Financial Management
Domain 9 - Financial Management - tests the objectives of financial management, the three financial decisions, capital structure and leverage, and working capital.
Meaning and objective
Financial management deals with procurement of funds and their effective utilisation. The primary objective is wealth maximisation for shareholders, preferred to profit maximisation because it accounts for the time value of money, risk and long-run value.
Three decisions
- Investment (capital budgeting): long-term assets; appraisal by NPV, IRR, payback, profitability index.
- Financing (capital structure): the debt–equity mix. Debt is cheaper because interest is tax-deductible, but it raises financial risk.
- Dividend: distributing profit versus retaining it.
Leverage
Financial leverage is the use of debt. Trading on equity benefits shareholders when return on investment exceeds the cost of debt.
Fixed and working capital
Fixed capital needs depend on nature of business, scale, technology and choice of technique. Working capital (current assets minus current liabilities) depends on the operating cycle, credit policy, seasonal factors and scale.
Worked example
Capital employed ₹10 lakh; EBIT ₹2 lakh; tax 50%. All-equity, 1,00,000 shares of ₹10 → PAT ₹1,00,000 → EPS ₹1.00. Half debt: ₹5 lakh at 10% → interest ₹50,000 → PBT ₹1,50,000 → PAT ₹75,000 → EPS = 75,000/50,000 = ₹1.50. Reasoning: ROI is 20%, above the 10% cost of debt, so leverage lifts EPS from ₹1.00 to ₹1.50. Had EBIT fallen below ₹1 lakh, EPS would drop below ₹1.00 - leverage magnifies both ways.
Traps
Wealth maximisation is not profit maximisation. Interest is tax-deductible but dividends are not - examiners test this in capital-structure answers.