Chapter 9: Financial Management – Class 12 Business Studies (Simplified Notes)

### 1. **Meaning of Financial Management:**

Financial management is concerned with planning, organizing, directing, and controlling

the financial activities of a business. It involves making decisions about the financial
resources of the business to achieve its goals.

### 2. **Objectives of Financial Management:**

- **Wealth Maximization:** The main objective is to increase the wealth of shareholders by

increasing the value of the business.

- **Ensuring Availability of Funds:** Financial management ensures that there are enough
funds available for business operations.

- **Efficient Utilization of Funds:** Funds must be used efficiently to achieve the best
possible results.

- **Minimizing the Cost of Finance:** Financial management aims to reduce the cost of
acquiring funds while ensuring they are available when needed.

### 3. **Financial Decisions in Financial Management:**

Financial decisions are the core of financial management and are divided into three main
types:

#### a) **Investment Decision:**

This refers to decisions regarding how a firm’s funds are invested in different assets to
maximize returns. It involves:

- **Fixed Capital Decisions:** Long-term investment in fixed assets like machinery,

buildings, etc.

- **Working Capital Decisions:** Short-term investment in current assets like inventory,

cash, and receivables.
#### b) **Financing Decision:**

It involves decisions regarding the sources of funds to finance investments and operations.
Businesses can raise funds from:

- **Equity (shareholders)**

- **Debt (borrowings like loans and bonds)**

- **Retained Earnings (profit reinvested in the business)**

The mix of debt and equity is known as the **capital structure**. The goal is to minimize the
cost of financing and optimize the capital structure.

#### c) **Dividend Decision:**

It refers to decisions regarding the distribution of profits to shareholders. The business can:

- **Distribute dividends** to shareholders

- **Retain earnings** for future growth

A balance must be maintained between paying dividends and retaining earnings.

### 4. **Factors Affecting Investment Decisions:**

- **Return on Investment (ROI):** Projects with higher expected returns are preferred.

- **Risk Involved:** Projects with lower risk are more attractive.

- **Cash Flow of the Project:** The project should generate regular and sufficient cash
flows.

- **Investment Criteria:** Businesses also consider the cost, payback period, and rate of
return when making investment decisions.

### 5. **Factors Affecting Financing Decisions:**

- **Cost of Finance:** Debt is cheaper than equity, but too much debt can be risky.

- **Risk:** More debt increases the financial risk of the business.

- **Cash Flow Position:** Businesses with steady cash flows can handle debt better.
- **Control Considerations:** Issuing more equity reduces the control of existing
shareholders.

- **Market Conditions:** Economic and stock market conditions affect financing

decisions.

### 6. **Factors Affecting Dividend Decisions:**

- **Earnings:** If a business has high earnings, it can pay higher dividends.

- **Cash Flow:** Adequate cash flow is necessary to pay dividends.

- **Shareholders’ Preferences:** Shareholders may prefer regular dividends or higher

reinvestment in the business.

- **Growth Opportunities:** If the company has good growth opportunities, it may retain
earnings instead of paying dividends.

- **Legal Constraints:** Companies must comply with legal regulations regarding

dividends.

### 7. **Fixed Capital:**

Fixed capital refers to the long-term investments of a business in assets like machinery,
buildings, and equipment that are used for more than a year.

#### **Factors Affecting Fixed Capital Requirements:**

- **Nature of Business:** Manufacturing businesses need more fixed capital compared to

service industries.

- **Scale of Operations:** Larger businesses require more fixed capital.

- **Technology:** Businesses using advanced technology require higher investments in

machinery.

- **Growth Prospects:** Companies with high growth prospects need more fixed capital for
expansion.

- **Availability of Finance:** Easy availability of finance allows businesses to invest more in

fixed capital.
### 8. **Working Capital:**

Working capital refers to the funds required for the day-to-day operations of the business,
such as purchasing raw materials and paying wages.

#### **Factors Affecting Working Capital Requirements:**

- **Nature of Business:** Trading firms require less working capital than manufacturing
firms.

- **Business Cycle:** During boom periods, businesses need more working capital to meet
increasing demand.

- **Production Cycle:** A longer production cycle requires more working capital.

- **Credit Policy:** Businesses that offer more credit to customers need higher working
capital.

- **Availability of Raw Materials:** If raw materials are easily available, businesses need
less working capital.

### 9. **Importance of Financial Planning:**

Financial planning refers to the process of estimating the capital required and determining
the sources of funds for the business. The importance includes:

- **Ensures Adequate Funds:** Financial planning ensures the business has enough funds
to operate smoothly.

- **Facilitates Growth and Expansion:** Proper planning helps businesses expand by

ensuring funds are available for new projects.

- **Reduces Uncertainty:** It prepares the business for financial emergencies.

- **Helps in Decision-Making:** Financial planning aids in making informed decisions

regarding investments and financing.

### 10. **Capital Structure:**

Capital structure refers to the mix of debt and equity that a company uses to finance its
operations.

#### **Factors Affecting Capital Structure:**

- **Cost of Debt:** Debt is cheaper but risky. Companies prefer debt when the cost is low.

- **Risk:** High debt increases financial risk.

- **Flexibility:** Companies prefer a flexible capital structure that allows them to raise
more funds if needed.

- **Control:** Issuing more equity reduces the control of existing shareholders.

- **Market Conditions:** Favorable market conditions may make it easier to raise equity.