ADVANCED CORPORATE FINANCIAL MANAGEMENT

Financial management is that part of managerial activity which is suitable under the given circumstances and
collection of funds in time and control over the utilization of funds mainly concerned with planning and control
of financial resources.
According to Joseph & Massie “Financial management is the operational activity of a business that is
responsible for obtaining and effectively utilizing the funds necessary for efficient operation”

Goals of Financial Management

The primary or basic objectives of financial Management are as follows:

 Maintenance of liquid assets: financial Management aims to maintain adequate

Liquid assets with the firm to meet its obligations at all times. The investment in liquid assets should
neither be too low nor too high. So the financial manager should maintain balance between liquidity
and profitability.

 Profit maximization: Profit is the excess of income over expenses. Profit maximization is a term
which devotes the maximum profit o be earned by an organization in a given period of time. The
survival of organization depends upon its ability to earn profits.
 Wealth maximization: Wealth maximization refers to the gradual growth of the value of the assets
of a firm in terms of benefits it can produce. Wealth maximization is to be considered as the main
objective of financial management. Maximum wealth means the maximization of the wealth of the
company and the market value of its equity shares.
 Maximization of returns: returns are mainly based on profit earned by a firm. If a firm earns
sufficient profit it will be able to satisfy the owners as well to the maximum possible extent. Hence
there is no
basic difference between profit and return maximization.

The Other objectives of financial Management are as follows:

 To ensure fair return to shareholders.

 To build up reserves for the expansion and growth.
 To utilize the finance effectively and efficiently.
 To ensure financial discipline in organization by coordinating the operations of various divisions.

Profit is the excess of income over expenses. Profit maximization is a term which devotes the maximum profit
o be earned by an organization in a given period of time. The survival of organization depends upon its ability
to earn profits.

Merits of Profit maximization:

 The success or failure of any business is measured in terms of profit.

 Profit is a barometer through the performance of a business unit is measured.
 Profit ensures maximum welfare to the shareholders, employees and prompts payment to creditors of a
company.
 Profit increases the expansion of business. Profit indicates the efficient use of funds for different
requirements.
 Profit helps to increase the return to share holders.
 In the absence of profit, business activity would remain at static.
Point against profit maximization:

 Profit is not clear term. It is accounting profit? Economic profit? PBT? PAT? Net profit? Gross profit or
earning per share.
 Profit encourages corrupt practices to increase the profit.
 Profit maximization does not consider the element of risk.
 Profit does not consider time value of money.
 Profit maximization attracts cut-throat competition.
 Huge amount of profit attracts government intervention.
 A huge profit invites problems from workers. They demand high salary and fringe benefits.
 True and fair picture of the organization not reflected through profit maximization.
 Profit maximization is a narrow concept, later it affects the long term liquidity of a company.

Wealth maximization refers to the gradual growth of the value of the assets of a firm in terms of benefits it can
produce.

Wealth maximization is to be considered as the main objective of financial management. Maximum wealth
means the maximization of the wealth of the company and the market value of its equity shares.

Merits of Wealth maximization:

 Wealth maximization is a clear term. It means the present value of cash flows is taken into
consideration.
 Wealth maximization considers the time value of money. The present value of cash inflows and cash
outflows helps the mgt to achieve the overall goals.
 The concept wealth maximization is universally accepted, because it takes cares of interest of financial
institution, owners, employees and society.
 Wealth maximization guides the management in framing consistent strong dividend policy to reach
maximum returns to the equity holders.

Point against Wealth maximization:

 The concept of wealth maximization is Descriptive.

 The concept of increasing the wealth of the wealth of the shareholders differs from one entity to
another entity. It is also leads to the confusion and misrepresentation of financial policy different
yard stick is used by different interest in accompany.

Analysis of Financial Statements

Financial statement analysis is the process of analyzing a company's financial statements for decision-making
purposes. External stakeholders use it to understand the overall health of an organization as well as to evaluate
financial performance and business value.

Methods of Analysing Financial Statements

1) Trend percentages are a type of horizontal analysis carried out on each component of financial statement. Under
this one of the year is taken as the base year and the amounts of all other years are compared with the base year
and are expressed in terms of percentages.
 2) Comparative statements refers to those statements where the elements of financial statements of different years
ar5e shown in comparative form to facilitate understanding of changes between two periods.

3) Common size statements refers to those statements where comparison of two firms are made by taking any one
of the component of financial statement as the base and all other amounts are compared with base year and
expressed in percentages.

4) DuPont Analysis: The DuPont analysis (also known as the DuPont identity or DuPont model) is a
framework for analyzing fundamental performance popularized by the DuPont Corporation. DuPont
analysis is a useful technique used to decompose the different drivers of return on equity (ROE). The
decomposition of ROE allows investors to focus on the key metrics of financial performance
individually to identify strengths and weaknesses.

5) Ratios are simple arithmetical expression of the relationship of one number to another. It is a process of
establishing quantitative relationship between figures mentioned in the financial statements.

Contents of Financial Statements

 Balance sheet is a statement showing the assets and liabilities of a concern on a specified date. Vertical form
represents sources of funds and applications of funds. Tabular form or horizontal form represents assets and
liabilities on the right and left side respectively.
 Profit and loss account is a nominal account which records all the incomes, expenses, losses and gains of a
business entity for a specific period of time. It gives the net result of the business by determining whether the
entity is running under profit or loss.
 Cash flow statement is a statement which describes the inflow and outflow of cash or cash equivalents during a
specific period of time. It summarizes the causes of changes in cash between two balance sheets.
 Notes to accounts: Specifies the underlying conditions followed in the preparation of the accounts.

ATTRIBUTES OF GOOD FINANCIAL STATEMENT ANALYSIS

 Objectivity: Results of financial statement analysis should be analyzed objectively to reduce the
possibility of any behavioral bias to minimum.
 Precision and Brevity: Financial statement analysis should done with precision and should
provide relevant information in concise form.

 Understandability: Information provided by financial statement analysis should be presented in

such a way that the analysis fosters understand ability.
 Relevance: Analysis of financial statement should be relevant to the purpose of the analysis.
Financial statements used in analysis should be timely and should have a predictive value.
 Reliability: The information derived from the analysis of financial statement must be free of
material error and bias and should provide full and fair disclosure of the financial performance
and other relevant information.

TYPES OF RATIOS

o Balance sheet ratio deal with the relationship between two items of the same balance sheet. Eg: proprietors funds
to fixed assets ratio.

o Profit and loss account ratio deal with establishing quantitative relationship between two items of the same profit
and loss account. Eg: G/P ratio, N/P Profit.

o Composite/ mixed and inter statement ratio are those ratios which exhibit the relationship between one item in
profit and loss account and one item in the balance sheet. Eg: Total assets to sales ratio.
o Liquidity ratios measure the short term solvency position of the firm. These ratios are calculated to know the firms
capacity to meet its current obligations. Eg: current ratio and liquid ratio.

o Long term solvency or leverage ratio measure the capacity of the firm to discharge interest obligations and also
repayment of long term capital. Eg: debt equity ratio, interest coverage ratio.

o Efficiency ratio or activity ratio measure the speed at which the assets are converted in to sales they are also
called turnover ratios. Eg: stock turnover ratio, capital turnover ratio.

o External analysis is made by those persons who are not connected with the enterprise. These people depend on
published statements to carry out their analysis.

o Internal analysis refers to those analysis made by the people who have access to the books of accounts. This
analysis is carried out with an intention of providing required data to the management to take decision.

o Long term analysis is carried out to study the solvency, liquidity and profitability of an enterprise. The purpose of
this analysis is to ensure the minimum earning capacity in the long run.

o Short term analysis is carried out to study the short term capacity in terms of stability and liquidity. The purpose
of this analysis is to know whether the enterprise is in a position to meet its short term obligation.

o Horizontal analysis refers to those analysis where the data of more than one year is taken in to consideration and
converted in to percentages with absolute changes in amounts between the years under consideration.

o Vertical analysis refers to those analyses where the data is analyzed for the same year taking in to consideration
the techniques like ratios.

DuPont Analysis Components

DuPont analysis breaks ROE into its constituent components to determine which of these factors are
most responsible for changes in ROE.

Net Profit Margin = Profit Margin=Revenue/Net Income

Asset Turnover Ratio= Revenue /Average Assets
Financial Leverage
Financial leverage, or the equity multiplier, is an indirect analysis of a company's use of debt to finance
its assets.

Financial Leverage=Average Equity/Average Assets

Formula:ROE=SalesNet Income×Assets
Sales×Shareholders’ EquityAssets

CALCULATION OF DU PONT ANALYSIS

A DuPont analysis is used to evaluate the component parts of a company's return on equity (ROE). This
allows an investor to determine what financial activities are contributing the most to the changes in ROE.
An investor can use analysis like this to compare the operational efficiency of two similar firms.
Managers can use DuPont analysis to identify strengths or weaknesses that should be addressed.

There are three major financial metrics that drive return on equity (ROE): operating efficiency, asset use
efficiency, and financial leverage. Operating efficiency is represented by net profit margin or net income
divided by total sales or revenue. Asset use efficiency is measured by the asset turnover ratio. Leverage is
measured by the equity multiplier, which is equal to average assets divided by average equity.
ADVANTAGES

 Analyse fundamental financial position: Helps in fundamental analysis based on the basic
requirements of an organization.
 Drivers of Return on Equity: It is going to target the drivers of return on equity and ensure that
sufficient split in the calculation is made for compatibility.
 Identity financial SWOC: It is going to identify the financial strengths weakness opportunities and
challenges and henceforth helps the company in proper planning and its execution.
 Operational efficiency: It is going to bring out the efficiency through split of profitability, leverage and
efficiency.
 Inter firm Comparison: Facilitates inter firm comparison with similar kind of operations carried out
with different net worth.

Limitations of Using DuPont Analysis:

 The biggest drawback of the DuPont analysis is that, while expansive, it still relies on accounting
equations and data that can be manipulated.
 Even with its comprehensiveness, the Dupont analysis lacks context as to why the individual
ratios are high or low, or even whether they should be considered high or low at all.

Tools of Financial Management

Meaning of Time of money

A rupee that is receivable today is more valuable than a rupee receivable in future. Put in simple words, today’s
money is more valuable was future money.

Reason for Time value of Money:

1. Risk and Uncertainty – As we know future is never certain and we can’t determines the risk involved
in future because outflow of cash is in our hand as payment where as there is no certainty for future cash
inflows.
2. Inflation - In an inflationary economy, the money received today, has more purchasing power than the
money to be received in future. In other words, a rupee today represents a greater real purchasing power
than a rupee in future.
3. Consumption - Individuals generally prefer current consumption to future consumption.
4. Investment opportunities - An investor can profitably use the received money today to get higher
return tomorrow or after a certain period of time. e.g.- if an individual is given an alternative either to
receive Rs.10,000 now or after one year, he will prefer Rs.10,000 now. This is because, today, he may
be in a position to purchase more goods with this money than what he is going to get for the same
amount after one year

Importance of TVM:
 In Investment Decisions - Small businesses often have limited resources to invest in business
operations, activities and expansion. One of the factors we have to look at is how to invest, is the time
value of money
 In Capital Budgeting Decisions - When a business chooses to invest money in a project - such as an
expansion, a strategic acquisition or just the purchase of a new piece of equipment -- it may be years
before that project begins producing a positive cash flow. The business needs to know whether those
future cash flows are worth the upfront investment.

Uses of Time Value Of Money

 The time value of money (TVM) 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.

This core principle of finance holds that, provided money can earn interest, any amount of money is
worth more the sooner it is received.

Time Value of Money (TVM) is an important concept in financial management. It can be used to
compare investment alternatives and to solve problems involving loans, leases, savings.

TVM help us in knowing the value of money invested. As time changes value of money invested on any
project/ firm also changes. And its present value is calculated by using “mathematical formula”, which
tell us the value of money with respect of time

Two most common methods of adjusting cash flows for time value of money:
1. Compounding/ Future Value Techniques- The process of calculating future values of cash flows. In this
concept, the interest earned on the initial principal amount becomes a part of the principal at the end of
the compounding period—
2. Discounting / Present value —the process of calculating present values of cash flows.

TOOLS

compunding Discounting
technique technique

FV of multiple futue valueof

FV single flow flows an annuity

Investments Investments Investments Investments

occur at the occur at the occur at the occur at the
end begining end begining

Compounding technique:

Compound value concept is used to find out the future value of present money. It is the same as the
concept of compound interest, wherein, the interest earned in preceding year is reinvested at prevailing rate of
interest for the remaining period.
Thus the accumulated amount (principal + interest) at the end of a period becomes the principal amount for
calculating the interest for the next period.
The compounding technique is to find out the future value (FV) of the present worth of money, can be
explained with reference to:

a) The future value of single present cash flows.

b) The future value of annuity/ series of cash flows.
 c) The future value of multiple cash flows.
Future value: It is the value of an asset at a specific date which measures the nominal future sum of money
wherein the sum of money is worth at a specific time in the future assuming a certain interest rate or more rate
of return. It is the present value multiplied by the accumulation function. The value does not include corrections
for inflation or other factors that affect the true of money in the future. This is used in time value of money
calculations.
“The future value refers to the value of an asset or cash at a particular date in the future which is equivalent to
the value of a specified sum at present. The future value can also be explained as the amount of money which
will be reached by a present investment as a result of its growth in the future.” As money features time value,
the future value is, obviously, expected to be higher than the present value.
FV= PV (1+r)n
FV= Future value
R=rate of interest
PV= present value
N= number of years

1. FUTURE VALUE OF A ISNGLE FLOW ( LUMP SUM)

The future value of a lump sum can be calculated by using the following formula:

FV = P [1+i] n
Where, Fv = Future Value, P =Principal, I = Rate of interest per unit [R/100] ,n = number of years.

2. FUTURE VALUE OF MULTIPLE FLOWS OR A SERIES OF FLOES

In many cases we may have to invest different amounts at different time periods. In such a case Future Value can be
calculated as follows
a) When the investments occur at the end of each period
FV = P1 [1+i] n-1+ P2 [1+i] n-2 + P3 [1+i] n-3 + P4 [1+i] n-4 +…………Pn
b) When the investments occur at the beginning of each period

FV =+P1 [1+i] n + P2 [1+i] n-1+ P3 [1+i] n-2 + P4 [1+i] n-3 +………Pn[1+i]

3. FUTURE VALUE OF AN ANNUITY
a) When the investments occur at the end of each period
𝑎
FV = [(1 + 𝑖)n-1]
𝑖
b) When the investments occur at the beginning of each period
When cash flows occur at the beginning of each period, the annuity is called annuity due. The future value of
annuity due can be calculated as follows;
𝑎
FV = (1 + 𝑖)[(1 + 𝑖)n-1]
𝑖

EFFECTIVE RATE OF INTEREST IN CASE OF MULTI-PERIOD COMPOUNDING ‘

When the interest is compounding annually, the nominal rate of interest is the ERI. But, in case of multi period
compounding, where the interest compounding is done at a frequency of a period which s less than one year, the rate of
interest received by the investor for one year becomes more than the given nominal rate. This is called effective rate of
interest. In such cases, the frequency of compounding may be half-yearly, quarterly or monthly or any other fraction of an
year.
𝑖
ERI = (1+𝑚)m-1

Where, ERI = Effective rate of interest, m = frequency of compounding , i= nominal rate of interest
𝑖
a) When the compounding is done monthly ERI = (1+ )m-1
𝑚
 𝑖
b) When the compounding is done quarterly ERI = (1+ )4-
4
𝑖
c) When the compounding is done half-yearly ERI = (1+ )2-1
2

Discounting technique /PRESENT VALUE technique

Tools

compunding discounting
technique technique

FV of futue PV of
FV single multiple PV single multiple PV of an
valueof an
flow flows flow annuity
annuity flows

Investments Investments Investments Investments

occur at the occur at the occur at the occur at the
end PV of PV of value
begining end begining of annuity
immediate
annuity due

The present value of an entity can be defined as the present worth of a prospective amount of money or
a stream of cash flows with a specified return rate. The present value is conversely related to the discount rate.
Thus, a higher discount rate implies a lower present value and vice versa. Accurate determination of cash flows
is, therefore, the key to appropriately valuing future cash flows, be it earnings or obligations.

The calculation of the present value holds extreme importance in different financial calculation like Net
present value, spot rates, bond yields, and pension obligation. The opposite definition for present value (PV) is
given as the current value of one or higher future cash payments which are discounted at a reasonable interest
rate
“
Present value of money is today’s value of money to be received in future. It is te future of money discounted
at a given rate of interest. “
a) The present value of single present cash flows.
b) The present value of annuity/ series of cash flows.
c) The present value of multiple cash flows.

A) The present value of single present cash flows.

𝐴
PV = [1+𝑖]𝑛

PV = present value , A =Amount at the end of the period “n” , I= interest rate , n- n years

B) The present value of annuity/ series of cash flows

Calculate of present value :

Year Cash flows Pv factor at percent PV (cash flows * PV factor)

C) The present value of multiple cash flows.

A series of equal amount of cash flows over a certain given years is called an annuity. the present value of an
annuity of amount A for n years at an effective rate if interest if I can be represented by the following formula:
𝐴 1
1) PV of immediate annuity : PV = [1-[1+𝑖]𝑛]
𝑖
𝐴 1
2) PV of value of annuity due : PV = (1+i)[1-[1+𝑖]𝑛]
𝑖

4. Perpetuity: It is a case of calculating the future value when the cash flows are consistent until the
existence of the security. It is in case of irredeemable debentures issued by the company that the interest
will be received in lifetime and that is when this calculation holds good.

𝐴 𝐴 𝐴
PV = [1+𝑖]+[1+𝑖]2+[1+𝑖]𝑛𝑡𝑒𝑟𝑚𝑠

Step ahead of Perpetuity is taken into consideration when the expectation of the growth is found
in the normal course of action, in case of ownership of a building and if it is rented the rental
value of the building increases every year which can be taken as the basis for calculating the
Perpetuity.

𝐴 𝐴 (1+𝑔𝑟𝑜𝑤𝑡ℎ) 𝐴 (1+𝑔𝑟𝑜𝑤𝑡ℎ)𝑛𝑡𝑒𝑟𝑚𝑠−1
PV = [1+𝑖]+ [1+𝑖]2
+ [1+𝑖]𝑛𝑡𝑒𝑟𝑚𝑠

Cost of capital

Cost of capital refers to the minimum amount of earnings that the company has to meet expressed in
terms of percentage in order to maintain the securities that they have issued to raise their capital.

Cost of equity
Cost of equity refers to the cost that is incurred by the organization to maintain its equity capital which
also consider the growth factor before calculating the cost.

Cost of debt and preference shares

Cost of debt and preference shares refers to the cost that is included in expressed in terms of percentage
for the purpose of maintenance of debt capital and preference shares. In case of debt capital, we would
consider the interest obligation and tax saving that organization is going to enjoy by making payment of
interest but while calculating the cost of preference it will not be taken into consideration as dividend is
not exempt from tax. Other than the three major instruments any other instruments that are raised by the
organization will attract the rate of interest so the calculation mechanism will be similar to the way it is
calculated for cost of debt.
 Weighted average cost of capital
Weighted average cost of capital is the extent of the combined cost that will be incurred to maintain the
securities in the organization. It is calculated by taking into consideration the percentage of each
security with the overall capitalization of the company and multiplying it with the cost that is incurred
by the organization to maintain each of the securities. The resultant value in terms of the total is
expressed again in percentage to indicate the minimum earning which should match with the return on
investment in order to sustain in the market.

Advantages

 It is going to provide clear roadmap to the company

 Helps in proper decision making
 Would help company to enjoy tax benefit by raising debt capital
 Will ensure that it management sets proper targets and objectives to be achieved by the
company.
 Calculation is more realistic in nature as the value of weights is derived from the
calculation made on Capital Asset pricing model.

Disadvantages

 It ensures proper reporting and timely e announcement of results which will have the
direct impact on share prices.
 It is sometimes going to be impractical while setting targets as it does not consider
extraordinary items.
 It is based on purely internal data, external data is not taken into consideration for
calculation.
 Based on certain assumptions which do not consider the inflation factor.
 Allocation of weights to the securities is based on the overall capitalisation without
considering the basis for raising the capitalisation.
 Sometimes provides relaxation if the growth of the company shows little higher in the
initial phase of the Year itself.

Capital Asset pricing model

Capital Asset pricing model is it tool to establish the relationship between risk and expected return,
organisation estimates the expected return on the stock and then compare it with the returns on
individual securities using this technique.

Capital Asset pricing model assumptions

 Expected return on market is based on risk premium beyond normal return.

 It is to compensate for business risk that is undertaken through investment.
 Calculation of market return is based on some assumptions.
 Mean values of past 10 years risk-free interest is taken for calculating the risk free rate. Usually
Government treasury bond rate is considered.

Expected return on market

Expected return on market is calculated with another option that the investor perceives that he has
to get the extra Returns which is called as risk premium ahead of the risk-free interest rate that is
prevailing in the market. Unless the confidence is provided with regard to the returns the risk
taking on investment is considered to be questionable.
 Expected return on individual security
Expected return on individual security is calculated by comparing the risk Returns with the beta
analysis, beta values indicates the extent to which the shared values are getting impacted by the
variation in the sensex. The beta values are multiplied with the difference in the assumed returns
with risk free return to arrive at the return on individual security.

Advantages
 It is more realistic as it considers the average of government points for risk free Returns.
 Beta analysis is considered, so historical data is used for the purpose of estimating the expected
Returns.
 It will consider the business premium as well to give extra income and profitability to the investors.
 Widely used model as the basis for the weighted average cost of capital.
 It indicates linearity and upward slope is always a positive Trend.
 It is going to help individuals and also investment organisations in planning their portfolio.

Disadvantages
 It leads to certain confusion while estimating the market return expected.
 Suitable only for large scale stock organisations.
 Based on multiple factors for makes it complex to calculate.
 Believe that stock traders are rational and well behave accordingly in trading.
 It assumes historical data for future prediction which sometimes may go wrong.

Beta analysis

Beta analysis values indicate the extent to which the shared values are getting impacted by the
variation in the sensex. A beta greater than 1.0 suggests that the stock is more volatile than the broader
market, and a beta less than 1.0 indicates a stock with lower volatility.

Unlevering Beta
Lever in short refers to borrowings; it is a portion of the interest obligation that the company has to
meet when they are raised by Debt capital. Unlevered beta/ asset beta based calculation is a scenario
where by the debt becomes zero, only equity is considered for the purpose of estimating the risk and
return. The concept underlines the fact based on certain assumptions that the beta of the equity
must be higher compared to the normal return that is prevailing in the market.

Relevering Beta
The suppression of the debt for the purpose of calculating the beta purely based on the assets, will
reinforce the proposed capital structure based on the obtained beta values on unlevering method to arrive at
understanding the most profitable capital structure in terms of risk return and debt. The data for cost of
equity is obtained from Capital Asset pricing model and the uncertainty in the projection of company's
cash flow is purely analyzed based on the components of Business and financial risk.