1.What do you mean by business finance. Discuss various approaches to financial function?

Business finance is the practice of using the information in company financial statements to
make strategic decisions. While accounting tracks and organizes your company's
financial information, business finance uses this information to help you manage your
money and make your operation more profitable.

A number of approaches are associated with finance function but for the sake of
convenience, various approaches are divided into two broad categories:
1. The Traditional Approach

2. The Modern Approach

1. The Traditional Approach:

The traditional approach to the finance function relates to the initial stages of its evolution
during 1920s and 1930s when the term ‘corporation finance’ was used to describe what is
known in the academic world today as the ‘financial management’. According to this
approach, the scope, of finance function was confined to only procurement of funds needed
by a business on most suitable terms.

The utilisation of funds was considered beyond the purview of finance function. It was felt
that decisions regarding the application of funds are taken somewhere else in the
organisation. However, institutions and instruments for raising funds were considered to be
a part of finance function.The scope of the finance function, thus, revolved around the study
of rapidly growing capital market institutions, instruments and practices involved in raising
of external funds.

2. The Modern Approach:

The modern approach views finance function in broader sense. It includes both rising of
funds as well as their effective utilisation under the purview of finance. The finance function
does not stop only by finding out sources of raising enough funds; their proper utilisation is
also to be considered. The cost of raising funds and the returns from their use should be
compared.

The funds raised should be able to give more returns than the costs involved in procuring
them. The utilisation of funds requires decision making. Finance has to be considered as an
integral part of overall management. So finance functions, according to this approach,
covers financial planning, rising of funds, allocation of funds, financial control etc.
The new approach is an analytical way of dealing with financial problems of a firm. The
techniques of models, mathematical programming, simulations and financial engineering
are used in financial management to solve complex problems of present day finance.

The modern approach considers the three basic management decisions, i.e., investment
decisions, financing decisions and dividend decisions within the scope of finance function.

2. What is financial management? Explain the objectives of financial management?

Financial Management means planning, organizing, directing and controlling the financial
activities such as procurement and utilization of funds of the enterprise. It means applying
general management principles to financial resources of the enterprise.

Objectives of Financial Management

Financial management is concerned with procurement and use of funds. It’s the main aim to
use business funds in such a way that the firm value/ earnings are maximised. Financial
management provides a framework for selecting a proper course of action and decicding a
viable commercial strategy. The main objective of a business is to maximise the owner’s
economic welfare.
The objective can be achieved by:

1.Profit maximization
2.Wealth Maximization

1.Profit maximization
Profit earning is the main aim of every economic activity. A business being an economic
institution must earn profit to cover its costs and provide funds for growth. No business
survives without earning profit. Profit is a measure of efficiency of a business enterprise.
Profits also serve as protection against risks which cannot be ensured. The accumulated
profits enable a business to face risks like fall in prices, competition from other units,
adverse government policies etc. Thus, profit maximization is considered as the main
objective of the business.

2.Wealth maximization
Wealth maximization is the appropriate objective of an enterprise. Financial theory asserts
that wealth maximization is the single substitute for a stockholder’s utility. When the firm
maximises the stockholder’s wealth, the individual stockholder can use this wealth to
maximise his individual utility. It means that by maximising stockholders within the firm is
operating consistently towards maximising stockholder’s utility. A stockholder’s current
wealth in the firm is the product of the number of shares owned, multiplied with the
current stock price per share.
3. Financial function is concerned with allocating funds to specific assets and obtaining the
best mix of financing in relation to overall valuation of the firm , Discuss?

4. Critically analyse the functions of financial manager in a large scale industrial investment.

The functions are as follows

1.Financial Forecasting and Planning: a financial manager has to estimate the financial
needs of a business. How much money will be required for acquiring assets? The amount
will be needed for purchasing fixed assets and meeting working capital needs. He has to
plan the funds needed in the future. How these funds will be acquired and applied is an
important function of a finance manager.

2.Acquisition of funds: After making financial planning, the next step will be to acquire
funds. There are number of sources available for supplying funds. These sources may be
shares, debentures, financial institution, commercial banks, etc. The selection of an
appropriate source is a delicate task. The choice of a wrong source for funds may create
difficulties at a later stage. The pros and cons of various sources should be analysed before
making a final decision.

3.Investment of Funds: The funds should be used in best possible way. The cost of acquiring
them and the returns should be compared. The channels which generate higher returns
should be preferred. The technique of capital budget may be helpful in selecting a project.
The objective of maximising profits will have achieved only when funds are efficiently used
and they do not remain idle at any time. A financial manager has to keep in the mind the
principles of safety, liquidity and soundness while investing funds.

4.Helping in valuation decisions: a number of merges and consolidations take place in the
present competitive industrial world. A finance manager is supposed to assist management
in making valuation etc. For the purpose, he should understand various methods of
valuating shares and other assets so that correct values are arrived at.

5.Maintain the proper liquidity: Every concern is required to maintain some liquidity for
meeting day to day needs. Cash is the best source for maintaining liquidity. It required to
purchase raw materials, pay workers, meet other expenses, etc. A financial manager is
required to determine the need for liquid assets and then arrange liquid assets in such a
way that there is no scarcity of funds.
5.Maximization of profit is regarded as the proper objective of investment decision but it is
not as exclusive as maximising a shareholders wealth , Comment ?

Wealth maximization not only serves servers shareholders’ interests by increasing the value
of holding but ensures security to lenders also. The employees may also try to acquire share
of company’s wealth through bargaining. Their productivity and efficiency is the primary
consideration in raising company’s wealth. The survival of management for a longer period
will be served if the interests of various groups are served properly. Management is elected
body of shareholders. The shareholders may not like to change management if it is able to
increase the value of their holdings. The efficient allocation of productive resources will be
essential for raising the wealth of the company. The interest of the society is served if
various resources are put to economical and efficient use.

6.What is a scope of financial function in a business enterprise. Should the goal be profit
maximization or wealth maximization?

1. Estimating Financial Requirements: The first task of a financial manager is to

estimate short term and long term financial requirements of his business. For the
purpose , he will prepare a financial plan for present as well as for future. The
amount required for purchasing fixed assets as well as needs of funds for working
capital will have to ascertained.

2.Deciding Capital Structure : The capital structure refers to the kind and proportion of
different securities for raising funds. After deciding about the quantum of funds
required it should be decided which type of securities should be raised. It may be wise
to finance fixed assets through long term debts.

3.Selecting Source Of Finance: After preparing a capital structure, an appropriate source

of finance is selected. Various sources from which finance may be raised, include : Share
capital, debentures, financial deposits and financial institutions may be appropriate; on the
other hand, if long term finances are required then share capital and debentures may be
useful.

4.Selecting A Pattern of Investment: When funds have been procured then decision about
pattern is to be taken. The selection of an investment pattern is related to the use of funds.
A decision will have to be taken as to which assets are to be purchased? The funds will have
to be spent first on fixed assets and then an appropriate portion will be retained for working
capital.

5.Proper Cash Investment: Cash management is also important task of financial manager. He
has to assess various cash needs at different times and then make arrangements for
arranging cash. Cash may be required (A)make payment to creditors (B) meet wage bills (C)
purchase raw material
(D) meet day to day expenses. The cash management should be in such that neither there is
a shortage of it and nor it is idle. Any shortage of cash will damage the creditworthiness of
the enterprise.

6.Implementing financial controls: An efficient system of financial management necessitates

the use of various control devices. Financial control devices generally used are, : (A)return of
investment (B) Budgetary Control (C) Break even Analysis (D) Cost control (E) Ratio Analysis
(F) Cost and internal Audit. Return on investment is the best control device to evaluate the
performance of various financial policies.

7.Proper Use of Surpluses: The utilisation of profits or surpluses is also an important factor in
financial management. A judicious use of surpluses is essential for expansion and
diversification plans and also in protecting the interests of shareholders. The ploughing back
of profits is the best policy of further financing but it clashes with the interest of
shareholders. A balance should be struck in using funds for paying dividend and retaining
earning for financial expansion plans, etc.

7.What do you understand by financial decision? Discuss the major financial decision?

The Financing Decision is yet another crucial decision made by the financial manager
relating to the financing-mix of an organization. It is concerned with the borrowing and
allocation of funds required for the investment decisions.

1. Investment Decisions:
Investment Decision relates to the determination of total amount of assets to be held in the
firm, the composition of these assets and the business risk complexions of the firm as
perceived by its investors. It is the most important financial decision. Since funds involve
cost and are available in a limited quantity, its proper utilisation is very necessary to achieve
the goal of wealth maximisation.

The investment decisions can be classified under two broad groups:

(i) Long-term investment decision and

ii) Short-term investment decision.

The long-term investment decision is referred to as the capital budgeting and the short-
term investment decision as working capital management.

Capital budgeting is the process of making investment decisions in capital expenditure.

These are expenditures, the benefits of which are expected to be received over a long
period of time exceeding one year. The finance manager has to assess the profitability of
various projects before committing the funds.

The investment proposals should be evaluated in terms of expected profitability, costs

involved and the risks associated with the projects.

The investment decision is important not only for the setting up of new units but also for
the expansion of present units, replacement of permanent assets, research and
development project costs, and reallocation of funds, in case, investments made earlier do
not fetch result as anticipated earlier.

Short-term investment decision, on the other hand, relates to the allocation of funds as
among cash and equivalents, receivables and inventories. Such a decision is influenced by
trade-off between liquidity and profitability.

2. Financing Decisions:
Once the firm has taken the investment decision and committed itself to new investment, it
must decide the best means of financing these commitments. Since, firms regularly make
new investments; the needs for financing and financial decisions are ongoing.

Hence, a firm will be continuously planning for new financial needs. The financing decision is
not only concerned with how best to finance new assets, but also concerned with the best
overall mix of financing for the firm.

A finance manager has to select such sources of funds which will make optimum capital
structure. The important thing to be decided here is the proportion of various sources in the
overall capital mix of the firm. The debt-equity ratio should be fixed in such a way that it
helps in maximising the profitability of the concern.

The raising of more debts will involve fixed interest liability and dependence upon outsiders.
It may help in increasing the return on equity but will also enhance the risk.
3. Dividend Decision:
The third major financial decision relates to the disbursement of profits back to investors
who supplied capital to the firm. The term dividend refers to that part of profits of a
company which is distributed by it among its shareholders.

It is the reward of shareholders for investments made by them in the share capital of the
company. The dividend decision is concerned with the quantum of profits to be distributed
among shareholders.

A decision has to be taken whether all the profits are to be distributed, to retain all the
profits in business or to keep a part of profits in the business and distribute others among
shareholders. The higher rate of dividend may raise the market price of shares and thus,
maximise the wealth of shareholders. The firm should also consider the question of dividend
stability, stock dividend (bonus shares) and cash dividend.

8. how should be the finance of enterprise be organised?

9.Investment, Financing and Dividend decision are all interrelated , Comment.

10. What is financial planning? What are the characteristics?

Financial Planning is the process of estimating the capital required and determining it’s
competition. It is the process of framing financial policies in relation to procurement,
investment and administration of funds of an enterprise.

(1) Simplicity:
A sound financial structure should provide simple financial structure which could be
managed easily and understandable even to a layman. “Simplicity’ is an essential sine qua
non which helps the promoters and the management in acquiring the required amount of
capital. It is also easy to work out a simple financial plan.

(2) Foresight:
Foresight must be used in planning the scope of operation in order that the needs for capital
may be estimated as accurately as possible. A plan visualised without foresight spells
disaster for the company, if it fails to meet the needs for both fixed and working capital. In
simple words, the canon of foresight means that besides the needs of ‘today’ the
requirements of ‘tomorrow’ should also be kept in view.

(3) Flexibility:
Financial readjustments become necessary often. The financial plan must be easily
adaptable to them. There should be a degree of flexibility so that financial plan can be
adopted with a minimum of delay to meet changing conditions in the future.

(4) Optimum use of funds:

Capital should not only be adequate but should also be productively employed. Financial
plan should prevent wasteful use of capital, avoid idle capacity and ensure proper utilisation
of funds to build up earning capacity of the enterprise.

There should be optimum utilisation of available financial resources. If this is not done, the
profitability will decline. There should be a proper balance between the fixed capital and the
working capital.

(5) Liquidity:
It means that a reasonable percentage of the current assets must be kept in the form of
liquid cash. Cash is required to finance purchases, to pay salaries, wages and other
incidental expenses. The degree of liquidity to be maintained is determined by the size of
the company, its age, its credit status, the nature of its operations, the rate of turnover etc.

(6) Anticipation of contingencies:

The planners should visualise contingencies or emergency situations in designing their
financial plan. This may lead to keeping of some surplus capital for meeting the unforeseen
events. It would be better if these contingencies are anticipated in advance.

(7) Economy:
Last but not the least, the financial open be made in such a manner that the cost of capital
procurement should be minimum. The capital mobilised should not impose
disproportionate burden on the company. The fixed dividend on preference shares, the
interest on loans and debentures should be related to the earning capacity. The fixed
interest payments should not reduce the profits of the company and hamper its sustained
growth.

11. What is financial planning ? How will you estimate long term and short term needs?

12.what are the objectives of financial plan ? does it suffer constraints

13. Discuss the determinants of financial plan?

14.

15.What is cost of capital? Explain the significance of cost of capital?

Cost of capital may be defined as the rate that must be earned on the net proceeds to
provides the cost elements of the burden at the time they are due.

The signifance of the cost of capital

1. As an Acceptance Criterion in Capital Budgeting:

In the words of James T.S. Posterfield ‘the concept of cost of capital has assumed growing
importance largely because of the need to devise a rational mechanism for making the
investment decisions of the firm’. Capital budgeting decisions can be made by considering
the cost of capital.

According to the present value method of capital budgeting, if the present value of
expected returns from investment is greater than or equal to the cost of investment, the
project may be accepted; otherwise; the project may be rejected.

The present value of expected returns is calculated by discounting the expected cash inflows
at cut-off rate (which is the cost of capital). Hence, the concept of cost of capital is very
useful in capital budgeting decision.

2. As a Determinant of Capital Mix in Capital Structure Decisions:

Financing the firm’s assets is a very crucial problem in every business and as a general rule
there should be a proper mix of debt and equity capital in financing a firm’s assets. While
designing an optimal capital structure, the management has to keep in mind the objective
of maximising the value of the firm and minimising the cost of capital.

Measurement of cost of capital from various sources is very essential in planning the capital
structure of any firm.

3. As A Basis for Evaluating the Financial Performance:

In the words of S.K. Bhattacharya the concept of cost of capital can be used to ‘evaluate the
financial performance of top management’. The actual profitability of the project is
compared to the projected overall cost of capital and the actual cost of capital of funds
raised to finance the project.
If the actual profitability of the project is more than the projected and the actual cost of
capital, the performance may be said to be satisfactory.

4. As a Basis for taking other Financial Decisions:

The cost of capital is also used in making other financial decisions such as dividend policy,
capitalisation of profits, making the rights issue and working capital.

16.Write short notes

1. cost of capital
Cost of capital refers to the opportunity cost of making a specific investment. It is the rate of
return that could have been earned by putting the same money into a different investment
with equal risk. Thus, the cost of capital is the rate of return required to persuade the
investor to make a given investment. Cost of capital is determined by the market and
represents the degree of perceived risk by investors. When given the choice between
two investments of equal risk, investors will generally choose the one providing the higher
return. Cost of capital is an important component of business valuation work. Because an
investor expects his or her investment to grow by at least the cost of capital, cost of capital
can be used as a discount rate to calculate the fair value of an investment's cash flows.

2.Retain Earning

Profits generated by a company that are not distributed to stockholders (shareholders) as

dividends but are either reinvested in the business or kept as a reserve for specific
objectives (such as to pay off a debt or purchase a capital asset).
A balance sheet figure shown under the heading retained earnings is the sum of all profits
retained since the company's inception. Retained earnings are reduced by losses, and are
also called accumulated earnings, accumulated profit, accumulated income, accumulated
surplus, earned surplus, undistributed earnings, or undivided profits. See also retention
ratio.

3.Components of cost of capital

The term cost of capital refers to the maximum rate of return a firm must earn on
its investment so that the market value of company’s equity shares does not fall. This is a
consonance with the overall firm’s objective of wealth maximization. This is possible only
when the firm earns a return on the projects financed by equity shareholders funds at a rate
which is at least equal to the rate of return expected by them. If a firm fails to earn return at
the expected rate, the market value of the shares would fall and thus result in reduction of
overall wealth of the shareholders. Thus, a firm’s cost of capital may be defined as “the rate
of return the firm requires from investment in order to increase the value of the firm in the
market place”.
 The three components of cost of capital are:
1. Cost of Debt
Debt may be issued at par, at premium or discount. It may be perpetual or redeemable.
2. Cost of Preference Capital
The computation of the cost of preference capital however poses some conceptual
problems. In case of borrowings, there is legal obligation on the firm to pay interest at fixed
rates while in case of preference shares, there is no such legal obligation.
3. Cost of Equity Capital
The computation of the cost of equity capital is a difficult task. Some people argue, as
observed in case of preference shares, that the equity capital does not involve any cost. The
argument put forward by them is that it is not legally binding on the company to pay
dividends to the equity shareholders.

4.Composite cost

A company's cost to borrow money given the proportional amounts of each type of debt
and equity a company has taken on. A company's debt and equity, or its capital structure,
typically includes common stock, preferred stock and bonds. A high composite cost of
capital, indicates that a company has high borrowing costs; a low composite cost of capital
signifies low borrowing costs.