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NIOS Class 12 Business Studies Chapter 10 Fundamental of Management
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Financial Planning and Management
Chapter: 10
Module – 3 Business Finance
INTEXT QUESTIONS 10.1
1. A company plans to buy a latest machine which operates on new technology in order to replace an old and outdated machine. Identify the type of decision involved:
(a) Investment decision.
(b) Financial decision.
(c) Dividend decision.
(d) All of the above.
Ans: (a) Investment decision.
2. A company decided to distribute a portion of the profits earned in the previous years among its share holders. Identity the type of decision involved.
(a) Financial decision.
(b) Investment decision.
(c) Dividend decision.
(d) All of the above.
Ans: (c) Dividend decision.
3. A company assured the funds required to execute an expansion programme. Identify the decision made by the company.
(a) Financial decision.
(b) Investment decision.
(c) Dividend decision.
(d) None of the above.
Ans: (c) Dividend decision.
4. Financing decision relates to:
(a) Liabilities side of balance sheet.
(b) Assets side of balance sheet.
(c) profit & loss account.
(d) All of the above.
Ans: (a) Liabilities side of balance sheet.
5. Investment decision relates to:
(a) Investment in fixed assets.
(b) Investment in current assets.
(c) Portfolio investment.
(d) All of the above.
Ans: (b) Investment in current assets.
INTEXT QUESTION 10.2
1. Wealth maximization objective of financial management relates to:
(a) Increasing profit.
(b) increasing revenue.
(c) earnings per share.
(d) all of the above.
Ans: (c) earnings per share.
2. Wealth maximization is superior to profit maximization because it considers:
(a) Time value of money.
(b) competition.
(c) cost.
(d) capital structure.
Ans: (a) Time value of money.
INTEXT QUESTION 10.3
1. Which of the following are not the essential characteristics of financial planning?
(a) Simplicity.
(b) Liquidity.
(c) Abundant availability of funds.
(d) Flexibility.
(e) Concentration on long term needs only.
(f) Economy.
Ans: (a) Simplicity.
(c) Abundant availability of funds.
(e) Concentration on long term needs only.
2. State whether the following are objectives of financial planning, by writing ‘Yes’ or ‘No’.
(a) Determining the requirement of fixed and working capital. ( )
Ans: No.
(b) Determining the sales output. ( )
Ans: No.
(c) To ensure the timely availability of funds. ( )
Ans: Yes.
(d) To determine the quantity of production. ( )
Ans: No.
(e) To raise funds at the lowest possible cost. ( )
Ans: Yes.
INTEXT QUESTION 10.4
1. Balance Sheet of a company is given as under:
| Liabilities | Amount(Rs.) | Assets | Amount(Rs.) |
| A Non-Current Liabilities: (a) Shareholder’s fund: (i) Equity share capital (ii) Reserve and Surplus General Reserve 4,000 Retained earnings 1,000 | 10,000 5,000 | A. Non-current Assets (a) Fixed Assets: (i) Land & buildings (ii) Plant & machinery (iii) Furniture, fixture & fitting | 15,000 20,000 5,000 |
| (b) 15% Preference Share Capital | 2,000 | (b) Intangible Assets: Patent, copyright, trademark | 5000 |
| (c) 12% Debentures | 15,000 | (c) Wasting Assets (oil well,) | 5000 |
| (d) Long term loans | 10,000 | ||
| (e) Working Capital loans | 3,000 | ||
| B. Current Liabilities: (i) Sundry trade Creditors. (ii) Short -term loans (iii) Bank overdraft (iv) Cash credit (v) Outstanding expenses | 10,000 5,000 5,000 4,000 1,000 | B. Current Assets: (i) Inventories (ii) Debtors (iii) Cash in hand (iv) Cash in bank (v) Prepaid expenses | 10,000 6,000 2,500 1,000 500 |
| Total: | 70,000 | 70,000 |
You are required to find out (a) Equity fund; (b) Debt fund; (c) Capital Structure; (d) Financial structure.
Ans: (a) Equity fund= Rs. 17,000.
(b) Debt fund= Rs. 28,000.
(c) Capital Structure= Rs. 45,000.
(d) Financial structure= Rs. 70,000.
2. A high geared company is exposed to:
(a) Business risk.
(b) financial risk.
(c) inflation risk.
(d) all of the above.
Ans: (b) financial risk.
3. High level of gearing means:
(a) Proportion of long-term debt to shareholder’s funds is low.
(b) Proportion of long-term assets to shareholder’s funds is high.
(c) Proportion of fixed assets to total assets is high.
(d) Proportion of loan funds to net worth is high.
Ans: (d) Proportion of loan funds to net worth is high.
INTEXT QUESTION 10.5
1. From the following information, calculate: (a) Operating Leverage; (b) Financial leverage; and (c) combined leverage.
| Items | Amount (Rs.) |
| Sales revenue (2,000 units @ Rs. 5 each) | 10,000 |
| Less: Variable cost (2,000 units @ Rs. 2 each) | 4,000 |
| Contribution (1-2) | 6,000 |
| Less: operating fixed cost | 2,000 |
| EBIT or Operating profit or Earning before interest and tax [3-4] | 4,000 |
| Less: Interest paid on borrowings | 2,000 |
| Earning before tax (EBT) [5-6] | 2,000 |
Ans: (a) C/EBIT=1.5.
(b) EBIT/EBT =2.
(c) C/EBT= 3.
2. A company produced and sold 20,000 units with a variable cost of Rs.20 per unit and Rs.30 per unit as selling price. The fixed overheads during the period was Rs.1,00,000. The operating leverage of the company is:
(a) 1
(b) 2
(c) 1.5
(d) 2.5
Ans: (a) 1.
3. If the operating leverage is 3 and financial leverage is 2, the combined leverage is?
(a) 1
(b) 2.5
(c) 4
(d) 6
Ans: (d) 6.
4. If combined leverage is 5 and operating leverage is 2, then the financial leverage is:
(a) 3
(b) 4
(c) 5
(d) 2.5
Ans: (d) 2.5.
INTEXT QUESTION 10.6
1. Fill in the blanks by choosing the correct answer.
(a) When a company sell its shares directly to a small group of investors like bank, financial institutions, mutual funds etc, it is called as ………..(private placement, public issue, right share)
Ans: Private placement.
(b) Retained earnings is an example of………..( fixed capital, current assets, liquid assets).
Ans: Fixed capital.
(c) Rights issue is very ……….. to collect fixed capital.(economical, expensive, neutral)
Ans: Economically.
(d) Fixed capital is capital that we invest in …………..(fixed assets,current assets, fictitious assets)
Ans: Fixed capital.
INTEXT QUESTION 10.7
1. Fill in the blanks:
(a) Working capital refers to the excess of current assets over…………..
Ans: Current liabilities.
(b) Gross working capital means investment in ……………………
Ans: Current Liabilites.
(c) Liquidity means closeness to………………..
Ans: Cash.
(d) Inventory is the component of ……………………..
Ans: Current Assets.
(e) Payment of loan instalment is ……………
Ans: Current Liabilities.
(f) Working capital is needed for meeting expenses of the ………….business.
Ans: Operation.
2. State whether we require ‘more’ or ‘less’ working capital in the following cases:
(a) A company manufacturing Iron & steel.
Ans: More.
(b) A bread manufacturing company having high inventory turnover.
Ans: Less.
(c) A large size business enterprise making toys.
Ans: More.
(d) Company manufacturing furniture against orders only.
Ans: Less.
(e) A company manufacturing coolers/refrigerators.
Ans: More.
3. Match the items in column A with column B.
| Column A | Column B |
| (a) Fixed Capital | (a) Short term finance |
| (b) Public utilities | (ii) working capital requirement |
| (c) Permanent working capital | (iii) long-term finance |
| (d) Goodwill | (iv) telephone company |
| (e) Fluctuating working capital | (v) intangible fixed assets |
| (f) Length of production | (vi) Fixed working capital |
Ans:
| Column A | Column B |
| (a) Fixed Capital | (iii) long-term finance. |
| (b) Public utilities | (iv) telephone company. |
| (c) Permanent working capital | (vi) Fixed working capital. |
| (d) Goodwill | (v) intangible fixed assets. |
| (e) Fluctuating working capital | (i) Short term finance. |
| (f) Length of production | (ii) working capital requirement. |
4. Balance Sheet of a company is given as under:
| Liabilities | Amount(Rs.) | Assets | Amount(Rs.) |
| A Non-Current Liabilities: (a) Shareholder’s fund: (i) Equity share capital (ii) Reserve and Surplus General Reserve 4,000 Retained earnings 1,000 | 10,000 5,000 | A. Non-current Assets (a) Fixed Assets: (i) Land & buildings (ii) Plant & machinery (iii) Furniture, fixture & fitting | 15,000 20,000 5,000 |
| (b) 15% Preference Share Capital | 2,000 | (b) Intangible Assets: Patent, copyright, trademark | 5000 |
| (c) 12% Debentures | 15,000 | (c) Wasting Assets (oil well,) | 5000 |
| (d) Long term loans | 10,000 | ||
| (e) Working Capital loans | 3,000 | ||
| B. Current Liabilities: (i) Sundry trade Creditors. (ii) Short -term loans (iii) Bank overdraft (iv) Cash credit (v) Outstanding expenses | 10,000 5,000 5,000 4,000 1,000 | B. Current Assets: (i) Inventories (ii) Debtors (iii) Cash in hand (iv) Cash in bank (v) Prepaid expenses | 10,000 6,000 2,500 1,000 500 |
| Total: | 70,000 | 70,000 |
Ans: (a) Rs.20,000. (b) Rs. 6,000.
INTEXT QUESTION 10.8
1. Give the full form of the following abbreviations.
(a) PAT.
Ans: Profit after tax.
(b) FBT.
Ans: Earnings before tax.
(c) EBIT.
Ans: Earnings before interest and tax.
2. In a company form of business, the wealth created is reflected in the of its shares.
(a) Dividends declared.
(b) Dividend growth.
(c) Market value.
(d) Assets value.
Ans: (c) Market value.
3. The dividend decisions are concerned with:
(a) Determination of quantum of profits to be distributed to the owners.
(b) The frequency of such payments.
(c) The amounts to be retained by the company.
(d) All of the above.
Ans: (d) All of the above.
4. The buyer of an ex-dividend stock is not entitled to the payment:
(a) Next dividend.
(b) Current divided.
(c) Past dividend.
(d) None of the above.
Ans: (a) Next dividend.
5. Paying dividend is.
(a) Not an expenses.
(b) The division of an asset.
(c) An inflows of funds.
(d) All of the above.
Ans: (b) The division of an asset.
6. A is a payment of additional shares to shareholders in lieu of cash.
(a) Split dividend.
(b) Stock dividend.
(c) Regular dividend.
(d) Extra dividend.
Ans: (b) Stock dividend.
| TERMINAL EXERCISE |
A. Very Short Answer Questions:
1. What do you understand about the financing decision?
Ans: Financing decision is concerned with the procurement of funds, in an economic and prudent manner after judicious identification of timing and quantum of various sources of funds to be raised. Funds are available through primary market, financial institution and through the commercial banks. The cost associated with each of the instrument or source of funds is different. The overall cost of capital must be kept at minimum.
2. What do you understand by dividend decision?
Ans: Dividend decision is concerned with taking decision with regards to the net profit distribution which is related either to pay dividend to shareholders or to retain in the business.
3. What do you understand by investment decision?
Ans: Investment decisions are influenced by cash flow by giving due care to time, value of money, risk involved, technological changes etc.To find out the viability of each capital expenditure decision,Capital budgeting, Cost-Volume-Profit analyses are the techniques generally used for the process of investment decisions.
4. What is meant by financial planning?
Ans: Financial planning is the process of identifying a firm’s investment and financing needs, given its growth objectives. Financial planning deals with framing of financial policies in relation to procurement of funds, investment of these funds and administration of funds of a business enterprise to achieve its objectives.
5. State the components of working capital.
Ans: (a) Current Assets A major component of working capital is current assets. A shortened definition of current assets is: a company’s cash plus its other resources that are expected to turn to cash within one year.
(b) Current Liabilities The other major component of working capital is current liabilities. A shortened definition of current liabilities is: a company’s obligations that will be due within one year.
6. Describe the components of debt and equity.
Ans: Debt Capital is a liability for the company that they have to pay back within a fixed tenure. Equity Capital is an asset for the company that they show in the books as the entity’s funds. Debt Capital is a short term loan for the organisation. Equity Capital is a relatively longer-term fund for the company.
7. Explain the importance of information signaling in dividend decision.
Ans: The important aspect of this decision is to determine how much amount of profit after tax is to be distributed to shareholders and how much amount is to be retained in the company for financing the growth and expansions of the business. Dividend announcements convey information to investors regarding the company’s future prospects. Suppose, if a company declared very high dividends, it gives a signal to prospective and present investors that the company has no future investment opportunities and vice-versa which decreases or increases the market price of the share. It is due to the information content of dividends.
B. Short Answer Questions:
1. Critically examine the objective of financial management.
Ans: The key objectives of financial management are:
(i) Profit Maximization: A business firm is an organization established for the primary purpose of making profit for its owner. Generally, profit maximization is regarded as the prime objective of the business.
(ii) Wealth Maximization and Value Maximization: It is commonly understood that the basic objective of a business is to maximize wealth which lies in maximization of the
value of shares held by owners as they are the contributors to initial capital. For achieving this objective, the financial manager allocates the funds in assets and controls their use
taking time, value of time into consideration.
2. Explain the concept of working capital and its choice.
Ans: Working capital is an amount used to serve the business on day-to-day basis fulfilling the requirement of everyday production and operation.Working capital can be increased by profitable business operation, sale of long-term assets, long-term borrowing and investment by owners. It can be decreased by unprofitable business operations; purchase of long-term assets without long-term financing, distributing cash to owners.
Choice of the concepts depends upon the objective of the study. If the objective is to assess the efficiency of the business, then the gross concept of working capital will be suitable. But if the objective is to assess the liquidity position, then net concept will be suitable.
3. State the sources of fixed capital.
Ans: (i) Issue of Share: It is the most important source of fixed capital. Generally, there are two types of shares as has been discussed in previous module.
(a) Equity share. and
(b) Preference share.
(ii) Issue of Right Shares: When a company decides to issue further share, it is first issued to its existing shareholders at a price below the market price. The share capital increases but the number of shareholders does not increase. Generally, rights issue is very economical to collect fixed capital.
(iii) Private Placement of Shares: It means the company sells its shares directly to a small group of investors like bank, financial institutions, mutual funds etc.
(iv) Issue of Debentures: It represents the borrowed capital of the company and holder of debenture gets interest on investment in debenture at predetermined stated rate.
(v) Term Loans: The company gets term loans from banks and financial institutions like HDFC, ICICI etc by submitting its project analysis report.
(vi) Retained Earnings: It is a part of undistributed profits earned by the company. This saved profit is called as ploughing back of profits.
(vii) Lease Financing: Under lease financing, lessor who is the owner of assets gives the assets on a lease-basis to the lessee and charges lease rent for using that assets.
4. Explain capital structure and its components.
Ans: The capital structure of a firm refers as a choice of that combination of debt and equity, which is used for financing the operations of business and to maximise the market value of the shares of the firm.
When a company is analysing what capital structure to adopt it can opt for:
(i) Capital structure with equity shares only.
(ii) Capital structure with equity and preference shares.
(iii) Capital structure with equity shares and debentures.
(iv) Capital structure with equity, preference shares and debentures.
5. Explain the cost and risk associated with equity and debt capital.
Ans: Debt and equity differ in cost and risk. Debt involves less cost as interest paid on debt is treated as a revenue expense and is subject to tax-shield, but it is risky because payment of regular interest on debt is a legal obligation for the business. In case the company fails to pay debt, debenture holders can claim over the assets of the company and if company fails to honour interest payment, it can even go to liquidation and stage of insolvency.
Equity securities are safe securities from company’s point of view as company has no legal obligation to pay dividend to equity shareholders even if company is running on profit or loss but equity are expensive as payment of dividend is not subject to taxshield and their expectation of return is high as well as the company has no legal obligation to pay their capital contribution during the life of the company as they are owners.
6. State any four objectives of financial planning.
Ans: The following aspects should be kept in mind so as to ensure the success of such an exercise in meeting the organizational objectives.
(a) The plan must be simple: Now-a-days you have a large variety of securities that can be issued to raise capital from the financial market. But it is considered better to confine to owned funds (equity shares) and simple fixed interest-bearing finance (debentures and loans).
(b) It must take a long-term view: While estimating the capital needs of a business and raising the required funds, a long-term view is to be taken into consideration which means that besides the need of ‘today’, the capital requirements of ‘tomorrow’ should also be kept in view.
(c) It must be flexible: It is absolutely necessary that the financial plan must be capable of being adjusted and revised without any difficulty and delay so as to meet the future requirements of funds in changed business environment. Because no one may be able to properly visualise the possible developments in future.
(d) It must ensure optimal use of funds: Whatever funds a business is raising, it has some cost which a firm has to pay to the provider of capital. Hence, capital should not be only adequate but should also be employed in a productive way and there should be proper balance between fixed capital and working capital.
7. Explain the different modes of dividend payments.
Ans: Here are the dividend payments modes:
(i) Cash Dividends: When a company shares a portion of its net earnings with its shareholders in the form of cash, we call it cash dividend.
(b) Stock Dividend: It is also known as bonus shares. A dividend can be paid out in the form of shares of stock. Under the stock dividend issue, the company issues additional shares in a ratio to the investor’s current holding.
(c) Stock Repurchase: Under this type of dividend, the existing shareholder gets an option to sell his shares back to the company at a fixed rate. Generally, the fixed rate is higher than the prevailing market rate.
8. Differentiate between fixed capital and working capital.
Ans:
| Basis | Fixed capital | Working capital |
| Meaning | Fixed capital is the investment done by the business for accruing long term benefits. | Working capital is the daily requirement pumped into business. |
| Acquiring of assets | Fixed capital is used to acquire non-current assets. | It is used to acquire current assets. |
| Conversion | Can’t be converted into cash or kind immediately. | Can be converted into cash within one year. |
| Tenure | Serves the business for longer period of time. | Serves the business for short period of time. |
| Benefits | Offer benefits for more than one accounting period. | Offer benefits for less than one accounting period. |
| Liquidity | Very low liquidity. | High liquidity. |
9. Distinguish between capital structure and financial structure.
Ans:
| Capital structure | Financial structure |
| Capital structure includes non-current liabilities. | Financial structure includes non-current liabilities and current liabilities. |
| Capital Structure consists of shareholders’ fund and long-term debt. | Financial structure consists of Shareholders fund, long-term debt and current liabilities. |
| Capital structure refers to the proportion of long-term debt and equity in the total capital of a company. | Financial structure refers to the net worth or shareholders’ fund or owners’ equity and all liabilities i.e., long-term and short term. |
| Capital structure of a company is a part of its financial structure. | Financial structure comprises capital structure and current liabilities. |
| Capital structure does not include short-term or current liabilities. | Financial structure is the sum of long-term as well as short-term liabilities. |
C. Long Answer Questions:
1. What is meant by ‘Financial Planning’? Explain any four requisites of a sound financial plan.
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