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Introduction
• Business Finance = Money or funds available for a business for its operations (that is, for some specific purpose) is called finance. It is indispensable for survival and growth of business, for production and distribution of goods and meeting day to day expenses etc.
• It involves acquiring funds to buy Fixed assets (tangible and intangible) and Raw materials and maintain working capital.
Financial Financial Management includes those business activities that are concerned with acquisition and conservation of capital funds in meeting the financial needs and overall objectives of a business enterprise.
Aims of Financial Financial Management:
Reduce cost of funds procured
Keep risks under control
Achieve effective employment of fund
Ensure availability of sufficient funds while avoiding idle funds
•bjectives of Financial Financial Management
• Primary objective: To maximize wealth of owners in the long run – Wealth Maximization concept.
• ‘Owners’ of a company are the shareholders.
• The term wealth refers to wealth of owners as reflected by the market price of their shares.
• The market price of shares is linked to three basic financial decisions:
• Investment decision • Financing decision and • Dividend decision
• Market price of a share will increase if benefits from a decision are greater than the cost involved in it.
• The goal of a firm should be to maximize the wealth of owners in the long run.
• Increase in the market price of shares is an indicator of the financial health of a firm.
• Other objectives that help a firm achieve the primary objective are:
Ensure availability of funds at reasonable costs:
Ensure effective utilization of funds:
Ensure safety of funds thro creation of reserves:
Maintain liquidity and solvency:
Financial Decisions
Financial Management class 12 Notes Business Studies
Every company is required to take three main financial decisions which are as follows:
1. Investment Decision
Resources are scarce and can be put to alternate use. A firm must choose where to invest so as to earn the highest possible profits.
Investment decision relates to decisions about how the firm‘s funds are invested in different assets that is, different investment proposals
Has two components:
• Working Capital Decisions – Short Term investment decisions.
• Capital Budgeting decisions – Long Term investment decisions
Factors affecting Investment Decisions/Capital Budgeting decisions
1. Cash flows of the project: The series of cash receipts and payments over the life of an investment proposal should be considered and analyzed for selecting the best proposal.
2. Rate of Return: The expected returns from each proposal and risk involved in them should be taken into account to select the best proposal.
3. Investment Criteria Involved: The various investment proposals are evaluated on the basis of capital budgeting techniques. These involve calculation regarding investment amount, interest rate, cash flows, rate of return etc.
2. Financing Decision
• These are decisions w.r.t quantum of finance or composition of funds from various longterm sources.(short term = working capital Financial Management)
• Financing decisions involve: a) Decision whether or not to use a combination of ownership and borrowed funds. b) Determining their precise ratio.
• Firm needs a judicious mix of debt and equity as :
• Debt involves ‘Financial Risk‘ = risk of default on payment of interest on borrowed funds and the repayment of the principle amount whereas
• Shareholders‘ funds involve no fixed commitment w.r.t payment of returns or repayment of capital.
• Ownership fund vs. Debt fund: They can be compared on the basis of factors such as examples, interest/dividend payout and repayment of principle, tax deductibility, and risk and floatation costs.
Factors Affecting Financing Decision
1. Cost: The cost of raising funds from different sources are different. The cheapest source should be selected.
2. Risk: The risk associated with different sources is different. More risk is associated with borrowed funds as compared to owner’s fund as interest is paid on it and it is repaid also, after a fixed period of time or on expiry of its; tenure