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Working capital cycle Working capital is the money needed to fund the

normal, day-to-day operations of your business. It ensures you have enough


cash to pay your debts and expenses as they fall due, particularly during
your start-up period. Very few new businesses are profitable as soon as they
open their doors. It takes time to reach your breakeven point and start
making a profit. *The working capital cycle measures the time between
paying for goods supplied to you and the final receipt of cash to you from
the sale. It is desirable to keep the cycle as short as possible as it increases
the effectiveness of working capital.* The working capital cycle is made up
of four core components: *Cash (funds available) *Creditors (accounts
payable) *Inventory (stock on hand) *Debtors (accounts receivable) ***For
example, a company holds raw materials on an average for 60 days, it gets
credit from the supplier for 15 days, production process needs 15 days,
finished goods are held for 30 days and 30 days credit is extended to
debtors. The total of all these, 120 days, i.e., 60 - 15 + 15 + 30 + 30 days is
the total working capital cycle. ***Pappali diagram bana. cash. uske niche
circle mein working capital cycle. circle ke left mein debtors. circle ke right
mein creditors. and niche inventory. arrow around.
Economic order quantity (EOQ) is the order quantity of inventory that
minimizes the total cost of inventory management. Two most important
categories of inventory costs are ordering costs and carrying costs. Ordering
costs are costs that are incurred on obtaining additional inventories. They
include costs incurred on communicating the order, transportation cost, etc.
Carrying costs represent the costs incurred on holding inventory in hand.
They include the opportunity cost of money held up in inventories, storage
costs, spoilage costs, etc. Ordering costs and carrying costs are quite
opposite to each other. If we need to minimize carrying costs we have to
place small order which increases the ordering costs. If we want minimize
our ordering costs we have to place few orders in a year and this requires
placing large orders which in turn increases the total carrying costs for the
period. We need to minimize the total inventory costs and EOQ model helps
us just do that. Total inventory costs = Ordering costs + Holding costs *By
taking the first derivative of the function we find the following equation for
minimum cost *EOQ = SQRT(2 Quantity Cost Per Order / Carrying Cost
Per Order) *Example *ABC Ltd. is engaged in sale of footballs. Its cost per
order is $400 and its carrying cost unit is $10 per unit per annum. The
company has a demand for 20,000 units per year. Calculate the order size,
total orders required during a year, total carrying cost and total ordering

cost for the year. *Solution *EOQ = SQRT(2 20,000 400/10) = 1,265
units **Annual demand is 20,000 units so the company will have to place 16
orders (= annual demand of 20,000 divided by order size of 1,265). Total
ordering cost is hence $64,000 ($400 multiplied by 16). **Average inventory
held is 632.5 ((0+1,265)/2) which means total carrying costs of $6,325 (i.e.
632.5 $10).
Factors Affecting Dividend Policy of company*A number of
considerations affect the dividend policy of company. The major factors are
*1. Stability of Earnings. The nature of business has an important bearing
on the dividend policy. Industrial units having stability of earnings may
formulate a more consistent dividend policy than those having an uneven
flow of incomes because they can predict easily their savings and earnings.
Usually, enterprises dealing in necessities suffer less from oscillating
earnings than those dealing in luxuries or fancy goods. 2. Age of
corporation. Age of the corporation counts much in deciding the dividend
policy. A newly established company may require much of its earnings for
expansion and plant improvement and may adopt a rigid dividend policy
while, on the other hand, an older company can formulate a clear cut and
more consistent policy regarding dividend. 3. Liquidity of Funds.
Availability of cash and sound financial position is also an important factor in
dividend decisions. A dividend represents a cash outflow, the greater the
funds and the liquidity of the firm the better the ability to pay dividend. The
liquidity of a firm depends very much on the investment and financial
decisions of the firm which in turn determines the rate of expansion and the
manner of financing. If cash position is weak, stock dividend will be
distributed and if cash position is good, company can distribute the cash
dividend. 4. Extent of share Distribution. Nature of ownership also
affects the dividend decisions. A closely held company is likely to get the
assent of the shareholders for the suspension of dividend or for following a
conservative dividend policy. On the other hand, a company having a good
number of shareholders widely distributed and forming low or medium
income group, would face a great difficulty in securing such assent because
they will emphasise to distribute higher dividend. 5. Needs for Additional
Capital. Companies retain a part of their profits for strengthening their
financial position. The income may be conserved for meeting the increased
requirements of working capital or of future expansion. Small companies
usually find difficulties in raising finance for their needs of increased working
capital for expansion programmes. They having no other alternative, use

their ploughed back profits. Thus, such Companies distribute dividend at low
rates and retain a big part of profits. 6. Trade Cycles. Business cycles also
exercise influence upon dividend Policy. Dividend policy is adjusted
according to the business oscillations. During the boom, prudent
management creates food reserves for contingencies which follow the
inflationary period. Higher rates of dividend can be used as a tool for
marketing the securities in an otherwise depressed market. The financial
solvency can be proved and maintained by the companies in dull years if
the adequate reserves have been built up. 7. Government Policies. The
earnings capacity of the enterprise is widely affected by the change in
fiscal, industrial, labour, control and other government policies. Sometimes
government restricts the distribution of dividend beyond a certain
percentage in a particular industry or in all spheres of business activity as
was done in emergency. The dividend policy has to be modified or
formulated accordingly in those enterprises. 8. Taxation Policy. High
taxation reduces the earnings of he companies and consequently the rate of
dividend is lowered down. Sometimes government levies dividend-tax of
distribution of dividend beyond a certain limit. It also affects the capital
formation. N India, dividends beyond 10 % of paid-up capital are subject to
dividend tax at 7.5 %. 9. Legal Requirements. In deciding on the
dividend, the directors take the legal requirements too into consideration. In
order to protect the interests of creditors an outsiders, the companies Act
1956 prescribes certain guidelines in respect of the distribution and
payment of dividend. Moreover, a company is required to provide for
depreciation on its fixed and tangible assets before declaring dividend on
shares. It proposes that Dividend should not be distributed out of capita, in
any case. Likewise, contractual obligation should also be fulfilled, for
example, payment of dividend on preference shares in priority over ordinary
dividend. 10. Past dividend Rates. While formulating the Dividend Policy,
the directors must keep in mind the dividend paid in past years. The current
rate should be around the average past rat. If it has been abnormally
increased the shares will be subjected to speculation. In a new concern, the
company should consider the dividend policy of the rival organisation. 11.
Ability to Borrow. Well established and large firms have better access to
the capital market than the new Companies and may borrow funds from the
external sources if there arises any need. Such Companies may have a
better dividend pay-out ratio. Whereas smaller firms have to depend on
their internal sources and therefore they will have to built up good reserves

by reducing the dividend pay out ratio for meeting any obligation requiring
heavy funds. 12. Policy of Control. Policy of control is another
determining factor is so far as dividends are concerned. If the directors want
to have control on company, they would not like to add new shareholders
and therefore, declare a dividend at low rate. Because by adding new
shareholders they fear dilution of control and diversion of policies and
programmes of the existing management. So they prefer to meet the needs
through retained earing. If the directors do not bother about the control of
affairs they will follow a liberal dividend policy. Thus control is an influencing
factor in framing the dividend policy. 13. Repayments of Loan. A
company having loan indebtedness are vowed to a high rate of retention
earnings, unless one other arrangements are made for the redemption of
debt on maturity. It will naturally lower down the rate of dividend.
Sometimes, the lenders (mostly institutional lenders) put restrictions on the
dividend distribution still such time their loan is outstanding. Formal loan
contracts generally provide a certain standard of liquidity and solvency to
be maintained. Management is bound to hour such restrictions and to limit
the rate of dividend payout. 14. Time for Payment of Dividend. When
should the dividend be paid is another consideration. Payment of dividend
means outflow of cash. It is, therefore, desirable to distribute dividend at a
time when is least needed by the company because there are peak times as
well as lean periods of expenditure. Wise management should plan the
payment of dividend in such a manner that there is no cash outflow at a
time when the undertaking is already in need of urgent finances. 15.
Regularity and stability in Dividend Payment. Dividends should be paid
regularly because each investor is interested in the regular payment of
dividend. The management should, inspite of regular payment of dividend,
consider that the rate of dividend should be all the most constant. For this
purpose sometimes companies maintain dividend equalization Fund.
Long term sources of finance: **Shares: Issue of shares is the most
important source for raising the permanent or long-term capital. A company
can issue various types of shares as equity shares, preference shares and
deferred shares. According to the Companies Act, 1956, however, a public
company cannot issue deferred shares.* # 2. Debentures:A debenture is
an instrument issued by the company acknowledging its debt to its holder. It
is also an important method of raising long-term or permanent working
capital. The debenture-holders are the creditors of the company. A fixed rate
of interest is paid on debentures. The interest on debentures is a charge

against profit and loss account.*# 3. Public Deposits: Public deposits are
the fixed deposits accepted by a business enterprise directly from the
public. This source of raising short term and medium-term finance was very
popular in the absence of banking facilities. In the past, generally, public
deposits were accepted by textile industries in Ahmedabad and Bombay for
periods of 6 months to 1 year. But now-a-days even long-term deposits for 5
to 7 years are accepted by the business houses.*# 4. Ploughing Back of
Profits: Ploughing back of profits means the reinvestments by concern of
its surplus earnings in its business. It is an internal source of finance and is
most suitable for an established firm for its expansion, modernization and
replacement etc. This method of finance has a number of advantages as it
is the cheapest rather cost-free source of finance; there is no need to keep
securities; there is no dilution of control; it ensures stable dividend policy
and gains confidence of the public. But excessive resort to ploughing back
of profits may lead to monopolies, misuse of funds, over capitalization and
speculation, etc. # 5. Loans from Financial Institutions: Financial
institutions such as Commercial Banks, Life Insurance Corporation, Industrial
Finance Corporation of India, State Financial Corporations, State Industrial
Development Corporations, Industrial Development Bank of India, etc. also
provide short-term, medium-term and long-term loans. This source of
finance is more suitable to meet the medium-term demands of working
capital. Interest is charged on such loans at a fixed rate and the amount of
the loan is to be repaid by way of installments in a number of years.
objectives or goals or financial management are- (a) Profit
maximization, (b) Return maximization, and (c) Wealth maximization. We
shall explain these three goals of financial management as under: (1) Goal
of Profit maximization. Maximization of profits is generally regarded as
the main objective of a business enterprise. Each company collects its
finance by way of issue of shares to the public. Investors in shares purchase
these shares in the hope of getting medium profits from the company as
dividend It is possible only when the company's goal is to earn maximum
profits out of its available resources. If company fails to distribute higher
dividend, the people will not be keen to invest their money in such firm and
persons who have already invested will like to sell their stocks. On the other
hand, higher profits are the barometer of its efficiency on all fronts, i.e.,
production, sales an management. A few replace the goal of 'maximization
of profits' to 'fair profits'. 'Fair Profits' means general rate of profit earned by
similar organisation in a particular area. (2) Goal of Return

Maximization. The second goal of financial management is to safeguard


the economic interest of the persons who are directly or indirectly
connected with the company, i.e.,shareholders, creditors and employees.
The all such interested parties must get the maximum return for their
contributions. But this is possible only when the company earns higher
profits or sufficient profits to discharge its obligations to them. Therefore,
the goal of maximization of returns are inter-related. 3. Goal of Wealth
Maximization. Frequently, Maximization of profits is regarded a the proper
objective of the firm but it is not as inclusive a goal as that of maximising it
value to its shareholders. Value is represented by the market price of the
ordinary share of the company over the long run which is certainly a
reflection of company's investment and financing decisions. The log run
means a considerably long period in order to work out a normalized market
price. The management ca make decision to maximize the value of its
shares on the basis of day-today fluctuations in the market price in order t
raise the market price of shares over the short run at the expense of the
long fun by temporarily diverting some of its funds to some other accounts
or by cutting some of its expenditure to the minimum at the cost of future
profits. This does not reflect the true wort of the share because it will result
in the fall of the share price in the market in the long run. It is, therefore, the
goal of the financial management to ensure its shareholders that the value
of their shares will be maximized in the long-run. In fact, the performances
of the company can well be evaluated by the value of its share.
Optimal Capital Structure: may be defined as that relationship of debt and
equity which maximizes the value of companys share in the stock
exchange.* the mixing of the permanent sources of funds used by the firm
in a manner that will maximize the companys common stock price by
minimizing the firms composite cost of capital. Features of Optimal Capital
Structure: *The salient features of an optimal capital structure are described
below: *a) The relationship of debt and equity in an optimal capital structure
is made in such a manner that the market value per equity share becomes
maximum. *b) Optimal capital structure maintains the financial stability of
the firm. *c) Under optimal capital structure the finance manager
determines the proportion of debt and equity in such a manner that the
financial risk remains low. *d) The advantage of the leverage offered by
corporate taxes is taken into account in achieving the optimal capital
structure. *e) Borrowings help in increasing the value of company leading
towards optimal capital structure. f) The cost of capital reaches at its

minimum and market price of share becomes maximum at optimal capital


structure.

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