Financial Management and

Capital Structure

GROUP MEMBERS:

RUMA KHATUN REZWAN SADAT AKIKUN NAHUR NUSRAT JAHAN NUSRAT JAHAN PROMA

B120202087
B110202003
B110202005
B110202077
B110202103

INTRODUCTION
Financial management is an integrated decision
making process, concerned with acquiring,
managing and financing assets to accomplish
overall goals within a business entity.
Speaking differently, it is concerned with
making decisions relating to investments in
long term assets, working capital, financing of
assets and so on.

Financial
Management:
The planning, directing, monitoring,
organizing, coordinating and controlling of
the monetary resources of an organization.

It is an area of finance dealing with financial

decision business enterprise make and the
tools and analysis used to make this decision.

financial Management can be defined as:

The management of the finances of

a business organization in order to
achieve financial objectives.

Financial management capacity is a cornerstone of

organizational excellence.
Financial management pervades the whole
organization as management decisions almost always
have financial implications.

FINANCIAL MANAGEMENT INVOLVES:

Financial planning:

IMPORTANCE OF FINANCIAL MANAGEMENT

Financial management is concerned with procurement and utilization
of funds in a proper way. It is important because of the following
advantages:
1. Helps in obtaining sufficient funds at a minimum cost.
2. Ensures effective utilization of funds.
3. Tries to generate sufficient profits to finance expansion and
modernization of the enterprise and secure stable growth.
4. Ensures safety of funds through creation of reserves,
re-investment of profits, etc

Fundamental financial
management decision:

Investment decision: proper allocation of

capital. Both fixed and working investment.

Financing decision: determination

Dividend decision:

Formulation of profit plan

Formulation of dividend policy
Formulation of retention policy
Investment of accumulated profit

of optimal
capital and financial structure of an enterprise.
Decision relates to the raising of finance from
various resources.

Investment decision:

This decision relates to the careful

selection of assets in which funds will be
invested by the firm. It Involves buying,
holding, reducing, replacing, selling &
managing assets.

Financing decisions:
Financing decisions involve the acquisition of funds needed
to support long-term investments.

While taking this decision, financial management weighs

the advantages and disadvantages of the different sources
of finance.

The business can either finance from its shareholder funds

which can be subdivided into equity share capital,
preference share capital and the accumulated profits.

Borrowings from outsiders include borrowed funds like

debentures and loans from financial institutions.

Dividend decisions:

This decision relates to the appropriation of profits earned. The

two major alternatives are to retain the profits earned or to
distribute these profits to shareholders.
While declaring dividend, a large number of considerations are
kept in mind such as:

Trend

of earnings
Stability in dividends
The trend of share market prices
The requirement of funds for future growth
The cash flow situation
Restrictions under the Companies Act
The tax impact on shareholders etc.

Capitalizati
on

ClapitaL
Structure

Management
of capital

Form of Capital:
Capital Structure

Definition:

In finance, capital structure refers to the way a corporation

finances its assets through some combination of equity,
debt, or hybrid securities. A firm's capital structure is then
the composition or 'structure' of its liabilities. For example,
a firm that sells tk20 billion in equity and tk80 billion in
debts is said to be 20% equity-financed and 80% debtfinanced. The firm's ratio of debt to total financing, 80% in
this example is referred to as the firm's leverage. In reality,
capital structure may be highly complex and include
dozens of sources. Gearing Ratio is the proportion of the
capital employed of the firm which come from outside of
the business finance, e.g. by taking a short term loan etc.

Capital structure
Equity Capital: This refers to money put up and owned by
the shareholders (owners). Typically, equity capital
consists of two types:
1.) Contributed capital
2.) Retained earnings.
Debt Capital: The debt capital in a company's capital
structure refers to borrowed money that is at work in the
business.

Business risk is the risk inherent in the operations of the

firm, prior to the financing decision. Thus, business risk is
the uncertainty inherent in a total risk sense, future operating
income, or earnings before interest and taxes (EBIT).
Business risk is caused by many factors. Two of the most
important are sales variability and operating leverage.

Financial risk is the risk added by the use of debt financing.

Debt financing increases the variability of earnings before
taxes (but after interest); thus, along with business risk, it
contributes to the uncertainty of net income and earnings per
share. Business risk plus financial risk equals total corporate
risk.

Capital structurer analysis:

EBIT EPS Analysis

ROI ROE Analysis

Ratio Analysis

Leverage Analysis

Cash Flow Analysis

Comparative Analysis

EBIT EPS ANALYSIS

The relationship between EBIT and

EPS is as follows:

(EBIT I) (1 t)

EPS =

EARNINGS PER SHARE UNDER

ALTERNATIVE FINANCING PLANS

Equity Financing

Debt Financing

EBIT : 2,000,000
EBIT : 4,000,000
EBIT : 2,000,000
EBIT : 4,000,000
Interest
Profit before taxes2,000,000
Taxes
1,000,000
Profit after tax
1,000,000
Number of equity
shares
2,000,000
Earnings per share
0.50

4,000,000
2,000,000
2,000,000

1,400,000
600,000
300,000
300,000

1,400,000
2,600,000
1,300,000
1,300,000

2,000,000
1.00

1,000,000
0.30

1,000,000
1.30

BREAK-EVEN EBIT LEVEL

The EBIT indifference point between two

alternative financing plans can be obtained

by solving the following equation for EBIT*

(EBIT * I1) (1 t)
=

(EBIT * I2) (1 t)

n1

n2

ROI ROE ANALYSIS

ROE = [ROI + (ROI r) D/E] (1 t)

where ROE = return on equity

ROI = return on investment

r

= cost of debt

D/E = debt-equity ratio

t

= tax rate

RATIO ANALYSIS
Interest Coverage Ratio

Earnings before interest and taxes

Interest on debt
Cash Flow Coverage Ratio
EBIT + Depreciation + Other non-cash charges
Loan repayment instalment
Interest on dept

(1 Tax rate)

Ratio analysis
n
PATi + DEPi + INTi + Li
i=1
DSCR =
n
INTi + LRIi
i=1
where

DSCR
PATi
DEPi
INTi
LRIi
Li
n

Li

= debt service coverage ratio

= profit after tax for year i
= depreciation for year i
= interest on long-term loan for year i
= loan repayment instalment for year i
= lease rental for year i
= period of the loan

CASH FLOW ANALYSIS

The key question in assessing the debt capacity of a firm

is whether the probability of default associated with a
certain level of debt is acceptable to the management.
The cash flow analysis establishes the debt capacity by
examining the probability of default.

COMPARATIVE ANALYSIS
A common approach to analysing the capital structure of
a firm is to compare its debt-equity ratio to the average
debt-equity ratio of the industry to which the firm
belongs.

Since the firms in an industry may differ on factors like

operating risk, profitability, and tax status it makes
sense to control for differences in these variables

 CAPITAL STRUCTURE POLICIES

Five common policies are:
1.No debt should be used
2.Debt should be employed to a very limited extent
3.The debt-equity ratio should be maintained around
1:1
4.The debt-equity ratio should be kept within 2:1
5.Debt should be tapped to the extent available

THEORIES OF CAPITAL STRUCTURE

Net

Income Approach (NI)

Net Operating Income Approach (NOI)
Traditional Approach (TA)
Modigliani and Miller Approach (MM)

Capital Structure =
Financial
Current
Structure
liabilities

Kinds of Capital
Structure
Equity Share Capital

Expansion

+ Retained
Earnings

Foundation

Debt + Preference
Share
Debt

Horizontal

Vertical

Pyramid
Shaped

Inverte
d
Pyrami

IMPORTANCE OF CAPITAL
STRUCTURE:

THINK

(LOADING..)

Ind
ris icato
kp
ro
f
the
rof
firm ile o
f

s
a
s
t
c
A
a
e
g
a
n
ma
t
n
e
m
tool

Reflects
the
firms
strategy

PURPOSE OF STUDY
VALUE OF FIRM

1. NET INCOME
APPROACH

ASSUMPTIONS:

IMPLICATIONS
INCREASE IN FIRMS
PROPORTION
OF CHEAP
DEBT
VALUE
INCREASES
SOURCE OF FUNDS INCREASE