NCERT Solutions For Class 12 Business Studies Chapter 9 Financial Management - 2025-26

```html 1. The cheapest source of finance is
Ans: Retained earnings are the cheapest source of finance. Retained income is the part of a company's profit kept back after paying dividends. This money can be used for expansion or modernization, with no repayment pressure and no cost for raising the funds compared to other sources.

2. A decision to acquire a new and modern plant to upgrade an old one is a
Ans: Purchasing a new and modern plant to replace an old one is an investment decision. This means investing money for a long-term return, affecting the company’s future working and earning capacity. It's different from working capital (for day-to-day needs) or financing decisions (about where to raise funds).

3. Other things remaining the same, an increase in the tax rate on corporate profit will
Ans: When taxes on company profits go up, debt becomes relatively cheaper. This is because interest paid on debt is subtracted before calculating tax, so a higher tax rate makes the actual cost of debt lower.

4. Companies with a higher growth potential are likely to
Ans: Companies planning for more growth often pay lower dividends. They need more money for expansion, so they keep more profits for investment and pay less as dividends.

5. Financial leverage is called favourable if
Ans: Financial leverage is favourable when return on investment (ROI) is higher than the cost of debt. This means when the company earns more from investments than it pays as interest, its earnings per share go up.

6. Higher debt-equity ratio results in
Ans: A higher debt-equity ratio means more debt compared to equity. It increases the company's financial risk, as there are more obligations to repay loans and pay interest.

7. Higher working capital usually results in
Ans: If a company has higher working capital, it usually means a higher current ratio, higher risk, and higher profits. Working capital is the difference between current assets and current liabilities.

8. Current assets are those assets which get converted into cash
Ans: Current assets are those which are turned into cash within one year. Examples include cash, inventory, debtors, and bills receivable.

9. Financial planning arrives at
Ans: Financial planning makes sure the company has just enough funds—not too few and not too many unused funds. This helps avoid problems of both shortage and waste in the business.

10. Higher dividend per share is associated with
Ans: If a company pays a higher dividend per share, this is usually linked with high earnings, high cash flow, stable earnings, and lower growth opportunities (since the company is not retaining much for growth).

11. A fixed asset should be financed through
Ans: Fixed assets (like machinery) should be financed with long-term liabilities because these assets are used for many years.

12. Current assets of a business firm should be financed through
Ans: Current assets can be financed through both long-term and short-term liabilities.

1. What is meant by capital structure?
Ans: Capital structure is the proportion of debt and equity used to fund a company’s operations. It shows how much of the company’s funds come from loans (debt) and how much from shareholders (equity). There is no fixed formula for the right capital structure, but it should try to maximize the value for shareholders. For example, capital structure can be shown as Debt/Equity or Debt/(Debt+Equity).

2. Discuss the two objectives of Financial Planning.
Summary: Financial planning ensures the right amount of funds are available at the right time and avoids having too much or too little money.

• Ensuring availability of funds when needed: The main goal is to make sure there is enough money for things like buying assets or daily expenses, and to specify the sources of these funds.
• To avoid unnecessary fundraising: Having too much money is not good either. Excess funds should be invested wisely; keeping them idle is a loss for the company. Financial planning aims for just the right amount of funds.

3. What is financial risk? Why does it arise?
Summary: Financial risk means a company might not be able to pay its fixed financial commitments like loan interest or repayments.

• It happens when there is more debt in the capital structure.
• More debt means higher payments to lenders (interest and principal), which increases the chance of not being able to pay.
• So, as a company borrows more, its financial risk goes up because missing payments could cause big problems.

4. Define a 'current asset'. Give four examples of such assets.
Ans: Current assets are assets meant to be turned into cash within a year. Examples include short-term investments, debtors, stocks (inventories), and cash equivalents.

5. Financial management is based on three broad financial decisions. What are these?
Summary: Financial management includes three main types of decisions: how to invest money, how to raise funds, and how to share profits.

• Investment decisions: Choosing where the company will put its money—both in fixed assets (long term) and in day-to-day needs (working capital).
• Financial decisions: Deciding where and how to get funds (sources, periods, costs, expected returns).
• Dividend decisions: Deciding what profit to give as dividend to shareholders and what to keep as reserves for company’s growth plans.

6. What are the main objectives of financial management? Briefly explain.
Summary: The main objectives of financial management are to make sure the business has enough money, uses money wisely, keeps investments safe, and creates value for owners.

• Ensure there’s always enough money for the business’s needs.
• Give shareholders the returns they expect, based on company’s performance.
• Use all funds as efficiently as possible, minimizing wastage and expense.
• Keep investments safe by choosing safe places to put money and aim to earn a good return.
• Maintain a balanced capital structure (balance of debt and equity).

7. How does working capital affect both the liquidity as well as profitability of a business?
Summary: Working capital affects both how easily a company can pay bills (liquidity) and how much profit it can make.

• More working capital means better liquidity because the business can pay for day-to-day expenses easily.
• But too much working capital can lower profitability, since money tied up in assets (like stock) does not earn much.
• Too little working capital can hurt daily business operations.
• A balance between liquidity and profitability is needed for success.

1. What is working capital? How is it calculated? Discuss five important determinants of working capital requirement.
Summary: Working capital is the money invested in current assets for day-to-day needs. It’s calculated as Current Assets minus Current Liabilities. Several factors affect how much working capital a company needs.

• Type of Business: A service or trading business needs less working capital than manufacturing, which has a longer cycle and needs more stock.
• Scale of Operations: Bigger companies need more working capital due to more stock and debtors.
• Business Cycle Fluctuations: During a boom, more working capital is needed due to increased production and sales; during a depression, less is needed.
• Production Cycle: The longer it takes to make products, the more working capital is needed.
• Growth Prospects: Growing companies need extra working capital to support growth in operations, sales, and inventory.

2. "Capital structure decision is essentially optimisation of risk-return relationship". Comment.
Summary: Choosing the right mix of debt and equity is about finding a balance between the risk of not meeting debt payments and the benefit of higher returns.

• Capital structure is the combination of loans (debt) and owner's funds (equity).
• Debt is cheaper but riskier; equity is safer but more expensive.
• Debt offers tax benefits since interest is tax-deductible.
• Banks and lenders expect less return, but shareholders expect more as they take more risk.
• If the company borrows too much (high debt), risk of default increases, even if returns are higher.
• The decision must balance higher possible profits (from more debt) with the higher risk.
• This balance is called the risk-return trade-off in capital structure.

3. "A capital budgeting decision is capable of changing the financial fortunes of a business." Do you agree? Why or why not?
Summary: Yes, big investment decisions (capital budgeting) can change a business’s future, as they involve large sums, have long-term impact, and are hard to reverse.

• Long-Term Implications: Investment in assets affects a company’s growth and future returns.
• Large Funds Needed: Buying fixed assets blocks large amounts of money for several years; decisions must be made carefully.
• High Risk: These decisions are risky as they can affect the business’s stability if returns are not as expected.
• Hard to Reverse: Once invested, these decisions are difficult and expensive to change.
• So, capital budgeting must be done carefully to avoid mistakes that can affect the whole business.

4. Explain the factors affecting the dividend decision.
Summary: Many factors influence how much profit a company pays as dividend or keeps as retained earnings.

• Legal Rules: Companies must follow certain legal rules when paying dividends (like net profit, capital, and insolvency rules).
• Liquidity: Even with high profits, the company needs cash to pay dividends.
• Repayment Needs: If loans need to be repaid soon, less profit is available as dividend.
• Expected Returns: If expected profits from investing earnings are high, the company may keep more money instead of paying dividends.
• Earnings Stability: Companies with steady profits can pay more consistent dividends.
• Desire for Control: Managers may retain more profits to avoid issuing new shares and reducing their control.
• Access to Capital Market: Companies that can easily raise funds from the market can pay more dividends.
• Shareholder Tax Position: If dividends are taxed more, shareholders may prefer lower dividends and more capital gains instead.

5. Explain the term "Trading on Equity". Why, when and how it can be used by a company?
Summary: Trading on equity means using more borrowed funds (debt) to increase earnings per share, especially when company profits rate is higher than the interest rate paid on loan.

• It works well only if the return on investment is greater than the interest paid on debt.
• If return is more than interest, earnings per share (EPS) go up.
• If the company’s profit falls below the interest rate, EPS can drop, making it a bad choice.
• Trading on equity should only be used when the company's returns are strong and stable.

Situation I	Situation II
Earnings before interest and tax (EBIT): 1,00,000	Earnings before interest and tax (EBIT): 1,00,000
Interest: -	Interest: 30,000
Earnings before tax (EBT): 1,00,000	Earnings before tax (EBT): 70,000
Tax: 30,000	Tax: 21,000
Earnings after tax (EAT): 70,000	Earnings after tax (EAT): 79,000
No. of equity shares: 50,000	No. of equity shares: 20,000
EPS = 70,000/50,000 = 1.4	EPS = 79,000/20,000 = 3.95

Situation I	Situation II
Earnings before interest and tax (EBIT): 40,000	Earnings before interest and tax (EBIT): 40,000
Interest: -	Interest: 10,000
Earnings before tax (EBT): 25,000	Earnings before tax (EBT): 10,000
Tax: 30,000	Tax: 3,000
Earnings after tax (EAT): 70,000	Earnings after tax (EAT): 7,000
No. of equity shares: 50,000	No. of equity shares: 20,000
EPS = 70,000/50,000 = 1.4	EPS = 79,000/20,000 = 3.95

Essential Points from Financial Management (Class 12 Business Studies NCERT Solutions)

• Financial Management Class 12 covers how firms manage their funds and make investment choices.
• The chapter explains capital structure, working capital, and key financial decisions using NCERT guidelines.
• Students learn to use stepwise methods for both theoretical and calculation-based Class 12 Business Studies Chapter 9 question answer types.
• NCERT solution Class 12 Business Studies Chapter 9 highlights factors affecting dividend decisions and financial planning in easy terms.
• These Financial Management Class 12 ncert solutions will help you build confidence for your board exams.

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