Financial Management — Class 12 Business Studies

Business finance refers to the money and credit employed in a business; financial management is concerned with the optimal procurement and usage of finance. Its primary aim is to maximise the wealth of the shareholders, that is, the market value of the firm's equity shares. Financial management involves three broad financial decisions. The investment decision (capital budgeting for long-term assets and working-capital decisions for short-term assets) decides where funds are committed; it is affected by cash flows, the rate of return and the investment criteria. The financing decision is about the proportion of funds raised from shareholders (equity) and from borrowing (debt), and is affected by cost, risk, the floatation cost, cash-flow position and control considerations. The dividend decision concerns how much profit is distributed as dividend and how much retained, influenced by earnings, stability, growth opportunities, cash-flow position and shareholders' preference. Financial planning is the preparation of a financial blueprint of an organisation's future operations; it ensures that enough funds are available and avoids surplus or shortage. Capital structure is the mix of debt and equity used to finance the business; the use of debt is called financial leverage or trading on equity, which raises the return to equity shareholders but also raises risk. The choice of an appropriate capital structure depends on cash-flow position, interest-coverage ratio, return on investment, cost of debt, tax rate, cost of equity, floatation cost, risk, flexibility, control, the regulatory framework and stock-market conditions. Decisions on fixed and working capital depend on the nature and scale of business, the business cycle and the operating cycle.