‘S’ Limited is manufacturing steel at its plant in India. It is enjoying a buoyant demand for its products as economic growth is about 7%-8% and the demand for steel is growing. It is planning to set up a new steel plant to cash on the increased demand. It is estimated that it will require about Rs. 5000 crores to set up and about Rs 500 crores of working capital to start the new plant.
a. Describe the role and objectives of financial management for this company.
b. Explain the importance of having a financial plan for this company. Give an imaginary plan to support your answer.
c. What are the factors which will affect the capital structure of this company?
d. Keeping in mind that it is a highly capital-intensive sector, what factors will affect the fixed and working capital. Give reasons in support of your answer.
a. Financial management of a company is concerned with effective and efficient management of funds. In ‘S’ Ltd, the financial management will look into –
● Procurement of funds, the capital fund of Rs. 5000 crores to set up and short term fund of Rs 500 crores
● Minimising the risk associated with procured funds – Capital as well as short term.
● Utilisation of available funds in most productive and effective manner
● Deciding the ratio of debt and equity while procuring funds.
The financial management of company will try to maximise wealth of the shareholders and profit of the company both.
Manufacturing cycle - The business having larger manufacturing cycle need more working capital than those having smaller manufacturing cycle.
Other factors –
a. Degree of coordination between production and distribution policy
b. Specialisation in the field of distribution
c. Development of the means of transportation and communication
d. The hazards and contingency related to with the type of business
b. The importance of financial planning for this company are listed below –
a) The financial planning will ensure the availability of required funds so as to meet the working capital as well as fixed capital requirements.
b) It will maintain a balance between inflow and outflow of funds so as to ensure liquidity.
c) The problem of shortage or surplus of funds in present scenario will be effectively dealt with.
d) It will ensure increased profitability by proper cost and benefit analysis and by avoiding wasteful operations.
Example – In the given example of the company S limited, the fixed capital requirement of Rs 5000 crores will be met effectively with help of financial planning and the plan will not only help in deciding the sources available but will also decide the leverage. Suppose the financial management finds that the cost of debt is lower than cost of equity so it decided to raise more from debt than equity as it will result in tax saving too.
c. Capital structure means the proportion of debt and equity funds in the capital of the business. The factors that will affect the capital structure of the company are –
S Ltd will decide to raise more from equity if –
● The funds are required for long period
● Financial risk in stock market is less
● Debts are not easily available
S Ltd will decide to raise more from debt if –
● Sufficient cash flow is available to meet fixed financial charges
● To reduce tax liability
● It does not want to dilute control over management
d. The working and fixed capital requirement of S Limited will be high due to following reasons
● The business is capital intensive and scale of operation is large
● Heavy investment is required for building production based and Technology upgradation
● In case of steel industry the major inputs are iron and coal so the raw material cost will be high and that it will require a higher working capital
● Longer operating cycle and the terms of credit for buying and selling