GSEB Class 12 Organization of Commerce and Management Important Questions Chapter 8 Financial Management

Gujarat Board GSEB Class 12 Organization of Commerce and Management Important Questions Chapter 8 Financial Management Important Questions and Answers.

GSEB Class 12 Organization of Commerce and Management Important Questions Chapter 8 Financial Management

Short Answer Type Questions

Question 1.
State the most common and understandable definition of finance.
Answer:
The management of finance is called financial management.

Question 2.
Define financial management.
Answer:
The activity done at managerial level for planning and controlling financial resources for the business enterprise is called financial management

Question 3.
State the definition of financial management as given by Raymond.
Answer:
According to Raymond J. Chambers, “Financial management means to take decisions about financial matters to implement them smoothly and to review, them.”

Question 4.
State Kimbal’s definition of financial management.
Answer:
According to Prof. M. Kimbal, “Financial management means acquisition of fund, its optimum utilization and its appropriate allocation

Question 5.
What does the scope of financial management include?
Answer:
Estimating the need of finance, acquirement, maximum utilization, proper allocation and its planning and controlling

Question 6.
Into which two parts can we classify financial management?
Answer:

Management of long term fixed capital and
Management of working capital.

Question 7.
What is profit maximization?
Answer:
The objective of maximizing income of the company is called

Question 8.
What is wealth maximization?
Answer:
The concept of increasing the value of the business in order to increase the value of the shares held by the shareholders is called wealth maximization.

Question 9.
What is NPV? How is it measured?
Answer:
Net Present Value (NPV) is used to measure the profit of the company. Profit under NPV is obtained by obtaining the difference between present value of wealth and investment required.

Question 10.
What is the problem with the approach of wealth maximization?
Answer:
It is based only on the concept of cash flow. It does not consider actual profit booked by the business.

Question 11.
State the formula to calculate NPV.
Answer:
Net present value of wealth = Present value of wealth – Investment required.

Question 12.
What is the key difference between profit maximization and wealth maximization?
Answer:
Profit maximization focuses on earning huge profits whereas wealth maximization focuses on improving the value of the company shares in the market.

Question 13.
What is the advantage of profit maximization?
Answer:
Through profit maximization the company can earn large profit in short term.

Question 14.
How does financial management help in maintaining liquidity in the business?
Answer:
By preparing cash flow statement and cash budget so that a definite cash balance can be maintained on hand.

Question 15.
State the importance of financial management in distribution of income.
Answer:
Financial management decides what part of profit is to be distributed as dividends among the shareholders and what part of profit is to be reinvested in the business.

Question 16.
What is capital structure?
Answer:
The combination of different sources utilized by the company to raise necessary capital for running the company is called the capital structure.

Question 17.
What is Gesternberg’s view on capital structure?
Answer:
Gesternberg opines that “Decisions regarding type of securities are reflected in the capital structure of the company.”

Question 18.
What does simple capital structure mean? How does it benefit
Answer:
A capital structure in which few securities are only used is called simple capital structure; Simple capital structure enables easy administration.

Question 19.
What should be properly balanced in capital structure?
Answer:
The proportion of owner’s capital and borrowed capital.

Question 20.
Why should the capital structure be impressive?
Answer:
If the capital structure is impressive, the investors will get impressed. An impressed investor will stay loyal to the company and even invest more.

Question 21.
Enlist the type of capital structure.
Answer:
(A) Capital structure of only equity of shares,
(B) Capital structure of preference shares with equity shares,
(C) Capital structure of debentures with equity shares and
(D) Capital structure of preference shares and debentures with equity shares.

Question 22.
How does the source of capital differ based on the duration of capital structure?
Answer:
If capital is required on a permanent basis, the company will prefer to issue equity shares. On the other hand, if capital is required for a short period, company will procure capital through debentures and preference shares.

Question 23.
How does an investor behave in a depressed market?
Answer:
When the market is low i.e. depressed, the investors prefer to invest safely in debentures rather than in risky equity.

Question 24.
How does the company raise capital when the taxation is high in the country? How does it benefit?
Answer:
When the taxation is high, the companies prefer to issue debentures for acquiring capital. By doing so, the income tax gives deduction of interest paid on the debentures to the company.

Question 25.
Who is Fll?
Answer:
A financial institution established and registered out of India and whose objective is to invest in prescribed securities in India in primary and secondary markets is known as foreign institutional investor or Fll.

Question 26.
Define working capital.
Answer:
Capital needed in the business to run day-to-day expenses is known as working capital.

Question 27.
State the need of working capital in the business.
Answer:
Working capital is needed in current assets of business such as purchasing raw material, making payment to creditors, paying utility bills, etc.

Question 28.
State the definition of working capital as given by Lincoln, Doris and . Stevens.
Answer:
“Working capital is the excess of current assets over current liabilities.”

Question 29.
State the definition of working capital as given by J. S. Mill.
Answer:
“The sum of the current assets means the working capital.”

Question 30.
Classify working capital into its main components.
Answer:

Gross working capital and
Net working capital.

Question 31.
What does gross working capital, include?
Answer:
Current assets such as bill receivables, debtors, short term marketable securities, bank balance, cash, etc.

Question 32.
What is negative working capital?
Answer:
When the current assets are lesser than the current liabilities it is called negative working capital.]

Question 33.
Why working capital is considered less risky?
Answer:
Working capital gets circulated for short term and it is easily convertible cash (i.e. it has high liquidity). Hence, there is less risk in working capital.

Question 34.
How production cycle affects capital requirement?
Answer:
Generally, longer the production cycle higher the capital needed.

Question 35.
How does shortage of raw material affect capital requirement?
Answer:
If a business needs raw material that is available in limited quantity or whose supply is irregular or is available in certain season only, then such raw material need to be kept in stock for continuous production. Hence, the company needs more capital for production.

Long Answer Type Questions

Question 1.
State important definitions of financial management.
Answer:
Finance:

In layman language, management of finance is called financial management.
Finance is the blood of business.
Business can neither be started without finance nor can it sustain without it. Thus, finance is the foundation stone of business.

Financial management:

The activity done at managerial level for planning and controlling financial resources for the business enterprise is called financial management.
Under financial management, the managers try to optimally manage the financial resources so that the business earns a satisfactory return.

Various definitions of financial management:

According to F. W. Paish, “In the modern economy, based on utilization of funds, financial management means acquiring of required funds at the required time.”
According to Raymond J. Chambers, “Financial management means to take decisions about financial matters to implement then smoothly and to review, them.”
According to Prof. M. Kimbal, “Financial management means acquisition of fund, its optimum utilization and its appropriate allocation.”
From all these definitions we can conclude that the scope of financial management is so wide that it covers all the financial decisions of business, right from the inception.

Question 2.
Enlist the characteristics of financial management and explain them briefly.
Answer:
Characteristics of financial management:
1. Branch of management:
Financial management is a branch of management. It includes the function of planning and control for the use of finance.

2. Wide scope:

The scope of financial management is extremely wide. Its scope includes estimating the need of finance, acquiring finance, maximum utilization, proper allocation and its planning and controlling.
It covers all financial operations, right from the inception of business.

3. Base of the managerial decisions:

Financial management is the base for managerial decisions.
All major decisions regarding production, sales, research, development, etc. are based on financial management.

4. Relation with financial decisions:

Financial management is also related with taking financial decisions.
Financial decisions such as new investment, capital structure, dividend policy, etc. are all associated with financial management.
Financial management makes use of modern mathematical techniques for taking financial decisions.

5. Goal of maximization of owner’s economic welfare:
Financial management aims at maximizing economic welfare of the business owner. For this, it works with two approaches: (i) Profit maximization and (ii) Wealth maximization.

6. Key position:
Financial management holds key position in organizational structure of business unit.

7. Relation with other areas of management:

If there is sufficient finance and proper financial management then the financial management will be more flexible in formulating policies related to production, sales, incentives, etc.
On this basis we can say that financial management is related with different areas of management such as production management, marketing management, personnel management, etc.

8. Division into two parts:

Financial management can be divided mainly into two parts namely
1. Management of long term fixed capital and
2. Management of working capital.
Fixed capital management includes planning for expansion of fixed assets such as building, machines, land, etc., while working capital management takes care of day-to-day expenses.

Question 4.
State the scope of financial management.
Answer:
Wide scope:

The scope of financial management is extremely wide. Its scope includes estimating the need of finance, acquiring finance, maximum utilization, proper allocation and its planning and controlling.
It covers all financial operations, right from the inception of business.

Question 5.
Write a note on profit maximization.
Answer:
The objective of maximizing income of the company is called profit maximization.

In market, investors purchase the shares of company with a hope of earning maximum dividend. As a result, company should earn maximum profit out of its available resources. Moreover, its dividend policy should be based on maximization of profit.
In addition, this approach suggests that company should take up only those business projects which can earn good profits i.e. which aims at profit maximization.
This approach increases the share price of the company. This in turn increases company’s per-share earning.

Question 6.
Explain in detail objective of wealth maximization as an objective of financial management.
Answer:
The concept of increasing the value of the business in order to increase the value of the shares held by the shareholders is called wealth maximization.

A term called Net Present Value (NPV) is used to measure the profit of the company. Profit under NPV is obtained by subtracting the present value of wealth from investment required over a period of time.
Wealth maximization focuses on building a profitable NPV. The net present value creates wealth for the shareholders.
Owing to this calculation, the organization should take up only such decisions which increase the net present value and hence the wealth.
A drawback of wealth maximization approach is that it is based only on the concept of cash flow. It does not consider actual profit booked by the business.
Only cash flow is considered as a measurement and the accounting profit is ignored.
The net present value of wealth is the difference between present value of wealth and investment required.

Question 7.
Differentiate between profit maximization and wealth maximization.
Answer:

Point of difference	Profit maximization	Wealth maximization
1. Objective	To earn a larger amount of profit	To improve the market value of its shares
2. Emphasizes on	Achieving short term objectives	Achieving long term objectives
3. Risk and uncertainty	It ignores risk and uncertainty	It recognizes risks and uncertainties
4. Advantage	Acts as a yardstick for computing the operational efficiency of the entity	Gaining a large market share

Question 8.
How does financial management help in increasing the creditworthiness of the business?
Answer:
Financial decisions:
Financial management takes important decisions regarding capital budget, dividend policy, reinvestment of profit, etc. It also co-ordinates various financial decisions such as co-ordination between dividend policy and reinvestment of profit, etc.

Question 9.
For which major problems does the financial management make decision? Explain them very briefly.
Answer:
Financial management has to take important decisions with respect to the following three problems:
(A) Decisions related to investment
(B) Decisions related to financing
(C) Decisions related to dividend

(A) Decisions related to investment:

Business requires capital investment in various assets that too for a long and fixed term. This includes investment in machinery, land, etc.
It is always a risk to identify the best asset in which investment should be made. Hence it is very crucial that decision of investment is evaluated in terms of expected return and risk.

(B) Decisions related to financing:
Investment decisions are connected with the assets of the company while financing decisions are related to the capital structure.

Capital structure of the company consists of
(a) equity shares
(b) equity shares and preference shares
(c) equity shares and debentures
(d) equity shares, preference shares and debentures.

Financial manager has to take decision regarding the portion to be maintained between equity and debt in capital structure. A fine balance between equity capital and debt is necessary so as to maximize the returns of the company.

Dividend is a part of profit of a company which is distributed among its shareholders. Dividend is a return to shareholders on their investment.
The financial manager has to tactfully decide what part of profit should be distributed as dividend and what part of profit should be retained in business.

Question 10.
Write a note on decisions related to investment that the financial management needs to take.
Answer:
Decisions related to investment:

Business requires capital investment in various assets that too for a long and fixed term. This includes investment in machinery, land, etc.
It is always a risky and tricky task for the financial manager to identify the best asset in which investment should be made. Hence it is very crucial that decision of investment is evaluated in terms of expected return and risk.
Investment decision is called capital budgeting. There are several methods of capital budgeting brought in use by the finance manager for deciding the investment decision to be taken for the company. Few of these methods are pay-back method, rate of return method, discounted cash flow method, etc.

Factors affecting investment decision:

Need of total capital
Estimated rate of return and profitability from investment
Estimated net cash receivable from investment
Element of risk involved in investment
Requirement of working capital after investment
Useful economic life of investment and its estimated life
Significance of investment
Capital rationing
Certainty or uncertainty of earning in future

Question 11.
Write a note on decisions related to financing and factors affecting it.
Answer:
Decisions related to financing:
Investment decisions are connected with the assets of the company while financing decisions are related to the capital structure.

Capital structure of the company consists of:
(a) equity shares
(b) equity shares and preference shares
(c) equity shares and debentures
(d) equity shares, preference shares and debentures

Capital structure is a mixture of owner’s capital and debt. Finance manager has to take decision regarding the portion to be maintained between equity and debt in capital structure. A fine balance between equity capital and debt is necessary so as to maximize the returns of the company.
Capital structure having a proper proportion of equity capital and debt is called optimum capital structure. Optimum capital structure is less risky and ensures maximum return.

Factors affecting financing:
The factors affecting financing can be classified as

Internal factors and
External factors.

1. Internal factors:
Type or nature of business, size of business, growth of business, financial requirement, nature of assets and requirement, attitude of directors are internal factors that affect financing decisions.

2. External factors:
Condition of capital market, expenses of issuing securities, attitude of investors, rate of interest prevailing in market, legal restrictions, institutional investors, etc. are external factors that affect financing decisions.

Question 12.
Enlist internal and external factors affecting financing.
Answer:
1. Internal factors:
Type or nature of business, size of business, growth of business, financial requirement, nature of assets and requirement, attitude of directors are internal factors that affect financing decisions.

Question 13.
What is dividend? For a finance manager what decisions are involved with respected to dividend? State the factors that affect the decision regarding dividend.
Answer:

Dividend is a part of profit of a company which is distributed among its shareholders. Dividend is a return to shareholders on their investment.
As per the Companies Act, dividends can be paid in cash or cheque on paid-up capital of share. The finance manager has to tactfully decide what part of profit should be distributed as dividend and what part of profit should be retained in business. Retained earnings in business are an important internal source of finance.
Payment of dividend affects the market value of share of the company. If a major portion of profit is distributed as dividend, it decreases the ploughing back of profit. On the other hand, if a major portion of profit is reinvested then less amount is left for distributing dividend.

Factors affecting dividend:

Divisible profit of the company during the current financial year
Estimation of income in future
Rate of dividend paid by the company in the past years
Need of ploughing back of profit in business
Financial condition and financial needs of company at present
Ratio of reserves with company
Future planning of profitable investment
Attitude of directors of company
Taxation policy
Legal restrictions
Expectation of shareholders of the company
Condition of capital market
Growth rate of company
Liquidity position of the company

Question 14.
State the important aspects of a financial plan.
Answer:
Any financial plan consists of two important aspects plan. They are:

To estimate need of capital (Problem of capitalization)
To determine sources of capital (Problem of capital structure)

Question 15.
What is capital structure? Explain.
Answer:

The combination of different sources utilized by the company to raise necessary capital for running the company is called the capital structure.
According to Hogland, “Capital structure means the proportion and magnitude of different securities issued and sources utilized by a company to raise its finance.”
Company can obtain necessary capital funds from various sources. It can raise capital by issuing various types of securities such as equity share, preference share, debenture, etc.
In this context, Gesternberg says that “Decisions regarding type of securities are reflected in the capital structure of the company.”
It is the responsibility of the finance manager to determine the proportion of various types of securities to be issued.

Question 16.
What are the characteristics of ideal capital structure?
Answer:
An ideal capital structure should have the following characteristics:

Simplicity: It becomes easy to administer capital structure, if lesser varieties of securities are issued.
Profitability: The capital structure should be planned in such a way that profit remains optimum.
Adequate finance: Various sources should be combined properly so that adequate finance can be obtained.
Flexibility: Capital structure of the company should be flexible so that it can be changed as per the requirements and circumstances.
Economy: Various sources should be combined in a manner that optimizes the cost of capital.
Balancing: There should be a proper equilibrium between owner’s capital and borrowed capital.
Liquidity: The capital structure should be so designed that few sources can be liquidated when needed so as to set-off the liability and debts of the company in time.
Attractiveness (Impressive): Capital structure should be designed in such a manner that investors find it impressive. An impressed investor will stay loyal to the company and even invest more.
Solvency: The proportion of borrowed capital should not be so large that burden of interest cannot be borne by the company and risk of insolvency increases.

Question 17.
Enlist the types of capital structure.
Answer:
Types of Capital Structure:
(A) Capital structure of only equity of shares
(B) Capital structure of preference shares with equity shares
(C) Capital structure of debentures with equity shares
(D) Capital structure of preference shares and debentures with equity shares

Question 18.
Enlist the factors affecting capital structure.
Answer:

Question 19.
Enlist the internal factors affecting capital structure.
Answer:
Internal Factors

Type of business
Size of business
Estimation of business income
Nature and requirement of assets
Attitude of directors
Financial requirements
Duration of capital requirement

Question 20.
Enlist the external factors affecting capital structure.
Answer:
External Factors

Condition of boom-depression in capital market
Present rate of interest in capital market
Cost of capital expenses of issuing securities
Legal restrictions
Taxation policy
Institutional investors
Foreign institutional investors

Question 21.
Discuss the internal factors that affect capital structure.
Answer:
Internal factors that affect the capital structure:
1. Type of business:

The type of business affects its capital structure. For example, manufacturing units require huge capital whereas normal trading units require less fixed capital
The fixed capital investment of a firm providing service depends on the type of service it provides. For example, a five star hotel requires huge capital as compared to a standard courier company.

2. Size of business:
A large scale business unit will require large fixed capital as compared to a small scale industrial unit. Moreover, a trading firm will require even lesser fixed capital.

3. Estimation of business income:
In business, although estimation of how much profit will be earned is done, still the estimation may go wrong. In such situation, the company has to depend on borrowed capital. In other words, the capital structure gets affected by estimation of business income.

4. Nature and requirement of assets:

If the business requires fixed assets on large scale, then the ratio of equity/share will be high in capital structure of that business.
Another key decision that affects capital structure is whether these high value fixed assets are to be purchased or are to be taken on lease.

5. Attitude of directors:
If the directors of the company desire to retain the managerial control on company they do not issue equity shares in greater proportion and depend more on preference shares and debentures.

6. Financial requirements:

If the need of capital is less, it can be raised only by issuing equity shares. However, if the need of capital is large, various types of securities need to be issued for raising the fund.
How much finance will be required in future for long term objectives and plans and possibility of future growth is also to be considered while formulating capital structure.

7. Duration of capita! requirement:
If capital is required on a permanent basis, the company will prefer to issue equity shares. On the other hand, if capital is required for a short period, company will procure capital through debentures and preference shares.

Question 22.
Discuss the impact of assets on capital structure.
Answer:

No business can be done without raising assets. Assets can be big, small, purchased or leased.
If the business requires fixed assets on large scale, then the ratio of equity share will be high in capital structure of that business.
Similarly, if the company needs high value assets then whether it procures them by purchasing or leasing affects the form of capital structure.

Question 23.
How will a company prefer to raise capital considering its short term and long term capital requirements?
Answer:
Duration of capita! requirement:
If capital is required on a permanent basis, the company will prefer to issue equity shares. On the other hand, if capital is required for a short period, company will procure capital through debentures and preference shares.

Question 24.
Discuss the external factors that affect the capital structure of the company.
Answer:
External factors that affect the capital structure of the company:
1. Condition of boom-depression in capital market:
When the market is low i.e. depressed, the investors prefer to invest safely in debentures rather than in risky equity. This earns them reasonable returns. On the other hand, when market is in boom, the investors invest in equity shares so as to earn higher dividends and profits.

Thus, how the capital structure will be formed is also decided by the trends prevailing outside the company in the capital market.

2. Current rate of interest in capital market:

If the current rate of interest is high in capital market, companies prefer to raise capital by issuing equity shares rather than borrowing capital since borrowing at high interest proves costly for the company.
If the interest rate is less, companies also prefer debentures.

3. Cost of capital expenses of issuing securities:

When a company issues securities for raising the capital, it has to incur several expenses. The expenses include releasing prospectus, underwriting commission, brokerage, etc. As a result, the cost of capital increases.
The expense on issuing debenture is lesser then issuing securities.

4. Legal restrictions:

There are various legal restrictions which a company has to follow and hence they affect its capital structure.
As per Companies Act, the company raising capital fund through securities has to compulsorily issue equity shares. In addition to this, rules of SEBI and RBI and provision of Companies Act are also to be considered while formulating the capital structure.

5. Taxation policy:

When the taxation is high, the companies prefer to issue debentures for acquiring capital. By doing so, the income tax gives deduction of interest paid on the debentures to the company.
Naturally, equity shares become more popular if the income of dividend is tax free or the rate is lower on the dividend income.

6. Institutional investors:

Insurance companies, banks, financial institutions of state and central government, etc. invest in shares and debentures of the companies as per their established rules and conditions.
Trends and conditions of all these institutions are considered at the time of formulating capital structure or at the time of alteration of capital structure.

7. Foreign institutional investor:

A financial institution established and registered outside India and whose objective is to invest in prescribed securities in India in primary and secondary markets is known as foreign institutional investor (Fll).
Foreign institutional investors have to get registered with SEBI. Then, such institutions are permitted to purchase shares and debentures of Indian company.
Involvement of these institutions in the capital market of India affects the capital structure of the companies.

Question 25.
State the impact of booming and depressive market on the capital structure.
OR
Capital structure depends upon the current behavior of the capital market.
Answer:
Condition of boom-depression in capital market:
When the market is low i.e. depressed, the investors prefer to invest safely in debentures rather than in risky equity. This earns them reasonable returns. On the other hand, when market is in boom, the investors invest in equity shares so as to earn higher dividends and profits.

Thus, how the capital structure will be formed is also decided by the trends prevailing outside the company in the capital market.

Question 26.
What is the cost of issuing securities?
Answer:

When a company issues securities for raising the capital, it has to incur expenses for doing so.
The expenses for issuing securities include releasing prospectus, underwriting commission, brokerage, etc. As a result, the cost of capital increases.
The expense on issuing debenture is lesser then issuing securities.

Question 27.
Which legal restrictions does the company face while setting-up its capital structure?
Answer:
Legal restrictions:

There are various legal restrictions which a company has to follow and hence they affect its capital structure.
As per Companies Act, the company raising capital fund through securities has to compulsorily issue equity shares. In addition to this, rules of SEBI and RBI and provision of Companies Act are also to be considered while formulating the capital structure.

Question 28.
What is working and fixed capital?
Answer:
Working capital:

Capital needed in the business to run day-to-day expenses is known as working capital.
Working capital is generally used in current assets of business such as purchasing raw material, making payment to creditors, paying utility bills, etc.
Working capital continuously circulates in the business.

Fixed capital:

Capital invested in business for a period of five years or above is called fixed capital.
Fixed capital is invested in fixed assets such as land, building, machinery, plant, furniture, etc. Thus, fixed capital remains in business for a long period.

Question 29.
State important definitions of working capital.
Answer:

According to Lincoln, Doris and Stevens, “Working capital is the excess of current assets over current liabilities.”
According to J. S. Mill, “The sum of the current assets means the working capital.”

Question 30.
Explain: Net working capital.
Answer:
Net working capital:
Net working capital means current assets minus current liabilities.

Therefore, Net working capital = Current assets – Current liabilities

If current assets > current liabilities, it is called positive working capital.
If current assets < current liabilities, it is called negative working capital.

Question 31.
Discuss the characteristics of working capital.
Answer:
Characteristics of working capital:

Short term capital: Working capital is a short term capital.
Investment in current assets: Working capital (Gross) is used in current assets such as bill receivables, debtors, short term marketable securities, bank balance, cash, etc.
Liquidity: Liquidity is the basic feature of working capital. All the current assets in which working capital is employed are converted into cash easily.
Less risk: Working capital gets circulated for short term and it is easily convertible cash (i.e. it has high liquidity). Hence, there is less risk in working capital.
Changing form: The form of working capital keeps on changing constantly. For example, raw material is converted into semi-finished goods and finally into finished goods. Finished goods are converted into debtors if they get sold on credit, and into cash, if sold on cash.
To pay day-to-day expenses: Working capital is needed constantly to pay day-to-day expenses.
No depreciation: Since the form of working capital keeps on changing, its depreciation is not calculated.
Requirement according to type and form of business: Need of working capital depends upon the form and type of business. Thus its ratio is different in each business.

Question 32.
Explain the characteristics of fixed capital.
Answer:
1. Long period:
Fixed capital is invested in business for a long period of 5 years or above.

2. Different ratio in different types of business:

The ratio of fixed capital is quite high in large industries such as those producing machinery, chemical industries, petrochemical industries, etc.
The ratio of fixed capital is relatively low in trading units.

3. Components:
Fixed capital includes components such as land, building, plant, machinery, vehicles, furniture, etc.

4. Less liquidity:
Fixed capital is invested for a long period in the business. Hence, its liquidity remains low. (For example: One cannot immediately and easily sell machinery and plant set-up worth crores of rupees.)

5. Risk:

Fixed capital remains blocked up in fixed assets for a longer period. So, there arises a risk of return on investment in case changes occur in technology, preference of consumers, etc. because the machinery or plant may become obsolete as compared to these changes.
Apart from this, changes in political, social and economic factors also tend to raise the rate of risk.

6. Depreciation:
As per the taxation laws, depreciation is charged on the fixed assets in which fixed capital is invested. As a result, the book value of fixed assets decreases with time.

7. Sources:
There are several sources from which fixed capital can be raised. These include promoters of the business, owners of the business, various types of securities, financial institutions, ploughing back of profit, etc.

Question 33.
Discuss the risk associated with fixed capital.
Answer:
Risk:

Fixed capital remains blocked up in fixed assets for a longer period. So, there arises a risk of return on investment in case changes occur in technology, preference of consumers, etc. because the machinery or plant may become obsolete as compared to these changes.
Apart from this, changes in political, social and economic factors also tend to raise the rate of risk.

Question 34.
What are the various sources through which fixed capital can be raised?
Answer:
Sources:
There are several sources from which fixed capital can be raised. These include promoters of the business, owners of the business, various types of securities, financial institutions, ploughing back of profit, etc.

Question 35.
Which factors affect the need of fixed capital? Discuss in detail.
Answer:
1. Type and nature of business:

Industrial units involved in heavy industrial activities such as shipping industry, iron and steel industry, mining industry, etc. require huge sum of fixed capital.
Units providing services comparatively require less fixed capital.

2. Size of unit:
Small sized units require less fixed capital than large size industrial units. Cottage industry requires less fixed capital than sugar industry or textile industry. Similarly, the units engaged in manufacturing vehicles require huge fixed capital owing to their large scale production.

3. Use of ownership/lease:
Whether the fixed assets are to be purchased or leased affects the need and risk of fixed capital. For example, if fixed assets like land, building, machinery are to be obtained on lease instead of purchasing, the investment as well as risk of fixed capital decreases.

4. Research expense:

In order to remain steady in the ever competitive market, industrial units engage in research of their products and services.
Research makes the product better, more useful, helps in reducing cost of production, improves shape, form, stability and attractiveness. Activities under research increase the need of fixed capital.

5. Modern technology:
As technology becomes advanced, the industrial units have to upgrade their machinery, plant, manufacturing processes, etc, This raises the need of fixed capital.

6. Government assistance and taxation policy:

To encourage industries and for balanced growth of various regions, government provides help in form of grant or subsidy to people.
The help can be in the form of cheap or free land, industrial shades at reasonable rates, machinery at subsidized rates, etc. All this reduces the need of fixed capital.
Taxation policy of the government also affects the need of fixed capital. For example, when the government gives tax benefits or adopts liberal policy towards sale of some new machineries then it helps the entrepreneurs because their need for fixed capital reduces.

7. Establishment expenses:

The establishment expense of sole proprietorship, partnership firm and co-operative society is less as compared to that of the formation of a company.
Company has to bear expenses on preparing documents such as registration fees, fees of experts, legal expenses, etc. These expenses are quite less in other form of firms. So, the form of business enterprise also affects the fixed capital needed.

Question 36.
What role government assistance and taxation policy plays in deciding the fixed capital?
Answer:
Government assistance and taxation policy:

To encourage industries and for balanced growth of various regions, government provides help in form of grant or subsidy to people.
The help can be in the form of cheap or free land, industrial shades at reasonable rates, machinery at subsidized rates, etc. All this reduces the need of fixed capital.
Taxation policy of the government also affects the need of fixed capital. For example, when the government gives tax benefits or adopts liberal policy towards sale of some new machineries then it helps the entrepreneurs because their need for fixed capital reduces.

Question 37.
The manager not only has to acquire finance but also optimize its utilization. Explain.
Answer:

The financial manager studies the position of working capital and fixed capital thoroughly. He also studies the factors that affect these capitals.
After studying the requirement the manager has to study the various sources of finance such as equity shares, preference shares, debentures, bank loan, etc. and prepare the right mix of finance sourcing.
The task does not get over at just acquiring finance. The manager also needs to see that it is utilized and allocated properly. Failure to do so can lead to disaster or losing important capital raised for the business.

Question 38.
Credit policy affects capital requirement. Explain.
Answer:

If the business sells its goods on cash, it will require less on hand capital. But, if sold on credit, the business will be cash deficient.
In the same way, if the business can acquire raw material on credit and sell the goods on credit or cash, it will affect the capital available with the business.
Naturally, the availability of capital with the business will decide its credit requirements and policy.

Question 39.
A business cannot afford to form capital structure ignoring the capital market.
Answer:

Boom and depression are the two faces of capital market.
When the market is in boom, the company earns good profit. Investors become positive and invest in the shares of the company. This enhances the capital structure of the company.
When the market is in depression, the investors tend to invest in debt market so that they can safeguard their returns.
Thus, how the market behaves plays a very important role in the formation of capital structure of the company and hence it cannot be ignored.

Multiple Choice Questions

Question 1.
Finance is the of business.
(A) Heart
(B) Blood
(C) Soul
(D) All of these
Answer:
(B) Blood

Question 2.
“In the modern economy, based on utilization of funds, financial management means acquiring of required funds at the required time.” Who gave this definition?
(A) Prof. M. Kimbal
(B) Gary Hamel
(C) F. W. Paish
(D) Raymond J. Chambers
Answer:
(C) F. W. Paish

Question 3.
Financial management includes which of the following management functions?
(A) Planning
(B) Controlling
(C) Directing
(D) Both (A) and (B)
Answer:
(D) Both (A) and (B)

Question 4.
Which approach does the financial management adopt for maximizing economic welfare of the business owner?
(A) Profit maximization
(B) Wealth maximization
(C) Profit and market-share maximization
(D) Both (A) and (B)
Answer:
(D) Both (A) and (B)

Question 5.
Prof. Solomon has favoured
(A) Wealth maximization
(B) Profit maximization
(C) Both (A) and (B)
(D) None of these
Answer:
(A) Wealth maximization

Question 6.
Financial management has to make important decision related to
(A) Decisions related to investment
(B) Decisions related to financing
(C) Decisions related to dividend
(D) All of these
Answer:
(D) All of these

Question 7.
Dividend is a part of of a company which is distributed among its shareholders.
(A) Profit
(B) Investment
(C) Capital
(D) Share
Answer:
(A) Profit

Question 8.
_______ provides base for managerial decisions.
(A) Finance management
(B) Production management
(C) Quality control management
(D) Sales and marketing management
Answer:
(A) Finance management

Question 9.
“Capital structure means the proportion and magnitude of different securities issued and sources utilized by a company to raise its finance.” Who gave this definition?
(A) F. W. Paish
(B) Gary Hamel
(C) Prof. M. Kimbal
(D) Hogland
Answer:
(D) Hogland

Question 10.
Planning of fixed capital management is not required for
‘ (A) Land
(B) Building
(C) Raw material
(D) Technology upgradation
Answer:
(C) Raw material

Question 11.
Which of the following is not an internal factor affecting capital structure?
(A) Type of business
(B) Nature and requirement of assets
(C) Institutional investors
(D) Financial requirements
Answer:
(C) Institutional investors

Question 12.
Who are the real owners of the company?
(A) Managing directors
(B) Chief Executive Officer
(C) Share holders
(D) All stake holders
Answer:
(C) Share holders

Question 13.
Which of the following is not an external factor affecting capital structure?
(A) Condition of boom-depression in capital market
(B) Cost of capital expenses of issuing securities
(C) Legal restrictions
(D) None of these
Answer:
(D) None of these

Question 14.
Investment decisions are related to _______
(A) Shares and debentures
(B) Outstanding dividend to issue
(C) Assets
(D) Borrowed capital
Answer:
(C) Assets

Question 15.
If the business requires fixed assets on large scale, then the ratio of _______ will be high in capital structure of that business.
(A) Debentures
(B) Borrowed capital
(C) Equity share
(D) Bank loan
Answer:
(C) Equity share

Question 16.
Which avenue of investment should be preferred during recession in the market?
(A) Debenture
(B) Capital
(C) Lending
(D) None of these
Answer:
(A) Debenture

Question 17.
How much money should be lent largely depends on
(A) Amount of borrowed capital
(B) Share holding by the company
(C) Debentures
(D) Dividend
Answer:
(C) Debentures

Question 18.
If the current rate of interest is high in capital market, companies prefer to raise capital by _______ rather than
(A) Issuing shares; Borrowing capital
(B) Taking bank loans; Issuing shares
(C) Borrowing capital; Bank loans
(D) Releasing bonds; Issuing shares
Answer:
(A) Issuing shares; Borrowing capital

Question 19.
For a capital to be called fixed capital, it should be invested in the company for at least _______ years.
(A) 2
(B) 5
(C) 7
(D) 10
Answer:
(B) 5

Question 20.
Which of the following is not a part of gross working capital?
(A) Bills receivables
(B) Short term marketable securities
(C) Furniture and fixture
(D) None of these
Answer:
(C) Furniture and fixture

Question 21.
Since the form of working capital keeps on changing, its _______ is not calculated.
(A) Interest
(B) Pay-out
(C) Depreciation
(D) Impact
Answer:
(C) Depreciation

Financial Management – GSEB Std 12 Organization of Commerce and Management Notes

Concept and definition of financial management:

In general, management of finance is called financial management.
Financial management take decisions related to financial matter, executes them acquire funds and optimally utilizes them.

Characteristics of financial management:

Branch of management
Wide scope
Base of managerial decisions
Relation with financial decisions
Goal of maximization of owner’s economic welfare
Key position
Relation with other areas of management
Division in two parts

Objectives of financial management:
It has two objectives:
(a) Profit maximization and
(b) Wealth maximization

(a) Objective of profit maximization:

The objective of maximizing income of the company is called profit maximization.
According to this approach, the company should earn maximum profit out of its available resources. Company can increase earnings per share through the objective of maximization of profit.

(b) Objective of wealth maximization:

The concept of increasing the value of the business in order to increase the value of the shares held by the shareholders is called wealth maximization.
The objective of wealth maximization is also known as ‘Net Present Value (NPV)’. Decisions resulting in net present value should be accepted by the company.

Importance of financial management:

Estimation of financial needs
Acquiring finance
Planning and controlling
Distribution of finance
Maintaining liquidity
Distribution of income
Management of current assets
Financial decisions
Raising credit of business

Financial decisions:
1. Decisions related to investment:

Business requires capital investment in various assets that too for a long and fixed term. This includes investment in machinery, land, etc.
It is always a risk to identify the best asset in which investment should be made. Hence it is very crucial that decision of investment is evaluated in terms of expected return and risk.

2. Decisions related to financing:

Investment decisions are connected with the assets of the company while financing decisions are related to the capital structure.
Capital structure of the company consists of:
(a) equity shares
(b) equity shares and preference shares
(c) equity shares and debentures
(d) equity shares, preference shares and debentures.
Financial manager has to take decision regarding the portion to be maintained between equity and debt in capital structure.
Factors affecting financing decisions:
1. Internal factors and
2. External factors

3. Decisions related to dividend:

Dividend is a part of profit of a company which is distributed among its shareholders. Dividend is a return to shareholders on their investment.
The financial manager has to tactfully decide what part of profit should be distributed as dividend and what part of profit should be retained in business.

Capital structure:
Concept and definition:

The combination of different sources utilized by the company to raise necessary capital for running the company is called the capital structure.
Company procures capital by issuing various types of securities. Decisions regarding type of securities are reflected in the capital structure of the company. In what proportion the various types of securities should be issued is determined by financial manager.

Characteristics of ideal capital structure:

Simplicity
Profitability
Adequate finance
Flexibility
Economy
Balancing
Liquidity
Attractiveness
Solvency

Types of capital structure:
(A) Capital structure of only equity shares
(B) Capital structure of preference shares with equity shares
(C) Capital structure of debenture with equity shares and
(D) Capital structure of preference shares and debentures with equity shares

Factors affecting capital structure:
(A) Internal factors:

Type of business
Size of business
Estimation of business income
Nature and requirement of assets

(B) External factors:

Condition of boom-depression in capital market
Present rate of interest in capital market
Capital cost-expenses of security issue
Legal restrictions
Taxation policy
Institutional investors
Foreign institutional investors

Working capital:
Capital needed in the business to run day-to-day expenses is known as working capital.

Concept of working capital:

Gross working capital: Sum of total investment in current assets of business means working capital.
Net working capital: Net working capital means current assets minus current liabilities.

Difference between Gross Working Capital and Networking Capital:

Meaning
Liquidity position
Financial position and measurement
Increase in current liabilities

Characteristics of working capital:

Short term capital
Investment in current assets
Liquidity
Less risk
Changing form
To pay day-to-day expenses
No depreciation
Requirement according to type and form of business

Factors affecting working capital:

Type of nature of business
Size of business
Production cycle
Production policy and type of demand
Stockpile of raw materials
Credit policy

Fixed capital:
Capital invested in business for a period of five years or above is called fixed capital.

Characteristics:

Long term
Different ratio in different types of business
Components
Less liquidity

Factors affecting the needs of fixed capital:

Type and nature of business
Size of the unit
Use of ownership/lease
Research expense
Modern technology
Government assistance and taxation policy
Establishment expense

Difference between fixed capital and working capital:

Meaning
Period
Liquidity
Risk

GSEB Class 12 Organization of Commerce and Management Important Questions Chapter 8 Financial Management

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