UNIT V : FINANCING DECISION AND WORKING CAPITAL MANAGEMENT ________________________________________________________________________ 1. INTRODUCTION The financing decision and working capital decisions of a firm are very crucial for its survival and growth. The financing decision of a firm refers to those activities which revolve around the finding of the cost of various sources of finance such as – Equity shares, Preference shares, Debentures etc and selecting those sources where the overall cost of the funds is the minimum. This is because, each source of finance has its own risk characteristics and depending on it, structures its cost. Similarly, working capital decision of a firm is also very important as it decides the quantum of investment in current assets and current liabilities. 2. LEARNING OBJECTIVES After going through this chapter, the reader is expected to – • Understand the meaning of capital structure • Also gain an awareness about the various factors that must be considered while deciding the capital structure decision of a firm • Understand an appreciate the features of a sound capital structure • Get exposed to the various factors Influencing Capital Structure • Know the meaning of Dividend Policy • Understand the various forms Of Dividend • Get an idea of the various types Of Dividend Policy • Understand the various factors that determine the Dividend Policy • Understand the meaning of Working Capital Management • Get an idea about the various concepts Of Working Capital • Know about the various types Of Working Capital • Get exposed to the various factors Effecting the Working Capital Needs Of Firms • Estimate the Working Capital Requirements 3. CAPITAL STRUCTURE DEFINTITION According to Gerstenberg, Capital structure refers to ‘the make up of a firm’s capitalisation’. In other words, it represents the mix of different sources of long term funds (such as equity shares, preference shares, long term loans, retained earnings, etc). Optional Capital Structure may be defined as that of Capital structure or Combination of debt and equity that leads to the maximum value of the firm. Capital structure planning aims at maximization of profits and the wealth of the shareholders, ensures the maximum value of a firm or minimum Cost of capital.
4. ESSENTIAL FEATURES OF A SOUND CAPITAL MIX A sound or an appropriate Capital structure should have the following essential features : → → → → Maximum possible use of leverage Capital structure should be flexible To avoid undue financial/business risk with the increase of debt The use of debt should be within the capacity of a firm. The firm should be in a position to meet its obligations in paying the loan and interest charges as and when due. It should involve minimum possible risk of loss of control It must avoid undue restrictions in agreement of debt
5. FACTORS INFLUENCING CAPITAL STRUCTURE/DETERMINANTS OF THE CAPITAL STRUCTURE 1. Financial leverage (or) Trading on equity
It is the use of long term fixed interest bearing debt and Preference shares along with equity share capital. The use of long term debt increases and magnifies the EPS if the firm yields a return higher than the cost of debt. This is positive leverage. However, if the firm yields a lower return than the cost of debt, it is Adverse leverage. EPS also increases with the use of preference share capital also, but due to the fact that interest is allowed to be deducted while computing the tax, the leverage impact of debt is more. 2. Growth & Stability of Sales If the sales of a firm are expected to remain fairly stable, it can raise a higher level of debt, as the firm may not face any difficulty in meeting its fixed commitments of interest repayment of debt. Usually, greater the rate of growth of sales, greater can be the use of debt in the financing of a firm. 3. Cost of Capital The capital structure should provide for minimum overall cost of capital depending upon the risk involved, out of...
References: FOR THE CHAPTER 1. I.M.Pandey, “Elements of management accounting”, Vikas Publishing House pvt .Ltd, 1993. 2. Eugene. F.Brigham, Michael.C.Ehrhardt, “Financial Management – theory and practice”, Thomson Southwestern, 2006.
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