Management

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Decision making is an essential part of planning. Decision making and problem solving are used in all management functions, although usually they are considered a part of the planning phase. A discussion of the origins of management science leads into one on modeling, the five-step process of management science, and the process of engineering problem solving.

Decision-making is an integral part of modern management. Essentially, Rational or sound decision making is taken as primary function of management. Every manager takes hundreds and hundreds of decisions subconsciously or consciously making it as the key component in the role of a manager. Decisions play important roles as they determine both organizational and managerial activities. A decision can be defined as a course of action purposely chosen from a set of alternatives to achieve organizational or managerial objectives or goals. Decision making process is continuous and indispensable component of managing any organization or business activities. Decisions are made to sustain the activities of all business activities and organizational functioning.

Relation to Planning

 

Managerial decision making is the process of making a conscious choice between two or more rational alternatives in order to select the one that will produce the most desirable consequences (benefits) relative to unwanted consequences (costs). If there is only one alternative, there is nothing to decide.

If planning is truly “deciding in advance what to do, how to do it, when to do it, and who is to do it” , then decision making is an essential part of planning. Decision making is also required in designing and staffing an organization, developing methods of motivating subordinates, and identifying corrective actions in the control process. However, it is conventionally studied as part of the planning function, and it is discussed here.

Occasions for Decision

 

the occasions for decision originate in three distinct fields:

(a) from authoritative communications from superiors;

(b) from cases referred for decision by subordinates; and

(c) from cases originating in the initiative of the executive concerned.

Types of Decisions

 

TYPES OF DECISIONS:

 

PROGRAMMED DECISIONS:

 

Programmed decisions are routine and repetitive, and the organization typically develops specific ways to handle them. A programmed decision might involve determining how products will be arranged on the shelves of a supermarket. For this kind of routine, repetitive problem, standard arrangement decisions are typically made according to established management guidelines.

 

NON PROGRAMMED DECISIONS:

 

Non programmed decisions are typically one shot decisions that are usually less structured than programmed decision.

 

Decision Making under Certainty

Decision making under certainty implies that we are certain of the future state of nature (or we assume that we are). (In our model, this means that the probability p of future N is 1.0, and all other futures have zero probability.) The solution, naturally, is to choose the alternative A that gives us the most favorable outcome O . Although this may seem like a trivial exercise, there are many problems that are so complex that sophisticated mathematical techniques are needed to find the best solution.

 

Marketing Management is a social and managerial process by which individuals or firms obtain what they need or want through creating, offering, exchanging products of value with each others.

 

CORE CONCEPTS OF MARKETING

 

• NEED/ WANT/ DEMAND:

 

Need: It is state of deprivation of some basic satisfaction.

 

Want: Desire for specific satisfier of need.

 

Demand: Want for a specific product backed up by ability and willingness

to buy.

 

Marketers cannot create needs. Needs pre exists. Marketers can influence wants. This is done in combination with societal influencers.

 

• PRODUCTS- GOODS/ SERVICES/ PLACE.

 

Product is anything that can satisfy need/ want.

 

Product component-              1.Physical Good.

2. Service.
3. Idea.

 

Hence, products are really a via- media for services.

Hence, in marketing, focus is on providing/ satisfying service rather than providing products.

 

Marketing Myopia:  Focus on products rather than on customer needs.

 

(3) VALUE/ COST/ SATISFACTION:

 

• Decision for purchase made based on value/ cost satisfaction delivered by product/ offering.
• Product fulfills/ satisfies Need/ Want.
• Value is products capacity to satisfy needs/ wants as per consumer’s perception or estimation.
• Each product would have a cost/ price elements attached to it.

 

VALUE– Products capacity to satisfy.

COST–    Price of each products.

 

• EXCHANGE/ TRANSACTION:

 

EXCHANGE: – The act/ process of obtaining a desired product from someone by offering something in return. For exchange potential to exist, the following conditions must be fulfilled.

1. There must be at least two parties.
2. Each party has something of value for other party.
3. Each party is capable of communication & delivery
4. Each party is free to accept/ reject the exchange offer.
5. Each party believes it is appropriate to deal with the other party.

 

TRANSACTION: – Event that happens at the end of an exchange. Exchange is a process towards an agreement. When agreement is reached, we say a transaction has taken place.

 

Proof of transaction is BILL/ INVOICE.

 

TRANSFER: – It is one way. Hence, differ from Transaction.

 

NEGOTIATION: – Process of trying to arrive at mutually agreeable terms.

Negotiation may lead to               – Transaction

– Decision not to Transaction

 

• RELATIONSHIP/ NETWORKING:

 

Relationship marketing:-    It’s a pattern of building long term satisfying relationship with customers, suppliers, distributors in order to retain their long term performances and business.

 

Outcome of Relationship Marketing is a MARKETING NETWORK.

 

MARKETING NETWORK:      It is made up of the company and its customers, employees, suppliers, distributors, advertisement agencies, retailers, research & development with whom it has built mutually profitable business relationship.

 

Competition is between whole network for market share and NOT between companies alone.

 

• MARKET:

A market consists of all potential customers sharing particular need/ want who may be willing and able to engage in exchange to satisfy need/ want.

 

Types of Markets:

1. Resource Market,
2. Manufacturing Market,

• Intermediary Market,

1. Consumer Market,
2. Government market.

 

• MARKETERS/ PROSPECTS:

 

Working with markets to actualize potential exchanges for the purpose of satisfying needs and wants.

 

One party seeks the exchange more actively, called as “Marketer”, and the other party is called “Prospect”.

 

Prospect is someone whom marketer identifies as potentially willing and able to engage in exchange.

 

Marketer may be seller or buyer. Most of time, marketer is seller.

A marketer is a company serving a market in the face of competition.

 

Marketing Management takes place when at least one party to a potential exchange thinks about the means of achieving desired responses from other parties.

 

AMA- American Marketing Association.

 

It defines marketing management as the process of planning & executing the conception of pricing, promotion, distribution of goods, services, ideas to create exchanges that satisfy individual and organizational goals.

• Can be practiced in any market.
• Task of marketing management is to influence the level, timing, composition of demand in a way that will help the organization to achieve its objective. Hence, marketing management is essentially demand management.

 

 

Traditional Concept of Marketing

 

According to this concept, marketing consists of those activities which are concerned with the transfer of ownership of goods from producers to consumers. Thus, marketing means selling of goods and services. In other words, it is the process by which goods are made available to ultimate consumers from their place of origin. The traditional concept of marketing corresponds to the general notion of marketing, which means selling goods and services after they have been produced. The emphasis of marketing corresponds is on the sale of goods and services. Consumer satisfaction is not given adequate emphasis. Viewed in this way, marketing is regarded as Production/Sales oriented.

 

Modern concept of Marketing

 

According to the modern concept, Marketing is the concerned with creation of customer. Creation of Customers means identification of Consumer needs and organising business to satisfy needs. Marketing in the modern sense involves decision regarding the following matters.

 

• Products to be produced.
• Prices to be charged from Customers.
• Promotional techniques to be adapted to contact and influence existing and potential customers.
• Selection of middlemen to be used to distribute goods and service.

 

Modern concept of marketing requires all the above decisions to be taken after due consideration of consumer needs and their satisfaction.

The business objective of earning profit is sought to be achieved through provision of consumer satisfaction. This concept of marketing is regarded as consumer oriented as the emphasis of business is laid on consumer needs and their satisfaction.

 

Five fundamental concept of marketing are –

1. Exchange concept
2. Production concept
3. Product concept
4. Sales concept
5. Marketing concept

 

1. Exchange Concept: The exchange concept holds that the exchange of a product between seller & buyer is the central idea of marketing Exchange is an important part of marketing, but marketing is much wider concept.

 

2. Production Concept: The production concept is one of the oldest concepts in business. It holds that consumers will prefer products that are widely available and expensive. Manager of Production oriented business concentrate on achieving high production efficiency low cost & mass distribution.

 

3. Product Concept: This concept holds that consumers will prefer those products that are high in quality, performance or innovative features. Managers in these organization focus on making superior products and improving them. Sometimes, this concept leads to marketing myopia, Marketing myopia is a short-sightedness about business. Excessive attention to production or the product or selling aspects at the cost of customers & his actual needs creates this myopia.

 

4. Selling Concepts: This concept focuses on aggressively promoting & pushing its products, it cannot except its product to get picked up automatically by the customer. The purpose is basically to sell more stuff to more people, in order to make profits.

 

5. Marketing Concept: The marketing concept emerged in the mid 1950’s. The business generally shifted from a product – cantered, make & sell philosophy, to a customer centered, sense & respond philosophy. The job is not to find the right customers for your product, but to find right products for your customers. The Marketing concept holds that the key to achieving organizational goals consist of the company being more effective than competitors in creating, delivering & communicating superior customers value. This concept puts the customers at both the beginning & the end of the business cycle. Every department & every worker should think customer & act customer.

 

Marketing involves a number of activities. To begin with, an organisation may decide on its target group of customers to be served. Once the target group is decided, the product is to be placed in the market by providing the appropriate product, price, distribution and promotional efforts. These are to be combined or mixed in an appropriate proportion so as to achieve the marketing goal. Such mix of product, price, distribution and promotional efforts is known as ‘Marketing Mix’.

 

 

 

So, Marketing Mix consists of 4Ps They are :-

 

• Products,
• Price,
• Place (distribution) and

 

These 4 ‘P’s are called as elements of marketing and together they constitute the marketing mix. All these are inter-related because a decision in one area affects decisions in other areas.

 

PRODUCT:

 

Product refers to the goods and services offered by the organisation. A pair of shoes, a plate of dahi-vada, a lipstick, all are products. All these are purchased because they satisfy one or more of our needs.  The term product is defined as “anything that can be offered to a market to satisfy a want”. It normally includes physical objects and services. So, in simple words, product can be described as a bundle of benefits which a marketer offers to the consumer for a price.

 

Product can be broadly classified on the basis of

 

 (1) USE,    (2) DURABILITY,   and    (3)TANGIBLITY

 

• Based onUSE, the product can be classified as:

 

   (a) Consumer Goods and

(b) Industrial Goods.

 

• Consumer goods: Goods meant for personal consumption by the households or ultimate consumers are called consumer goods. This includes items like toiletries, groceries, clothes etc. Based on consumers’ buying behaviour the consumer goods can be further classified as :

 

(i) Convenience Goods;   (ii) Shopping Goods; and  (iii) Speciality Goods.

 

• Convenience Goods :

 

The convenience goods are bought frequently without much planning or shopping effort and are also consumed quickly. Buying decision in case of these goods does not involve much pre-planning. Such goods are usually sold at convenient retail outlets.

 

• Shopping Goods:

 

These are goods which are purchased less frequently and are used very slowly like clothes, shoes, household appliances. In case of these goods, consumers make choice of a product considering its suitability, price, style, quality and products of competitors and substitutes, if any. In other words, the consumers usually spend a considerable amount of time and effort to finalise their purchase decision as they lack complete information prior to their shopping trip. shopping goods involve much more expenses than convenience goods.

 

• Speciality Goods :

 

As  some special characteristics of certain categories of goods, people generally put special efforts to buy them. They are ready to buy these goods at prices at which they are offered and also put in extra time to locate the seller to make the purchase. Examples of speciality goods are cameras, TV sets, new automobiles etc.

 

(b) Industrial Goods:  Goods meant for consumption or use as inputs in production    of other products or provision of some service is termed as ‘industrial goods’. These are meant for non-personal and commercial use and include (i) raw materials, (ii) machinery, (iii) components, and (iv) operating supplies (such as lubricants, stationery etc). The buyers of industrial goods are supposed to be knowledgeable, cost conscious and rational in their purchase and therefore, the marketers follow different pricing, distribution and promotional strategies for their sale.

 

• Based on DURABILITY , the products can be classified as :

 

(a) Durable Goods and

 (b) Non-durable Goods

 

• Durable Goods : Durable goods are products which are used for a long period i.e., for months or years together. Examples of such goods are refrigerator, car, washing machine etc. In case of these goods, seller’s reputation and presale and after-sale service are important determinants of purchase decision.

 

• Non-durable Goods: Non-durable goods are products that are normally consumed in one go or last for a few uses. Examples of such products are soap, salt, pickles, sauce etc. These items are consumed quickly and we purchase these goods more often. Such items are generally made available by the producer through large number of convenient retail outlets. Profit margins on such items are usually kept low.

 

 

• Based on TANGIBLITY , the products can be classified as:

 

(a) Tangible Goods and

(b) Intangible Goods.

 

• Tangible Goods : Most goods, whether these are consumer goods or industrial goods and whether these are durable or non-durable, fall in this category as they have a physical form, that can be touched and seen. Thus, all items like groceries, cars, raw-materials, machinery etc. fall in the category of tangible goods.

 

• Intangible Goods : Intangible goods refer to services provided to the individual consumers or to the organisational buyers (industrial, commercial, institutional, government etc.). Services are essentially intangible activities which provide want or need satisfaction. Medical treatment, postal, banking and insurance services etc., all fall in this category.

 

PRICING

 

 

It is the exchange value of goods and services in terms of money. Pricing (determination of price to be charged) is another important element of marketing mix and It plays a crucial role in the success of a product in the market.

 

It has to be fixed after taking various aspects into consideration. The factors usually taken into account while determining the price of a product can be broadly described as follows:

 

• Cost: No business can survive unless it covers its cost of production and distribution. In large number of products, the retail prices are determined by adding a reasonable profit margin to the cost. Higher the cost, higher is likely to be the price, lower the cost lower the price.

 

• Demand: Demand also affects the price in a big way. When there is limited supply of a product and the demand is high, people buy even if high prices are charged by the producer. The price is dependent upon prospective buyers’ capacity and willingness to pay and their preference for the product. In this context, price elasticity, i.e. responsiveness of demand to changes in price should also be kept in view.

 

 

• Competition: The price charged by the competitor for similar product is an important determinant of price. A marketer would not like to charge a price higher than the competitor for fear of losing customers.

 

• Marketing Objectives: A firm may have different marketing objectives such as maximisation of profit, maximisation of sales, bigger market share, survival in the market and so on. The prices have to be determined accordingly.

 

• Government Regulation: Prices of some essential products are regulated by the government under the Essential Commodities Act. For example, prior to liberalisation of the economy, cement and steel prices were decided by the government. Hence, it is essential that the existing statutory limits, if any, are also kept in view while determining the prices of products by the producers.

 

METHODS OF PRICE FIXATION

Methods of fixing the price can be broadly divided into the following categories-

 

1. Cost based pricing
2. Competition based pricing
3. Demand based pricing
4. Objective based pricing

 

1. Cost Based Pricing: Under this method, price of the product is fixed by adding the amount of desired profit margin to the cost of the product. While calculating the price in this way, all costs (variable as well as fixed) incurred in manufacturing the product are taken into consideration.

 

2. Competition Based Pricing: In case of products where market is highly competitive and there is negligible difference in quality of competing brands, price is usually fixed closer to the price of the competing brands. It is called ‘young rate pricing’ and is a very convenient method because the marketers do not have to worry much about demand and cost and effect the change as per the changes by the industry leaders.

 

3. Demand Based Pricing: At times, prices are determined by the demand for the product. Under this method, without paying much attention to cost and competitor’s prices, the marketers try to ascertain the demand for the product. If the demand is high they decide to take advantage and fix a high price. If the demand is low, they fix low prices for their product

 

4. Objective Based Pricing: This method is applicable to introduction of new (innovative) products. If, at the introductory stage of the products, the organisation wishes to penetrate the market i.e., to capture large parts of the market and discourage the prospective competitors to enter into the fray, it fixes a low price. Alternatively, the organisation may decide to skim the market i.e., to earn high profit by taking advantage of a group of customers who give more importance to their status or distinction and are willing to pay even a higher price for it. In such a situation they fix quite high price at the introductory stage of their product and market it to only those customers who can afford it.

 

 

PLACE/DISTRIBUTION

 

A distribution channel consists of the set of people and firms involved in the transfer of title to a product as the product moves from producer to ultimate consumer or business user. Basically it refers to the vital links connecting the manufacturers and producers and the ultimate consumers/users. It includes both the producer and the end user and also the middlemen/agents engaged in the process of transfer of title of goods.

 

 

 

TYPES OF CHANNELS OF DISTRIBUTION

 

• Zero stage channel of distribution

 

Manufacturer —-> Consumer

 

Zero stage distribution channel exists where there is direct sale of goods by the producer to the consumer. This direct contact with the consumer can be made through door-todoor salesmen, own retail outlets or even through direct mail.

 

• One stage channel of distribution

 

Manufacturer—–>Retailer——–> Consumer

 

This type of distribution channel is preferred by manufacturers of consumer durables like refrigerator, air conditioner, washing machine, etc. where individual purchase involves large amount.

 

• Two stage channel of distribution

 

Manufacturer—->Wholesaler—>Retailer—>Consumer

 

This is the most commonly used channel of distribution for the sale of consumer    goods. In this case, there are two middlemen used, namely, wholesaler and retailer. This is applicable to products where markets are spread over a large area, value of individual purchase is small and the frequency of purchase is high.

 

• Three stage channel of distribution

 

Manufacturer—->Agents—-> Wholesaler—>Retailer—>Consumer

 

When the number of wholesalers used is large and they are scattered throughout the country, the manufacturers often use the services of mercantile agents who act as a link between the producer and the wholesaler. They are also known as distributor.

 

 

PROMOTION

 

Promotion refers to the process of informing and persuading the consumers to buy certain product. By using this process, the marketers convey persuasive message and information to its potential customers.

 

It is thus a persuasive communication and also serves as a reminder. A firm uses different tools for its promotional activities which are as follows:

 

– Advertising

– Publicity

– Personal selling

– Sales promotion

 

These are also termed as four elements of a promotion mix.

 

 

 

 

• Advertising: Advertising is the most commonly used tool for informing the present and prospective consumers about the product, its quality, features, availability, etc. It is a paid form of non-personal communication through different media about a product, idea, a service or an organisation by an identified sponsor. It can be done through print media like newspaper, magazines, billboards, electronic media like radio, television etc. It is a very flexible and comparatively low cost tool of promotion.

 

• Publicity: This is a non-paid process of generating wide range of communication to contribute a favourable attitude towards the product and the organisation. As the articles in newspapers about an organisation, its products and policies. The other tools of publicity are press conference, publication and news in the electronic media etc. It is published or broadcasted without charging any money from the firm. Marketers often spend a lot of time and effort in getting news items placed in the media for creation of a favourable image of the company and its products.

 

 

• Personal selling: It is a direct presentation of the product to the consumers or prospective buyers. It refers to the use of salespersons to persuade the buyers to act favourably and buy the product. It is most effective promotional tool in case of industrial goods.

 

• Sales promotion: This refers to short-term and temporary incentives to purchase or induce trials of new goods. The tool includes contests, games, gifts, trade shows, Discounts, etc. Sales promotional activities are often carried out at retail levels.

 

 

 

Concept:

 

 

Wealth maximization is the concept of increasing the value of a business in order to increase the value of the shares held by stockholders. The concept requires a company’s management team to continually search for the highest possible returns on funds invested in the business, while mitigating any associated risk of loss.

 

Wealth maximization simply means maximization of shareholder’s wealth. It is a combination of two words viz. wealth and maximization. A wealth of a shareholder maximizes when the net worth of a company maximizes.

 

Objectives:

 

 

1. Measurement of Wealth
2. Market Value of Shares
3. Common Goal
4.  D’s Of Financial Decisions
5. Shareholder’s Expectations

 

 

1. Measurement of Wealth

 

The main Principle of financial management is the Maximization of Shareholders Wealth. Shareholder’s Wealth is measured on the basis of economic value. Economic value is based on cash flows and not profit. Economic Value is defined as: “The present value of future cash flows generated by a decision, discounted at appropriate rate of discount which reflects the degree of associated risk“.

 

2. Market Value of Shares

 

The future cash flow is estimated for the present value. The present value is the Market price of share. As Shareholder’s wealth is equal to the market price of shares held by him, any increase in Market price of shares would result in an increase in Shareholder’s Wealth.

 

3. Common Goal

The Maximization of Shareholder’s Wealth is the common goal between the Shareholders and the Management. The recognition of this goal motivates the Management to allocate the available resources in an optimum way.

 

 

 

 

 

4. 3 D’s Of Financial Decisions

The Maximization of Shareholder’s wealth indicates that the Market price of share is related to three basic financial decisions:

The investment decisions,

The financing decision,

The dividend decision.

 

5. Shareholder’s Expectations

 

Shareholder’s expectations are about future cash flows based on current cash flows and projected future growth. The market price of share shows these expectations.

 

Sources of finance are the most explored area especially for the entrepreneurs about to start a new business. It is perhaps the toughest part of all the efforts. There are various sources of finance classified based on time period, ownership and control, and source of generation of finance.

 

The process of selecting right source of finance involves in-depth analysis of each and every source of finance. For analyzing and comparing the sources of finance, it is required to understand all characteristics of the financing sources. There are many characteristics on the basis of which sources of finance are classified.

On the basis of a time period, sources are classified into long term, medium term, and short term. Ownership and control classify sources of finance into owned capital and borrowed capital. Internal sources and external sources are the two sources of generation of capital. All the sources of capital have different characteristics to suit different types of requirements. Let’s understand them in a little depth.

 

ACCORDING TO TIME-PERIOD:

 

Sources of financing a business are classified based on the time period for which the money is required. Time period is commonly classified into following three:

• Long Term Sources of Finance:

 

Long-term financing means capital requirements for a period of more than 5 years to 10, 15, 20 years or maybe more depending on other factors. Capital expenditures in fixed assets like plant and machinery, land and building etc of a business are funded using long-term sources of finance. Part of working capital which permanently stays with the business is also financed with long-term sources of finance. Long term financing sources can be in form of any of them:

 

• Share Capital or Equity Shares
• Preference Capital or Preference Shares
• Retained Earnings or Internal Accruals
• Debenture / Bonds
• Term Loans from Financial Institutes, Government, and Commercial Banks
• Venture Funding
• Asset Securitization
• International Financing by way of Euro Issue, Foreign Currency Loans, ADR, GDR etc.

 

• Medium Term Sources of Finance:

 

Medium term financing means financing for a period of 3 to 5 years. Medium term financing is used generally for two reasons. One, when long-term capital is not available for the time being and second, when deferred revenue expenditures like advertisements are made which are to be written off over a period of 3 to 5 years. Medium term financing sources can in the form of one of them:

 

• Preference Capital or Preference Shares
• Debenture / Bonds
• Medium Term Loans from
  • Financial Institutes
  • Government, and
  • Commercial Banks
• Lease Finance
• Hire Purchase Finance.

 

• Short Term Sources of Finance: Short term financing means financing for a period of less than 1 year. Need for short term finance arises to finance the current assets of a business like an inventory of raw material and finished goods, debtors, minimum cash and bank balance etc. Short term financing is also named as working capital financing. Short term finances are available in the form of:

 

• Trade Credit
• Short Term Loans like Working Capital Loans from Commercial Banks
• Fixed Deposits for a period of 1 year or less
• Advances received from customers
• Creditors
• Payables
• Factoring Services
• Bill Discounting etc.

 

There are two main categories of sources from which the firm can get the required funds for their business. These are:

 

 (1) Internal sources; and

(2) External sources.

When the businessman invests his own money (called owner’s capital), and retains a part of the profits earned in the business it constitute the internal sources of finance. It is an integral part of every business organisation and it is cost effective. But, this source has its own limitations. Hence the business houses have to resort to the external sources of finance. The various external sources from where businessmen can get the finance include, friends and relatives, banks and other financial institutions, moneylenders, capital market, manufacturers and producers, customers, foreign financial institutions and agencies, etc. It is observed that the scope of raising funds also depends upon the nature and form of business organisation.

 

The following are the usual sources of finance. (a) Capital Market (b) Financial Institutions (c) Public Deposits (d) Commercial Banks (e) Leasing Companies (f) Investment Trusts (g) Retained Profits

 

The financial requirement of a firm can be met through ownership capital and/or borrowed capital. The ownership capital refers to the amount of capital contributed by the owners. In case of a company, it refers to the amount of funds raised by issuing shares. The main characteristic of the ownership capital is that its contributors are entitled to get dividend out of earnings after the payment of interest and taxes. Hence, the rate of return on such capital depends upon the level of profits earned, and, if there are no profits, no dividend may be paid.

 

Borrowed capital, on the other hand, refers to the amount of funds raised through long term loans and debentures on which its contributors are entitled to a fixed rate of interest which has to be paid at regular intervals (half-yearly or yearly) irrespective of the profits earned. There is also a commitment that the principal amount shall be repaid on maturity. However, it is still considered advantageous to finance business activities through borrowed capital because if the rate of earnings from the planned business investment is expected to be better than the rate of interest on the borrowed funds, it shall ensure higher returns on owners’ funds. Let us take an example and understand this concept more clearly.

 

“The mix of equity and debt actually used by a company for meeting its requirement of capital is known as its capital structure.”

 

Thus, the term capital structure refers to the makeup of a firm’s capital in terms of the planned mix of different kinds of long-term funds like equity shares, preference shares, debentures and long term funds. So capital structure involves two basic decisions:

 

(a) The type of securities to be issued or raised; and

(b) The relative proportion of each type of security

 

Factors Determining the Capital Structure

 

1. Expected earnings and their stability: If the expected earnings, in terms of rate of return on the amount to be invested are sufficiently large, use of debt is considered quite desirable. Not only that, the stability of earnings should also be taken into account because if the firm is engaged is business activities in which sales and profits are subject to wide fluctuations, it will be risky to use higher proportion of debt. In other words, if there is an element of uncertainty about the expected earnings it is considered better to rely more on equity share capital. However, with assured prospects of rising earnings, there should be greater reliance on debt so as to take advantage of leverage effect.

 

2. Cost of debt : If the rate of interest on borrowings is lower than the expected rate of return on capital employed, then debt may be preferred. With lower cost of debt financing, the overall cost of financing is reduced and the return on equity capital will be higher, as explained earlier.

 

3. Right to manage the business: You know that the debenture holders and preference shareholders do not have much say in management of the company. This authority lies primarily with the equity shareholders who have the voting rights. Hence, while deciding on the mix of equity and debt, the promoters/existing management of the company may also take into account the possible effect of raising funds through equity shares on the right to control the business. In order to retain their right to control the affairs of the company, they may prefer to raise additional funds mainly through debentures and preference shares.

 

4. Capital market conditions: The conditions in the capital market also influence the capital structure decision. At times capital market is so depressed that the investors are unwilling to subscribe to shares. In such a situation, it is considered better to rely on debt or defer the decision till a favourable market condition is restored.

 

5. Regulatory norms : While deciding on the capital structure, the legal constraints like the limit on debt-equity ratio should also be kept in view. At present, such limit is 2:1 in most cases. This implies that at any point of time, the debt should not be more than twice the amount of share capital. This limit keeps on changing with changing economic environment and varies from industry to industry.

 

6. Flexibility: The planned capital structure should be flexible enough to raise additional funds without much difficulty. The company should be able to raise additional capital in the form of debt or equity whenever required. But if the company’s capital structure has too much debt, then the lenders may not be able to give more loan to the company. In a such a situation it may be forced to raise the funds only through shares for which the capital market condition may not be conducive. Similarly, when on account of declining business and lack of other investment opportunities the funds need to be refunded, it may not be possible to do so if the company has heavily relied on equity shares which cannot be redeemed easily. Hence, to ensure an element of flexibility, it is better if the firm relies more on redeemable securities that can be paid off if necessary and, at the same time, have some unused debt raising capacity so that future financial needs can be fully taken care of without much difficulty.

 

7. Investors’ attitude towards investment: While planning the capital structure of a company one must bear in mind that all investors do not have the same attitude towards their investment. Some are highly conservative who prefer safety to return. For such investors, debentures are considered most suitable. As against this, there are some who are interested in high return on their investments and are ready to take the risk involved. Such investors prefer equity shares. Then, there are many who are willing to take a limited risk provided the return is better than the rate on secured debentures and bonds. Preference shares are most suitable for this category of investors. In order to attract all categories of investors, it is considered more desirable to issue different types of securities especially when the amount of capital requirement is large.

 

COST OF CAPITAL

 

The primary meaning of cost of capital is simply the cost an entity must pay to raise funds. The term can refer, for instance, to the financing cost (interest rate) a company pays when securing a loan.

 

In other words, Cost of capital refers to the opportunity cost of making a specific investment. It is the rate of return that could have been earned by putting the same money into a different investment with equal risk. Thus, the cost of capital is the rate of return required to persuade the investor to make a given investment.

 

The cost of various capital sources varies from company to company, and depends on factors such as its operating history, profitability, credit worthiness, etc. In general, newer enterprises with limited operating histories will have higher costs of capital than established companies with a solid track record, since lenders and investors will demand a higher risk premium for the former.

 

Concept and Main theories of Leadership and Motivation, Communication, Basics of recruitment, selection, induction, training & development are covered in Functions of Management