The document discusses financial planning and capitalization. It covers estimating capital requirements, theories of capitalization, and determining if a company is under or over capitalized. The key points are: - Companies must estimate fixed and working capital needs. The cost and earnings theories of capitalization are used to determine how much funding is required. - Under or over capitalization can be identified by comparing a company's book value per share to its real value, calculated using earnings and industry capitalization rate. - If book value is greater than real value, the company is over capitalized. If book value is less than real value, the company is under capitalized. Book value equal to real value means proper capitalization

1. Financial Planning
• Three Major Decision for Financial Manager
– How Big should be the corporate
• How much fund do I need, How do I Generate these
funds
• Financing Decisions(Capital Structure Decisions)
– How to earn on the Funds ? Where to Invest
• Investing Decisions (Capital Budgeting Decisions)
– How to part with the profit
• Dividend Decisions

2. Financial Planning
• Meaning of Financial Planning
– Quantum of Financing
• How much fund do I need to generate
– Pattern of Financing
• Types of Securities
• Proportion of Securities
– Policy of Financing
• Timing
• Administration/Management of Funds

3. Financial Planning
• Principles to be kept in mind in preparation of
a Financial Plan
– Simplicity
• Simple financial structure which can be managed easily
• Number of securities should manageable
– Long Term view
• Should be prepared keeping in mind the long term view
of the organization
– Foresight
• Should be prepared keeping in view the future
requirements of the corporation
• Technology, Economy, Resource Availability etc

4. Financial Planning
– Optimum Use
• Neither undercapitalized nor overcapitalized
• A proper balance between the long term and short
term funds
– Liquidity
• Should be have adequate liquidity to have flexibility
– Economy
• The cost of raising the funds should be minimum

5. Financial Planning
• Estimating the capital Requirements
– Two Types of Capital Requirements of a corporate
• Fixed Capital Requirements
• Working Capital Requirements
– Meaning of Fixed Capital
• Fixed Capital is required to acquire
– Tangible assets
» Building, Plant, Machinery, furniture
– Intangible
» Goodwill, Patents, copyrights etc
– Once invested, its for a long term
– Not only for new acquisition but also for expansion,
diversification

6. Financial Planning
– Meaning of Working Capital
• Capital is required for
– Day to day operations of the company
– Factors affecting the amount of fixed capital
Requirement
• Nature of Business
– Public utility companies
» Electricity, Gas, water supplies, Transportation
» Online trading, small manufacturing unit
– Types of Products
» Oil exploration ,Heavy Machinery
» Small toy manufacturing unit

7. Financial Planning
• Diversity of Product Line
– Conglomerate vs. Single Product
• Method of Production
– Whole Value chain vs. Vendor based
• Method of Acquisition
– Hard Cash vs. Leasing (Airlines Industry)

8. Financial Planning
– Theories of Capitalization ( for new companies)
• The quantum of funding has been estimated
• How much securities needs to be issued.
• The theories of capitalization answer these questions
– Cost Theory
– Earning Theory
– Cost Theory of Capitalization
• Total amount of capitalization of the company is arrived
at by adding up the
1. Cost of fixed assets
2. Amount of working Capital
3. Cost of establishment( Book-Building,Underwriting,
commissions etc)
4. Add up 1+2+3 to arrive at cost of Capitalization

9. Financial Planning
– Earning Theory of Capitalization
• True capitalization depends upon the earning capacity of
the firm
• Worth of the company is not measured by the amount
raised but by the productive usage of the capital raised
• Thus in order to estimate how much capital needs to be
raised the company must know in advance the ROI of
that particular industry
– Other companies
– Historical Data etc
– Example
• ROI is 10 %.Company expects to earn Rs 50000 in one
year
• Capital to be raised = 50,000 /.10 = Rs 500,000

10. Financial Planning
– Earning Theory of Capitalization
• True capitalization depends upon the earning capacity of
the firm
• Worth of the company is not measured by the amount
raised but by the productive usage of the capital raised
• Thus in order to estimate how much capital needs to be
raised the company must know in advance the ROI of
that particular industry
– Other companies
– Historical Data etc
– Example
• ROI is 10 %.Company expects to earn Rs 50000 in one
year
• Capital to be raised = 50,000 /.10 = Rs 500,000

11. Financial Planning
– Estimating Over/Under Capitalization
• ROI way
– A company is earning Rs 1,50,000 on an investment of
Rs 15,00,000.What is the ROI of the company?
– The average ROI of this industry is also 10 %
» The company is ok
– What if the company was earning Rs 90,000
» Company ROI is 90,000/15,00,000 = 6%
» Avg ROI of the industry is 10 %
» The company is Over Capitalized
– What is the company was earning Rs 20,00,00
» Company ROI is 2,00,000/15,00,000 = 13.3%
» Avg ROI of the industry is 10 %
» The company is Undercapitalized

12. Financial Planning
– Estimating Over/Under Capitalization
• Book Value vs. Real Value
– Under Capitalization overcapitalization can be
ascertained by comparing the Book value and Real value
of the equity shares of the company
–What is Book Value of the equity share
– Net Assets available to the equity share holders as per
the books
– What are Net Assets?
» NA= Total Assets –Total Liabilities
» BV = NA/n , where n = No of shares of the company

13. Financial Planning
–What is Real Value of the equity share
– Calculated based on the earning capacity of the firm
– Real Value = Earnings / Capitalization Rate (ROI industry)
= E/k
– How to estimate Over/Under capitalization
once both Book Value and Real Value has
been calculated

14. Financial Planning
–Decision Criteria
–BV > Real Value
• Firm is over capitalized
–BV < Real Value
• Firm is Under capitalized
–BV = Real Value
• Firm is Properly capitalized

15. Financial Planning
Liabilities Assets
Share Capital :
1000 share @
Rs 10 each
Rs 10000 Sundry Assets Rs 40000
1000 Preference
Share @10% of Rs
10 each
Rs 10000
Reserves and
Surplus
Rs 10000
Sundry Creditors RS 10000
Total Rs 40000 40000
Balance Sheet of Company ABC ltd as on 31.12.2008

16. Financial Planning
–Calculating Book Value
• BV = Net Assets/ no of shares
• Net Assets = Assets- Liabilities
• Assets = Sundry Assets
• Liabilities
– Creditors
– Preference Share( Debt)
• What about reserves and surpluses?
– Owners capital is represented on the liability side
• NA = Rs 40,000- (10,000+10000)
= Rs 20,000
BV = 20000/1000 = Rs 20

17. Financial Planning
–Calculating Real Value
• What data do I need for calculating the Real Value
– Earnings
– ROI
– No of Shares
• Let earning capacity of the industry 15%
• Earning of ABC limited Rs 1000
• Assess Needed to Earn Rs 1000
» 1000/.15 = Rs 6667
» Net Assets of the ABC = Rs 20,000
» RV = 6667/1000 = Rs 6.67
» BV> RV
• ABC is
– Over capitalized

18. Financial Planning
–Do calculations for the following cases
• Earning is Rs 5000 , earning capacity of the industry 15%
– BV = Rs 20
– RV = Rs 33.33
– BV< RV
– Undercapitalized
• Earning is Rs 3000 , earning capacity of the industry 15%
– BV = Rs 20
– RV = Rs 20
– BV=RV
– Properly Capitalized

19. Financial Planning
Liabilities Assets
Share Capital :
5000 share @
Rs 10 each
Rs 50000 Fixed Assets Rs 50000
Current Assets 40000
Reserves and
Surplus
Rs 25000
Sundry Creditors RS 15000
Total Rs 90000 Rs 90000
Balance Sheet of Company ABC ltd as on
31.12.1998

20. Financial Planning
–What is the BV of the equity share
• Rs 15
–Estimate whether the company is
• Under, Over or properly capitalized
• earning capacity of the industry 15%
• Earning is Rs 6000
– BV = Rs 15
– RV = Rs 8
– BV> RV
– Overcapitalized
• Earning is Rs 7500
– BV = Rs 15
– RV = Rs 10
– BV>RV

21. Financial Planning
• Earning is Rs 10000 and earning capacity is now 8%
– BV = Rs 15
– RV = Rs 25
– BV<RV
– Undercapitalized
• Read pages B-13 to B-15 from the text book regarding the
Under and Overcapitalization