Tata Steel’s $12 billion acquisition of Corus in 2007, financed through a mix of debt and equity, highlights the critical role of financial management in major business decisions. Financial management ensures optimal use of funds to support business operations, growth, and shareholder value.
Example: Tata Steel raised $8 billion in debt and $2 billion in equity via a special purpose vehicle to fund the Corus acquisition, impacting its capital structure.
Business finance refers to the money required for carrying out business activities, such as establishing, running, modernizing, expanding, or diversifying a business. It funds tangible assets (e.g., machinery, buildings) and intangible assets (e.g., patents, trademarks), as well as day-to-day operations like paying salaries and bills.
Example: A factory needs finance to purchase new equipment and pay suppliers, ensuring smooth operations.
Financial management involves the optimal procurement and usage of finance to minimize costs, control risks, and maximize returns. It ensures funds are available when needed, avoids idle funds, and deploys resources efficiently.
Role and Importance:
Example: A company’s decision to invest ₹100 crores in new machinery increases fixed assets and working capital needs, guided by financial management.
The primary objective is to maximize shareholders’ wealth by increasing the market price of equity shares. This is achieved through efficient decision-making in investment, financing, and dividend policies, ensuring benefits exceed costs.
How Achieved:
Example: Choosing a machine that boosts production efficiency increases profits, enhancing share value.
Financial management involves three key decisions:
Example: A firm decides to fund a new plant with 60% debt and 40% equity, balancing cost and control considerations.
Financial planning is the preparation of a financial blueprint to ensure funds are available when needed, avoiding shortages or wasteful surpluses. It estimates fund requirements, timing, and sources for smooth operations.
Objectives:
Importance:
Example: A company forecasts a 20% sales growth and plans fund allocation for inventory and machinery, preparing for varied scenarios.
Capital structure is the mix of owners’ funds (equity, preference shares, retained earnings) and borrowed funds (debt, debentures). It’s calculated as the debt-equity ratio (Debt/Equity) or proportion of debt (Debt/(Debt+Equity)). An optimal structure maximizes shareholder wealth by balancing profitability and financial risk.
Key Concepts:
EBIT-EPS Analysis:
| Company X Ltd. | Situation I (No Debt) | Situation II (₹10L Debt) | Situation III (₹20L Debt) |
|---|---|---|---|
| EBIT | ₹4,00,000 | ₹4,00,000 | ₹4,00,000 |
| Interest (10%) | ₹0 | ₹1,00,000 | ₹2,00,000 |
| EBT | ₹4,00,000 | ₹3,00,000 | ₹2,00,000 |
| Tax (30%) | ₹1,20,000 | ₹90,000 | ₹60,000 |
| EAT | ₹2,80,000 | ₹2,10,000 | ₹1,40,000 |
| Shares | 3,00,000 | 2,00,000 | 1,00,000 |
| EPS | ₹0.93 | ₹1.05 | ₹1.40 |
In Company X, EPS rises with debt (ROI 13.33% > 10% debt cost), showing favorable leverage. In Company Y (ROI 6.67%), EPS falls, indicating unfavorable leverage.
Example: Tata Steel’s use of $8 billion debt for Corus acquisition leveraged lower-cost debt to enhance EPS, assuming ROI exceeded debt cost.
Example: A firm with high cash flows and low operating risk opts for more debt to lower capital costs, maintaining control.
Fixed Capital: Investment in long-term assets (e.g., machinery, buildings) lasting over a year, funded by long-term sources. Decisions (capital budgeting) impact growth, profitability, and risk.
Importance:
Factors Affecting Fixed Capital:
Working Capital: Investment in current assets (e.g., cash, inventory) convertible to cash within a year, minus current liabilities. Net working capital (CA - CL) ensures liquidity for daily operations.
Factors Affecting Working Capital:
Example: A textile firm diversifying into cement manufacturing increases fixed capital for new plants and working capital for raw materials.
Short Answer Type: Question: What are the main objectives of financial management? Briefly explain.
Answer: The primary objective of financial management is to maximize shareholders’ wealth by increasing the market price of equity shares. This is achieved by making efficient investment, financing, and dividend decisions, ensuring benefits exceed costs, minimizing risks, and optimizing fund allocation to enhance profitability and share value.
Business finance is the money needed for business activities, managed through financial management to optimize procurement and usage. Financial management maximizes shareholders’ wealth via investment (capital budgeting, working capital), financing (debt-equity mix), and dividend decisions, balancing risk and return. Financial planning ensures fund availability and avoids excess, preparing for uncertainties and coordinating functions. Capital structure, the mix of debt and equity, impacts profitability and risk, with trading on equity enhancing EPS when ROI exceeds debt cost. Fixed capital funds long-term assets, driving growth but involving high risk, while working capital supports daily operations, balancing liquidity and profitability. Factors like business nature, scale, and market conditions influence capital needs.