Transcript Finance is the blood stream of every business Kuchal S. C.
Slide 1
Slide 2
Finance is the blood stream of every business
Kuchal S. C. has defined Financial Management
as
“Financial Management deals with procurement
of funds and their effective utilization in the
business”
Slide 3
Raising funds
Two aspects of financial
management
Efficient use of funds
Slide 4
Working
capital
requirements
Fixed Capital
Requirements
Shop
Franchise
Slide 5
Finance
S
U
D
A
R
De
It is important for Goli to decide the following:
1. Purpose of funds-
2.
Amount requiredGoli has to determine for what all purposes funds are required i.e. For
Franchisee agreement or Raw material or Salary of employee or all of
the following.
Slide 6
Finance
S
U
D
A
R
3. When – Funds are required in the beginning or after a
certain period of time.
4. Duration of FundsRepayment Schedule
5. Kind of Funds- Own Funds or Borrowed Funds.
De
Slide 7
Finance
S
Own Funds
U
D
A
R
De
Borrowed Funds
Always better to strike a balance between the two.
Slide 8
Finance
S
U
D
A
R
Once money is received
Long Term Funds
Short Term Funds
De
Slide 9
Finance
S
U
D
A
R
De
Once profits are earned goli has to take the
decision whether to reap the profits and take it
as dividend or keep it in business for future
expansion.
This decision is taken in financial management
Slide 10
Finance
S
U
D
Since Financial resources are
scare a company has to
analyze
Utilization of funds in an
efficient manner
Cost of raising funds is
reasonable
( dividend and interest is
the cost )
A
R
De
Slide 11
Finance
S
U
D
A
R
Gives advice on pricing
policy , mergers &
acquisitions (M&A),
expansion policy, dividend
policy, hiring policy etc.
De
Slide 12
Finance
S
U
D
Financial Books
Financial Statements
Group of people : Debtors ,
Creditors and Directors.
A
R
De
Slide 13
Profit
maximisation
Objectives of
financial
management
Wealth
maximisation
Social
objective
Slide 14
Profit Maximization
•
•
Social Objective
Earning profit is the prime objective
Expenses
•
Wealth
Maximization
Increase
Profits
Income
Financial management aims at efficient use of monetary
funds. This leads to reduction is finance cost.
Importance of profit maximization:
Difficult for a business without profits
Enables business to run smoothly
Helps business to generate employment
Helps in distributing higher dividend
Creates good public image
Slide 15
Profit Maximization
Wealth
Maximization
Social
Objective
Wealth maximization is a broad concept and includes profit
maximization.
Maximizing
wealth of
shareholders
Maximizing the
value or net
worth of the
business
The wealth of the shareholders is based on the market
price of the shares of the company.
Market price of shares
wealth of shareholders
Slide 16
Profit Maximization
Wealth
Maximization
Social
Objective
Need of social objective
Business organization cannot operate in
isolation
Works in society and needs the society to grow.
Give and take relationship
Slide 17
Profit Maximization
Wealth
Maximization
Social
Objective
Sr No Particulars
Particulars
1
Employees
by providing adequate compensation,
incentives, good work environment etc
2
Customers
3
Suppliers
offering good quality products, affordable
prices etc
making proper payment on time
4
Government Disclosing correct income and paying taxes
on time
Society as a by optimum utilization of resources, following
whole
fair trade practices, not causing pollution.
5
Slide 18
J.H.Boneville has defined financial planning as
“The financial plan of a corporation has two-fold aspects, it refers not
only to capital structure of the corporation, but also to the financial
policies which corporation has adopted or intends to adopt”.
Capital Structure
Two-fold aspects of
financial planning
Financial policies adopted or
intended to be adopted
Slide 19
H
I
T
C
1. Helps in achieving growth:
• Because of financial plan,
business can determine how
much funds are required and
the source of raising the
same.
• Thus financial planning helps
in getting the funds on time as
a result helping in expansion
of business.
I
D
Slide 20
H
I
T
C
2. Improving image:
With financial planning, funds
are available when payments
are to be made hence there are
no
defaults
resulting
in
improvement in the image of
business.
I
D
Slide 21
H
I
T
C
3. Team Spirit:
Financial plan is a master plan
and considers requirements of
all departments. Therefore, the
process of financial planning
requires information from all the
departments
which
are
interlinked with each other. This
process helps them to think in
the same direction and helps
build team spirit throughout the
organization.
I
D
Slide 22
H
I
T
4. Cost of funds:
Loans / Debentures/
Public Deposits
Equity and
preference shares
Interest
Dividend
This cost fluctuates due to
various changes in economy
like change in tax rates,
monetary policy, economic
conditions etc. Financial
planning takes into
consideration such changes.
C
I
D
Slide 23
H
I
T
C
I
D
5. Improves co-ordination:
All the divisions of business such as
production, purchase, sale, distribution, finance
etc. have to work together to create a effective
and efficient Financial Plan.
Slide 24
H
I
T
6. Decision making:
Financial plan helps to
take the decision as to
whether there is need for
funds and accordingly
either borrow or use
retained earnings.
C
I
D
Slide 25
Slide 26
Equity Share Capital
Capital Means
Long Term Funds
Structure means
Composition
Preference Share
Capital
Borrowed Capital
Components of
Capital Structure
Retained Earnings
According to R. H. Wessel, capital structure is “the long term sources of funds
employed in a business enterprise”
Slide 27
1. Equity share capital:
Money raised by issue of equity shares is called as equity share
capital.
The equity shareholders are the owners of the company and like
every owner, they bear the risk and enjoy returns in form of
dividend.
The dividend earned by equity shareholders is not fixed and it
depends on the profits earned by the company.
Components of
Capital Structure
2. Preference share capital:
Money raised by issue of preference share is referred to as
preference share capital.
Preference shareholders are given preference over the equity
shareholders while distributing dividend and also in repayment of
capital at the time of liquidation.
Further, they enjoy fixed dividend every year. They also get to
vote on matters related to them.
Slide 28
3. Borrowings:
A company can raise long term funds by way of
debt. A company can borrow funds from outsiders
in the following ways:
1. Bonds, debentures and public deposits
2. Loans
4. Retained profits:
Components of
Capital Structure
Retained profits = Net Profit – Dividend distributed
to shareholders
Retained profits are the profits of the business that
remain after dividend is paid to shareholders.
Slide 29
Internal factors
Factors
influencing the
capital structure
External factors
Slide 30
S
F
-
I
N
T
E
R
N
A
L
1. Size of business:
Small Business
Large Business
Limited Borrowing
Capacity
Huge Borrowing
Capacity
Greater risk for
investor
Less risk For investors
As less asset
base
As More assets
Opts for Own
Funds
Opts for Both own funds
and borrowed funds
Slide 31
S
F
-
I
N
T
E
R
N
A
L
2. Future capital requirements:
A company will not require funds only once. It may require
funds at various stages.
If the company requires large amount of funds in the future,
it may opt for debt funds at present and later raise funds by
issue of equity shares
Slide 32
S
F
-
I
N
T
E
R
N
A
3. Ideology of management:
Risk involved with borrowed capital.
Borrowed capital not repaid, the assets of the
company can be sold to repay the amount.
Risk appetite
Risk appetite
Borrowings
Borrowings
L
Slide 33
S
F
-
I
N
T
E
R
N
A
4. Nature of business:
Manufacturing
Company
Trading
Company
Needs more
funds for plant
and machinery
Needs less
funds for plant
and machinery
Opts for Own
Funds and
Borrowed Funds
Opts for Own
Funds.
L
Slide 34
S
F
-
I
N
T
E
R
N
A
5. Trading on equity:
Profit occurs in the following situation:
More
Rate of return
on
Investments
Less
Rate of
Interest on
Borrowed
Funds
Therefore, a company which adopts trading on equity may
raise funds by issue of debentures and loans.
L
Slide 35
Particulars
Company A
Company B
Equity Capital (FV 10/-)
100000
500000
10% loan
900000
500000
Total capital
10,00,000
10,00,000
Net profit before interest
2,00,000
2,00,000
Less: Interest
90,000
50,000
Net profit for share
holders
1,10,000
1,50,000
Total shares
10,000
50,000
Earning per share
11
3
Company A has more debt funds than Company B. The rate of return on
investment is 20 percent (2,00,000*100/10,00,000). The cost of debt is 10
percent. As long as the rate of return is more than cost of debt, it will always be
beneficial to have more debt than equity as can be seen from the above
example. In the current scenario, the capital structure of company A is
favourable. However, if the rate of return falls below cost of debt, capital
structure of company B will be more favourable.
Slide 36
S
F
-
I
N
T
E
R
N
A
L
6. Expected business risk:
Interest has to be paid when
funds are borrowed
irrespective of profit or loss.
Payment of dividend is not mandatory and the
company which suffers a loss may choose not
to pay dividend.
Greater risk
Lower risk
Borrowings
Borrowings
Slide 37
S
F
-
I
N
T
E
R
N
7. Requirement period:
• Long Period
• Regular basis
Equity
Share
• Short Period
• Specific
Purpose
Loans or
Debentures
A
L
Slide 38
S
F
-
I
N
T
E
8. Nature of cash flow:
Interest and principal on
loan is to be paid
periodically
Continuous fixed outflow
of money.
Hence,
Stable cash flow a Borrowings a
Unstable cash flow a Borrowings X
R
N
A
L
Slide 39
S
F
-
I
N
T
E
R
N
A
L
9. Age of company:
New company - difficult to borrow funds from
outsiders
Old companies - opt for mix of equity and debt
– easier and cheaper
Slide 40
S
F
-
I
N
T
E
R
N
A
10. Level of control:
If Equity shareholders do not want to dilute
their holding they will opt for Debt Funds.
L
Slide 41
E
X
T
E
R
N
A
L
-
G
1. Expected cost of capital:
The rate of return to be paid to the providers of
capital is the “cost of capital”
Equity shareholders - higher risk - high rate of
return in
Preference shareholders and debenture holders
– lower risk- lower rate of return.
Slide 42
E
X
T
E
R
N
A
L
-
G
2. Extent of development of capital market:
Capital Market is the place where equity shares
are traded.
Good network of capital market a
Investors willing to invest in equity shares a
Slide 43
E
X
T
E
R
N
3. Terms of lending:
Rate of interest for raising
debt
Complex terms of lending a
Issue of preference shares /
equity shares a
A
L
-
G
Slide 44
E
X
T
E
R
N
A
L
-
4. Economical conditions
Generally, when an economy
is going through a recession,
the investor sentiment is low
and people stay away from
equity shares as it involves high risk.
Practical example: In the early part of 2013, two
IPOs were withdrawn due to poor investor
response. (Hindustan Times Report on 5th May,
2013)
G
Slide 45
E
X
T
E
R
N
5. Risk appetite of investors:
Investor
Risk Taker
Conservative
Invest in
equity shares
Invest in
debentures
May or may
not get returns
Gets fixed
Income
A
L
-
G
Slide 46
E
X
T
E
R
N
6. Need to consider taxes:
Tax rates are high, debt
funds preferred as interest is
deductible expenditure
A
L
-
G
Slide 47
E
X
T
E
R
N
A
7. Attitude of rating agencies:
If the rating agencies give poor
ratings to debentures of a
company, then the company
may have to source a major
part of its funds by issue of
equity shares.
L
-
G
Slide 48
E
X
T
E
R
N
A
L
-
8. Level of competition:
Generally, if the competition is high, the
profit margins are low. In such cases,
company would prefer equity funds over
debt funds.
G
Slide 49
E
X
T
E
R
N
A
L
-
9. Government policies:
The ratio of debt funds to equity funds of a company
is called as “debt-equity” ratio. The Securities
Exchange Board of India (SEBI) has prescribed a
maximum debt equity ratio of 2:1 i.e. the debt in a
company’s balance sheet cannot exceed twice the
amount of subscribed equity share capital. Thus,
companies have to take into consideration rules and
regulations of the government.
G
Slide 50
Fixed capital is that portion
of total capital which is
invested in fixed
assets such as land,
buildings, equipment, etc. It
is real or physical assets
that are not used directly in
the production of goods.
National Accounts defines Fixed Capital as “The stock of tangible, durable
fixed assets owned or used by resident enterprises for more than one year.
This includes building, plant, machinery, vehicle, equipment etc”.
Slide 51
S
U
N
S
1. Size of business:
The bigger the business, the
more is the fixed capital
requirement.
Size may be measured in
terms of turnover, assets,
number of employees etc.
E
T
Slide 52
S
U
N
S
2. Use of technology:
Use of modern technology
requires large amount of fixed
capital as such technology is
very costly.
On the other hand, labor
intensive or tradition
technology does not require a
very high fixed capital.
E
T
Slide 53
S
U
N
S
E
T
3. Nature of business:
Generally, large engineering companies,
construction companies, hotels, public utility
providing companies (electricity, railways, airways)
etc have large fixed capital requirement.
Slide 54
S
U
N
S
E
T
4. Scope of business activities:
If the scope of business is vast, then it requires
large fixed capital.
For eg: Since, “Jumbo King” manufactures,
distributes and sells vada pavs by itself, it requires
huge capital for manufacturing, distribution and
setting up stalls.
Slide 55
S
U
N
S
E
T
5. Expansion plans:
If a business is planning to expand its operation by
setting up a new manufacturing unit, its fixed
capital requirement will be high.
Slide 56
S
U
N
S
E
6. The phase of business:
More Fixed Capital
requirement during
Introduction and
Growth stage
Less Fixed Capital
requirement during
Maturity and
Decline stage
T
Slide 57
Narrow Sense
Broad Sense
Current Assets
Minus Current
Liabilities
All of Current
Assets
Current assets are short term assets such as cash, short
term securities, amount receivables, inventories etc.
Current liabilities are short term liabilities such as
creditors, short term loans, bills payable etc.
Bead, Baker and Mallot have defined the term ‘working capital’ as
“Working capital means current assets”
Slide 58
C
A
P
I
T
A
L
-
B
D
1. Conditions of purchase and sale:
If the company enjoys a good credit from its
suppliers (creditors), it requires less working
capital.
Similarly, if the company allows a longer credit
period to its debtors, the working capital
requirement will be more.
E
Slide 59
C
A
P
I
T
A
L
-
B
D
2. Affected by size of business:
A big company has large number of operations, has to
maintain huge amount of stock and may also have large
amount of debtors outstanding. Hence required more
Working Capital.
For eg. Working capital of Big Bazaar is more than working
capital of a local kirana store.
E
Slide 60
C
A
P
I
T
A
3. Production time cycle:
If time taken to convert raw
material to finished product
is long, higher working
capital is required because
the business has to sustain
expenses for a long period
of time till the finished
product is sold and
converted to cash.
L
-
B
D
E
Slide 61
C
A
P
I
T
A
L
4. Intensity of competition:
In case of competitive
market, company has to
maintain large inventory as
the buyers may shift to
competitor’s product if the
goods are not available in the
market. In such market
conditions, working capital
requirement is high.
-
B
D
E
Slide 62
C
A
P
I
T
A
L
-
B
D
E
5. The nature of business:
Service sector company like bus transport - less working
capital
On the other hand, Big Bazaar has to stock a lot of goods
- Requires comparatively higher working capital.
Slide 63
C
A
P
I
T
A
L
-
B
D
E
6. Affected by seasonal fluctuations:
Seasonal businesses have fluctuating working
capital.
Ceiling fans manufacturing company - peak sales
during summer.
Working capital needs increase in summer
Slide 64
C
A
P
I
T
7. Liquidity requirement
Large cash dealing more liquid funds
Unpredictable payment
cycles - more liquid
funds
Therefore have a high
working capital
requirement.
A
L
-
B
D
E
Slide 65
C
A
P
I
T
A
8. Business cycle
Boom period - Sales
increase – more working
capital
Recession - sales decrease
– less working capital
L
-
B
D
E
Slide 66
C
A
P
I
T
A
9. Development plans
Management becomes
aggressive - large working
capital
Management expects a
modest growth rate – less
working capital
L
-
B
D
E
Slide 67
C
A
P
I
T
A
L
-
B
D
E
10. External factors
If the company gets funds on a short notice and at
cheap rates from banks or financial institutions –
Less capital
Do not provide funds on easy terms – high
working capital
Slide 68
Slide 2
Finance is the blood stream of every business
Kuchal S. C. has defined Financial Management
as
“Financial Management deals with procurement
of funds and their effective utilization in the
business”
Slide 3
Raising funds
Two aspects of financial
management
Efficient use of funds
Slide 4
Working
capital
requirements
Fixed Capital
Requirements
Shop
Franchise
Slide 5
Finance
S
U
D
A
R
De
It is important for Goli to decide the following:
1. Purpose of funds-
2.
Amount requiredGoli has to determine for what all purposes funds are required i.e. For
Franchisee agreement or Raw material or Salary of employee or all of
the following.
Slide 6
Finance
S
U
D
A
R
3. When – Funds are required in the beginning or after a
certain period of time.
4. Duration of FundsRepayment Schedule
5. Kind of Funds- Own Funds or Borrowed Funds.
De
Slide 7
Finance
S
Own Funds
U
D
A
R
De
Borrowed Funds
Always better to strike a balance between the two.
Slide 8
Finance
S
U
D
A
R
Once money is received
Long Term Funds
Short Term Funds
De
Slide 9
Finance
S
U
D
A
R
De
Once profits are earned goli has to take the
decision whether to reap the profits and take it
as dividend or keep it in business for future
expansion.
This decision is taken in financial management
Slide 10
Finance
S
U
D
Since Financial resources are
scare a company has to
analyze
Utilization of funds in an
efficient manner
Cost of raising funds is
reasonable
( dividend and interest is
the cost )
A
R
De
Slide 11
Finance
S
U
D
A
R
Gives advice on pricing
policy , mergers &
acquisitions (M&A),
expansion policy, dividend
policy, hiring policy etc.
De
Slide 12
Finance
S
U
D
Financial Books
Financial Statements
Group of people : Debtors ,
Creditors and Directors.
A
R
De
Slide 13
Profit
maximisation
Objectives of
financial
management
Wealth
maximisation
Social
objective
Slide 14
Profit Maximization
•
•
Social Objective
Earning profit is the prime objective
Expenses
•
Wealth
Maximization
Increase
Profits
Income
Financial management aims at efficient use of monetary
funds. This leads to reduction is finance cost.
Importance of profit maximization:
Difficult for a business without profits
Enables business to run smoothly
Helps business to generate employment
Helps in distributing higher dividend
Creates good public image
Slide 15
Profit Maximization
Wealth
Maximization
Social
Objective
Wealth maximization is a broad concept and includes profit
maximization.
Maximizing
wealth of
shareholders
Maximizing the
value or net
worth of the
business
The wealth of the shareholders is based on the market
price of the shares of the company.
Market price of shares
wealth of shareholders
Slide 16
Profit Maximization
Wealth
Maximization
Social
Objective
Need of social objective
Business organization cannot operate in
isolation
Works in society and needs the society to grow.
Give and take relationship
Slide 17
Profit Maximization
Wealth
Maximization
Social
Objective
Sr No Particulars
Particulars
1
Employees
by providing adequate compensation,
incentives, good work environment etc
2
Customers
3
Suppliers
offering good quality products, affordable
prices etc
making proper payment on time
4
Government Disclosing correct income and paying taxes
on time
Society as a by optimum utilization of resources, following
whole
fair trade practices, not causing pollution.
5
Slide 18
J.H.Boneville has defined financial planning as
“The financial plan of a corporation has two-fold aspects, it refers not
only to capital structure of the corporation, but also to the financial
policies which corporation has adopted or intends to adopt”.
Capital Structure
Two-fold aspects of
financial planning
Financial policies adopted or
intended to be adopted
Slide 19
H
I
T
C
1. Helps in achieving growth:
• Because of financial plan,
business can determine how
much funds are required and
the source of raising the
same.
• Thus financial planning helps
in getting the funds on time as
a result helping in expansion
of business.
I
D
Slide 20
H
I
T
C
2. Improving image:
With financial planning, funds
are available when payments
are to be made hence there are
no
defaults
resulting
in
improvement in the image of
business.
I
D
Slide 21
H
I
T
C
3. Team Spirit:
Financial plan is a master plan
and considers requirements of
all departments. Therefore, the
process of financial planning
requires information from all the
departments
which
are
interlinked with each other. This
process helps them to think in
the same direction and helps
build team spirit throughout the
organization.
I
D
Slide 22
H
I
T
4. Cost of funds:
Loans / Debentures/
Public Deposits
Equity and
preference shares
Interest
Dividend
This cost fluctuates due to
various changes in economy
like change in tax rates,
monetary policy, economic
conditions etc. Financial
planning takes into
consideration such changes.
C
I
D
Slide 23
H
I
T
C
I
D
5. Improves co-ordination:
All the divisions of business such as
production, purchase, sale, distribution, finance
etc. have to work together to create a effective
and efficient Financial Plan.
Slide 24
H
I
T
6. Decision making:
Financial plan helps to
take the decision as to
whether there is need for
funds and accordingly
either borrow or use
retained earnings.
C
I
D
Slide 25
Slide 26
Equity Share Capital
Capital Means
Long Term Funds
Structure means
Composition
Preference Share
Capital
Borrowed Capital
Components of
Capital Structure
Retained Earnings
According to R. H. Wessel, capital structure is “the long term sources of funds
employed in a business enterprise”
Slide 27
1. Equity share capital:
Money raised by issue of equity shares is called as equity share
capital.
The equity shareholders are the owners of the company and like
every owner, they bear the risk and enjoy returns in form of
dividend.
The dividend earned by equity shareholders is not fixed and it
depends on the profits earned by the company.
Components of
Capital Structure
2. Preference share capital:
Money raised by issue of preference share is referred to as
preference share capital.
Preference shareholders are given preference over the equity
shareholders while distributing dividend and also in repayment of
capital at the time of liquidation.
Further, they enjoy fixed dividend every year. They also get to
vote on matters related to them.
Slide 28
3. Borrowings:
A company can raise long term funds by way of
debt. A company can borrow funds from outsiders
in the following ways:
1. Bonds, debentures and public deposits
2. Loans
4. Retained profits:
Components of
Capital Structure
Retained profits = Net Profit – Dividend distributed
to shareholders
Retained profits are the profits of the business that
remain after dividend is paid to shareholders.
Slide 29
Internal factors
Factors
influencing the
capital structure
External factors
Slide 30
S
F
-
I
N
T
E
R
N
A
L
1. Size of business:
Small Business
Large Business
Limited Borrowing
Capacity
Huge Borrowing
Capacity
Greater risk for
investor
Less risk For investors
As less asset
base
As More assets
Opts for Own
Funds
Opts for Both own funds
and borrowed funds
Slide 31
S
F
-
I
N
T
E
R
N
A
L
2. Future capital requirements:
A company will not require funds only once. It may require
funds at various stages.
If the company requires large amount of funds in the future,
it may opt for debt funds at present and later raise funds by
issue of equity shares
Slide 32
S
F
-
I
N
T
E
R
N
A
3. Ideology of management:
Risk involved with borrowed capital.
Borrowed capital not repaid, the assets of the
company can be sold to repay the amount.
Risk appetite
Risk appetite
Borrowings
Borrowings
L
Slide 33
S
F
-
I
N
T
E
R
N
A
4. Nature of business:
Manufacturing
Company
Trading
Company
Needs more
funds for plant
and machinery
Needs less
funds for plant
and machinery
Opts for Own
Funds and
Borrowed Funds
Opts for Own
Funds.
L
Slide 34
S
F
-
I
N
T
E
R
N
A
5. Trading on equity:
Profit occurs in the following situation:
More
Rate of return
on
Investments
Less
Rate of
Interest on
Borrowed
Funds
Therefore, a company which adopts trading on equity may
raise funds by issue of debentures and loans.
L
Slide 35
Particulars
Company A
Company B
Equity Capital (FV 10/-)
100000
500000
10% loan
900000
500000
Total capital
10,00,000
10,00,000
Net profit before interest
2,00,000
2,00,000
Less: Interest
90,000
50,000
Net profit for share
holders
1,10,000
1,50,000
Total shares
10,000
50,000
Earning per share
11
3
Company A has more debt funds than Company B. The rate of return on
investment is 20 percent (2,00,000*100/10,00,000). The cost of debt is 10
percent. As long as the rate of return is more than cost of debt, it will always be
beneficial to have more debt than equity as can be seen from the above
example. In the current scenario, the capital structure of company A is
favourable. However, if the rate of return falls below cost of debt, capital
structure of company B will be more favourable.
Slide 36
S
F
-
I
N
T
E
R
N
A
L
6. Expected business risk:
Interest has to be paid when
funds are borrowed
irrespective of profit or loss.
Payment of dividend is not mandatory and the
company which suffers a loss may choose not
to pay dividend.
Greater risk
Lower risk
Borrowings
Borrowings
Slide 37
S
F
-
I
N
T
E
R
N
7. Requirement period:
• Long Period
• Regular basis
Equity
Share
• Short Period
• Specific
Purpose
Loans or
Debentures
A
L
Slide 38
S
F
-
I
N
T
E
8. Nature of cash flow:
Interest and principal on
loan is to be paid
periodically
Continuous fixed outflow
of money.
Hence,
Stable cash flow a Borrowings a
Unstable cash flow a Borrowings X
R
N
A
L
Slide 39
S
F
-
I
N
T
E
R
N
A
L
9. Age of company:
New company - difficult to borrow funds from
outsiders
Old companies - opt for mix of equity and debt
– easier and cheaper
Slide 40
S
F
-
I
N
T
E
R
N
A
10. Level of control:
If Equity shareholders do not want to dilute
their holding they will opt for Debt Funds.
L
Slide 41
E
X
T
E
R
N
A
L
-
G
1. Expected cost of capital:
The rate of return to be paid to the providers of
capital is the “cost of capital”
Equity shareholders - higher risk - high rate of
return in
Preference shareholders and debenture holders
– lower risk- lower rate of return.
Slide 42
E
X
T
E
R
N
A
L
-
G
2. Extent of development of capital market:
Capital Market is the place where equity shares
are traded.
Good network of capital market a
Investors willing to invest in equity shares a
Slide 43
E
X
T
E
R
N
3. Terms of lending:
Rate of interest for raising
debt
Complex terms of lending a
Issue of preference shares /
equity shares a
A
L
-
G
Slide 44
E
X
T
E
R
N
A
L
-
4. Economical conditions
Generally, when an economy
is going through a recession,
the investor sentiment is low
and people stay away from
equity shares as it involves high risk.
Practical example: In the early part of 2013, two
IPOs were withdrawn due to poor investor
response. (Hindustan Times Report on 5th May,
2013)
G
Slide 45
E
X
T
E
R
N
5. Risk appetite of investors:
Investor
Risk Taker
Conservative
Invest in
equity shares
Invest in
debentures
May or may
not get returns
Gets fixed
Income
A
L
-
G
Slide 46
E
X
T
E
R
N
6. Need to consider taxes:
Tax rates are high, debt
funds preferred as interest is
deductible expenditure
A
L
-
G
Slide 47
E
X
T
E
R
N
A
7. Attitude of rating agencies:
If the rating agencies give poor
ratings to debentures of a
company, then the company
may have to source a major
part of its funds by issue of
equity shares.
L
-
G
Slide 48
E
X
T
E
R
N
A
L
-
8. Level of competition:
Generally, if the competition is high, the
profit margins are low. In such cases,
company would prefer equity funds over
debt funds.
G
Slide 49
E
X
T
E
R
N
A
L
-
9. Government policies:
The ratio of debt funds to equity funds of a company
is called as “debt-equity” ratio. The Securities
Exchange Board of India (SEBI) has prescribed a
maximum debt equity ratio of 2:1 i.e. the debt in a
company’s balance sheet cannot exceed twice the
amount of subscribed equity share capital. Thus,
companies have to take into consideration rules and
regulations of the government.
G
Slide 50
Fixed capital is that portion
of total capital which is
invested in fixed
assets such as land,
buildings, equipment, etc. It
is real or physical assets
that are not used directly in
the production of goods.
National Accounts defines Fixed Capital as “The stock of tangible, durable
fixed assets owned or used by resident enterprises for more than one year.
This includes building, plant, machinery, vehicle, equipment etc”.
Slide 51
S
U
N
S
1. Size of business:
The bigger the business, the
more is the fixed capital
requirement.
Size may be measured in
terms of turnover, assets,
number of employees etc.
E
T
Slide 52
S
U
N
S
2. Use of technology:
Use of modern technology
requires large amount of fixed
capital as such technology is
very costly.
On the other hand, labor
intensive or tradition
technology does not require a
very high fixed capital.
E
T
Slide 53
S
U
N
S
E
T
3. Nature of business:
Generally, large engineering companies,
construction companies, hotels, public utility
providing companies (electricity, railways, airways)
etc have large fixed capital requirement.
Slide 54
S
U
N
S
E
T
4. Scope of business activities:
If the scope of business is vast, then it requires
large fixed capital.
For eg: Since, “Jumbo King” manufactures,
distributes and sells vada pavs by itself, it requires
huge capital for manufacturing, distribution and
setting up stalls.
Slide 55
S
U
N
S
E
T
5. Expansion plans:
If a business is planning to expand its operation by
setting up a new manufacturing unit, its fixed
capital requirement will be high.
Slide 56
S
U
N
S
E
6. The phase of business:
More Fixed Capital
requirement during
Introduction and
Growth stage
Less Fixed Capital
requirement during
Maturity and
Decline stage
T
Slide 57
Narrow Sense
Broad Sense
Current Assets
Minus Current
Liabilities
All of Current
Assets
Current assets are short term assets such as cash, short
term securities, amount receivables, inventories etc.
Current liabilities are short term liabilities such as
creditors, short term loans, bills payable etc.
Bead, Baker and Mallot have defined the term ‘working capital’ as
“Working capital means current assets”
Slide 58
C
A
P
I
T
A
L
-
B
D
1. Conditions of purchase and sale:
If the company enjoys a good credit from its
suppliers (creditors), it requires less working
capital.
Similarly, if the company allows a longer credit
period to its debtors, the working capital
requirement will be more.
E
Slide 59
C
A
P
I
T
A
L
-
B
D
2. Affected by size of business:
A big company has large number of operations, has to
maintain huge amount of stock and may also have large
amount of debtors outstanding. Hence required more
Working Capital.
For eg. Working capital of Big Bazaar is more than working
capital of a local kirana store.
E
Slide 60
C
A
P
I
T
A
3. Production time cycle:
If time taken to convert raw
material to finished product
is long, higher working
capital is required because
the business has to sustain
expenses for a long period
of time till the finished
product is sold and
converted to cash.
L
-
B
D
E
Slide 61
C
A
P
I
T
A
L
4. Intensity of competition:
In case of competitive
market, company has to
maintain large inventory as
the buyers may shift to
competitor’s product if the
goods are not available in the
market. In such market
conditions, working capital
requirement is high.
-
B
D
E
Slide 62
C
A
P
I
T
A
L
-
B
D
E
5. The nature of business:
Service sector company like bus transport - less working
capital
On the other hand, Big Bazaar has to stock a lot of goods
- Requires comparatively higher working capital.
Slide 63
C
A
P
I
T
A
L
-
B
D
E
6. Affected by seasonal fluctuations:
Seasonal businesses have fluctuating working
capital.
Ceiling fans manufacturing company - peak sales
during summer.
Working capital needs increase in summer
Slide 64
C
A
P
I
T
7. Liquidity requirement
Large cash dealing more liquid funds
Unpredictable payment
cycles - more liquid
funds
Therefore have a high
working capital
requirement.
A
L
-
B
D
E
Slide 65
C
A
P
I
T
A
8. Business cycle
Boom period - Sales
increase – more working
capital
Recession - sales decrease
– less working capital
L
-
B
D
E
Slide 66
C
A
P
I
T
A
9. Development plans
Management becomes
aggressive - large working
capital
Management expects a
modest growth rate – less
working capital
L
-
B
D
E
Slide 67
C
A
P
I
T
A
L
-
B
D
E
10. External factors
If the company gets funds on a short notice and at
cheap rates from banks or financial institutions –
Less capital
Do not provide funds on easy terms – high
working capital
Slide 68