Fixed Capital and Working Capital

Financial planning refers to the process of estimating the fund requirement of a business and specifying the sources of funds and ensuring that there are no idle funds. Proper understanding of financial planning helps in forecasting financial results, providing a link between investments and financing decisions, avoiding business shocks and surprises, etc. Factors affecting financial planning:
•    nature of industry,
•    size and reputation of the firm,
•    capital market conditions, etc.

Capital structure refers to the mix between owner’s funds (equity) and Borrowed Funds (Debt). Capital structure consists of Owner’s fund i.e., equity and Borrowed funds i.e., debt. Owner’s fund comprises equity shares, preference shares, retained earnings whereas borrowed funds comprise debentures, loans from banks and loans from financial institutions. Capital gearing refers to the ratio between equity and debt funds. When proportion of debt is high, it is called as high gearing whereas when proportion is low, it is called as low gearing. Factors influencing capital structure are management control, state of capital markets, flexibility, regulatory framework, etc.
Business needs funds to invest into two ways i.e., fixed and working capital.
•    Fixed capital refers to the amount of capital investments in fixed assets like plant & machinery, land & building etc, and this is financed through long-term sources. Factors affecting fixed capital requirements a re nature of business, scale of operations, choice of techniques, technology upgradation, etc.
•    Working capital refers to investment in current assets. Working capital is classified into Permanent and Temporary working capital. Permanent working capital is classified into initial and regular working capital whereas temporary working capital is classified into seasonal and special working capital. The factors affecting working capital requirements are credit availed, operating efficiency, availability of raw materials, growth prospects, level of competition and inflation.

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  • Q1

    Owner's fund includes

    Marks:1
    Answer:

    share capital.

    Explanation:
    While taking financial decision, a finance manager needs to decide how much source of finance is to be raised from owner's fund and how much from borrowed fund. Share capital and retained earnings constitute owner's fund. Debentures, bonds, loans, etc., constitute borrowed fund.
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  • Q2

    What is fixed capital and how does its requirement get affected by techniques of production?

    Marks:3
    Answer:

    Fixed capital refers to procurement and utilisation of long term funds. Long term funds are required for investment in purchase of land, building, plant and machinery, etc. In other words, management of fixed capital is the process of generating, evaluating and selecting capital expenditure alternatives.

    Choice of technique of production affects the fixed capital requirement of a company. If company is using more of capital intensive techniques, then it requires use of plant and machinery, therefore more fixed capital is required. On the other hand, if the company is using more of labour intensive technique then requirement of long term funds will be low.

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  • Q3

    Explain Capital Structure.

    Marks:3
    Answer:

    Capital structure refers to the mix between owners and borrowed funds.

    Owner’s funds consist of equity share capital, Preference share capital, Reserves & surplus.

    Borrowed funds consist of Debentures, Loans, Deposits, etc. A company needs to decide upon the optimum mix of these sources, which refers to the capital structure.

    It can be calculated as -

    Debt or Debt

    Equity Debt + Equity

    Capital structure decision of a company, affects its profitability and financial risk.

    Debt and equity differ in their cost and riskiness for the firm. Debt is cheaper but is more risky

    for a business because payment of interest and the return of principal is mandatory, else the company can go into liquidation. On the other hand, equity is more expensive for a company, but less risky.

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  • Q4

    Vikrant & Co is undertaking the exercise of financial planning for the next accounting year. Why does it need to conduct this exercise?

    Marks:3
    Answer:

    Financial Planning is conducted to fulfill the following objectives:

    1) To ensure availability of funds whenever these are required:- This include a proper estimation of the funds required for different purposes such as for the purchase of long-term assets or to meet day-to day expenses of business etc. There is need to estimate the time at which these funds are to be made available.
    2) To see that the firm does not raise resources unnecessary:- Excess fund is almost as bad as inadequate funding. Even if there is some surplus money, good financial planning would put it to the best possible use so that the financial resources are not left idle and don’t unnecessarily add to the cost.

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  • Q5

    Differentiate between financial management and financial planning.

    Marks:3
    Answer:

    Basis

    Financial management

    Financial Planning

    Meaning

    It refers to efficient acquisition, utilization and disposal of surplus for the smooth flow of an organisation

    It refers to estimation of capital required and deciding the sources of funds

    Scope

    It is wider in scope, it includes financial planning

    It is narrow in scope as it is one segment of financial management

    Objective

    Its objective is to manage all the activities related to finance

    Its objective is to ensure availability of funds and to see that the firm does not raise the funds unnecessarily

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