1] a) What is strategic financial management?

Strategic Financial Management (SFM) is the identification of the

possible strategies capable of maximizing an organization’s net present
value, the allocation of scarce capital resources between competing
opportunities and the implementation and monitoring of the chosen
strategy so as to achieve stated objectives". SFM combines the principles
of two disciplines - Strategic management and Financial management.
SFM refers to both financial management of all strategies; as well as the
strategic management of finances. The prefix "strategic", to financial
management, means that financial decisions have to be based on strategic
factors; and strategy must be based on financial evaluations.
Nature of Strategic Financial Management
i. SFM gives a financial dimension to strategic management and
control,
ii. SFM provides information on the financial aspects of strategic
plans and -planning financial aspects of their implementation
iii. SFM supports managers throughout the organization in the task of
managing the organization in the interests of all its stakeholders.
iv. SFM places an emphasis on using information from a wide variety
of internal and external sources in order to evaluate performance,
appraise proposed projects and make decisions.
v. SFM focuses on the external environment, such as suppliers,
customers, competitors and the economy in general as much as the
organization itself
vi. SFM monitors performance in line with the organization’s strategic
objectives in both financial and non-financial terms.
b) Functions of Strategic Financial Management
Strategic financial management is the management of the finances of the
organization in order to achieve the financial objectives of the
organization. Since financial management involved planning, control and
decision making to achieve the organizations goals the functions of SFM
are:
i. Financial Planning
ii. Financial Control
iii. Financial Decisions

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Financial Planning
The Chief Financial Officer (CFO) who is in charge of strategic financial
management will need to plan to ensure that enough funding is available
at the right time to meet the needs of the organization for short, medium
and long-term capital. In the short term, funds may be needed to pay for
purchases of inventory, or to smooth out changes in receivables, payables
and cash: the CFO has to ensure that the working capital requirements are
met. In the medium or long term, the organization may have planned
purchases of fixed assets (capital expenditure) such as plant and
equipment, for which the CFO must ensure that funding is available.

Financial Control
The control function of the CFO becomes relevant once funding has been
raised. The CFO has to analyze questions such as - Are the various
activities of the organization meeting its objectives? Are assets being
used efficiently? To answer these questions, the CFO may compare data
on actual performance

Financial Decisions
In the modern times, strategic financial management includes the three
main decisions namely investment, financing and dividend. Investments
in fixed and current assets must be planned. SFM is also concerned the
financing and management of short-term and long-term funds. Financial
management is also concerned with the dividend decision: how much of
the profits should the company pay out as dividends and how much
should it retain for investment to provide for future growth? The
following types of financial decisions also need to be made

- Decision Internal to the Business

 Whether to undertake new projects
 Whether to invest in new plant and machinery
 Research and development decisions
 Investment in a marketing or advertising campaign

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 - Decisions involving external parties
 Whether to enter in a joint venture with another enterprise
 Whether to carry out a takeover or a merger involving another
business
- Disinvestment Decisions
 Whether to sell off unprofitable divisions of the business
 Whether to sell old or surplus plant and machinery
 The Sale of Subsidiary companies

c) Techniques Employed by Strategic Financial Management

SFM consists of setting goals and strategies which help in identifying and
completing all of the company’s financial goals. Some of the techniques
employed By SFM are

- Budgeting
Budgeting is the most basic form of strategic management in addition to
creating budgets for the coming year, management conducts budget
variance analyses to determine where previous budgets were not accurate
and why. Using this information, the strategic management team makes
changes to the areas that caused negative budget results and looks to take
advantage of practices that caused better-than-budgeted results.

- Pricing Analysis
Pricing analysis helps determine setting the price of product and services,
projecting the effects of price increases and decreases can help managers
create strategic pricing strategies, such as selling at a low price to create
higher volumes or selling at higher prices, which might result in lower
volumes. Once this analysis is finished, managers can determine how
these strategies will affect gross profits.

- Cost Evaluation
One technique for analyzing the finances of a business is to calculate
overhead and production costs. Overhead costs are expenses related to
running a business regardless of what your sales levels are. Cost
evaluation helps with setting prices and can tell the management team if it
needs to undertake cost-containment as one strategy to achieve or
improve profitability. The analysis might determine that the company

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 cannot reduce production costs further and must reduce overhead
expenses, or vice versa.

- Cash Flow Management

Strategic management includes managing cash flow, ensuring the
company has enough cash or credit to pay its bills. Part of this strategy
includes setting procedures for issuing credit to customers, negotiating
credit terms with suppliers and maintaining cash reserves. This strategic
management of cash helps prevent losing access to supplies and
materials, which can lead to production stoppages and loss of customers.

- Performance Analysis
If a business is considering buying another company or shutting down a
division, management reviews the performance of the business or
division to determine not only its profitability performance, but also its
financial effects on the rest of the company. Acquiring a profitable
business might put too much stress on the acquiring company’s
administrative staff or debt-service abilities. Shutting down a division
that is not profitable might free up resources the company could use to
generate larger profits in other division

c) Scope of Strategic Financial Management

Strategic financial management involves a lot of steps and processes to
ensure all the financial goals are met in time some functions of SFM are
i. Strategic investment management decisions
Strategic Financial Management involves a lot of decisions making
related to the short term and long-term benefits of the company,
a lot of capital budgeting techniques are available to analyze the
risk and return levels to understand and make proper decisions

ii. Strategic financial management decisions

SFM takes into the account the amount of funds which are required
in the long run for which we need to determine how much of debt
and how much of fixed sources are to be considered.

iii. Strategic liquidity management decisions

It is very important to understand the liquidity management of the
companies to understand how much cash reserves should be kept

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 for future contingencies, if there is no liquidity there will be agony
in the future.

iv. Strategic value creation of the firm

If the market status of the firm shows it as consistently well
performing and achieving results it will win the trust of existing
and potential stakeholders and investors which indirectly also
increases the worth of the companies in the capital market.

v. Strategic profitability management

One of the main goals of the company is make profits and a
company cannot sustain in future unless adequate profits have been
generated for the company.

2) What are cash credit and public deposit as a source of finance.

Explain their merits and demerits of each?

Cash credit and public deposits are source of funds for raising short- and
medium-term requirement of funds mainly for working capital
The sources of funds refer to the mediums by which an organization
raises its long-term capital and working capital,
The organization can select any of the sources of funds depending upon
the need and gestation period of the project to be financed.
There are several sources of funds available to any company an effective
evaluation of various sources of funds available to the company is a must
to achieve its main objects. Some of the factors that need to be considered
while choosing a source of fund are:
- Cost source of fund
- Term
- Leverage planned by the company
- Financial conditions prevalent in the economy
- Risk profile of the company as well as this industry in which it
operates

Public Deposits
Public deposits are very important source of short term and medium-term
finances particularly due to the credit squeeze by the Reserve Bank of
India. A company can accept public deposits subject to the stipulations of
the Reserve Bank of India from time to time maximum up to 35% of its

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paid-up capital and reserves from public and shareholders, these deposits
may be accepted for a period of six months to three years. Public deposits
are unsecured they should to be used to buy fixed assets as they are to be
repaid within a period of three years these are mainly used to finance
working capital requirement’s
The merits of public deposits are:
For the Company
i. The procedure for obtaining public deposits is fairly simple
ii. No restrictive covenants are involved
iii. No security is offered against public deposits
iv. The post-tax cost is fairly reasonable
For the Investor
i. The rate of interest is higher than several alternative forms of
financial investment
ii. The maturity period is fairly short one to three years.

The demerits of public deposits are:

For the Company
i. The quantum of funds that can be raised by public deposits is
limited
ii. The maturity is relatively short
For the Investor
i. There is no security offered by the company
ii. The interest from public deposits is not exempt from taxation

Cash Credit
Cash credit is a form of short-term loan advance given from banks
cash credit is an arrangement in which a customer is allowed an advance
up to a certain limit against credit granted by the bank ,Under this
arrangement, a customer need not borrow the entire amount of advance at
one time he can only draw to the extent of his requirements and deposit
the surplus funds in his account. Interest is not charged on the full amount
of the advance but on the amount actually availed of by him. Generally,

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cash credit limits are sanctioned against the security of tradable goods by
way of pledge or hypothecation. Though these accounts are repayable on
demand, banks usually do not recall such advances, unless they are
compelled to do so by adverse factors. Hypothecation is an equitable
charge on movable goods for an amount of debt where neither possession
nor ownership is passed on to the creditor. In case of pledge, the borrower
delivers the goods to the creditor as security for repayment of debt. Since
the banker, as creditor, is in possession of the goods, he is fully secured
and in case of emergency he can fall back on the goods for realization of
his advance under proper notice to the borrower.

The merits of cash credit are:

i. Fulfills the working capital requirement for day to day business
ii. Interest is only charged on the amount withdrawn
iii. Cash credits are arranged at ease and at short notice by the bankers.
iv. Cash credit is very flexible and can make withdrawals and deposits
any time

The demerits of cash credit are:

i. Higher rate of interest
ii. Minimum commitment charges
iii. Restricted Time Period
iv. Withdrawal for a specific purpose
v. More difficult for new businesses to secure

3) What are the assumptions of the Baumol’s Model?

The Baumol model of cash management is extensively used and highly
useful for the purpose of cash management. The Baumol model enables
companies to find out their desirable level of cash balance under
certainty.
The Baumol model developed by William J Baumol assumes that the
concerned company keeps all its cash in interest yielding deposits from
which they withdraw as and when required. It also assumes that the cash
usage is linear over time, the amount of money is withdrawn in such a
way that the cost of withdrawal is optimally balanced with those of
interest forgone by holding cash

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 The Formula for economic lots size = √2AT/H
A = Projected cash requirement
T = Conversion Cost per Lot
H = Interest earned on marketable securities per Annum
The model has the following assumptions
 The cash needs of the firm are known with certainty
 The cash is used uniformly over a period of time and it’s also know with
certainty
 The holding cost is known and constant
 The transaction cost remains constant
 Funds can be held in either money or short-term investments (e.g.,
marketable securities)
The disadvantages of the model are
 In reality it’s unlikely to be possible to predict amounts required over
future periods with much certainty
 No buffer/inventory cash is allowed and there maybe costs associated
with running out of cash
 There may be other normal costs of holding cash which increase with the
average amount of cash held.

4) Practical Problem

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 Calculation of Initial Cash Flow
Particulars Amt Amt
Cost of New Machine   1,00,000
Less: Sales Proceeds of Old Machine 20,000  
Tax savings on loss of sale of old machinery 5,000  
Release of Working Capital 10,000 -35,000
Net Cash outflow   65,000

Calculation of Variable Cost Per Unit (Labour + Material +Overheads)

Particulars Amt
Old Machine 23
Less: On New Machine -15
Variable cost saving per unit 8

Calculation of Cash Inflow Per Annum

Particulars Amt Amt
Cost Savings (6,000 x 8) 48,000  
Less: Tax @ 50% -24,000 24,000
Tax Savings on Account of additional depreciation    
Depreciation on New Machine 10,000  
Less Depreciation on Old Machine -3,000  
Additional Depreciation 7,000  
Less Tax -3,500 3,500
Net Cash Inflow   27,500

PV of Cash Inflow
Years Net Cash Inflow PV of Annuity Total PV
1 to 9 27,500 5.759 1,58,373
10 27,500 0.386 10,615
1,68,988
Total PV of Cash Inflow: 1,68,988
(-) Less PV of Cash Outflow: 65,000
NPV - 1,03,988
NPV is Positive hence the proposal shall be accepted and equipment acquired.
Depreciation for new and old machine calculated on SLM method