BUSINESS FINANCE

VERY SHORT ANSWER (MARKS-1)

1. How is working capital determined?

Ans: Working Capital = Current Assets- Current Liabilities.

2. What are the two types of capital?

Ans: The two types of capital are: Debt capital and Equity Capital.

3. Give the second name for fixed assest management.

Ans: Capital Budgeting.

4. Mention two components of ownership funds.

Ans: Equity share capital and Retained Earnings.

5. Give any two factor affecting working capital requirement of a company.

Ans: Nature of Business and Sale of operations.

6. A decision is taken to raise money for long term capital needs of the business
from certain sources. What is this decision called? 2018

Ans: Financing Decision.

7. Name the concept which increases the return on equity shares with a change
in the capital structure of a company.

Ans: Trading on Equity.

8. State why working capital needs for a service industry are different from that
of a manufacturing industry?

Ans: Service industry do not keep very high stock of finished goods and sell good
on cash basis can manage with less working capital. But manufacturing industry
are required to keep huge stocks have to arrange for higher amount of working
capital.

9. Capital structure refers to what?

Ans: Capital structures refer to the proportions of different kind of securities

issued by a company to raise long term finance.

10. A decision is taken to distribute a certain portion of the profit after tax among
the shareholders. What is this decisions called?

Ans: Dividend decision.

11. Name the financial decision which affects the liquidity as well as profitability
of a business.

Ans: Dividend decision.

12. “Fixed capital decisions involve more risks.” How?

Ans: Fixed capital decisions involve more risks because the use of debt capital
affects the return and risk of the equity share capital.

13. Why is working capital needed? Give any one reason? 2014

Ans: Working capital is needed for buying raw materials to produce finish goods.

14. Which is the most costly capital for a company? 2015

Ans: Fixed capital.

15. State one objectives of financial management.

Ans: To ensure effective utilization of funds.

16. When working capital becomes negative? 2016

Ans-

17. What is the other name of long term investment decisions? 2017
Ans-

18. Which is the most risky capital of a company? 2018

Ans-

QUESTIONS

1. What is Financial Management? Explain the objectives of Financial

Management.
2. Discuss the role and function of a financial manager in a corporate enterprise.
3. State in brief the three decisions involved in financial management.
4. What is an investment decision or capital budgeting decisions? Explain the
factor affecting investment decisions.
5. Explain the factor affecting financing decisions of a company.
6. “Financing decisions of a company is affected by a number of factors.” Explain
in brief any four factors.
7. What is a dividend decision? What are the aspects of dividend decisions?
Explain the factor affecting dividend decisions..
8. “The dividend decision of a company is determined by a number of factors.”
Explain the statement.
9. What is financial planning? Write three aspects of financial planning? State
some objectives of financial planning? Explain the importance of financial
planning
10. What is capital structure? Explain any five factors which affect capital
structure of a company.
11. Explain in brief any five factors that should be taken into considerations while
determining capital structure of a business enterprise.
12. Determination of capital structure of a company is influenced by a number of
factors.” Explain any six such factors.
13. What are the factors to be kept in mind while determining the capital
structure of a company?
14. Describe in brief any four features of sound capital structures.
15. What is working Capital? Explain any five factors affecting the working capital
requirements.
16. Explain any five factors which might influence the amount of working capital
needed bya business enterprise.
17. What is fixed capital? Explain any five factors affecting the fixed capital
requirements.
18. Distinguish between Fixed capital and working capital.
 19. To avoid the problem of shortage and surplus of funds what is required in
financial management? Name the concept and explain any three points of
importance.
20. Explain four importance of capital budgeting decisions.
21. You are the finance manager of a company. The Board of Directors has asked
you to determine the working capital requirements of the company. State the
factors that you would take into consideration while determining the
requirements of working capital of the company.

___________________________________________________________________________

I. What is Financial Management? Explain the objectives of Financial

Management. 2013, 2014, 2017, 2019

ANS- Financial management deals with planning, organizing, directing and

controlling financial activities like procurement and utilization of funds of an
enterprise in a proper way. The primary objective of financial management is to
maximize owner’s wealth.

OBJECTIVES OF FINANCIAL MANAGEMENT

The objectives of financial management are as follows-

I. To estimate accurately the amount of capital to be required.

II. To determine the form and proportionate amount of securities to be issued.
III. To raise funds at minimum cost and at most advantageous terms.
IV. To maintain financial liquidity and flexibility.
V. To ensure safety of funds.

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2. Discuss the role and function of a financial manager in a corporate enterprise.

2014 2017

ROLE OF A FINANCIAL MANAGER IN A CORPORATE ENTERPRISE

The roles of a financial manager in a corporate enterprise are as follows-

 I. ESTIMATING CAPITAL REQUIREMENTS- The financial manager estimates the long
term and short term capital requirements of the company.
II. DETERMINING SOURCE OF FUNDS- Before procuring funds, the financial manager
has to determine the various sourceslike equity shareholder, preference share
holder, public deposit etc from which funds are to be procured.
III. PROCUREMENTS OF FUNDS- The financial manager take steps to procure the
funds required for the business. It might require negotiations with creditors and
financial institution, issue of prospectus.
IV. UTILISATIONS OF FUNDS- The funds procured by the financial manager are to be
effectively invested in various assets so as to maximize the return on investment.
V. MANAGEMENT OF CASH- Finance manager must ensure that adequate cash is
available at all times to pay wages and salaries, pay creditors, to purchase raw
materials other day to day expenses etc.
VI. FINANCIAL CONTROLS- One of the important functions of financial manager is to
exercise proper control over corporate funds so that various financial decisions
yield maximum advantage.

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3. State in brief the three decisions involved in financial management.

2015, 2017
OR
Explain three basic areas of financial management? 2016

THREE FINANCIAL DECISIONS TAKEN BY A FINANCIAL MANAGER

The three financial decisions taken by a financial manager are as follows-

I. INVESTMENT DECISIONS- The first and foremost decisions which a business

must take is to allocate resources or capital to different investment proposals.
The financial manager has to decide about investment of funds in various
business activities. Funds have to be invested in fixed assets such as machines
and equipment’s, building etc and also in currents assets such as raw materials,
stock of finished goods etc.
 II. FINANCING DECISIONS- The second decisions which concerns a company is, how
to finance the activities of the business. The finance manager must decide when,
where, how to procure funds to meet the requirements of the company. These
sources include shareholders, debenture holders, banks, financial institutions,
trade creditors etc.
III. DIVIDEND DECISIONS- The third decisions to be taken is the disposal of profits.
Profits are required for a number of purposes. Some amount of profits has to be
recycled in the business for reinvestment and expansion of business and some
profits has to be distributed to shareholders in the form of dividends.
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4. What is an investment decision or capital budgeting decisions? Explain the

factor affecting investment decisions.

INVESTMENT DECISION OR CAPITAL BUDGETING DECISIONS

Capital Budgeting is the technique of making long term planning decisions for
investment and their finance. A decision on capital expenditure is difficult as future
is uncertain. It is employed to evaluate long term expenditure decisions which
involve current outlays and the benefits that occur in the future years.

FACTOR AFFECTING INVESTMENT DECISIONS OR CAPITAL BUDGETING DECISIONS

The factor affecting investment decisions or capital budgeting decisions are as

follows-

I. CASH FLOW OF THE PROJECT- When the company has to decide about the long
term projects, it has to see the cash inflows and outflows during the life of the
project. If the sum of the cash inflow is more than the sum of cash out
outflows, then the investment decision is taken otherwise alternative is
considered.
II. RATE OF RETURN- The expected returns are estimated on various alternatives
where in money has to be invested. The project which is going to yield higher
rate of return is accepted as the most profitable investments.
III. INVESTMENT CRITERIA INVOLVED- Investment decisions do not depend on a
single factor. There are various other factors on the basis of which the
investment decisions are taken like cash inflow and cash outflow, amount of
investment involved, expected rate of return and other such calculations.
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5. Explain the factor affecting financing decisions of a company. 2016

FACTOR AFFECTING FINANCING DECISIONS OF A COMPANY

The factor affecting financing decisions of a company are as follows-

I. COST- The cost of raising finance from various sources is different and finance
manager always prefer the source with minimum cost. Cost of raisingowners
funds is higher than the cost of raising borrowed funds as owners fund involve
many legal formalities than borrowed funds.
II. RISK- More risk is associated with borrowed funds due to fixed commitments
of interest payments and timely repayment of principal amount as compared
to fund securities.
III. CASH FLOW POSITION- The cash flow position of the company also helps in
selecting the securities. With smooth and steady cash flows, companies can
easily afford borrowed fund securities but when companies have shortage of
cash flow, they must go for owners fund securities only.
IV. CONTROL CONSIDERATIONS- If existing shareholders wish to retain the
complete control on the business; they prefer borrowed securities to raise
further funds. On the other hand, if they do not mind to lose control, they may
also go for owners funds.
V. PERIOD OF FINANCE- Equity capital must be issued to provide permanent base
for the company. Preference shares and debentures can be issued for meeting
long term and medium term requirements and can be paid back or redeemed.
VI. Nature and Size of the Business- The type of business and its size greatly
influence financing decisions. Large manufacturing or industrial companies
 typically require substantial funds for operations and expansion, giving them
access to diverse financing options such as equity, debentures, and bank
loans. In contrast, small businesses or service-oriented firms usually rely on
internal funds or short-term borrowings due to limited access to capital
markets.
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6. “Financing decisions of a company is affected by a number of factors.” Explain

in brief any four factors.

SAME AS ANSWER NO. 5

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7. What is a dividend decision? What are the aspects of dividend decisions? Explain
the factor affecting dividend decisions. 2016

MEANING OF DIVIDEND DECISION

This decision is concerned with distribution of surplus funds. The profit of the
firm is distributed among various parties such as creditors, employees,
shareholders, debenture holders etc. Under this decisions the finance manager
decided how much to be distributed and how much to be kept aside as retained
earnings.

ASPECTS OF DIVIDEND DECISIONS

The aspects of dividend decisions are as follows-

This decision is concerned with distribution of surplus funds. The profit of the
firm is distributed among various parties such as creditors, employees,
shareholders, debenture holders etc. Under this decisions the finance manager
decided how much to be distributed and how much to be kept aside as retained
earnings.
 FACTOR AFFECTING DIVIDEND DECISIONS OF A COMPANY

The factor affecting dividend decisions of a company are as follows-

I. AMOUNT OF EARNINGS- Dividends is paid out of current and previous year

earnings. If there are more earnings, the company declares high rate of
dividend whereas during low earning period, the rate of dividend is also low.
II. STABILITY OF EARNINGS- Companies which have stable or smooth earnings
prefer to give high rate of dividend whereas companies with irregular
earnings prefer to give low rate of earnings.
III. CASH FLOW POSITION- Paying dividends means outflow of cash. Companies
declare high rate of dividend only when they have surplus cash. In situation of
shortage of cash, companies declare no or very low dividend.
IV. TAXATION POLICY- The rate of dividend also depends upon the taxation policy
of the government. Under present taxation system, dividend income is a tax
free income for shareholders whereas the company has to pay tax on dividend
given to shareholders. If tax rate is higher, the company would prefer to pay
less dividends.
V. STOCK MARKET REACTIONS- If high rate of dividend is declared, stock market
reacts positively but if the rate of dividends is declared low, the stock markets
reacts negatively.
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8. “The dividend decision of a company is determined by a number of factors.”

Explain the statement. 2012

ANS- SAME AS ANSWER NO.-7

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9. What is financial planning? Write three aspects of financial planning? State

some objectives of financial planning? Explain the importance of financial
planning. 2012, 2015, 2017, 2018, 2019
MEANING OF FINANCIAL PLANNING

Financial Planning relates to the estimations of funds required to be invested in fixed

assets and current assets, raising long term funds by issuing shares, debentures and
raising loans for the purchase of fixed assets, raising short term funds for procuring
current assets and taking decisions relating to distribution of profits.

ASPECTS OF FINANCIAL PLANNING

The three aspects of financial planning are as follows-

I. Creation of wealth- It includes setting financial goals and constructing a savings

and investment plan. This aspect of financial planning talks about wealth building,
tax planning, and budgeting.

II. Protection of Wealth- Primarily this is about insurance. A proper risk protection
strategy will protect us from the most common risks.

III. Succession of Wealth- Wealth succession is about realizing our goals and
managing for the future. This means retirement planning and estate planning.

OBJECTIVES OF FINANCIAL PLANNING

The objectives of financial planning are

I. The main objectives of financial planning is that sufficient fund should be available
in the company for different purpose.

II. To see that firm does not raise resources unnecessarily because excess funding is
as bad as inadequate or shortage of funds.

III. To balance cost with the risk in order to protect owners from the hazard loss.

IMPORTANCE OF FINANCIAL PLANNING

The importance of financial planning is

 I. The financial planning estimates the precise requirements of funds which
means to avoid wastage of funds.
II. Financial planning suggests how the funds are to be allocated for various
purposes by comparing various investment proposals.
III. With the help of financial planning, we can estimates the fund requirements
for various time periods.
IV. Financial planning acts as basis for checking the financial activity by
comparing the actual revenue with estimated revenue and actual cost with
estimated cost.
V. Financial planning ensures that the funds raised for the different purposes are
being utilized for those purposes only.
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10. What is capital structure? Explain any factors which affect capital structure of a
company. 2012, 2019.

MEANING OF CAPITAL STRUCTURE

Capital structure refers to the proportions of different kinds of securities issued by a

company to raise long term finance. Thus capital structure denotes the type of
securities issued i.e equity shares, preference shares and debentures and the
relative proportions of each type of security. In other words, capital structure
represents the proportions of equity capital and debt capital used for financing the
operations of a business.

FIVE FACTORS WHICH AFFECT CAPITAL STRUCTURE OF A COMPANY

The five factors which affect capital structure of a company are as follows-

I. STABILITY OF SALES- For a company having a high sales turnover, a higher

proportion of debt is suitable. For a company with fluctuations sales, a higher
proportion of equity is possible.
II. CONTROL- To retain control over the management of the company,
debentures and preference shares should be issued to raise capital.
III. FLEXIBILITY- Equity allows for more flexibility to change its capital structure
according to market conditions while debt restricts this freedom.
IV. SIZE OF THE COMPANY- Large companies are able to raise capital through
shares more easily while smaller companies have to depend on their own
sources or retained earnings as they do not get loans easily.
V. TAX RATE- It will be beneficial for the company to raise funds through debt if
taxes rates are high. Tax rate influences cost of debt as interest is a tax
deductible item.
VI. COST OF EQUITY- More debt means more risk for the equity holders which
increase their desired rate of return. To control cost of equity, limit should be
imposed on the use of debt.
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11. Explain any five internal and external factors which affect capital structure of
a company

ANS- Internal Factors Affecting Capital Structure

1. Profitability of the Company-Profitable companies often rely on internal funds like

retained earnings for financing their operations and expansion. High profits reduce
dependence on external debt or equity, enabling firms to maintain a lower debt-equity
ratio. Conversely, less profitable firms may need more external financing, affecting their
capital structure.
2. Business Risk-The inherent risk associated with a company’s operations influences the
proportion of debt and equity. Firms with high business risk prefer lower debt levels to
avoid financial strain, while stable businesses with predictable earnings can afford higher
debt in their capital structure.
3. Financial Flexibility-A company’s ability to raise funds in the future affects its current
capital structure. Firms with high financial flexibility can maintain an optimal mix of debt
and equity, whereas firms with limited access to funds may need to rely heavily on one
source, such as equity.
4. Management Philosophy-The attitude of the company’s management toward risk and
control shapes financing decisions. Risk-averse managers may prefer equity over debt to
avoid the burden of interest payments, whereas aggressive management may favor debt
to maximize shareholder returns.
5. Company Size and Growth Prospects-Large and rapidly growing firms often have
access to multiple financing sources and can afford higher debt levels. Small or slow-
growing companies may stick to equity or internal financing to maintain financial
stability and avoid the risk of over-leverage.
External Factors Affecting Capital Structure
1. Market Conditions-Prevailing economic conditions, stock market trends, and investor
sentiment affect the availability and cost of finance. During booming markets, raising
equity is easier, while low-interest rates encourage companies to borrow debt.
2. Interest Rates-The cost of borrowing influences a firm’s debt levels. Low-interest rates
make debt financing attractive, while high rates may push firms toward equity financing
to reduce interest burden.
3. Tax Policies-Tax regulations significantly impact capital structure decisions. Since
interest on debt is tax-deductible, companies may prefer debt financing to take advantage
of tax savings, while dividends on equity are not tax-deductible.
4. Legal and Regulatory Framework-Government regulations, such as borrowing limits,
disclosure norms, and industry-specific guidelines, affect the type and proportion of
capital a company can raise. Companies must comply with these rules while planning
their capital structure.
5. Economic Environment-Factors such as inflation, recession, and economic stability
affect financing decisions. During uncertain times, firms may reduce debt levels to avoid
financial risk, whereas in stable environments, they may take on more debt to fund
expansion.

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12. Determination of capital structure of a company is influenced by a number of

factors.” Explain any six such factors. 2014

ANS- SAME AS ANSWER NO. – 9

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13. What are the factors to be kept in mind while determining the capital
structure of a company? 2012

ANS- SAME AS ANSWER NO. – 9

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14. Describe in brief any four features of sound capital structures.

ANS- The four features of sound capital structures are as follows-

I. MAXIMUM RETURN- The financial structure of accompany should be guided by

clear cut objective. Its objective can be maximization of the wealth of the
shareholders or maximization of return to the shareholders.
 II. LESS RISKY- The capital structure should represent a balance between
different types of ownership and debt securities. This is essential to reduce
risk on the use of debt capital.
III. SAFETY- A sound capital structure should ensure safety of investment. It
should be so determined that fluctuations in the earnings of the company do
not heavy strain on its financial structure.
IV. FLEXIBILTY- A sound capital structure should facilitate expansion and
contraction of funds. The company should be able to procure more capital in
times of need and should be able to pay all its debts when it does not require
funds.

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15. What is working Capital? Explain any five factors affecting the working
capital requirements. Explain the different types of Working Capital. 2012,
2013, 2014, 2017

ANS- Working capital refers to the difference between the sum of short term
assets of the firm such as cash, bank, trade receivables, etc and sum of short term
liabilities such as creditors, bills payable etc.

Five factors affecting the working capital requirements-

The five factors affecting the working capital requirements are as follows

I. TYPES OF PRODUCT MANUFACTURED- Certain products which require

heavy capital investment in plant and machinery do not require much
working capital. Labour intensive activities, require large stocks of raw
materials, inventories etc require more working capital.
II. LENGTH OF OPERATING CYCLE- Operating cycle refers to the length of the
manufacturing cycle i.e., the periods taken to convert raw materials to
finished sales products. Longer period means more working capital is
required and vice versa.
 III. SALES LEVEL- Higher sales level means ready convertibility into cash and
thus, there is not much investment required in working capital as there is
inflow of cash. Similarly, a lower sales level requires more investment in
working capital.
IV. CREDIT POLICY- If liberal credit terms are given and a liberal policy is
followed, then the company would require more working capital as there
is less cash inflows and vice- versa.
V. NATURE OF BUSINESS- Manufacturing firm requires high amount of
working capital as compared to a trading organization, to convert raw
materials into finished goods.
VI. SEASONAL FACTOR- Higher amount of working capital is required by the
organization during its peak season and less during lean season.

Working capital refers to the difference between a company’s current assets and current
liabilities. It indicates the short-term financial health and operational efficiency of a business.
Depending on purpose, liquidity, and nature, working capital can be classified into various types.

1. Permanent (Fixed) Working Capital

 This is the minimum amount of current assets that a company always needs to
maintain to carry out its day-to-day operations.
 It is “permanent” because these assets are constantly required, regardless of seasonal
fluctuations in business.
 Example: Minimum inventory, cash, and receivables needed at all times.

2. Temporary (Variable) Working Capital

 Temporary working capital is the additional working capital required to meet

seasonal or unexpected business demands.
 It fluctuates depending on the production cycle, sales, or market conditions.
 Example: Extra raw materials or inventory during festive seasons or peak demand
periods.

3. Gross Working Capital

 Gross working capital refers to the total investment in current assets of a company,
such as cash, inventory, receivables, and marketable securities.
 It focuses on the total resources available to meet short-term obligations but does not
consider current liabilities.
  Example: If a company has ₹50 lakh in current assets, this represents its gross working
capital.

4. Net Working Capital

 Net working capital (NWC) is the difference between current assets and current
liabilities.
 It indicates the short-term liquidity position of the business and its ability to meet
obligations.
 Positive NWC: Current assets > Current liabilities (healthy liquidity).
 Negative NWC: Current assets < Current liabilities (possible liquidity issues).

5. Positive and Negative Working Capital

 Positive Working Capital: When current assets exceed current liabilities, the company
can efficiently meet short-term obligations and invest in growth.
 Negative Working Capital: When current liabilities exceed current assets, the company
may face liquidity problems and risk operational disruptions.

6. Regular and Seasonal Working Capital

 Regular Working Capital: The minimum level of working capital maintained

throughout the year for smooth operations.
 Seasonal Working Capital: The additional working capital required to handle seasonal
peaks in production or sales.

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16. Explain any five factors which might influence the amount of working capital
needed by a business enterprise.

ANS- SAME AS ANSWER NO.– 15

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17. What is fixed capital? Explain any five factors affecting the fixed capital
requirements. 2015 2018

ANS- MEANING OF FIXED CAPITAL

Management of fixed capital means the sum of fixed assets required by

an organisation and their sources of funds in the form of equity shares,
preferences shares, debentures and long term loans. These decisions are also
called capital budgeting decisions or fixed capital decisions or investment
decisions.

The five factors affecting the fixed capital requirements are as follows-

I. NATURE OF BUSINESS- The type of business organization involved is the

first factor which helps in deciding the requirement of fixed capital. A
manufacturing company needs more fixed capital as compared to a
trading company, as trading company does not require plant machinery
etc.
II. SCALE OF OPERATIONS- The companies which are operating on a large
scale require more fixed capital as they need more machineries and other
assets whereas small scale enterprises need less amount of fixed capital.
III. CHOICE OF TECHNIQUE- Companies using capital intensive technique
require more capital because capital intensive techniques make use of
plant and machinery and company needs more fixed capital to buy plant
and machinery.
IV. TECHNOLOGY UPGRADATION- Industries in which technology
upgradation is fast, need more amount of fixed capital whereas companies
where technology upgradation is slow require less amount of fixed
capital.
V. GROWTH PROSPECTS- Companies which are expanding and have higher
growth plans require more fixed capital, to expand they need to increase
their production capacity, companies need more plant and machinery, so
more fixed capital is required.
VI. DIVERSIFICATIONS- Companies which have plan to diversify their
activities by including more range of products require more fixed capital
as to produce more products.
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18. Distinguish between Fixed capital and working capital. 2015, 2018

ANS-
 BASIS FIXED CAPITAL WORKING CAPITAL
Defination Fixed capital is invested in fixed assets like
Working Capital is invested
land and buildings, plant and machinery, in current assets like raw
furniture etc. materials semi-finished
goods, debtors, bills
receivable etc.
Nature It remains sunk in business It fluctuates from time to
time
Term It is required for meeting the permanent It is required for meeting
long term need of business. the short term needs of the
business.
Purpose It is needed for financing fixed assets It is used for meeting the
day to day expenses.
Circulation Fixed capital is blocked in fixed assets Working capital is realized
permanently and re invested again and
again.
Sources Fixed capital is raised from long term and Working capital is raised
medium term sources of finances from short term sources of
finances.

19. To avoid the problem of shortage and surplus of funds what is required in
financial management? Name the concept and explain any three points of
importance.

ANS- The concept of financial planning is needed.

The importances of financial planning are

SAME AS ANSWER NO. – 9

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20. Explain four importances of capital budgeting decisions.

ANS- The four importances of capital budgeting decisions are-

I. LONG TERM EFFECTS- Capital Budgeting decisions have long term

implications. Since fixed assets account for a sizable proportions of the
total assets and their life extends over a good number of years, any
investment in fixed assets must be made carefully.
 II. COMMITMENT OF FUNDS- Capital investment decisions involve blocking
up of large amount of funds in fixed assets. Capital budgeting helps the
management in estimating the amount of funds to be invested in long
term assets and probable schedule of their recovery.
III. RISK FACTOR- Investment in fixed assets is a risky proportions as it
involves huge fund getting blocked in long term assets. It affects the
revenue of the firm in the long run.
IV. IRREVERSIBLE DECISIONS- Capital investment decisions involve
commitment of large funds for a long term. Such decisions are not
reversible without incurring heavy losses.

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21. You are the finance manager of a company. The Board of Directors has asked
you to determine the working capital requirements of the company. State the factors
that you would take into consideration while determining the requirements of
working capital of the company.

ANS- SAME AS ANSWER NO. - 15.