Financial Management Class XII Weightage 12 Marks BUSINESS STUDIES.

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Financial ManagementClass XIIWeightage 12 MarksBUSINESS STUDIES1Meaning of Business FinanceMoney is required to conduct various activities in business.

It is the acquisition and conservation of capital funds to meet the financial needs and overall objectives of business.

2Financial ManagementFinancial Management means planning, organising, directing and controlling the financial activities such as procurement and utilisation of funds of the enterprise. It includes 3 decisions:

Investment decisions estimating total capital requirement for fixed assets and current assets(working capital). Financing decisions - raising of finance from various resources considering type of source, period of financing, cost of financing and the returns thereby.Dividend decision Decisions on how to divide the net profit i.e.. How much we give the shareholders and how much we keep as retained earnings to invest back in the company. 3Concept of Risk and ReturnReturn on an investment is the financial outcome for the investor.Return = Amount realised Amount investedRisk is present whenever investors are not certain about the outcomes an investment will produce.

Risk refers to the dispersion or deviation of returns from the average return of such investment. Risk is measured by calculating Standard Deviation( think Statistics)Risk and return have direct relationship. (They move together)

Thumb Rule Higher the risk, greater is the return demanded!4Case of Investing in a BusinessSachins friend Prateek had an idea of creating a photography service that went to school functions, such as games, annual days and other functions, to take candid pictures. The pictures would be available to purchase the following week. He needed Rs. 50,000 to buy additional equipment and start an advertising campaign, so he asked Sachin for a loan and promised to pay him back the loan amount and share 25% of his profits from the first semester. Sachin was not happy with this and asked for a 20% interest on the loan and did not want any share in the profits. Prateek sold a few pictures the first week of school but quit going to events to take pictures. Now Sachin is following him to get his money back.

Discuss the case in terms of risk for Sachin and returns demanded by him.

500005Case on Saving for FutureRishab spent his three years of college working and doing odd jobs after classes. He wanted to save some money for his education abroad after college. While his parents would pay the tuition, he wanted to save enough money to pay for his living expense. He decided to keep his money as a fixed deposit in his bank. The deposits earned 6% interest. He anticipated that he would have enough money for two years of living expenses. When he got to his college town, he realised that food and rent, along with many other prices, were much higher than he had originally estimated. Prices rose faster than the value of his savings.

How would you describe his situation in risk-return paradigm?

6Concept of costEach source of fund comes at different cost but the basic hierarchy remains the same. Retained earnings has no explicit cost as they are internally generated and no payments have to be made in lieu of them.Debt is a cheaper source than equity. Interest and principal has to be paid back but the cost is predefined. As the risk of investment is lower, returns are low.Equity holders are owners. They take the risk and demand the highest return!Cheapest cheaper than equityMost Expensive7Role of Financial ManagementForecasting Capital Requirement

Capital Budgeting or Investing Decisions

Capital Structure Decisions

Working Capital Decisions

Decisions on Sources of Finance

Understanding Effects on Financial Statements

8Objectives of Financial Management9Objectives of Financial ManagementA business concern exist to earn profit. Earning profit is mandatory for a businesss survival and growth.

But it is very difficult to define profit. What should a enterprise measure its growth in - gross profit, net profit, EBIT, profit after dividends etc. It is theoretical concept.A business exist to undertake an activity which creates value. Carrying that activity is the basic objective of any organisation.

Wealth Maximisation is a more holistic objective of business. It is a realistic concept.

It maximises the market value of existing owners equity i.e. the current value of equity shares.

It looks at both time and risk of business. 10Financial Decision 111. Long Term Investment or Capital Budgeting Decisions The process of planning and managing a firms long-term investments is called capital budgeting. It means to identify investment opportunities that are worth more to the firm than they cost to acquire.Factors Affecting the Investing Decisions Cash Flows of the Project - size, timing, and risk of future cash flows is the essence of capital budgeting.Rate of Return - The gain or loss on an investment over a specified period, expressed as a percentage increase over the initial investment cost.Decision Criteria There are various capital budgeting techniques that can be applied but all look at the following perspectives like profitability, economic constraints, financial volatility and market conditions.

122) Financing Decisions

All about sources of funds . We decided how much money we need now we think from where do we raise it, as each source will have a different cost and risk associated to it.

Two basic sources

Shareholder Funds Equity capital comprising of equity and preference shares and retained earnings.

Borrowed Funds- includes all sources of debt including long term and short term debt and debentures. 13Factors affecting Financing Decisions

Cost debt financing is cheaper than equityRisk- high levels of debt brings risk of default and insolvency.Floatation cost its cheaper to raise loans but the cost associated with issues of shares and debentures are too high.Strength of companys financials- company with a stronger balance sheet and cash flow position can raise debt easily. Fixed operating cost and revenue positions - debt increases out fixed cost as interest has to be paid. Ownership issues - Equity issues dilutes ownership of pre existing shareholders. State of Market buoyant markets bullish on equity.

14Dividend Decisions It is the portion of profits distributed to shareholders. Not mandatory and competes with what we can reinvest in business as retained earning to increase future profitability.

Factors effecting Dividend Decisions

How much we earn- higher the firm earns more will the owners.Stability of earnings- stable incoming cash flows makes dividend payment easier.Dividend policy firm may follow stable dividend policy or stable percentage of dividend policy.Growth opportunities if firm has good projects to invest in, they will want higher retained earnings. Cash Flow position a firm earning profits but not receiving cash wont be able to pay dividend. Think accrual accounting!

15Shareholders preference- A bird in the hand vs. two in a bush. Sometimes shareholder prefers to receive the cash instead for wealth maximisation( this he gets when he sells his share)

Taxation Policy dividend and capital gains are taxed differently. Generally capital gains are taxed higher.

Market Reactions - stock market reactions have an impact. Firms declare dividends just to maintain stock prices.

Access to funds- firms which have easier access to other sources of capital do not depend on retained earnings.

Debt Covenant some lenders esp. banks put restrictions on future dividend payments to ensure higher degree of retained earnings and firms ability to repay debt. 16Case Dividend Policy Microsoft is known globally as number one software company . Its founder Bill Gates, created the company in year 1975 after dropping out of Harvard at the age of 19. He teamed up with his friend Paul Allen to set up a company. Microsoft came up with revolutionary products like Windows Operating system and Office Suite. The company went public in year 1986 and grew by leaps and bounds till 2002 and earned substantial profits. But it never paid any dividends to its shareholders. The first dividend was paid in year 2003 and then onwards it pays dividends once a year and follows a progressive policy. Since then the dividend payout has increased by many times. The board of director reviews the quantum(big or small) of dividend on an annual basis. The payment decision is based on future capital requirements for research and development, investments, legal and business risk.

17ProblemsDiscuss Microsofts dividend policy.

What kept the shareholders satisfied even when they were not receiving any dividends?

Do you agree with Board of Directors Dividend payment policy.

18Financial PlanningTo have just enough capital !

It is the blueprint of future financial operations of the firm. It is the process of framing financial policies in relation to procurement, investment and administration of funds of an enterprise.

Objectives of financial planningdetermining capital requirements- short and long term, depends upon factors like cost of current and fixed assets, promotional expenses and long- range planning. Determining capital structure- is the composition of capital, i.e., the relative kind and proportion of capital required in the business. This includes decisions of debt- equity ratio- both short-term and long- term.Framing financial policies with regards to cash control, lending, borrowings, e