1.

Role of Finance Management

Finance management involves planning, organizing,
directing, and controlling financial resources to achieve
business objectives. It ensures proper fund allocation,
risk management, capital budgeting, and profit
maximization.
2. Source of Long-Term Finance
Long-term finance sources include:
 Equity Shares
 Debentures
 Bank Loans
 Retained Earnings
 Bonds
 Leasing & Hire Purchase
3. CAPM (Capital Asset Pricing Model)
CAPM calculates the expected return on an investment
considering risk. Formula:
R=Rf+β(Rm−Rf)R = R_f + \beta (R_m - R_f)R=Rf
+β(Rm−Rf)
Where:
 RRR = Expected return
 RfR_fRf = Risk-free rate
 RmR_mRm = Market return
 β\betaβ = Risk coefficient of the asset
4. Importance of Time Value of Money
Money today is worth more than the same amount in
the future due to earning potential. Key concepts
include Present Value (PV), Future Value (FV), and
Discounting.
5. Capital Budgeting Tools
 PBP (Payback Period): Time taken to recover
initial investment.
 IRR (Internal Rate of Return): Discount rate
making NPV zero.
 NPV (Net Present Value): Present value of cash
inflows minus outflows.
 ARR (Accounting Rate of Return): Average
annual profit divided by investment cost.
6. Capital Structure Decision
Based on:
 NI (Net Income Approach): Higher debt leads to
lower WACC and higher firm value.
 NOI (Net Operating Income Approach): Capital
structure has no impact on firm value.
 M&M (Modigliani & Miller Theorem): Under
certain conditions, capital structure is irrelevant.
7. What is Optimum Capital Structure?
It is the best mix of debt and equity to minimize the cost
of capital and maximize firm value.
8. Dividend Signaling
Theory stating that dividend changes convey
information about a firm’s future earnings.
9. Dividend Policy
Strategy a company follows to decide the size and
timing of dividend payments.
10. Importance of Working Capital (Receivable
Management)
 Ensures smooth business operations.
 Maintains liquidity.
 Prevents cash flow problems.
 Efficient receivable management improves cash
conversion cycle.
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Here are detailed explanations of the topics from your

notes:

1. Role of Finance Management

Finance management involves the efficient and
effective planning, directing, and controlling of
financial activities. Its primary goal is to maximize
shareholder wealth while ensuring financial stability.
Functions of Financial Management:
 Investment Decisions: Choosing the best
projects/assets to invest in.
 Financing Decisions: Deciding on the mix of debt
and equity for funding.
 Dividend Decisions: Determining whether to
retain profits or distribute dividends.
 Liquidity Management: Ensuring the firm has
enough cash flow for operations.

2. Sources of Long-Term Finance

Long-term finance is used for business expansion, asset
acquisition, and infrastructure development.
Main Sources:
 Equity Shares: Ownership stake in a company,
with voting rights and dividends.
 Preference Shares: Shares with fixed dividends
but limited voting rights.
 Debentures & Bonds: Loans from investors with
fixed interest payments.
 Bank Loans: Long-term borrowings from financial
institutions.
  Retained Earnings: Profits reinvested into the
business instead of paying dividends.
 Venture Capital: Funding from investors in
exchange for equity in a startup.
 Leasing & Hire Purchase: Acquiring assets by
paying periodic installments.

3. Capital Asset Pricing Model (CAPM)

CAPM is used to determine the expected return on an
investment considering its risk level.
Formula:
R=Rf+β(Rm−Rf)R = R_f + \beta (R_m - R_f)R=Rf
+β(Rm−Rf)
Where:
 RRR = Expected return on the investment
 RfR_fRf = Risk-free rate (e.g., government bonds)
 RmR_mRm = Market return
 β\betaβ = Risk measure (higher beta means higher
risk)
💡 Example: If the risk-free rate is 5%, market return is
10%, and stock beta is 1.2:
R=5%+1.2(10%−5%)=11%R = 5\% + 1.2(10\% - 5\%)
= 11\%R=5%+1.2(10%−5%)=11%
This means the expected return is 11%.
4. Importance of Time Value of Money (TVM)
TVM states that money today is worth more than the
same amount in the future due to earning potential.
Key Concepts:
 Present Value (PV): The current worth of future
cash flows.
 Future Value (FV): The amount money will grow
over time with interest.
 Discounting: Converting future values into present
values.
 Compounding: Growing present value into a
future sum using interest.
💡 Example:
₹1000 today at 10% annual interest will be worth
₹1100 in a year.

5. Capital Budgeting Tools

Capital budgeting helps businesses evaluate long-term
investment decisions.
Methods:
1. Payback Period (PBP): Time taken to recover the
initial investment.
o Shorter payback = Less risk.

o Ignores time value of money.

 2. Internal Rate of Return (IRR): The discount rate
that makes NPV zero.
o Higher IRR = More attractive investment.

o Used in project comparisons.

3. Net Present Value (NPV): Present value of cash

inflows minus initial cost.
o Positive NPV = Profitable investment.

o Considers time value of money.

4. Accounting Rate of Return (ARR): Profitability

measure based on accounting profits.
o Formula:

ARR=Average Annual ProfitInitial Investment

×100ARR = \frac{\text{Average Annual
Profit}}{\text{Initial Investment}} \times
100ARR=Initial InvestmentAverage Annual Pr
ofit×100
o Ignores cash flow timing.

6. Capital Structure Decision

Capital structure is the mix of debt and equity used for
financing a business.
Theories of Capital Structure:
1. Net Income (NI) Approach:
o More debt = Lower WACC = Higher firm

value.
o Assumes debt is cheaper than equity.

2. Net Operating Income (NOI) Approach:

 Capital structure does not affect firm value.
o

o Changing debt-to-equity ratio has no impact on

cost of capital.
3. Modigliani & Miller (M&M) Theorem:
o Under perfect market conditions, capital

structure is irrelevant.
o With tax benefits, debt financing is better due

to interest deductions.

7. Optimum Capital Structure

The best mix of debt and equity that minimizes the
cost of capital and maximizes firm value.
Factors Affecting Capital Structure:
 Cost of Capital: Lower cost means better
structure.
 Business Risk: Stable firms can take more debt.
 Growth Rate: Growing firms may prefer equity.
 Taxation: Higher tax benefits encourage debt
financing.
💡 Example: If debt costs 8% and equity costs 12%, a
company may take more debt to lower its overall
financing cost.

8. Dividend Signaling
Dividend decisions provide signals to investors about a
company's financial health.
Key Points:
 Higher Dividends = Positive Signal: Company
expects stable earnings.
 Lower Dividends = Negative Signal: Company
might face financial trouble.
 Stable Dividend Policy = Confidence: Investors
prefer consistent dividends.

9. Dividend Policy
A company's strategy for distributing profits as
dividends.
Types of Dividend Policies:
1. Stable Dividend Policy: Consistent payout,
preferred by investors.
2. Constant Payout Ratio: Fixed percentage of
profits paid as dividends.
3. Residual Dividend Policy: Dividends given after
funding all investments.
4. No Dividend Policy: Profits reinvested into the
business.
💡 Example: If a company earns ₹10 lakh and follows a
constant 40% payout ratio, dividends paid = ₹4 lakh.
10. Importance of Working Capital (Receivable
Management)
Working capital is the difference between current
assets and current liabilities.
Why It Matters:
 Ensures smooth operations (enough cash to pay
expenses).
 Helps maintain liquidity.
 Avoids cash flow issues.
 Supports credit sales while ensuring timely
collections.
Receivable Management Strategies:
1. Credit Policy: Setting credit limits for customers.
2. Credit Period: Deciding how long customers can
take to pay.
3. Collection Policy: Strategies to recover
outstanding dues.
4. Discounts for Early Payments: Encouraging
faster payments.
💡 Example: If a company allows customers to pay in
60 days but suppliers demand payment in 30 days, it
may face a cash shortage.