Justify the following statements.
1. The firm has multiple choices of sources of financing.
(a) Finance is the life-blood of the organisation. The business firm has access to the capital market to fulfill its financial needs.
(b) The firm has multiple choices of sources of financing. Different types of securities like shares, debentures, etc. can be issued to raise funds.
(c) Funds may also be borrowed from financial institutions and lenders. The finance manager must ensure that the firm is well capitalised.
(d) Thus, it is rightly justified that the firm has multiple choice of sources of financing.
2. There are various factors affecting the requirement of fixed capital.
There are various factors affecting the requirement of fixed capital. Some of them are as follows:
(a) Nature of Business: The nature of business plays a vital role in determining fixed capital requirements.
For instance, a manufacturing company needs more fixed capital as compared to a trading company. This is because the trading company does not need a plant, machinery, etc.
(b) Size of business: The companies which are operating at large scale require more fixed capital as they need more machinery and other assets.
Whereas, small scale business needless amount of fixed capital. Hence, the size of the firm, either in terms of its assets or sales, affects the need for fixed capital.
(c) Scope of business: The scope of business is the maximum extent up to within which a business can act or perform its business activities.
If the scope of business is vast, it needs higher fixed capital. For instance, a company involved in multiple activities like manufacturing processing, and assembling usually needs a substantial amount of fixed capital. Similarly, if the scope of business is limited, then it requires less fixed capital.
For instance, if a company does only assembling activities, it needs a fewer amount of fixed capital.
(d) The extent of lease or rent: If companies can arrange financial and leasing facilities easily then they require less fixed capital as they can acquire assets on easy instalments instead of paying a huge amount at one time.
On the other hand, if the easy loans and leasing facilities are not available then more fixed capital is needed as companies will have to buy plants and machinery by paying huge amounts together.
(e) 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 labour, need less fixed capital.
3. Fixed capital stays in the business almost permanently.
Fixed capital refers to capital invested in fixed assets. Fixed Capital is invested in long term assets such as land, building, equipment, etc.
Investor invests money in fixed capital to make a future profit. It is permanent capital.
Fixed capital is usually required at the time of the establishment of the company.
However, existing companies may also need such capital for their expansion and development, Replacement of equipment, etc.
Thus, it is rightly justified that, fixed capital stays in the business almost permanently as it is invested in fixed assets.
4. Capital structure is composed of owned funds and borrowed funds.
Capital structure constitutes two words i.e. capital and structure. ‘Capital’ refers to the investment of funds in the business while ‘structure’ means the arrangement of different components in proper proportion.
Thus, capital structure means ‘mix-up of various sources of funds in desired proportion’. A company can raise its capital from different sources i.e. owned capital or borrowed capital or both.
The owned capital consists of equity share capital, preference share capital, reserves, and surplus. On the other hand, borrowed capital are debentures, loans, etc. The proportion of different sources are used in the capital structure.
Thus, it is rightly justified that, capital structure is composed of owned funds and borrowed funds.
5. There are various factors affecting the requirement of working capital.
There are various factors affecting the requirement of working capital. Some of them are as follows:
(a) Nature of business: The requirement of working capital depends on the nature of business. The nature of business is usually of two types:
• Manufacturing Business and
• Trading Business.
– In the case of a manufacturing business, it takes a lot of time in converting raw material into finished goods. Therefore, more working capital is required.
– On the contrary, in the case of trading business, the goods are sold immediately after purchasing, or sometimes the sale is affected even before the purchase itself. Therefore, less working capital is required.
(b) Size of Business: There is a direct link between working capital and the size of the business.
In other words, more working capital is required in the case of a big organisation. Whereas, less working capital is required in the case of a small organisation.
(c) Business cycle: The need for working capital is affected by various stages of the business.
For instance :
During the boom period, the demand for a product increases, and sales also increase. Thus, more working capital is required.
During the depression period, the demand declines and it affects both the production and sales of goods. Thus, less working capital is required.
(d) Production cycle: Production cycle means the time involved in converting raw material into a finished product. When the period of the production cycle is more, more working capital will be needed.
On the contrary, when the period of the production cycle is less, less working capital will be needed.
(e) Volume of Cycle: This is the most important factor affecting the size of working capital. The volume of sale and the size of working capital are directly related to each other. For instance, if the volume of sales is more, there is an increase in the amount of working capital. But if the volume of sales is less, there is a decrease in the amount of working capital.