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| Financial Planning |
It refers to estimate the amount of capital and its composition without financial planning company may have to face problem of excess or shortage of funds.So financial planning helps in reducing financial wastage and helps in facilitating control throughout the organisation.So, we can conclude that durable success of a business depends on proper financial planning.
Capital Structure...
To determine the proportion of various sources of funds such as shares, debentures, loans etc create a structure called capital structure .Proper balance must be obtaining during the formation of Capital structure so that it may be able to maximize the wealth of shareholders or owners.
Features of Capital Structure...
1) it should give maximum return.
2) it should have flexibility can be changed accordingly.
3) the debt should be used carefully as it risk to the company.
4) it should have the capacity to meet companies obligations.
Financial Leverage...
A company can raise capital by issuing 3 types of securities.
1) Equity Shares
2) Preference shares
3) Debentures..
Preference shares carries a fixed rate of dividend and debentures carry a fixed rate of interest whereas equity shares are paid dividend out of profits left after payment of interest on debentures and dividend on preference shares.If rate of return on fixed return securities is lower than the rate of earnings then the returns on equity shares will be high .The situation is known as Financial Leverage or Capital Gearing.Thus , Financial Leverage is an arrangement under which fixed return securities (preference shares and debentures) are used to raise cheaper funds to increase the return to equity shareholders.
Factors affecting Capital Structure:
1) Financial Leverage
2) Cash Flow Ability -Debentures and preference shares are to be paid back after their maturity so the expected cash flows must be sufficient to meet the interest liability on debentures.Thus, Debentures are not suitable for those company's which are likely to have irregular cash flows.
3) Control Over the Company -it is entrusted to the board of directors elected by the shareholders if the board of directors and owners of a company wish to control over the company in their hands ,they may not allow to issue further shares in such a case more funds can be raised by issuing preference shares and debentures.
4) Flexibility -A good capital structure should be flexible and in order to bring flexibility those securities hould be issue which can be paid of after a number of years . Preference shares and Debentures can be paid off whenever the company feels necessary.It provides elasticity in the structure.
5) Floatation Cost -Cost of raising finance should be estimated carefully to decide which of the alternatives is cheapest ,it is also essential to considered the floatation cost involved in the issue of shares debentures such as printing of prospectus and advertisements etc.
6) Market Condition-the conditions prevailing in the capital market influence on the determination of security to be issued for example during depression people do not prefer to take risk and so are not interested in equity shares but during boom period investors are ready to take risk and invest in equity shares.
7). Legal Requirement -the structure of capital of a company is also affected by its legal requirements for example banking companies have been prohibited by the Banking Regulation Act to issue any type of securities except equity shares.
Capitalization -
The Capitalization of a company is the sum total of all long term funds and those reserves meant for distribution.It comprises share capital, debentures,long -term borrowings and free reserves of the company.
The amount of capitalization should be related to the earning capacity of the company.There are 3 possible situations of capitalization:
i) Fair or Normal Capitalization - it means the business has employed correct amount of capital and its earnings are same as the average rate of earnings of the company.
ii) Over Capitalization - it means business has employed more capital then required and it's earnings are less than the average rate of earning of the company.
iii). Under Capitalization - it means that the business has employed less capital and its earnings are more than the average rate of earnings of the company .
Q1 Explain the relevance of time value of money in financial decisions?
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| Time value of money.. |
Time value of money in financial decisions
The finance manager is required to make decisions on investment, financing and dividend keeping in view the objectives of a company.The investing and financing decisions effect the cash flows in different time periods.These cash inflows and outflows at different time period are not comparable because a rupee received now is not comparable with a rupee to be received in future.However they can be made comparable by introducing the interest factor.This concept is called as time value of money.The cash flows arising at different periods can be made comparable by using any one of two ways:-
1)By compounding - That is calculating the value of money in future.
2) By discounting - That is by calculating the present value of money.
There are three reasons that the money received today is of more worth than rupee received tomorrow:
1) Risk - There is uncertainty about the receipt of money in future.
2) Preference for present consumption -A person always prefers to consume money now than to consume it in future.
3) Investment opportunities - If the money is recieved now than it can be invested somewhere to earn something on it .
