Scope of Financial Management

Financial Management involves the application of general management principles to particular financial operation

Objectives of Financial Management

 Maximization of shareholders wealth

Financial Management Decisions

 Financing  Investment  Dividend  Working capital management

Difficulties
 Measurement problems  Uncertainty  Temporal spread

Investment decisions-Capital Expenditure decisions

Importance
 Long term effects  Irreversibility  Substantial outlays

Investment decisions-Capital Expenditure decisions

Difficulties  Measurement problems  Uncertainty  Temporal spread

Phases of capital budgeting

 Planning  Analysis  Selection  Implementation  Review

SELECTION
Criterion Pay back period (PBP) Accept when PBP < target period

Accounting rate of ARR > target rate return(ARR) Net present value (NPV) NPV > 0 Internal Rate of IRR > cost of capital Return(IRR) Benefit cost ratio (BCR) BCR > 1 /Profitability Index

Various facets of project Analysis

 Market analysis  Technical analysis  Financial analysis  Economic analysis  Ecological analysis

Sources of finance
Permanent sources
 Share capital  Retained profits

Long term sources

 Redeemable preference shares  Debentures  Long term loans  Seed capital / venture capital

Sources of finance
Medium term sources
 Medium term loans  Deferred credit  Public deposits  Working capital term loans

Sources of finance
Short term sources
 Cash credit  Overdraft  Bills discounting  Commercial paper  Trade credit

Study of financial Statements:

Financial Statements means Balance Sheet, P & L A/c and sources and uses of funds statement

Basic concepts underlying financial Accounting  Entity concept  Money measurement concept  Stable monetary unit concept  Going concern concept  Cost concept  Conservatism concept  Dual aspect concept

Finance topics- Balance Sheet

Share capital Equity/preference Reserves & Surplus Secured Loans Debentures Loans & Advances Unsecured loans Current Lia/provisions Trade creditors Provisions Capital Structure Cost of capital

Working capital financial policy

Finance topics- Balance Sheet

Fixed Assets (Net) Investments Cash & Bank Receivables Inventories Capital budgeting decisions Security Analysis Cash Management Credit Management Inventory Management

Basics of Financial Statement analysis

 Horizontal analysis- analysis involves the computation of amount changes and percentage changes  Vertical Analysis- uses percentages to show the relationship of the different items to the total in a single statement. Sets a total figure equal to 100 % and compute the percentage of each component of that figure

Basics of Financial Statement analysis

 Trend Analysis :Percentage changes are calculated for several successive years instead of between two years.  Ratio Analysis: Represent meaningful relationship between two numbers

Common size statements

 The numbers are brought to common base i.e. per cent.  Make comparisons of business enterprises of different sizes more meaningful  It can be prepared in vertical analysis format or horizontal analysis format

FUND FLOW STATEMENT, CASH FLOW STATEMENT

The fund flow and cash flow statement potrays the flow of funds through the business during the given accounting period.

Funds are defined as working capital or as cash.

The sources and uses of funds statement, on working capital basis, present I). Sources of working capital ii). Uses of working capital and iii) net changes in working capital.

Here working capital is defined as the net working capital which is simply the difference between the current assets and current liabilities.

The sources of working capital and uses of working capital are as under:

SOURCES Operations( net profit + Depreciation) Issue of Working share capital capital Pool Long term borrowing Sale of non current assets

USES Dividend payment Repayment of long term borrowings Purchase of non current assets

The sources and uses of funds statement: cash basis The sources and uses of fund statement, on cash basis shows, I ) the sources of cash ii) the uses of cash and iii) the net change in cash.

The sources and uses of cash are listed below:

SOURCES Operations( net profit + Depreciation) Issue of share capital Long term borrowing Sale of non current assets Increase in current liabilities Decrease in current assets other than cash

USES Dividend payment Repayment of long term borrowings Purchase of non current assets Decrease in current liabilities Increase in current assets other than cash

RATIO ANALYSIS: A Ratio is an arithmetical relationship between two figures. Financial ratios have been classified into five categories as follows:

LIQUIDITY RATIO Current Ratio= CA /CL Quick ratio = Quick assets* / current Liabilities * excl. inventories

LEVERAGE RATIO DER = Debt /Equity Int.coverage.ratio = PBIT+Depreciation / Int. on debt. DSCR = PAT+Dep+Int. on debt /Int. on debt + installment of debt

TURNOVER RATIO Inventory turnover ratio = cost of goods sold / Av. Inventory Fixed assets turnover ratio = Net sales /Av. Net fixed assets. Total asset turnover ratio = Net sales / Av. Total assets

PROFITABILITY RATIO GP margin = Gross profit / Net sales Net profit margin = Net profit / sales Return on total assets = PAT / Av. Total assets

VALUATION RATIO EPS = Equity earnings / Number of shares Price Earning Ratio = Market price per share/ EPS Yield = Dividend + price change /Initial price.

A CASH FLOW EXAMPLE

The timing of the cash flows is critical for determining the Project's value. below the line for cash investments or above the line for returns.

Rs.51 Lakh Year 1 Rs.102 lakh

Rs.51 Lakh Year 2

Rs.61 Lakh Year 3

Year 0

Net Present Value Year Cash Flow Dis. Factor @10% 0 -102 1 1 51 0.90909 2 51 0.82645 3 61 0.75131 NPV

Present Value -102 46.36359 42.14895 45.82991 32.34245

The evaluation of any project depends on the magnitude of the cash flows, the timing and the discount rate. The discount rate is highly subjective. The higher the rate , the less a rupee in the future would be worth today. The risk of the project should determine the discount rate.

Internal Rate of Return (IRR) IRR is the rate at which the discounted cash flows in the future equal the value of the investment today. To find the IRR one must try different rates until the NPV equals zero.

@27% 0 1 2 3 NPV -102 51 51 61 1 0.78740 0.62000 0.48818

Value -102 40 32 30 0