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Class 12 Financial Management: cheat sheet
CBSE Business Studies. Managing a firm’s funds: the investment, financing and dividend decisions, financial planning, capital structure and trading on equity, and fixed and working capital.
Key ideas
- Financial management gets the right amount of funds at the right time and cost and puts them to good use; its main aim is to maximise shareholders’ wealth.
- The investment decision chooses the assets (long-term ones by capital budgeting), the financing decision the mix of debt and equity, and the dividend decision how much profit to pay out.
- Financial planning estimates how much money is needed and where it will come from, so funds are ready when needed and not raised needlessly.
- Capital structure is the mix of debt and equity; debt is cheaper because interest is tax deductible, but it raises financial risk.
- Trading on equity uses debt to raise EPS; it works only when the return on investment is higher than the rate of interest.
- Fixed capital needs depend on the nature and scale of business, the technique and technology used, growth and diversification.
- Working capital needs depend on the nature and scale of business, the business cycle, seasons, the production cycle, credit allowed and taken, and operating efficiency.
Remember
| Net working capital | current assets − current liabilities |
| Return on investment | EBIT ÷ total funds × 100 |
| Earnings per share | (EBIT − interest) × (1 − tax rate) ÷ number of equity shares |
| Interest coverage ratio | EBIT ÷ interest |
| Debt–equity ratio | debt ÷ equity |
| Trading on equity pays when | ROI > rate of interest on debt |
| Current assets | cash, bank, debtors, bills receivable, raw materials, work in progress, finished goods, prepaid expenses, marketable securities |
Watch out
- Forgetting tax: EPS uses earnings after interest AND tax.
- Counting patents, furniture or debentures issued as current assets.
- Thinking more debt always raises EPS: when ROI is below the interest rate, it lowers EPS.
Worked example
Tarang Motors Ltd needs total funds of ₹3,000,000 and expects EBIT of ₹360,000; tax is 25%; shares are of ₹10 each. Option I: all equity. Option II: ₹1,000,000 as 10% debt and the rest equity. (a) Find the EPS under each option. (b) Which gives the higher EPS? (c) Explain why, using ROI.
Working: ROI = 360,000 ÷ 3,000,000 × 100; EPS = (EBIT − interest) × 0.75 ÷ shares
Answer: (a) I: ₹0.9; II: ₹0.98 (b) with debt (c) ROI is 12% against a cost of debt of 10%; debt raises EPS only when ROI is higher than the interest rate
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