Answer the following questions.
1. Discuss the importance of corporate finance.
Importance of Corporate Finance: In the functional management of a business enterprise, importance is given to production, finance, marketing, and personnel activities. Among all these activities, the utmost importance is given to financial activities. The importance of corporate finance may be discussed as follows
1. Helps in decision making: Most of the important decisions of business enterprises are determined on the basis of the availability of funds. It is difficult to perform any function of a business enterprise independently without finance. Every decision in the business is needed to be taken keeping in view of its impact on profitability. There may be a number of alternatives but the management is required to select the best one which will enhance profitability. A business organisation can give a green signal to the project only when it is financially viable. Thus corporate finance plays a significant role in the decision making process.
2. Helps in Raising Capital for a project: Whenever a business firm wants to start a new venture, it needs to raise capital. A business firm can raise funds by issuing shares, debentures, bonds, or even by taking loans from the banks.
3. Helps in Research and Development: Research and Development must be undertaken for the growth and expansion of the business. Detailed technical work is essential for the execution of projects. Research and Development is a lengthy process and therefore funds have to be made available throughout the research work. This would require continuous financial support.
4. Helps in smooth running of business firms: A smooth flow of corporate finance is needed so that salaries of employees are paid on time, loans are cleared on time, the raw material is purchased whenever required, sales promotion of existing products is carried out smoothly and new products can be launched effectively.
5. Brings coordination between various activities: Corporate finance plays a significant role in the control and coordination of all activities in an organisation. For e.g. Production will suffer if the finance department does not provide adequate finance for the purchase of raw materials and meeting other day-to-day financial requirements for a smooth running of production unit. Due to this, sales will also suffer and consequently, the income of concern, as well as rate of profit, will be affected. Thus the efficiency of every department depends upon effective financial management.
6. Promotes expansion and diversification: Modern machines and modern techniques are required for expansion and diversification. Corporate finance provides money to purchase modern machines and technologies. Therefore finance becomes mandatory for the expansion and diversification of a company.
7. Managing Risk: Company has to manage several risks, such as sudden fall in sales, loss due to natural calamity, loss due to strikes, etc. The company needs financial aid to manage such risks
8. Replace old assets: Assets such as plant and machinery become old and outdated over the years. They have to be replaced by new assets. Finance is required to purchase new assets.
9. Payment of dividend and interest: Finance is needed to pay a dividend to shareholders, interest to creditors, banks, etc.
10. Payment of taxes/fees: Companies have to pay taxes to the Government such as Income Tax, Goods and Service Tax (GST), and fees to the Registrar of Companies on various occasions. Finance is needed for paying taxes and fees.
2. Discuss the factors determining working capital requirement.
Meaning : Working capital is the capital that is used to carry out the day to day business activities. The business firm has to arrange capital for making an investment in short term assets such as cash, account receivable, inventory, etc. The capital invested in these assets is referred to as ‘Working Capital. An investor invests money in working capital for getting an immediate return.
Definition: According to Gerstenbergh, “Working capital is the excess of current assets over liability”. This approach is called Net Working Capital.
Factors affecting working capital requirement: There are no precise standards to measure working capital adequacy. Management has to determine the size of working capital in the light of certain aspects of the business firm and the economic environment within which the firm operates.
1. Nature of business: Firms engaged in manufacturing essential products of daily consumption would need relatively less working capital as there would be constant and sufficient cash inflow in the firm to take care of liabilities. Likewise, public utility concerns have to maintain small working capital because of continuous flow of cash from their customers.
2. Public utility concern: These concerns provide services such as transport, gas, electricity, etc. On the contrary, if the business is dealing with luxurious products, it requires a huge amount of working capital, as sale of luxurious items are not frequent. Trading/merchandising firms that are concerned with the distribution of goods have to carry big inventories of goods to meet customer’s demand and have to extend credit facilities to attract customers. Hence they need a large amount of working capital. Merchandising firms are those which are concerned with buying and selling of goods, either as wholesaler or retailer, without altering the physical form of goods.
3. Size of business: The size of the business also affects the requirement of working capital. A firm with large scale operations will require more working capital.
4. The volume of sales: This is the most important factor affecting the size of working capital. The volume of sales and the size of working capital are directly related to each other. If the volume of sales increases, there is an increase in the amount of working capital and vice versa.
5. Production cycle: The process of converting raw material into finished goods is called production cycle. If the period of the production cycle is longer, then the firm needs more amount of working capital. If the manufacturing cycle is short, it requires less working capital.
6. Business cycle: When there is a boom in the economy, sales will increase. This will lead to an increase in investment in stocks. This requires additional working capital. During a recession, sales will decline and hence the need for working capital will also decline.
7. Terms of purchases and sales: If the firm does not get credit facility for purchases but adopts a liberal credit policy for its sales, then it requires more working capital. On the other hand, if credit terms of purchases are favourable and terms of credits sales are less liberal, then the requirement of cash will be less. Thus working capital requirements will be reduced.
8. Credit control: Credit control includes factors such as the volume of credit sales, the terms of credit sales, the collection policy, etc. If a credit control policy is sound, it is possible for the company to improve its cash flow. If credit policy is liberal, it creates a problem of the collection of funds. It can increase the possibility of bad debts. Therefore a firm requires more working capital. The firm making cash sales requires less working capital.
9. Growth and Expansion : The working capital requirement of a firm will increase with the growth of a firm. A growing company needs funds continuously to support large scale operations.
10. Management ability : The requirement of working capital is reduced if there is proper co-ordination between the production and distribution of goods. A firm stocking on heavy inventory calls for a higher-level for working capital.