Financial Management Test - 4

Retained earning is a part of profit which is not distributed among shareholders as dividends but is retained in the business for future use. It is also known as self financing. It is available free of cost for the business.

The Investment decision refers to the decision of investing funds in different assets. It can be long term or short term. A Long term Investment decision is also called 'Capital Budgeting Decision' . It involves investing the finance in capital assets like making investment in a new machine to replace an existing one, etc. 

Cost of Debt is affected by tax rate because Interest on Debt is a deductible expense. A higher tax rate, thus, makes debt relatively cheaper as compared to equity. For Example: If the firm borrows @10% and tax rate is @30%, then the after cost of debt will be @7%.

Companies with higher growth opportunities tend to retain more money out of their earnings so as to finance the required investments. Therefore, higher growth prospects result in lower dividend payment.

Financial leverage is the degree to which a company uses fixed-income securities such as debt. Therefore, financial leverage is favorable when the uses to which debt can be put generate returns (ROI) greater than the interest expense associated with the debt (Cost of Debt).

Financial Risk refers to the chance that a firm will fail to meet its payment obligations. A higher debt to equity ratio indicates that more creditor financing (bank loans) is used than investor financing (shareholders). Higher use of debt increases the fixed financial charges (Interest on Debt) of a firm. As a result, increased used of debt increases the financial risk of a firm.

Working capital refers to excess of current assets over current liabilities.Higher current ratio, higher risks, higher profits indicates large scale operation thus require large working capital.

These are the assets which can be converted into cash and cash equivalents within one year in the normal routine of business. e.g. inventories, debtors, bills receivable etc.

Financial planning is the process of estimating the fund requirement of a business and specifying the sources of funds. It decides how much to spend and on what to spend. Thus ensures optimal utilisation of funds.

The dividend decision involves how much of the profit earned by company is to be distributed to the shareholders and how much of it should be retained in the business for meeting investment requirement.  High earning, high cash flow, stable earning and low growth opportunities etc. affects the rate of dividend.