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Course Facilitator: Prof.

Radhakrishna

Financing is concerned with the procurement of required long-term funds at the proper time. It is concerned with the identification of the sources from which funds can be raised, and the determination of the amount of funds that can be raised from each source, which make up the capital structure of an enterprise.

According to C.W Gerstenberg capital structure refers to the make-up, form or composition of a firms capitalization, i.e., the types of securities to be issued and the relative proportion of each type of securities in the total capitalization The capital structure of a company refers to a combination of the long-term finances used by the firm.

It means estimating the total amount of longterm capital required by a company for financing its business and determining the composition and the proportion of the securities to be issued to raise the required capital.

Is quite essential for the successful promotion and smooth functioning of any business undertaking. In fact, many technically sound and economically viable projects have failed simply because of poor capital structure planning. Is must not only in the case of big enterprises, but also in the case of small enterprises.

Would ensure liquidity of funds. Would bring to light the surplus funds available funds available for expansion . Would ensure availability of sufficient funds for meeting permanent working capital and emergencies. Contribute to rational utilization of the available resources. Would contribute to the elimination of wastes. Make things easy for the management team to function smoothly. For determining the total capital requirements of undertaking and for fixing the relative proportion.

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Estimating the total amount of long term capital funds needed by a company for financing its business. Determining the form and the proportion of the securities to be issued for raising the funds Setting the companys financial objectives Formulation of financial policies

Trading on Equity

The term equity means equity share capital and term trading means taking advantage of. So, trading on equity means taking advantage of equity share capital as base to raise funds through the issue of preference shares and or debentures on reasonable terms to ensure higher return on equity share capital. the use of borrowed funds or preferred stock, for financing is known as trading on equity. The degree to which debt is used in acquiring assets is called trading on equity.

Desire to retain control Nature of the enterprise: Pubilc utilities (Debt) or manufacturing co. (equity) Size of the Company: Small Co.(Equity) and Large Co. (Debt) Purpose of finance: productive purposes (Debt) and Nonproductive purposes (Equity) Period of finance: if funds are required more or less permanently (equity) and for 8 to 10 years (Debt)

Desire to have flexibility or elasticity of financial plan Need to make provision for the future: Legal requirements Requirements or preferences of investors Market situations or market sentiments Government policies

Optimum capital structure refers to that capital structure at which there is an ideal relationship between debt and equity securities, resulting in maximizing the value of the companys equity shares in the stock exchange and minimizing the average cost of capital.

Maximization of return or profit Minimization of cost Minimization of risk preservation of control Maintaining of proper liquidity Full utilization of resources Flexibility

In the general sense, leverage means force, power of influence. In other words, it means force applied at a particular point of time to have a desired effect at another point. In financial management, the term leverage means the influence of one financial variable over some other related financial variable. To be more specific, the term is used to describe, the ability of a company to use fixed charges sources of funds to magnify the returns to shareholders.

There are three measures of leverage commonly used in financial analysis. They are Operating Leverage Financial Leverage Combined or Composite Leverage

Operating leverage may be defined as the ability of a concern to use fixed operating costs to magnify the effect of change in sales on its operating profits. In other words, it is the tendency of the operating profits to change disproportionately with sales, when a firm employs more fixed costs in the production process in relation to total operating costs.

Contribution Operating profit Where Contribution = Sales Variable cost

Measurement or Computation of Operating Leverage:

Operating profit (EBIT) = Sales Variable cost Fixed cost

operating leverage refers to the percentage of change in operating profit, resulting from a percentage of change in sales. It can be calculated as follows. Percentage of change in operating profit Percentage of change in sales

Degree of Operating Leverage (DOL): Degree of

Indicates the impact of change in sales on the operating profit. Measures the business risk (i.e., the variability of operating profit).

Financial leverage may be defined as the use of fixed interest bearing securities along with equity share capital in the capital structure of a company with view to produce more gains for the equity shareholders. In other words the term financial leverage refers to the relationship between operating profit or earnings before interest and tax and earnings per share

The financial leverage is measured or calculated with the help of the following formula.

Operating profit (EBIT) Earnings before tax (EBT) Degree of Financial leverage (DFL) indicates the percentage of change in earnings per share in relation to percentage of change in earnings before interest and taxes. Percentage of change in EPS Percentage of change in EBIT

Helpful to know how the taxable profit of a concern would respond to a given change in the operating profit. Better tool than operating leverage to know the earnings per share and marker price per share. Measures the financial risk (i.e., the variability of earnings per share) taking place due to the employment of long-term borrowings.

Combined leverage is the combination of operating leverage and financial leverage. The combined leverage expresses the effect of a change in sales over change in the taxable profits of the company. Combined Leverage = Operating leverage x financial leverage CL = Contribution x EBIT EBIT EBT CL = Contribution / EBT DCL = % change in EPS / % change in Sales

Helpful to know the change in earnings per share taking place as a result of changes in sales. Measures the total risk (i.e., the variability of earnings per share). This leverage is useful to forecast the future sales level and the resultant increase or decrease in taxable profits.

Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders A distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders. It is the reward of the shareholders for investments made by them in the shares of the company.

There are many forms of dividend. They are 1. Cash dividend 2. Stock dividend 3. Scrip dividend (Scrip dividend means payment of dividend in scrip of promissory notes.) 4. Bond dividend 5. Property dividend

Once a company makes a profit, management must decide on what to do with those profits. They could continue to retain the profits within the company, or they could pay out the profits to the owners of the firm in the form of dividends. Once the company decides on whether to pay dividends they may establish a somewhat permanent dividend policy, which may in turn impact on investors and perceptions of the company in the financial markets. What they decide depends on the situation of the company now and in the future. It also depends on the preferences of investors and potential investors.

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External Factors General state of the economy State of capital market Legal restrictions Contractual restrictions Tax policy of the Government and tax position of the shareholders Inflation Costs differential between external equity and retained earnings

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Internal Factors Dividend payout ratio Access to capital market Stability of dividends Dilution of control Rate of return on the alternative investment of the shareholders Nature of Earnings or Profits of the company Liquidity position of the company Shareholders preference Other factors

The various types of dividend policies are follows: Regular Dividend Policy Stable Dividend Policy Irregular Dividend Policy No Dividend Policy Residual Dividend Policy

Payment of dividend at the usual rate is termed as regular dividend. The investors such as retired persons, widows and other economically weaker persons prefer to get regular dividends. However, it must be remembered that regular dividends can be maintained only by companies of long standing and stable earnings. A company should establish the regular dividend at a lower rate as compared to the average earnings of the company

The term stability of dividends means consistency or lack of variability in the stream of dividend payments. In more precise terms, it means payment of certain minimum amount of dividend regularly. A stable dividend policy may be established in any of the following three forms. (a) Constant dividend per share (b) Constant pay out ratio (c) Stable rupee dividend plus extra dividend

Some companies follow irregular dividend payments on account of the following: a. Uncertainty of earnings. b. Unsuccessful business operations. c. Lack of liquid resources. d. Fear of adverse effects of regular dividends on the financial standing of the company.

A company may follow a policy of paying no dividends presently because of its unfavourable working capital position or on account of requirements of funds for future expansion and growth.

Under the Residual approach, dividends are paid out of profits after making provision for money required to meet upcoming capital expenditure commitments