CBSE Class 12 Business Studies Financial Management Assignment

Introduction :-
Money required for carrying out business activities is called business finance. Finance is needed to establish a business, to run it, to modernise it, to expand or diversify it.

Finanicial management is the activity concerned with the planning, raising controlling and administering of funds used in the business. It is concerned with optimal procurement as well as usuage of finance. It aims at ensuring availability of enough funds whenever required as well as avoiding idle finance.

The Main Objective of Financial Management is to maximise shareholder s wealth, for which achievement of optimum capital structure and proper utilisation of funds is a must. Every company is required to take three main financial decisions which are as follow:

1. Investment Decision :-
It relates to how the firm s funds are invested in different assets. Investment decision can be long-term or short term. A long term investment decision is called capital budgeting decisions which involve huge amounts of investments and are irreversible except at a huge cost while short term investment decisions are called working capital decisions, which affect day to day working of a business.

2. Financing Decison :-
It relates to the amount of finance to be raised from various long term sources. The main sources of funds are owner s funds i.e. equity / share holder s funds and the borrowed funds i.e. Debts. Borrowed funds have to be repaid at a fixed time and thus some amount of financial risk (i.e. risk of default on payment) is there in debt financing. Morever interest on borrowed funds have to be paid regardless of whether or not a firm has made a prof it. On the other hand shareholder funds involve no commitment regarding payment of returns or repayment of capital. A firm mixes both debt and equity in making financing decisions.

3. Dividend Decision :- 
Dividend refers to that part of the profit which is distributed to shareholders. A company is required to decide how much of the profitearned by it should be distributed among shareholders and how much should be retained. The decision regarding dividend should be taken keeping in view the overall objective of maximising shareholder s wealth.

Financial Planning :-
The process of estimating the fund requirement of a business and specifying the sources of funds is called financial planning. It ensure that enough funds are available at right time so that a firm could honour its commitments and carry out, its plans.

Importance of Financial Planning

1. To ensure availbility of adequate funds at right time.
2. To see that the firm does not raise funds unnecessarily.

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 analysed 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. Which involve calculation regarding investment amount, interest rate, cash flows, rate of return etc.

Factors Affecting Financing Decision

1. Cost :- The cost of raising funds from different sources are different. The cheapset 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 rapaid also, after a fixed period of time or on expiry of its tenure.

3. Flotation Cost :- The cost involved in issuing securities such as broker s commission, underwriters fees, expenses on prospectus etc is called flotation cost. Higher the flotation cost, less attractive is the source of finance.

4. Cash flow position of the business :- In case the cash flow position of a company is good enough then it can easily use borrowed funds.

5. Control Considerations : In case the existing shareholders want to retain the complete control of business then finance can be raised through borrowed funds but when they are ready for dilution of control over business, equity can be used for raising finance.

6. State of Capital Markets : - During boom, finance can easily be raised by issuing shares but during depression period, raising finance by means of debt is easy.

Factors affecting Dividend Decision :

1. Earnings : - Company having high and stable earning could declare high rate of dividends as dividends are paid out of current and past earnings.

2. Stability of Dividends : Companies generally follow the policy of stable dividend. The dividend per share is not altered/changed in case earning changes by small proportion or increase in earning is temporary in nature.

3. Growth Prospects : In case there are growth prospects for the company in the near future them it will retain its earning and thus, no or less dividend will be declared.

4. Cash Flow Positions : Dividends involve an outflow of cash and thus, availability of adequate cash is foremost requirement for declaration of dividends.

5. Preference of Shareholders : While deciding about dividend thepreference of shareholders is also taken into account. In case shareholders desire for dividend then company may go for declaring the same.

6. Taxation Policy : A company is required to pay tax on dividend declared by it. If tax on dividend is higher, company will prefer to pay less by way of dividends whereas if tax rates are lower then more dividends can be declared by the company.

Capital Structure
Capital structure refers to the mix between owner s funds and borrowed funds. It will be said to be optimal when the proportion of debt and equity is such that it results in an increase in the value of the equity share. The proportion of debt in the overall capital of a firm is called financial Leverage or capital gearing. When the proportion of debt in the total capital is high then the firm will be called highly levered firm but when the proportion of debts in the total capital is less then the firm will be called low levered firm.

Factors affecting Capital Structure.

1. Cash flow position : In case a company has strong cash flow position then it may raise finance by issuing debts.

2. Interest Coverage Ratio : It refers to the number of times earning before interest and taxes of a company covers the interest obligation. High Interest coverage ratio indicate that company can have more of borrowed funds.

3. Return on Investment : If return on investment is higher than the rate of interest on debt then it will be beneficial for a firm to raise finance through borrowed funds.

4. Flotation Cost : The cost involved in issuing securities such as brokers commission, under writers fees, cost of prospectus etc is called flotation cost. While selecting the source of finance flotation cost should be taken into account.

5. Control : When existing shareholders are ready to dilute their control over the firm then new equity shares can be issued for raising finance but in reverse situation debts should be used.

6. Tax Rate : Interest on debt is allowed as a deduction, thus in case of high tax rate debts are prefered over equity but in case of low tax rate more preference is given to Equity.
In addition, cost of debt, cost of equity, flexibility, risk consideration etc are other factors affecting capital structure.

Fixed Capital and Factors affecting Fixed Capital
Fixed capital refers to investment in long-term assets. Investment in fixed assets is for longer duration and they must be financed through long-term sources of capital. Decisions relating to fixed capital involve huge capital/ funds and are not reversible without incurring heavy losses. The factors affecting the requirement of fixed capital are as follows.

1. Nature of Business : Manufacturing concern require huge investment in fixed assets & thus huge fixed capital is required for them but trading concern needs less fixed capital as they doesn t require to purchase plant and machinery etc.

2. Scale of Operations : An organisation operating on large scale require more fixed capital as compare to an organisation operating on small scale.

3. Choice of Technique : An organisation using capital intensive techniques require more investment in plant & machinery as compare to organisation using labour intensive techniques.

4. Technology upgradation : Organisations using assets which become obsolete faster require more f ixed capital as compare to other organisations.

5. Growth Prospects : Companies having higher growth plan require more fixed capital. In order to expand production capacity more plant & machinery are required.

6. Diversification : In case a company go for diversification then it will require more fixed capital to invest in fixed assets like plant and machinery.

Working Capital and Factors affecting working capital
Working Capital refers to the capital required for day to day working of an organisation. Apart from the investment in fixed assets every business organisation needs to invest in current assets, which can be converted into cash or cash equivalents within a period of one year. They provide liquidity to the business. Working capital is of two types : Gross working capital and Net working capital Investment in all the current assets is called gross working capital whereas the excess of current assets over current liabilities is called net
working capital. Following are the factors which affect working capital requirements of an organisation.

1. Nature of Business : A trading organisation needs a lower amount of working capital as compared to a manufacturing organisation as trading organisation undertake no processing work.

2. Scale of operations : - An organisation operating on large scale will require more inventory and thus, its working requirement will be more as compared to small organisation.

3. Business Cycle : In the time of boom more production will be undertaken and so more working capital will be required during that time as compared to depression.

4. Seasonal Factors : During peak season demand of a product will be high and thus high working capital will be required as compared to lean season.

5. Credit allowed : If credit is allowed by a concern to its customers than it will require more working capital but if goods are sold on cash basis than less working capital is required.

6. Credit availed : If a firm is able to purchase raw material on credit from its suppliers then less working capital will be required.
In addition to above growth prospects, operating efficiency, inflation, level of competition etc also affect working capital requirement.

Trading on Equity :
It refers to the increase in profit earned by the equity shareholders due to the presence of fixed financial charges like interest. Trading on equity happen when the rate of earning of an organisation is higher than the cost at which funds have been borrowed and as a result equity shareholders get higher rate of dividend per share.

 Important Questions for NCERT Class 12 Business Studies Financial Management

 

 Question. Financial Planning links

(a) Investment and dividend decision
(b) Investment and financing decision
(c) Dividend and financing decision
(d) None of the above

Answer : B

Question. What is influenced by the financing decision?
(a) Market price of shares
(b) Cost of capital
(c) Both (a) and (b)
(d) None of these

Answer : C

Question. Which branch of management does take care of the efficient planning and controlling of the financial activities of an organisation?
(a) Production management
(b) Financial management
(c) Marketing management
(d) Personnel management

Answer : B

Question. What is the cost of raising funds called? R
a. Flotation Cost
b. Marginal Cost
c. Fixed Cost
d. Variable Cost

Answer : A

Question. Working capital refers: R
a. Excess of Current Assets over Current Liabilities
b. Excess of Current Liabilities over Current Assets
c. Excess of Fixed Assets over Current Liabilities Fixed Cost
d. Excess of Current Assets over Fixed Assets

Answer : A

Question. What is the chief financial question before an organisation?
(a) How much finance will be required for various business activities.
(b) How much amount can be acquired from various resources.
(c) How the profit of the business will be divided.
(d) All of these

Answer : D

Question. A person buys 100 shares @ ™100 per share of XYZ company. After some time the market price of shares becomes ™120 per share. How much wealth shall he have in the company.
(a) ™12,000
(b) ™ 8,000
(c) ™ 10,000
(d) ™ 10,120

Answer : A

Question. What is included in financial planning?
(a) Determining financial objectives
(b) Determining financial policies
(c) Determining financial procedures
(d) All of these

Answer : D

Question. If return on investment is less than the rate of interest, then company must prefer
(a) Equity
(b) Debt
(c) Both (a) and (b)
(d) None of the above

Answer : A

Question. Floatation cost is high in
A equity shares
B retained earnings
C debentures
D dividend
Answer :  A

Question. Financial leverage is called favorable if: 
a. Return on Investment is lower than the cost of debt
b. Return on Investment is higher than the cost of debt
c. Debt is easily available
d. If the degree of existing financial leverage is low
Answer :   B

Question. Higher debt-equity ratio results in: 
a. lower financial risk
b. higher degree of operating risk
c. higher degree of financial risk
d. higher Earning Per Share
Answer :  C

Question. The extent of retained earning is influenced by which decision:
A. Investment decision
B. Dividend decision
C working capital decision
D. Financing decision
Answer :  B

Question. EBIT refers to:
a. Earning Before Interest and Tax
b. Earning Before Income and Tax
c. Earning Before Investment and Tax
d. Earning Before Installment and Tax
Answer :   A

Question. Operating Cycle starts with:
a. Procurement of Raw Material
b. Manufacturing of Goods
c. Realize cash from debtors
d. Payment to creditors
Answer :  A

Question. Unfavourable financial leverage leads to
a. Increase in EPS
b. Decrease in EPS
c. EPS is not affected dlncrease in tax
Answer :  B

Question. When can a business use trading on equity to increase the earnings of its shareholders.
Answer: When ROI is greater than Rate of interest on debts.

Question. State the objective of financial management.
Answer: To maximise the shareholders wealth

Question. Name the financial decision which affects the liquidity as well as profitability of a business.
Answer: Investment decision

Question. Name the type of investment decision which relates to short-term and affects day to day operation of a company.
Answer: Working capital decisions or short term investment decisions

Question. Give the second name for fixed asset management?
Answer: Capital budgeting.

Question. A Company wants to establish a new unit in which a machinery of worth Rs10 lakhs is involved. Identify the type of decision involved in financial management.
Answer: Investment decision/capital budgeting decision.

3 and 4 marks questions

Question. What is the aim of financial management? State the value that should be kept in mind while setting the objectives of financial management.
Answer: wealth maximization of shareholders
Honesty
Social Responsibility
Commitment

Question. Explain in brief any four objectives of financial management.
Answer: Objectives of financial management are as follows:-
(1) Wealth maximization: (2) Profit maximization: (3) Efficient Utilization of resources: .
(4) Meeting financial commitments:

Question. Explain the factors affecting financing decisions.any four
Answer: Financing decision is the decision about the quantum of finance to be raised from various long term sources and how much is to be raised from each source.
The following are the main factors affecting decision:
i. Cost: the cost of obtaining funds through debt or equity is different and the least expensive source is opted for.
ii. Risk: like cost, the risk associated with different sources for obtaining finance is different.
iii. Flotation Cost: higher floatation cost makes the source for raising funds less attractive.
iv. Cash flow position of the business: If a business enterprise is having a strong cash flow position, it would be beneficial for it to opt for debt financing instead of equity.
v. Control Consideration: fear of reduction in management's control over business enterprise results in giving more preference to debt financing rather than equity.
Vi .State of capital markets: health of capital market greatly affects the choice for a source of fund. people are willing to invest in the market when it is rising. However, it may be very difficult for a company to issue equity shares in depressed capital market.

Question. How does trading on equity increase return on equity shares? Explain with an example.
Answer: Trading on equity is a practice followed by a company under which earning per share is increased by employing cheaper debt. The sole objective enterprises are always interested in employing debts whose interest is less than the average rate of return on capital employed.
The position will be reversed if interest on debt is much more than the average rate of return on capital employed.

5 and 6 marks questions

Question. Identify the financial decision which determines the amount of profit earned to be distributed and to be retained in the business. Explain the factors affecting this.
Answer: Dividend Decision.
factors affecting this Amount of earning Stability of earning Stability of dividends Growth opportunities Cash flow position Shareholders preference Taxation policy Stock market conditions Access to capital markets Legal constraints Contractual constraints.

Question. One of the major decisions taken by a Finance Manager is the decision regarding maintenance of liquidity and at the same time maximization of profitability. Which type of decision is referred to in the statement and what are the factors responsible for it.
Explain in brief.
Answer: Working Capital Decision
Factors affecting:
1.Nature of business
2.Scale of operations
3.Business cycle
4.Seasonal factors
5.Production cycle
6.Credit allowed
7.Credit availed
8. Availability of raw materials

Question. What are the factors to be kept in mind while deciding the capital structure of a company.
Answer: factors affecting
i) cost of capital
ii) control
iii) risk
iv) cost of equity
v) cost of debt
vi) ROI

Question. What is meant by 'Fixed capital'? Describe any four factors which affect the requirement of fixed capital requirement of a company.
Answer: Fixed capital: investment made in fixed assets is known as fixed captial.it is usually financed through long term source of finance .
Factors affecting fixed capitals needs are:
1. nature of business
2. scale of operation
3. Growth Prospects
4. Diversification

Fill in the blanks

1. Working capital is calculated by reducing current liabilities out of current assets.-

2. Equity is related to shareholder’s funds.

3. Capital structure includes proportion of debt and equity.-

4. Gross working capital relates to current assets.-

5. Cost of raising funds is called flotation cost.

6. Another name for long term investment decision is capital budgeting.

7. Financial leverage is proportion of debt in overall capital.

8. Favourable financial leverage is when Return on Investment is greater than rate of interest on debt.

9. Fixed capital is related to investment decision.

10. Capital budgeting decisions include purchase of fixed assets.

11. Current assets get converted into cash within an accounting year.

12. Inflation is related to rise in price.

13. If there is shortage of cash then company employs more of equity in capital structure.

14. High Interest coverage ratio means companies can have more borrowed funds.

15. Low rate of Interest of Company with more of debt as compared to equity.

Important Questions for NCERT Class 12 Business Studies Financial Management

Question. That part of management which is connected with the financial activities is called ________ management.
(a) Personnel
(b) Financial
(c) Production
(d) All the above

Answer : B

Question. Fixed assets investment decision is called ________ .
(a) Management of working capital
(b) Capital budgeting
(c) Financing decision
(d) None of these

Answer : B

Question. What is the decision to invest in fixed assets called?
(a) Management of working capital
(b) Capital budgeting
(c) Financing decision
(d) None of these

Answer : B

Question. Which investment decisions are difficult to be changed?
(a) Fixed capital decision
(b) Working capital decision
(c) Both (a) & (b)
(d) None of these

Answer : A

Question. Shareholder’s current wealth in a company = ________ × ________ .
(a) Face value of shares × Market price per share
(b) Number of shares × Face value of shares
(c) Number of shares × Market price per share
(d) Number of shares × Profit per share

Answer : C

Question. Financial planning means ________ of financial activities.
(a) Determining
(b) Pre-determining
(c) Later -determining
(d) Not determining

Answer : B

Question. Under financial management a forecast of receipts and payments is made and the shortage or sufficiency of ________ is ensured.
(a) Capital
(b) Human resource
(c) Material
(d) All the above

Answer : A

Question. With the help of the financial planning a situation of continuous ________ can be maintained.
(a) Minimum Capital
(b) Liquidity
(c) Maximum Capital
(d) (b) and (c)

Answer : B

Question. ________ is the example of a financial decision.
(a) Investment decision
(b) Financing decision
(c) Dividend decision
(d) All of these

Answer : D

Question. What is included in financial management according to the traditional approach?
(a) Arranging finance
(b) Using finance effectively
(c) Both (a) and (b)
(d) None of these
Answer : A

Question. The concept which makes sure the availability of right amount of finance at the right time is called
(a) Financial Planning
(b) Capital Structure .
(c) Working Capital
(d) Fixed Capital

Answer : A

 

True/False, give reason in support of your answer.

Question.. Companies with higher growth potential pay lower dividends.
Answer : True because it needs funds for expansion/growth of company.

Question.. If cash flow position of a company is weak more debt financing is not recommended.
Answer : True. It will be difficult for a company to pay interest on time, hence more risk.

Question.. An ‘Advertising agency’ needs to have large fixed capital.
Answer : False because it is a service Co. & need not maintain any inventory.

Question.. Capital budgeting decisions are very crucial for any business.
Answer : True because they are irreversible.

Question.. Trading on equity takes place when ROI is less than the rate of interest.
Answer : False because E.P.S. will be low. ROI should be more than rate of interest.

 

Fill in the blanks.

Question.. Current assets get converted into cash within a period of.
Answer : 1 year

Question.. Objective of financial management is.
Answer : maximisation of shareholders wealth

Question.. Inflation will result in an increase in capital requirements.
Answer : Working

Question.. As the financial leverage increases, the cost but risk.
Answer : decreases, increases

Question.. An increase in debt raises risk.
Answer : Financial

Fill in the blanks

1. Distribution of surplus funds is related to dividend decision.

2. Selection of asset related to investment decision.

3. If earning is higher, then company declares high rate of dividend.

4. If there is shortage of cash, company must employee more of equity in its capital structure.

5. Company having higher tax rate prefer debt instead of Equity.

6. Essential ingredients of sound Working Capital Management are cash and inventory and receivables

7. Different techniques to evaluate investment proposal are known as capital budgeting techniques

8. During the period when stock market is rising more people invest in equity

9. Company having high fixed operating cost would opt for debt

10. Company has to follow contractual and legal constraints while paying dividends
 
11. If tax on dividend is higher, Company pay less by way of dividend.

12. The preparation of a financial blueprint of an organisation is known as financial planning

13. Capital structure is a mix of debt & equity

14. If return on investment is higher than cost of debt it leads to use trading on equity to increase its EPS

15. With an increase in debt component in capital structure it leads to increase financial risk

 

Very short answer type questions

Question. “During annual general meeting of Prakash Ltd. CEO, Mr. Rajnesh put the expansion plan for the coming year before shareholders and asked for suitable source of finance to finance manager. Finance manager Mr. Kant proposed issue of debentures than equity with a plan that they can be paid back whenever requirement of funds is over”
In the above paragraph, which component affecting financing decision has been highlighted? Explain the component.
Answer : Flexibility

Question. What is the impact of business risk on Capital structure?
Answer : Increase in risk will decrease use of debt

Question. Tata sons has debt equity ratio of 4:1 and Bajaj has 1:1 debt equity ratio. Name the advantage, Tata sons may have over Bajaj.
Answer : Trading on equity

Question. ‘Cost of debt’ is lower that the ‘Cost of equity share capital’. Give reason, why even then a company cannot work only with debt.
Answer : Because equity share capital is a permanent source of capital &provide risk capital

Question. Dabur India has decided to increase credit limit and duration of credit to its customers to boost its sales. Name the type of decision involved.
Answer : Working capital

Question. Bharti Ltd. is a leading mobile company. It is planning to acquire Queen Ltd’s (its close competitor) business worth Rs. 1,000 crore. Which financial decision is involved in it? Explain it.
Answer : Investment

Question. State the formula for calculating financial leverage.
Answer : Debt/ Equity

Question. HCL Company’s finance manager has decided to retain its entire profit to meet financial requirement for its growth. Name the type of decision involved.
Answer : Dividend

Question. Jai Bharat Company Ltd. is an auto part supplier company in Guru Gram, Haryana. Its business is spread over several cities. The CEO of company wants to open a factory in Gujrat near Tata Motors Ltd. but due to recession for the last two years, its business is facing slow down. Company needs capital. Rakesh Gupta is CA and financial advisor of the company. He opines that during recession profit falls and investors prefer to invest indebentures to earn fixed income. Therefore, the company should issue debentures.
In this paragraph, which factor affecting financing decision has been highlighted? Explain
Answer : State of capital market

Question. Under what situation, will an increase in debt decrease the EPS?
Answer : When rate of return is less than rate of interest. Decrease in earnings

Question. Amita Ltd. does not have any debt in its capital structure but Kajal Ltd. has debt @ 15% in its capital structure. Rate of return of both companies is 20%. Which company enjoys the benefits of trading on equity and why?
Answer : Kajol Ltd. because interest is a tax deductible item.

Question. ‘REI Agro Food Ltd ‘is a famous multinational company. Mr. S.K.Nagi is its finance manager. He is making efforts to increase the market value of capital invested by the equity shareholders. He already knew it could be possible only when price of the shares increases and price of shares increase only if Financing, Investment and dividend decisions are taken optimally. He did the same and achieved success.
Which objective of financial management has been referred here? Explain.
Answer : wealth maximisation

Question. “Tax benefits are available only in case of payment of interest and not on the payment of preference dividend.” Why?
Answer : Interest is an expense while dividend is an appropriation

Question. How will increase in number of creditors affect the working capital requirements of a company?
Answer : If both debtors and creditor increase with the same amount then net change in working capital is zero. So working capital does not change if both increase with the same amount.

Question. Name the factor due to which a petro chemical company requires much higher investment in fixed capital than an information technology company. However both may generate same amount of revenue.
Answer : Nature of business

Question. What is favourable financial leverage?
Answer : When capital structure has more debt than equity

 

Short Answer type questions

Question. Pankaj is engaged in Warehousing - Business Identify the working capital requirements of Pankaj stating the reason in support of your answer. Pankaj is also planning to start his Transport business. Explain any two factors that will affect his fixed capital requirements.
Answer : Nature of Business:
Scale of Operation:
Technique of Production:
Technology Up-gradation:
Growth Prospects:

Question. Somnath Ltd. is engaged in the business of export of garments. In the past, the performance of the company had been upto the expectations. In line with the latest technology, the company decided to upgrade its machinery. For this, the Finance Manager, Dalmia estimated the amount of funds required and the timings. This will help the company in linking the investment and the financing decisions on a continuous basis. Dalmia therefore, began with the preparation of a sales forecast for the next four years. Fie also collected the relevant data about the profit estimates in the coming years. By doing this, he wanted to be sure about the availability of funds from the internal sources of the business. For the remaining funds he is trying to find out alternative sources from outside.
a. Identify the financial concept discussed in the above para.
b. Also state the objectives to be achieved by the use of financial concept, so identified.
Answer : 1.Financial planning is the financial concept discussed in the above paragraph. The process of estimating the fund requirements of a business and specifying the sources of funds is called financial planning. It relates to the preparation of a financial blueprint of an organisation‘s future operations.
2.The objectives to be achieved by the use of financial concept are stated below:
• To ensure availability of funds whenever required which involves estimation of the funds required, the time at which these funds are to be made available and the sources of these funds.
• To see that the firm does not raise resources unnecessarily as excess funding is almost as bad as inadequate funding. Financial planning ensures that enough funds are available at right time.

Question. “Ranbaxy Ltd. has been earning handsome profits since last 15 years. Company enjoy fair goodwill in the market, so company can easily arrange debt as well equity from the market, whenever needed. Therefore company decided to declare dividend with a hike of 15% from, last year.” Which two components affecting dividend decision have been highlighted in the above paragraph?
Answer : (i. Stability of earning ii. Access to capital markets)

Question. Explain briefly any four factors which affect the choice of capital structure of a company.
Answer : The four factors which affect the choice of capital structure of a company are described below:
• Risk: Financial risk refers to a situation when a company is unable to meet its fixed financial charges. Financial risk of the company increases with the higher use of debt. This is because issue of debt involves fixed commitment in terms of payment of interest and repayment of capital.
• Flexibility: Too much dependence on debt reduces the firm‘s ability to raise debt during unexpected situations. Therefore, it should maintain flexibility by not using debt to its full potential.
• Interest Coverage ratio (ICR): The interest coverage ratio refers to the number of times earnings before interest and taxes of a company covers the interest obligation. This may be calculated as follows:
ICR = EBIT/Interest.
If the ratio is higher, lower is the risk of company failing to meet its interest payment obligations hence debt may be issued or vice versa. But besides interest payment related repayment obligations should also be considered.
• Cash flow position: The issue of debt involves a fixed commitment in the form of payment of interest and repayment of capital. Therefore if the cash flow position of the company is weak it cannot meet the fixed obligations involved in issue of debt it is likely to issue equity or vice versa.

Question. Explain the objectives of Financial Planning.
Answer : i) Helps in forecasting alternative business plans.
(ii) Helps to avoid business shocks.
(iii) Helps in coordinating various business functions.
(iv) Helps in linking present with the future.

Question. Chandra Ltd. is a manufacturer of Laptops. It made a profit of 1000 crores. The director have proposed a dividend of 38%. As a finance manager of the company. What factors would you consider while formulating a dividend policy of the company? 
Answer : Firm's liquidity position, Repayment need, Expected rate of return, Stability of earning.

Question. The board of director asked you to design the capital structure of a company. What are the factors you would consider to add?
Answer : The factors included in the capital structure of a company are.
Interest Coverage Ratio (ICR)
Cash Flow Situation
Debt Service Coverage Ratio (DSCR)
Regulatory Framework
Return on Investment (ROI)
Tax rate

Question. Explain briefly any four factors that affect the working capital requirement of a company.
Answer : The four factors that affect the working capital requirements of a company are explained below:
Credit availed: In case the suppliers from whom the firm procures the raw material needed for production or finished goods follow a liberal credit policy, the business can be operated on minimum working capital or vice versa.
Credit allowed: The credit terms may vary from firm to firm. However, if the level of competition is high or credit worthiness of its clients is good the firm is likely to follow a liberal credit policy and grant credit to its clients it results in higher amount of debtors, increasing the requirement of working capital or vice versa.
Scale of operations: The amount of working capital required by a business varies directly in proportion to its scale of business. For organisations which operate on a higher scale of operation, the quantum of inventory, debtors required is generally high. Such organisations, therefore, require large amount of working capital as compared to the organisations which operate on a lower scale.
Growth prospects: The business firms who wish to take advantage of a forthcoming business opportunity or plan to expand its operations will require higher amount of working capital so that is able to meet higher production and sales target whenever required or vice versa .

Question. How does ‘Trading on Equity’ affect the Capital structure of a company? Explain with the help of a suitable example.
Answer : Trading on equity refers to the increase in profits earned by the equity shareholders due to the presence of fixed financial charges like interest. With example

Question. Explain briefly any four factors that affect the fixed capital requirements of a company.
Answer : The four factors that affect the fixed capital requirements of a company are explained below:
• Nature of business: The kind of activities a business is engaged in has an important bearing on its fixed capital requirements. On one hand a trading concern does not require to purchase plant and machinery etc. and needs lower investment in fixed assets. Whereas on the other hand a manufacturing organisation is likely to invest heavily in fixed assets like land, building, machinery and needs more fixed capital.
• Scale of operations: The amount of fixed capital required by a business varies directly in proportion to its scale of business. A larger organisation operating at a higher scale needs bigger plant, more space etc. and therefore, requires higher investment in fixed assets when compared with the small organisation.
• Diversification: If a business enterprise plans to diversify into new product lines, its requirement of fixed capital will increase as compared to an organisation which does not have any such plans.
• Growth prospects: If a business enterprise plans to expand its current business operations in the anticipation of higher demand, its requirement of fixed capital will be more as compared to an organisation which doesn‘t plan to persue any such plans.