Financial Management

Capital structure refers to the financing pattern of a business, i.e. the proportion of owners’ funds and borrowed funds used in raising money. It is often expressed as the debt-equity ratio or as the proportion of debt in total capital.

Financial planning has two main objectives:

1. To ensure availability of funds whenever required — the business should have funds at the right time for long-term assets and day-to-day expenses.
2. To see that the firm does not raise resources unnecessarily — excess funds increase cost and may remain idle, so only required funds should be raised.

The concept of financial management that increases the return to equity shareholders due to the presence of fixed financial charges is called Trading on Equity. It refers to the increase in profit earned by equity shareholders because of fixed charges like interest.

A transport service usually requires less working capital because it is a service industry and does not need to keep much inventory. Since money is not blocked in raw materials or finished goods, the working capital requirement is relatively low.

Yes, it will affect working capital, and it will reduce the requirement of working capital.

Reason:
- Purchasing components on three months credit means the firm does not have to pay cash immediately, so cash is saved.
- Selling the final product in cash means cash is received quickly and debtors are not created.
- Therefore, less money remains blocked in current assets, so the working capital requirement falls.

Financial risk means the chance that a firm may fail to meet its fixed financial charges such as interest payment, preference dividend, and repayment obligations.

It arises because when a firm uses borrowed funds, it must pay:
- interest regularly, and
- principal on maturity,

whether or not it earns enough profit. Hence, more debt increases financial risk.

Current assets are assets that are expected to be converted into cash or cash equivalents within one year in the normal course of business.

Four examples are:
- Cash in hand
- Cash at bank
- Debtors
- Bills receivable

Other examples include inventory and marketable securities.

The primary objective of financial management is wealth maximisation, meaning the company should aim to maximise the market price of equity shares and thus the wealth of shareholders.

This is achieved by taking financial decisions that add value:
- investment decisions should give returns higher than cost,
- financing decisions should reduce cost of funds and control risk,
- dividend decisions should balance current dividend and retained earnings.

So, financial management tries to increase the current price of equity shares and thereby the owners’ wealth.

Financial management is based on three broad financial decisions:
1. Investment Decision
2. Financing Decision
3. Dividend Decision