Financial mgmt

1. The determinant of capital structure of a company? OR ‘Determination of capital
structure of a company is influenced by a number of factors’ explain six such factors.
Ans. Capital structure refers to the relative proportion of different sources of long
term finance. Following factors are to be considered before determining capital
structure. a) Cash flow position: The cash available with the company should be enough
to meet the fixed interest liabilities. Interest on debt is to paid irrespective of
profits. A company has to meet working capital requirements, invest in fixed assets and
also pay the interest and principal amount of debt after a particular stipulated period. If
cash position is sound, debt van be raised, and if not sound debt should be
avoided. b) Interest coverage ratio : it is the ratio that expresses the number of times
the Net profit before interest and tax covers the interest liabilities. Higher the
ratio, better is the position of the firm to raise debt. c) Control : Issue of Equity shares
dilutes the control of the existing shareholders , whereas issue of debt does not as the
debenture holders do not participate in the management decisions as they are not the
owners of the fir. Thus if control is to be retained, equity should be avoided. d) Stock
market conditions : If the stock market is bullish, the investors are adventurous
and are ready to invest in risky securities, equity can be issued even at a premium
whereas in the Bearish phase, when the investors become cautious, debt should be
issued as there is a demand for fixed cost security. e) Regulatory framework : Before
determining the capital structure of a company , the guidelines of SEBI and
concerned regulatory authority is to be considered. For e.g companies Act,
Banking regulation Act etc are to considered. f) Tax rate : As interest on debt is
treated as an expense, it is tax deductable. Dividend on equity is the distribution of
profit so is not tax deductable. Thus if the tax rates are high, issue of debt is an
attractive means as it is economical in nature.
‘Efficient’ cash management will aim at maximising the cash inflows and slowing
cash outflows’. Discuss this statement.
Cash management involves the following three basic problems:
1. Controlling Level of Cash : One of the basic obiectives of cash management is to
minimise the level of cash balances with the firm, This obiective is sought to be
achieved by means of the following :
 a. Preparing Cash Budget : The cash budget is the most significant tool for
planning and regulating cash usage. It is a prediction of the firm’s future cash
receipts and cash payments over various time intervals. It shows the financial
management the date and quantity of expected cash receipts and payments
throughout time. Based on this information, the finance manager may forecast
the firm’s future cash needs, plan for financing these needs, and exercise control
over the company’s cash and liquidity.
 b. Providing for Unpredictable Discrepancies : The cash budget displays the
differences between cash revenues and payments based on routine business

2. activity. It does not account for certain unforeseeable differences in cash inflows
and outflows caused by unforeseen circumstances such as strikes, lock-outs,
recessions, abrupt increases in raw material prices, natural calamities, and so
on. A reasonable cash balance must consequently be maintained to face such
unforeseeable eventualities. Provision for contingencies is made based on past
experiences and some future intuitions.
 c. Consideration of Short Costs : The term ‘Short Costs’ refers to the cost
incurred as a consequences of shortage of cash. Such cost may take any of the
following forms :
 i. The failure of the firm to discharge its obligations in time may result in legal
action by the creditors against the firm. This will cost in terms of fall in the
firms goodwill, in addition to the financial costs of defending the suit.
 ii. The firm may have to borrow funds at high rates of interest and may also
be required to pay penalties to banks for not meeting the obligation in time.
 iii. There may also be the loss of cash discount, besides losing opportunity of
purchases at lower prices.
2. Controlling Inflows of Cash: In order to prevent fraudulent diversion of cash
receipts and speeding up collections of cash, an adequate control on cash inflow is
necessary. A properly installed internal check system can, to a great extent, minimise
the possibility of fraudulent diversion of cash.
Speedier collection of cash can be made possible by adoption of the following two
techniques, which have been found quite useful and effective in the USA.
 a. Concentration Banking System : It is a system of decentralizing collections
of account receivable. According to this system company’s regional branch
offices are authorised to Collect the payments from the customers and deposit in
the local bank accounts. instructions are given to the regional or local collection
centres to transfer the funds over a certain limit to the company’s head office
bank daily either telegraphically or by telex. Regional offices on the collection
centres maintain an account of cost of remittances paid by them. This system
facilitates fast movement of funds. On the basis of the daily report received from
the head office bank about the collected funds, the treasurer can use them for
disbursement as per requirements. This system is good in case of large firm
having their Spread over a large area. The system of concentration banking,
therefore, helps in quicker collections of cash.
 b. Lock Box System : This system is more popular in the USA and is a further
step in speeding up collection of cash. Under this system the company hires a
post office box and instruct its customers to mail their remittances to the box. The
company’s local bank is authorised to pick the remittances directly from the local
box, The bank picks up the mail several times a day and deposits the cheques in
the company’s account. Standing instructions are also given to the local banks to

3. transfer the collected funds to the head office bank when they exceed a certain
limit. This system speeds up collection of cheques and the firm comes to know
about the dishonored cheques and weak credit situation very soon. It also
reduces the chances of fraud in the cash collection pro cess and controls the
cash inflows better. In order to avoid the unnecessary pockets of idle funds, the
company should maintain minimum number of bank accounts.
3. Controlling Outflows of Cash : An effective control over cash outflow is equally
important for conserving cash and reducing financial requirements. Control over cash
outflows signifies slow disbursements. A combination of fast collections and slow
disbursements will, obviously, result in maximum availability of cash funds. In order to
control the outflows of cash efficiently, a firm should keep in view the following
considerations :
 a. Centralised system for cash payments should be followed as compared to
decentralised system. All payments should be made from a single control
account, i.e. from the central office of the company. However, local expenses
may be paid by the local office of the company. This will result in delay in
presenting cheques for payment by creditors who are away from the place of
control account.
 b. Payment should be made on the due dates neither before nor after. The
company should neither lose cash discount nor its prestige on account of
delayed payments. The company should, therefore, made payments within the
terms offered by the suppliers.
 c. ‘Playing Float’ techniques should be used by the company for maximising the
availability of funds. The term float’ means the account tied up in cheques which
have been issued by the company but have not yet been presented for payment
by the creditors. As a result of a time-lag between issue of a cheque and its
actual presentation, the actual bank balance of a firm may be more than the
balance shown by its books. This difference is called ‘payment in float’. The
longer the lost period’ the greater would be the benefit to the firm, If the financial
manager can accurately estimate the time-lag between issue of cheques and
actual presentation for during the intermittent period. In the meanwhile,
necessary cash may be arranged and deposited in the bank before the
presentation of cheques for payment. However, playing float is a risky game and
should be played very cautiously. In case, the cheques issued by the company
are dishonoured, the goodwill of the firm will be at stake and it may have
seriously adverse consequences for the firm.