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Financial Management Unit 2

Sikkim Manipal University Page No. 18

Unit 2 Financial Planning

Structure:

2.1 Introduction

Learning Objectives

Objectives of financial planning

Benefits that accrue to a firm out of financial planning

Guidelines for financial planning

2.2 Steps in Financial Planning

Forecast of income statement

Forecast of balance sheet

Computerised financial planning system2.3 Factors affecting Financial Plan

2.4 Estimation of Financial Requirements of a Firm

2.5 Capitalisation

Cost theory

Earnings theory

Over-capitalisation

Under-capitalisation

2.6 Summary

2.7 Terminal Questions

2.8 Answers to SAQs and TQs

2.1 Introduction

Liberalisation and globalisation policies initiated by the government have

changed the dimension of business environment. Therefore, for survival and

growth, a firm has to execute planned strategies systematically. To execute

any strategic plan, resources are required. Resources may be manpower,

plant and machinery, building, technology or any intangible asset.

To acquire all these assets, financial resources are essentially required.

Therefore the finance manager of a company must have both long-range

and short-range financial plans. Integration of both these plans is required

for the effective utilisation of all the resources of the firm.

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The long-range plans must include:

Funds required for executing the planned course of action

Funds available at the disposal of the company

Determination of funds to be procured from outside sources

2.1.1 Learning objectives

After studying this unit you should be able to:

Explain the steps involved in financial planning.

Explain the factors effecting financial planning.

List out the cases of over-capitation.

Explain the effects of under-capitation.

2.1.2Objectives of financial planning

Let us start with defining financial planning as an essential objective.

Financial planning is a process by which funds required for each course of

action is decided.

A financial plan has to consider capital structure, capital expenditure and

cash flow. Decisions on the composition of debt and equity must be taken.

Financial planning or financial plan indicates:

The quantum of funds required to execute business plans

Composition of debt and equity, keeping in view the risk profile of theexisting business, new business to be taken up and the dynamics of

capital market conditions

Formulation of policies, giving effect to the financial plans under

consideration

2.1.3 Benefits of financial planning

Financial planning also helps firms in the following ways.

A financial plan is at the core of value creation process. A successful

value creation process can effectively meet the bench-marks of

investors expectations.

Financial planning ensures effective utilisation of the funds. To manage

shortage of funds, planning helps the firms to obtain funds at the right

time, in the right quantity and at the least cost as per the requirements of

finance emerging opportunities. Surplus is deployed through well

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planned treasury management. Ultimately, the productivity of assets is

enhanced. Effective financial planning provides firms the flexibility to change the

composition of funds that constitute its capital structure in accordance

with the changing conditions of the capital market.

Financial planning helps in formulation of policies and instituting

procedures for elimination of wastages in the process of execution of

strategic plans.

Financial planning helps in reducing the operating capital of a firm.

Operating capital refers to the ratio of capital employed to the sales

generated. Maintaining the operating capability of the firm through the

evolution of scientific replacement schemes for plant and machinery andother fixed assets will help the firm in reducing its operating capital.

A study of annual reports of Dell computers will throw light on how Dell

strategically minimised the operating capital required to support sales.

Such companies are admired by investing community.

2.1.4 Guidelines for financial planning

The following are the guidelines of a financial plan:

Never ignore the coordinal principle that fixed asset requirements be met

from the long term sources.

Make maximum use of spontaneous source of finance to achieve highest

productivity of resources.

Maintain the operating capital intact by providing adequate out of the

current periods earnings. Give due attention to the physical capital

maintenance or operating capability.

Never ignore the need for financial capital maintenance in units of

constant purchasing power.

Employ current cost principle wherever required.

Give due weight age to cost and risk in using debt and equity.

Keeping the need of finance for expansion of business, formulate plough

back policy of earnings.

Exercise thorough control over overheads.

Operating capital = Capital employed / Sales generated

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Seasonal peak requirements to be met from short term borrowings

from banks.

2.2 Steps in Financial Planning

There are six steps involved in financial planning which are as shown in

figure 2.1

Figure 2.1: Steps in financial planning

Establish corporate objectives

The first step in financial planning is to establish corporate objectives.

Corporate objectives can be grouped into qualitative and quantitative.

For example, a companys mission statement may specify create

economic value added. However this qualitative statement has to be

stated in quantitative terms such as a 25 % ROE or a 12 % earnings

growth rates. Since business enterprises operate in a dynamic

environment, there is a need to formulate both short run and long run

objectives.

Formulate strategies

The next stage in financial planning is to formulate strategies for

attaining the defined objectives. Operating plans helps achieve thepurpose. Operating plans are framed with a time horizon. It can be a five

year plan or a ten year plan.

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Delegate responsibilities

Once the plans are formulated, responsibility for achieving sales target,operating targets, cost management bench-marks, profit targets is to be

fixed on respective executives.

Forecast financial variables

The next step is to forecast the various financial variables such as sales,

assets required, flow of funds and costs to be incurred. These variables

are to be translated into financial statements.

Financial statements help the finance manager to monitor the deviations

of actual from the forecasts and take effective remedial measures. This

ensures that the defined targets are achieved without any overrun of

time and cost.

Develop plans

This step involves developing a detailed plan of funds required for the

plan period under various heads of expenditure. From the plan, a

forecast of funds that can be obtained from internal as well as external

sources during the time horizon is developed. Legal constrains in

obtaining funds on the basis of covenants of borrowings is given due

weight-age. There is also a need to collaborate the firms business risk

with risk implications of a particular source of funds. A control

mechanism for allocation of funds and their effective use is alsodeveloped in this stage.

Create flexible economic environment

While formulating the plans, certain assumptions are made about the

economic environment. The environment, however, keeps changing with

the implementation of plans. To manage such situations, there is a need

to incorporate an inbuilt mechanism which would scale up or scale down

the operations accordingly.

2.2.1 Income Statement

There are three methods of preparing income statement: Percent of sales method or constant ratio method

Expense method

Combination of both these two

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Percent of sales method

This approach is based on the assumptions that each element of cost bearssome constant relationship with the sales revenue.

Caselet

Raw material cost is 40% of sales revenue for the year ended 31.03.2007.

However, this method assumes that the ratio of raw material cost to sales

will continue to be the same in 2008 also. Such an assumption may not

look good in most of the situations.

If in case, raw material cost increases by 10% in 2008 but selling price of

finished goods increases only by 5%. In this case raw material cost will be

44 / 105 of the sales revenue in 2008. This can be solved to some extentby taking average for same representative years. However, inflation,

change in government policies, wage agreements and technological

innovation totally invalidate this approach on a long run basis.

Budgeted expense method

Expenses for the planning period are budgeted on the basis of anticipated

behaviour of various items of cost and revenue. This demands effective

database for reasonable budgeting of expenses.

Combination of both these methods

The combination of both these methods is used because some expenses

can be budgeted by the management taking into account the expected

business environment while some other expenses could be based on their

relationship with the sales revenue expected to be earned.

2.2.2 Balance sheet

The following steps discuss the forecasting of the balance sheet.

Compute the sales revenue, having a close relationship with the items of

certain assets and liabilities, based on the forecast of sales and the

historical database of their relationship

Determine the equity and debt mix on the basis of funds requirements

and the companys policy on capital structure

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Case Study

The following details have been extracted from the books of X Ltd

Table 2.1: Income statement

2006 2007

Sales less returns 1000 1300

Gross Profit 300 520

Selling Expenses 100 120

Administration 40 45

Deprecation 60 75

Operating Profit 100 280

Non operating income 20 40EBIT (Earnings Before Interest & Tax) 120 320

Interest 15 18

Profit before tax 105 302

Tax 30 100

Profit after tax 75 202

Dividend 38 100

Retained earnings 37 102

Table 2.2: Balance sheet

Liabilities 2006 2007 Assets 2006 2007

Shareholders fund Fixed assets 400 510

Share capital Less depreciation 100 120

Equity 120 120 300 390

Preference 50 50 Investments 50 50

Reserves andsurplus

122 224

Secured loans 100 120 Current assets,Loans and

AdvancesUnsecured loans 50 60 Cash at bank 10 12

Receivables 80 128

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Current liabilities Inventories 200 300

Trade creditors 210 250 Loans andAdvances

50 80

Provisions Miscellaneousexpenditure

10 24

Tax 10 60

Proposeddividend

38 100

700 984 700 984

Forecast the income statement and balance sheet for the year 2008 based onthe following assumptions:

Sales for the year 2008 will increase by 30% over the sales value for 2007.

Use percent of sales method to forecast the values for various items ofincome statement using the percentage for the year 2007.

Depreciation is charged at 25% of fixed assets.

Fixed assets will increase by Rs.100 million

Investments will increase by Rs.100 million

Current assets and current liabilities are to be decided based on theirrelationship with the sales in the year 2007

Miscellaneous expenditure will increase by Rs.19 million

Secured loans in 2008 will be based on its relationship with the sales in theyear 2007

Additional funds required, if any, will be met by bank borrowings

Tax rates will be 30 %

Dividends will be 50 % of the profit after tax

Non operating income will increase by 10%

There will be no change in the total amount of administration expenses tobe spent in the year 2008

There is no change in equity and preference capital in 2008

Interest for 2008 will maintain the same ratio as it has in 2007 with thesales of 2007

The forecast of the income statement and the balance sheet for the year 2008has been briefly explained in table 2.3 and in the table 2.4

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Table 2.3: Income statement

Particulars Basis Working Amount (Rs.)

Sales Increase by 30% 1300 x 1.3 1690

Cost of sales Increase by 30% 780 x 1.3 1014

Gross profit Sales-cost of sales 1690-1014 676

Selling expenses 30% increase 120 x 1.3 156

Administration No change 45

Depreciation % given

4

100390

123(Rounded off)

Operating profit C - (D + E + F) 352Non-operating income Increase by 10% 1.1 x 40 44

Earnings BeforeInterest and Taxes(EBIT)

396

InterestSalesof

1300

18

1300

169018

23

(Decimal

ignored)

Profit before tax 373

Tax 112

Profit after tax 261

Dividends 130

Retained earnings 131


Particulars Basis Working Amount (Rs.)

Assets

Fixed Assets Given 510

Add: Addition 100

610

Depreciation 120 + 123243

1. Net fixed assets 367

2. Investments 150

3. Current Assets &Loans & advances

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Cash at bank

1300

12

1300

169012

16

(Rounded off)Receivables

1300

128

1300

1690128

166

Inventories

1300

300

1300

1690300

390

Loans & Advances

1300

80

1300

169080

104

4. Miscellaneous

ExpenditureGiven 24 + 19 43

Total 1236

Liabilities

1. Share Capital

Equity 120

Preference 50

2. Reserves & Surplus Increase bycurrent yearsretainedearnings

355

3. Secured Loan

1300

60

1300

169060

78

Bank borrowings 40

(DifferenceBalancing

figure)

4. Unsecured Loan 60 60

5. Current Liabilities &Provision

Trade creditors

1300

250

1300

1690250

325

Provision for tax

1300

60

1300

169060

78

Proposed Dividend Current year given 130

Total Liabilities 1236

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2.2.3 Computerised financial planning system

All corporate forecasts use computerised forecasting models. Additionalfunds required to finance the increase in sales could be ascertained using a

mathematical relationship based on the following:

Additional Funds Required = Required Increase in Assets Spontaneous

increase in Liabilities Increase in Retained Earnings

(This formula has been recommended by Eugene F. Brigham and Michael

C. Earnhardt in their book Financial Management Theory and Practice,

10th edition, published on 31st July 1998)

Prof. Prasanna Chandra, in his book Financial Management,(6th edition-

manohar publishers and distributors) has given a comprehensive formula forascertaining the external financial requirements.

Here

)s(S

A = Expected increase in assets, both fixed assets and current

assets, required for the expected increase in sales in the next year.

)s(SL

= Expected spontaneous finance available for the expected

increase in sales.

MS1 (1-d) = It is the product of profit margin, expected sales for the next

year and the retention ratio.

Retention ratio = 1 payout ratio

Payout ratio refers to the ratio of the dividend paid to the earnings per

share.

1m = Expected change in the level of investments and miscellaneous

expenditure.

SR = It is the firms repayment liability on term loans and debenture for

the next year.

EFR =S

)s(L

S

)s(A

ms (1-d) (1m + SR)

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The formula described above has certain features:

Ratios of assets and spontaneous liabilities to sales remain constantover the planning period

Dividend payout and profit margin for the next year can be reasonably

planned in advance

Since external funds requirements involve borrowings from financial

institution, the formula rightly incorporates the managements liability on

repayments

Solved Problem

X Ltd. has given the following forecasts: Sales in 2008 will increase from

Rs. 1000 to Rs. 2000 in 2007. The balance sheet of the company as on

December 31, 2007 gives the details as shown below:


Liabilities Rs. Assets Rs.

Share Capital Net Fixed Assets 500

Equity (Shares of Rs.10each)

100 Inventories 200

Reserves & Surplus 250 Cash 100

Long term loan 400 Bills Receivable 200

Creditors for expenses

outstanding

50

Trade creditors 50

Bills Payable 150

1000 1000

Taking into account the following information, the external funds

requirements for the year 2008 has to be ascertained:

The companys utilisation of fixed assets in 2007 was 50 % of capacity

but its current assets were at their proper levels.

Current assets increase at the same rate as sales.

Companys after-tax profit margin is expected to be 5%, and its payout

ratio will be 60 %.

Creditors for expenses are closely related to sales (Adapted from IGNOU

MBA).

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Solution

Preliminary workings

A = Current assets = Cash + Bills Receivables + Inventories

= 100 + 200 +200 = 500

500.Rs10001000

500)s(

S

A

L = Trade creditors + Bills payable + Expenses outstanding

= 50 + 150 + 50 = Rs. 250

250.Rs10001000

250)s(

S

L

M (Profit Margin) = 5 / 100 = 0.05

S1 = Rs.2000

1-d = 1 0.6 = 0.4 or 40 %

1m = NIL

SR = NIL

Therefore: sS

L

S

)s(AEFR

- ms1 (1-d) (1m + SR)

= 500 250 (0.05 x 2000 x 0.4) (0 + 0)

= 500 250 40 - (0 + 0)

= Rs. 210

Therefore external fund requirements for 2008 will be Rs. 210. Thisadditional fund requirement will be procured by the firm, based on its

policy on capital structure.

Self Assessment Questions

Fill in the blanks

1. Corporate objectives could be group into ___ and ___.

2. Control mechanism is developed for _____ and their effective use.

3. Seasonal peak requirements to be met from __________________

from banks.

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2.3 Factors affecting Finanical Plan

The various other factors affecting financial plan are listed down in figure 2.2

Figure 2.2: Factors affecting financial plan

Nature of the industry

The very first factor affecting the financial plan is the nature of the

industry. Here, we must check whether the industry is a capital intensive

or labour intensive industry. This will have a major impact on the totalassets that a firm owns.

Size of the company

The size of the company greatly influences the availability of funds from

different sources. A small company normally finds it difficult to raise

funds from long term sources at competitive terms.

On the other hand, large companies like Reliance enjoy the privilege of

obtaining funds both short term and long term at attractive rates

Status of the company in the industry

A well established company enjoys a good market share, for its products

normally commands investors confidence. Such a company can tap the

capital market for raising funds in competitive terms for implementing

new projects to exploit the new opportunities emerging from changing

business environment

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Sources of finance available

Sources of finance could be grouped into debt and equity. Debt is cheapbut risky whereas equity is costly. A firm should aim at optimum capital

structure that would achieve the least cost capital structure. A large firm

with a diversified product mix may manage higher quantum of debt

because the firm may manage higher financial risk with a lower business

risk. Selection of sources of finance is closely linked to the firms

capability to manage the risk exposure.

The capital structure of a company

The capital structure of a company is influenced by the desire of the

existing management (promoters) of the company to retain control over

the affairs of the company. The promoters who do not like to lose theirgrip over the affairs of the company normally obtain extra funds for

growth by issuing preference shares and debentures to outsiders.

Matching the sources with utilisation

The prudent policy of any good financial plan is to match the term of the

source with the term of the investment. To finance fluctuating working

capital needs, the firm resorts to short term finance. All fixed asset

investments are to be financed by long term sources, which is a cardinal

principle of financial planning.

FlexibilityThe financial plan of a company should possess flexibility so as to effect

changes in the composition of capital structure whenever need arises. If

the capital structure of a company is flexible, there will not be any

difficulty in changing the sources of funds. This factor has become a

significant one today because of the globalisation of capital market.

Government policy

SEBI guidelines, finance ministry circulars, various clauses of Standard

Listing Agreement and regulatory mechanism imposed by FEMA and

Department of corporate affairs (Govt. of India) influence the financial

plans of corporates today. Management of public issues of shares

demands the compliances with many statues in India. They are to be

complied with a time constraint.

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2.4 Estimations of Financial requirements of a Firm

The estimation of capital requirements of a firm involves a complex process.Even with expertise, managements of successful firms could not arrive at

the optimum capital composition in terms of the quantum and the sources.

Capital requirements of a firm could be grouped into fixed capital and

working capital.

The long term requirements such as investments in fixed assets will

have to be met out of funds obtained on long term basis

Variable working capital requirements which fluctuate from season to

season will have to be financed only by short term sources

Any departure from this well accepted norm causes negative impact onfirms finances.

2.5 Capitalisation

Capitalisation of a firm refers to the composition of its long term funds andits capital structure. It has two components Debt and Equity.


Fill in the blanks

8. Capital requirement of a firm could be grouped into ____ and _____.

9. Variable working capital will have to be financed only by _______.


Fill in the blanks:

4. ______ has a major impact on the total assets that the firm owns.

5. Sources of finance could be grouped into ______ and _____.

6. ___________ of any good financial plan is to match the term of the

source with the term of the source with the term of the investment.

7. _____ refers to the ability to _____ whenever needed.

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After estimating the financial requirements of a firm, the next decision that

the management has to take is to arrive at the value at which the companyhas to be capitalised.

There are two theories of capitalisation for the new companies:

Cost theory

Earnings theory

Figure 2.3 displays the two theories.

Figure 2.3: Theories of capitalisation

2.5.1 Cost theory

Under this theory, the total amount of capitalisation for a new company is

the sum of:

Cost of fixed assets

Cost of establishing the business

Amount of working capital required

It helps promoters to estimate the amount of capital required for

incorporation of company, conducting market surveys, preparing

detailed project report, procuring funds, procuring assets both fixed

and current, running a trial production and successfully producing,

positioning and marketing its products or rendering of services

If done systematically, it will lay foundation for successful initiation of

the working of the firm

Merits of cost a roach

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If the firm establishes its production facilities at inflated prices, the

productivity of the firm will become less than that of the industry.

Net worth of a company is decided by the investors and the earnings

of a company. Earning capacity based net worth helps a firm to

arrive at the total capital in terms of industry specified yardstick

(operating capital based on bench marks in that industry), cost

theory fails in this respect.

2.5.2 Earnings theory

Earnings are forecasted and capitalised at a rate of return, which actually isthe representative of the industry. Earnings theory involves two steps:

Estimation of the average annual future earnings

Estimation of the normal earning rate of the industry to which the

company belongs

Earnings theory is superior to cost theory because of its lesser

chances of being either under or over capitalisation

Comparison of earnings approach to that of cost approach will makethe management to be cautious in negotiating the technology and

the cost of procuring and establishing the new business

The major challenge that a new firm faces is deciding on

capitalisation and its division thereof into various procurement

sources

Arriving at the capitalisation rate is equally a formidable taskbecause the investors perception of established companies cannot

be really unique of what the investors perceive from the earning

power of the new company

Demerits of cost a roach

Merits of earnin s theor

Demerits of earnin s theor

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Due to this problem, most of the new companies are forced to adopt the

cost theory of capitalisation. Ideally every company should have normalcapitalisation, which is a utopian way of thinking.

Changing business environment, role of international forces and dynamics

of capital market conditions force us to think in terms of what is optimal

today need not to be so tomorrow.

Even with these constraints, management of every firm should continuously

monitor its capital structure to ensure and avoid the bad consequences of

over and under capitalisation.

2.5.3 Over-capitalisation

A company is said to be over-capitalised, when its total capital (both equityand debt) exceeds the true value of its assets.

It is wrong to identify over-capitalisation with excess of capital because most

of the over-capitalised firms suffer from the problems of liquidity. The correct

indicator of over-capitalisation is the earnings capacity of the firm.

If the earnings of the firm are less than that of the market expectation, it will

not be in a position to pay dividends to its shareholders as per their

expectations. This is a sign of over-capitalisation. It is also possible that a

company has more funds than its requirements based on current operation

levels and yet have low earnings.Over-capitalisation may be considered on the account of:

Acquiring assets at inflated rates

Acquiring unproductive assets

High initial cost of establishing the firm

Companies which establish their new business during boom condition

are forced to pay more for acquiring assets, causing a situation of over-

capitalisation once the boom conditions subside

Total funds requirements have been over estimated

Unpredictable circumstances (like change in import-export policy,

change in market rates of interest and changes in international economic

and political environment) reduce substantially the earning capacity of

the firm. For example, rupee appreciation against US dollar has affected

earning capacity of the firms engaged mainly in the export business

because they invoice their sales in US dollar

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Inadequate provision of depreciation, adversely effects the earning

capacity of the company, leading to over-capitalisation of the firm Existence of idle funds

Effects of over-capitalisation

Decline in earnings of the company

Fall in dividend rates

Market value of the companys share falls, and the company loses

investors confidence

Company may collapse at any time because of anaemic financial

conditions which affect its employees, society, consumers and its

shareholders. Employees will lose jobs. If the company is engaged in the

production and marketing of certain essential goods and services to the

society, the collapse of the company will cause social damage

Remedies of over capitalisation

Over-capitalisation often results in a company becoming sick Restructuring

the firm helps avoid such a situation. Some of the other remedies of over-

capitalisation are:

Reduction of debt burden

Negotiation with term lending institutions for reduction in interest

obligation

Redemption of preference shares through a scheme of capital reduction

Reducing the face value and paid-up value of equity shares

Initiating merger with well managed profit making companies interested

in taking over ailing company

2.5.4 Under-capitalisation

Under-capitalisation is just the reverse of over-capitalisation. A company is

considered to be under-capitalised when its actual capitalisation is lower

than the proper capitalisation as warranted by the earning capacity.

Symptoms of under-capitalisation

The following bullets display the symptoms of under-capitalisation.

Actual capitalisation is less than the warranted by its earning capacity

Rate of earnings is exceptionally high in relation to the return enjoyed by

similar situated companies in the same industry

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Causes of under-capitalisation

The following bullets display the causes of under-capitalisation. Under estimation of the future earnings at the time of the promotion of

the company

Abnormal increase in earnings from the new economic and business

environments

Under estimation of total funds requirement

Maintaining very high efficiency through improved means of production

of goods or rendering of services

Companies which are set-up during the recession period will start

making higher earning capacity as soon as the recession is over

Purchase of assets at exceptionally low prices during recession

Effects of under-capitalisation

The following bullets display some of the effects of under-capitalisation.

Under-capitalisation encourages competition by creating a feeling that

the line of business is lucrative

It encourages the management of the company to manipulate the

companys share prices

High profits will attract higher amount of taxes

High profits will make the workers demand higher wages. Such a feeling

on the part of the employees leads to labour unrest High margin of profit may create an impression among the consumers

that the company is charging high prices for its products

High margin of profits and the consequent dissatisfaction among its

employees and consumer, may invite governmental enquiry into the

pricing mechanism of the company

Remedies

The following bullets display the remedies of under-capitalisation.

Splitting up of the shares, which will reduce the dividend per share

Issue of bonus shares, which will reduce both the dividend per share and

the earnings per share

Both over-capitalisation and under-capitalisation are detrimental to the

interests of the society.

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2.6 Summary

Financial planning deals with the planning, execution and the monitoring of

the procurement and utilisation of the funds. Financial planning process

gives birth to financial plan. It could be thought of as a blue-print explaining

the proposed strategy and its execution

There are many financial planning models. All these models forecast the

future operations and then translate them to income statements and balance

sheets. It will also help the finance managers to ascertain the funds to be

procured from the outside sources The essence of all these is to achieve a

least cost capital structure which would match with the risk exposure of the

company

Failure to follow the principle of financial planning may lead a new firm of

over or under capitalisation, when the economic environment undergoes a

change

Ideally every firm should aim at optimum capitalisation or it might lead to a

situation of over or under capitalisation. Both are detrimental to the interests

of the society. There are two theories of capitalisation - cost theory and

earnings theory.


Fill in the blanks

10. _____ of a firm refers to the composition of its long term funds.

11. Two theories of capitalisation for new companies are ______ and

earnings theory.

12. A company is said to be ________, when its total capital exceeds

the true value of its assets.

13. A company is considered to be _______ when its actual

capitalisation is lower than its proper capitalisation as warranted by

its earning capacity.

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2.7 Terminal Questions

1. Explain the steps involved in Financial Planning2. Explain the factors affecting Financial Plan

3. List out the causes of over-capitalisation

4. Explain the effects of under-capitalisation

2.8 Answers to SAQs and TQs

Answers to Self Assessment Questions

1. Qualitative, Quantitative

2. Allocation of funds

3. Short term borrowings

4. Nature of the industry

5. Debt, Equity

6. The product policy

7. Flexibility in capital structure, effect changes in the composites of

capital structure

8. Fixed capital, working capital

9. Short term sources

10. Capitalisation

11. Cost theory

12. Over-capitalised

13. Under-capitalised

Answers to Terminal Questions

1. Refer to 2.2

2. Refer to 2.3

3. Refer to 2.5.3

4. Refer to 2.5.4

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