Business Studies Ii Chapter 9 Financial Management

Wealth Maximisation is an important decision of financial management. It means to increase the capital invested in the business by the shareholders. Market price of the shares is the index of the capital invested. If the market price of the shares increases, it can be said that capital (wealth) invested by the shareholders has been appreciating. On the contrary, fall in the market price of the shares has an adverse effect on their wealth. Wealth of the shareholders can be computed by the following formula:

Shareholder’s Current Wealth in a Company = Number of Shares × Market Price Per Share

For example, a person buys 100 shares of XYZ Co. at the rate of र 100 per share. It means that his wealth in the company is worth र 10,000 (100 ×100). After some time, market price of the share rises to र 120 per share. It means that his wealth in the company has gone up to र 12,000 (100 × 120). In other words, his wealth has increased by र 2,000. On the contrary, if the market price of the share falls to र 80 per share, then his wealth in the company will be reduced to र8,000 (100 × 80).

It is, therefore, clear that wealth maximisation is possible only when market price of the shares rises. Question arises what steps should be taken by the financial manager to raise the market price of his company’s shares? Answer to this question is that he should take all the three main financial decisions as under:

(i) Optimum Investment Decision: It means he should take such decisions regarding investment as are relatively more profitable.

(ii) Optimum Financing Decision: It means that he should make such a mix of debt capital and share capital as has the minimum cost of capital.

(iii) Optimum Dividend Decision: It means that total profits of the company should be distributed among the shareholders in such a manner that they feel satisfied and at the same time company also has sufficient reserve to meet its future requirements.

The objective of financial management is to maximise the wealth of the owners of the business to the maximum extent.

According to this approach, owners’ interest can be best served by wealth maximisation. Wealth maximisation means to increase the capital invested in the business by the shareholders. Market price of the shares is the index of the capital invested. If the market price of the shares increases, it can be said that capital (wealth) invested by the shareholders has been appreciating. On the contrary, fall in the market price of the shares has an adverse effect on their wealth. Wealth of the shareholders can be computed by the following formula:

Shareholder’s Current Wealth in a Company = Number of Shares x Market Price Per Share.

Shareholder’s Current Wealth in a Company = Number of Shares र Market Price Per Share.

Financial management refers to that part of the management which is concerned with the efficient planning and controlling of financial affairs of the enterprise.

The three main financial decisions which are generally taken by a finance manager are as under: (i) Investment Decision: It refers to the selection of assets in which funds will be invested by the business. Assets which are obtained by the business are of two types, i.e., long-term assets and short-term assets. On this basis, investment decision is also divided into two parts:

(a) Long-term Investment Decision: This is referred to as the Capital Budgeting Decision. It relates to the investment in long-term assets. For example, buying a new machine. For the same purpose, the finance manager has to make a comparative study of various alternates available in the market on the basis of their cost and profitability. These decisions are very important as they affect the earning of the business over the long run.

(b) Short-term Investment Decision: This is referred to as the Working Capital Management. It relates to the investment in short-term assets, such as, cash, stock, debtors, etc. Finance manager has to ensure that there is sufficient investment in these assets as they affect the liquidity position of the business. For the same purpose, the relative profitability and liquidity of these assets are compared.

(ii) Financing Decision: It refers to the determination as to how the total funds required by the business will be obtained from various long-term sources. Long-term financial sources chiefly include equity share capital, preference share capital, retained earnings, debentures, long-term loan, etc. For taking financing decision, an analysis of the cost and benefits of all the sources is made.

(iii) Dividend Decision: It refers to the determination of how much part of the earning should be distributed among shareholders by the way of dividend and how much should be retained for meeting future needs as retained earnings.

The following factors affect the financing decision:

(i) Cost: The cost of all the sources of finance is different. The rate of interest on debt, fixed rate of dividend to be paid on preference share capital and the expectations of the shareholders on the equity share capital are in the form of costs. If the situations happen to be favourable, the benefit of cheap finance can be availed of by choosing debt capital.
(ii) Risk: Debt capital is most risky and from the point of view of risk it should not be used.

(iii) Floatation Cost: From the point of view of floating costs, retained profit is the most appropriate source. Therefore, its use should be made.

(iv) Cash Flow Position: If the cash flow position of the company is good, the payment of interest on the debt and the refund of capital can be easily made. Therefore, in order to take advantage of cheap finance, debt capital can be given priority.

(v) Level of Fixed Operating Costs: In business, there are mainly two types of costs:

(a) Fixed Operating Costs, e.g., rent of the building, payment of salary, insurance premium, etc.

(b) Fixed Financial Costs, e.g., interest on debt, etc.

If the level of fixed operating costs is in excess, it is better to keep the fixed financial costs at their minimum. Therefore, debt capital should not be used. On the contrary, if the level of fixed operating cost is low, the use of debt capital is profitable.

(vi) Control Consideration: The ultimate control of the company is that of the equity shareholders. Greater the number of equity shareholders, the greater will be the control in the hands of more people. This is not a good situation. Therefore, from this point of view the equity share capital should be avoided.

The chief factors affecting dividend decision are the following:

(i) Earning: The dividend is paid out of the present and reserved profits. Therefore, greater amount of total profit will ensure greater dividend.

(ii) Stability of Earnings: A company having stable earnings is in a position to declare more dividends and vice-versa.

(iii) Stability of Dividend: Every company adopts the policy of maintaining the stability of dividend per share. (Here the stability of dividend means that the dividend will, in no case, be allowed to fall. It is always good if the dividend remains stable or increases.) From this point of view, a little change in profit should not be allowed any increase or decrease in the dividend.

(iv) Growth Opportunities: If the company has more opportunities for growth, it will require more finance. In such a situation, a major part of the income should be retained and a small part of it should be paid as dividend.

(v) Cash Flow Position: The payment of dividend results in outflow of cash. It is possible that the company may have enough income but it is equally possible that it may not have sufficient cash to pay dividend. In this way, the cash flow position of the company is a factor that determines the dividend decision. The better the cash flow position of the company, the better will be the capacity of the company to pay dividend.

(vi) Shareholder Preference: There are two types of shareholders from the point of view of investment: (a) those who invest with the purpose of getting some regular income and (b) those who invest in the company to gain capital profit. If the majority of the shareholders are of the former type, the company must declare dividend according to their expectation. On the contrary, if the majority of the shareholders are of the latter type the company enjoys freedom about declaring dividend.

It refers to the determination of how much part of the earning should be distributed among shareholders by the way of dividend and how much should be retained for meeting future needs as retained earnings.
Factors affecting dividend decision are the following:
(i) Earning: The dividend is paid out of the present and reserved profits. Therefore, greater amount of total profit will ensure greater dividend.

(ii) Stability of Earnings: A company having stable earnings is in a position to declare more dividends and vice-versa.

(iii) Stability of Dividend: Every company adopts the policy of maintaining the stability of dividend per share. (Here the stability of dividend means that the dividend will, in no case, be allowed to fall. It is always good if the dividend remains stable or increases.) From this point of view, a little change in profit should not be allowed any increase or decrease in the dividend.

(iv) Growth Opportunities: If the company has more opportunities for growth, it will require more finance. In such a situation, a major part of the income should be retained and a small part of it should be paid as dividend.

It refers to the determination as to how the total funds required by the business will be obtained from various long-term sources. Long-term financial sources chiefly include equity share capital, preference share capital, retained earnings, debentures, long-term loan, etc. For taking financing decision, an analysis of the cost and benefits of all the sources is made. Following factors affect the financing decision:

(i) Cost: The cost of all the sources of finance is different. The rate of interest on debt, fixed rate of dividend to be paid on preference share capital and the expectations of the shareholders on the equity share capital are in the form of costs. If the situations happen to be favourable, the benefit of cheap finance can be availed of by choosing debt capital.
(ii) Risk: Debt capital is most risky and from the point of view of risk it should not be used.

(iii) Floatation Cost: From the point of view of floating costs, retained profit is the most appropriate source. Therefore, its use should be made.

(iv) Cash Flow Position: If the cash flow position of the company is good, the payment of interest on the debt and the refund of capital can be easily made. Therefore, in order to take advantage of cheap finance, debt capital can be given priority.

Following factors affect the Long-Term and Short-term Investment decisions:

(i) Long-Term Investment Decisions (Capital Budgeting Decision): Following factors affect these decisions:

(a) Cash Flows of the Project: As we know investment decision (capital budgeting decision) is related with investment in long-term assets. These assets involve both cash outflows and cash inflows over a series of years. The amount needed for investment is known as cash outflow, on the other hand, returns from the same investment is known as cash inflows. Both of these need to be analysed carefully before finalising the investment.

(b) The Rate of Return: A project may not be profitable as compared to other. The criteria to decide the profitability of various projects is their respective rate of returns. The rate of return is calculated on the basis of expected return of the project and risk attached with it. If two projects are of the same risk class, the project having higher rate of return will be accepted.

(c) Investment Criteria Involved: There may be many criteria of the investor while investing in the long-term assets. These are: funds involve, rate of interest, rate of return, cash flow, etc. All these factors influence the decision to go for a particular investment or not. For the same purpose, capital budgeting techniques are applied and accordingly decisions are taken.

(ii) Short-Term Investment Decisions: Following factors affect the short-term investment decisions:

This decision is related to working capital management. Keeping of adequate amount of working capital at all times in the business is called management of working capital. Adequate amount means that amount of working capital should neither be more nor less than required. Both these situations are harmful. If the amount of working capital is more than required, it will no doubt increase liquidity but decrease profitability. For instance, if large amount of cash is kept as working capital then this excessive cash will remain idle and cause the profitability to fall. On the contrary, if the amount of cash and other current assets are very little, then lot of difficulties will have to be faced in meeting daily expenses and making payment to the creditors. Thus, the objective of management of working capital is to determine optimum amount of both current assets and current liabilities so that profitability of the business remains intact and there is no fall in liquidity. In short, liquidity and profitability are the main factors which affect the short-term investment decision.

The chief factors affecting dividend decision are the following:

(i) Earning: The dividend is paid out of the present and reserved profits. Therefore, greater amount of total profit will ensure greater dividend.

(ii) Stability of Earnings: A company having stable earnings is in a position to declare more dividends and vice-versa.

(iii) Stability of Dividend: Every company adopts the policy of maintaining the stability of dividend per share. (Here the stability of dividend means that the dividend will, in no case, be allowed to fall. It is always good if the dividend remains stable or increases.) From this point of view, a little change in profit should not be allowed any increase or decrease in the dividend.

(iv) Growth Opportunities: If the company has more opportunities for growth, it will require more finance. In such a situation, a major part of the income should be retained and a small part of it should be paid as dividend.

(v) Cash Flow Position: The payment of dividend results in outflow of cash. It is possible that the company may have enough income but it is equally possible that it may not have sufficient cash to pay dividend. In this way, the cash flow position of the company is a factor that determines the dividend decision. The better the cash flow position of the company, the better will be the capacity of the company to pay dividend.

The following factors affect the financing decision:

(i) Cost: The cost of all the sources of finance is different. The rate of interest on debt, fixed rate of dividend to be paid on preference share capital and the expectations of the shareholders on the equity share capital are in the form of costs. If the situations happen to be favourable, the benefit of cheap finance can be availed of by choosing debt capital. (ii) Risk: Debt capital is most risky and from the point of view of risk it should not be used.

(iii) Floatation Cost: From the point of view of floating costs, retained profit is the most appropriate source. Therefore, its use should be made.

(iv) Cash Flow Position: If the cash flow position of the company is good, the payment of interest on the debt and the refund of capital can be easily made. Therefore, in order to take advantage of cheap finance, debt capital can be given priority.

(v) Level of Fixed Operating Costs: In business, there are mainly two types of costs:

(a) Fixed Operating Costs, e.g., rent of the building, payment of salary, insurance premium, etc.

(b) Fixed Financial Costs, e.g., interest on debt, etc.

If the level of fixed operating costs is in excess, it is better to keep the fixed financial costs at their minimum. Therefore, debt capital should not be used. On the contrary, if the level of fixed operating cost is low, the use of debt capital is profitable.

Long-term Investment Decision: This is referred to as the Capital Budgeting Decision. It relates to the investment in long-term assets. For example, buying a new machine. For the same purpose, the finance manager has to make a comparative study of various alternates available in the market on the basis of their cost and profitability. These decisions are very important as they affect the earning of the business over the long run.

Factors affecting Long-Term Investment Decision (Capital Budgeting Decision):

Following factors affect this decision:

(i) Cash Flows of the Project: As we know investment decision (capital budgeting decision) is related with investment in long-term assets. These assets involve both cash outflows and cash inflows over a series of years. The amount needed for investment is known as cash outflow, on the other hand, returns from the same investment is known as cash inflows. Both of these need to be analysed carefully before finalising the investment.

(ii) The Rate of Return: A project may not be profitable as compared to other. The criteria to decide the profitability of various projects is their respective rate of returns. The rate of return is calculated on the basis of expected return of the project and risk attached with it. If two projects are of the same risk class, the project having higher rate of return will be accepted.

It is dividend decision and the factors affecting this decision are as follows:

(i) Earning: The dividend is paid out of the present and reserved profits. Therefore, greater amount of total profit will ensure greater dividend.

(ii) Stability of Earnings: A company having stable earnings is in a position to declare more dividends and vice-versa.

(iii) Stability of Dividend: Every company adopts the policy of maintaining the stability of dividend per share. (Here the stability of dividend means that the dividend will, in no case, be allowed to fall. It is always good if the dividend remains stable or increases.) From this point of view, a little change in profit should not be allowed any increase or decrease in the dividend.

(iv) Growth Opportunities: If the company has more opportunities for growth, it will require more finance. In such a situation, a major part of the income should be retained and a small part of it should be paid as dividend.

Following are the main decisions which are involved in financial management:

(i) Investment Decision: It refers to the selection of assets in which funds will be invested by the business. In other words, these decisions are concerned with the effective utilisation of funds in one activity or other.

(ii) Financing Decision: It refers to the determination as to how the total funds required by the business will be obtained from various long-term sources.

(iii) Dividend Decision: It refers to the determination of how much part of the earning should be distributed among shareholders by the way of dividend and how much should be retained for meeting future needs as retained earning.

It refers to the selection of assets in which funds will be invested by the business.

From this point of view ‘Retained Earning’ is the most appropriate source.

From this point of view equity share capital should be avoided.

There is a positive relationship between the both.

It is short-term investment decision.

It is Long-term Investment Decision (also known as Capital Budgeting Decision).

Investment decision.

Because it increases the financial risk of the company and burden of interest.

Short-term Investment Decision.

Financial planning pertains functions of finance and includes the determination of firm’s financial objectives, financial policies and financial procedures.
Main points of the importance of financial planning are as under:
(i) Helps to Face the Eventualities: It tries to forecast various business situations. On this basis, alternative financial plans are prepared. By doing so, it helps to face the eventual situations in a better way.

(ii) Helps in Avoiding Business Shocks and Surprises: Proper provision regarding shortage or surplus of funds is made by anticipating future receipts and payments. Hence, it helps in avoiding business shocks and surprises.

(iii) Helps in Coordination: It helps in coordinating various business activities, such as, sales, purchase, production, finance, etc.

(iv) Helps in Avoiding Wastage of Finance: In the absence of financial planning, wastage of financial resources may take place. This arises due to the complex nature of business operations, such as, excessively over or under estimation of finance for a particular business operation. Such type of wastages can be avoided through financial planning.

(v) Helps to Link the Present with the Future: It makes efforts to link the present with the future. By doing so, it helps to minimise the risk of future uncertainties.

(vi) Helps in creating Link between Investment and Financing Decisions: It helps in deciding that where to invest and from where the required funds will be made available. Under it the mix of share capital and debt capital is made in such a manner that cost of capital is reduced to minimum.

Following are the objectives of financial planning:

(i) To Ensure Timely Availability of Finance: The first objective of financial planning is to make finance available in time. Under it, the long-term and short-term financial needs are anticipated and then the sources of availability of finance are located.

(ii) To Ensure Proper Balance of Finance: It is always ensured that the balance of cash should neither be in excess nor in short. The balance of cash in both these situations is harmful. For example, if the balance of cash needed is rupees five lakh but the actual cash balance is ten lakhs, the cash of five lakhs will remain idle and it will incur loss of interest. On the contrary, if only rupees three lakh are available instead of rupees five lakh, it will damage the reputation of the company for not making timely payments.

In short, it can be said that the objective of the financial planning is to make finance available in appropriate quantity and make it available well in time.

Capital structure refers to relative proportion of different sources of long-term finance.

Capital structure refers to mix sources of long-term finance. Sources of finance include 
Share Capital Borrowed fund and Retained earnings. The appropriate proportion of funds is made in such a manner that it can give more benefit or return to the shareholders.

Some of the chief factors affecting the choice of the capital structure are the following:

1. Cash Flow Position: While making a choice of the capital structure, the future cash flow position should be kept in mind. Debt capital should be used only if the cash flow position is really good because a lot of cash is needed in order to make payment of interest and refund of capital.
2. Interest Coverage Ratio ICR: With the help of this ratio, an effort is made to find out how many times is the Earning Before Interest and Tax (EBIT) available to the payment of interest. The capacity of the company to use debt capital will be in direct proportion to this ratio. This ratio can be found out with the help of the following formula:
              ICR = EBIT/Interest
3. Debt Service Coverage Ratio (DSCR): This ratio removes the weakness of ICR. This shows the cash flow position of the company. 
4. Return on Investment (ROI): If the RoI of the company is higher, it can choose to use trading on equity to increase its EPS, i.e., its ability to use debt is greater.
5. Cost of Debt: The capacity of a company to take debt depends on the cost of debt. In case the rate of interest on the debt capital is less, more debt capital can be utilized and vice-versa.

Trading on Equity: Trading on equity means to raise fixed cost capital (borrowed capital and preference share capital) on the basis of equity share capital so as to increase the income of equity shareholders. Although it is possible only when the rate of return of the company is greater than the rate of interest on borrowed capital or the rate of dividend on preference shares.

Now the question arises how the income (earning) of the equity shareholders can increase when the company raises fixed cost capital (borrowed capital). Following EBIT-EPS Analysis answers this question:

Example:

EBIT - EPS Analysis

It is clear from the above table that both the companies have raised र 10,00,000 as total capital. But X-Co. has raised it by issuing equity capital. On the other hand, Y-Co. has raised र 4,00,000 by issuing equity capital and र 6,00,000 by issuing debentures bearing 10% fixed interest rate. Suppose, both the companies have earned EBIT र 2 lakh each and Tax Rate is 30%.

EBIT - EPS Analysis

In the above example, shareholders of X-Co. are getting र 1.40 return on their investment as against र 2.45 return to shareholders of Y-Co. Both companies raised equal total capital 10 lakh each) and earned equal total profit 2 lakh each), yet the earning of Y-Co.’s shareholders is more. The reason being that Y-Co. has taken advantage of the process of “trading on equity”. In other words, Y-Co. has raised fixed cost capital (borrowed capital) along with equity share capital. On fixed cost capital (borrowed capital), it paid fixed interest at the rate of 10 per cent (10% debentures) and the remainder is distributed as dividend to equity shareholders. Obviously, return on equity shares of Y-Co. is greater than that of X-Co.

With a loan (borrowed capital) component in the total capital, shareholders are likely to have the benefit of a higher rate of return on the share capital. This is is because loans carry a fixed charge and the amount of interest paid is deductible from the Earning Before Tax (EBT). Although it is possible only when the rate of return of the company is greater than the rate of interest on borrowed capital.

Example:

EBIT - EPS Analysis

It is clear from the above table that both the companies have raised र 10,00,000 as total capital. But X-Co. has raised it by issuing equity capital. On the other hand, Y-Co. has raised र 4,00,000 by issuing equity capital and र 6,00,000 by issuing debentures bearing 10% fixed interest rate. Suppose, both the companies have earned EBIT र 2 lakh each and Tax Rate is 30%.

EBIT - EPS Analysis

In the above example, shareholders of X-Co. are getting र 1.40 return on their investment as against र 2.45 return to shareholders of Y-Co. Both companies raised equal total capital 10 lakh each) and earned equal total profit 2 lakh each), yet the earning of Y-Co.’s shareholders is more. The reason being that Y-Co. has taken advantage of the process of “trading on equity.” In other words, Y-Co. has raised fixed cost capital (borrowed capital) along with equity share capital. On fixed cost capital (borrowed capital), it paid fixed interest at the rate of 10 per cent (10% debentures) and the remainder is distributed as dividend to equity shareholders. Obviously, return on equity shares of Y-Co. is greater than that of X-Co.

There are two types of risks in business:

(i) Operating Risk or Business Risk: This refers to the risk of inability to discharge permanent operating costs (e.g., rent of the building, payment of salary, insurance instalment, etc).

Capital structure is influenced by the industry to which a company is related. All companies related to a given industry produce almost similar products, their costs of production are similar, they depend on identical technology, they have similar profitability, hence the pattern of their capital structure is almost similar. Because of this fact, there are different debt-equity ratios prevalent in different industries. Hence, at the time of raising funds a company must take into consideration that the debt-equity ratio prevalent in the related industry.

It refers to the risk of the company not being able to cover its fixed financial costs. The higher levels of risks are attached to higher degrees of financial leverage. With the increase in fixed financial costs, the company is also required to raise its operating profit (EBIT) to meet financial charges. If the company cannot cover these financial charges, it can be forced into liquidation.

The inclusion of the fixed cost capital (debt capital and preference share capital) along with equity share capital in the capital structure is called financial leverage. With the increase of financial leverage the ratio of cheap capital in the total capital of the company increases. Consequently, the total capital cost decreases and the company is in a profitable situation.

EBIT is that profit of the business from which the payment of interest and tax remains to be deducted. It is also known as the operating profit of business. This is an index of the profit earning capacity of the business. For example, the EBIT in case of two companies is rupees eight crore and ten crore respectively while their EAIT (Earning After Interest and Taxes) is five crore and four crore respectively. Here, it can be said that on the basis of EBIT the second company has a more profit earning capacity.

The ‘cash flow position’ is one of the important factors which affects the capital structure decision. As per this factor, while making a choice of the capital structure the future cash flow position should be kept in mind. Debt capital should be used only if the cash flow position is really good because a lot of cash is needed in order to make payment of interest and refund of capital. Hence, on this basis it can be said that share capial is better than debt capital.

Capital market conditions refer to upward or downward trends in capital market. Both these conditions have their influence on the selection of sources of finance. When the market is dull, investors are mostly afraid of investing in share capital due to high risk. On the contrary, when conditions in capital market are cheerful, they treat investment in share capital as the best choice to reap profits. Companies should, therefore, make selection of capital sources keeping in view the conditions prevailing in capital market.

Yes, the shareholders of a company likely to gain with a debt component in the capital employed. It is clarified in the following example:

EBIT - EPS Analysis

It is clear from the above table that both the companies have raised र 10,00,000 as total capital. But X-Co. has raised it by issuing equity capital. On the other hand, Y-Co. has raised र 4,00,000 by issuing equity capital and र 6,00,000 by issuing debentures bearing 10% fixed interest rate. Suppose, both the companies have earned EBIT र 2 lakh each and Tax Rate is 30%.

EBIT - EPS Analysis

In the above example, shareholders of X-Co. are getting र 1.40 return on their investment as against र 2.45 return to shareholders of Y-Co. Both companies raised equal total capital 10 lakh each) and earned equal total profit 2 lakh each), yet the earning of Y-Co.’s shareholders is more. The reason being that Y-Co. has taken advantage of the process of “trading on equity.” In other words, Y-Co. has raised fixed cost capital (borrowed capital) along with equity share capital. On fixed cost capital (borrowed capital), it paid fixed interest at the rate of 10 per cent (10% debentures) and the remainder is distributed as dividend to equity shareholders. Obviously, return on equity shares of Y-Co. is greater than that of X-Co.

The reason is that the payment of interest is considered an expense while preference dividend is the division of profit.

With the help of this analysis it can be found out as to what will be the effect of various combinations of long-term financial sources on the EPS at a certain EBIT level.

Because it influences cost of capital and market price of shares.

Equity share capital is the most costly capital even the rate of dividend is not certain on it.

It is ‘Trading on Equity’.

Fixed Capital: It refers to that capital which is used for the purchase of fixed assets, such as land, building, machinery, furniture, etc.
Amount of fixed capital depends upon the following factors:

1. Nature of Business: The requirement of fixed capital depends on the nature of the business. Manufacturing business requires the heavy amount of fixed capital to invest in the fixed assets like- Land&Building, Plant and Machinery, Furniture etc, whereas trading concern business requires less capital. 
2. Scale of Operations: Business operating on a larger scale requires a larger amount of fixed capital as they need heavy and bigger machinery and equipment. However, firms operating at small scale need relatively lesser fixed capital. 
3. Choice of Technique: Those manufacturing enterprises which make use of modern and automatic machines need a large amount of fixed capital. On the other hand, those enterprises in which production is carried out mainly through laborer, need for fixed capital is very little.
4. Technology Upgradation: There are some businesses where a fixed asset is used and which does require immediate change. These days computer technology is undergoing rapid changes. Therefore, those companies whose business is computer-based need more fixed capital.
5. Growth Prospects: There are two types of organizations from the point of view of growth: (a) Organisations, which have no possibility of growth. They do not need additional fixed capital in future. (b) Organisations which have more possibilities of growth. They need more additional fixed capital.
6. Diversification: Diversification means running a business in more products than merely in one product. Those organizations which wish to adopt diversification certainly need more fixed capital.

Yes, we agree with the statement. These decisions are more important because of the following reasons:

(i) Long-term Growth and Effect: These decisions are concerned with long-term assets. These assets are helpful in production. Profit is earned by selling the goods so produced. It can, therefore, be said more correct these decisions are, greater will be the growth of business in the long run. In addition to that, these decisions affect future possibilities of the business.

(ii) Large Amount of Funds Involved: Decisions regarding fixed assets are included in the preview of capital budgeting. Large amount of capital is invested in these assets. If these decisions turn out to be wrong, there occurs heavy loss of capital which is a scarce means,

(iii) Risk Involved: Capital budgeting decisions are full of risk. There are two reasons for it. First, these decisions refer to a long-period, as such expected profits for several years are to be anticipated. These estimates may turn out to be wrong. Second, because of heavy investment involved, it is very difficult to change the decision once taken.

(iv) Irreversible Decisions: Nature of these decisions is such that it cannot be changed so quickly. For instance, if soon after setting-up a cotton mill, it is thought of changing it, then the old machinery and other fixed assets will have to be sold at down price. In doing so, heavy loss will have to be incurred. Changing of these decisions is, therefore, very difficult.

(a) As it is a service industry, the working capital requirement would be less. Working capital requirement would be for the payment of salary, fuel charges, maintenance of vehicles, etc.
(b) Factors affecting the Fixed Capital Requirement:

(i) Scale of Operations: Larger the spread of business activities, greater is the need for fixed capital.

(ii) Diversification: Diversification means running business in more products than merely in one product. Those organisations which wish to adopt diversification certainly need more fixed capital.

Factors affecting the Fixed Capital Requirement:

(i) Scale of Operations: Larger the spread of business activities, greater is the need for fixed capital.

(ii) Diversification: Diversification means running business in more products than merely in one product. Those organisations which wish to adopt diversification certainly need more fixed capital.

Choice of Technique: Those manufacturing enterprises which make use of modern and automatic machines, need large amount of fixed capital. On the other hand, those enterprises in which production is carried out mainly through labourer, need for fixed capital is very little.
Nature of Business: Need of fixed capital depends upon the nature of business. Usually, nature of business is of two kinds: Manufacturing Business and Trading Business. In case of manufacturing business, large investment is made in land, building, machinery, etc. Thus, there is need for large amount of fixed capital. On the contrary, in case of trading business in which finished goods are bought and sold, less amount of fixed capital is needed.

Generally for making investment in fixed assets long-term capital sources are used (e.g., equity share capital, preference share capital, debentures, etc.). However, another source of finance has emerged these days. This is called leasing. If a company makes use of this source, it acquires fixed assets on lease rather than buying them. In such a situation, the need for fixed capital decreases.

Because these decisions involve huge capital investment and are related for long period.

It refers to that capital which is used for the purchase of fixed assets, such as land, building, machinery, furniture, etc.

It refers to the decision regarding investment in fixed assets that yield income for a long time.

Larger the spread of business activities, greater is the need for fixed capital.

Meaning: It refers to the excess of current assets over current liabilities.

Computation: Net Working Capital = Current Assets - Current Liabilities.
Determinants: The following factors affect the requirement of working capital:

(i) Scale of Operations: There is a direct link between the working capital and the scale of operations. In other words, more working capital is required in case of big organisations while less working capital is needed in case of small organisations.

(ii) Business Cycle: The need for the working capital is affected by various stages of the business cycle. During the booming period, the demand of a product increases and sales also increase. Therefore, more working capital is needed. On the contrary, during the period of depression, the demand declines and it affects both the production and sale of goods. Therefore in such a situation, less working capital is required.

(iii) Production Cycle: By production cycle is meant the time involved in converting raw material into finished product. Longer this period, more will be the time for which the capital remain blocked in raw material and semi-manufactured products. Thus, more working capital will be needed. On the contrary, where period of production cycle is little, less working capital will be needed.

(iv) Credit Allowed: Those enterprises which sell goods on cash payment basis need little working capital but those who provide credit facilities to the customers need more working capital.

(v) Credit Availed: If raw material and other inputs are easily available on credit, less working capital is needed. On the contrary, if these things are not available on credit, then to make cash payment quickly, large amount of working capital will be needed.

The following factors affect the requirement of working capital:

(i) Scale of Operations: There is a direct link between the working capital and the scale of operations. In other words, more working capital is required in case of big organisations while less working capital is needed in case of small organisations.

(ii) Business Cycle: The need for the working capital is affected by various stages of the business cycle. During the booming period, the demand of a product increases and sales also increase. Therefore, more working capital is needed. On the contrary, during the period of depression, the demand declines and it affects both the production and sale of goods. Therefore in such a situation, less working capital is required.

(iii) Production Cycle: By production cycle is meant the time involved in converting raw material into finished product. Longer this period, more will be the time for which the capital remain blocked in raw material and semi-manufactured products. Thus, more working capital will be needed. On the contrary, where period of production cycle is little, less working capital will be needed.

(iv) Credit Allowed: Those enterprises which sell goods on cash payment basis need little working capital but those who provide credit facilities to the customers need more working capital.

(v) Credit Availed: If raw material and other inputs are easily available on credit, less working capital is needed. On the contrary, if these things are not available on credit, then to make cash payment quickly, large amount of working capital will be needed.

It refers to the assets which are expected to get converted into cash or cash equivalents within a period of one year. Following are the examples of current assets:

(i) Cash in hand/cash at bank
(ii) Marketable securities

(iii) Bills Receivable 
(iv) Debtors.

The working capital should neither be more nor less than required. Both these situations are harmful. If the amount of working capital is more than required, it will no doubt increase liquidity but decrease profitability. For instance, if large amount of cash is kept as working capital then this excessive cash will remain idle and cause the profitability to decrease. On the contrary, if the amount of cash and other current assets is very little, then lot of difficulties will have to be faced in meeting daily expenses and making payment to the creditors. Thus, optimum amount of both current assets and current liabilities should be determined so that profitability of the business remains intact and there is no fall in liquidity.

Operating efficiency means completing the various business operations efficiently. Operating efficiency of every organisation happens to be different. Some such examples are: (i) Converting raw material into finished goods at the earliest, (ii) Selling the finished goods quickly, and (iii) Quickly getting payments from the debtors. A company which has a better operating efficiency has to invest less in stock and the debtors. Therefore, it requires less working capital, while the case is different in respect of companies with less operating efficiency.

High level of competition increases the need for more working capital. In order to face competition, more stock is required for quick delivery and credit facility for a long- period has to be made available.

Inflation means rise in prices. In such a situation, more capital is required than before in order to maintain the previous scale of production and sales. Therefore, with the increasing rate of inflation, there is a corresponding increase in the working capital.

By production cycle is meant the time involved in converting raw material into finished product. Longer this period, more will be the time for which the capital remain blocked in raw material and semi-manufactured products. Thus, more working capital will be needed. On the contrary, where period of production cycle is little, less working capital will be needed.

It refers to the aggregate of current assets.

It refers to the net working capital.

(i) Bills Receivable (ii) Debtors.

To pay the daily expenses.

The organisations which have sufficient possibilities of growth require more working capital, while the case is different in respect of companies with low growth prospects.

Service industries require no inventory and manufacturing process, hence, require less working capital.

(i) cash in hand/cash at bank and (ii) Marketable securities.

Not getting fair returns by investors in shares/shareholders.

(i) Tendency of providing incomplete information by the company

(ii) Not abiding the rules

(iii) Intention of increasing the market value of share by false information.

(i) Promoting hoarding and black marketing of goods

(ii) By participating in social works he still fulfils his social objectives.

1) Nature of Business: The type of business has a bearing upon the fixed capital requirements. For example, a trading concern needs lower investment in fixed assets compared with a manufacturing organisation; since it does not require to purchase plant and machinery, etc.

2) Scale of Operations: A larger organisation operating at a higher scale needs bigger plant, more space etc. and therefore, requires higher investment in fixed assets when compared with the small organisation.

3) Choice of Technique: Some organisations are capital intensive whereas others are labour intensive. A capital-intensive organisation requires higher investment in plant and machinery as it relies less on manual labour. The requirement of fixed capital for such organisations would be higher. Labour intensive organisations on the other hand require less investment in fixed assets. Hence, their fixed capital requirement is lower.

4) Growth Prospects: Higher growth of an organisation generally requires higher investment in fixed assets. Even when such growth is expected, a company may choose to create higher capacity in order to meet the anticipated higher demand quicker. This entails larger investment in fixed assets and consequently larger fixed capital.

According to Gerstenberg, Capital structure refers to “the makeup of a firm’s capitalisation”. It is the proportion of a company’s capital, financed through owners and borrowed funds. In other words, it represents the mix of long-term funds such as equity shares, preference shares, long-term loans, retained earnings etc., in the total capitalisation of a firm.

Inflation is a situation of sustained increase in the general price level of goods and services. In such a situation, the working capital required to maintain a normal level of production and sale also increases. Inflation leads to increase in the cost of raw material, rise in wage rate, and rise in all other expenses and thus lead to a need for more working capital. The working capital requirement of a business thus, become higher with higher rate of inflation.

Financial planning is the process of preparation of a financial blueprint of an organisation’s future operations. The objective of financial planning is to ensure that enough funds are available at right time.
The importance of financial planning is:
(i) It helps in forecasting what may happen in future under different business situations. By doing so, it helps the firms to face the eventual situation in a better way. By preparing a blueprint of these three situations the management may decide what must be done different situations.
(ii) It helps in avoiding business shocks and surprises and helps the company in preparing for the future.
(iii) If helps in co-ordinating various business functions, e.g., sales and production functions, by providing clear policies and procedures.
(iv) Detailed plans of action prepared under financial planning reduce waste, duplication of efforts, and gaps in planning.
(v)  It tries to link the present with the future.
(vi)  It provides a link between investment and financing decisions on a continuous basis.

(i) Scale of Operations: A larger organisation operating at a higher scale needs bigger plant, more space etc. and therefore, requires higher investment in fixed assets when compared with the small organisation.
(ii) Choice of Technique: Some organisations are capital intensive whereas others are labour intensive. A capital-intensive organisation requires higher investment in plant and machinery as it relies less on manual labour. The requirement of fixed capital for such organisations would be higher. Labour intensive organisations, on the other hand require less investment in fixed assets. Hence, their fixed capital requirement is lower. 
(iii) Technology Up gradation: In certain industries, assets become obsolete sooner and, their replacements become due faster. Higher investment in fixed assets may, therefore, be required in such cases. Thus, such organisations which use assets which are prone to obsolescence require higher fixed capital to purchase such assets.
(iv) Financing alternatives: A developed financial market may provide leasing facilities as an alternative to outright purchase. When an asset is taken on lease, the firm pays lease rentals and uses it. By doing so, it avoids huge sums required to purchase it. Availability of leasing facilities, thus reduce the fixed capital requirements.

(i) Stability Earnings: Other things remaining the same, a company having stable earning is in a better position to declare higher dividends. As against this, a company having unstable earnings is likely to pay smaller dividend.
(ii) Growth Opportunities: Companies having good growth opportunities retain more money out of their earnings so as to finance the required investment. Thus in growth companies, payment of dividend will be less as compared to non-growth companies.
(iii) Cash Flow Position: The payment of dividend involves outflow of cash. Hence if the company is facing shortage of cash, they will pay less dividend. Hence cash flow position affects dividend payment.
(iv) Taxation Policy: The choice between the payment of dividend and retaining the earnings is affected by the difference in the tax treatment of dividends and capital gains. If tax on dividend is higher, it is better to pay less dividends. If tax on dividend is less, higher dividends may be declared. Dividends are free of tax in the hands of shareholders but, a dividend distribution tax is levied on companies.

When a company is having higher growth prospects, the requirement for working capital will be more due to higher production and sales target.

Financial management is concerned with the procurement and utilisation of funds in a proper manner so as to accomplish the objectives of the organization.
Its primary objectives include:
a) Maintenance of adequate liquid assets and
b) Profit maximization of the organisation

A long-term investment decision is otherwise called as Capital Budgeting decision. It involves investment for a long period of time. Capital budgeting decisions are very important as it involves huge investment of fund for a long period of time and are irreversible in nature.

Factors which affect capital budgeting decisions are:
(a) Cash flows of the project: When a company takes an investment decision involving huge amount it expects to generate some cash flows over a period. These cash flows are in the form of a series of cash receipts and payments over the life of an investment. The amount of these cash flows should be carefully analysed before considering a capital budgeting decision. If the cash inflow exceeds cash outflow, a project can be selected otherwise rejected. Time value of cash should also be taken into account for better decision making.
(b) The rate of return: The most important criterion is the rate of return of the project. The expected rate of return from each project must be considered and compared. The project that will give the maximum rate of return must be selected.
(c) The investment criteria involved: The decision to invest in a particular project involves a number of calculations regarding the amount of investment, interest rate, cash flows and rate of return. There are different techniques to evaluate investment proposals which are known as capital budgeting techniques. These techniques are applied to each proposal before selecting a particular project.

(i) Scale of Operations: A larger organisation operating at a higher scale needs bigger plant, more space etc. and therefore, requires higher investment in fixed assets when compared with the small organisation.

(ii) Choice of Technique: Some organisations are capital intensive whereas others are labour intensive. A capital-intensive organisation requires higher investment in plant and machinery as it relies less on manual labour. The requirement of fixed capital for such organisations would be higher. Labour intensive organisations, on the other hand require less investment in fixed assets. Hence, their fixed capital requirement is lower.
(iii) Technology Upgradation: In certain industries, assets become obsolete sooner and, their replacements become due faster. Higher investment in fixed assets may, therefore, be required in such cases. Thus, such organisations which use assets which are prone to obsolescence require higher fixed capital to purchase such assets.

(iv) Financing alternatives: A developed financial market may provide leasing facilities as an alternative to outright purchase. When an asset is taken on lease, the firm pays lease rentals and uses it. By doing so, it avoids huge sums required to purchase it. Availability of leasing facilities, thus reduce the fixed capital requirements.

(i) Stability Earnings: Other things remaining the same, a company having stable earning is in a better position to declare higher dividends. As against this, a company having unstable earnings is likely to pay smaller dividend.

(ii) Growth Opportunities: Companies having good growth opportunities retain more money out of their earnings so as to finance the required investment. Thus in growth companies, payment of dividend will be less as compared to non-growth companies.

(iii) Cash Flow Position: The payment of dividend involves outflow of cash. Hence if the company is facing shortage of cash, they will pay less dividend. Hence cash flow position affects dividend payment.

(iv) Taxation Policy: The choice between the payment of dividend and retaining the earnings is affected by the difference in the tax treatment of dividends and capital gains. If tax on dividend is higher, it is better to pay less dividends. If tax on dividend is less, higher dividends may be declared. Dividends are free of tax in the hands of shareholders but, a dividend distribution tax is levied on companies.

Financial Management is defined as “all activities concerned with the planning, raising, controlling and administering of funds used in the business.” It is concerned with the procurement and utilisation of funds in a proper manner so as to accomplish the objectives of the organization.
Its primary objectives include:
a) Maintenance of adequate liquid assets and
b) Profit maximization of the organisation.

i) Cost: Different sources of capital involve different cost. The cost of capital is the minimum rate of return a firm must earn on its investment, so that the market value of the companies’ equity capital does not fall.

ii) Cash flow position of business: A stronger cash flow position may make debt financing more viable than funding through equity.

iii) Level of fixed operating cost: If a business has high fixed operating costs it must reduce fixed financing costs. Hence, lower debt financing is better. Similarly, if fixed operating cost is less, more of debt financing may be preferred.

iv) Control Considerations: Issues of more equity may lead to dilution of management’s control over the business. Hence issue of more equity shares result in less control over business. For more control, issuance of debt fund is preferred.

Neelabh is engaged in a trading business which needs a small amount of working capital compared to a manufacturing business. A manufacturing business needs to spend on raw materials, pay labour charges for manufacturing and also incur other indirect expenses. As Neelabh is engaged in transport business and transport of fruits and vegetables, he need not have to spend on manufacturing or producing goods. On the other hand, fruits and vegetables are perishable goods, so he has to take the good immediately to the sellers and thus expense on warehousing will also be nil. Thus other factors remaining the same, Neelabh requires less working capital.
If Neelabh has a plan to expand and diversify his business the following factors will affect his working capital requirements
1) Level of Competition: Higher level of competitiveness may necessitate larger stocks of goods to meet urgent orders from customers. This increases the working capital requirement.
2) Operating Efficiency: Neelabh’s need for working capital also depends on his own operational efficiency. A better debtor’s turnover ratio will enable him to reduce the amount tied up in receivables which reduces his working capital requirement. Better sales effort may reduce the average time for which inventory is held. Such efficiencies may reduce the level of finished goods and debtors resulting in lower requirement of working capital.

Financial Management is defined as “all activities concerned with the planning, raising, controlling and administering of funds used in the business.” It is concerned with the procurement and utilisation of funds in a proper manner so as to accomplish the objectives of the organization.

Capital structure refers to the proportion of a company’s capital, financed through owners and borrowed funds. Determining the relative proportion of various types of funds depends upon various factors, and they are:
1) Cost of debt: A firm’s ability to borrow at a lower rate increases its capacity to employ higher debt. Thus, more debt can be used if debt can be raised at a lower rate.
2) Tax Rate: Since interest is a deductible expense, cost of debt is affected by the tax rate. A higher tax rate, makes debt relatively cheaper and increases its attraction vis-à-vis equity.
3) Cost of Equity: Stock owners expect a rate of return from the equity which comes with the risk they are assuming. When a company increases debt, the financial risk faced by the equity  holders, increases. Consequently, their desired rate of return may increase. It is for this reason that a company cannot use debt beyond a point.
4) Floatation Costs: Process of raising resources also involves some cost. Public issue of shares and debentures requires considerable expenditure. Getting a loan from a financial institution may not cost so much. These considerations may also affect the choice between debt and equity and hence the capital structure.
5). Control: Debt normally does not cause a dilution of control. A public issue of equity may reduce the managements’ holding in the company and make it vulnerable to takeover. This factor also influences the choice between debt and equity especially in companies in which the current holding of management is on a lower side

A sound financial planning is an important part of the success of any business enterprise. It aims at enabling the company to tackle the uncertainty in respect of the availability and timing of the funds and helps in smooth functioning of an organisation.
The importance of financial planning are:
(i) It helps in forecasting what may happen in future under different business situations. By doing so, it helps the firms to face the eventual situation in a better way. By preparing a blueprint of these three situations the management may decide what must be done different situations. 
(ii) It helps in avoiding business shocks and surprises and helps the company in preparing for the future.
(iii) If helps in coordinating various business functions, e.g, sales and production functions, by providing clear policies and procedures.
(iv) Detailed plans of action prepared under financial planning reduce waste, duplication of efforts, and gaps in planning.
(v) It tries to link the present with the future. 
(vi) It provides a link between investment and financing decisions on a continuous basis.

Determination of amount of fixed capital is to be done very cautiously as it involves large amount of fund, impact is for long term, existence of high risk, and decision is irreversible.
Factors to be considered are:
1) Nature of Business: The type of business has a bearing upon the fixed capital requirements. For example, a trading concern needs lower investment in fixed assets compared with a manufacturing organisation; since it does not require to purchase plant and machinery, etc
2) Scale of Operations: A larger organisation operating at a higher scale needs bigger plant, more space etc. and therefore, requires higher investment in fixed assets when compared with the small organisation.
3) Choice of Technique: Some organisations are capital intensive whereas others are labour intensive. A capital-intensive organisation requires higher investment in plant and machinery as it relies less on manual labour. The requirement of fixed capital for such organisations would be higher. Labour intensive organisations on the other hand require less investment in fixed assets. Hence, their fixed capital requirement is lower.
4) Growth Prospects: Higher growth of an organisation generally requires higher investment in fixed assets. Even when such growth is expected, a company may choose to create higher capacity in order to meet the anticipated higher demand quicker. This entails larger investment in fixed assets and consequently larger fixed capital.

The concept of Financial planning has been discussed in the paragraph. Financial planning involves identifying the sources from where the funds can be obtained and ensuring that the required funds are available to the firm as and when needed or required.
Two main objectives of financial planning are:
i.Timely availability of funds: financial planning helps in making an estimation regarding the amount of funds to be required for various business operations and activities at the right or correct time at which the funds would be needed.
ii. Proper utilisation: To ensure that there is proper utilisation of funds in the sense that there is neither surplus nor inadequate funds in a firm. In other words, it ensures that situations of both excess or shortage of funds are avoided. This is because while inadequate funds obstruct operations of the firm, excess funding leads to wasteful expenditure by the firm. Thus, proper financial planning ensures optimal and proper utilisation of funds. 

Investment Decision.

Capital Budgeting Decision or Investment Decision.

Financing Decision.

Financial risk refers to inability to meet fixed financial charges like interest payment, preference dividend and repayment obligations.

Dividend Decisions.

Conservative dividend policy, i.e. such company should pay less dividend.

Trading concern requires less fixed capital as compared to manufacturing organization because trading concern requires relatively much less investment in fixed assets.

Yes, it will reduce the need for working capital as there are no debtors due to cash sales and there is less investment in inventory due to credit availed.

Companies having growing opportunities in near future declare lesser dividend as compared to companies, which do not have any growth plans.

The firms which have sufficient possibilities of growth prospects in future require more working capital. However, for companies with lesser prospects, less working capital is needed.

Long-term Investment decision/ Capital Budgeting Decision: It is concerned with investment of firm’s fund in different fixed assets like buying of machinery.

Factors Affecting:

1. Cash flow positions of the company: Before considering an investment option, business must carefully analyse the net cash flow expected from the investment during the life of the investment. Investment should be made if net cash flow is more.
2. Return on investment: Investment should be done in the projects which earn the higher rate of return. It should be calculated on the basis of the expected return of the projects.
3. Investment criteria: Before taking decision, each investment opportunity must be compared by using the various capital budgeting techniques. These techniques involve calculation of rate of return, cash flow during the life of investment, cost of capital etc.

Dividend Decision: It refers decisions related to the amount of profit to be distributed among shareholders and amount of profit to be retained in the business for further growth of the business.

Factors Affecting Dividend Decision:

1. Stability of Earnings: It affects dividend decision as a company having stable earnings is in a position to declare higher dividends.
2. Cash Flow Position: A good cash flow position is necessary for declaration of dividend. ‘There is availability of enough cash in the company’.
3. Growth prospects: If a company has good growth opportunities, it pays out fewer dividends. ‘Good prospects for the growth in the future’.
4. Shareholders’ Preferences: Shareholders’preference is kept in mind by the management before declaring dividends. ‘It may have shareholders who prefer to receive regular income from their investments’.

Working capital refers to the amount which is invested in current assets. This fund also needed for payment of daily expenses, payment of current liabilities etc. this investment facilitates smooth business operation.

Factors affecting the requirement of working capital:

1. Nature of Business: The requirement of working capital depends on the nature of business. Manufacturing business requires more amount of working capital because it takes a lot of time in converting raw materials into finished goods while trading business requires less amount of working capital.
2. Scale of Operation: Business operating on a larger scale requires more funds to maintain the high quantum of inventory, debtors or meet day to day expenses as compared to small-scale business.
3. Business Cycle: Different phases of business cycle affect the requirement of working capital by a firm. In case of boom, there is an increase in production and scales leading to the increased requirement for working capital whereas the requirements for working capital reduce during depression.
   4. Seasonal Factors: Many businesses may have high level of activity during specific period of time which may be referred as seasonal time. Therefore, during peak season the level of activity is high leading to increased need of working capital as compared to the capital during lean period.

Financing decision: This decision is concerned with raising of finance using shareholders fund or borrowed fund. It involves identification of various sources of finance and the quantum of finance to be raised from long-term and short-term sources.

Four factors affecting the financing decision:

1. Cost:  Cost of raising fund influences the financing decisions. A prudent financial manager selects the cheapest source of finance.
2. Risk: Debt capital is most risky and from the point of view of risk it should not be used.
3. Flotation cost: From the point of view of floating costs, retained profit is the most appropriate source. Therefore, it should be made.
4. Cash Flow position: If the cash flow position of the company is good, the payment of interest on the debt and the refund of capital can be easily made. Therefore, in order to advantage of cheap finance, debt can be given priority.
5. Level of Fixed Operating Costs: If a business has a high level of fixed operating costs (e.g., building rent, Insurance premium, Salaries etc.), It must opt for lower fixed financing costs. Hence, lower debt financing is better. Similarly, if fixed operating cost is less, more of debt financing may be preferred.