UNIT 1
hat is Finance?
W
FINANCE is the art & science of managing money”.
► The field of FINANCE refers to the concepts of time, money and risk and how they are
interrelated.
“Financial management is about planning income and expenditure, and making decisions
that will enable you to survive financially”.
► “Financial Management is concerned with that managerial decision that result in the
acquisition & financing of long term & short term credits for firm”.
▪ “Financial management is concerned with the acquisition, financing and management of
assets with some overall goal in mind”
- J C Van Horne
reas of finance
A
Financial services
✔ concerned with the design & delivery of advice & financial product
✔ to individuals, businesses & govt.
✔ within the areas of banking & related institutions, personal financial planning, investments,
real estate, insurance…
Financial management ✔ concerned with the duties of the financial manager in the business firm
hy do you need FM ?
W
IT REPRESENTS THE BRIDGE BETWEEN REAL ASSETS AND FINANCIAL ASSETS.
► FM refers to that part of managerial activity concerned with
► Procurement and
► Utilization of funds for business purposes.
► It involves the application of general management principles to financial operations
► Estimation of wc requirements
► Formulation of capital structure
► Management of earnings
bjective of FM
O
PROFIT MAXIMIZATION
► WEALTH MAXIMIZATION
► Logical managerial justification
► Time value of money
► Risk & uncertainty of future earnings
► Dividend vs market price of shares
PROFIT MAXIMIZATION
Actions that increase profits/EPS should be undertaken
►
► The investment, financing and dividend policy decisions of a firm should be oriented to
the maximization of profits/EPS.
► PROFITABILITY
bjections
O
It does not specify the time of expected returns
It does not take into consideration the uncertainity of future earnings
It does not consider the effect of dividend policy on the market price of shares
It does not consider the interest of consumers, workers and the society
It does not differentiate between short term and long term profits
EALTH MAXIMIZATION
W
Aims at maximum market price /share
► Market price represents the real value of the company
► MP serves as an indicator of company progress.
► MP considers the timing of earnings, dividend policy
► Based on the concept of cash flows generated rather than accounting profit.
► Considers both the quantity and quality dimensions of benefits
S ome limitations still...
✔ Business is confronted with a more demanding Socio economic environment which is omitted
✔ Financial management should take into consideration the firm’s legal obligation to the govt,
employees etc.
IMS OF FM
A
1. Increase in profits
2. Reduction in cost
3. Sources of funds
4. Minimize risks
5. Long run value
I t has two approaches :
1 Traditional
2. Modern
TRADITIONAL APPROACH
CORPORATION FINANCE
► Procurement of funds
► Institutional arrangement – financial institutions
► Financial instruments – capital markets
Legal and accounting relationships
►
- Emphasis on raising the funds only
- Concentrates mainly on financial administration of the joint stock companies
- Represents the episodic view of the finance function
- Emphasis on long term financial requirements
ODERN APPROACH
M
► Financial management – broad sense
► Business Finance
► The finance function – acquisition of funds and their allocations/ utilization
► What is the total volume of funds an enterprise should commit?
► What specific assets should an enterprise acquire?
► How should the funds required be financed?
TYPES OF FINANCIAL DECISIONS
1. Financial decision
2. Dividend decision
3. Investment decision
INANCING DECISION
F
► HOW SHOULD THE REQUIRED FINANCING BE RAISED?
– Where do firms raise/acquire the funds for value-creating investments?
– What mix of owner’s money (equity) or borrowed money(debt) should the firm use?
– Also called Capital Structure
► Capital structure – How should we pay for our assets? – Should we use debt or equity?
I NVESTMENT DECISION
► WHAT INVESTMENT SHOULD THE FIRM MAKE?
► Capital budgeting – What long-term investments or projects should the business take on?
► Working capital management – How do the business manage the day-to-day finances of the
firm
IVIDEND DECISION
D
HOW CAN THE FINANCIAL DECISIONS HELP TO ADD VALUE TO
THE FIRM?
✔ How much of a firm’s funds should be reinvested in the business and how much should be
returned to the owners?
✔ Includes Dividend –pay out ratio
✔ Proportion of how much to be paid to share holders and how much to be kept as retained
Earnings.
OLE OF FINANCIAL MANAGER
R
► ASSESSING--- THE CURRENT BUSINESS
► ASSESSING--- FUTURE FINANCIAL NEEDS
► ASSESSING--- FUTURE INVESTMENT
► DEVELOPING -- LONG TERM FINANCIAL STRATEGIES
Financial structure
►
► Foreign exchange management
► Investor communication
► Management control
► Investment planning
Indian Financial System
➢ Financial assets
► Financial intermediaries
► Financial markets
► Financial rate of return
INANCIAL ASSETS
F
► Money- issued by RBI and the Ministry of finance, Govt.. of India ( paper currency and
coins) and by Commercial banks as demand deposits
► Debt- issued by Govt and its agencies
a) by term loans from Financial Institutions,
b) Working Capital advances from Commercial Banks
c) issue of debentures
► Stock is issued by business organizations
INANCIAL INTERMEDIARIES
F
RBI
► Commercial banks--- provide working capital advances to industry
► Term lending FI- IDBI, IFCI, ICICI, SFC, STATE INDUSTRIAL DEVELOPMENT
CORPORATIONS
► Agricultural financing institutions- NABARD
► Insurance companies- LIC, GIC
► Other public sector FI- post office savings bank
INANCIAL MARKETS
F
► RBI
► Commercial banks--- provide working capital advances to industry
► Term lending FI- IDBI, IFCI, ICICI, SFC, STATE INDUSTRIAL DEVELOPMENT
CORPORATIONS
► Agricultural financing institutions- NABARD
► Insurance companies- LIC, GIC
► Other public sector FI- post office savings bank
► Money market
► Capital market- corporate securities and gilt-edged securities
Securities issued by the central govt , state govt, semi govt authorities autonomous institutions
►
and public sector enterprises are referred to as GILT EDGED SECURITIES.
INANCIAL PLANNING
F
• Whilst making profit is the mark of corporation success , money is the energizer which makes it
possible.
• Financial planning is the process of determining the
– Objectives
– Policies
– Procedures
– and program to deal with the financial activities of an organization. Concerned with economic
procurement and profitable use of funds
UNIT 2
ools for financial analysis
T
• Comparative Statement/ Inter- period comparison statement/ Intra- firm comparison
• Common Size Statement
• Trend analysis
• Ratio Analysis
• Cash flow statement
• Fund flow statement
• Break - Even Point analysis
omparative Statement/ Inter- period comparison statement/ Intra- firm comparison
C
• Comparative statements or comparative financial statements are statements of financial
position of a business at different periods. These statements help in determining the
profitability of the business by comparing financial data from two or more accounting
periods.
• The data from two or more periods are updated side by side, which is why it is also known
as Horizontal Analysis.
• The advantage of such an analysis is that it helps investors to identify the trends of business,
check a company’s progress and also compare it with that of its competitors.
• The financial data will be considered to be comparative only when the same set of accounting
principles are being used for preparing the statements.
ypes of Comparative Statements
T
• There are two types of comparative statements which are as follows
1. Comparative income statement/ Comparative profit and loss statement
2. Comparative balance sheet
omparative Income Statement
C
• It provide the progress made by the business over a period of a few years.
• This statement also helps in ascertaining the changes that occur in each line item of the income
statement over different periods.
• The comparative income statement not only shows the operational efficiency of the business
but also helps in comparing the results with the competitors, over different time periods.
• This is possible by comparing the operational data spanning multiple periods of accounting.
teps in preparing a comparative income statement
S
• Specify absolute figures of all the items related to the accounting period under consideration.
• Determine the absolute change that has occurred in the items of the income statement. It
can be achieved by finding the difference between previous year values with the current year
values.
• Calculate the percentage change in the items present in the current statement with respect to
previous year statements.
omparative Balance Sheet
C
• Comparative balance sheet analyses the assets and liabilities of business for the current
year and also compares the increase or decrease in them in relative as well as absolute
parameters.
• A comparative balance sheet not only provides the state of assets and liabilities in different
time periods, but it also provides the changes that have taken place in individual assets and
liabilities over different accounting periods.
• The following points should be studied when analysing a comparative balance sheet
• 1. The present financial and liquidity position (study working capital)
• 2. The financial position of the business in the long term
• 3. The profitability of the business
ommon Size Financial Statements
C
The statements in which amounts of the various items of financial statements are converted into
percentages to a common base.
• Types of Common Size Statements:
• 1. Common Size Balance Sheet; and
• 2. Common Size Statement of Profit and Loss.
COMMON SIZE B/S
REND ANALYSIS
T
The TPA is an important tool of historical analysis.
• It can be of immense help in making a comparative analysis over a series of years.
• The TPA provides brevity and easy readability to several financial statements as the
percent- ages figures disclose more than the absolute figures
recautions must be taken while using the TPA
P
• There should not be a significant and material change in accounting policies over the
years. This consistency is necessary to ensure meaningful comparability.
• (ii) Proper care must be taken while selecting the base year. It must be a normal and a
representative year. Generally the initial year is taken as base year, but intervening year
can also be taken as the base year, if the initial year is not found to be normal year.
• (iii) The trend percentages should be analyzed vis-a-vis the absolute figure to avoid any
misleading conclusions.
• iv) If possible, the figures for different years should be adjusted for variations in price level
also.
• For ex- ample, increase in Net Sales by 30% (from 100 in 2017 to 130 in 2020) over 3
years might have resulted primarily because of increase in selling price and not because
of increase in volume. often, it may be difficult to interpret the increase or decrease in any
item (in absolute terms or in percentages) as a desirable change or an undesirable
change.
UNIT 4
APITAL BUDGETING
C
Capital Budgeting is the process by which the firm decides which long-term investments to make
Capital Budgeting projects, i.e., potential long-term investments, are expected to generate cash
flows over several years.
ature of Investment Decisions
N
The investment decisions of a firm are generally known as the
capital budgeting, or capital expenditure decisions.
The firm’s investment decisions would generally include expansion, acquisition,
modernisation and replacement of the long-term assets. Sale of a division or business
(divestment) is also as an investment decision.
Decisions like the change in the methods of sales distribution, or an advertisement campaign
or a research and development programme have long-term implications for the firm’s
expenditures and benefits, and therefore, they should also be evaluated as investment decisions.
eatures of Investment Decisions
F
The exchange of current funds for future benefits.
The funds are invested in long-term assets.
The future benefits will occur to the firm over a series of years.
I mportance
Growth
Risk
Funding
Irreversibility
Complexity
ypes of decisions or Capital expenditure
T
Classification - 1
Expansion of existing business
Expansion of new business
Replacement and modernisation
Yet another useful way to classify investments is as follows:
Mutually exclusive investments Independent investments Contingent investments
rocess of CE
P
1. Project Generation (Identification of investment proposals)
2. Project Evaluation (Screening the proposals, Evaluation of various proposals using evaluation
criteria)
3 . Project Selection
4. Project Execution
5. Follow up
Evaluation criteria
1. Non-discounted Cash Flow Criteria
Also known as Traditional method
Unsophisticated method
Time value of money not considered.
2. Discounted Cash Flow (DCF) Criteria
Also known as Time adjusted method
Time value of money considered
1 . Non-discounted Cash Flow Criteria
Payback Period (PB)
Discounted payback period (DPB)
Accounting Rate of Return (ARR)
2. Discounted Cash Flow (DCF) Criteria
Net Present Value (NPV)
Internal Rate of Return (IRR)
Profitability Index (PI)
Advantages ❖ It is simple to understand and easy to calculate ❖ It gives importance on
liquidity
❖ It acts as an yardstick in comparing the profitability of two Projects
❖ It helps to understand the period required to recover the original investment, thus helping to
know the risk associated with the investment
Disadvantages ❖ It ignores the time value of money
❖ It fails to consider the post payback profit
❖ It over emphasis liquidity and ignores the life of an asset
❖ It doesn't consider the cost of capital
IMPROVEMENTS IN TRADITIONAL PAY BACK
iscounted Pay back period
D
It recognises the time value of money (money available at the present time is worth more than
the same amount in the future)
Using Present value table
The discounted payback period is the number of periods taken in recovering the investment
outlay on the present value basis.
The discounted payback period still fails to consider the cash flows occurring after the
payback period.
2. Pay Back profitability
Also known as Post Payback profitability method
Post pay back profitability Index =
Post Pay Back profit *100
Initial Investment
Post pay back profit= Total earnings beyond PBP + Scrap value
3 . Pay- Back reciprocal
Pay –Back reciprocal =
1
Pay-back period
CCEPTANCE RULE
A
The project would be accepted if its payback period is less than the maximum or standard
payback period set by management.
As a ranking method, it gives highest ranking to the project, which has the shortest payback
period and lowest ranking to the project with highest payback period.
VALUATION of ARR
E
The ARR method may claim some merits
Simplicity – Simple to calculate and easy to understand
It considers savings over the entire life of the project
Emphasis on profitability and not on liquidity
he ARR method may claim some demerits
T
✔ It ignores time value of money
✔ Average earnings is calculated considering the life period but investment is acsertained with
out reference to the life period
✔ It makes use of accounting profit and not cash flows
VALUATION OF PI METHOD
E
Time value:It recognises the time value of money.
Value maximization: It is consistent with the shareholder value maximization principle. A
project with PI greater than one will have positive NPV and if accepted, it will increase
shareholders’ wealth.
Relative profitability:In the PI method, since the present value of cash inflows is divided by
the initial cash outflow, it is a relative measure of a project’s profitability.
Like NPV method, PI criterion also requires calculation of cash flows and estimate of the
discount rate. In practice, estimation of cash flows and discount rate pose problems.
*REFER PPT FROM SLIDE 35*
