FAQ

Unit 1
Question 1 What is Financial Management?
Financial management involves planning, organizing, directing, and
controlling financial activities such as procurement and utilization
Answer of funds. It aims to apply general management principles to the
firm's financial resources, focusing on optimal resource utilization
for maximizing wealth creation.
Question 2 What are the primary objectives of financial management?
The main objective is to maximize shareholder wealth, often
reflected in the market value of the firm's shares. This involves
Answer balancing risk and profitability while ensuring efficient resource
utilization and maintaining a balance between inflows and outflows
of funds.
Question 3 How has financial management evolved over time?
Initially, financial management was primarily about raising funds
and maintaining financial records. Over time, the scope expanded
Answer to include efficient allocation of funds, capital budgeting, and
strategic planning, influenced by technological innovations and
market globalization.
What is the difference between profit maximization and wealth
Question 4
maximization as objectives of financial management?
Profit maximization focuses on increasing the firm's earnings in the
short term, often neglecting the risk and timing of returns. On the
other hand, wealth maximisation considers the long-term growth
and sustainability of the firm, focusing on maximizing the market
Answer value of the firm's shares, thereby reflecting the interests of
shareholders more comprehensively.
 What is the role of a financial manager in a modern business
Question 5
environment?
A modern financial manager plays a dynamic role in
decision-making, focusing on optimal fund allocation, profit
Answer planning, understanding capital markets, and influencing the firm's
risk and return profile. They are integral in shaping the firm's
financial strategy, aligning it with overall business objectives.
 Misconceptions
Unit 1
Misconception 1 Financial management only involves managing a company's
investments.
Explanation Financial management encompasses a broader scope,
including procurement and effec ve u liza on of funds,
decision-making related to investment, financing, and
dividend policies, and ensuring the balance between risk and
profitability.
Misconception 2 The sole objec ve of financial management is profit
maximiza on.
Explanation While profit is important, the primary objec ve is wealth
maximiza on, which focuses on long-term growth and
sustainability by maximizing the market value of the firm's
shares, considering risk, return, and the ming of cash flows.
Misconception 3 Financial management has always been about strategic
decision-making.
Explanation Tradi onally, financial management was more about raising
funds and maintaining records. Its role in strategic decision-
making and comprehensive financial planning evolved over
me with economic changes and advancements in
management techniques.
Misconception 4 Financial management is separate from other business
func ons.
Explanation Financial management is deeply interconnected with other
business func ons such as marke ng, produc on, and human
resources. Decisions in financial management impact and are
influenced by these areas, requiring a cohesive approach to
ensure overall business efficiency.
Misconception 5 Financial managers primarily focus on external fund sourcing.
Explanation While sourcing funds is crucial, modern financial managers
also focus on the op mal alloca on and u liza on of these
funds, internal financial control, and aligning financial strategy
with broader business objec ves.
 FAQ
Unit 2
Question 1 What are the objec ves of financial statement analysis?
Financial statement analysis aims to understand a business's
financial status and performance by comparing various items from
balance sheets and profit and loss accounts. Different stakeholders
Answer
like investors, creditors, management, employees, and government
agencies use this analysis for diverse purposes, such as assessing
profitability, solvency, and overall company performance.
What is the difference between external and internal financial
Question 2
statement analysis?
External analysis is conducted by par es outside the firm, like
lenders and employees, using publicly available informa on. In
Answer contrast, internal analysis is carried out within the enterprise by
management using detailed, confiden al data to inform
decision-making.
Question 3 What are horizontal and ver cal financial analysis?
Horizontal analysis involves comparing financial data over several
years or across different firms in the same year to iden fy trends or
performance changes. Ver cal analysis, on the other hand,
Answer
examines the rela onship between various items within a single
financial statement, providing insights into the structure and
components of the firm's finances.
Question 4 What is ra o analysis in financial management?
Ra o analysis is a method of interpre ng financial statements by
establishing various ra os (quan ta ve rela onships between
figures). This technique helps in understanding the financial
Answer strengths and weaknesses of a firm, guiding decision-making
processes. However, it requires careful selec on, calcula on, and
interpreta on of appropriate ra os.
Question 5 What are the limita ons of financial statement analysis?
Financial statement analysis, par cularly ra o analysis, has
limita ons. A single ra o might not provide a complete picture and
requires interpreta on within a broader context. There are no
Answer
universally accepted standards for all ra os, making interpreta on
challenging. Addi onally, financial statements' historical nature
might not accurately reflect future prospects.
 Misconceptions
Unit 2
Misconception 1 Financial statement analysis only benefits investors.
Explanation While investors are major users, financial statement analysis is
also crucial for creditors, management, employees, and other
stakeholders, each with different analy cal focus areas.
Misconception 2 Horizontal analysis is the same as ver cal analysis.
Explanation Horizontal analysis compares financial data over me or across
different firms, focusing on trends and performance changes.
Ver cal analysis examines rela onships within a single
financial statement to understand the firm's structural
composi on.
Misconception 3 Ra o analysis offers conclusive financial insights.
Explanation While ra o analysis is a powerful tool, it has limita ons. Ra os
need to be interpreted in context, and all ra os have no
universal standards. Also, reliance on historical data might not
accurately predict future condi ons.
Misconception 4 Financial analysis is only relevant for short-term assessment.
Explanation Financial analysis caters to both short-term and long-term
assessments. Short-term creditors may focus on liquidity
ra os, while long-term creditors and investors might be more
interested in the firm's solvency, profitability, and growth
prospects.
Misconception 5 All financial ra os are equally important.
Explanation Different ra os serve different purposes and have varying
degrees of importance based on the user's objec ves. Some
ra os are considered primary, being of prime importance for
certain analyses, while others are secondary and support the
primary ra os.
 FAQ
Unit 3
Question 1 What is the me value of money?
The me value of money is a financial concept sta ng that money
available now is worth more than the same amount in the future
Answer due to its poten al earning capacity. This core principle of finance
holds that provided money can earn interest, any amount of money
is worth more the sooner it is received.
Question 2 How is future value computed?
The future value of a single cash flow can be calculated using the
formula: FV = PV × (1 + r)n, where PV is the present value, r is the
Answer interest rate, and n is the number of periods. This formula
compounds the present value at a given rate of interest to find its
value in the future.
Question 3 What is an annuity, and how is its future value determined?
An annuity is a series of equal payments made at regular intervals.
The future value of an annuity can be calculated using the formula:
Answer
, where P is the payment amount, r is the interest rate
per period, and n is the number of periods.
Question 4 What is compounding, and how does it affect future value?
Compounding is the process of earning interest on both the ini al
principal and the accumulated interest from previous periods.
Compounding can occur annually, semi-annually, quarterly, or
Answer
monthly. The more frequently compounding occurs, the higher the
future value, as the effec ve interest rate increases with more
frequent compounding.
Question 5 How is the present value calculated?
Present value is the current value of a future sum of money or
stream of cash flows, given a specified rate of return. The present
Answer
value formula is , where FV is the future value, r is the
discount rate, and n is the number of periods.
 Misconceptions
Unit 3
Misconception 1 The me value of money is only relevant for large investments.
Explanation The me value of money concept is relevant for any amount of
money because it emphasizes the poten al earning capacity of
money, regardless of the amount.
Misconception 2 Annui es always provide payments at the end of each period.
Explanation Annui es can be regular (payments at the end of each period)
or annui es due (payments at the beginning of each period).
The ming of payments affects the calcula on of their future
value.
Misconception 3 Compounding is only done annually.
Explanation Compounding can occur at various frequencies - annually,
semi-annually, quarterly, or monthly. The frequency of
compounding affects the future value of an investment.
Misconception 4 Present value is only important for future cash flows.
Explanation Present value is also crucial in comparing investments and
making decisions between different financial op ons, as it
provides a way to assess the value of money at the present
me.
Misconception 5 Perpetui es are not realis c financial instruments.
Explanation Perpetui es, which are annui es with an infinite dura on, do
exist in the real world, o en in the form of preferred stocks or
certain types of bonds.
 FAQ
Unit 4
Question 1 What is leverage in financial management?
Leverage in financial management refers to the use of debt
(borrowed capital) in addi on to equity in the capital structure to
finance a company's opera ons and investments. It is a strategy to
increase the poten al return on equity through the use of debt.
There are two main types of leverage: opera ng leverage and
Answer
financial leverage. Opera ng leverage is concerned with the ra o of
fixed opera ng expenses to total expenses and its effect on a
company's earnings, while financial leverage deals with the use of
debt in the firm's capital structure and its impact on earnings per
share (EPS).
Question 2 How does opera ng leverage affect a company's earnings?
Opera ng leverage measures the propor on of fixed costs in a
company's total costs. It impacts earnings by magnifying the effects
of changes in sales on the earnings before interest and taxes (EBIT).
Answer
A company with high opera ng leverage has a greater poten al for
increased profitability with rising sales, as its fixed costs remain
constant while revenue increases.
What is financial leverage, and how does it affect earnings per
Question 3
share (EPS)?
Financial leverage involves using debt to finance a company's
opera ons. It affects a company's EPS by changing the propor on
of debt in its capital structure, influencing the amount of interest
Answer
paid and, consequently, the earnings available to shareholders.
Higher financial leverage can lead to higher EPS if the company's
earnings are sufficient to cover the interest expenses.
Question 4 What is combined leverage, and how is it calculated?
Combined leverage is a measure of a company's total risk,
Answer combining both opera ng and financial leverage. It shows the
impact of fixed opera ng and financial costs on EPS. The Degree of
 Combined Leverage (DCL) is calculated as the product of the Degree
of Opera ng Leverage (DOL) and the Degree of Financial Leverage
(DFL).
How do different capital structure theories affect the market value
Question 5
of a firm?
There are several theories regarding the impact of capital structure
on a firm's market value. The Net Income Approach suggests that
increasing financial leverage can lower the cost of capital and
increase market value. The Net Opera ng Income Approach argues
Answer that capital structure doesn't affect the firm's market value, which
depends solely on opera ng income and risk. The Tradi onal
Approach balances these views, sugges ng that an op mal level of
debt can enhance value, but excessive debt increases risk and
poten ally lowers value.
 Misconceptions
Unit 4
Misconception 1 Leverage only increases financial risk.
Explanation While leverage does increase financial risk, it also has the
poten al to increase returns on equity. The key is in how
effec vely the borrowed capital is u lized.
Misconception 2 High opera ng leverage always leads to higher profits.
Explanation High opera ng leverage can magnify profits when sales are
rising, but it can also magnify losses when sales decline due to
the high fixed costs.
Misconception 3 Financial leverage is always beneficial for increasing EPS.
Explanation Financial leverage can increase EPS, but only if the company's
return on investment is greater than the interest rate on the
borrowed funds. If not, it can decrease EPS.
Misconception 4 Capital structure decisions do not impact a company's value.
Explanation Capital structure decisions can significantly impact a
company's risk profile and cost of capital, affec ng its market
value.
Misconception 5 The op mal capital structure is the same for all firms.
Explanation The op mal capital structure varies depending on a firm's
specific circumstances, including its industry, market
condi ons, and risk profile.
 FAQ
Unit 5
Question 1 What is working capital in business management?
Working capital refers to the funds a business requires for its
day-to-day opera ons. It is essen al for maintaining the smooth
func oning of a business and is calculated as the difference
Answer between a company's current assets and current liabili es.
Managing working capital effec vely is crucial to ensure a business
has sufficient cash flow to meet its short-term obliga ons and
opera onal needs.
Question 2 How is working capital classified?
Working capital is classified into various types:
a. Gross Working Capital: Total investment in current assets.
b. Net Working Capital: Difference between current assets and
current liabili es.
Answer c. Permanent Working Capital: Minimum level of current assets
needed to con nue opera ons throughout the year.
d. Temporary or Variable Working Capital: Addi onal current assets
needed at different mes during the year due to seasonal or
cyclical demands.
Question 3 What is the importance of adequate working capital?
Adequate working capital is vital for a business as it ensures the
firm can meet its current obliga ons, maintain a good credit
standing, efficiently manage its opera ons, and withstand periods
Answer
of financial uncertainty. It also helps in maintaining sufficient
inventory levels and extending favourable credit terms to
customers.
Question 4 What are the dangers of excessive working capital?
Excessive working capital can lead to inefficiencies and
complacency in managing resources. It may encourage overtrading,
Answer
excessive stock holding, and could result in an imbalance between
liquidity and profitability. Ul mately, it could lead to reduced
 efficiency and overcapitaliza on.
Question 5 What factors determine the working capital needs of a firm?
The working capital needs of a firm are determined by various
internal factors (like the nature and size of business, produc on
Answer
policy, credit policy, etc.) and external factors (such as business
fluctua ons, technological developments, import policy, etc.).
 Misconceptions
Unit 5
Misconception 1 Working capital only refers to cash reserves.
Explanation Working capital encompasses all current assets, not just cash.
It includes inventory, accounts receivable, and other short-
term assets that are crucial for daily opera ons.
Misconception 2 Only large businesses need to manage working capital.
Explanation Both small and large businesses need effec ve working capital
management. Small businesses, in par cular, may rely more
heavily on working capital due to limited access to capital
markets and other funding sources.
Misconception 3 Having high working capital is always good.
Explanation While adequate working capital is necessary, having too much
can be inefficient. Excessive working capital might e up funds
that could be used more produc vely elsewhere in the
business.
Misconception 4 Working capital management is only about managing cash.
Explanation Working capital management involves managing all aspects of
current assets and liabili es, not just cash. It includes
managing inventory levels, accounts receivable and payable,
and short-term financing decisions.
Misconception 5 The working capital cycle is the same across all industries.
Explanation The working capital cycle can vary significantly between
industries due to differences like opera ons, produc on
cycles, and credit terms.