2nd PUC Business Studies Question Bank Chapter 9 Financial Management

Students can Download Business Studies Chapter 9 Financial Management Questions and Answers, Notes Pdf, 2nd PUC Business Studies Question Bank with Answers helps you to revise the complete Karnataka State Board Syllabus and to clear all their doubts, score well in final exams.

Karnataka 2nd PUC Business Studies Question Bank Chapter 9 Financial Management

Question 1.
What is Business Finance? ( 1 Mark )
Answer:
Money required for carrying out business activities is called business finance.
(OR)
Funds needed to establish, to run, to modernize, to expand and to diversify the business is called business finance.

Question 2.
What do you understand by financial management? ( 2 Marks )
Answer:
Financial management is concerned with optimal procurement and usage of finance. Thus, financial management means procurement of required funds at minimum cost and utilization of such funds in an effective manner.

Question 3.
State the primary objective / aim of financial management. ( 1 Mark )
Answer:
The primary objective / aim of financial management is to maximize shareholders wealth; i.e., wealth maximization.

(Note: Shareholder’s wealth can be maximized by maximizing the market value of equity shares. Market value of (i.e., market price) a company’s shares can be maximized (i.e., increased) by taking efficient financial decisions. i.e., by ensuring that the benefit of a financial decision exceeds the cost involved in such a decision. For this purpose, in case of investment decision, it should be ensured that benefits from the investment exceed the cost. Similarly, when finance is procured, the aim should be to reduce the cost.)

Question 4.
State any two types of financial decisions. ( 2 Marks )
Answer:
Types of financial decisions

Investment decision
Financing decision
Dividend decision

Question 5.
Give the meaning of investment decision with an example. ( 2 Marks )
Answer:
Investment decision is a financial decision which relates to how the firm’s funds are invested in different assets. For example, a decision to make investment of Rs. 5 crore in a new machine or a decision to make investment of Rs. 2 crore to open a new branch and so on.

[Note: The management must take investment decision in such a manner that the company is able to earn highest possible return for the investors. Investment decision can be long term investment decision i.e., capital budgeting decision – investment in fixed assets or short term investment decision i.e., working capital decision-investment in current assets. Long term investment decisions are very crucial for any business since they affect its earning capacity in the long run].

Question 6.
What is capital budgeting decision? Explain briefly the factors affecting capital budgeting decisions. ( 4 Marks )
Answer:
A long term investment decision is called capital budgeting decision. In short, it is a decision to invest in fixed assets. For example, A decision to make investment in a new machine, a decision to open a new branch etc. These decisions usually involve huge amounts of investment. They affect the earning capacity of the business in the long run.

Factors affecting capital budgeting decisions:

Cash flows of the project: A series of cash receipts (∴ cash inflow) and cash payments (i.e., cash outflow) over the life of an investment project should be carefully analysed before considering a capital budgeting decision. The project which gives maximum cash inflow is to be selected.
The rate of return: The expected rate of return is another factor affecting capital budgeting decision. Usually the project which gives highest rate of return should be selected.
The investment criteria involved: While taking capital budgeting decision, the amount of investment, interest rate, cash flows and rate of return involved in each investment proposal should be evaluated by applying different capital budgeting techniques.

Question 7.
What is financing decision? Give an example. ( 2 Marks )
Answer:
The decision about the quantum (i.e., amount) of finance to be raised from various long term and short term sources of finance is called financing decision. Thus, it is concerned with how much funds to be raised and from which source.

For example, a decision taken to raise Rs. 1 crore by the issue of equity shares worth Rs. 60 lakh by the issue of debentures worth Rs. 20 lakh and by borrowings from bank Rs. 20 lakh.

[Note: The main sources of funds for a firm are shareholders’ Funds and borrowed (Debt) funds. Shareholders’ fund includes equity capital, preference capital and retained earnings. Borrowed funds include debentures and other borrowings from banks and other financial institutions. A firm has to decide the right proportion of shareholders’ funds and borrowed funds. The financing decision determines the overall cost of capital and the financial risk of the enterprise.]

Question 8.
Explain any four factors affecting financing decision. ( 4 marks )
Answer:
Factors affecting financing decisions:
The important factors affecting financing decisions are:

Cost : The cost of raising funds through different sources is one of the factors affecting financing decisions. Usually, a prudent financial manager chooses a source which is the cheapest.
Risk: Risk associated with each of the sources is to be evaluated and the source with least risk should be preferred.
Floatation costs: The floatation or fund raising costs are to be considered. The source with lower floatation costs are to be preferred.
Cash flow position of the company: An enterprise with stronger cash flow position can go for debt financing than funding through equity.
Fixed operating costs: If a business has high fixed operating costs (such as building rent, insurance premium and salaries), it must reduce its debt financing. If fixed operating cost is less, more of debt financing may be preferred.
Control considerations: Companies afraid of a takeover bid would prefer debt to equity.
State of capital market: Health of the capital market may also affect the choice of source of fund. During the period when stock market is rising, companies can easily raise funds by the issue of equity shares.
(Write any four points)

Question 9.
Give the meaning of dividend decision. ( 2 Marks )
Answer:
Dividend decision is a financial decision which relates to how much of the profits earned by the company (after paying tax) is to be distributed to the shareholders and how much of it should be retained in the business. Thus, it relates to the appropriation of profit.

Question 10.
Explain any four factors affecting dividend decision. ( 4 Marks )
Answer:
Factors affecting dividend decision:
Some of the important factors affecting dividend decisions are:

Amount of earnings: Since dividends are paid out of current and past earnings, amount of earnings is a major determinant of the decision about dividend.
Stability of earnings: Normally a company having stable earnings is in a better position to declare higher dividends.
Stability of dividends: Stable dividend policy of a company will see that dividend per share is not altered if the change in earnings is small.
Growth opportunities: Companies having good growth opportunities retain more money out of their earnings so as to finance the required investment. Therefore, the divided is smaller in growth companies.
Cash flow position: Availability of enough cash is necessary for declaration of dividend. Therefore, a business which earns profit with sufficient cash position can pay dividend.
Share holders’ preference to get regular dividend is also one of the factors to be considered to declare dividend.
Taxation policy: If the tax on dividends is higher, less dividend is paid to shareholders.
Stock market reaction: The possible impact of dividend policy on the equity share price is one of the important factors considered by the management while taking a decision about it. Usually when dividend is declared, stock market reacts positively.
Access to capital market: Easy accessibility to capital market enable companies to pay higher dividends. Because they need not retain their earnings to finance their growth.
Legal constraints: Certain provisions of the Companies Act must be adhered to while declaring the dividend.
(Write any four points)

Question 11.
Give the meaning of Financial Planning. ( 2 Marks )
Answer:
The preparation of a financial blue print of an organisation’s future operations is called financial planning.
The objective of financial planning is to ensure that enough funds are available at right time.
OR
The process of estimating the fund requirement of a business and specifying the sources of funds is called financial planning.

Question 12.
State the twin (i.e., two) objectives of financial planning. ( 2 Marks )
Answer:
The twin objectives of financial planning are:

To ensure availability of funds whenever required.
To see that the firm does not raise resources (i.e., funds) unnecessarily.

Question 13.
Explain the importance of financial planning with any four points. ( 4 Marks )
Answer:
Importance of financial planning:

It helps in forecasting what may happen in future under different business situations. Accordingly it develops alternative financial plans to face different situations. Thus, it makes the firm better prepared to face the future.
It helps in avoiding business shocks and surprises and helps the company in preparing for the future.
It helps in coordinating various business functions e.g., sales and production functions, by providing clear policies and procedures.
Detailed plans of action prepared under financial planning helps to reduce waste and duplication of efforts.
It tries to link the present with the future.
It provides a link between investment and financing decisions on a continuous basis.
It makes the evaluation of actual performance easier by specifying the detailed objectives for various business segments.
(Write any four points)

Question 14.
What do you understand by capital structure? (OR) Give the meaning of capital structure. ( 1 Mark )
Answer:
Capital structure refers to the mix between owners’ funds (i.e., equity) and borrowed funds (i.e., Debt).

Note 1: Owners’ funds consist of equity share capital, preference share capital and reserves and surplus or retained earnings. Borrowed funds can be in the form of loans (borrowed from banks or other financial institutions), debentures, public deposits etc

Note 2: Cost of debt (i.e., interest) is lower than the cost of equity (i.e., dividend). However, debt is more risky while equity is risk less for a business.

Note 3: A capital structure is said to be optimal when the proportion of debt and equity is such that it results in an increase in the value of the equity share.

Question 15.
What is financial leverage? Write the formula to calculate the financial leverage. ( 2 Marks )
Answer:
The proportion of debt in the overall capital is called financial leverage.
Formula to calculate financial leverage
Financial leverage = \(\frac{D}{E}\) or \(\frac{D}{D+E}\)
Where, D = Debt and E = equity

Question 16.
Give the meaning of ‘Trading on Equity’. ( 2 Marks )
Answer:

Trading on equity refers to the increase in profit earned by the equity shareholders due to the presence of fixed financial charges like interest.
It is a situation where companies employ more cheaper debt in their capital structure to enhance the earnings per share (EPS).

Question 17.
Explain any four factors affecting the choice of capital structure. ( 4 Marks )
Answer:
Factors affecting the choice of capital structure:

Cash flow position: Size of the projected cash flows must be considered before borrowing.
Interest coverage ratio (ICR): It is the number of times earnings before interest and tax of a company covers the interest obligation. ICR = \(\frac{\mathrm{EBIT}}{\text { Interest }}\)
Debt service coverage ratio (DSCR): Here, cash profits generated are compared with the total cash required.
Return on investment (ROI): If the ROI of the company is higher, it can choose to use trading on equity to increase its EPS.
Cost of debt: More debt can be used if debt can be raised at a lower rate of interest.
Tax rate: A higher tax rate makes debt relatively cheaper.
Cost of equity (i.e., dividend to be paid) is another factor to be considered.
Floatation costs: Fund raising cost is also to be considered while deciding the capital structure.
Risk consideration: If a firm’s business risk is lower, its capacity to use debt is higher.
Flexibility in borrowing is another factor to be considered.
Control: The issue of control over company is also another factor to be considered.
Regulatory framework: The relative regulatory norms to be followed while raising funds may also have a bearing upon the choice of the source of finance.
Stock market conditions: The bullish stock market conditions favour shares and a bearish stock market conditions favour debentures to raise funds.
Capital structure of other companies: A debt equity ratio of other companies in the same industry may also be considered with due care.
(Write any four points)

Question 18.
As a financial consultant, give the list of any 10 factors which affect the choice of capital structure. ( 5 Marks )
Answer:
Following is the list of factors which affect the choice of capital structure.

Cash flow position
Interest coverage ratio (ICR)
Debt service coverage ratio (DSCR)
Return on investment (ROI)
Cost of debt
Tax rate
Cost of equity
Floatation costs
Risk consideration
Flexibility
Control
Regulatory framework
Stock market conditions
Capital structure of other companies
(Write any ten points)

Question 19.
Write the formula to calculate debt service coverage ratio. ( 2 Marks )
Answer:

Question 20.
Write the meaning of financial risk. ( 1 Mark )
Answer:
Financial risk refers to a position when a company is unable to meet its fixed financial charges namely interest payment, preference dividend and repayment obligations.

Question 21.
What is fixed capital? ( 1 Mark )
Answer:
Fixed capital refers to investment in long term assets or fixed assets such as investment in plant and machinery, investment in building etc.

Question 22.
What are fixed assets? ( 2 Marks )
Answer:
Fixed Assets are those which remain in the business for more than one year, usually for much longer period e.g. Land and building, Machinery, Furniture etc.

Question 23.
Give an example for fixed asset. ( 1 Mark )
Answer:
Examples of fixed assets:

Land and Building
Plant and Machinery
Furniture
Vehicles
(Write any one example)

Question 24.
Explain any four factors affecting the fixed capital requirement of an organisation. ( 4 Marks )
Answer:
Factors affecting the fixed capital requirements of an organisation.
(1) Nature of business: The nature of the business determines the amount of fixed capital requirement to a great extent. For example, a trading concern needs lower investment on fixed assets; while manufacturing concerns and public utility undertakings such as railways, electricity supply companies etc. require more fixed capital to be invested on fixed assets.

(2) Scale of operations: A business concern with large scale operations requires more fixed capital as it needs bigger plant, more space etc., while a business concern with small scale operations requires less fixed capital.

(3) Choice of technique or method of production: A capital intensive organisation requires higher investment in fixed assets such as machinery and thus it needs more fixed capital. While labour intensive organisation requires less investment in fixed assets resulting in lower fixed capital requirements.

(4) Technology upgradation: The organisation using assets which are prone to obsolescence require higher fixed capital to purchase new assets.

(5) Growth prospects: An organisation having higher growth prospects generally requires higher investments in fixed assets and needs more fixed capital.

(6) Diversification: A concern which chooses to diversify its production requires more fixed capital. E.g. a textile factory is diversifying and starting a cement manufacturing plant, and then it needs more fixed capital investment.

(7) Financing alternatives: Organisations purchasing fixed assets on cash basis require a large amount of fixed capital. Those organisations which acquire fixed assets on hire purchase or installment system or on lease basis require lesser amount of fixed capital.

(8) Level of collaboration: Certain business concerns may share each other’s facilities, e.g., A bank may use ATM of other bank. Such collaboration reduces the level of investment in fixed assets.
(Write any four points)

Question 25.
What is working capital? ( 1 Mark )
Answer:
Working capital is the excess of current assets over current liabilities, i.e., working capital = current assets – current liabilities.

Question 26.
How do you calculate net working capital? ( 1 Mark )
Answer:
Net working capital (NWC) can be calculated by deducting current liabilities (CL) from current assets (CA)
i.e., NWC = CA – CL

Question 27.
Give the meaning of current assets. ( 2 Marks )
Answer:
Current assets are those assets which, in the normal routine of the business, get converted into cash or cash equipments within one year.
e.g., inventories, debtors, bill receivables etc.

Question 28.
Give an example for current asset. ( 1 Mark )
Answer:
Examples of current assets:

Cash in Hand
Cash at Bank
Marketable securities
Bills receivable
Debtors
Inventory
(a) Finished goods
(b) Raw materials
Work in progress
Prepaid expenses
(Write any one point)

Question 29.
Give the meaning of current liabilities. ( 2 Marks )
Answer:
Current liabilities are those payment obligations which are due for payment within one year, such as bills payable, creditors, outstanding expenses etc.

Question 30.
Explain any four factors affecting the working capital requirement of a business (or an organisation) ( 4 Marks )
Answer:
Factors affecting the working capital requirements of a business:

Nature of business: The nature of business influences the amount of working capital required. For instance, a trading business and service industries require less working capital. While manufacturing business requires more working capital since raw materials needs to be converted into finished goods.
Scale of operation: A business with large scale operations needs large amount of working capital to hold more inventory. On the other hand, a business concern with small scale operations needs less working capital.
Business cycle: In case of a boom, demand for goods increases, requiring large amount of working capital. In case of recession and depression, demand for goods declines, requiring lesser amount working capital.
Seasonal factors: In peak season, due to higher level of activity, larger amount of working capital is required. On the other hand, during lean season, the working capital requirement will be lower.
Production cycle: Working capital requirement is higher in concerns with longer production cycle and lower in concerns with shorter production cycle.
Credit allowed: A concern which allows liberal credit to its customers will require large amount of working capital than a firm which restricts credit to its customers.
Credit availed: A firm enjoying liberal credit facilities from its suppliers will need lower working capital than a firm which does not enjoy liberal credit facilities from its suppliers.
Operating efficiency: Operating efficiency may reduce the level of raw materials, finished goods and debtors resulting in lower requirement of working capital.
Availability of raw materials: If the raw materials and other required materials are available continuously, lower stock levels may be sufficient requiring less amount of working capital.
Growth prospects: When there is growth and expansion in the business of an enterprise, it will require large amount of working capital.
Level of competition: Higher level of competition necessitates a business concern to hold larger stocks of finished goods. It also forces the firm to extend liberal credit facilities. As a result of which a firm needs more working capital.
Inflation: If the rate of inflation is high, the firm needs more working capital.
(Write any four points)

I. Multiple choice questions (1 Mark each)

Question 1.
The cheapest source of finance is:
(a) debenture
(b) equity share capital
(c) preference share
(d) retained earning
Answer:
(a) debenture

Question 2.
A decision to acquire a new and modern plant to upgrade an old one is a:
(a) financing decision
(b) working capital decision
(c) investment decision
(d) None of the above
Answer:
(c) investment decision

Question 3.
Other things remaining the same, an increase in the tax rate on corporate profits will:
(a) make the debt relatively cheaper
(b) make the debt relatively the dearer
(c) have no impact on the cost of debt
(d) we can’t say
Answer:
(a) make the debt relatively cheaper

Question 4.
Companies with a higher growth pattern are likely to:
(a) pay lower dividends
(b) Pay higher dividends
(c) dividends are not affected by growth considerations
(d) none of the above
Answer:
(a) pay lower dividends.

Question 5.
Financial leverage is called favourable if:
(a) Return on Investment is lower than the cost of debt
(b) ROI is higher than the cost of debt
(c) Debt is easily available
(d) If the degree of existing financial leverage is low
Answer:
(b) ROI is higher than the cost of debt

Question 6.
Higher debt-equity ratio results in:
(a) lower financial risk
(b) higher degree of operating risk
(c) higher degree of financial risk
(d) higher EPS
Answer:
(c) higher degree of financial risk

Question 7.
Current assets are those assets which get converted into cash:
(a) within six months
(b) within one year
(c) between one and three years
(d) between three and five years
Answer:
(b) within one year

Question 8.
Financial planning arrives at:
(a) minimising the external borrowing by resorting to equity issues
(b) entering that the firm always have significantly more fund than required so that there is no paucity of funds
(c) ensuring that the firm faces neither a shortage nor a glut of unusable funds.
(d) doing only what is possible with the funds that the firms has at its disposal
Answer:
(c) ensuring that the firm faces neither a shortage nor a glut of unusable funds.

Question 9.
Higher dividend per share is associated with:
(a) high earnings, high cash flows, unstable earnings and higher growth opportunities.
(b) high earnings, high cash flows, stable earnings and high growth opportunities.
(c) high earnings, high cash flows, stable earnings and lower growth opportunities
(d) high earnings, low cash flows, stable earnings and lower growth opportunities
Answer:
(b) high earnings, high cash flows, stable earnings and high growth opportunities.

Question 10.
A fixed asset should be financed through:
(a) a long-term liability
(b) a short-term liability
(c) a mix of long and short-term liabilities
Answer:
(a) a long-term liability

Question 11.
Current assets of a business Arm should be financed through:
(a) current liability only
(b) long-term liability only
(c) both types (i.e., long and short term liabilities).
Answer:
(c) both types (i.e., long and short term liabilities).