Financial Management
Financial management deals with planning, raising and using funds to maximise owner wealth while managing risk. The exam tests objectives, financial decisions, capital structure, working capital and cost of capital.
Core rules
- Three decisions: investment (which assets/projects), financing (debt–equity mix) and dividend (distribution versus retention).
- Wealth maximisation is broader than profit maximisation because it considers time value, risk and long-term value.
- Fixed capital supports long-term assets; working capital supports day-to-day operations. Working capital = current assets − current liabilities.
- Debt is often cheaper than equity because interest is tax-deductible, but too much debt raises financial risk and fixed commitments.
Worked example
A project costs ₹10 lakh and yields ₹3 lakh per year for five years, total ₹15 lakh. The payback period is ₹10 lakh ÷ ₹3 lakh = 3.33 years. If the firm’s policy requires payback within four years, the project passes on this criterion. The reasoning does not stop there: the firm should also compare the project’s return with the cost of capital.
Traps
Do not treat profit and wealth maximisation as identical. Dividend decision is not the same as financing decision. Working capital is not fixed capital. Do not claim debt is always better because it is cheaper; risk and cash-flow stability matter.