Read the following text and answer the following questions on the basis of the same.
Charvi, after acquiring a degree in Hotel Management and Business Administration took over her family food processing company of manufacturing pickles, jams and squashes. The business was established by her great grandmother and was doing reasonably well. However, the fixed operating costs of the business were high and the cash flow position was weak. She wanted to undertake modernization of the existing business to introduce the latest manufacturing processes and diversify into the market of chocolates and candies. She was very enthusiastic and approached a Financial Consultant, who told her that approximately Rs. 50 lakhs would be required for undertaking the modernization and expansion programme. The Financial Consultant advised her about the judicious mix of equity (40%) and Debt (60%). He also suggested her to take loan from Financial Institution as the cost of raising funds from Financial Institutions is low. Though this will increase the financial risk, but will also raise the return to equity shareholders. He also apprised her that issue of debt will not dilute the control of equity shareholders. At the same time, the interest on loan is a tax deductible expense for computation of tax liability. After due deliberations with the Financial Consultant, Charvi decided to raise funds from a Financial Institution.
“The Financial Consultant advised her about the judicious mix of equity (40%) and Debt (60%).” Identify the concept of Financial Management as reflected in the above situation.
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → Capital Structure
Option (1) Investing decision — Incorrect. The investment decision is about which assets to put the money into, such as new machinery. It is not about where the money comes from.
Option (2) Capital Structure — Correct. Capital structure is the mix of owners’ funds (equity) and borrowed funds (debt) in a business. A 40 : 60 mix of equity and debt is such a mix. It is decided through the financing decision.
Option (3) Dividend decision — Incorrect. The dividend decision is about how much of the profit to pay to shareholders and how much to keep in the business.
Option (4) Finance outlay — Incorrect. There is no concept of financial management by this name.
NCERT (2026-27 Edition): “Capital Structure … On the basis of ownership, the sources of business finance can be broadly classified into two categories viz., ‘owners’ funds’ and ‘borrowed funds’. Owners’ funds consist of equity share capital, preference share capital and reserves and surpluses or retained earnings. Borrowed funds can be in the form of loans, debentures, public deposits etc. …” “Capital structure refers to the mix between owners and borrowed funds. These shall be referred as equity and debt in the subsequent text. …” |