Unit 4: Financial Management

Syllabus:

Introduction of Financial Management, Objectives of Financial Management, Functions and Importance of Financial Management. Brief Introduction to the concept of capital structure and various sources of finance.

PYQ Analysis

High Priority Topics (15 marks)

1. Financial Management - Objectives, Functions, Importance - Jul-21, Jul-22, May-23
2. Capital Structure - Jul-21, Jul-22, May-23
3. Sources of Finance - Jul-22, May-23
4. Role of Financial Manager - Jul-22
5. Financial Management Decisions - May-23

Short Answer Topics (3 marks)

1. Capital Budgeting - Jul-21, May-23
2. Importance of Financial Management - Jul-22
3. Meaning of Capital Structure - Jul-22
4. Source of Finance - May-23
5. Working Capital Management - May-23

1. Introduction to Financial Management

PYQ: What is financial management and their objective? (Jul-21, 15 marks)
PYQ: What is Financial Management? What is the role of financial manager of a company? (Jul-22, 15 marks)
PYQ: What is Financial Management? If you are a finance manager, which type of main decisions you will take? (May-23, 15 marks)

1.1 Meaning

Financial Management is the planning, organizing, directing, and controlling of financial activities such as procurement and utilization of funds in an organization.

Simple Definition: Financial management means managing money in a business - how to get money (sources) and how to use it (investment) to maximize profit.

In Simple Words: It's like managing your personal finances but for a company - earning money, saving it, spending wisely, and investing for future growth.

Example: A startup needs ₹1 crore to expand. Financial management involves:

1. Deciding how to raise ₹1 crore (bank loan, investors, or own savings?)
2. Deciding where to invest (new machines, marketing, or hiring?)
3. Managing daily expenses (salaries, rent, bills)
4. Planning for profit distribution (reinvest or pay shareholders?)

1.2 Scope

1. Investment Decisions (Capital Budgeting):

• Where to invest money for maximum returns
• Example: Should Tata Motors invest ₹500 crore in electric vehicle plant or expand existing factory?

2. Financing Decisions:

• How to raise money - debt (loan) or equity (shares)
• Example: Should Flipkart raise ₹1000 crore through bank loan or by selling shares to investors?

3. Dividend Decisions:

• How much profit to distribute to shareholders vs retain for growth
• Example: Reliance earned ₹10,000 crore profit - pay ₹4,000 crore as dividend or reinvest all?

4. Working Capital Management:

• Managing day-to-day finances (cash, inventory, receivables)
• Example: Ensure ₹50 lakh cash always available for monthly salaries and expenses

2. Objectives of Financial Management

PYQ: What is financial management and their objective? (Jul-21, 15 marks)

2.1 Primary Objectives

1. Profit Maximization (Traditional Objective):

Meaning: Earning maximum profit from business operations.

Example: A company can earn ₹10 crore profit by:

• Cutting costs (using cheap raw materials)
• Increasing prices
• Reducing employee salaries

Limitations:

1. Ignores Time Value of Money:

   • ₹100 today ≠ ₹100 after 5 years (due to inflation, interest)
   • Example: Project A gives ₹10 lakh profit today, Project B gives ₹10 lakh after 5 years. Both seem equal, but Project A is better!

2. Ignores Risk:

   • High profit may come with high risk
   • Example: Investing in cryptocurrency may give 100% profit or 100% loss - very risky!

3. Short-term Focus:

   • Focus on immediate profit, ignores long-term sustainability
   • Example: Company cuts R&D budget to increase this year's profit, but loses competitiveness in future

4. May Compromise Quality:

   • Using cheap materials increases profit but damages brand reputation
   • Example: Using low-quality ingredients in food products to save cost

2. Wealth Maximization (Modern Objective):

Meaning: Maximizing the market value of company's shares or total wealth of shareholders.

Formula: Wealth = Share Price × Number of Shares

Example:

• Company has 1 crore shares at ₹100 each = ₹100 crore wealth
• After good financial management, share price rises to ₹150
• New wealth = ₹150 crore (₹50 crore increase!)

Advantages:

1. Considers Time Value of Money:

   • Uses NPV (Net Present Value) to evaluate projects
   • Example: ₹10 lakh today is worth more than ₹10 lakh after 5 years

2. Considers Risk:

   • Balances risk and return
   • Example: Choose moderate-risk project with 15% return over high-risk project with 25% return

3. Long-term Focus:

   • Sustainable growth, not quick profits
   • Example: Invest in R&D, employee training for future competitiveness

4. Shareholder Value Creation:

   • Increases share price, benefits all shareholders
   • Example: Apple's focus on innovation increased share price from $1 to $150+ over years

Why Wealth Maximization is Better:

Real Example:

• Amazon focused on wealth maximization - made losses for years but invested in growth. Result: Share price grew from $18 (1997) to $3,000+ (2021)
• If Amazon focused only on profit maximization, it would have remained a small bookstore

2.2 Other Objectives

1. Ensuring Adequate Funds:

• Sufficient money available when needed, no shortage
• Example: Maintain ₹10 crore working capital to pay salaries, suppliers on time

2. Proper Utilization of Funds:

• Use funds efficiently, no wastage, invest in profitable projects
• Example: Don't keep ₹100 crore idle in bank; invest in expansion or new products

3. Ensuring Safety of Funds:

• Minimize risk, protect capital from losses
• Example: Diversify investments - don't put all money in one risky project

4. Maintaining Sound Capital Structure:

• Right balance of debt and equity
• Example: 60% equity + 40% debt = balanced structure (not too risky, not too expensive)

3. Functions of Financial Management

PYQ: What is financial management and their objective? (Jul-21, 15 marks)

1. Financial Planning:

• Estimating fund requirements, preparing budgets for future
• Example: Plan that next year we'll need ₹50 crore for expansion - ₹30 crore from bank loan, ₹20 crore from retained earnings

2. Financial Control:

• Monitoring expenses, comparing actual vs planned, taking corrective action
• Example: Budget was ₹10 lakh for marketing, but spent ₹15 lakh - investigate why and control future spending

3. Investment Decisions (Capital Budgeting):

PYQ: Capital Budgeting (Jul-21, 3 marks; May-23, 3 marks)

Capital Budgeting is evaluating and selecting long-term investment projects.

Process:

• Identify investment opportunities
• Evaluate using techniques (NPV, IRR, Payback Period)
• Select profitable projects
• Allocate funds

Example: Reliance has ₹10,000 crore. Should they invest in:

• Option A: New refinery (₹10,000 crore, 15% return)
• Option B: Telecom expansion (₹10,000 crore, 20% return)
• Decision: Choose Option B (higher return)

Techniques:

• Payback Period: How long to recover investment? (Shorter is better)
• NPV: Present value of future cash flows (Positive NPV = Accept)
• IRR: Rate of return (Higher IRR = Better)

4. Financing Decisions:

• How to raise funds - debt (loan) or equity (shares)
• Affects capital structure, cost of capital, risk
• Example: Need ₹100 crore - raise through ₹60 crore equity + ₹40 crore debt

5. Dividend Decisions:

• How much profit to distribute as dividend vs retain for growth
• Example: Earned ₹100 crore profit - pay ₹40 crore dividend (40% payout), retain ₹60 crore for expansion

6. Working Capital Management:

PYQ: Working Capital Management (May-23, 3 marks)

Working Capital = Current Assets - Current Liabilities

Managing day-to-day finances to ensure smooth operations.

Components:

• Current Assets: Cash, inventory, receivables
• Current Liabilities: Payables, short-term loans

Example:

• Current Assets: ₹50 lakh (₹20L cash + ₹20L inventory + ₹10L receivables)
• Current Liabilities: ₹30 lakh (₹30L payables)
• Working Capital = ₹50L - ₹30L = ₹20 lakh (Good - positive working capital)

Importance: Ensures company can pay salaries, suppliers, bills on time

7. Cash Management:

• Ensuring adequate cash for daily operations
• Example: Maintain minimum ₹5 lakh cash balance always

8. Credit Management:

• Managing receivables (money customers owe), minimizing bad debts
• Example: Give 30-day credit to reliable customers, cash-only for new customers

9. Risk Management:

• Identifying financial risks, developing mitigation strategies
• Example: Hedge foreign exchange risk, diversify investments

10. Financial Reporting:

• Preparing financial statements (Balance Sheet, P&L, Cash Flow)
• Example: Quarterly reports for shareholders, annual reports for regulators

4. Importance of Financial Management

PYQ: What is the importance of financial management? (Jul-22, 2.5 marks)

1. Financial Planning and Forecasting:

• Estimates fund requirements, plans for future needs
• Example: Zomato planned it would need ₹5,000 crore for expansion over 3 years, arranged funding in advance

2. Acquisition of Funds at Lowest Cost:

• Identifies best sources, raises funds at minimum cost
• Example: Company compares bank loan (12% interest) vs bonds (10% interest) - chooses bonds to save cost

3. Proper Utilization of Funds:

• Allocates efficiently, invests in profitable projects, avoids wastage
• Example: Infosys invests profits in R&D and employee training instead of keeping money idle

4. Better Financial Decisions:

• Informed investment, financing, and dividend decisions
• Example: Using NPV analysis, Tata rejected low-return project and invested in high-return project

5. Improves Profitability:

• Efficient resource use, cost control, revenue maximization
• Example: Walmart's efficient inventory management reduces costs and increases profit margins

6. Increases Shareholder Wealth:

• Maximizes company value, increases share price
• Example: Apple's strong financial management increased share price from $7 (2009) to $150+ (2021)

7. Ensures Financial Stability:

• Maintains liquidity, manages risks, ensures solvency
• Example: Companies with good cash reserves survived COVID-19 crisis, others went bankrupt

8. Facilitates Growth and Expansion:

• Provides funds for expansion, new products, market entry
• Example: Jio's financial planning enabled ₹1.5 lakh crore investment in telecom infrastructure

9. Builds Investor Confidence:

• Good financial management attracts investors, lenders
• Example: Companies with strong financials get loans easily at lower interest rates

10. Ensures Survival:

• Poor financial management = bankruptcy; good management = long-term survival
• Example: Kingfisher Airlines failed due to poor financial management; IndiGo thrives with strong financial discipline

5. Role of Financial Manager

PYQ: What is the role of financial manager of a company? (Jul-22, 15 marks)

1. Financial Planning:

• Estimate fund requirements, prepare budgets and forecasts
• Example: Plan capital budget of ₹100 crore for next year's expansion

2. Raising Funds:

• Identify best sources, negotiate with banks/investors for lowest cost
• Example: Negotiate with 5 banks to get loan at 9% instead of 11%

3. Investment Decisions:

• Evaluate investment proposals, select most profitable projects
• Example: Analyze 10 projects, select 3 with highest NPV and lowest risk

4. Cash Management:

• Maintain adequate cash for operations, optimize cash flows
• Example: Ensure ₹10 crore cash always available for emergencies and daily needs

5. Credit Management:

• Set credit policies, manage receivables, minimize bad debts
• Example: Give 30-day credit to A-grade customers, 15-day to B-grade, cash-only for C-grade

6. Dividend Policy:

• Recommend dividend rate, balance between distribution and retention
• Example: Recommend 40% dividend payout, retain 60% for expansion

7. Financial Control:

• Monitor expenses, compare with budget, take corrective action
• Example: If marketing spending exceeds budget by 20%, investigate and control

8. Risk Management:

• Identify financial risks (forex, interest rate, credit), develop hedging strategies
• Example: Use forward contracts to protect against rupee depreciation

9. Financial Reporting:

• Prepare accurate financial statements, ensure regulatory compliance
• Example: Quarterly reports to stock exchange, annual reports to shareholders

10. Coordination with Departments:

• Work with production, marketing, HR to align financial goals
• Example: Coordinate with marketing on advertising budget, with production on capital expenditure

5.1 Financial Management Decisions

PYQ: If you are a finance manager, which type of main decisions you will take? (May-23, 15 marks)

As a Financial Manager, key decisions:

1. Investment Decisions (Capital Budgeting):

What: Where to invest company's funds for maximum returns

Considerations:

• Expected returns vs risk
• Payback period, NPV, IRR
• Alignment with business strategy

Example Decision: Company has ₹500 crore. Three options:

• Option A: Build new factory (₹500 cr, 18% return, 5-year payback)
• Option B: Acquire competitor (₹500 cr, 15% return, 7-year payback)
• Option C: Invest in technology (₹500 cr, 25% return, 3-year payback)

Decision: Choose Option C (highest return, shortest payback)

2. Financing Decisions:

What: How to raise funds - debt (borrowing) or equity (ownership)

Considerations:

• Cost of capital (interest vs dividend)
• Tax benefits (interest is tax-deductible)
• Control (debt doesn't dilute ownership)
• Risk (high debt = high financial risk)

Example Decision: Need ₹1,000 crore for expansion. Options:

• Option A: 100% bank loan (11% interest, tax benefit, no dilution, high risk)
• Option B: 100% equity (expensive, dilutes control, low risk)
• Option C: 60% equity + 40% debt (balanced approach)

Decision: Choose Option C (optimal balance of cost, risk, and control)

3. Dividend Decisions:

What: How much profit to distribute as dividend vs retain for growth

Considerations:

• Shareholder expectations
• Future investment needs
• Company growth stage
• Cash availability

Example Decision: Earned ₹1,000 crore profit. Options:

• Option A: Pay 70% dividend (₹700 cr) - shareholders happy but less money for growth
• Option B: Pay 30% dividend (₹300 cr) - more funds for expansion but shareholders may be unhappy
• Option C: Pay 50% dividend (₹500 cr) - balanced approach

Decision: Choose Option C if company needs funds for expansion but also wants to keep shareholders satisfied

Real Example:

• Startups (Zomato, Swiggy) pay 0% dividend - retain all profits for growth
• Mature companies (ITC, Hindustan Unilever) pay 50-70% dividend - stable business, less growth needs

4. Working Capital Decisions:

What: Managing day-to-day finances - cash, inventory, receivables, payables

Considerations:

• Maintain liquidity for operations
• Optimize inventory levels
• Balance receivables and payables
• Seasonal fluctuations

Example Decision: Retail business needs to decide:

• Cash: Maintain ₹50 lakh minimum balance (for emergencies)
• Inventory: Keep 30 days stock (₹2 crore) - not too much (blocks money), not too little (stockout risk)
• Credit Policy: Give 30-day credit to customers, negotiate 45-day credit from suppliers
• Result: Positive working capital, smooth operations

5. Risk Management Decisions:

What: Identify and manage financial risks

Types of Risks:

• Foreign exchange risk (currency fluctuations)
• Interest rate risk (loan rates may increase)
• Credit risk (customers may not pay)
• Market risk (share prices may fall)

Example Decision: Indian company imports goods worth $10 million from USA:

• Risk: If rupee depreciates from ₹80/$1 to ₹85/$1, cost increases by ₹5 crore
• Options:
  • Do nothing (risky)
  • Use forward contract to lock exchange rate (safe but costs premium)
• Decision: Use forward contract to hedge risk if amount is large

6. Capital Structure

PYQ: Explain the capital structure and its sources of finance. (Jul-21, 15 marks)
PYQ: What do you mean by capital structure? Qualities of optimum capital structure. (Jul-22, 15 marks)
PYQ: Capital Structures (May-23, 15 marks)

6.1 Meaning

PYQ: What is the meaning of capital structure? (Jul-22, 2.5 marks)

Capital Structure is the mix of debt and equity used by a company to finance its operations.

Components:

• Equity Capital: Equity shares, preference shares, retained earnings
• Debt Capital: Debentures, bonds, long-term loans

Example: Company has ₹100 crore capital:

• Equity: ₹60 crore (60%)
• Debt: ₹40 crore (40%)
• Capital Structure = 60:40

6.2 Importance

1. Maximizes Returns:

• Optimal mix increases profitability, reduces cost of capital
• Example: Using 40% debt (cheaper) instead of 100% equity reduces overall cost from 15% to 12%

2. Minimizes Financial Risk:

• Balanced structure reduces risk of bankruptcy
• Example: Too much debt (90%) = high interest burden, may lead to bankruptcy if profits fall

3. Provides Flexibility:

• Ability to raise more funds when needed
• Example: Company with low debt (30%) can easily borrow more during expansion

4. Maintains Control:

• Debt doesn't dilute ownership, equity does
• Example: Promoter owns 51% shares. Taking loan maintains 51% control; issuing new shares reduces to 40%

5. Tax Benefits:

• Interest on debt is tax-deductible, reduces tax burden
• Example: ₹10 crore interest on loan saves ₹3 crore tax (30% tax rate)

6.3 Factors Affecting Capital Structure

1. Cost of Capital:

• Choose cheaper source to minimize cost
• Example: If loan costs 10% and equity costs 15%, prefer more debt

2. Risk Tolerance:

• High debt = high financial risk (must pay interest even in losses)
• Example: Risky tech startup prefers equity; stable utility company can take more debt

3. Control Considerations:

• Debt doesn't dilute ownership, equity does
• Example: Family-owned business prefers debt to maintain control

4. Cash Flow Stability:

• Debt requires regular interest payments - need stable cash flow
• Example: Real estate company with irregular cash flows prefers equity

5. Tax Benefits:

• Interest on debt is tax-deductible
• Example: High-profit company benefits more from debt's tax shield

6. Market Conditions:

• Bull market (high share prices) = good time to issue equity
• Example: Zomato issued shares during market boom at high valuation

7. Nature of Business:

• Stable, mature business = can take more debt
• Example: Power companies (stable) have 70% debt; IT startups (risky) have 20% debt

8. Flexibility Needs:

• Need for future fundraising
• Example: Company planning expansion keeps debt low now to borrow later

6.4 Optimum Capital Structure

PYQ: Qualities of optimum capital structure. (Jul-22, 15 marks)

Optimum Capital Structure maximizes firm value while minimizing cost of capital.

Qualities:

1. Maximum Returns: Maximizes earnings per share, highest returns to shareholders

2. Minimum Cost: Lowest weighted average cost of capital (WACC)

3. Minimum Risk: Balanced financial risk, not too much debt

4. Flexibility: Can raise more funds when needed

5. Control: Maintains ownership control

6. Tax Benefits: Utilizes tax shield of debt

7. Solvency: Total assets > Total liabilities, financially sound

Examples of Optimum Capital Structure:

Real Example:

• Reliance Industries: 40% Debt + 60% Equity (stable, profitable, can service debt)
• Infosys: 90% Equity + 10% Debt (asset-light, prefers low debt)
• Tata Steel: 50% Debt + 50% Equity (capital-intensive, stable business)

7. Sources of Finance

PYQ: Explain sources of finance with pros and cons. (Jul-21, 15 marks)
PYQ: Explain various sources of finance in details. (Jul-22, 15 marks)
PYQ: Source of Finance (May-23, 3 marks; 15 marks)

7.1 Internal Sources

1. Retained Earnings (Ploughing Back of Profits):

Profits not distributed as dividend, kept in business for reinvestment.

Example: Infosys earned ₹20,000 crore profit, paid ₹8,000 crore dividend, retained ₹12,000 crore for expansion.

Advantages:

• No cost: No interest or dividend payment required
• No dilution: Ownership control remains same
• Readily available: No lengthy procedures
• Increases creditworthiness: Strong reserves attract lenders

Disadvantages:

• Limited amount: Can't retain unlimited profits
• Not available for new companies: Startups have no profits yet
• Shareholder dissatisfaction: Investors may want higher dividends

Best For: Profitable, mature companies like TCS, Infosys, Reliance

2. Depreciation Funds:

Money set aside annually for replacing worn-out assets, can be used for other purposes meanwhile.

Example: Company sets aside ₹10 crore annually as depreciation; after 5 years, has ₹50 crore to replace old machinery.

3. Sale of Assets:

Selling unused, old, or surplus assets for quick cash.

Example: Company sells old factory building for ₹50 crore and uses money for expansion in new location.

7.2 External Sources - Long Term

1. Equity Shares (Ordinary Shares):

Ownership capital - shareholders are part-owners of the company.

Example: Zomato raised ₹9,375 crore through IPO by issuing equity shares to public in 2021.

Advantages:

• No fixed obligation: Pay dividend only when company makes profit
• Permanent capital: Never needs to be repaid
• No charge on assets: Assets remain free for other borrowings
• Voting rights: Shareholders participate in major decisions
• Increases creditworthiness: Strong equity base attracts lenders

Disadvantages:

• Dilutes control: More shareholders = less control for promoters
• Expensive: Dividend not tax-deductible, flotation costs high
• Complex procedures: SEBI regulations, stock exchange listing requirements
• Profit sharing: Must share profits with more people

Best For: Startups, high-growth companies, companies wanting permanent capital

2. Preference Shares:

Hybrid security - features of both equity and debt. Get fixed dividend and preference in payment.

Example: Company issues 10% preference shares of ₹100 crore - must pay ₹10 crore dividend annually before paying equity shareholders.

Advantages:

• No dilution of control: Preference shareholders usually don't have voting rights
• Fixed dividend rate: Predictable cost (e.g., 10% annually)
• No charge on assets: Assets remain free

Disadvantages:

• Dividend not tax-deductible: Unlike interest on debt
• Fixed burden: Must pay even if profits are low
• Cumulative liability: If dividend not paid, it accumulates

Best For: Companies wanting capital without diluting control

3. Debentures/Bonds:

Long-term borrowing from public, fixed interest rate, must be repaid after maturity.

Example: Reliance issued ₹10,000 crore bonds at 8% interest for 10 years - must pay ₹800 crore interest annually and repay ₹10,000 crore after 10 years.

Advantages:

• Interest is tax-deductible: Saves tax (e.g., ₹800 cr interest saves ₹240 cr tax at 30%)
• No dilution of control: Debenture holders are creditors, not owners
• Cheaper than equity: Interest (8-10%) < Dividend (12-15%)
• Trading on equity: Use borrowed money to earn higher returns

Disadvantages:

• Fixed obligation: Must pay interest even in losses
• Charge on assets: Assets mortgaged as security
• Increases financial risk: High debt = risk of bankruptcy
• Must be repaid: Unlike equity, debentures have maturity date

Best For: Profitable companies with stable cash flows, capital-intensive industries

4. Term Loans (Bank Loans):

Long-term loans from banks/financial institutions for 5-10 years.

Example: Tata Motors took ₹5,000 crore term loan from SBI at 10% interest for 7 years to build new plant.

Advantages:

• No dilution of control: Lenders are not owners
• Interest tax-deductible: Tax benefit
• Large amounts available: Banks can lend ₹100s of crores
• Flexible terms: Can negotiate repayment schedule

Disadvantages:

• Fixed obligation: Must pay EMI regularly
• Security required: Must pledge assets as collateral
• Restrictive covenants: Bank may impose conditions (maintain certain ratios, no dividends above limit)
• Processing time: Takes 2-3 months for approval

Best For: Established companies with assets to pledge, stable cash flows

5. Venture Capital:

Funding for startups and high-risk, high-growth companies by specialized investors.

Example: Sequoia Capital invested ₹500 crore in Zomato in early stages; now their stake is worth ₹10,000+ crore.

Advantages:

• Large funds available: VCs invest ₹10-100 crore in promising startups
• Expertise and guidance: VCs provide mentorship, network, strategic advice
• No repayment burden: Not a loan, it's equity investment
• Credibility: VC backing attracts more investors

Disadvantages:

• Dilution of control: VCs take 20-40% ownership, board seats
• Share profits: Must share future profits and exit gains
• Exit pressure: VCs want exit (IPO/sale) in 5-7 years
• Stringent terms: Performance milestones, anti-dilution clauses

Best For: Tech startups, innovative businesses with high growth potential but no profits yet

Famous VCs in India: Sequoia Capital, Accel Partners, Tiger Global, SoftBank

7.3 External Sources - Short Term

1. Bank Overdraft:

Withdraw more than bank balance up to a sanctioned limit for short-term needs.

Example: Company has ₹10 lakh in bank, overdraft limit ₹20 lakh. Can withdraw up to ₹30 lakh total.

Advantages:

• Flexible - use only when needed
• Interest only on amount used and number of days
• Quick access to cash

Disadvantages:

• High interest rate (12-15%)
• Repayable on demand by bank
• Requires security

2. Trade Credit:

Credit from suppliers - buy goods now, pay after 30-90 days.

Example: Retailer buys ₹50 lakh goods from supplier, pays after 60 days. Free credit for 60 days!

Advantages:

• No cost if paid on time
• Easy to obtain
• No formal procedures

Disadvantages:

• Short period (30-90 days)
• May lose cash discount (2-3%)
• Affects credit rating if not paid on time

3. Commercial Paper (CP):

Short-term unsecured promissory note issued by large companies (7 days to 1 year).

Example: Reliance issues ₹1,000 crore commercial paper at 7% for 90 days to meet working capital needs.

Advantages:

• Cheaper than bank loan (7-8% vs 11-12%)
• No security needed
• Quick fundraising

Disadvantages:

• Only for large, creditworthy companies (minimum ₹5 crore)
• Short-term only
• Market dependent

4. Factoring:

Selling accounts receivable (customer dues) to factor company for immediate cash at discount.

Example: Company has ₹1 crore receivables (customers owe money). Factor pays ₹95 lakh immediately, collects ₹1 crore from customers later.

Advantages:

• Immediate cash (within 24 hours)
• No bad debt risk (factor bears loss)
• Saves collection effort

Disadvantages:

• Costly (5-10% discount)
• Customer relations may be affected
• Not suitable for small amounts

7.4 Comparison

Quick Revision

Financial Management:

• Objectives: Profit Maximization → Wealth Maximization (better)
• Functions: Planning, Control, Investment, Financing, Dividend, Working Capital

Financial Manager's Decisions:

1. Investment (Where to invest)
2. Financing (How to raise)
3. Dividend (Distribute or retain)
4. Working Capital (Day-to-day)
5. Risk Management

Capital Structure:

• Mix of Debt and Equity
• Optimum: Maximum returns, Minimum cost & risk, Flexibility, Control

Sources of Finance:

Internal: Retained Earnings, Depreciation Funds

External - Long Term:

• Equity (ownership, no fixed payment, dilutes control)
• Debentures (fixed interest, tax benefit, must repay)
• Term Loans (bank loans, tax benefit)

External - Short Term:

• Bank Overdraft, Trade Credit, Commercial Paper, Factoring

Key: Working Capital = Current Assets - Current Liabilities

These notes were compiled by Deepak Modi
Last updated: December 2025