Financial Planning

To determine what is to be done in future before,is called planning. A Financial manager must have a future view about future Finance requirment,it's procurement and utilisation. Financial planning, therefore, refers to predetermining of Financial activities so that the objective of the organisation could be achieved.

Process of FINANCIAL planning:

1. Determination of financial objectives : In first stage, Financial objectives of the organisation are determined. It includes "Short-term Financial Objectives" like maintenance of adequate liquidity in the organisation and "Long-term financial objectives" like adequate finance from different sources so as to increase the efficiency of the organisation.

2. Determination of financial policies : In the second stage of Financial planning, Financial policies are determined so that Financial objectives could be achieved. { It includes capitalisation policy, capital structure policy , dividend policy, working capital management policy, credit policy,etc.} In respect of capital structure,the policy of the company maybe to depend on equity share in initial years; regarding distribution of dividend,the policy may be  to keep the rate of dividend low in the initial year ; regarding credit sale the policy of the organisation may be to sell goods on credit to creditworthy customer alone.

3. Determination of Financial Procedures:  In the third stage of Financial planning, Financial Procedures are determined .It is more clear than policies. It laid down in what order a job will be performed.{like decision regarding depending on equity capital in the initial years of the company is a policy but the different steps taken to procure equity capital fall under the category of financial procedure. Similarly,credit sale is a policy but prescribing the sequence of action to be taken in the case of non-realisation of payment on time, is financial procedure.

OBJECTIVES OF FINANCIAL PLANNING

1. To Ensure Timely Availability of Fund whenever Required: This include a proper estimation of the funds required for different purposes such as for the purchase of long-term assets or to meet day-to-day expenses. There is a need to estimate the time at which these funds are to be made available and what will be its possible sources.

2. To See that the Firm does not raise Resources Unnecessarily: It is always ensured that the balance of cash should neither be in excess nor short.The balance of cash in both these situations is harmful.

In short, it can be said that the objective of the financial planning is to make finance available in appropriate quantity and make it available well in time.

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Capital Structure and Tax saving

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Capital structure refers to relative proportion of different sources of long-term finance.  In order to understand clearly the meaning of capital structure, it essential to know the meaning of two other related terms : Capitalisation and  Financial structure.

• Financial structure : Financial structure includes both long-term and short-term source of capital.

• Capitalisation:  It refers to only long term assts excluding current liabilities from the capital structure.

A company requires finance in order to run its business properly. It is mostly obtained from the following sources:

1. Equity share capital

2. Preference shares capital

3. Borrowed capital

4. Retained profit

5. Current liabilities

Tax saving...........

In an economy , at the end of the accounting period a firm get EBIT{ EARNING BEFORE INTEREST ON TAX} . First preference is given to payment of interest on the debt followed by EBT{EARNING BEFORE TAX} Tax to the government and the remaining EAT{ EARNING AFTER TAX} is being distributed among the shareholders . In shareholders Preference shareholders are given priority over Equity shareholders.

After the payment of every expenditure the remaining amount is distributed among the shareholders in agreed proportion or in equally if no such agreement is made.

 { A bond fund or debt fund is a fund that invests in bonds, or other debt securities. Bond funds typically pay periodic dividends that include interest payments on the fund's underlying securities plus periodic realized capital appreciation. Debt fund have high risk because whether the firm is making profit or not the interest on debt fund is to be paid.}. Every sources of finance have it's own cost { the cost of capital is the cost of a company's funds, or, from an investor's point of view "the required rate of return on a portfolio company's existing securities". It is used to evaluate new projects of a company.} so cost refers to the interest paid for that particular source . For example : If debt or loan is taken form the bank of amount 1,00,000 and it is said that 5% p.a. is to be paid on it , so here the cost of the debt is 5000 as 1,00,000 is the loan which is to be returned .

Now let's see how tax is being saved and helps in increment of benefit of the shareholder : 

Two companies { R Ltd.} and (S Ltd.} , both have equal numbers of shares (10000) ,they don't have any debt in the capital. government charges tax @40% p.m. The firm made a profit of 10,00,000.

	R Ltd.	S. Ltd
EBIT	10,00,000	1,00,000
Interest	000	000
EBT@40% p.a. tax	(4,00,000)	(4,00,000)
EAT	6,00,000	6,00,000
Interest that each shares EAT/number of shares	6,00,000/10,000	6,00,000/10,000

         hence each share will get interest of 60 p.a.

Financial manager of R Ltd. analysed the capital structure and decided to include debt in the capital of amount 10,00,000 and interest on debt is 10%p.m.  The also decreased the number of shares from 10,000 to 6,0000  because the firm can make the same capital amount with debt and 6,000 shares .other hand S Ltd. make no changes in their firm. So the change in R Ltd.firm are 

	R Ltd.
EBIT	10,00,000
Interest @ 10% p.a.	(1,00,000)
EBT	9,00,000
Tax @40% p.a.	(3,60,000)
EAT	5,40,000
Interest that each share will get	5,40,000/6000

Hence, Now interest for each shares is increased form 60 to 90

Financial status and tax is analysed and then necessary changes in the capital structure is made . And hence we can save the tax....

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Financial Decisions

For the wealth maximisation the financial manager need to take some important decisions (These are also known as Finance function.) And they are:

• Investment Decision

• Financing Decision

• Dividend Decision

1. INVESTMENT DECISIONS

      It refers to deciding about how the funds are invested in different assets so that they are able to earn the highest possible return for the in investor.

Assets which are obtained by the business are of two types ,I.e. Long-term assets and short-term assets.

A. Long-term Investment Decision: This referred to as capital budgeting Decision, for the investment in the long-term assets. For example, buying a new machine. For the same purpose the financial manager has to make a comparative study of various alternative available in the market on the basis of their cost and profitability. These decision are very crucial as they affect the earning of the business over the long run.

Factors Affecting Long-term Investment Decision or Capital Budgeting Decision:

• Cash flow of the project: Capital Budgeting Decision is related with investment in long-term assets. These assets involve both cash outflow and cash inflow over a series of years.{ The amount needed for investment or that go out form the company is known as outflow,on the other hand, return for the same amount is known as inflow or then cash earned by the company} , cash inflow> cash outflow for the investment.

• The rate of Return :  The criterion to decide the profitability of various projects in their respective rate of return. The rate of return is calculated on the basis of expected return or revenue from the project and risk attached with it. If two projects are of same risk ,then project having higher rate of return will be accepted.

• Investment criteria Involved: There maybe many criteria of the investor while investing in the long-term assets. These are : funds involved,rate of interest, rate of return. , Cash flow ,etc. All these factors influence the decision to go for a particular investment or not .

B. Short-term Investment Decision

      This decision is related to the working capital management. Keeping adequate amount of the working capital at all the time in the business is called management of the working capital.  Adequate amount means that amount of working capital should neither be more nor less than required. For example-  if more amount is retained with the company then company will generate less revenue from investment on the other hand,if the company investment more amount then working capital will for be enough and the company performance may go down.

2. FINANCING DECISION

   It refers to the determination as to how the total funds required by the business will be obtained from various long-term sources. Long-term financial sources chiefly include equity share capital, preference share capital, retained earning , debenture , long-term loan ,etc.

   { Debt capital is the cheapest of all the sources ,but although if the company faces loss then also they need to pay interest in debt . On the other hand ,shares capital is higher in cost but they need not to pay any interest if the company faces loss}

Factors Affecting Financing Decision:

• Cost: The cost of the sources of finance is different. The company need to find the cheap source of finance according to their company situation.

• Risk : Debt capital is most risky and from the point of view of risk it should not be used.

• Cash flow position: If the cash flow position of the company is good means inflow is higher than outflow ,then the payment on the interest on the debt can easily be made. So debt can be given priority as the source of cheap Finance.

• Control Consideration: The ultimate control of the company is with the Equity shareholders. If more of equity share are issued then control may spread with many and a mutual Decision may take time. So from this point of view the equity share capital should be avoided.

• State of Capital Market : Bright time being more profit. Therefore,the people like to invest more in the equity share. On the other hand, uncooperative situation bring losses and therefore people like to invest more in the debt capital. Therefore,the sources of finance should be chosen keeping in the view the position of the market.

3. DIVIDEND DECISION

     It refers to the determination of how much part of the earning should be distributed among shareholders by the way of dividend and how much should be retained for meeting future needs as retained earning. The shareholders want that they should get the maximum dividend and managers want that the maximum amount of money should be kept to fulfill the future need of the business. The financial manager has to strike a balance so that both the parties remain satisfied.

 

Factors Affecting Dividend Decision

• Amount of Earning: The dividend is paid out of the present and reserved profit. Therefore, greater amount of total profit will ensure greater dividend.

• Growth Opportunity : If the company has more opportunities for growth, it need more Finance. In such situations,a major part of the income should be retained and a small part of it should be paid as dividend.

• Cash flow position: The payment of dividend is the result of outflow of cash. If the company have better Cash flow means inflow is higher than outflow ,then the company will pay the better dividend.

• Access to Capital Market:  In case of need if a company can easily collect finance in the capital market ,it should declare dividend at a higher rate otherwise not.

 

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Financial Management

The major goal of any business concern is to make profit for its owner by selling their goods and services. To achieve this objective finance plays an important role. Finance is required for in a business firm for following activities:

      • To establish a business .

      •  To run the business.

      • To expand (Enlarge) the business and many more.

In every business,three  main questions arise regarding finance are:

1. How much finance will be required for different business  activities?

2. How much of it will be obtained from different sources?

3. How will the profit earned  from different  business  activities be distributed?

Answers to all these questions is inherent in financial management . In layman's language,under financial management first of all need of finance is estimated and then different sources of obtaining finance and finally arrangements are made for the distribution of profit.

Role of Financial Management:

• Determination of Fixed Assets: Under this the total Investment on assets are determined i.e. how much should be invested in fixed asset. This done through Capital Budgeting .  For example, if it  has been decided in the capital budgeting to invest rupees 20 crore in fixed asset (land or machines) ,then there will be an increase of rupees 500 crore in fixed assets(land or machines).

• Determination of current Assets : Under this the total Investment in current assets are determined. For example,if the investment in current assets is rupees 10 crore, it will then be determined how much should be invested in cash ,stock etc.

• Determination of amount of long-term and short-term Finance: All the financial needs of business are fulfilled through these two sources. Under financial management,a proportion of both the finance sources is determined. Long-term sources provide capital for business for a long time . The cost of long-term Finance is higher than the cost of short-term Finance. Therefore,if there is more liquidity (liquidity means  capacity to make quick payment in respect of daily payment) is required in the business,more cost shall have to be borne,and vice-versa. Under financial management,the proportion of both these sources is determined on the basis of liquidity and cost analysis.

• Determination of Proportion of various sources of long-term Finance:  Long-term financial source include primarily Equity share capital, preference shares capital , debentures etc. Under financial management ,the proportion of various long-term financial sources is determined, after comparing all the merits and demerits of the various sources and then a balanced decision is made.

• Determination of various Items of profit and loss Account:  Various items included in the profit and loss get influenced or affected by different financial decisions. Fir example- interest on debt , depreciation is related to the amount of long-term assets.

Objectives of Financial Management:

Objectives of Financial Management are directly related to the fact that what decision should be taken by financial manager for the wealth maximisation or maximum extent of the business. The main three decision are  investment decision, financial decisions and dividend decision. 

Wealth maximisation means to increase the capital invested in the business by the shareholders.  If the market price of the shares increases,it can be said that capital invested by the shareholders has been appreciating and vice-versa.

for example , a  person let be call him Joe buys 200 shares of tmt Ltd. @₹ 100 per share. It means that his wealth in the company is worth ₹ 20,000 (200×100). After 2 months the price of the shares rises to ₹120 per share. It means the Joe's wealth in the company has rises to ₹24,000 ,which means his shares values has been increased . Similarly if the price of the shares falls to ₹80 per share then Joe's worth in the country falls to ₹ 16,000 .

 Hence it is clear that wealth maximisation is possible only when market price of the shares rises.

so, what steps should be taken by financial manager to raise the market price of his company's shares?

Answer to this question is that he should take all the three main finance decisions i.e.

 • Optimum Investment Decision: It means he should take such decision regarding as are relatively more profitable.

• Optimum Financing Decision: It means that he should make such a mix of debt capital and share capital as has the minimum cost of capital.

• Optimum Dividend Decision: It means that total profit of the company should be distributed among the share holder so that they feel satisfied and company can also retain some reserve to meet its future requirements.

Therefore,it can be said that wealth maximisation is the main objective of the financial management. This objective also serves the interest of the company in the best manner.

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