Juraz- Enhance Your Commerce Skills with Us 6. Solution to financial problems.

Advantages of wealth maximisation

Objectives / Goals of financial management 1. It considers the time value of money.
FINANCIAL MANAGEMENT (B.COM ) Financial Objectives Non-financial objectives 2. It is universally accepted approach.
MODULE I Maximisation of profit Employee satisfaction and welfare
3. It consider the risk factor.
Maximisation of wealth Management satisfaction
Introduction to Financial Management Value maximisation Quality services to customers. 4. It focuses long term growth of the organisation.

Finance Function 5. It guides management in framing suitable dividend policy.

A) Maximisation of profit Criticism of wealth maximisation approach
Finance function is the process of acquiring and utilising funds by a
business. It is the main objective of the business enterprises. According to this 1. It is useful only in large business.
view, the aim of financial management is to earn maximum rate of
Financial management 2. It is not socially desirable.
profits on capital employed.
According to PJ Hastings, “Financial management is the art of raising 3. It leads to confusion of financial policy.
Advantages of profit maximisation
and spending money.”
1. it is essential for survival. 4. It is an indirect name of profit maximisation.
Nature / Characteristics of financial management
2. Achievement of social welfare. Difference between profit maximisation and wealth maximisation
1. Management of money.
3. It attract investors to invest their savings in securities. Profit Maximisation Wealth Maximisation
2. Financial planning and control. Short term objective Long term objective
4. It is a measurement of standard. Aims at maximising profit. Aims at maximising wealth.
3. Determination of business success.
5. It is a sufficient fund for future expansion. It is a traditional approach. It is a modern approach.
4. Focus on decision making. It ignores risk factor. It consider risk factor.
Criticism of profit maximisation It ignores society. It considers society.
5. Centralised in nature.
1. It ignores time value of money. It ignores time value of money. It considers time value of money.
6. Multidisciplinary.
2. It attracts cut-throat competition.
Importance of financial management C) Value Maximisation
3. It exploits workers and consumers.
1. Successful promotion. Another objective of financial management is to increase the value
4. It does not take into consideration the welfare of the society.
2. Smooth running of business. of the organisation. It maximises the long term market value of the
5. Profit cannot be ascertain well in advance. organisation.
3. Coordination of functional activities.
B) Maximisation of wealth Scope of financial management
4. Decision making.
The wealth maximisation approach aims at maximising the wealth of 1. Investment decision.
5. Determinants of business success.
the shareholders by increasing earnings per share.
2. Working capital decision.

3. Financing decision. 2.Discounting b) Financial risk

4. Dividend decision. The process of calculating present value of future money is called It refers to risk arises due to the presence of debt I the capital
discounting. structure of a firm.
5. Ensure liquidity.
Risk Return
6. Profit management.
7. Cash management According to Roman, “Risk is the probability of failure to accomplish It simply refers to benefits accrued on original investment made in
an objective.” an asset or investment.
Role / Responsibilities of financial manager
Types of risk Approaches to measurement of return
1. Performing financial analysis and planning.
1) Systematic Risk 1. Profit approach
2. investment decision.
It is a non-diversifier risk. It arises due to factors like economic, 2. Income approach
3. Financing decision. sociological, political, etc. 3. Cash flow approach.
4. Dividend decision. a) Market risk
4. Ratio approach.
5. Foreign exchange management. It refers to variability in stock prices due to change in investors
Risk-Return Trade-off
6. Investment planning. attitudes.
A particular combination where both risk and return are optimised is
Time Value of Money b) Interest rate risk
known as risk-return trade off.
The concept of time value is based on the fact money has a time It refers to risk arises due to change in value of security prices due to
value. This means value of money depends upon time. The value of change in interest rate in the market.
money changes over a period. c) Purchasing power risk MODULE II
Application / Uses of Time Value of Money It refers to risk arises due to inflation. It is also known as inflation Investment Decision
1. Bond valuation. risk.
Capital budgeting
2. stock valuation. 2) Unsystematic Risk
It is the process of making capital investment decisions.
3. Financial analysis of firms. It is a type of risk arises due to factors peculiar to a particular firm
Nature / Features of capital budgeting
such as labour strike, change in management etc.
4. Accept or rejection decisions for project management. 1. Funds are invested in long term activities.
a) Business risk
Techniques of time value of money 2. it involves large outlays.
It refers to variability in the actual earnings of a firm from its
1. Compounding 3. It involves high degree of risk.
expected earnings.
The process of calculating future value of present money is called 4. it requires careful planning.
compounding.

5. Gestation period is long. 3. Project evaluation Advantages of payback period Disadvantages of payback period
It is simple to understand It ignores time value of money
Role and importance of capital budgeting It is the process of evaluating profitability of each proposal.
It is easy to apply It ignores profitability
1. It involves huge investment in assets. 4. Project selection It is important for cash budgeting, It does not measure rate of return
2. It has long term affect on future profitability. It is a process of selection and approval of the best proposal. forecasting etc..
It considers liquidity It completely ignores cash inflow
3. Capital budgeting decision cannot be reversed easily. 5. Project execution after payback
4. It involves greater risk. After the election of project, funds are allocated for them and a It is useful in case of uncertainty
capital budget is prepared. Average rate of return method (ARR)
5. It affect the growth of a firm.
6. Performance review This method takes into account the earnings expected from the
6. It is difficult to make capital budgeting decision. investment over its whole life. It is based on accounting profit.
7. It facilitates cost control. In this stage, progress must be reviewed at periodical intervals.
Merits of ARR Demerits of ARR
Investment appraisal methods (Techniques of capital budgeting) It is simple to understand It ignores cashflows
Limitations of capital budgeting
Traditional Methods Modern Methods It is easy to apply It ignores time value of money
1. High degree of risk.
(Non-discounting techniques) (Discounting methods) It considers the profitability of It does not consider the life of the
2. It is difficult to estimate cost of capital. Urgency method Discount pay back method. investments project
Payback period method Net present value method It considers accounting income It ignored the fact profit can be
3. It is difficult to estimate rate of return.
Average rate of return method Benefit cost ratio reinvested
4. It is difficult to estimate period of investment. Internal rate of return Net Present Value Method (NPV)
5. It is expensive. Net terminal value method. Net present value is equal to the present value of all the future cash
Urgency method flows of a project less the initial outlay of project.
6. It is irreversible in nature.
In this method most urgent projects are taken up first. Advantages and Disadvantages of NPV
Capital budgeting process (Steps in capital budgeting)
Merits of urgency method Demerits of urgency method Advantages of NPV Disadvantages of NPV
1. Project generation It is a simple technique It is not based on scientific test
Capital budgeting process begins with identification of investment It is useful to short term projects Selection is based on situation It considers time value of Difficult to select discount rate.
proposals. money.

2. Project screening This method suitable when cash Complicated calculations

inflows are not uniform.
Each proposal is subject to a preliminary screening in order to assess Payback period method
technical feasibility. It is highly useful in case of This method is not suitable
It is the commonly used technique of evaluating proposals. It is a
mutually exclusive projects. when project having different
cash-based technique. Pay back period is the period required to
amount of investment.
recover the initial cost of the projects.
 It considers cash flow of entire It is not suitable when project Cost of capital need not be Applicability mainly in large It makes decision making easy. It does not help in decision
life of the project. having different useful lives. calculated. projects. making.
It focuses wealth maximisation Different discount rate will gives Considers cash flow of the Mutually exclusive projects are
objective. different present values. project. ignored.
Net Terminal Value Method (NTV)
Profitability Index Method (Discounted benefit cost Ratio) It gives a true picture of the Different terms of project is not This method is based on the assumption that each annual cash
profitability of a project. considered. inflows is received at the end of year and reinvested in another asset
It is the ratio of benefits to cost. It measures the present value of
returns. It is particularly useful to compare project having different It shows return on original at a certain rate of return from the moment it is received till
investment outlays. money invested. termination.
Advantages and Disadvantages of Profitability Index Advantages and Disadvantages of NTV
Advantages of Profitability Index Disadvantages of Profitability Index Comparison between NPV and IRR Advantages of NTV Disadvantages of NTV
It is scientific and logical. It is a difficult method. Similarities It is a simple technique. It is difficult to project the future
rate of return.
It considers fair rate of return. This method is not based on 1. Both consider time value of money.
accounting principles and concepts. It is simple to understand. It does not consider comparative
2. Both use cash inflows after tax.
evaluation of mutually exclusive
It is useful in case of capital Difficult to estimate effective life of 3. Both consider cash inflow through out the life of the project. projects.
rationing. a project.
4. Both lead to same acceptance or rejection decision. It is more suitable for cash
It considers time value of money. It cannot be used for project having
Difference between NPV and IRR budgeting.
unequal lives.
NPV IRR It avoids influence of cost of
It considers all cash flows during
capital.
the life of the project. It gives absolute return It gives percentage return.
Internal Rate of Return Method (IRR) It follows wealth maximisation It does not follow wealth
IRR is the interest rate at which the net present value of all the cash objective. maximisation objective. MODULE III
flows from a project equal to zero. NPV of different project can be IRR of different projects cannot
Cost of Equity
Advantages and disadvantages of IRR added. be added.
Cost of capital
Advantages of IRR Disadvantages of IRR Cost of capital is assumed to be Cost of capital is to be
known. determined. It refers to minimum required rate of return or the cut off rate for
It considers time value of It involves complicated capital expenditures.
money. calculations.

Features of cost of capital 3. Specific cost. Capital Asset Pricing Model (CAPM)
1. It is a rate of return required on the projects. It refers to the cost of a specific source of a capital. This approach was developed by William S Sharpe. According to this
approach, return on equity shares depends on amount of risks
2. It is the reward for business and financial risks. 4. Composite cost
associated with it. If more risk is associated with it, it will provide
3. It is the minimum rate of return on a firm. It refers to the combined cost of various source of capital. more return. If less risk, it will provide less return.
4. It is a riskless cost of particular source. 5. Average cost Weighted Average Cost of Capital (WACC)
Importance of cost of capital It refers to weighted average cost of capital calculated on the basis of It simply refers to average cost of various sources of finance.
cost of each source of capital and weights assigned to them in the
1. Useful in investment decision. Merits of WACC
ration of their share to total capital fund.
2. Useful in designing capital structure. 1. It is a straight forward approach.
6. Marginal cost
3. Useful in deciding method of finance. 2. It is useful in capital budgeting.
It is the cost of obtaining an extra one of finance.
4. Optimum mobilisation of resources. 3. It is more accurate when profits are normal.
7. Explicit cost
5. Useful in evaluation of performance of management. 4. It consider all changes in the capital structure.
It is a discount rate which equates the present value of cash inflows
Factors determining cost of capital with the present value of cash outflows. Limitations of WACC
1. General economic conditions. 8. Implicit cost 1. It is not suitable in case of low profits.
2. Risk. Implicit cost refers to rate of return which can be earned by investing 2. It is very difficult to assign weights.
3. Amount of finance required. the funds in alternative investment.
3. It is not suitable in case of excessive low cost debt.
4. Floatation cost. Cost of debt
Source of Finance
5. Taxes. It is the payment of interest on debentures or bonds or loans from 1) Share capital
financial institutions.
Classification of cost of capital The capital of a company is divided into small units. Those units are
Irredeemable debt called share.
1. Historical cost
These are the debts which are not repayable during the life of the
It refers to the cost which has already been incurred for financing a a) Equity share capital
company.
project. Shares which are not preference shares are called equity shares.
Redeemable debt
2. Future cost These are ordinary shares.
These are the debt issued to be redeemed after a certain period
It refers to the expected cost of fund to be raised for financing a b) Preference share capital
during the lifetime of a firm. Preference shares are those shares which carries preferential right
project.
with respect to payment of dividend and repayment of capital.

2) Debenture capital Difference between capital structure and finance structure 5. Safety
Debenture simply refers to acknowledgment of debt.
Capital structure Finance structure 6. Maximum return.
3) Term Loan
It includes long term and short It includes only long term source
A term loan is granted on the basis of agreement between borrower 7. Maximum control.
term source of fund. of the fund.
and the lending institution.
It means the entire liability side It means long term liabilities of Leverage
4) Venture capital
of the balance sheet. the company. Leverage may be defined as relative change in profits due to a
It refers to giving capital to enterprise that has risk and adventure.
5) Lease finance It consists of all source of It consists equity, preference
change in sales.
capital. and retained earning capital.
A lease is contractual arrangement calling for lessee to pay the lessor
It is not important while It is important while determining Types of leverage
for the use of an asset.
6) Retained earnings determining value of firm. value of firm. 1. Financial leverage
A part of profit earned every year shall be retained in the business.
The using of fixed cost capital with the equity share capital is known
The amount retained in the business is known as retained earnings. Factors determining capital structure
as financial leverage. It is also known as capital leverage.
Internal Factors External Factors
2. Operating leverage
Capital Structure Profitability Conditions in the capital market.
Liquidity Attitudes of investors. The presence of fixed cost is known as operating leverage. It
Capital Structure measures the changes in operating profit to changes in sales.
Flexibility Cost of financing.
According to CW Gerstenberg, “ Capital structure refers to the kind Size of business Legal requirements Difference between financial leverage and operating leverage
of securities that make up capitalisation.” Nature of business Taxation policy
Trading on equity Attitude of management Financial leverage Operating leverage
Capitalisation It show the relationship between It show the relationship between
Asset structure
It is a total amount of capital raised through shares, debentures, Desire to retain control operating profit and return on profit and return on equity.
bonds and retained earnings. equity.
It influences EAT. It influences EBIT.
Difference between capitalisation and capital structure Optimum Capital Structure It is the second stage leverage. It is the first stage leverage.
Capitalisation Capital Structure It is the capital structure at which the weighted average cost of the It deals with financial risk. It deals with business risk.
It is a quantitative concept It is a qualitative concept. capital is minimum and value of firm is maximum. It deals with investment decision. It deals with financing decision.
It is classified as over and under It is high or low geared. It related to liability side of the It related to asset side of the
Essentials / requisites of optimal capital structure balance sheet. balance sheet.
capitalisation.
It is influenced by internal needs It is influenced by external force. 1. Economy Combined leverage
of the company It refers to combination of operating leverage and financial leverage.
2. Liquidity and solvency
It is the total amount of capital It is the make up of
It is the relationship between contribution and taxable income. It is
raised through shares, capitalisation. 3. Flexibility
also known as overall leverage.
debentures etc. 4. Simplicity
 MODULE IV Factors/Determinants of dividend policy Dangers of Stable Dividend Policy

Dividend Internal factors External factors 1) Once a stable dividend is followed by a company, it is not easy to
Stability and size of earnings Trade cycle change it.
It is a part of profit of which is distributed to shareholders of the
Liquidity of funds Legal requirements 2) If the company cannot pay stable dividend in one year, investors
company.
Investment opportunities Corporate tax may lose the confidence.
Types/Forms of dividend Past dividend rates General state of economy
3) If the company pays stable dividend in spite of its incapacity, it will
1. Cash dividend Ability to borrow Government policy be suicidal in the long term.
Dividend paid in the form of cash is called cash dividend. It maybe of Need to repay debt Conditions in the capital market
2) Regular and Extra Dividend Policy
two types Attitude of management towards
control Under this policy shareholders are paid a fixed percentage regular
a) Regular dividend: It is the dividend declared and paid at the end of dividend along with extra dividend.
the accounting period. It is also called final dividend. Types of Dividend Policy
3) Regular Stock Dividend Policy
b) Interim dividend: It is the dividend declared before declaration of 1. Stable Dividend Policy
final dividend. Under this policy shareholders are paid bonus shares in addition to
Stable dividend means payment of certain minimum amount of
cash dividend.
2. Stock dividend dividend regularly.
4) Regular dividends plus stock dividend policy
If company do not have sufficient fund to pay dividend in the form of Advantages of stable dividend policy
cash, company may pay dividend in the form of stock. This is known Under this policy, regular dividend is paid in cash and extra dividend
A) Advantages to Shareholders
as stock dividend. in stock.
1) It increases the confidence of the shareholders.
3. Scrip dividend 5) Irregular dividend Policy
2) It meets expectation of investors by providing regular income.
It is a type of dividend which is issued by the company to its Under this policy higher rates of dividend shall be paid in the years of
shareholders in the form of promissory notes. 3) It stabilises the market value of shares. higher profits and lower rates of dividends in the year of lesser
4) It attracts investments from institutional investors. profits.
4. Bond dividend
B) Advantages to Company Optimal Dividend Policy
It is a type of dividend which is issued by the company to its
shareholders in the form of debentures or bond. 1) It increases the goodwill of the company Optimal dividend policy is one that maximise the firms value or its
share price.
5. Property dividend 2) It helps in preparing financial planning.
Dividend pay out ratio
Dividend paid in the form of assets is called property dividend. 3) It is a sign of continued normal operation of the company.
It is a type of ratio which establishes the relationship between
Dividend policy dividend per share and earnings per share.
It refers to policy relating to the distribution of profits as dividend.

Dividend Theories (Dividend Models) Walter’s Dividend Model (Walter’s Dividend Theory) 4. Cost of capital is constant.
The important dividend theories are: Prof. James E Walter has developed a dividend model. In this theory, 5. The firm has long term life.
Walter argues that dividend decision of a firm is relevant. Hence this
1) Modigliani and Miller Theory 6. Corporate taxes do not exist.
is a theory of relevance. This means dividend policy has an impact on
2) Walter’s Dividend Model market price of the share. Thus dividend policy affects the value of Residual Theory of Dividend
3) Myron Gordon’s Model the firm. According to this theory, dividends are paid out of the residual
Assumptions of Walter’s Model profits after meeting the requirement of the investment
1) Modigliani and Miller Irrelevancy Theory
opportunities.
This theory states that a firms dividend policy has no effect on value 1- The firm does not use external sources of fund.
of the firm or shareholders wealth. MM theory states that the value 2- The IRR and cost of capital are constant.
MODULE IV
of firm is unaffected by dividend policy i.e. dividend are irrelevant to
3- Earnings and dividend remains constant. Working Capital Management
shareholders wealth.
4- The firm has very long life. Working capital
Assumptions of MM Theory
5- All earnings are either distributed as dividend. It is the capital required for day to day working of an enterprise.
1- There are perfect capital market.
Criticism of Walter’s model
2- Investors behave rationally.
1. IRR does not remain constant. Nature of working capital
3- There is no floatation and transaction cost.
2. Cost of capital do not remain constant. 1. It is used for day to day activities of an enterprise.
4- There are no taxes.
3. We cannot predict firm has a very long life. 2. It is the amount invested in current assets.
5- The firm has a fixed investment policy.
4. Risk factor is not considered. 3. It involves cash management and inventory management.
6- No investor is large enough to affect the market price of shares.
3. GORDON’S MODEL 4. Two major concepts of working capital are gross concept and net
Criticisms of MM Theory
concept.
Gordon suggested dividends are relevant and it will affect the value
1. Perfect capital market does not exist in reality.
of the firm. According to Gordon, the market value of a share is equal 5. These are financed through short term sources.
2. Existence of floatation cost. to the present value of future infinite stream of dividends. Components of working capital
3. Differential rate of tax. Assumptions: 1. Current assets
4. Existence of transaction cost. 1. The firm is an all-equity firm. Current assets are those assets which can be easily converted into
5. Firms need not follow a fixed investment policy. 2. Retained earnings are the only source of financing the investment cash.
3. The rate of return on the firm’s investment (r) is constant. Eg: Cash, Bank, Debtors, Bills receivables

2. Current liabilities 2. Variable working capital 5. Liberal dividend policy encouraged.

Current liabilities are those liabilities which are repayable during a It is the working capital which varies with volume of business. Operating cycle
short period of time.
a) Seasonal working capital It refers to average time elapses between purchase of raw material
Eg: Sundry creditors, Bills payable, Outstanding expenses. and final cash realization.
It is the additional working capital needed at the busy season.
Concepts of working capital b) Special working capital Factors determining working capital requirements
1. Gross concept 1. Nature of business
It is the extra working capital to be maintained for special
According to gross concept, working capital refers to the amount of operations. 2. Size of business
fund invested in the current assets.
Importance/Need/Role of working capital 3. Production cycle
The working capital as per gross concept is called gross working
1. Continuity in business operation. 4. Turnover
capital.
2. Repayment of long term loans. 5. Terms of trade
2. Net concept
3. Helps to fight competition. 6. Business cycle fluctuations
According to net concept, working capital refers to excess of current
assets over current liabilities. 4. Increase creditworthiness. 7. Seasonal fluctuations

The working capital as per net concept is called net working capital. 5. Boost efficiency and productivity. 8. Company policies

Types of working capital Dangers of deficiency of working capital Hard-core working capital

1. Permanent working capital 1. It may lead to business failure. It refers to minimum amount of working capital required to invest in
raw materials, stores and working progress.
It is the minimum capital required for normal business operations. It 2. Trade discount will be lost.
is also called fixed working capital. 3. Cash discount will be lost. Working capital management

a) Initial working capital It simply refers to management of current assets and current
4. It affects dividend policy negatively.
liabilities.
Working capital needed at the initial stage is called initial working 5. Rate of return falls.
capital. Sources of working Capital
Danger for excessive working capital
b) Regular working capital Long term sources Short term sources Transactionary sources
1. Rate of return falls. Shares Commercial bank Trade creditors
It the amount needed for continuous operation of the business. Debentures Public deposit Depreciation
2. Encourage speculation.
c) Cushion working capital Loan Indigenous bankers Tax liability
3. Inefficiency may be encouraged. Retained earnings Factoring
It is the excess of working capital over the regular working capital. It
4. Efficiency of management may deteriorate.
is also called reserve margin.
Ploughing back of profit 4. Size and area of the operation. 6. To avoid under stocking of inventories.
It is the undistributed profit accumulated every year and retained for 5. Cash cycle. 7. To minimise loss on account of obsolescence, wastage etc.
meeting financial needs.
Cash Management Techniques of inventory management
Factoring
It is a process of managing cash inflows and cash outflows. 1. EOQ
It is a financial service in which business entity sell its bills receivables Scope / Functions of cash management The quantity of material to be ordered at one time is known as
to third party at a discount in order to raise fund.
economic order quantity.
1. Cash planning.
Cash 2. ABC analysis
2. Managing cash flows.
Cash means currency and equivalence of cash such as cheque, draft,
3. Managing optimum cash balance. It is an inventory management technique that determine value of
money orders etc.
inventory items based on their importance to business.
Motives for holding cash 4. Investing cash.
3. VED analysis
1. Transaction motive. 5. Maintaining relations with bank.
It is an inventory management technique that classifies inventory
Cash is necessary for business operation. It is required for financing Lock box system based on its functional importance.
transactions. It is a system of speedy collection of cash from debtors. It reduces 4. JIT (Just In Time)
2. Precautionary motive mail time delay.
It is an inventory management method whereby labour, material and
The firm need to hold some cash to meet unpredictable needs. Inventory goods are scheduled to arrive exactly when needed in the
It is the raw material used to produce goods as well as the goods that manufacturing process.
3. Speculative motive
are available for sale. 5. Reordering level
A firm sometime holds cash to take advantage of unexpected
opportunities. Inventory management It is that point of level of stock of a material where the storekeeper
4. Compensating motive It simply refers to management of inventory. It includes acquisition, starts the process of initiating purchase requisition for fresh supplies
storage and uses of materials. of that materials.
It is a motive for holding cash to compensate bank for providing
services or loans. Objectives of inventory management 6. Safety lock level
1. To ensure availability of inventories. It is also known as minimum level. It is the minimum quantity of
Factors determining the cash level or cash needs
material which must be maintained in hand at all times.
1. Credit policy 2. To minimise investment fund in the inventories.
Maximum level
2. Distribution channel 3. To minimise cost of ordering and carrying.
It is the maximum of stock which should be held in stock at any
3. Nature of the product 4. To maximise profitability.
period of year
5. To avoid over stocking of inventories.

Danger level 6. Collection policy.

It is a level of stock at which normal issue of materials are stopped 7. Quality of customers.
and issues are made only under specific instructions.
7. Perpetual Inventory system
This is just a theory short notes from all the modules. You all need to
A system of records maintained by the controlling departments focus on problem section well while preparing for the exams
which reflects the physical movements of stock and their current
balance.
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Receivables
Receivables are the debts owed to the company. It is also known as For more details, Prepared By:
accounts receivables or trade receivables.
8089778065 (WhatsApp only) JUBAIR MAJEED
Receivables Management
It refers to planning and control of receivables of a firm.
Objectives of receivables management
1. To increase sales.
2. To increase profitability.
3. To increase market share.
4. To increase customer base.
5. To evaluate and control receivables.

Factors affecting size of receivables

1. Credit policy.
2. Credit terms.
3. Nature of business.
4. Stability of sales.
5. Cost of receivables.