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Skrill Ludo off kuch kaam, Schemes and Mind Maps of Mathematics

University of Madras Mathematics

Prof. Rahul Raj

The definition and importance of financial planning, including its role in collecting optimum funds, fixing the appropriate capital structure, investing finance in the right projects, and coordinating various business functions. It also covers the advantages of financial planning, such as cost controls, cash flow management, improved debt management, and accurate tax compliance. Additionally, the document explains the factors governing capital structure, including cost, risk, business risk, financial risk, control, and flexibility principles. Finally, it defines and compares operating leverage and financial leverage.

Typology: Schemes and Mind Maps

2020/2021

Available from 10/17/2022

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1.Definition of Financial Planning

Financial Planning is the process of estimating the capital required and determining it’s competition.

It is the process of framing financial policies in relation to procurement, investment and

administration of funds of an enterprise.

Importance of Financial Planning:

Sound financial planning is essential for success of any business enterprise. Its need is felt because of

the following reasons:

1.It Facilitates Collection of Optimum Funds:

The financial planning estimates the precise requirement of funds which means to avoid

wastage and over-capitalization situation.

2.It Helps in Fixing the Most Appropriate Capital Structure:

Funds can be arranged from various sources and are used for long term, medium term and

short term. Financial planning is necessary for tapping appropriate sources at appropriate time

as long term funds are generally contributed by shareholders and debenture holders, medium

term by financial institutions and short term by commercial banks.

3.Helps in Investing Finance in Right Projects:

Financial plan suggests how the funds are to be allocated for various purposes by comparing

various investment proposals.

4.Helps in Operational Activities:

The success or failure of production and distribution function of business depends upon the

financial decisions as right decision ensures smooth flow of finance and smooth operation of

production and distribution.

5.Base for Financial Control:

Financial planning acts as basis for checking the financial activities by comparing the actual

revenue with estimated revenue and actual cost with estimated cost.

6.Helps in Proper Utilisation of Finance:

Finance is the life blood of business. So financial planning is an integral part of the corporate

planning of business. All business plans depend upon the soundness of financial planning.

7.Helps in Avoiding Business Shocks and Surprises:

By anticipating the financial requirements financial planning helps to avoid shock or surprises

which otherwise firms have to face in uncertain situations.

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1.Definition of Financial Planning Financial Planning is the process of estimating the capital required and determining it’s competition. It is the process of framing financial policies in relation to procurement, investment and administration of funds of an enterprise. Importance of Financial Planning: Sound financial planning is essential for success of any business enterprise. Its need is felt because of the following reasons:

1. It Facilitates Collection of Optimum Funds:  The financial planning estimates the precise requirement of funds which means to avoid wastage and over-capitalization situation.  2. It Helps in Fixing the Most Appropriate Capital Structure:  Funds can be arranged from various sources and are used for long term, medium term and short term. Financial planning is necessary for tapping appropriate sources at appropriate time as long term funds are generally contributed by shareholders and debenture holders, medium term by financial institutions and short term by commercial banks.  3. Helps in Investing Finance in Right Projects:  Financial plan suggests how the funds are to be allocated for various purposes by comparing various investment proposals.  4. Helps in Operational Activities:  The success or failure of production and distribution function of business depends upon the financial decisions as right decision ensures smooth flow of finance and smooth operation of production and distribution.  5. Base for Financial Control:  Financial planning acts as basis for checking the financial activities by comparing the actual revenue with estimated revenue and actual cost with estimated cost.  6. Helps in Proper Utilisation of Finance:  Finance is the life blood of business. So financial planning is an integral part of the corporate planning of business. All business plans depend upon the soundness of financial planning.  7. Helps in Avoiding Business Shocks and Surprises:  By anticipating the financial requirements financial planning helps to avoid shock or surprises which otherwise firms have to face in uncertain situations.

 8. Link between Investment and Financing Decisions:  Financial planning helps in deciding debt/equity ratio and by deciding where to invest this fund. It creates a link between both the decisions.  9. Helps in Coordination:  It helps in coordinating various business functions such as production, sales function etc.  10. It Links Present with Future:  Financial planning relates present financial requirement with future requirement by anticipating the sales and growth plans of the company. 2.The Advantages of Financial Planning Cost Controls One of the most crucial benefits of financial planning is the ability to control costs. Creating annual budgets lets you see your big expenses, plan for them, reduce them if necessary, and monitor them to see if you are on track to meet your goals. Setting a budget doesn’t necessarily solve your problems. You will need to track it each month to make sure your revenues are keeping pace with your expense and profit targets, and to determine whether or not you projected your expenses correctly. Cash Flow Management Just because sales are good doesn’t mean you’ll have that money when you need it. Financial planning includes cash flow management, identifying in advance your cash needs each month, regardless of your revenues. If you have slow payables or bad debt during times when you have high bills, you might lose the ability to order goods and services that keep your business running. In addition to creating a master budget that shows your average monthly income and expenses, create a cash flow budget that shows your anticipated actual income and expenses each month. Improved Debt Management The interest on credit lines, loans and credit cards is a hidden cost many small-business owners don’t track, because interest is tacked on to a balance and doesn’t require a cash payment each month. A financial plan should address your monthly interest payments, putting them into your budget so you learn your real financial performance. Your plan should address accelerating debt repayment, if possible, to reduce your interest expense. Accurate Tax Compliance Financial planning includes estimating your taxes and adjusting your estimates as your sales rise and fall. Failing to pay income, property or payroll taxes on time can result in serious problems, including fines, penalties, and liens placed against your business. If you pay quarterly taxes, budget for those payments and put that money aside. Work with your accountant to determine how to set up your tax payments and make them on time. Types of Financial Planning

additional profits that equity shareholders earn because of issuance of debentures and preference shares. It is based on the thought that if the rate of dividend on preference capital and the rate of interest on borrowed capital is lower than the general rate of company’s earnings, equity shareholders are at advantage which means a company should go for a judicious blend of preference shares, equity shares as well as debentures. Trading on equity becomes more important when expectations of shareholders are high. Degree of control - In a company, it is the directors who are so called elected representatives of equity shareholders. These members have got maximum voting rights in a concern as compared to the preference shareholders and debenture holders. Preference shareholders have reasonably less voting rights while debenture holders have no voting rights. If the company’s management policies are such that they want to retain their voting rights in their hands, the capital structure consists of debenture holders and loans rather than equity shares. Flexibility of financial plan - In an enterprise, the capital structure should be such that there is both contractions as well as relaxation in plans. Debentures and loans can be refunded back as the time requires. While equity capital cannot be refunded at any point which provides rigidity to plans. Therefore, in order to make the capital structure possible, the company should go for issue of debentures and other loans. Choice of investors - The company’s policy generally is to have different categories of investors for securities. Therefore, a capital structure should give enough choice to all kind of investors to invest. Bold and adventurous investors generally go for equity shares and loans and debentures are generally raised keeping into mind conscious investors. Capital market condition - In the lifetime of the company, the market price of the shares has got an important influence. During the depression period, the company’s capital structure generally consists of debentures and loans. While in period of boons and inflation, the company’s capital should consist of share capital generally equity shares. Period of financing- When company wants to raise finance for short period, it goes for loans from banks and other institutions; while for long period it goes for issue of shares and debentures. Cost of financing - In a capital structure, the company has to look to the factor of cost when securities are raised. It is seen that debentures at the time of profit earning of company prove to be a cheaper source of finance as compared to equity shares where equity shareholders demand an extra share in profits. Stability of sales - An established business which has a growing market and high sales turnover, the company is in position to meet fixed commitments. Interest on debentures has to be paid regardless of profit. Therefore, when sales are high, thereby the profits are high and company is in better position to meet such fixed commitments like interest on debentures and dividends on preference shares. If company is having unstable sales, then the company is not in position to meet fixed obligations. So, equity capital proves to be safe in such cases. Sizes of a company - Small size business firms capital structure generally consists of loans from banks and retained profits. While on the other hand, big companies having goodwill, stability and an

established profit can easily go for issuance of shares and debentures as well as loans and borrowings from financial institutions. The bigger the size, the wider is total capitalization.

4. Factors Governing Capital Structure

Well , while choosing a suitable financing pattern, certain fundamental principles should be kept in mind , which is discussed below:

Cost principle :According to this principle an ideal pattern or capital structure is one that minimizes cost of capital structure and maximizes earnings per share (EPS). For e.g Debt capital is cheaper than equity capital from the point of its cost and interest being deductible for income tax purpose , where no such deductions is allowed for dividends.
Risk principle :- According to this principle , reliance is placed more on equity for financing capital requirements than excessive use of debt. Use of more and more debt means higher commitment in form of interest payout. These are two risks associated with this principle.
Business risk :- It is an unavoidable risk because of the environment in which the firm has to operate and business risk is represented by the variability of earnings before interest and tax (EBIT). The variability in turn is influenced by revenues and expenses. Revenues and expenses are affected by demand of firm products , variations in prices and proportion of fixed cost in total cost.
Financial risk :It is a risk associated with the availability of earnings per share caused by use of financial leverage. It is also unavoidable if firm does not use debt in its capital structure. Generally , a firm should neither be exposed to high degree of business risk and low degree of financial risk or vice-versa , so that shareholders do not bear a higher risk.
C) Control Principle :-While designing a capital structure , the finance manager may also keep in mind that exiting management control and ownership remains undisturbed. Issue of new equity will dilute exiting control pattern and also it involves higher cost. Issue of more debt causes no dilution in control, but causes a higher degree of financial risk. (d) Flexibility principle: – By flexibility it means that the management chooses such a combination of sources of financing which it finds easier to adjust according to changes in need of funds in future too. While debt could be interchanged (if the company is loaded with a debt of 18% and funds are available at 15% , it can return old debt with new debt, at a lesser interest rate)but the same option may not be available in case of equity investment. (e) Other considerations :- Besides above principles , other factors such as nature of industry , timing of issue and competition in the industry should also be considered. Industries facing severe competition also resort to more equity than debt.
LEVERAGE

Leverage is the term which is commonly used to describe the organizations’ ability to utilize the

assets which are having fixed costs (or) different sources of funds to increase the returns to the

firm.

According to James Home, “Leverage is the employment of an asset

or sources of funds for which the firm has to pay a fixed

cost(operating cost) or fixed return(financial cost)”.

OPERATING LEVERAGE

Operating Leverage is defined as the firm’s ability to use the fixed operating costs to generate

more revenue to the firm. Operating costs are divided into three types as Fixed costs(depreciation,

BASIS FOR COMPARISON OPERATING LEVERAGE FINANCIAL LEVERAGE company's operations for which it has to pay fixed costs is known as Operating Leverage. company's capital structure for which it has to pay interest expenses is known as Financial Leverage. Measures Effect of Fixed operating costs. Effect of Interest expenses Relates Sales and EBIT EBIT and EPS Ascertained by Company's Cost Structure Company's Capital Structure Preferable Low High, only when ROCE is higher Formula DOL = Contribution / EBIT DFL = EBIT / EBT Risk It give rise to business risk. It give rise to financial risk.