Key Points

Financial Management is concerned with the optimal procurement and usage of finance. It aims to reduce the cost of funds procured, keep risk under control, and achieve effective deployment of such funds.

The primary objective is wealth maximization, which means maximizing the market price of the company's equity shares. This is achieved when the benefits of a financial decision exceed its costs.

Financial management is based on three broad decisions: the Investment Decision, the Financing Decision, and the Dividend Decision. These decisions together impact the company's value.

This decision relates to how a firm invests its funds in different assets. Long-term investment decisions, or capital budgeting, involve large funds, are often irreversible, and affect long-term profitability.

This decision concerns the sources from which a firm will raise long-term funds. It involves deciding the optimal mix of debt (borrowed funds) and equity (owner's funds).

This decision determines how much of the after-tax profit is distributed to shareholders as dividends and how much is retained in the business (retained earnings) for future growth.

Financial planning is the preparation of a financial blueprint for an organization's future operations. Its twin objectives are to ensure funds are available when needed and to avoid raising funds unnecessarily.

Capital structure refers to the mix between owner's funds (equity) and borrowed funds (debt). It can be calculated as a debt-equity ratio and affects both the profitability and financial risk of a firm.

Financial leverage is the proportion of debt in the total capital. Trading on Equity is the practice of using cheaper debt to increase the Earnings Per Share (EPS), which is profitable only when the Return on Investment (ROI) exceeds the cost of debt.

Financial leverage is favorable when Return on Investment (ROI) is higher than the interest rate on debt, which increases EPS. It is unfavorable when ROI is lower than the interest rate, which decreases EPS.

Major factors influencing the choice of capital structure include cash flow position, Interest Coverage Ratio (ICR), cost of debt, tax rate, control considerations, and stock market conditions.

Fixed capital refers to the investment in long-term assets such as land, buildings, plant, and machinery. These decisions are called capital budgeting decisions and affect long-term growth and risk.

The requirement for fixed capital is determined by factors like the nature of the business, scale of operations, choice of technique (capital-intensive vs. labor-intensive), and growth prospects.

Working capital is the capital invested in current assets like cash, inventory, and receivables, needed for smooth day-to-day operations. Net Working Capital is calculated as Current Assets minus Current Liabilities.

Key factors influencing working capital needs include the nature of business, scale of operations, business cycle, production cycle, and credit policies (both allowed to customers and availed from suppliers).