Financial Management (Capital, Working Capital, Sources of Finance)
Financial Management tests decisions on raising funds, investing them and managing daily liquidity. The exam expects objectives, capital structure, working capital and sources of finance.
Core decisions
The finance function covers investment, financing and dividend decisions. Profit maximisation is a narrow objective; wealth maximisation considers risk and time value. Capital structure is the mix of debt and equity. Debt is usually cheaper because interest is tax-deductible, but it raises financial risk and fixed obligations. Equity carries no compulsory dividend but dilutes control. Working capital is current assets minus current liabilities. Gross working capital is total current assets; net working capital is the excess of current assets over current liabilities. Needs depend on the nature of business, seasonality, operating cycle, credit policy and growth.
Sources
Internal: retained earnings. External: equity shares, preference shares, debentures, bank loans, trade credit, public deposits and lease finance. Long-term sources fund fixed assets; short-term sources fund working capital.
Worked example
Current assets are Rs 6,00,000 and current liabilities Rs 2,50,000. Net working capital is Rs 3,50,000. The current ratio is 6,00,000 divided by 2,50,000, or 2.4. If inventory is Rs 1,50,000, quick assets are Rs 4,50,000 and the quick ratio is 1.8. The firm has adequate short-term cushion, but a high inventory share still needs scrutiny.
Traps
Working capital is not the same as total current assets. Debenture interest is a compulsory charge; equity dividend is not. A low-cost debt mix can still be risky. Retained earnings are not free of opportunity cost.