'S' Ltd. is manufacturing steel at its plant in India. It is enjoying a buoyant demand for its products as economic growth is at about 7-8% and the demand for steel is growing. It is planning to set-up a new steel plant to capitalise on the increased demand. It is estimated that it will require about Rs. 5000 crore to set-up and about Rs. 500 crore of working capital to start the new plant. What are the role and objectives of financial management for this company?
'S' Ltd. is manufacturing steel at its plant in India. It is enjoying a buoyant demand for its products as economic growth is at about 7-8% and the demand for steel is growing. It is planning to set-up a new steel plant to capitalise on the increased demand. It is estimated that it will require about Rs. 5000 crore to set-up and about Rs. 500 crore of working capital to start the new plant. What are the role and objectives of financial management for this company?
Financial management decisions have a bearing on the financial health of a business by affecting the following:
(i) Size and composition of fixed assets: 'S' Ltd requires Rs. 5,000 crores, which is a huge sum. Financial management will have to ensure that the composition is carefully decided. Since it is in the infrastructure industry, it has a long gestation period between investments and returns. Thus, the goal should be to minimise the risk of investing in most productive assets and the latest technology, which in no case should remain idle.
(ii) Quantum of current assets and their break-up: Rs 500 crores are required for current assets to finance working capital. The company should ensure correct break-up and optimum utilisation.
(iii) Amount of long-term and short-term financing to be used: Long-term assets require long-term financing, whereas, short-term assets require short-term financing. The choice is between liquidity and profitability. An optimum mix of two is required.
(iv) Breakup of long-term financing into debt and equity: Since, setting up of the new steel plant is a long-term task, a large amount of debt is required. Accordingly, the debt to equity ratio might be more.
(v) Items of profit and loss account: Higher debt is likely to increase the interest expense of the company. This and other likely expenses must be kept in mind before taking financing decisions.
Objectives of Financial Management:
The objective of financial management is the maximisation of shareholders' wealth. The investment decision, financial decision and dividend decision help an organisation in achieving this objective. In the given situation, S Ltd envisages growth prospects of the steel industry due to the growing demand.
To expand the production capacity, the company needs to invest. However, investment decision will depend on the availability of funds, the financing decision, and the dividend decision. The company will take those financial decisions which result in value addition. i.e. the benefits are more than the cost. This leads to an increase in the market value of the shares of the company.
Financial management decisions have a bearing on the financial health of a business by affecting the following:
(i) Size and composition of fixed assets: 'S' Ltd requires Rs. 5,000 crores, which is a huge sum. Financial management will have to ensure that the composition is carefully decided. Since it is in the infrastructure industry, it has a long gestation period between investments and returns. Thus, the goal should be to minimise the risk of investing in most productive assets and the latest technology, which in no case should remain idle.
(ii) Quantum of current assets and their break-up: Rs 500 crores are required for current assets to finance working capital. The company should ensure correct break-up and optimum utilisation.
(iii) Amount of long-term and short-term financing to be used: Long-term assets require long-term financing, whereas, short-term assets require short-term financing. The choice is between liquidity and profitability. An optimum mix of two is required.
(iv) Breakup of long-term financing into debt and equity: Since, setting up of the new steel plant is a long-term task, a large amount of debt is required. Accordingly, the debt to equity ratio might be more.
(v) Items of profit and loss account: Higher debt is likely to increase the interest expense of the company. This and other likely expenses must be kept in mind before taking financing decisions.
Objectives of Financial Management:
The objective of financial management is the maximisation of shareholders' wealth. The investment decision, financial decision and dividend decision help an organisation in achieving this objective. In the given situation, S Ltd envisages growth prospects of the steel industry due to the growing demand.
To expand the production capacity, the company needs to invest. However, investment decision will depend on the availability of funds, the financing decision, and the dividend decision. The company will take those financial decisions which result in value addition. i.e. the benefits are more than the cost. This leads to an increase in the market value of the shares of the company.
