Financial Management
What the domain tests
Financial management deals with procurement and effective use of funds. RBSE tests objectives, financial decisions, capital structure, financial leverage, and fixed vs working capital. Expect factors affecting capital structure and working capital.
Core rules
- Objectives: wealth maximisation (primary) and profit maximisation; also ensure liquidity and financial discipline.
- Three decisions: investment (capital budgeting), financing (debt-equity mix), dividend (distribution of profit).
- Capital structure is the mix of debt and equity. Debt is cheaper but increases financial risk; equity dilutes control.
- Financial leverage = use of debt in capital structure. Higher debt can raise EPS in good times but magnify losses.
- Fixed capital is for long-term assets; working capital supports day-to-day operations. Working capital needs rise with seasonality and credit sales.
Worked example
A firm needs ₹50 lakh. Plan A uses ₹50 lakh equity; Plan B uses ₹30 lakh equity and ₹20 lakh 10% debt. In a good year with operating profit ₹10 lakh, Plan B pays ₹2 lakh interest, leaving ₹8 lakh for fewer shareholders, so EPS may be higher. In a bad year with ₹1 lakh operating profit, interest still consumes ₹2 lakh, causing loss. The exam wants this risk-return reasoning, not “debt is always bad” or “debt is always cheap”.
Traps
Do not equate profit maximisation with wealth maximisation; wealth maximisation considers risk and time value. Capital structure is not capital budgeting. A high dividend is not always optimal-it may reduce retained funds. Do not treat working capital as only cash; it includes inventory and receivables.