Short Notes — Ch 18 Financial Management
⚡ Ch 18 — Financial Management
PYQ: 2 questions — 2024·Q48 (current ratio) · 2024·Q53 (financial leverage). MCQ bank: only 4 questions (Q243–246) — but both PYQs came from material the book does NOT contain. ⚠️ Study the ADDENDUM section below — that is where the marks actually are.
1️⃣ The core
Financial Management = planning, organising, directing and controlling the procurement and utilisation of funds.
WEALTH MAXIMISATION of the owners/shareholders — NOT profit maximisation. Profit maximisation ignores timing, risk and the time value of money; wealth maximisation accounts for all three.
5 Objectives
- Ensure regular and adequate supply of funds
- Ensure adequate returns to shareholders
- Ensure optimum utilisation of funds
- Ensure safety on investment
- Plan a sound capital structure (balance of debt and equity)
5 Functions
Estimation of capital requirements → Determination of capital composition → Investment of funds → Management of cash → Financial controls (via ratio analysis, forecasting, cost & profit control)
Capital budgeting = long-term investment / fixed-asset decisions. Working capital management = short-term — current assets & current liabilities.
2️⃣ ⭐⭐ RATIO ANALYSIS — the 2024 question
⚠️ The book only names ratio analysis. These formulas came from the addendum. 2024·Q48 asked the Current Ratio directly.
Liquidity
| Ratio | Formula | Ideal |
|---|---|---|
| ⭐ Current Ratio | Current Assets ÷ Current Liabilities | 2 : 1 |
| Quick / Acid-Test | (Current Assets − Stock − Prepaid) ÷ Current Liabilities | 1 : 1 |
Solvency
| Ratio | Formula | Ideal |
|---|---|---|
| Debt–Equity | Long-term Debt ÷ Shareholders' Funds | 2 : 1 |
| Proprietary | Shareholders' Funds ÷ Total Assets | 0.5+ |
| Interest Coverage | EBIT ÷ Interest | 6–7× |
Profitability & Turnover
| Ratio | Formula |
|---|---|
| Gross Profit Ratio | (Gross Profit ÷ Net Sales) × 100 |
| Net Profit Ratio | (Net Profit ÷ Net Sales) × 100 |
| ROI | (EBIT ÷ Capital Employed) × 100 |
| EPS | (Net Profit − Preference Dividend) ÷ No. of Equity Shares |
| Stock Turnover | COGS ÷ Average Stock |
| Debtors Turnover | Net Credit Sales ÷ Average Debtors |
Working Capital = Current Assets − Current Liabilities
3️⃣ ⭐⭐ LEVERAGE — the other 2024 question
| Leverage | Formula | Measures |
|---|---|---|
| Operating (DOL) | Contribution ÷ EBIT | sensitivity of EBIT to a change in SALES |
| ⭐ Financial (DFL) | EBIT ÷ EBT (or %Δ EPS ÷ %Δ EBIT) | ⭐ sensitivity of EPS to a change in EBIT |
| Combined (DCL) | DOL × DFL (or Contribution ÷ EBT) | sensitivity of EPS to SALES |
"Financial leverage measures the sensitivity of EPS with respect to a % change in the EBIT level." — that is verbatim the correct option in 2024·Q53. Trading on equity = using debt so equity shareholders earn more — financial leverage in action.
4️⃣ 🎯 PYQs from this chapter
2024 · Q48 — Current Ratio = ______
a) Current assets / Current liabilities b) Fixed assets / Current liabilities c) Debt / Current assets d) Debt / Equity → Ans: A ⚠️ The book gives no formula — learn it from the addendum.
2024 · Q53 — What does financial leverage measure?
a) No change with EBIT and EPS b) Sensibility of EBIT w.r.t. % change in output c) The sensibility of EPS w.r.t. % change in the EBIT level d) % variation in production → Ans: C ⚠️ Also not defined in the book — from the addendum.
5️⃣ High-frequency MCQ traps
| MCQ | Point |
|---|---|
| Q243 | Financial management = all features of obtaining and using funds |
| Q244 | ⭐ Primary goal = maximise WEALTH (not minimise risk, not maximise profit) |
| Q245 | Capital budget → fixed / long-term assets |
| Q246 | ⭐ Profit Maximisation is NOT an important objective |
| Q242 | Investment = use of funds to earn a return |
6️⃣ If you remember nothing else
Goal = WEALTH maximisation, not profit maximisation · Current Ratio = CA ÷ CL (ideal 2:1) · Quick Ratio excludes stock (1:1) · Debt–Equity 2:1 · Financial leverage = sensitivity of EPS to a change in EBIT (EBIT ÷ EBT) · Operating leverage = Contribution ÷ EBIT · Capital budgeting = long-term investment decisions · Working Capital = CA − CL
🔗 Related
- Full notes + the ratio/leverage addendum: L-18-FINANCIAL MANAGEMENT · MCQs Q243–246 in MCQs
- Prev: SN-17-Single-Entry-System · Next: SN-19-Financial-Audit
