xii Business studies

3. Objectives financial planning
• To supply adequate funds to ensure optimum
utilization of resources
• To minimize cost of raising funds
• To protect the owners against loss of control of
the business
• To provide flexibility in the financial structure
• To keep financial plan simple and consistent
with other objectives

4. Importance of financial planning
• It integrates the different functional departments
• It helps to eliminate waste and ensures maximum profitability
• It ensures adequate supply of funds
• It reduces uncertainty about the availability of funds
• It attempts to achieve a balance between the inflow and
outflow of funds
• It serves the basis of financial control
• It helps reduce the cost of financing
• It enables the optimum utilization of financial resources
• It enables to communicate the goals of the top management
properly

6. • Capital structure is the proportion of debt and equity
used for financing the operations of a business.
• There are two types of long term funds:- Ownership
fund(shares…) & borrowed fund(long term loans…)
• Capital structure refers to the mix or composition of
long term sources of funds such as debentures, long
term debt, preference share capital , equity share
capital and reserves and surplus

7. Features of capital structure
• Maximum return: The capital structure must give
maximum return to its shareholders.
• Minimum risk: The optimum capital structure should
minimize cost and maximize return
• Flexibility: The capital structure should be flexible to
make changes according to changing conditions of the
business
• Control: The capital structure should not involve the loss
of control of the share holders
• Solvency: The capital structure should ensure solvency to
the business

8. Capital Gearing
• Capital gearing is the ratio of equity share capital to
the total capitalization.
• When the proportion of equity to total
capitalization is very small, the company said to be
High geared.
• When the proportion of equity to total
capitalization is more, the company said to be Low
geared.

9. Capital Gearing
Company A Company B
a Equity Share Capital 500000 1500000
b Debentures 1500000 500000
Total Capitalization 2000000 2000000
Capital Gearing
= Equity share capital x 100
Total capitalization
500000 x 100
2000000
= 25% (high geared)
1500000 x 100
2000000
= 75% (low geared)

10. Factors determining capital structure
• Financial Leverage: The use of debt and preference shares
in the capital structure with a view to maximize the
earnings per share of equity shareholders is called financial
leverage or trading on equity.
• Cash flow ability for servicing the debt: Servicing of debts
means paying of interest and principal amount of loans as
and when it is due for payment.
• Growth and stability of sales: Companies may not face
difficulty in meeting its obligations if the sales are fairly
stable.

11. • Cost of capital: Cost of capital means the minimum
return expected by the suppliers of capital. Debt
capital is a cheaper source of finance in terms of
cost of capital, because, the suppliers expect less
return.
• Nature and Size of the firm: Large scale business
depends on debt capital, where as small firms may
have to depends on equity capital
• Control: Equity shareholders have complete control
over the affairs of the company. If the company
prefers tight control over the company, it includes
more debt and preference share capital in the
capital structure. If it increases the number of
equity shares, the control will be diluted.

12. • Flexibility: The capital structure should be flexible
enough to raise additional funds without undue delay
and cost.
• Capital Market conditions: The conditions of the
capital market determines the kind of shares to be
issued
• Floatation cost: The issue of share or debentures may
involve with floatation cost like advertisement, printing,
statutory fees, etc.
• Legal frame work: The structure of capital of a
company also depends on legal formalities (Banking
Regulation Act,SEBI guide lines etc..).

16. FIXED CAPITAL
• Fixed capital is that portion of the capital which
is invested in fixed assets or long term assets.
• It is also called as block capital. (E.g. Land &
Building, goodwill etc).
• The money invested in fixed capital is blocked
and not available for day to day operations.

17. Fixed capital
• These are invested for a long term on
permanent basis to increase the earning
capacity of the businesses
• Management of fixed capital refers to
procurement and allocation of firm’s capital on
different assets for a longer period.
• These decisions are called investment decision
or capital budgeting

18. Factors Determining Fixed capital
– Nature of business: the nature and type of activities
determine the volume of fixed capital requirement
– Mode of acquisition of fixed assets: If the assets are
purchased on installment or rent, less fixed capital is
required. If it is purchased on cash basis, more fixed
capital is required
– Size and Scale of the business: If the size of the business
is large, it will require large amount of fixed capital

19. Factors Determining Fixed capital
– Productionprocess: The techniques of production process
determine the requirement of working capital. Mechanized
production process involve larger fixed capital than labor
intensive process.
– Typeof manufacturingprocess: Assembling and service industries
require fixed capital. But processing industries require
larger fixed capital
– Type of Products: Companies producing consumer articles
require smaller amount of fixed capital than those
companies which produces vehicles, machines, etc.

24. Eg:cash, inventories Account receivables and
prepaid expenses
This may be defined as the excess of current asset over current
liabilities.