📘 Chapter 1: Scope and Objectives of Financial Management

(Fully extracted from your ICAI study material, Module 1)

1. Introduction

Financial Management involves decisions related to:

Investment (what assets to acquire)

Financing (how to raise money)

Dividend (how much to return to shareholders)

It’s the science of planning, organizing, directing, and controlling financial activities like
procurement and utilization of funds, aiming to maximize shareholder wealth.

2. Meaning of Financial Management

Defined as:
  “Planning and controlling of the firm’s financial resources.”

It includes forecasting, sourcing, and using funds effectively. It covers:

Procurement of funds (equity, debt, internal sources)

Utilization of funds (capital budgeting, working capital)

3. Evolution of Financial Management

Traditional Phase: Focused on procurement during special events (mergers, liquidation)

Transitional Phase: Attention to short-term fund problems

Modern Phase: Integration of financial theory and practice; emphasis on decision-making, risk
analysis, and shareholder value

4. Finance Functions / Decisions

Finance decisions affect the value of the firm:
V = f (I, F, D) where

I = Investment decisions

F = Financing decisions

D = Dividend decisions

Also includes Working Capital Management (short-term function).

5. Importance of Financial Management

It ensures:

Adequate capital for operation

Proper allocation of resources

Financial discipline and control

Strategic decision-making
It directly impacts profitability, liquidity, and solvency of a business.

6. Scope of Financial Management

According to Ezra Solomon, scope includes:

Determining size of the firm and growth strategy

Asset composition

Capital structure (debt-equity mix)

Planning and control of financial performance

7. Objectives of Financial Management

Two core objectives:

1. Profit Maximization – Short-term goal; lacks focus on risk, timing, and social
responsibility
 2. Wealth Maximization – Preferred objective:

Based on cash flows, not accounting profit

Includes time value of money and risk

Focused on long-term value creation for shareholders

 Wealth = Present Value of Benefits – Present Value of Costs

8. Conflict Between Profit & Wealth Maximization

Criteria Profit Maximization Wealth Maximization

Time value Ignored Considered

Risk Ignored Considered
Long-term impact Ignored Emphasized
Wealth maximization is broader and more sustainable.

9. Role of Finance Executive

The CFO today is:

A strategist and advisor

Oversees budgeting, pricing, risk, M&A, treasury, financial planning, IT, and compliance

Bridges the gap between operations and financial performance

10. Financial Distress and Insolvency

Financial Distress: When cash inflows can’t cover obligations

Insolvency: Long-term inability to repay debts; leads to legal consequences

11. Relation with Other Disciplines

Financial Management overlaps with:

Accounting: Provides data for decisions

Economics: Concepts like demand, cost, marginal utility, etc.

Marketing/Production/Quant Methods: Impacts financing and investment decisions

12. Agency Problem and Cost

Agency Problem: Managers may act in self-interest instead of shareholder interest

Agency Costs: Monitoring and aligning interests (e.g., performance-based pay)

✅ Summary:

FM involves investment, financing, and dividend decisions

Wealth maximization is the modern, preferred objective

CFO’s role has expanded significantly

Agency problems and financial distress must be managed proactively

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📘 Chapter 2: Types of Financing

(CA Inter Paper 6A: Financial Management – Full Detail)

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1. Introduction to Financing

Financing means acquiring funds required for business operations. The

choice of financing sources depends on:

Cost of capital

Risk and return

Control

Time horizon (short, medium, long)

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2. Classification of Sources of Finance

🔹 Based on Time Period

Type Description Examples

Long-term More than 5 years Equity shares, debentures, term loans

Medium-term 1–5 years Lease financing, bank loans

Short-term Up to 1 year Trade credit, bank overdraft

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🔹 Based on Ownership

Type Description Examples

Owned Funds Provided by owners/shareholders Equity share capital,

retained earnings

Borrowed Funds Raised through borrowings Debentures, loans from

banks, public deposits
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🔹 Based on Source of Generation

Type Description Examples

Internal Sources Generated within the business Retained earnings,

depreciation provisions

External Sources From outsiders Loans, debentures, share capital

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3. Equity Shares (Ordinary Shares)

Represent ownership in the company

Have residual claim on income and assets

Carry voting rights

Returns in form of dividends and capital gains

Riskier, but offer higher return in long term

📌 Merits:

Permanent capital

No repayment obligation

Enhances creditworthiness

📌 Demerits:

High flotation costs

Dilution of control

Dividend not tax deductible

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4. Preference Shares

Hybrid of equity and debt

Fixed dividend, but no voting rights (except in specific cases)

Priority over equity in dividends and liquidation

📌 Types:

Cumulative vs Non-cumulative

Redeemable vs Irredeemable

Participating vs Non-participating

Convertible vs Non-convertible

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5. Debentures

Instruments acknowledging debt

Fixed interest

No ownership
Can be secured/unsecured

📌 Types:

Convertible vs Non-convertible

Registered vs Bearer

Secured vs Unsecured

Redeemable vs Irredeemable

📌 Merits:

Less costly than equity

Fixed cost; no ownership dilution

Tax-deductible interest

📌 Demerits:

Financial risk increases

Fixed obligation regardless of profits

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6. Term Loans

Loans from financial institutions/banks

Used for acquiring fixed assets

Generally secured by charge on assets

📌 Features:

Repayable in installments

Fixed/floating interest

Suitable for medium to large capital investments

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7. Retained Earnings

Profits reinvested instead of distributed as dividends

Internal source of finance

📌 Advantages:

No dilution of control

No interest/dividend obligations

Increases financial strength

📌 Limitations:

May not be sufficient

Could signal lack of good investment opportunities

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8. Lease Financing

Using an asset without owning it

Lessor retains ownership; lessee pays rent

📌 Types:

Operating lease

Finance lease

Sale and leaseback

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9. Venture Capital

High-risk capital for startups/innovative projects

Provided by VC firms or angel investors

Funding in exchange for equity + control

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10. Trade Credit

Short-term credit from suppliers

Widely used in day-to-day business

📌 Merits:

Easily available

No formal agreement required

Flexible

📌 Demerits:

May affect credit rating

Not suitable for large needs

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11. Commercial Papers

Short-term unsecured promissory notes

Issued by large corporations

Maturity: 15 days to 1 year

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12. Public Deposits

Funds raised directly from public

Maturity: 6 months to 3 years

Regulated under Companies Act

📌 Merits:

Simple, no collateral
Cheaper than bank loans

📌 Demerits:

Limited amount can be raised

Risk of default damages reputation

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13. International Financing

Sources outside India:

ADRs (American Depository Receipts)

GDRs (Global Depository Receipts)

External Commercial Borrowings (ECBs)

Foreign Currency Convertible Bonds (FCCBs)

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✅ Summary

Financing is essential for running and growing a business

Multiple sources exist based on time, ownership, generation

Each has advantages, disadvantages, cost, risk, and suitability

A balanced mix (capital structure) is crucial for financial health

📘 Chapter 3: Financial Analysis and Planning – Ratio Analysis

(CA Inter Paper 6A: Financial Management – Full Detail)

1. Meaning of Financial Analysis

Financial Analysis is the process of identifying the financial strengths and weaknesses of a firm
by properly establishing relationships between different items in financial statements.
 2. Objectives of Financial Analysis

Assess profitability and financial position

Facilitate decision making

Help in forecasting and planning

Aid in comparison with industry standards

3. Types of Financial Analysis

Type Basis

Internal Done by management using internal records

External Done by outsiders like investors, creditors
Horizontal Compares financial data over different periods
Vertical Involves relationship of items on a single statement
Trend Analysis Time-series data is analyzed for patterns
Ratio Analysis Mathematical relationships between figures
 4. Ratio Analysis

Ratio = One figure expressed in terms of another

Ratios are tools for interpreting accounting information.

5. Classification of Ratios

A. Liquidity Ratios

Used to measure the short-term solvency of the firm.

(i) Current Ratio

= Current Assets / Current Liabilities
Ideal: 2:1

(ii) Quick Ratio (Acid-Test Ratio)

= (Current Assets – Inventory – Prepaid Expenses) / Current Liabilities
Ideal: 1:1

B. Leverage Ratios (Capital Structure Ratios)

Measure the degree of financial risk.

(i) Debt-Equity Ratio

= Total Long-Term Debt / Shareholders’ Funds
Lower ratio is preferred for safety.

(ii) Total Debt Ratio

= Total Liabilities / Total Assets

(iii) Interest Coverage Ratio

= EBIT / Interest
Indicates ability to pay interest out of profits.

C. Turnover Ratios (Activity Ratios)

Measure the efficiency of resource utilization.

(i) Inventory Turnover Ratio

= Cost of Goods Sold / Average Inventory

(ii) Debtors Turnover Ratio

= Net Credit Sales / Average Accounts Receivable

(iii) Creditors Turnover Ratio

= Net Credit Purchases / Average Accounts Payable

(iv) Working Capital Turnover Ratio

= Net Sales / Working Capital

(v) Asset Turnover Ratio

= Net Sales / Total Assets

D. Profitability Ratios

Show the efficiency of operations and profit generation.

(i) Gross Profit Ratio

= Gross Profit / Net Sales × 100

(ii) Net Profit Ratio

= Net Profit / Net Sales × 100

(iii) Operating Profit Ratio

= Operating Profit / Net Sales × 100

(iv) Return on Investment (ROI)

= Net Profit before Interest and Tax / Capital Employed × 100

(v) Return on Equity (ROE)

= Net Profit after Tax / Shareholders’ Equity × 100

(vi) Earnings per Share (EPS)

= (Net Profit after Tax – Preference Dividend) / Number of Equity Shares

(vii) Price Earning Ratio (P/E)

= Market Price per Share / Earnings per Share

E. Coverage Ratios

Show the firm’s ability to meet fixed obligations.

(i) Dividend Payout Ratio

= Dividend per Share / Earnings per Share

(ii) Interest Coverage Ratio

= EBIT / Interest (already discussed)

6. DuPont Analysis

Breaks down ROE as: ROE = Net Profit Margin × Asset Turnover × Equity Multiplier

It links profitability, efficiency, and leverage.

 7. Uses of Ratio Analysis

Simplifies complex data

Identifies trends

Helps inter-firm and intra-firm comparison

Aids in forecasting and control

8. Limitations of Ratio Analysis

Based on historical data

Ignores qualitative factors

Affected by window dressing

Different firms may follow different accounting policies

 9. Financial Planning

It’s the process of estimating capital required and determining its composition.

Objectives:

Ensure availability of funds

Proper utilization of funds

Avoid under or over capitalisation

Financial discipline

✅ Summary

Financial analysis includes various tools like ratio, trend, vertical and horizontal analysis

Ratio analysis gives key indicators of performance

Classification includes liquidity, leverage, turnover, profitability, and coverage

DuPont Analysis gives a deeper view of ROE

Limitations must be understood in decision-making context

📘 Chapter 4: Cost of Capital

(CA Inter Paper 6A: Financial Management – Fully Explained)

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1. Meaning of Cost of Capital

Cost of capital refers to the minimum rate of return a company must earn on
its investment projects to maintain its market value and attract funds.

It's also called the opportunity cost of using funds for a specific purpose.

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2. Significance of Cost of Capital

Used in capital budgeting as a discount rate

Helps in decision-making: whether to accept/reject projects

Affects valuation of firm

Useful in designing an optimal capital structure

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3. Classification of Cost

Type Description

Explicit Cost Actual payment of interest/dividend

Implicit Cost Opportunity cost of own capital

Average Cost Weighted average of all capital sources

Marginal Cost Cost of additional capital

Historical Cost Past cost of funds

Future Cost Expected cost in future period

Specific Cost Cost of individual capital source

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4. Components of Cost of Capital

A. Cost of Debt (Kd)

If interest is tax-deductible:

> Kd = I × (1 – Tax rate)

For redeemable debt: Kd = [I + (RV – NP)/N] / [(RV + NP)/2] × (1 – Tax rate)

Where:

I = Annual Interest, RV = Redemption Value, NP = Net Proceeds, N = Years

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B. Cost of Preference Share Capital (Kp)

If irredeemable:

> Kp = D / NP
If redeemable:

> Kp = [D + (RV – NP)/N] / [(RV + NP)/2]

Where D = Dividend, RV = Redemption Value, NP = Net Proceeds, N = Years

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C. Cost of Equity Capital (Ke)

Three approaches:

1. Dividend Discount Model (DDM):

> Ke = D1 / P0 + g

Where D1 = Dividend expected next year, P0 = Current Price, g = Growth

rate

2. Earnings/Price Ratio Approach:

> Ke = E / P0

3. Capital Asset Pricing Model (CAPM):

> Ke = Rf + β(Rm – Rf)

Where Rf = Risk-free rate, β = Beta, Rm = Market return

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D. Cost of Retained Earnings (Kr)

Opportunity cost for shareholders

> Kr = Ke × (1 – Brokerage – Tax rate)

OR

Kr = D1 / MP + g
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5. Weighted Average Cost of Capital (WACC)

> WACC = (E/V)×Ke + (D/V)×Kd(1 – Tax) + (P/V)×Kp

Where:

E = Equity, D = Debt, P = Preference, V = Total Capital

Ke, Kd, Kp = Respective costs

Weights:

Book value weights or

Market value weights (more appropriate)

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6. Marginal Cost of Capital (MCC)

Cost of raising one additional unit of capital. Used when capital requirement
is large and cost of capital changes at higher levels.

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7. Factors Affecting Cost of Capital

Capital structure

Risk of business

Dividend policy

Inflation

Interest rate levels

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8. Practical Considerations
Cost of capital is used as a benchmark rate for investment appraisal

Needs to be recalculated when capital mix or market conditions change

WACC reflects average hurdle rate for projects

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✅ Summary

Cost of capital is the required return to justify an investment

Includes cost of debt, preference shares, equity, retained earnings

Calculated using models like DDM, CAPM

WACC provides a comprehensive view and is widely used in decision-making

📘 Chapter 5: Capital Structure Decisions

(CA Inter Paper 6A: Financial Management – Fully Explained)

 1. Meaning of Capital Structure

Capital Structure refers to the mix (proportion) of debt and equity a firm uses to finance its
operations.

 It’s the composition of long-term sources of funds, i.e., equity, preference capital,
debentures, term loans, retained earnings, etc.

2. Factors Affecting Capital Structure

Factor Description

EBIT Level & Stability High, stable EBIT allows more debt
Cost of Capital Aim is to minimize overall cost
Control ConsiderationIssuing equity may dilute control
Risk Higher debt increases financial risk
Flexibility Mix should allow flexibility in raising funds
Taxation Policy Interest is tax deductible, dividends are not
Market Conditions Favorable conditions ease equity/debt issue
 3. Optimal Capital Structure

The capital structure that maximizes the value of the firm and minimizes WACC is called the
Optimal Capital Structure.

4. Approaches to Capital Structure Theories

🔹 A. Net Income (NI) Approach

Assumes cost of debt < cost of equity

More debt → lower WACC → higher value of firm

Conclusion: Firm should use more debt to maximize value

🔹 B. Net Operating Income (NOI) Approach

WACC remains constant regardless of capital structure

Value of firm = EBIT / WACC

Conclusion: Capital structure is irrelevant to value

🔹 C. Traditional Approach

Initially, debt reduces WACC

Beyond a point, more debt increases risk and Ke → WACC rises

Conclusion: There’s an optimal capital structure

🔹 D. Modigliani & Miller (MM) Approach (No Taxes)

Assumes perfect capital markets

Capital structure does not affect firm value

Value depends only on EBIT and risk

 V = EBIT / Ke = EBIT / WACC (constant)

5. MM Approach (With Corporate Taxes)

Interest is tax-deductible → reduces taxable income

More debt leads to higher firm value

 V = Value without tax + (Tax rate × Debt)

6. Capital Structure Planning

Capital structure should:

Ensure financial flexibility

Maintain control

Optimize cost of capital

Ensure solvency and liquidity

 7. EBIT-EPS Analysis

Used to analyze impact of financing choice on Earnings Per Share (EPS) at different EBIT
levels.

EPS = (EBIT – Interest) × (1 – Tax) / Number of equity shares

 Helps identify indifference point – the EBIT level at which EPS under different financing
options is the same.

8. Trading on Equity (Financial Leverage)

Using fixed cost funds (like debt) to magnify returns on equity.

Effective when Return on Investment (ROI) > Cost of Debt.

9. Capital Gearing

Describes the proportion of fixed cost capital (debt and preference) to equity.

Type Features
High Gearing More fixed-cost capital than equity
Low Gearing More equity than fixed-cost capital

✅ Summary

Capital structure is about the mix of debt and equity

Optimum structure minimizes WACC and maximizes firm value

Theories (NI, NOI, MM, Traditional) offer different perspectives

EBIT-EPS analysis helps decide best financing option

Trading on equity increases returns when ROI > cost of debt

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📘 Chapter 6: Leverages

(CA Inter Paper 6A: Financial Management – Fully Explained)

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1. Meaning of Leverage

Leverage refers to the use of fixed costs (either operating or financial) to magnify the returns to
shareholders.

There are three types of leverage:

Operating Leverage – arises from fixed operating costs

Financial Leverage – arises from fixed financial charges (interest)

Combined Leverage – combination of both

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2. Operating Leverage (OL)

It refers to the effect of fixed operating costs on Earnings Before Interest and Tax (EBIT).

> Operating Leverage = % change in EBIT / % change in Sales

Or

> DOL = Contribution / EBIT

Contribution = Sales – Variable Costs

🔹 High OL means a small change in sales causes a larger change in EBIT

🔹 High OL = High business risk

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3. Financial Leverage (FL)

It arises due to fixed financial costs like interest on debt and preference dividends.

> Financial Leverage = % change in EPS / % change in EBIT

Or

> DFL = EBIT / EBT

(Where EBT = Earnings Before Tax)
🔹 High FL = Higher financial risk

🔹 Indicates sensitivity of EPS to changes in EBIT

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4. Combined Leverage (CL)

Shows total risk — combined effect of operating and financial leverage.

> Combined Leverage = Operating Leverage × Financial Leverage

Or

> DCL = Contribution / EBT

🔹 High combined leverage = High total risk

🔹 Firm should be cautious with both high OL and FL

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5. Numerical Illustration

Let’s assume:

Sales = ₹10,00,000

Variable Cost = ₹6,00,000

Fixed Operating Cost = ₹2,00,000

Interest = ₹50,000

🔹 Contribution = 10,00,000 – 6,00,000 = ₹4,00,000

🔹 EBIT = 4,00,000 – 2,00,000 = ₹2,00,000

🔹 EBT = 2,00,000 – 50,000 = ₹1,50,000

Now:

Operating Leverage = 4,00,000 / 2,00,000 = 2

Financial Leverage = 2,00,000 / 1,50,000 = 1.33

Combined Leverage = 2 × 1.33 = 2.66

This means a 1% change in sales will cause a 2.66% change in EPS.

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6. Importance of Leverages

Helps determine risk level

Assists in designing capital structure

Shows how sensitive profits are to sales fluctuations

Aids in EBIT-EPS analysis

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7. Favorable vs. Unfavorable Leverage

Favorable FL: ROI > Cost of Debt → enhances EPS

Unfavorable FL: ROI < Cost of Debt → decreases EPS

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8. Limitations

Increases business and financial risk

High leverage is dangerous in recession

Misuse can lead to financial distress

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✅ Summary

Operating Leverage measures business risk

Financial Leverage measures financial risk

Combined Leverage reflects total risk

Understanding leverage helps in making informed financing and operating decisions

📘 Chapter 7: Investment Decisions

(CA Inter Paper 6A: Financial Management – Fully Explained)

1. Introduction

Investment decisions refer to allocating funds into long-term assets that will
generate returns over time.

They are also called capital budgeting decisions.

2. Features of Investment Decisions

Long-term commitment of funds

Significant capital outlay

Irreversible in nature

Affects profitability and risk of the firm

Includes expansion, replacement, modernization, diversification, etc.

 3. Capital Budgeting

Capital budgeting is the process of:

 Identifying, evaluating, and selecting investment projects that are

expected to yield returns over a long period.

4. Importance of Capital Budgeting

Helps in long-term growth

Affects risk and profitability

Ensures optimal allocation of funds

Helps in cost control and financial forecasting

 5. Steps in Capital Budgeting Process

1. Identification of investment opportunities

2. Evaluation using appraisal techniques

3. Selection of the most profitable project

4. Implementation of project

5. Monitoring & review of performance

6. Investment Evaluation Techniques

A. Non-Discounted Techniques

(i) Payback Period (PBP)

Time required to recover initial investment.

  PBP = Initial Investment / Annual Cash Inflows

🔹 Simple to use

🔹 Ignores time value of money

🔹 Ignores cash flows after payback

(ii) Accounting Rate of Return (ARR)

 ARR = Average Accounting Profit / Average Investment × 100

🔹 Based on accounting profits, not cash flows

🔹 Ignores time value of money

B. Discounted Cash Flow (DCF) Techniques

(i) Net Present Value (NPV)

Present value of cash inflows – Present value of cash outflows

 NPV = ∑ [Ct / (1 + r)^t] – C0

If NPV > 0 → Accept

If NPV < 0 → Reject

🔹 Considers time value of money

🔹 Most widely used method

(ii) Internal Rate of Return (IRR)

Rate at which NPV = 0

Solve:

 0 = ∑ [Ct / (1 + IRR)^t] – C0

If IRR > Cost of Capital → Accept

🔹 More complex to calculate

🔹 Assumes reinvestment at IRR

(iii) Profitability Index (PI)

  PI = Present Value of Inflows / Present Value of Outflows

If PI > 1 → Accept

If PI < 1 → Reject

🔹 Useful when capital is limited

7. Comparison of Methods

Method Time Value Decision Rule Risk

Payback ❌ PBP < cutoff ❌

ARR ❌ ARR > target ❌

NPV ✅ NPV > 0 ✅

IRR ✅ IRR > Cost ✅

PI ✅ PI > 1 ✅

8. Capital Rationing
When funds are limited, and projects must be ranked.

🔹 Choose combination of projects that maximizes NPV

🔹 PI may be used to rank projects in such cases

9. Risk in Capital Budgeting

Types of risk:

Project-specific: demand, cost uncertainty

Firm-specific: operational inefficiencies

Market risk: inflation, competition

Economic risk: policy changes, recession

🔹 Risk-adjusted discount rate, sensitivity analysis, scenario analysis, and

simulations are used to account for risk.

✅ Summary
Capital budgeting is essential for long-term planning

DCF methods (NPV, IRR, PI) are superior

Payback and ARR are simpler but ignore time value

Risk should be incorporated in analysis

Good decisions ensure growth and financial strength

📘 Chapter 8: Dividend Decisions

(CA Inter Paper 6A: Financial Management – Fully Explained)

1. Meaning of Dividend

Dividend is the portion of profit distributed to shareholders.

The dividend decision involves deciding how much of the earnings should be
distributed and how much should be retained.
 2. Types of Dividend

Type Description

Cash Dividend Most common; paid in cash

Stock Dividend (Bonus Shares) Shares given instead of cash

Interim Dividend Declared during the year

Final Dividend Declared at year-end by shareholders

Property/Asset Dividend Rare; non-cash assets distributed

3. Dividend Policy

A firm’s approach toward distributing profits:

Stable Dividend Policy Types:

Constant Dividend per share

Constant payout ratio

Stable rupee dividend + extra when high profits

 4. Factors Affecting Dividend Decisions

Factor Impact

Earnings Higher earnings → more dividend possible

Liquidity Availability of cash is crucial

Growth Opportunities Retained earnings preferred for growth

Cost of External Financing Higher cost → prefer retention

Taxation Policy Dividends taxed in hands of shareholders

Control Retained earnings prevent dilution

Legal & Contractual Restrictions Govern dividend declarations

Inflation Need more retained earnings to maintain capital

5. Relevance of Dividend Theories

🔹 A. Walter’s Model

 P = [D + (r / ke)(E – D)] / ke

Where:
P = Market Price of Share

D = Dividend

E = Earnings per share

R = Return on retained earnings

Ke = Cost of equity

Key Insight:

If r > ke → Retain earnings (growth firms)

If r < ke → Pay out dividends (declining firms)

If r = ke → Dividend policy has no effect

🔹 B. Gordon’s Model

 P = [E(1 – b)] / (ke – br)

Where:

P = Price of share

E = Earnings per share

B = Retention ratio
Ke = Cost of equity

R = Return on investment

Key Insight: Similar to Walter’s. Dividend is relevant under imperfect

markets.

6. Irrelevance Theory

🔹 C. Modigliani and Miller (MM) Theory

Dividend policy is irrelevant in perfect capital markets.

Investors are indifferent between dividend and capital gains.

Assumptions:

No taxes

No transaction costs

Perfect markets

Investment decision not affected by dividend

  Value of firm depends only on investment decisions, not dividend
policy.

7. Bonus Shares (Stock Dividend)

Shares issued free of cost from accumulated profits.

Effects:

Increases number of shares

Lowers EPS and market price per share

Doesn’t change total equity

Sign of confidence and future profitability

8. Stock Split vs. Bonus Issue

Basis Bonus IssueStock Split

Source Reserves/Profits No impact on reserves

Face Value No change Changes (e.g., ₹10 to ₹5)

EPS/DPS Decrease Proportionally adjusted

Objective Capitalization of reserves Market liquidity

✅ Summary

Dividend decision is about balancing distribution vs. retention

Theories: Walter and Gordon (relevance), MM (irrelevance)

Factors: earnings, liquidity, growth, tax, control

Bonus shares and stock splits affect share structure, not firm value directly

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📘 Chapter 9: Working Capital Management

(CA Inter Paper 6A: Financial Management – Fully Explained)

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1. Meaning of Working Capital

Working Capital = Current Assets – Current Liabilities

Types:

Gross Working Capital: Total current assets

Net Working Capital: Current assets – current liabilities

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2. Importance of Working Capital Management

Ensures smooth business operations

Prevents liquidity crisis

Helps maintain creditworthiness

Enhances profitability through efficient cycle management

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3. Classification of Working Capital

Type Basis

Permanent WC Minimum required always

Temporary WC Seasonal/fluctuates with business volume

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4. Operating Cycle (Cash Conversion Cycle)

Measures the time between:

Purchase of raw materials → collection of cash from sale

> Operating Cycle = Inventory Conversion + Receivables Collection –

Payables Deferral
Components:

Inventory Period: Raw material + WIP + Finished goods holding period

Debtors Collection Period

Creditors Payment Period

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5. Factors Affecting Working Capital Requirements

Nature of business (trading needs more WC)

Production cycle

Credit policy

Inventory policy

Market conditions

Operating efficiency
Level of sales & growth

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6. Estimation of Working Capital Requirement

Step-by-step estimation:

Estimate costs of raw materials, WIP, finished goods, debtors

Deduct creditors, outstanding expenses

Add safety margin

Formula-based methods may also be used.

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7. Working Capital Financing

Sources of WC finance: | Source | Type | |--------|------| | Trade credit |

Spontaneous | | Bank credit (CC/OD) | Short-term borrowings | | Public
deposits | Short-medium term | | Commercial paper | Unsecured short-term |
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8. Bank Finance for Working Capital

Bank lending approaches:

Tandon Committee Norms:

1. Borrower brings 25% of total WC

2. Borrower finances 25% of current assets from long-term funds

Nayak Committee: For small borrowers

20% of projected turnover is considered WC requirement

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9. Working Capital Turnover Ratio

> WCTR = Net Sales / Average Working Capital

Indicates efficiency of WC usage.

Higher ratio → better efficiency.

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10. Inventory Management Techniques

EOQ (Economic Order Quantity)

ABC Analysis – categorization based on value

JIT (Just-in-Time)

Reorder Level, Safety Stock, Lead Time analysis

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11. Receivables Management

Involves:
Credit policy

Credit terms (cash discounts, credit period)

Collection policy

Trade-off between sales increase and default risk

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12. Cash Management

Key objectives:

Maintain liquidity

Control cash flow

Invest surplus cash profitably

Techniques:

Cash budget
Accelerating collections

Delaying payments

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✅ Summary

Working capital ensures liquidity and operational continuity

Must balance between profitability and risk

Efficient management improves return on capital employed

Tools: operating cycle, WC ratios, EOQ, credit policies, cash budgeting