Group 2

TOPIC 1
Financial Planning
Definition:

Financial Planning is the process of estimating the capital required and determining it’s competition. It is the
process of framing financial policies in relation to procurement, investment and administration of funds of an
enterprise.

Significance of Financial Planning

Financial Planning is process of framing objectives, policies, procedures, programmes and budgets regarding
the financial activities of a concern. This ensures effective and adequate financial and investment policies. The
importance can be outlined as:

- Adequate funds have to be ensured.

- Financial Planning helps in ensuring a reasonable balance between outflow and inflow of funds so that
stability is maintained.

- Financial Planning ensures that the suppliers of funds are easily investing in companies which exercise
financial planning.

- Financial Planning helps in making growth and expansion programmes which helps in long-run survival of the
company.

- Financial Planning reduces uncertainties with regards to changing market trends which can be faced easily
through enough funds.

- Financial Planning helps in reducing the uncertainties which can be a hindrance to growth of the company.
This helps in ensuring stability an d profitability in concern.

Functions of financial planning

Financial planning helps you determine your short and long-term financial goals and create a balanced plan to
meet those goals.

Income: It's possible to manage income more effectively through planning. Managing income helps you
understand how much money you'll need for tax payments, other monthly expenditures and savings.

Cash Flow: Increase cash flows by carefully monitoring your spending patterns and expenses. Tax planning,
prudent spending and careful budgeting will help you keep more of your hard earned cash.
Capital: An increase in cash flow, can lead to an increase in capital. Allowing you to consider investments to
improve your overall financial well-being.

Family Security: Providing for your family's financial security is an important part of the financial planning
process. Having the proper insurance coverage and policies in place can provide peace of mind for you and your
loved ones.

Investment: A proper financial plan considers your personal circumstances, objectives and risk tolerance. It
acts as a guide in helping choose the right types of investments to fit your needs, personality, and goals.

Standard of Living: The savings created from good planning can prove beneficial in difficult times. For
example, you can make sure there is enough insurance coverage to replace any lost income should a family
bread winner become unable to work.

Financial Understanding: Better financial understanding can be achieved when measurable financial goals are
set, the effects of decisions understood, and results reviewed. Giving you a whole new approach to your budget
and improving control over your financial lifestyle.

Assets: A nice 'cushion' in the form of assets is desirable. But many assets come with liabilities attached. So, it
becomes important to determine the real value of an asset. The knowledge of settling or canceling the liabilities,
comes with the understanding of your finances. The overall process helps build assets that don't become a
burden in the future.

Savings: It used to be called saving for a rainy day. But sudden financial changes can still throw you off track.
It is good to have some investments with high liquidity. These investments can be utilized in times of
emergency or for educational purposes.

Ongoing Advice: Establishing a relationship with a financial advisor you can trust is critical to achieving your
goals. Your financial advisor will meet with you to assess your current financial circumstances and develop a
comprehensive plan customized for you.

Budgeting
Definition:

Budgeting in its general sense is the act of quantifying objectives in financial terms. Budgeting assists managers
in decision making process in an organization. It is the process of preparing detailed projections of future
amounts. Companies often engage in two types of budgeting:

• Operational budgeting

• Capital budgeting

Operational Budgeting

In a business, the budgeting for operations will include preparing the following projections for the next
accounting year:

• Amounts for sales

• Amounts for producing goods

• Amounts for each department's expenses

• Summarizing the above budgets into a master budget or profit plan

• Cash receipts and disbursements for a cash budget

• Projected financial statements also referred to as pro-forma financial statements

Once prepared and approved, the budgeted amounts are used as a guide or road map in controlling the next
year's business activities.

Capital Budgeting

It involves future projects which overlap several or many future accounting periods. Capital budgeting usually
means listing each project along with its cash outlays and expected cash inflows for each year. The amounts
should be discounted to their present values and also ranked by priority and profitability.

Once prepared, the capital budget provides a guide for investing in future fixed assets as well as arranging for
the financing of the projects.

Significance for Budgeting

Planning. In the development of operational and project plans, proposed activities like acquisition of new
equipment or system, creation of a new product or product line, or increasing sales volume,etc., should involve
profit generation. The profit to be generated in the execution of the plan is found in the pro-forma or budgeted
income statements. The budgeted income statement helps management in planning the way to achieve the
desired profit found in the budgeted income statement.

Coordination. Budgeting tends to synchronize the firm’s operations, because the budget serves as a guide as to
what the company should achieve.

Control. As mentioned, budgeting provides the barometer or the yardstick against which the firm can measure
and compare their actual results of operations. The differences or variances between budget and actual results
are then assessed so that adjustments may be done if needed.

Functions of Budgeting:

Planning orientation. The process of creating a budget takes management away from its short-term, day-to-day
management of the business and forces it to think longer-term. This is the chief goal of budgeting, even if
management does not succeed in meeting its goals as outlined in the budget - at least it is thinking about the
company's competitive and financial position and how to improve it.

Profitability review. It is easy to lose sight of where a company is making most of its money, during the
scramble of day-to-day management. A properly structured budget points out what aspects of the business
produce money and which ones use it, which forces management to consider whether it should drop some parts
of the business or expand in others.
Assumptions review. The budgeting process forces management to think about why the company is in
business, as well as its key assumptions about its business environment. A periodic re-evaluation of these issues
may result in altered assumptions, which may in turn alter the way in which management decides to operate the
business.

Performance evaluations. You can work with employees to set up their goals for a budgeting period, and
possibly also tie bonuses or other incentives to how they perform. You can then create budget versus actual
reports to give employees feedback regarding how they are progressing toward their goals. This approach is
most common with financial goals, though operational goals (such as reducing the product rework rate) can also
be added to the budget for performance appraisal purposes. This system of evaluation is called responsibility
accounting.

Funding planning. A properly structured budget should derive the amount of cash that will be spun off or
which will be needed to support operations. This information is used by the treasurer to plan for the company's
funding needs. This information can also be used for investment planning, so that the treasurer can decide
whether to park excess cash in short-term or longer-term investment instruments.

Cash allocation. There is only a limited amount of cash available to invest in fixed assets and working capital,
and the budgeting process forces management to decide which assets are most worth investing in.

Budgetary Control
Definition:

Budgetary control refers to a method of management control and accounting, wherein the budgets are
established, by forecasting the activities beforehand to the maximum extent and a constant comparison is made
between the actual results and the budgeted figures, so as calculate the variances (if any) and take corrective
steps accordingly to ensure the achievement of targets.

Significance :

The budgetary control system help in fixing the goals for the organization as whole and concerted efforts are
made for its achievements. It enables ‘economies in the enterprise.

1. Maximization of Profits:

The budgetary control aims at the maximization of profits of the enterprise. To achieve this aim, a proper
planning and coordination of different functions is undertaken. There is a proper control over various capital
and revenue expenditures. The resources are put to the best possible use.

2. Co-ordination:

The working of different departments and sectors is properly coordinated. The budgets of different departments
have a bearing on one another. The co-ordination of various executives and subordinates is necessary for
achieving budgeted targets.

3. Specific Aims:
The plans, policies and goals are decided by the top management. All efforts are put together to reach the
common goal, of the organization. Every department is given a target to be achieved. The efforts are directed
towards achieving some specific aims. If there is no definite aim then the efforts will be wasted in pursuing
different aims.

4. Tool for Measuring Performance:

By providing targets to various departments, budgetary control provides a tool for measuring managerial
performance. The budgeted targets are compared to actual results and deviations are determined. The
performance of each department is reported to the top management. This system enables the introduction of
management by exception.

5. Economy:

The planning of expenditure will be systematic and there will be economy in spending. The finances will be put
to optimum use. The benefits derived for the concern will ultimately extend to industry and then to national
economy. The national resources will be used economically and wastage will be eliminated.

6. Determining Weaknesses:

The deviations in budgeted and actual performance will enable the determination of weak spots. Efforts are
concentrated on those aspects where performance is less than the stipulated.

7. Corrective Action:

The management will be able to take corrective measures whenever there is a discrepancy in performance. The
deviations will be regularly reported so that necessary action is taken at the earliest. In the absence of a
budgetary control system the deviations can be determined only at the end of the financial period.

8. Consciousness:

It creates budget consciousness among the employees. By fixing targets for the employees, they are made
conscious of their responsibility. Everybody knows what he is expected to do and he continues with his work
uninterrupted.

9. Reduces Costs:

In the present day competitive world budgetary control has a significant role to play. Every businessman tries to
reduce the cost of production for increasing sales. He tries to have those combinations of products where
profitability is more.

10. Introduction of Incentive Schemes:

Budgetary control system also enables the introduction of incentive schemes of remuneration. The comparison
of budgeted and actual performance will enable the use of such schemes.

Functions:

- Setting up of budgets

- Policymaking
- Comparing the actual and budgeted results.

- Taking corrective steps and remedial measures, (if possible) or Revising the budgets (if required).

- Placing responsibility when there is a failure to attain the target.

Budgetary control implies a system that involves an ongoing comparison of the actual performance with the
budgets and taking remedial steps immediately, to ensure adherence to the plan.

Financial Leverage
Definition:

Financial leverage is the use of borrowed money (debt) to finance the purchase of assets with the expectation
that the income or capital gain from the new asset will exceed the cost of borrowing.

In most cases, the provider of the debt will put a limit on how much risk it is ready to take and indicate a limit
on the extent of the leverage it will allow. In the case of asset-backed lending, the financial provider uses the
assets as collateral until the borrower repays the loan. In the case of a cash flow loan, the general
creditworthiness of the company is used to back the loan.

Significance:

1. To use as basis in making financing and investment decisions.

2. To provide a variety of financing sources by which the firm can achieve its target earnings.

3. To identify the potential pitfalls in running effective plan to boost earnings.

Function:

The financial leverage formula is measured as the ratio of total debt to total assets. As the proportion of debt to
assets increases, so too does the amount of financial leverage. Financial leverage is favorable when the uses to
which debt can be put generate returns greater than the interest expense associated with the debt. Many
companies use financial leverage rather than acquiring more equity capital, which could reduce the earnings per
share of existing shareholders.

Operating Leverage
Definition:

Operating leverage is a cost-accounting formula that measures the degree to which a firm or project can
increase operating income by increasing revenue. A business that generates sales with a high gross margin and
low variable costs has high operating leverage.

Significance:
DOL is a very useful concept to understand how fixed costs need to be planned to keep the impact on leverage
on profits high.

Measurement of operating risks- Operating risk refers to the risk of the firm not being able to cover its fixed
operating costs. Since operating leverage depends on fixed operating costs, larger fixed operating costs indicates
higher degree of operating leverage and thus, higher operating risk of the firm. High operating leverage is good
when sales are rising but badly when they are falling.

Increase profitability- Leverage is an effort or attempt by which a firm tries to show high result or more benefit
by using fixed costs assets and fixed return sources of capital. It insures maximum utilization of capital and
fixed assets in order to increase the profitability of a firm, It helps to know the reasons not having more profit
by a company.

Function:

Operating leverage measures a company’s fixed costs as a percentage of its total costs. It is used to
evaluate the breakeven point of a business, as well as the likely profit levels on individual sales.

OPERATING LEVERAGE

High Operating Leverage Low Operating Leverage

Large proportion of the Large proportion of the

company’s cost is fixed company’s sales is
cost. variable cost, so it only
incurs cost if there is a
Usually found in a company sale.
that relies on expensive
equipment and technology to Generally occurs in labor-
produce its products. intensive firms because
their costs are more
variable.

Example:

A software company has substantial fixed costs in the form of developer salaries, but has almost no
variable costs associated with each incremental software sale; this firm has high operating leverage.
Conversely, a consulting firm bills its clients by the hour, and incurs variable costs in the form of
consultant wages. This firm has low operating leverage.

' margin∗¿
Operating leverage= entit y s contribution ¿
net operating income

*Contribution margin= sales- variable expenses

Note: When using the operating leverage measurement, constant monitoring of operating leverage is more
important for a firm having high operating leverage, since a small percentage change in sales can result
in a dramatic increase (or decrease) in profits. A firm must be especially careful to forecast its sales in
these situations, since a small forecasting error translates into much larger errors in both net income and
cash flows.

Contribution Margin
Definition:

Contribution margin is a product’s price minus all associated variable costs, resulting in the incremental profit
earned for each unit sold. The total contribution margin generated by an entity represents the total earnings
available to pay for fixed expenses and to generate a profit. The contribution margin concept is useful for
deciding whether to allow a lower price in special pricing situations. If the contribution margin at a particular
price point is excessively low or negative, it would be unwise to continue selling a product at that price. It is
also useful for determining the profits that will arise from various sales levels (see the example). Further, the
concept can be used to decide which of several products to sell if they use a common bottleneck resource, so
that the product with the highest contribution margin is given preference.

he contribution margin concept can be applied throughout a business, for individual products, product lines,
profit centers, subsidiaries, distribution channels, sales by customer, and for an entire business.

To determine the contribution margin, subtract all variable costs of a product from its revenues, and divide by
its net revenue. Product variable costs typically include, at a minimum, the costs of direct materials and sales
commissions. The calculation is:

(Net product revenue - Product variable costs) ÷ Product revenue

Significance:

The amount of contribution margin should be sufficient to cover all fixed costs as well as to contribute towards
profit. If the amount of contribution margin is not enough to cover all fixed costs, the business will suffer a loss.

Contribution margin figure is even more important for multi-product companies. Normally, all products sold by
a company are not equally profitable. High contribution margin products are more profitable because they
contribute more for covering fixed costs and providing for profit. A multi-product company can increase its net
operating profit by focusing its attention to increase the sales of high contribution margin products or finding
the ways to reduce variable cost of low contribution margin products.

Function:

The contribution margin is the sales price of a unit, minus the variable costs involved in the unit's production. It
is used to find an optimal price point for a product.

It also measures whether the product is generating enough revenue to pay for fixed costs and determine the
profit it is generating. The contribution margin can be calculated in dollars, units, or a percentage.

Additionally, the contribution margin is used to determine the break-even point, which is the number of units
produced or revenues generated to break even.

Time Value of Money

Definition:

The time value of money (TVM) is the concept that money you have now is worth more than the identical sum
in the future due to its potential earning capacity. This core principle of finance holds that provided money can
earn interest, any amount of money is worth more the sooner it is received. TVM is also sometimes referred to
as present discounted value.

Significance:

The time value of money is the idea that money available at the present time is worth more than the same
amount in the future due to its potential earning capacity. Time value of money is a widely used concept in the
literature of finance. Financial decision models based on finance theories basically deal with the maximization
of the economic welfare of shareholders. A fundamental idea in finance that money that one has now is worth
more than money one will receive in the future.

The concept of time value of money contributes to this aspect to a greater extent. The significance of the
concept of time value of money could be stated as below:

• Investment Decision

The investment decision is concerned with the allocation of capital into long-term investment projects. The cash
flow from long-term investment occurs at a different point in time in the future. In other words, investment
decisions are concerned with the question of whether adding to capital assets today will increase the revenues of
tomorrow to cover costs. They are not comparable to each other and against the cost of the project spent at
present. To make them comparable, the future cash flows are discounted back to present value. As such
investment decisions are concerned with the choice of acquiring real assets over the time period in a productive
process.

The concept of time value of money is useful to securities investors. They use valuation models while making
an investment in securities such as stock and bonds. These security valuation models consider the time value of
cash flows from securities.

• Financing Decision

Financing decision is concerned with designing optimum capital structure and raising funds from the least cost
sources. The concept of time value of money is equally useful in financing decision, especially when we deal
with comparing the cost of different sources of financing. It is concerned with the borrowing and allocation of
funds required for the investment decisions. The effective rate of interest of each source of financing is
calculated based on the time value of money concept. Similarly, in leasing versus buying decision, we calculate
the present value of the cost of leasing and the cost of buying. The present value of costs of two alternatives is
compared against each other to decide on an appropriate source of financing. The objective of financial decision
is to maintain an optimum capital structure, i.e. a proper mix of debt and equity, to ensure the trade-off between
the risk and return to the shareholders.

Besides, the concept of time value of money is also used in evaluating proposed credit policies and the firm’s
efficiency in managing cash collection under current assets management.

Functions:
The time value of money draws from the idea that rational investors prefer to receive money today rather than
the same amount of money in the future because of money's potential to grow in value over a given period of
time. For example, money deposited into a savings account earns a certain interest rate and is therefore said to
be compounding in value

• Time value of money is based on the idea that people would rather have money today than in the future.

• Given that money can earn compound interest, it is more valuable in the present rather than the future.

• The formula for computing time value of money considers the payment now, the future value, the
interest rate, and the time frame.

• The number of compounding periods during each time frame is an important determinant in the time
value of money formula as well.

TOPIC 2

DEFINITION SIGNIFICANCE FUNCTION

Working Working capital - The goal of working capital 1. Expansion of investment

management is a management is to maximize portfolio
Capital business strategy operational efficiency. The Funds released through
Management designed to ensure that main objectives of working sound working capital
a company operates capital management include management practices act as
efficiently by maintaining the working a cheap source of finance
monitoring and using capital operating cycle and that can be used for
its current assets and ensuring its ordered expansion of existing
liabilities to the best operation, minimizing the projects or for investment in
effect. The primary cost of capital spent on the new spheres of investment.
purpose of working working capital, and 2. Increased profitability
capital management is maximizing the return on Increasing profitability is
to enable the company current asset investments. one of the main objectives of
to maintain sufficient engaging in working capital
cash flow to meet its - Working capital is a management. One of the
short-term operating prevalent metric for the ways of increasing
costs and short-term efficiency, liquidity and profitability through
debt obligations. overall health of a company. adequate working capital
It is a reflection of the results management is in saving of
Effective working of various company activities, financial cost that would
capital management including revenue collection, have otherwise been incurred
encompasses several debt management, inventory but for managing short-term
aspects of short-term management and payments to assets and liabilities.
finance: maintaining suppliers. 3. Ensure the availability of
adequate levels of cash, sufficient resources
converting short-term - Management of working Through stock management
assets (i.e., accounts capital includes inventory which is a component of
receivable and management and working capital
inventory) into cash, management of accounts management, a business is
and controlling receivables and accounts able to ensure that resources
outgoing payments to payables. Managing working are sufficient at all times.
vendors, employees, capital means managing Optimal stock level, for
and others. To do this inventories, cash, accounts instance, is determined using
successfully, payable and accounts some models outside the
companies invest short- receivable. scope of this article.
term funds in working 4. Solidifies the going
capital portfolios of - Efficient working concern status of a
short-dated, highly capital management helps company
liquid securities, or maintain smooth operations In business, it is very
they maintain credit and can also help to improve common to find a profitable
reserves in the form of the company's earnings and company goes out of
bank lines of credit or profitability. business if it fails to meet up
access to financing by with the short-term financial
issuing commercial - An effective working needs of the business.
paper or other money capital management system Businesses need to satisfy its
market instruments. helps businesses not only short term and medium term
cover their financial obligations in order to be in
obligations but also boost business and still remain
their earnings. competitive.
Working capital 5. Improves overall
management is a broad- efficiency of a company
based function. The overall operational
Effective execution excellence of a company
requires managing and would be greatly improved
coordinating several by an effective working
tasks within the capital management system.
company, including Where this system is in
managing short-term place, finances are managed
investments, granting in such a way that it poses no
credit to customers and hindrance or obstacle to any
collecting on this aspect of the entity.
credit, managing 6. Helps a company
inventory, and avoid overtrading
managing payables. Overtrading is one of the
Effective working fastest ways to business
capital management failure. One main
also requires reliable characteristic of overtrading
cash forecasts, as well is mismatching assets and
as current and accurate finances. The business goes
information on beyond set financial goals
transactions and bank and objectives, and in the
balances. long run, it meets with ruin.
Some trends signaling
overtrading will include
uncontrolled, out of
proportion business
expansion.
7. Maintain good
relation with suppliers and
other creditors
Where a business engages in
the proper management of its
working capital and other
financial indices, Trade
creditors and other non-trade
creditors are poised to
continue doing business with
it. Their knowledge of the
existence of this system goes
a long way to boost their
confidence in the business
and their dealings.
8. Avoid underutilization
of resources:
While we condemn
overtrading and tag it as a
negative impact on the
functionality of the business,
we must also reiterate that
under trading can cost a
business a fortune in an
unearned profit. Through
proper management of
working capital, a company
can ensure that there are no
idle resources.
9. Provides better insight
into the true financial state
of a company:
Through working capitals
ratios, analysts and financial
experts can gain a better
understanding of a business.
The working capital
management affords the
business the opportunity of
taking a closer look at all of
its financial indices.
10. Allocation of
resources:
Management of working
capital is essential in the
allocation of resources. It
assists the business
management incorrectly
allocating the right resources
to appropriate quarters.
Applying the ratios revealed
 upon the utilization of the
management system, as well
as all other necessary
analysis, areas with surplus
resources and the shortage of
resources are identified and
followed swiftly with
appropriate even distribution
of resources to all.
Cash management, also 1. To assess to meet the long- 1.) Inventory management
known as treasury term needs of the business.
shares is the efficient Higher stock in hand means
collection, 2. To vitalize the company trapped sales and trapped
disbursement, and expenses, repay investors and sales means less liquidity.
investment of cash in expand the business. Hence, an organization must
an organization while aim at faster stock out to
maintaining the 3. It generates good rotation ensure movement of cash.
company’s liquidity. In of cash in the company. (i.e.
other words, it is the too much cash on hand, out 2.) Receivables Management
way in which a of precaution and having an
particular organization inadequate supply it results An organization raises
manages its financial that company missing the invoices for its sales. In these
operations such as opportunity to invest the cash cases, the credit period for
investing cash in to produce additional receiving the cash can range
different short-term earnings) between 30 – 90 days. Here,
projects, collection of the organization has
revenues, payment of recorded the sales but has
expenses, and liabilities not yet received cash for the
while ensuring it has transactions.
sufficient cash So the cash management
Cash available for future use. function will ensure faster
Management recovery of receivables to
In the real world, avoid a cash crunch. If the
organizations have average time for recovery is
strict cash management shorter, the organization will
controls to monitor its have enough cash in hand to
inflows and outflows make its payments. Timely
while retaining a payments ensure lesser costs
sufficient amount in (interests, penalties) to the
order to take advantage organization.
of attractive
investments or handle 3.) Payables Management
unforeseen liabilities.
While receivables
Efficient management management is one of the
of cash prevents loss of primary areas in the cash
money due to theft or management function,
error in processing payables management is also
transactions. Numerous important. Payables arise
best practices are when the organization has
adopted to enhance made purchases on credit
management of and needs to make payments
company’s funds. for the same within a fixed
time.
This involves
shortening of cash 4.) Cash-management
collection periods,
regular follow ups for An organization can take
collections, negotiation short-term credit from banks
of favorable terms with and financial institutions.
suppliers allowing However, these credit
delay in payment facilities come at a cost and
periods, and therefore, an organization
preparation of cash must ensure that they
flow forecasts. maintain a good liquidity
Businesses also use of position; this will help in
technology to speed up timely repayments of debts.
cash collection process
while maintaining 5.) Forecasting
adequate amount of
funds to meet daily While planning investments,
operations. the managers need to be very
careful as they need to plan
for future contingencies and
also ensure profitability. For
this, they must use efficient
forecasting and management
tools. When the cash inflows
and outflows are efficiently
managed it gives the firm
good liquidity.

6.) Short-term investments

Avoiding cash crunch,

insolvency and ensuring
financial stability are the
main criterias of cash
management. But it is
equally important to invest
the surplus cash in hand
wisely. Despite being a
liquid asset, idle cash does
not generate any returns.
While investing in short-
term investments an
organization must ensure
liquidity and optimum
returns. Therefore, this
decision needs to be taken
with prudence. Here, the
quantum/amount of
investment needs to be
calculated and decided
carefully. This caution is
necessary because an
organization cannot invest
all the available funds.
Businesses need to reserve
cash for contingencies (cash
in hand) too.

7.) Other functions

Cash management also
includes monitoring the bank
accounts, managing
electronic banking, pooling
and netting of assets, etc. So
the cash management for
treasury can also be a core
function. Although for large
corporates this function is
managed by softwares, small
businesses have to monitor it
manually and ensure
liquidity at all times. To add,
large businesses have access
to credit facilities at
competitive rates. For small
businesses that access is not
available.

Therefore cash management

is vital for them. However,
even large corporations need
to monitor their systems time
and again to avoid a situation
of bankruptcy.
 - ‘Credit is the soul of 1. It provides extra capital to The basic purpose of the
business.’ support operations and lowers firm’s receivable
the company’s net debt. management is to determine
- The process of effective credit policy that
making decisions 2. It is considered as 'liquid increases the efficiency of a
relating to investment asset' used as collateral to firm’s credit and collection
in trade debtors. secure a loan to help meet department and contributes
Certain investment in short-term obligations. to the maximization of the
receivables is necessary value of the firm. The
to increase the sales 3. It maximizes the return on specific purposes of
and the profits of the investment in receivables and receivable management are
firm. But at the same the sales to the extent the risk as follows:
time investment in this involved remains within the
asset involves cost acceptable limit. - To evaluate the
consideration also. creditworthiness of
customers before granting
- Defined as collection or extending the credit.
of steps and procedure - To minimize the cost of
Receivable required to properly investment in receivables.
weigh the costs and - To minimize the possible
Management benefits attached with bad debt losses.
the credit policies. The - To formulate the credit
receivables terms in such a way that
management consists results in maximization of
of matching the cost of sales revenue and still
increasing sales maintaining a minimum
(particularly credit investment in receivables.
sales ) with the benefits - To minimize the cost of
arising out of increased running a credit and
sales with the objective collection department.
of maximising the - To maintain a trade-off
return on investment of between costs and benefits
the firm. associated with credit
policy.
 - It is a systematic 1. To minimize the waste of Inventory management is a
approach to sourcing, inventories vital need of a company.
storing, and selling 2. To maintain a optimum The things how the
inventory—both raw size of inventory for efficient Inventory Management
materials (components) and smooth production and works in a company are
and finished goods sales operations listed below:
(products). 3. To provide right quantity
and quality goods at right •To provide maximum
- In business terms, time at proper value. supply service, consistent
inventory management with maximum efficiency
means the right stock, and optimum investment.
at the right levels, in •To provide cushion
the right place, at the between forecasted and
right time, and at the actual demand for a
right cost as well as material
price. •Avoid uncertainties in
supplies
- Is the supervision of •Permit to meet new
non-capitalized assets, demands
or inventory, and stock •Allow continuous and
items. As a component smooth production system
of supply chain •Makes a rational
management, inventory production system possible.
management supervises
Inventory the flow of goods from The main function of
Management manufacturers to inventory management is to
warehouses and from determine the sufficient
these facilities to point amount and type of input
of sale. A key function products, products in
of inventory process and finished
management is to keep products, facilitating
a detailed record of production and sales
each new or returned operations and minimizing
product as it enters or costs by keeping them at an
leaves a warehouse or optimal level.
point of sale. Efficient inventory
management is essential to
ensure that the business has
enough products stored to
meet consumer demand. If
it is not handled correctly it
can result in the business
losing money on potential
sales that cannot be satisfied
or that you waste money
taking care of too much
inventory. An inventory
management system can
prevent these types of errors
from occurring.
Economic - The economic order - Inventory is expensive (in
quantity is the optimum terms of manufacturing and
Order quantity of an item to keeping in stock). That’s
Quantity be purchased at one why, companies can use
time in order to Economic Order Quantity
minimize the combined (EOQ) in order to prevent
annual costs of shortage while not
ordering and carrying maintaining excess
the item in inventory. inventories.
- The formula for EOQ
is: - Minimize storage and
holding costs.
Q = √(2DS/H) Storing inventory may be
expensive for small business
where: owners. The main advantage
Q=EOQ units of the EOQ model is the
D=Demand in units customized recommendations
(typically on an annual provided regarding the most
basis) economical number of units
S=Order cost (per per order. The model may
purchase order) suggest buying a larger
H=Holding costs (per quantity in fewer orders to
unit, per year) take advantage of discount
- The EOQ formula is bulk buying and minimizing
best applied in order costs. Alternatively, it
situations where may point to more orders of
demand, ordering, and fewer items to minimize
holding costs remain holding costs if they are high
constant over time. and ordering costs are
relatively low.
- Specific to the business.
Maintaining sufficient
inventory levels to match
customer demand is a
balancing act for many small
businesses. Another
advantage of the EOQ model
is that it provides specific
numbers particular to the
business regarding how much
inventory to hold, when to re-
order it and how many items
to order. This smoothes out
the re-stocking process and
results in better customer
service as inventory is
available when needed.
The EOQ (Economic Order
Quantity) provides a model
for calculating the
appropriate reorder point
and the optimal reorder
quantity to ensure the
instantaneous
replenishment of inventory
with no shortages. It can be
a valuable tool for small
business owners who need to
make decisions about how
much inventory to keep on
hand, how many items to
order each time, and how
often to reorder to incur the
lowest possible costs.
The EOQ model assumes
that demand is constant, and
that inventory is depleted at
a fixed rate until it reaches
zero. At that point, a specific
number of items arrive to
return the inventory to its
beginning level. Since the
model assumes instantaneous
replenishment, there are no
inventory shortages or
associated costs. Therefore,
the cost of inventory under
the EOQ model involves a
tradeoff between inventory
holding costs (the cost of
storage, as well as the cost of
tying up capital in inventory
rather than investing it or
using it for other purposes)
and order costs (any fees
associated with placing
orders, such as delivery
charges). Ordering a large
amount at one time will
increase a small business's
holding costs, while making
more frequent orders of
fewer items will reduce
holding costs but increase
order costs. The EOQ model
finds the quantity that
minimizes the sum of these
costs
The EOQ formula is best
 applied in situations where
demand, ordering, and
holding costs remain
constant over time.
INVENTORY CONTROL SYSTEMS
An inventory control system is a system that encompasses all aspects of managing a company's inventories;
purchasing, shipping, receiving, tracking, warehousing and storage, turnover, and reordering. In different firms
the activities associated with each of these areas may not be strictly contained within separate subsystems, but
these functions must be performed in sequence in order to have a well-run inventory control system.
Computerized inventory control systems make it possible to integrate the various functional subsystems that are
a part of the inventory management into a single cohesive system.

COMPUTERS AND INVENTORY

Automation can dramatically impact all phases of inventory management, including counting and monitoring of
inventory items; recording and retrieval of item storage location; recording changes to inventory; and
anticipating inventory needs, including inventory handling requirements. This is true even of stand-alone
systems that are not integrated with other areas of the business, but many analysts indicate that productivity—
and hence profitability—gains that are garnered through use of automated systems can be further increased
when a business integrates its inventory control systems with other systems such as accounting and sales to
better control inventory levels. As Dennis Eskow noted in PC Week, business executives are "increasingly
integrating financial data, such as accounts receivable, with sales information that includes customer histories.
The goal: to control inventory quarter to quarter, so it doesn't come back to bite the bottom line. Key
components of an integrated system '¦ are general ledger, electronic data interchange, database connectivity, and
connections to a range of vertical business applications."

The Future of Inventory Control Systems

New technologies have greatly improved the tools used to manage inventories. Powerful computer systems that
are linked into networks are now able to receive information from handheld devises. The wireless handheld
devices scan bar codes on inventory items and send data to a tracking database in real time. The increased
efficiency of inventory systems over the past 25 years made some things possible that would have been
impossible in earlier times, like the popular just-in-time manufacturing system.

The newest trend in the area of inventory control and management are vendor-managed inventory (VMI)
systems and agreements. In a VMI system distributors and/or manufacturers agree to take over the inventory
management for their customers. Based on daily reports sent automatically from the customer to the distributor,
the distributor replenishes the customers stocks as needed. The distributor or manufacturer sees what is selling
and makes all necessary arrangements to send the customer new products or parts automatically. No phone calls
or paperwork are necessary allowing the supply chain process to remain uninterrupted.

The benefits that can accrue to both parties in a VMI arrangement are noteworthy. Both parties should
experience a savings of time and labor. The customer is able to maintain fewer items in stock and can rely upon
a steady flow of products or parts. The vendor or distributor benefits in two ways. First, a supplier is able to
better anticipate production requirements. Second, the supplier benefits from a strong relationship with the
customer, one that is more difficult to alter than would be a vendor-customer relationship in which such
automated systems did not exist.
As with all outsourcing arrangements, there are potential negatives to a VMI system. The first is the partial loss
of control experienced by the customer in managing his or her own inventories. Second is the problem this type
of system poses on a vendor in the case of volatile sales periods. It is very difficult for a distributor or
manufacturer to hold large inventories for one customer on a VMI system who is experiencing a slowdown in
sales while having to ramp up for another customer who is experiencing rising demand. Both parties to a VMI
agreement must weigh the pros and cons of such a system thoroughly and be sure to include in any VMI
agreement prearranged methods for dealing with periods of volatile sales patterns. The popularity of VMI
suggests that there are many applications in which these systems produce net benefits for both parties.

WAREHOUSE LAYOUT AND OPERATION

The trend toward automation in inventory management naturally has moved into the warehouse as well. Citing
various warehousing experts, Sarah Bergin contended in Transportation and Distribution magazine that "the key
to getting productivity gains from inventory management '¦ is placing real-time intelligent information
processing in the warehouse. This empowers employees to take actions that achieve immediate results. Real-
time processing in the warehouse uses combinations of hardware including material handling and data
collection technologies. But according to these executives, the intelligent part of the system is sophisticated
software which automates and controls all aspects of warehouse operations."

Another important component of good inventory management is creation and maintenance of a sensible,
effective warehousing design. A well-organized, user-friendly warehouse layout can be of enormous benefit to
small business owners, especially if they are involved in processing large volumes of goods and materials.
Conversely, an inefficient warehouse system can cost businesses dearly in terms of efficiency, customer service,
and, ultimately, profitability.

Transportation and Distribution magazine cited several steps that businesses utilizing warehouse storage
systems can take to help ensure that they get the most out of their facilities. It recommended that companies
utilize the following tools:

Stock locator database—"The stock locator database required for proactive decision making will be an adjunct
of the inventory file in a state-of-the-art space management system. A running record will be maintained of the
stock number, lot number, and number of pallet loads in each storage location. Grid coordinates of the reserve
area, including individual rack tier positions, must therefore be established, and the pallet load capacity of all
storage locations must be incorporated into the database."

Grid coordinate numbering system—Warehouse numbering system should be developed in conjunction with the
storage layout, and should be user-friendly so that workers can quickly locate currently stocked items and open
storage spaces alike.

Communication systems—Again, this can be a valuable investment if the business's warehouse requirements
are significant. Such facilities often utilize fork lift machinery that can be used more effectively if their
operators are not required to periodically return to a central assignment area. Current technology, makes it
possible for the warehouse computer system to interact with terminal displays or other communications devices
on the fork lifts themselves. "Task assignment can then be made by visual display or printout, and task
completion can be confirmed by scanning, keyboard entry, or voice recognition," observed Transportation and
Distribution.
Maximization of storage capacity—Warehouses that adhere to rigid "storage by incoming lot size" storage
arrangements do not always make the best use of their space. Instead, businesses should settle on a strategy that
eases traffic congestion and best eases problems associated with ongoing turnover in inventory.

Some companies choose to outsource their warehouse functions. "This allows a company that isn't as confident
in running their own warehousing operations to concentrate on their core business and let the experts worry
about keeping track of their inventory," wrote Bergin. Third-party inventory control operations can provide
companies with an array of valuable information, including analysis of products and spare parts, evaluations of
their time sensitivity, and information on vendors. Of course, businesses weighing whether to outsource such a
key component of their operation need to consider the expense of such a course of action, as well as their
feelings about relinquishing that level of control.

TOPIC 3

TERMINOLOGY DEFINITION
A merger is an agreement that unites two existing companies into one new company.
There are several types of mergers and also several reasons why companies complete
mergers. Mergers and acquisitions are commonly done to expand a company’s reach,
Merger
expand into new segments, or gain market share. All of these are done to increase
shareholder value. Often, during a merger, companies have a no-shop clause to prevent
purchases or mergers by additional companies.
To consolidate (consolidation) is to combine assets, liabilities, and other financial items
of two or more entities into one. In the context of financial accounting, the term
consolidate often refers to the consolidation of financial statements wherein all
Consolidation subsidiaries report under the umbrella of a parent company.

Consolidation also refers to the union of smaller companies into larger companies
through mergers and acquisitions.
Goodwill is an intangible asset that is associated with the purchase of one company by
another. Specifically, goodwill is the portion of the purchase price that is higher than
the sum of the net fair value of all of the assets purchased in the acquisition and the
Goodwill
liabilities assumed in the process. The value of a company’s brand name, solid
customer base, good customer relations, good employee relations, and proprietary
technology represent some reasons why goodwill exists.
A hostile takeover is the acquisition of one company (called the target company) by
another (called the acquirer) that is accomplished by going directly to the company's
Hostile take - over shareholders or fighting to replace management to get the acquisition approved. A
hostile takeover can be accomplished through either a tender offer or a proxy fight.
Leverage Leverage refers to the use of debt (borrowed funds) to amplify returns from an
investment or project.
 Investors use leverage to multiply their buying power in the market.

Companies use leverage to finance their assets: instead of issuing stock to raise capital,
companies can use debt to invest in business operations in an attempt to increase
shareholder value.
A buyout is the acquisition of a controlling interest in a company and is used
synonymously with the term acquisition.

Buy - out If the stake is bought by the firm’s management, it is known as a management buyout,
while if high levels of debt are used to fund the buyout, it is called a leveraged buyout.

Buyouts often occur when a company is going private.

Controlling interest allows the shareholder, or shareholders, to veto or overturn
decisions made by existing board members.

Controlling interest gives ownership of operational and strategic decision-making

Controlling Interest
processes.

Controlling interest grants an investor, or investors, leverage to increase their

shareholding stake in a company in a merger or acquisition.
A minority interest is ownership or interest of less than 50% of an enterprise.

Minority interests generally range between 20% and 30%, and stakeholders have very
Minority Interest little say or influence in the enterprise.

Companies with a majority interest will list the minority interest on their balance sheet
as a noncurrent liability.

TYPES OF BUSINESS COMBINATION

Combinations may take several forms such as horizontal, vertical, lateral, and diagonal, circular or
maybe a mixture of two or more of these types.

Horizontal Combination

A horizontal combination comes into being when units carrying on the same trade or pursuing the same
productive activity join together with a common end in view.

The intensity of competition is naturally reduced when several units competing in the same line of
business join together. The combining units can well take advantage of the various economics associated with
large scale production by making common purchases, pooling resources for research, common advertising, etc.
Vertical Combinations

Vertical integration is the combination of firms in successive stages of the same industry. It implies the
integration of various processes of an industry.

Vertical combinations are brought into existence with the following objects in view:

1. To eliminate the wasteful and unnecessary expenses involved in carrying on the connected processes
separately.

2. To eliminate middlemen functioning between various units

3. To securer economies in marketing, advertising, and transport

4. To maintain control over the quality of raw materials and finished products.
Lateral Combination

Lateral integration refers to the combination of those firms which manufacture different kinds of
products though they are ‘allied in some way’. It can be of two kinds;

I. Convergent lateral integration

II. Divergent lateral integration.

The convergent lateral combination comes into existence when different forms join together to supply
goods and services to help the functioning of major undertakings.

Divergent lateral combination represents combination of one supplier of a common raw material with
different users. The example of divergent lateral integration is provided by a flour mill supplying flour to a
number of units like bakery, confectionary, and hotel.
Diagonal Combination

It is also called ‘Service’ integration Diagonal integration comes into existence when a unit providing
auxiliary goods and services to industry is combined with a unit engaged in the mainline of production, within
the organization.

Circular Combination

When firms belonging to different industries and producing altogether, different products and combine
together under the banner of a central agency, it is called a mixed or circular combination.

This is affected to ensure smooth conduct of business operations by making timely availability of
auxiliary services within the organization.
 TYPE PROS
1. Avoidance of wasteful competition.
2. It ensures better control over markets.
3. It helps realize economies of scale.
4. It aids standardization of products.
Horizontal Combination
5. Overall costs of operation will be
cheaper. This translates to lower costs of
operation and thus a higher profit margin
for the merged companies.
1.Reduce transportation costs if common
ownership results in closer geographic
proximity
2. Improve supply chain coordination.
3. Provide more opportunities to
differentiate by means of increased control
over inputs.
4.Capture upstream or downstream profit
margins
5. Increase entry barriers to potential
competitors, for example, if the firm can
gain sole access to a scarce resource.
6. Gain access to downstream distribution
channels that otherwise would be
Vertical Combination inaccessible.
7. Facilitate investment in highly
specialized assets in which upstream or
downstream players may be reluctant to
invest.
8. Lead to expansion of core competencies.
1. Economies in management take place
since the units can employ common
managerial experts.
2. Marketing costs are considerably
Lateral Combination reduced.
3. Uninterrupted and regular supply of raw
material is ensured.
1. It helps in achieving self-sufficiency in
operations.
Diagonal Combination
2. It ensures regular and uninterrupted
CONS
1. It may lead to monopoly
situations.
2. It may result in restriction of
output, increase in prices and
exploitation of consumers.
3. When the business grows beyond
a particular size, control becomes
difficult.
1. Limited Utility. Vertical
integration of firms can only be
possible where finished products on
one unit become the raw material
of another unit and different
processes are complementary and
where control over the supply of
raw material is required to maintain
certain standard of quality.
2. Economies of Large Scale
Production not Possible. Because
the constituent firms perform
different activities, production on
large scale cannot be possible.
3. Mutual Dependence. In vertical
integration the firms become
mutually dependent and they are
not free to produce the goods in
quantity. The units become
inelastic and they may find it
almost difficult to change to new
lines and models.
4. Less Co – ordination. It is not
easy to bring co – ordination in the
activities of integrated enterprises
consisting of dissimilar units. The
cost of co – ordination may
outflank the gains expected from
integration.
1. Such combinations become
monopolies and therefore are anti –
social.
2. The output of constituent units is
purposely restricted and they do not
use full capacity because they
produce only that quantity which
gets consumed with the
combination.
1. Demand Cutback: In difficult
economic times, consumers usually
cut back on services. They focus on
 service to the manufacturing industry. products they need to survive and
3. Wastage of time due to breakdowns is prosper, and services are often
reduced to a great extent. looked upon as extras. For
4. It ensures services of the required example, a person who has been
quality and standards. paying for oil changes might decide
5. Costs of services are maintained at a to do his own oil changes to save
stable rate without undue increase. money. A person who has been
6. The main organization need not depend hiring a dog walker may decide that
on outside suppliers. she can to the job herself and save
money. You should evaluate your
service to see how you can make it
more valuable to your customers so
they see your service as a necessity.
1. Efficient management: When firms from 1. Problems in co-ordination:
different industries come together, they can Expansion beyond a particular level
share their knowledge of best practices in would lead to problems in
different areas. For e.g. if one firm has coordination and control.
implemented Total Quality Management Inefficiencies might creep in
successful while another has implemented resulting in dis-economies and
Total Productive Maintenance, they can would affect all the businesses.
share their knowledge. Managerial talent 2. Concentration of economic
can be better utilized which would lead to power: It might result in
efficiency in managing the organization. concentration of economic power
2. Economies in operations: The firms can in a few hands and inequalities in
integrate their transportation, income distribution in the
administration and marketing costs. This economy.
Circular Combination
leads to economies and reduction in costs. 3. Loss of employment: Integration
3. Evils of monopoly voided: Unlike a of operations might results in
horizontal combination, a circular downsizing and employees in
combination does not result in monopolies combining organizations might lose
and consumers are spared from the evils of their jobs.
monopolies.
4. Spread of benefits: If a firm which was
successful and efficient in one line of
business engages in other businesses it
would run them also in a successful
manner. Therefore more customers are
benefited.

EXAMPLES OF BUSINESS COMBINATION

Horizontal Combination

Example

- Disney’s 2006 acquisition of Pixar.

- Facebook’s 2012 acquisition of Instagram.

- Cement companies joining together (acquisition of Gujarat Ambuja Cement by Lafarge of France) or steel
manufacturers joining together (Tata Iron and Steel Co., acquiring Natsteel of Singapore) etc.

Vertical Combinations

Example

- An example of a company that is vertically integrated is Target, which has its own store brands and
manufacturing plants. They create, distribute, and sell their products eliminating the need for outside entities
such as manufacturers, transportation, or other logistical necessities.

- Nirma has set up a plant for manufacturing LAB, a basic raw material required for producing detergents.

- A car manufacturer acquiring outlets to markets his cars an FMCG company acquiring an advertising agency
to market its products.

Lateral Combination

Example

- For instance a book publishing may join with other units producing paper, doing printing work and providing
bookbinding services.

Diagonal Combination

Example

- For example, if an industrial enterprise combines with a transport company, a power station or a repairs and
maintenance workshop, and makes these facilities available within the organization, it will be said to have
effected diagonal integration.

- A machinery manufacturer combining with a repair workshop.

- An electronic goods manufacturer combining with a retailers showroom or with a firm providing repairs and
maintenance service.

- Automobile company combining with a transport company which transports its automobiles In such cases, the
services required for the main process of production is provided within the organization itself. It is also known
as services combination.

Circular Combination

Example

- For example, Godrej is engaged in the manufacturing of cosmetics, electrical goods, office equipment locks,
etc. The object is to secure the benefits of large-scale operations arising out of co-operation.
- A cell phone manufacturer combining with a car manufacturer or a company manufacturing consumer durable
combining with an automobile manufacturing company.