definition:- (2marks)
According to John J.Hampton.
Capital structure is the combination of debt and equity securities that
comprise a firms financing of its assets.
According to I.M.Panday.
Capital structure is the permanent financing of the firm, represented by
long-term debt, preferred stock and net worth.
According to Rebort H.Wersel.
The term capital structure of frequently user to indicate the long term
sources of funds employed in a business Enterprises.
One should know the concept of financial structure, capital structure and assets
structure:v Financial structure:- It refers to the way the firms assets are financed, it is the entire
left hand side of the balance sheet. It included all long term and short term
obligations of the firm.
Financial structure = Long term funds + current liabilities.
v Capital structure:- It includes long term debt, preference shares and equity share
capital. In equity capital we include ordinary share capital, surplus and reserves and
retained earnings.
Capital structure = Long term funds or
Capital structure = Ordinary share capital + Preference share
capital+
reserves and surplus + Long term debt.
v Assets structure:- This means total assets of the firm. This is the total of fixed assets
and current assets.
Assets structure = Foxed Asset + current assets + other assets [if any].
Patter of capital structure [2marks]
Capital structure with equity shares only.
Capital structure with both equity shares and preference shares.
Capital structure with equity shares and debentures.
Capital structure with equity shares, preference shares and debentures.
Factors affecting capital structure:- (5 marks)
Success of any business mainly depends upon the financial plan and capital
structure.
A company or firm should try to construct an optimum capital structure.
A firm should consider all those factors which affect its capital structure.
Generally factors affecting capital structure are:A) Internal factors:1) Nature of Business
2) Regularity and certainty of income.
3) Desire to control the business.
4) Future plans.
5) Attitude of management
6) Freedom of working.
7) Operating ratio.
8) Trading on equity.
1)
2)
3)
4)
3) Cost of capital:Each source of capital involves cost capital structure combine various sources of
optimum capital mix, involving the least average cost of capital and in this way
helping in maximizing of returns.
4) Legal requirements:The SEBI has issued guidelines for the issues of shares and debentures.
According to the companies act, they have to perform it.
CAPITALISATION
Meaning:Capitalization refers to the combination of different types of securities of a business
of a business concern.
Definition of Capitalization:According to Husband and Dockeray,
Capitalization is the computation, appraisal or estimation of the present values. [or]
The sum of the par value of the outstanding stocks and the bonds.
Bases of capitalization:There are two recognized theories of capitalization for new companies.
a) Cost theory.
b) Earning theory.
a) Cost theory:According to this theory the total amount of capitalization for a new company is
arrived at, by adding up the cost of fixed assets, the amount of working capital and
the cost of establishing the business.
b) Earning theory:According to this theory, the true value of an enterprise depends upon its earning
capacity.
In other words, the worth of a company is not measured by the capital raised but,
the earning made out of the productive harnessing of the capital.
Formula = Average annual future earning*100
Capitalization rate
CHAPTER-2
LEVERAGE:In financial Management the term leverage is user to describe the firms
ability to use fixed assets or funds to increase the returns to its owners; i.e, equity
shareholders.
It must noted that higher is the degree of leverage higher is the risk as well as
return to the owners.
There are basically types of leverages. They are:1) Operating leverage.
2) Financial leverage.
3) Combined leverage.
1) Operating leverage:It may be defined as the ability of a concern to use fixed operating costs to
magnify (to increase) the effect of change in sales on its operating profits.
Operating leverage=Contribution
Operating profit/EBIT
Degree of operating leverage:It refers to the percentage change in operating profit, resulting from a
percentage change in sales. It can be expresser with following formula:Therefore, Degree of operating leverage=% Change in EBIT
% Change in Sales.
2) Financial leverage or Trading on Equity:The use of long term fixed interest bearing debt and preference share term
fixed interest bearing debt and preference share capital along with equity share
capital is called as financial leverage or trading on equity.
Financial leverage = EBIT
EBT
Degree of financial leverage:The degree of financial leverage measures the impact of a change in EBIT
measures the impact of a change in EBIT on change in Earning on equity per share
Therefore, Degree of Financial leverage = % Change in EPS
% Change in EBIT.
3) Combiner leverage / Composite leverage:It is the Combination of operating and financial leverage. It called as
combiner leverage.
Combined leverage = Operating leverage x Financial leverage
CHAPTER 3
DIVIDENT DECISIONS
The term dividend refers to that portion of net profits which is distributed among the
shareholders. It is the reward of the shareholders for investments made by them in
the shares of the company. If a company pays out as dividend most of what it earn
then for business requirement and for the expansion, it will have to depend upon
outside source such as issue of debt or new shares. Dividend policy of a firm thus
effects both the long-term financing and the wealth of the shareholders.
DIVIDEND POLICY:The term dividend policy refers to the policy concerning the amount of profit to be
distributed as dividends It refers to the decisions whether to retain earnings in the
firm for capital investment and other purposes or to pay out the earnings in the
form of cash dividend to shareholders.
FORMS OF DIVIDEND:Generally, the dividend is paid in cash. But, it can be paid in other forms also these
are as follows. On the basis of medium in which they are paid.
1. CASH DIVIDEND:- Cash dividend is the dividend which is distributed to the
shareholders in cash out of the earnings of the business. It is the most commonly
used term for the payment of dividend. Generally, the company which has enough
cash balance is likely to pay dividend in cash but payment of dividend in cash
results in outflows of funds the firm was declared the dividend in cash only when it
financial position is strong and have adequate cash balance at, its at its disposal
without effect ting its liquidity position.
2. SCRIP DIVIDEND:- Such form of dividend is not practices in India during the
storage of cash and the companys cash position is temporarily weak and does not
permit cash dividend in that case the company may declare dividend in the form of
scrip or promissory note. This ensures or promises the shareholder, the dividend at
a certain date in near future. The strong reason behind the issue of scrip dividend is
to postpone due payment of cash for short time and the company is waiting for the
conversion of current assets into cash in the course of operations.
3. BOND DIVIDEND:- Sometimes, during shortage of cash and the company also has
no idea about now much time it would take to generate cash. The company may
issue the bonds to its shareholders for long period. The issue of bond dividends
increases the long-term ability of the company. This form of dividends is also not
prevalent in India.
4. PROPERTY DIVIDEND:- This involves a payment with assets other than cash. This
form of dividend may be followed wherever there are assets that are no longer
necessary in the operation of the business. Under exceptional circumstances
property dividend is paid to its shareholders in some kind rather than this form of
dividend the company may also give its own products in place of cash dividend.
For ex:- A biscuit manufacturing company may give biscuit of its shareholders as
property dividend Again, this form of dividend is not prevalent in India.
STOCK DIVIDEND OR BONDS SHARES:- Stock dividend is the dividend which is paid
to shareholders in kind when stock dividend are paid. A portion of surplus is
transferred to the capital account and shareholders are issued additional share
certificates. This dividend is declared to only equity shareholders and such issue of
bonds shares increases the total number of share of the existing shareholding.
INTERIM DIVIDEND:- It is dividend which is declared by the director of the company
between two annual general meetings of the company.
COMPOSITE DIVIDEND:- It means a part of dividend that is paid in cash and another
part is paid in the form of property.
EXTRA DIVIDEND:- In any year if the company earns a handsome profits, it may
decide to give some extra dividends to its shareholder along with the regular
dividends.
FACTORS INFLUENCING THE DIVIDEND POLICY
1. STABILITY OF DIVIDENDS:- It refers to the payment of dividend regularly and
shareholders generally prefer such stable dividend payment which will increase over
the years. This is the most important factor influencing the dividend policy.
Generally, the concerns which deal in necessities suffer less from fluctuating
incomes rather than those concerns which deal with luxurious goods.
2. FINANACIAL POLICY OF THE COMPANY:- Dividend policy may be effected and
influenced by financing policy of the company. If the company decides to meet its
expenses from its earnings then it will have to pay less dividends to its
shareholders.
3. LIQUIDITY OF FUNDS:- Liquidity is the continuous ability of a company to meet
the maturing obligations as and when they become due. The dividend policy of a
firm is largely influenced by the availability of liquid assets or resources. For the
payment of dividend, a company requires cash and it is not compulsory that highly
profitable company will have large amount of cash at its disposal. So, a firm may
have adequate earning but it may not be in a position to pay dividend due to
liquidity problem.
4. DESIRE OF THE SHAREHOLDER:- Even if the Directors have considerable liberty
regarding the disposal of firms earnings. The shareholders are technically the
owners of the company and therefore their desire cannot be overlooked by the
directors while taking the dividend decisions.
5. FINANCIAL NEEDS OF THE COMPANY:- This may be indirect conflict with the desire
of the shareholders to receive large dividends. However, a prudent (wise)
management should give proper weight age to the financial needs of the company.
So, growth firms are likely to follow low pay-out ratio and declining companies are
likely to follow high payout ratio.
6. DESIRE FOR CONTORL:- If a growth of company requires additional funds it has to
issue additional equity shares and if the existing equity shareholders are enable to
buy the additional shares there voting power is diluted so, the management cannot
pay more dividend in the fear of losing control over the company.
7. LEGAL RESTRICITIONS:- While declaring dividend the Board of Directors also have
to consider the legal restrictions and provisions which is specified in sec 93, 205 A,
206 and 207 of the company act, 1956.
8. DEBT OBLIGATIONS:- A firm which has incurred heavy indebtedness is not in a
position to pay higher dividend to shareholders.
9. ABILITY TO BORROW:- Every company requires finance both for expansion and
for meeting unanticipated expenses. The new company generally, find it difficult, to
borrow from the market and hence cannot offer to pay higher rate of dividend.
10. PAST DIVIDEND RATE:- The company while declaring dividend also have to take
into consideration, the dividend declared in previous years.
11. DIVIDNED POLICY OF THE COMPETITIVE CONCERN:- This is one more factor
which have to be considered while declaring dividend.
12. CORPORATE TAXATION POLICY:- Corporate taxes affects the rate of dividend of
the concern high rate of taxation reduces the profits available for distribution to the
shareholders.
13. TAXATION POSITION OF THE SHAREHOLDERS:- This is another influencing factor
influencing the dividend decisions but it should be noted here that capital gain tax
will be less when compared to the income tax they should have paid when each
dividend was declared and added to the personal income of the shareholders.
14. EFFECT OF TRADECYCLE: - This is also one of the important factor which
influences the dividend policy of the concern. For example:- during the period of
inflection funds generated from depreciation may not be adequate to replace the
assets, consequently there is a need for retain carriage in enter to preserve the
earning power of the firm
15. ATITUDE OF INTERESTED GROUP:- A concern may have certain group of
interested and powered shareholders who have certain attitude towards the
payment of dividend and have a definite say in policy formulation regarding
dividend payments. If they are not interested in higher rate of dividend shareholders
are not in higher rate of dividend. On the other hand, if they are interested in higher
rate of dues they will manage to make company declare higher rate of dividend
even in the force of many odds.
TYPES OF DIVIDEND POLICY:1. REGULAR DIVIDEND POLICY:- The payment of dividend at the usual rate is termed
as regular dividend. The investors such as retired persons, widows and other
economically weaker persons prefer to get regular dividend.
The following are some of the advantages of this type of policy.
a) It creates confidence among the shareholders.
b) The shareholders views dividends as a source of funds to meet their day-to-day
expenses.
c) It stabilities the market value of the shares.
d) It establishes the profitable record of the company.
ownership in the company. Issue of bonus shares increases the paid-up capital and
decreases the reserves of the company. Bonus shares does not result in the cash
inflow or outflow.
This dividend is declared to only equity shareholders and it may take two forms:1. Making the partly paid equity share fully paid without asking for cash from the
shareholders.
2. Issuing or allotting equity shares to existing shareholders in a definite proportion
out of profits.
OBJECTS OF ISSUING BONUS SHARES:A company may issue stock dividends for any one of the following reasons:1. TO CONSERVE CASH:- The issue of bonus shares does not involve the payment of
cash.
2. FINANCING EXPANSION PROGRAMMES:- Through the issue of Bonus shares
corporate savings become the permanent capital of the company.
3. TO LOWER THE RATE OF DIVIDEND: The rate of dividend may be reduced after
the issue of bonus shares because the increase in the number of shares reduces the
rate of dividend per share.
4. TO ENHANCE PRESTAGE:- The company which issues Bonus shares will have
increased credit standing in the market.
5. WIDEN THE MARKET:- A company interested in widening the ownership of its
shares may issue bonus shares where income of the old shareholders may sell their
new shares.
ADVANTAGES OF BONUS SHARES:1) FROM THE COMPANY POINT OF VIEW:
1. RETAINED CASH:- It permits the company to pay dividends without outflow of
cash. Retained cash can be invested in future profitable project and the company
need not to have additional funds from external sources.
2. SATISFACTION OF THE SHAREHOLDERS:- By the issue of bonus shares the equity
of shareholders in the company increases.
3. ECONOMICAL ISSUE OF CAPITALISATION:- The issue of bonus shares involve
minimum cost and hence, it is the most economical issue of securities.
4. ENHANCE PRESTIGE:- By issuing Bonus shares the company increases its credit
standing and its borrowing capacity is gone high in the eyes of lending institution.
5. WIDENING THE SHARES OF MARKET:- A company which is interested in widening
of the ownership of the shares may issue bonus shares.
6. FINANCE FOR EXPANSION PROGRAMMES:- By issuing bonus shares the expansion
and modernization of a company can be easily financed.
7. CONSERVATION OF CONTROL:- Maintenance of existing control is possible by
issuing bonus shares.
8. This is best remedy for companies which has earned sufficient profits but lacks
sufficient cash for the payment of dividends as this type of dividend is not paid in
the form of cash.
ADVANTAGES OF INVESTORS:1. IT INCREASES THE FUTURE DIVIDEND:Stock dividend increases the total number of shares of existing shareholders.
The company can declare more dividends in future by investing the available cash
in the business with regular dividend
1. BONUS SHARES INCREASES THE MARKET VALUE OF SHARES:-
this company may resort to pay dividend out of capital which results in weakening
of results in the liquidation of the company and ultimately results in the liquidation
of the company.
3. This policy is suitable only for well established compares and not for new and
young companies.
Imp
What is a dividend decision?
A dividend decision refers to the formulation of divided policy which determines the
division of earnings between payments to shareholders and retrained earnings.
Formulation of proper divided policy is one f the major financial decisions to be
taken by financial manger.
CHAPTER-4
WORKING CAPITAL MANAGEMENT
The term working capital in the broad sense refers to investments made in current
assets which comprises of cash, debtors, bills receivable, inventories, etc.
In other words, it is the aggregate of all the currents assets held by a firm as on the
given date it is that part of the capital i.e., retained in liquid form
In accounting working capital is defined as the difference between the inflows. It is
defined as the excess of current assets over current liabilities and provisions.
Working capital also refers to that part of total capital which is used for carrying out
the routine or regular business operations.
TYPES OF WORKING CAPITAL:1. Gross working capital
2. Net working capital
3. Negative working capital
4. Permanent working capital
5. Temporary working capital
1. GROSS WORKING CAPITAL:This is also known as circulating capital, operating capital or current capital.
It refers to the total of investments on current assets such as cash in hand, cash at
bank, accounts receivable, stock of finished goods, work-in-progress, stock of raw
materials, prepaid expenses, etc
Gross working capital = total of current assets
2. NET WORKING CAPITAL:This refers to the difference between current assets and current liabilities.
3. NEGATIVE WORKING CAPITAL:It is also known as working capital deficit which means the excess of current
liabilities over current assets.
Negative working capital = current liabilities current assets.
4. PERMANENT WORKING CAPITAL:-
It is also known as fixed working capital which refers to the minimum amount of
investments in current assets required throughout the year for carrying out the
business operations.
5. TEMPORARY WORKING CAPITAL:It is represents the total working capital which is required by the business over
and above the permanent working capital. It is also known as various or fluctuating
working capital, as it goes on fluctuating from time to time with the change in the
volume of business activities.
FACTORS AFFECTING WORKING CAPITAL:The following are the factors which has its own effect on the working capital
requirements of a concern
1. NATURE OF THE BUSINESS:His factors affect the working capital requirements to a great extent. The public
utilities like transport organization services have large fixed assets so that their
requirements of current assets will be low whereas, industrial and manufacturing
enterprises need more working capital as they have to invest substantially on
inventories and accounts.
2. SCALE OF OPERATION:A concern which carries its activities on a small scale requires less working
capital when compared to the concerns carrying its activities on a large scale.
3. GROWTH AND EXPANSION OF THE BUSINESS:When there is a growth and expansion plans such firms require more working
capital.
4. LENGTH OF MANUFACTURING PROCESS:Longer the manufacturing process higher will be the amount of working capital
requirements and shorter the manufacturing process. Working capital requirement
is less.
5. LENGTH OF THE OPERATING CYCLE:Requirements of working capital depends upon the operating cycle the longer the
operating cycle the greater will be the requirements of working capital like
manufacturing concerns and shorter the operating cycle lesser will be the
operating capital like trading concerns.
6. PRODUCTION POLICIES:It has its great impact on the working capital needs. A capital intensive industry
require more fixed capital than working capital but labour intensive industry
requires less fixed capital but more working capital.
7. RAPIDITY OF TURNOVER:This has the great impact on the working capital requirements because a firm
which can affect its sales with great speed requires less working capital than the
firms which cannot effect its sales at a great speed.
8. SEASONAL FLUCTUATIONS:This factor effects working capital requirements because seasonal factors create
production and shortage problems.
For ex:-seasonal agricultural production must be purchased in the month of
production for smooth running of business for the full year. Similarly, demand of
woolen clothes is in the winter only but has to be manufactured throughout the year
resulting in more working capital.
9. DIVIDEND POLICY:A company which follows a liberal dividend policy which require more working
capital than a company which declares stable dividend policy
10. TAXES:Higher taxes are a strain on the working capital of the firm.
11. DEPRECIATION POLICY:This has an indirect effect on the working capital of the firm because when a
company charges higher depreciation it reduces the profit available for dividend and
results in the less outflow of cash in the form of dividend.
12. PROFIT LEVEL:A company which can earn high profits can contribute to the generation of internal
funds which results in contribute to the generation of internal funds which results in
contribution to more working capital.
13. GOVERNMENT REGULATIONS:This has a great effect on the working capital requirements because government
regulation like tendon committee has person prescribe norms for holding
inventories and debtors which a concern is not expected to exceed which will
certainly effect the working capital requirements of the concern.
14. CREDIT POLICY OF THE CENCERN:A concern which follows liberal credit policy requires more working capital than a
concern which follows light credit policy.
15. PRICE LEVEL CHANGES:In the periods of raising prices a concern who has to pay more for the purchases it
makes but cannot increase the prices of its products considerably requires more
working capital.
ADVANTAGES OR NEED OR IMPORTANCE OF ADEQUATE WORKING CAPITAL:Working capital is the art of business. Just as circulation of blood in the body for
maintaining the life, a main spring to a watch for the smooth functioning, working
capital is very essential to maintain the smooth running of a business. If heart
becomes weak i.e, if the working capital is weak the business can hardly proper and
survive. The following are the few advantages of adequate working capital in the
business.
1. CASH DISCOUNT:- It helps the firm to avail of the cash discount facilities offered
by the suppliers for prompt payment.
2. GOODWILL:- Any company which is prompt in making payment can earn goodwill
which is possible only through sufficient cash balance (working capital in the
organization).
3. SOLVENCY OF THE BUSINESS:- Working capital in helps in maintaining the
solvency of the business.
4. REGULAR SUPPLY OF RAW-MATERIALS:- It helps in regular supply of raw-materials
for continuation of business as the firm is able to procure raw-materials on time by
meeting the payment to the suppliers promptly.
5. ABILITY TO FACE CRISIS:- without adequate capital a firm cannot face any crisis in
the business.
6. GOOD BANK RELATION:- If businessmen is having cash in bank in the form of
current account deposits, fixed deposits, etc. The relation of business men and the
bank will be good and cordial. Further, with adequate working capital a firm can pay
interest on loans borrowed from bank promptly.
7. HIGH MORALE:- It improves the morale of the executives and he employees of the
firm.
8. CREDIT WORTHINESS:- an adequate working capital enhances the credit
worthiness of the firm.
5. Excessive working capital may lead to speculative transitions due to which the
company may become liberal with regard to dividend policy.
15marks:SOURCES OF WORKING CAPITAL:A business concern may procure funds from various sources to meet its working
capital requirements.
The sources of working capital can be broadly classified into two:1. Short term sources for meeting the variable working capital requirements.
2. Long term sources for meeting the permanent working capital requirements.
THE IMPORTANT SOURCES OF SHORT-TERMS WORKING CAPITAL ARE:1. Trade credit
2. Bank credit
3. Advances from customers
4. Short-term public deposits
5. Indigenous bankers
6. Installment credit
7. Factoring
THE IMPORTANT SOURCES OF LONG-TERMS WORKING CAPITAL ARE:1. Issue of debentures
2. Sale of fixed assets
3. Public deposits
4. Redeemable preference shares
5. Ploughing back of profits
6. Term finance from industrial finance corporations
SHORT-TERM CREDIT:1) TRADE CREDIT:- If refers to the credit obtained from the suppliers of goods in the
normal course of trade. This type of credit is common to all types of business which
is granted without any security except the credit standing of the concern. The
duration of the credit is usually 15 days to 90 days. The three types of trade credit
are:a) OPEN ACCOUNTS OR ACCONTS PAYABLE:- Under which goods are sold to
customers without accepting any document or instrument evidencing the debts
due.
b) NOTES PAYABLE:- Under which goods are sold on credit to the customers by
executing the promissory notes as a proof of debt.
c) TRADE ACCEPTANCES:- Under which goods are sold on credit to the customers by
accepting the drafts or bills of exchange drawn by the suppliers.
THE MAIN ADVANTAGES ARE:1. It is easy to obtain trade credit.
2. No security is to be provided for obtaining such debt.
3. It is a cheap source of debt.
4. It increases with the growth of the firm.
THE MAIN DISADVANTAGES ARE:1. The price of the goods bought on credit will normally be high.
2. The duration of credit is very short.
3. This type of credit is meant for only good credit
4. No cash discount is provided.
2) BANK CREDIT:- It refers to the credit, financial accommodation or advance
provided by commercial banks. It may be unsecured or against guarantee or against
hypothecation, pledge or mortgage of assets. The bank credit may take various
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forms like short-term loans, over drafts, cash credit, discounting and purchasing of
bills of exchange and also commercial letter of credit.
3) ADVANCES FROM CUSTOMERS:- If refers to the advances received from the
customers before the delivery of the goods. These advances are generally a part of
the price of the good ordered by the customers. The time of credit depends upon
the time of the delivery of goods. No interest is allowed on customer advances.
4) SHORT-TERM PUBLIC DEPOSITS: If refers to the deposits accepted by a concern
from the general public from a short period not exceeding one year. These deposits
are accepted without offering any security. Normally, 10% to 12% interest is allowed
on such deposits. This type of deposits is meant only for the concerns having high
credit standing.
5) INDIGENOUS BANKERS:- This type of the source of working capital is very popular
among small concern in India. The main reasons b behind the popularity of
indigenous bankers are easy accessibility, flexible working hours, easy
accommodation of loans in times of difficulties lending against all types of
securities. The main drawbacks are:1. Limited funds
2. High rate of interest
3. Secrecy in maintain their accounts and
4. Mal practices
6) INSTALMENT CREDIT:- It refers to the credit obtained by a concern for the
purchase of equipments, vehicles, etc. It will be normally on hire purchase or on
installment basic.
7) FACTORING:- It can be defined as the system of financing under which a factor
undertakes to collect the accounts receivables or book debts of its client and remit
the money collected to the client and also advances money to the client against the
security of accounts receivables in case the client needs money in advance.
Different types of factoring are:Invoice discounting
Advance factoring
Full factoring
Outright purchase of accounts receivables
With resource factoring
Without resource factoring
Maturity factoring
Undisclosed factoring
THE OTHER SOURCES OF SHORT-TERM WORKING CAPITAL ARE:1. Accrued expenses (expenses incurred not yet due and also not yet paid).
2. Deferred incomes (Incomes received in advance).
3. Commercial papers (Instrument to raise short-term funds in the money market).
LONG-TERM SOURCES OF WORKING CAPITAL:1) ISSUE OF DEBENTURES:- By the issue of redeemable debentures the company
can raise long term finance. They enjoy a lot of benefits through the issue of
debentures like low interest rates fixed interest, interest chargeable to profits for the
purpose of income-tax and so on.
The main disadvantages are It can be issued only by public limited
companies and the company has pay interest on debentures even if it does not earn
any profits.
2) SALE OF FIXED ASSETS:- Any idle fixed assets can be sold and this fund can be
utilized for financing the working capital requirements.
3) PUBLIC DEPOSITS:- Long term public deposit not exceeding 3 years also has
become one of the important sources of long-term working capital requirements.
The main merits are:1. Less formalities in the collection of deposits.
2. It does not create any charge on the asset of the borrower.
The main disadvantages are:1. Deposits are unreliable and undependable.
2. There is a restriction on the total amount of their deposits.
4) REDEEMABLE PREFERENCE SHARES:- The main merits of this type of source is
that the dividend on preference shares is fixed and it does not create any charge on
the assets of the company. Further, the redemption of preference shares is a
remedy to the over capitalization problems.
The demerits are:They are costlier than debentures and it involves legal formalities for its issue and
so on.
5) PLOUGHING BACK OF PROFITS:- It means the re-investment by a concern of its
surplus earnings in its business. A part of the earned profits may be ploughed back
by the concern in meeting their long-term working capital requirements. It is
internal sources of finance and it is the cheapest source of working capital.
The main disadvantage is that there will be a reduction in the rate of dividend to the
shareholders.
6) TERM FINANCE FROM INDUSTRIAL FINANCE CORPORTIONS:- There institutions
give loans for a period varying from 3 to 7 years and the financial institutions which
provide such loans are LIC, SFC, UTI and ICICI.
WORKING CAPITAL MANAGEMENT:It refers to the management of all the aspects of working capital i.e, current assets
and current liabilities.
According to Smith.K.V. Working capital management is concerned with the
problems that arise in attempting to manage the current assets, the current
liabilities and the inter relationship that exists between them.
There are two objectives of working capital management:1. Maintenance of working capital
2. Availability of sufficient funds at the time of need.
COMPONENTS OF THE MANAGEMENT OF WORKING CAPITAL:1. Estimation of working capital
2. Determination of the size of the working capital.
3. Decisions regarding the ratio of short-term and long-term capital.
4. To locate the appropriate sources of working capital.
FORCASTING TECHIQUES OF WORKING CAPITAL
1. PERCENTAGE OF SALES METHODS:- Where working capital is determined on the
basis of part experience, but the condition is both sales and working capital should
be stable.
2. ESTIMATION OF THE COMPONENTS OF WORKING CAPITAL:- Since working capital
is the difference of current assets and current liabilities, its assessment can be
made by estimating the amounts of different constituents of working capital such as
inventories, accounts receivables accounts payables, etc.
3. OPERATING CYCLE METHOD:- Under this method, working capital is calculated
taking into consideration the operating cycle of the business.
PRINCIPLES OF WORKING CAPITAL MANAGEMENT:-
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or post office box in their area. The firms local bank picks up the mails and deposits
the cheques into the firms account. It also transfers the funds to the head office
bank through telegraphic transfers, when this exceeds or specified limit.
III) CONTROLLING THE OUTFLOW OF CASH:1. Centralized system of disbursements to slow down the disbursements.
2. Payments only on due date which helps to slow down the payments but also to
enjoy cash discount for prompt payments and to keep up its prestige.
3. TECHNIQUE OF PLAYING FLOAT:- The term float refers to the amount lied up in
cheques, but has been issued, but not yet, been presented for payment. The period
between the issue of cheque and its actual presentation for payments is called float
period.
The technique of taking advantage of the float period issuing cheques without
having sufficient cash balance during the float period is called the technique of
playing float.
IV) INVESTMENT OF SURPLUS CASH:The two basic problems involved in regard to investment of surplus cash are:1. Determination of the amount of surplus cash
2. Determination of the channels of investments.
But, while investing the surplus cash the firm should take into account the
liquidity, safety, maturity and yield.
MANAGEMENT OF ACCOUNTS (DEBTORS) RECEIVABLES:It refers to the amount receivable by a firm from its customers for the goods or
services provided on credit.
The main costs involved are:1. COSTS OF FINANCING:- Cost of funds locked up in accounts receivable.
2. ADMINISTRATIVE COSTS:- Cost of maintenance of records with regard to credit
sales and payments from the customers.
3. COLLECTION COSTS:- Cost of collection of debts like legal charges, cost of
sending reminders.
4. DEFAULITNG COSTS:- Bad debts.
The two facts which influence the size of accounts receivables are volume of
credit sales, credit policy and terms of trade.