Difference between fixed and working capital

Financial planning is an important part of overall planning of any business organisation.It is the process of determining the objectives, policies, procedures, programmes and budgets to deal with the corporate financial activities of an enterprise.
Importance of Financial Planning
The importance of financial planning can be explained as follows:
(i) It helps in forecasting what may happen in future under different business situations
(ii) It helps in avoiding business shocks and surprises and helps the company in preparing for the future.
(iii) It helps in coordinating various business functions.
(iv) It tries to link the present with the future.
(v) It provides a link between investment and financing decisions on a continuous basis.
(vi) It helps in reducing waste, duplication of efforts and gaps in planning.
(vii) It acts as the basis of control, by spelling out the objective of various business segments. 

It is concerned with optimal procurement as well as usage of funds.It aims to reduce the cost of funds, achieve keep the risks under control and achieve effective deployment of funds.Financial management plays a vital role in an organisation.

(i) Availability of adequate funds, whenever required,through financial planning. 
(ii) Procurement of funds at reasonable cost, through financing decision.
(iii) Effective utilisation of funds, through investing decision. 

The capital invested in fixed assets like land and buildings, plant and machinery, furniture and fixtures etc, known as fixed capital. How much is to be invested in fixed assets is determined by many factors.
(i) Scale of operations
A larger organisation operating at a larger scale needs higher investment in fixed assets as compared to a small organisation.
(ii) Choice of Technique
Some organisation are capital intensive, whereas, others are labour intensive. A capital intensive organisation requires higher investment in plant and machinery as it relies less on manual labour. The requirement of fixed capital for such organisations would be higher. Labour intensive organisations, on the other hand, require less investment in fixed assets.
(iii)  Technology Upgradation
In certain industries, assets become obsolete sooner. Consequently, their replacements become due faster. Higher investment in fixed assets may, therefore, be required in such cases, e.g. computers become obsolete faster and are replaced much sooner than say furniture. Thus, such organisations which use assets, prone to obsolescence, require higher fixed capital to purchases.
(iv) Financing alternatives
If alternatives of leasing or hire purchase are available, the assets are not be purchased outrightly, but only rent or instalments have to be paid. This reduces the requirement of fixed capital.

Adequate working capital is essential for smooth and efficient working of every business enterprise
Adequate working capital provides the following advantages to a business enterprise:
(i) A firm with adequate working capital can meet its liabilities promptly.prompt payment helps to raise the credit-standing or reputation of the enterprise.
(ii) Adequacy of working capital enables the firm to take advantage of any favourable business opportunity,e.g. to purchase raw materials at a discount or to execute a special order.
(iii) Financial soundness of business boosts the morale of employees.
(iv) Lack of adequate working capital may result in interruptions in operations and underutilisation of plant capacity.
(v) Adequate working capital permits timely and regular payment of cash dividends.This helps to maintain cordial relations with shareholders.

The following factors decide a company's capital structure:
(a) Cash flow position: A company must have enough cash in hand or liquidity if it has to raise capital through debentures to pay interest in time. If cash inflows are not enough, then it should issue shares.
(b) Cost of debt: A firm's ability to borrow at a lower rate increases its capacity to employ higher debt. Thus, more debt can be used if debt can be raised at a lower rate.
(c) Control: To retain control over the management of the company, debentures and preference shares should be issued to raise capital.
(d) Flexibility: Equity allows more flexibility to change its capital structure according to market conditions while debt restricts this freedom.
(e) Size of the company: Large companies are able to raise capital through shares more easily while smaller companies have to depend on their own sources or retained earnings as they do not get loans easily.
(f) Tax rate: It will be beneficial for the company to raise funds through debt if tax rates are high. Tax rate influences cost of debt as interest is a tax deductible item.
(g) Stock market conditions: If there is a boom period, then company will be in a better position to issue shares and that also at a premium. On the other hand, if there is depression in the market then investors may not be in a mood to take risk and therefore it is advisable for the company to issue debentures.
(h) Risk consideration: More risk is attached to debt as compare to shares such as interest payment, repayment etc. If level of fixed operating costs (like rent of the building) are high, then business should go in favour of issuing more of equity instead of debt.
(i) Cost of equity: More debt means more risk for the equity holders which increases their desired rate of return. To control cost of equity, limit should be imposed on the use of debt.
(j) Return on investment: Trading on equity/financial leverage can be used to increase earnings per share if ROI is higher.
(k) Floatation costs: It refers to costs involved in the issue of shares or debentures. These costs are high in case of equity as compared to debt.
(l) Interest coverage ratio: Risk of company is lower if ICR is higher. But it is not a full proof measure.
\(\mathrm{ICR}=\frac{\text { Earning before Interest and Taxes }}{\text { Interest }}\)
(m) Debt service coverage ratio: Company can use more debt, if DSCR is higher.
\(\)DSCR = \(\begin{array}{c} \text { Profit after tax }+\text { Depreciation }+\text { Interest } \\ \quad+\text { Non cash expenses } \\ \hline \begin{array}{c} \text { Preference dividend }+\text { Interest } \\ +\text { Repayment obligation } \end{array} \end{array}\)
(n) Regulatory framework: The Companies Act and SEBI provide guidelines from time to time regarding the raising of funds from the public. All these rules and regulations should be considered before taking a decision that whether company would like to issue shares or debentures or take loan from a financial institution.
(o) Capital structure of other companies: A company, before taking decision on the capital structure, should observe/study the relative proportion of various sources of funds in the capital structure of other companies in the same industry.

Financing decision is concerned with the decisions about how much funds are to be raised from which long-term source,i.e. by means of shareholders' funds or borrowed funds.
Shareholders'  funds include share capital, reserves and surplus and retained earnings, whereas, borrowed funds include debentures, long-term loans and public deposits.
Cost
The cost of raising funds from different, A wise finance manager opt for the cheapest source of finance.
Cash Flow Position
A stronger cash flow position may make debt financing more viable than funding through equity.
Level of Fixed Operating Cost
If a firm is having a higher fixed operating burden like payment of interests, premiums, salaries, rent, etc.then it should avoid financing through debt.This because it will further increase the interest payment burden and the firm can reach an unfavourable position.However, if the firm has lower operating cost, then the firm can borrow funds
Control Consideration  
Issue of more equity may dilute shareholders' control over the business.Therefore, a company afraid of a takeover bid may prefer debt to equity.  

Dividend decision relates to how much of the company's net profit is to be distributed to the shareholders and how much of it should be retained in the business for meeting the investment requirements.
This decision should be taken,keeping in view the overall objective of maximising shareholders, wealth.
(i) Stability of Earnings
A company having higher and stable earnings can declare higher dividends than a company with lower and unstable earnings.
(ii) Growth Opportunities
Companies having good growth opportunities retain more money out of their earnings so as to finance the required investment.The dividend declared in growth companies is, therefore, our flow smaller than that in the non-growth companies.
(iii) Cash Flow position
Dividend involves an outflow of cash.Availability of enough cash is necessary for payment or declaration of dividends.
(iv) Taxation of policy
If the tax on the dividends is higher,it is  better to pay less by way of dividentd.But if the tax rates are lower, higher dividends may be declared. This is because as per the current taxation policy, a dividend distributions tax is levied on companies.However, dividends shareholders prefer dividends, as dividends are tax free in the hands of shareholders

Investment decision can be long term or short term. A long term investment decision is also called a capital budgeting decision. It involves commiting the finance on a long term basis, e.g., making investment in a new machine to replace an existing one or acquiring a new fixed assets or opening a new branch etc. These decisions are very crucial for any business. They affect its earning capacity over the long-run, assets of a firm, profitability and competitiveness, are all affected by the capital budgeting decisions. Moreover, these decisions normally involve huge amounts of investment and are irreversible except at a huge cost. Therefore, once made, it is almost impossible for a business to wriggle out of such decisions. Therefore, they need to be taken with utmost care. These decisions must be taken by those who understand them comprehensively A bad capital budgeting decision normally has the capacity to severely damage the financial fortune of a business.