Advanced Financial Management

Theory Questions Submitted To

Prof. Ghanachari

By Tarkesh Chavan 10 Prathamesh Deo 11 Mandar Deshmukh 12 Chintamani Dhamapurkar 13 Priyam Gaekwad 15


Q. It is an estimate of two essential future financial outcomes for a business – your projected income and expenses. or plan for them accordingly in your next budget. balance sheets and. financial forecasts are an estimate of future income and expenses for a business over the next year and are used to develop the projections of profit and loss statements. like your business plan. take any remedial action necessary to correct the problem. A financial forecast is the best guess of what will happen to your business financially over a period of time. instead of it controlling you. However. A financial forecast is a vital tool in the financial management of your business and. or financial plan) helps you achieve your goals and get your business to where you want it to be. a financial forecast (often called a cash budget. Examine why variations have occurred. You will then know exactly how much you need to make every month for a profitable business. It allows you to control your money so you are more likely to achieve your desired net profit. frequent forecasting with adjustments as required will promote more accurate forecasting. 2 . Predicting the financial future of your business is not easy. most critically. the cash flow forecast. so you can control the cash flow of your business. especially if you are starting a business and do not have a trading history. especially if it is for the purpose of getting a bank loan. good forecasting can help reduce your business risk. Explanation of Financial Forecast: A financial forecast is simply a financial plan or budget for your business. cash flow. your financial forecasts will be inexact and inaccurate. Much like a map helps you plan a long road trip. Create a cash flow forecast by adding income and expenses as they are due. Initially. Preparation of a Financial Forecast: The financial forecast is critical to your business plan. be sure to compare the actual results against your budget forecasts. However.1 What do you understand by Financial Forecasting? How a proforma of Profit and Loss Accounts and Balance Sheet is constructed? The lack of planning and control of cash resources is the reason often given for the failure of many small businesses in Australia. A financial forecast is a tool that allows you to use your resources where they're most needed. Usually. requires regular review and amendment to be effective. you are an investor in your own business and you must have confidence in the validity of your business concept. More importantly. Use a financial forecast to prove to yourself that your business will generate your desired profit and when it will start to make that profit. Once the period for which you prepared the budget is over.

Lenders and investors require financial forecasts to show your capacity to repay the loan. Use the components listed below to develop a cash flow forecast for your own small business. your sales forecast should reflect the capacity of production equipment mentioned in the operational section. You may need help from your accountant to assemble the figures in the conventional format.  Allows you to measure the actual financial operation of the business against the forecast financial plan and make adjustments where necessary. Allows you to construct a model of how your business might perform financially if certain strategies.  Identifies potential risks and cash shortfalls to keep the business out of financial trouble.  Assists you to secure a bank loan or other funding. and what resources you need to keep the business profitable. Combine the components of your financial forecasts to generate projected financial statements.      Cash flow forecast Establishment costs Sales forecast Cost of goods sold forecast Expenses forecast 3 . The components of a Financial Forecast: Creating a financial forecast shows you the financial requirements to start the business. but the research and operational assumptions should be your own. make sure your estimates and assumptions are realistic. For example. Be consistent and make sure that your financial forecast reflects the rest of the business plan. You can develop your own financial forecast by using the spread sheets to complete the individual components.  Allows you to guide your business in the right direction and take control of your cash flow. Your financial forecast will be based on information gathered from industry and market research. and profit and loss statement). convince you and your bank of the viability of your business or your business growth.  Provides a benchmark against which to measure future performance. Since you will be responsible for achieving the predetermined financial objectives.  Provides an estimate of future cash needs and whether additional private equity or borrowing is necessary. (balance sheet. Then add the timing dimension (when you expect to receive payment and the amount) over 12 months to generate an annual cash flow forecast. events and plans are carried out.Advantages of an effective financial forecast:  Demonstrates the financial viability of a new business venture.

it is a capital asset. For example. inventory and pre-paid expenses (such as pre-paid insurance).How to Do a Balance Sheet for A Business Start-up The start-up balance sheet is simple if you know how to make and sort a list. If you purchase a vehicle to re-sell it. so you may need to finance your starting inventory with bank debt or equity.Forecasting Your Assets: A: Determine and Budget your Current Assets Starting Cash (You must have enough to cover your start-up expenses) Starting Inventory Pre-Paid Expenses (Usually Insurance) Other Current Assets Total Current Assets (A) B: Determine your Capital Asset needs. Fixturing & Other Automobiles Computers and Data Processing Equipment Leasehold Improvements Tools and other assets valued at Less than $200 Computer Software (Excluding Systems software) Other Capital or Intangible Assets Total Capital Assets (B) Your Total Assets are A + B Step II. licenses. Sometimes there is a third asset list. They are: 1.Forecasting your Liabilities and Equity Now that you have an estimate of how much you need to get started. quotas. Venture Capital for start-up businesses is exceedingly rare. You need to make two lists to get started. if you purchase a vehicle to use in the business. These are items you purchase with the intention of keeping them and using them to run the business. their suppliers and the bank. patents and trademarks. Although Accounts Receivable is another example of a current asset. There are typically three sources of debt financing in a business start-up. The first list is your list of Current Assets. These are assets (things your business owns) which will be used up within the first year of doing business. Supplier credit is not always afforded to a new business. There are only two places this money comes from when you are starting up − loans or investment. Either way it is considered as a loan to the company. you must determine how best to finance your business start-up. there are no accounts receivables in a business start-up. Typically they include cash. however. goodwill. however some suppliers will provide longer term financing for equipment or automobiles. Most businesses are financed through three sources: the owners. Usually this is for inventory. These are not common in most business situations except where you are purchasing an existing business. Supplier Credit: Sometimes a supplier will provide credit to their customers. Machinery and Equipment Office Furnishings. then that vehicle is inventory. These are known as Intangible Assets and are things such as franchise fees. 4 . The second list is the Capital Assets. Step I.

which are the profits. as a shareholder. lend money to the corporation. The loan is repaid over a period of time. You. Bank Line of Credit: This is similar to an overdraft for a business. It is not usual to finance a business start-up with a line of credit. kept in the business to ensure its growth. Shareholders Loans: This can only happen in a limited company. and the interest rate may be fixed or floating. One sure way to have a cash flow crunch is to have used all your cash and line of credit to purchase a piece of equipment. It is. Using the information discussed above you can create the starting Balance Sheet: Starting Balance Sheet Assets Liabilities Current Assets Current Liabilities Cash Line of Credit Inventory Supplier Credit Prepaid Expenses C Total Current Liabilities A Total Current Assets $ _____ Non Current Liabilities Capital Assets Term Loans Machinery & Equipments Vendor Credit Office. Seek professional advice before deciding if using a shareholder loan is the best strategy for your business start-up. It is important to use the line of credit to finance current assets and the term loan to finance capital assets. This is an alternative method of investing in the company. 3. Bank Term Loan: A bank term loan is usually used for financing the capital assets of the business. Futuring Shareholder Loans & other D Total Non Current Liabilities Automobiles Computers & Data Processing C + D Total Liabilities Equipments Leasehold Improvements Equity Tools and Other assets valued Investment At less than $200 Computer Software (excluding E Total Equity systems software) C+D+E Other Capital or Intangible Assets Total Liabilities + Equity B Total Capital Assets $____ A + B Total Assets $____ $ ____ $ ____ $ ____ $ ____ $ ____ 5 . Investment: This is the equity investment you put into your own company.2. acceptable to finance short-term cash deficits using your line of credit. only to run out of cash due to a late paying customer. however. Furnishings. It can sometimes be used to finance part of a business start-up or business acquisition. after income tax. The other type of equity is Retained Earnings. There is no retained earnings in a start-up company.

A weather forecast is something you try to forecast. You will need to forecast the number of units of each type you plan to sell. The sum of the cost of goods is then part of the income statement. for a researcher.g. A sales forecast is not like a weather forecast. You can then develop a sales forecast using the following equation: Price per unit × Number of Units sold = Revenue Your marketing section must support sales volume and price and your operating section must support this level of production. The Sales Forecast The sales forecast is probably the most difficult part of the business to forecast. Try to compare this to the market size and the number of competitors in the market. then forecast the revenue in each area for the total sales forecast.000 items in a gift store. 6 .Note That Total Assets (A+B) Are equal to Total Liabilities + Equity (C+D+E) The Income Statement Forecast The purpose of the Income Statement Forecast is to project the revenues and expenses of your business over a given period of time – usually one year. you may use either the unit costing method or the percentage cost method. A sales forecast is a goal you set for the business that you proactively try to achieve. Forecasting with the Sales Method Sometimes a business cannot use unit sales. Other terms for this are budgeted income statement or pro forma income statement. In the case of an existing business. and then account for new products to be added or old products to be taken away. for a craftsperson. The Cost of Goods Forecast The cost of goods forecast relates directly to the sales forecast. To calculate the cost of goods forecast. especially for a starting business. you must do this for each unit sold. Different businesses and industries use different unit measures (e. a unit could be one hour of time).. you use cost per unit. Unit Costing Method This method is exactly like the unit sales forecast. The sales forecast must reflect your business strategies and objectives. the break-even can provide a starting point for creating the sales forecast. If the business is broken down into logical departments or categories. Cost of goods = Number of units sold x Cost per unit Just as in the unit forecast. a unit may be one wooden item. except instead of using price. You should see if your sales are trending up or down. but something over which you have no control. You will have to estimate the selling price for each unit. Demonstrate that you can make this number of units. the cost of goods projection and the overhead projection. some business owner will go directly to revenue forecast. sell this number of units and justify the price you charge. The cost of producing goods varies directly with the level of sales. There are three things that need to be predicted to forecast your income statement: the sales projection. Sometimes. you should look at the sales history. as it would be impossible to predict the unit sales for each of 5. In this case. Forecasting using the Unit Method List all the products or services you plan to sell.

The Percentage Cost Method In retail businesses. It should also be noted that in a proprietorship. For example. You can use the historical cost complement or industry standards to forecast the cost of goods and gross profit for your income statement. You may do them monthly. The profits kept in the business are known as retained earnings. you will have to make a management decision about how much you plan to spend in order to achieve your revenue objectives. If you have a business history. it is common to use the cost complement to calculate the cost of goods.e. in an existing business. describing the key expense of forecasted items (i. you may have a quote from a broker for your insurance projection). or annually. however. which represents the cost of goods. These earnings are reflected in the owners’ equity portion of the balance sheet. 7 . This list should be similar to the list developed for the fixed costs of your break-even analysis. Typical overhead expenses include:  Advertising and Promotion  Automobile  Bank and Finance Charges  Communications  Depreciation  Insurance  Entertainment and Meals  Occupancy  Owners’ Drawing or Wage  Mail and Office Supplies  Professional Fees  Professional Development  Wages and Benefits  Travel and Accommodations & Others. there is a large change in the statement. or the selling price. The cost complement is the percent of the revenue.00 and is priced at $20. This is especially true if. You should make a brief note to the reader of the plan.00 / $20.00 = 60%. where mark-ups and markdowns predominate. income tax is paid on the net profit – not the owner’s draw. Note: The term draw in a Proprietorship refers to the money that the owner takes out of the company. if an item costs $12. Some of your forecasts will be a matter of calling a supplier and asking for a quote – insurance is an example of this kind of overhead. The Overheads Forecast The overhead forecast is an estimate of your expenses for the year. you will eventually need to know your monthly expenditure in each area for your cash flow forecast. (If the cost complement is 60% then the Gross Profit Margin is 40%). Sometimes. The next step is to make cost estimates for each area.00 then the cost complement is $12. making sure that increases and decreases in cost are consistent with your revenue objectives. you should use that history as a guide.

provisioning of bad debts. 4) New private sector banks were licensed and branch licensing restrictions were relaxed. the banking system probably had a negative net worth when all financial assets and liabilities were restated at fair market values . marking to market of investments. public equity issues and subordinated debt. however. With the possible exception of two or three weak banks. The threat of insolvency that loomed large in the early 1990s was. 3) Pre-emption of bank resources by the government was reduced sharply. At the peak of this crisis.This unhappy state of affairs had been brought about partly by imprudent lending and partly by adverse interest rate movements. classification of assets. At the beginning of the reform process. painted a very different rosy picture. 2) Prudential norms were introduced and progressively tightened for income recognition. Important reforms taken place in India in the following sector since 1991 . but also permitted them to recognize as income the overdue interest on these loans. 2001 Sales XXXX Less Cost of Goods XXX Gross Profit XXX Expenses Advertising XXX Depreciation XXX Interest XXX Rent XXX Travel XXX Wages XXX Total Expenses XXX Net Profit Less Owner’s Draw XXX Net Profit after Draw XXX Q. 8 .2. by and large. corrected by the government extending financial support of over Rs 100 billion to the public sector banks. Accounting policies not only allowed the banks to avoid making provisions for bad loans. The major reforms relating to the banking system were: 1) Capital base of the banks were strengthened by recapitalization. Capital adequacy has been further shored up by revaluation of real estate and by raising money from the capital markets in the form of equity and subordinated debt.Emphasizing on Banking sector and Capital Market (Primary and Secondary market). the public sector banks have now put the threat of insolvency behind them. the balance sheets of the banks.Sample Income Statement: XYX PROPRIETORSHIP Income Statement Year Ending December 31. The banks have also used a large part of their operating profits in recent years to make provisions for non-performing assets (NPAs). The severity of the problem was thus hidden from the general public.

That should be the true test of the success of the banking reforms. The higher end of this range probably reflects excessive pessimism. Concomitantly. They have been forced to raise resources at market rates of interest. Interest rate deregulation and financial repression Perhaps the single most important element of the financial sector reforms has been the deregulation of interest rates. whether the banks now possess sufficient managerial autonomy to resist the kind of political pressure that led to excessive NPAs in the past through lending to borrowers known to be poor credit risks. 9 . It is pertinent to note that independent estimates of the percentage of bank loans which could be problematic are far higher than the reported figures on non-performing assets worked out on the basis of the central bank’s accounting standards. It is too early to judge the success of these attempts. In the process. There are really two questions here. it will be several more years before the unhealthy legacy of the past (when directed credit forced banks to lend to uncreditworthy borrowers) is wiped out completely by tighter provisioning. Responding to these changes. 1991). governments in developed countries like the United States have expended 3-4% of GDP to pull their banking systems out of crisis (International Monetary Fund. For example. financial institutions have attempted to restructure their businesses and move towards the universal banking model prevalent in continental Europe. Turning to financial institutions.5) At the same time. several operational reforms were introduced in the realm of credit policy: 6) Detailed regulations relating to Maximum Permissible Bank Finance were abolished 7) Consortium regulations were relaxed substantially 8) Credit delivery was shifted away from cash credit to loan method. Though bank profitability improved substantially in 1996-97. a recent report estimates potential (worst case) problem loans in the Indian banking sector at 35-60% of total bank credit (Standard and Poor. The working results of the banks for 1995 96 which showed a marked deterioration in the profitability of the banking system was a stark reminder that banks still have to make large provisions to clean up their balance sheets completely. Second. most bank lending. The even more daunting question is whether the banks' lending practices have improved sufficiently to ensure that fresh lending (in the deregulated era) does not generate excessive non-performing assets (NPAs). economic reforms deprived them of their access to cheap funding via the statutory pre-emptions from the banking system. the subsidized rates at which they used to lend to industry have given to market driven rates that reflect the institutions’ cost of funds as well as an appropriate credit spread. whether the banks' ability to appraise credit risk and take prompt corrective action in the case of problem accounts has improved sufficiently. 1997).5% of GDP. institutions have been exposed to competition from the banks that are able to mobilize deposits at lower cost because of their large retail branch network. 1993) and governments in developing countries like Chile and Philippines have expended far more (Sunderarajan and Balino. By comparison. First. However. The government support to the banking system of Rs 100 billion amounts to only about 1. Interest rates were freed on corporate bonds. It is difficult to give an affirmative answer to either of these questions (Varma 1996b). it would be incorrect to jump to the conclusion that the banking system has been nursed back to health painlessly and at low cost. and bank deposits above one year maturity. but the lower end of the range is perhaps a realistic assessment of the potential problem loans in the Indian banking system.

priority sector lending. Administered interest rates are now confined mainly to short term bank deposits. sub-brokers and other intermediaries Dematerialization of scrips was initiated with the creation of a legislative framework and the setting up of the first depository On-line trading was introduced at all stock exchanges. and tentative moves were made towards a rolling settlement system. Loan syndication most often occurs in situations where a borrower requires a large sum of capital that may either be too much for a single lender to provide. and deposits of non-banking financial companies. In the last five years. Q. bankers to the issue and other intermediaries In relation to the secondary market too. quite often the ceiling has not been a binding constraint in the sense that actual interest rates have often been below the regulatory ceiling. Margining system was rigorously enforced. at an appropriate rate agreed upon by all the lenders. Capital Markets: The major reform in the capital market was the abolition of capital issues control and the introduction of free pricing of equity issues in 1992.Introduction of auctions coupled with reduced pre-emption led to more market determined interest rates for government securities. For all practical purposes. SEBI has framed regulations on a number of matters relating to capital markets. underwriters. financial markets are increasingly able to perform the important function of allocating resources efficiently to the most productive sectors of the economy.3 what is Loans Syndication? When does a company need to raise its Syndicate Loans? Definition: The process of involving several different lenders in providing various portions of a loan. Similarly. or may be outside the scope of a lender's risk exposure levels. Thus. carry forward trading was banned and then reintroduced in restricted form. Even on short term retail bank deposits which are still regulated. the prices of most other financial assets are also now determined by the more or less free play of market forces. several changes were introduced: Capital adequacy and prudential regulations were introduced for brokers. financial repression is a thing of the past. multiple lenders will work together to provide the borrower with the capital needed. Moreover. the ceiling rate is well above the historic average rate of inflation. Some of the measures taken in the primary market include: Entry forms for capital issues were tightened Disclosure requirements were improved Regulations were framed and code of conduct laid down for merchant bankers. Settlement period was reduced to one week. Simultaneously the Securities and Exchange Board of India (SEBI) was set up as the apex regulator of the Indian capital markets. This must count as one of the most enduring and decisive successes of the financial reforms. mutual funds. Consequently. 10 .

each lender limits its loan amount to a manageable size. less obvious advantages to going with a syndicated loan.Explains: Mainly used in extremely large loan situations. loan syndications involve a lead financial institution. In these cases. the burden of repaying the loan and syndication fee is shouldered ultimately by the borrower. often more than a single lender is able or willing to provide. How It Works/Example: When a project is unusually large or complex. identifying lenders while negotiating terms and conditions. including repayments. acquisitions and buyouts. These benefits include: 11 . the amount of the loan may be too large. Advantages of Syndicate Loans: Economists and syndicate executives contend that there are other. where borrowers often need very large sums of capital to complete a transaction. If one loan is too large. Usually. it may exceed the capacity of a single lender. Loan syndication is common in mergers. For example. Loan syndication fees can be expensive. While the syndication fee is usually financed. the loan syndication limits the liability of each lender to its share of the loan interest. the risks too high. Loan syndications involve a large amount of coordination and negotiation. reporting and compliance. such transactions require the services of a specialist who syndicates the loan on behalf of the borrower. each lender may have a collateral interest in a unique or specialized asset from the borrower. At the same time. which organizes and administers the transaction. In this way. a financial institution may bring other lenders into the deal. or syndicate agent. it may overweight the bank's portfolio. banks may pursue a syndication to accommodate a loan and keep its portfolio in balance. Therefore. because the lender isn't the only creditor. the collateral may be in different locations. syndication allows any one lender to provide a large loan while maintaining a more prudent and manageable credit exposure. loan syndications may incur a large expense to the borrower. and limits its risk exposure. Often. and loan monitoring. Why It Matters: Loan syndications can be a useful tool for banks to maintain a balanced portfolio of loan assets among a variety of industries. Typically. fees. and even representing the borrower throughout disbursements. ranging from 5% to 10% of the loan principal. such as a piece of equipment. or the uses of capital may require special expertise to understand and manage it. Additionally.

     12 . and prepayment rights without penalty. including multi-currency options. Syndicated loan facilities can increase competition for your business. Loan terms can be abbreviated. Borrowers have a variety of options in shaping their syndicated loan. Syndicated loans bring the borrower greater visibility in the open market. prompting other banks to increase their efforts to put market information in front of you in hopes of being recognized. Syndicated facilities bring businesses the best prices in aggregate and spare companies the time and effort of negotiating individually with each bank. risk management techniques. Flexibility in structure and pricing. Syndicate banks sometimes are willing to share perspectives on business issues with the agent that they would be reluctant to share with the borrowing business. Increased feedback.

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