Financial Management Class 12 Notes CBSE Business Studies Chapter 9 (Free PDF Download)

Meaning of Business Finance

• The money required to carry out business activities is known as business finance. Finances are needed to operate a business, as well as to carry out day to day activities of the business. 

Financial Management

• Financial Management is concerned with the proper procurement and usage of finance. It includes business activities such as procuring funds, reducing the cost of funds, keeping the risk under control and deployment of such funds. 

• Financial management involves two dimensions, that is finance and management. Hence, Financial management can be said as the application of the management functions, particularly planning and controlling functions in the finance function of the business.

• Financial Management is very important as it has a direct emphasis on the financial health of a business. Financial management decisions affect all the items of the financial statement directly or indirectly.

Importance of Financial Management

• The size and composition of fixed assets of the business: Over investment in fixed assets may block funds and increase the size of fixed assets which may not be healthy for business whereas, little investment may hamper the growth of business.

• The quantum of current assets and its break up into cash, inventory and receivables: The financial decisions about investments in fixed assets, the credit policy, inventory management, etc., influence the amount of working capital required by a business enterprise.      

• Break-up of long-term financing into debt, equity etc: It is important for a financial manager to decide the way by which the proportions of debt and/or equity in a business has to be pumped in. The decisions of the finance managers affect debt, equity share capital, preference share capital and is an integral part of financing management.

• The amount of long term and short term financing to be used: Financing decision decides the proportion of funds raised from long term and short term sources.

• All items in the profit and loss account: Financing decisions affect the value of items appearing in the profit and loss account.

All the financial decisions taken by the financial managers in the past largely affect the current financial decisions as well as the future financial decisions. The overall health of finance is determined by the quality of financial management.

Objective of Financial Management

• Profit maximization: This was the primary  objective of firms which are concerned with the increasing earning per share (EPS) of the company. It is also the traditional objectives of the financial management that focuses on the fact that all the financial efforts should be made to increase the overall profit of the company,

• Wealth maximization: Financial management mainly aims to maximize shareholders' wealth which is also referred to as wealth-maximization. This objective focuses on increasing the overall shareholder wealth of the company, by directing the financing efforts on increasing the share price of the company. Higher the share price, higher is the wealth of the shareholders. The goal of financial management in this is to optimize the current value of the company's equity shares. The market price of the shares of the company are highly influenced by the financial decisions of the company.

• Other objectives: There can be other objectives such as optimum utilisation of financial resources, choosing the most appropriate source, ensuring easy availability of funds at reasonable costs etc.

Financial Decisions

The financial decision is one of the most important decisions that the finance managers of an organization exercise. The financial decisions of the company are determined by and are concerned with the three important decisions taken:

• Investment decision

• Financing decision

• Dividend decision

1. Investment Decision

• Each and every organization has limited resources in comparison to the uses of the resources. So it is very important for a firm to decide the source in which the funds should be invested in so as to fetch the best returns.

• Investment decisions in an organization are taken in both long term and short term.

• There are two types of decisions: 

• Long term investment decisions: These are also called capital budgeting decisions. This also implies that the funds are invested in a resource for a longer period of time. These decisions affect the profitability and size of assets.

• Short term investment decision: These are also known as working capital decisions. This also implies that the funds are invested in a resource for a shorter period of time. These decisions affect the day to day operations and activities of the organization.  It also affects the liquidity and profitability of the business.

• The essential contents in a working capital are: 

• Inventory management,

• Receivables management and 

• Efficient cash management.

Factors affecting Capital budgeting decisions.

There are a huge number of ventures and businesses available in the market for the purpose of investment. It is important to evaluate each and every venture carefully to assess the profitability and return on investment. The factors affecting the decisions are:

1. Cash flow of the project: It is important to analyse the pattern of cash flows in terms of inflows and outflows over a period of time.

2. Rate of return: This is one of the most important factors to be considered before investing in any venture. These are based on expected returns and the risk involved in each proposal.

3. The investment criteria involved: It is important to evaluate various investment proposals by considering factors like interest rate, cash flows, etc. 

2. Financing Decision

• Under this the Financial managers of the organization decide the sources from which to raise long-term funds. The main source of funding is shareholders' fund and borrowed funds. 

• Shareholders' funds include share capital, reserves and surpluses and retained earnings.

• Borrowed funds refer to funds raised through issue of debentures and other forms of debt.

• The decision of raising funds from various sources in appropriate proportion lies in the hands of the financial managers.

• Interest on loan has to be paid regardless of the profitability of the project.

• Debt is considered to be the cheapest form of finance.

Factors affecting Financing Decision

1. Cost: Cost of raising funds influences the financing decisions. A prudent financial manager selects the cheapest source of finance.

2. Risk: Each source of finance has a different degree of risk. For example, borrowed funds have high financial risk as compared to equity capital.

3. Floatation cost: A finance manager estimates the flotation cost of various sources and selects the source with least flotation cost.

4. Cash Flow position of the company: A business with a strong cash flow position prefers to raise funds from debts as it can easily pay interest and the principal.

5. Fixed operating costs: For a business with high operating cost, funds must be raised from equity and lower debt financing would be better.

6. Control consideration: A company would prefer debt financing if it wants to retain complete control of the business with the existing shareholders. On the other hand if a company is ready to lose control, it can raise funds from equity.

7. State of capital markets: During boom periods investors are ready to invest in equity but during depression investors look for second options for investment.

3. Dividend Decision

• Dividend is that part of profit which has to be distributed among the shareholders of a company. This decision relates to the distribution of dividends among various groups. In this decision, it must be decided that, 

• If all profits are to be dispersed, 

• Whether all earnings will be retained in the business, or 

• Whether a portion of profits will be retained in the business and the remainder distributed among shareholders.

Factors affecting dividend decision

1. Amount of earning: Dividend represents the share of profits distributed amongst shareholders. Thus, earning is a major determinant of dividend decisions.

2. Stability Earnings: A company with stable earnings is not only in a position to declare higher dividend but also maintain the rate of dividend in the long run.

3. Stability of Dividends: In order to maintain dividend per share a company prefers to declare the same rate of dividend to its shareholders.

4. Growth Opportunities: The growing companies prefer to retain a larger share of profits to finance their investment requirements, hence they prefer distributing less dividends.

5. Cash Flow position: A profitable company is in a position to declare dividend but it may have liquidity problems as a result of which it may not be in a position to pay dividends to its shareholders.

6. Shareholders' Preference: Management of a company takes into consideration its shareholders expectations for dividend and try to take dividend decisions accordingly.

7. Taxation policy: Dividends are a tax free income for shareholders but the company has to pay tax on the share of profit distributed as dividend.

8. Legal Constraints: Every company is required to adhere to the restrictions and provisions laid by the companies Act regarding dividend payouts. 

9. Contractual Constraints: Sometimes companies are required to enter into contractual agreements with their lenders with respect to the payment of dividend in future.

10. Stock Market: A bull or bear market, also affects the dividend decision of the firm.

Financial Planning

Financial planning refers to the preparation of a plan to ensure the adequacy of funds at the time of requirement. In case, the funds are not available on time the company will not be able to fulfill its activities

Objectives of Financial Planning

1. It ensures that the funds are readily available at the time of need.

2. It also checks that the firm need not unnecessarily raise resources.

Importance of Financial Planning

1. Forecasting: It helps in forecasting the future under different circumstances. This helps the firms and organizations in dealing with contingencies.

2. Prepares for uncertainties: It helps in preparing firms for various future ventures by avoiding business shocks and surprises.

3. Coordination: It helps in better coordination of various business functions like production, sales, etc.

4. Building links: It builds a link between the present of the organization with its future. It also provides a link between the financing and investment decisions on a regular basis. 

5. Easy Performance Evaluation: It makes the evaluation of the performance easier and in a detailed way.

Capital Structure

• It is one of the most important decisions under financial management to decide the pattern or the proportion of various sources that should be used for raising the funds.

• Capital structure is a blend of debt and equity or borrowed funds and owners' funds respectively. It is calculated as debt-equity ratio.

\[\text{i}\text{.e}\text{. }\left[ \frac{\text{Debt}}{\text{Equity}} \right]\]

Or

The proportion of debt out of total capital i.e. \[\left[ \frac{\text{Debt}}{\text{Debt+Equity}} \right]\]

Classification of Sources of Business Finance: On the Basis of Ownership:

This can be classified into two categories: 

• Owners' Funds: It  consists of equity share capital, preference share capital, reserves and surplus and retained earnings.

• Borrowed funds: It can be in the form of loans, debentures, various types of public deposits, borrowed funds from banks and other financial institutions.

Features 

• The cost of debt and equity differ significantly.

• The risks involved in debt and equity financing are different.

• The cost of debt is lower than the cost of equity.

• The interest that is paid on the debt is a deductible expense while computing tax liability whereas the dividend that is paid to the shareholders is paid out of after tax profit.

• Debt is a cheaper source of finance as compared to that of equity but it is more risky for a business because the payment of interest and the return of the principal value is mandatory for the business.

• Default in payment of the interest on debt may result in liquidation of the business whereas there is no such compulsion in case of equity.

Factors affecting the Choice of Capital Structure.

1. Cash Flow Position: Before raising finance business must consider the projected flow to ensure that it has sufficient cash to pay fixed cash obligations.A company with high liquidity and a good cash flow position can issue debt capital, as the company will have less chances of facing financial risk than the company with a low cash position.

2. Size of business: Small businesses generally go for retained earnings, and equity capital, as if they go for debt or borrowed capital, the company has to face a fixed interest burden. However in the case of large companies, issuing debt is not a big issue, and they can raise long term finance from borrowed sources cheaper than that of small firms.

3. Interest Coverage Ratio: It refers to the number of times a company can cover its interest obligations from the profits and higher ICR reduces the risk of failing to meet interest obligations.

4. Debt Service Coverage Ratio: It indicates the company's ability to meet cash commitments for interest and principal amount of debt.

5. Return on Investment: If a company earns hai returns it has the capacity to opt for death as a source of finance.

6. Cost of debt: A company may raise funds from debts if it has the capacity to borrow funds at a lower interest rate.

7. Tax Rate: Higher the tax rate, more preference for debt capital in the capital structure, as interest on debt capital being a tax deductible expense makes the debt cheaper.

8. Cost of equity: If a company has high risk, its shareholder may expect a high rate of return resulting in increased cost of capital.

9. Floatation cost: Choosing a source of fund depends on the flotation cost to be incurred to raise such funds, flotation cost makes this show less attractive.

10. Risk Consideration: A company chooses debts as a source of finance depending on its operating risk and overall business risk.

11. Flexibility: The choice of debts depends on the company's potential to borrow and the level of flexibility it wants to retain for choosing a source of funds in future. 

12. Regulatory Framework: The guidelines norms for documentation procedures influence the decision to choose a source of finance.

13. Stock Market Conditions: If the stock market is flourishing, and there is a condition of boom then the companies may prefer more equity over debt in the capital structure. However, in the case of a bear market, to avoid any more risks, the companies will prefer more debt over equity in the capital structure.

14. Capital Structure of other companies: Capital structure of other companies in the industry may be considered as a guideline while planning a firm’s capital structure but the final decision must be based on companies capacity to afford financial risk.

Fixed and Working Capital

1. Fixed Capital: 

• Fixed capital is that amount of capital which is incurred in procurement or buying the fixed assets for a business or an organization. The fixed assets of an organization are those assets which remain with the business for more than one year. 

• For example: Plant and Machinery, land, furniture and fixtures vehicles, etc.

Importance of Management of Capital budgeting/ Fixed Capital

1. Long-term growth: Capital budgeting decisions have long term effects on growth and profitability of the business in the future.

2. Large amount of funds involved: Capital budgeting decisions involving high amounts of funds block for a long period of time.

3. Risk involved: Investment in fixed capital and the related financial risks affect the overall business risk in the long term.

4. Irreversible decisions: The investment decision cannot be reversed without incurring heavy losses and wasteful expenditure.

Factors affecting the requirement of Fixed Capital

1. Nature of Business: The requirement of fixed capital largely depends upon the type and nature of the business a company or organization is involved in. Trading requires less fixed capital, while manufacturing business requires more fixed capital due to the involvement of heavy plant and machinery. 

2. Scale of operations: Larger the business operation, bigger is the investment and lower the level of business operation smaller is the investment.

3. Choice of Technique: The requirement of fixed capital of an organization largely depends upon the technique of operation in the organization. An organization that is capital-intensive requires a huge amount of investment in plant and machinery because it does not rely on manual labour whereas if an organization is labour-intensive it requires a comparatively less amount of investment in its fixed assets. 

4. Technology Upgradation: The organizations whose assets become obsolete in a very short duration need to upgrade their technology from time to time which may result in a higher amount of  investment in fixed assets. 

5. Growth Prospects: If an organization aspires for higher growth, the investment in fixed assets should be on a higher side. 

6. Diversification: Diversification needs investment in fixed assets. If a jute textile manufacturing company diversifies into FMCG it requires huge investment.

7. Financing Alternatives: There are many tools that act as alternatives to huge investment in assets. For example: Plant and Machinery may be available on a lease and the firm may use the asset for the required time and pay the rentals thereby reducing huge capital investment.

8. Level of Collaboration: It has become a common practice to collaborate with different organizations in the industry and use each other's resources for a common good. For example: One single ATM machine can be used to withdraw funds from accounts of different banks, this practice reduces the investment cost at a large scale.

2. Working Capital: 

1. Working capital is that amount of capital which is used in the day-to-day operations of the business this may be in cash or cash equivalents. The working capital is utilised by the business within one year. 

2. For example: stocks and inventories, debtors, bills receivables, etc.

3. Various type of Current assets that contribute to the working capital are:

1. Cash in hand/cash at Bank 

2. Marketable securities 

3. Bills receivable 

4. Debtors

5. Finished goods 

6. Inventory 

7. Work-in-progress

8. Raw material 

9. Prepaid expenses

4. Various sources of Current liabilities that contribute to the working capital are:

1. Bills payable

2. Creditors

• Outstanding expenses and advances received from customers.

Factors affecting the Working Capital requirements advances from customers.

• Nature of Business: Manufacturing business requires more working capital as compared to trading business or service provider.

• Business Cycle: During boom period firms require a large amount of working capital to manage the increased sales and production.

• Seasonal Factors: Seasonal businesses require more working capital during their season time.

• Scale of Operations: Businesses operating on a large scale require larger amounts of working capital as compared to small business firms.

• Credit Allowed: A business extending a longer credit period to its buyers will need more working capital as compared to a business doing cash business or offering a lesser credit period.

• Production Cycle: Businesses with longer production cycles require more working capital as compared to businesses with short-term production cycles.

• Credit Availed: A business organisation receiving longer credit period from their supplier will require lesser working capital as compared to business purchases goods for cash or receive short credit period.

• Operating Efficiency: A business operating efficiently is able to convert current assets into cash easily and thus will require lesser working capital.

• Availability of Raw Material: A business having each and continuous availability of raw material will not require large stock levels and thus, can manage with lesser working capital.

• Growth Prospects: Firms with high growth rate targets need higher working capital to meet increased sales target.

• Level of Competition: Tougher competition forces businesses to offer discounts liberal credit and maintain high levels of stock requiring larger amounts of working capital.

• Inflation: Inflation increases prices as a result firms require large amounts of working capital to meet the same volume of purchase and operating expenses.

NCERT Solutions Chapter 9 Class 12 Business Studies Revision Notes PDF

The Financial Management Class 12 Business Studies Revision Notes are available for download in PDF format. This makes it easy to access the Class 12 Business Studies Notes solution for Chapter 9 as per one’s needs. If you are confused regarding a certain topic, then instead of reading the entire chapter, go through these notes to clarify all your doubts. The PDF copy of the notes can also be printed to keep a hardcopy with you always when you wish to refer to it. These NCERT Class 12 Revision Notes Business Studies Chapter 9 solutions by Vedantu can be of great assistance while preparing for Board or other competitive exams.

Class 12 Business Studies Chapter 9 Revision Notes

Go through the crucial notes that are covered in the chapter on Financial Management and get through with the topic.

• Business finance is the money that is needed to carry out various activities for your business.

• Financial management refers to the acquisition and then the efficient utilization of finance. It includes the distribution and disposal of the surplus for the smooth working of a company.

Financial Management

This refers to the acquisition of finance efficiently, utilization of the finance, and disposal and distribution of the surplus for the business's smooth working. Financial management is about the application of the general principles of management to any particular financial operation.

The financial management role is the sizing and composition of the fixed assets, amount and composition of the current assets, fixing the debt-equity ratio in the capital, deciding on the long and short term financing, and all the items in the profit and loss account.

Financial Decision

A financial function is related to the major decisions which every financial manager needs to take. These are decisions related to investment, financing, and dividend.

• An investment decision relates to the careful asset selection in which a firm will invest the funds. The factors that affect the capital or investment budgeting decision are the project's cash flow, the risk involved, return on investment, and investment criteria.

• A financing decision is associated with the composition of securities in the company's capital structure. The main source of finance could be the owner's fund and the borrower's fund. Cost, risk control consideration, cash flow position, fixed operating cost, floatation cost and state of the capital market are the factors involved.

• A dividend decision relates to how the distribution of the profit will be earned. The main alternative is to retain earnings or whether to distribute the money as dividends to shareholders. There are many factors like earning, earning stability, growth opportunism, taxation policy, legal restrictions, cash flow position, and preference of shareholders that affect the decisions of paying out dividends.

Financial Planning

Financial planning refers to deciding as to how much money to spend and what to spend the money on as per the funds at your disposal. Financial planning helps to offer the availability of funds where the money is required. It also sees that the firm does not raise the resources uselessly. Financial planning helps collect optimum funds, invest the money in the correct place, fix the appropriate capital structure, link between the investment and the financial decisions, and avoid business surprises and shocks.

Capital Structure

Capital structure is the proportion of debt and equity that is used to finance business operations.

Factors Affecting Working Capital

The length of the operating cycle, the business nature, seasonal factors, business cycle fluctuation, scale of operation, credit availability, production, and technology cycle are the factors that affect the working capital.

Factors Affecting the Need for Fixed Capital

The nature of the business, the operating scale, availability of leasing and financial faculty, the technique of production growth perspective, and level of joint ventures or collaboration are the factors that affect the fixed capital.

Chapter-wise Revision Notes on Class 12 Business Studies  

• Chapter 1 - Nature and Significance of Management Notes

• Chapter 2 - Principles of Management Notes

• Chapter 3 - Business Environment Notes

• Chapter 4 - Planning Notes

• Chapter 5 - Organising Notes

• Chapter 6 - Staffing Notes

• Chapter 7 - Directing Notes

• Chapter 8 - Controlling Notes

• Chapter 10 - Financial Markets Notes

• Chapter 11 - Marketing Notes

• Chapter 12 - Consumer Protection Notes

• Chapter 13 - Entrepreneurship Development Notes

Class 12 Subject-wise Revision Notes

• Class 12 Maths Revision Notes

• Class 12 Physics Revision Notes

• Class 12 Chemistry Revision Notes

• Class 12 Biology Revision Notes

• Class 12 Business Studies Revision Notes

• Class 12 Economics Revision Notes

Subject-wise Solutions for Class 12

• NCERT Solutions for Class 12 Maths

• NCERT Solutions for Class 12 Physics

• NCERT Solutions for Class 12 Chemistry

• NCERT Solutions for Class 12 Biology

• NCERT Solutions for Class 12 English

• NCERT Solutions for Class 12 Business Studies

• NCERT Solutions for Class 12 Economics

• NCERT Solutions for Class 12 Accountancy