CH1: Introduction to financial management Business concerns require financing in order to satisfy their needs in the global economy. The financial situation affects all corporate activities. It is therefore referred to as the lifeblood of a company organization. No matter how big or little, businesses require funding to carry out their operations. 1/ MEANING OF FINANCE: Finance may be defined as the art and science of managing money. It includes financial service and __ financial instruments. Finance also is referred as the provision of Finance can be broadly divided into two main categories: - Private Finance, which includes the Individual, Firms, Business or Corporate Financial activities to meet the requirements. - Public Finance, which includes tax systems, government expenditures, budget procedures, debt issues, and other government concerns.1/2 SOURCES OF FINANCE: categories according to the following important heads: 1/2/1 Based on the period: Sources of Finance may be classified under various categories based on the period of financial requirement ,it may be long term and short-term financial requirements. a) Long-term sources: such as purchase of fixed assets such as , land and buildings, Long-term sources of finance include: and is offered for sale so as to raise capital for the company.company as well as a vote in the AGMs of the company. Such a shareholder has to share the profits and also bear the losses incurred by the company. On the other hand, preference shares earn their holders only dividends, which are fixed, giving no voting rights. Equity shareholders are regarded as the real owners of the company. When the shares are offered for sale directly by the company for the first time, they are offered in the primary market, whereas the trading of shares takes place in the secondary market. Debenture /Bonds: are loans made to a company. They normally carry a fixed interest rate and a certain date of maturity. Interest is paid every year and principal is paid on the date of maturity. Long-term Loans: are generally considered to be a loan with a repayment term longer than five years. Fixed Deposits: It is a financial instrument offered by banks or non-bank financial institutions that provide investors with a higher rate of interest than a regular savings account, until the specified maturity date, where no withdrawals can be made before maturity. Retained earnings (RE): are the amount of net income left over for the business after it has paid out dividends to its shareholders. The decision to retain the earnings or distribute them among shareholders is usually left to company management. The company's undistributed or retained earnings are utilized to meet its financial obligations. A mortgage: A mortgage is a type of loan that's used to finance the purchase or maintenance of a property, 7land, or other types of rental properties. The lender agrees to pay back the loan over some time, generally in a series of regular installments divided into principal and interest. Mortgages'are"" Secured'loans": finance to business firms, which are known as bank credit. When bank credit is granted, the borrower gets the right to draw the amount of credit at one time or in installments as and when needed. Bank credit may be granted by way of loans, cash credit, overdrafts, and discounted bills. Short term Loans: When a bank advances money that must be paid back after a particular length of time. Cash credit: is an arrangement by which a bank allows his customer to borrow money up to certain limit against the security of the commodity. Overdraft: Overdraft is an arrangement with a bank by which a current account holder is allowed to withdraw more than the balance to his credit up to acertain limit. This limit is granted purely on the basis of credit worthiness of the borrower. Bill_discounting: is short-term finance for traders wherein they can sell unpaid invoices, due on a future date, to financial institutions in lieu of a commission. The Bank purchases the bill (Promissory Note) before its due date and credits the bill’s value after a discount charge to the customer’s account. The Bank will realize the bill amount on the bill’s due date directly from the debtor. This helps the traders optimize their cash flows and business (payment) cycles without disturbing their balance sheets. This type of credit does not make the funds available in cash but it facilitates purchases without making immediate payment. Customers generally agree to make advances when such goods are not easily available in the market or there is an urgent need of goods. Customer advances | 4 > oamount of interest is included while deciding on the amount of installment. On the basis of ownership, the source can be classified into Owner's funds and Borrowed funds 2 z= 3 a g a xh = 5 a a include - Shares capital: is the money a company raises by issuing common or preferred stock. - Retained earnings: is when the business makes a profit, it can leave some or all of this money in the business and reinvest it in order to expand. - Venture Capital: refers to an individual or group that is willing to invest money into a new or growing business in exchange for an agreed share of the profit. These funds are different from the capital owned by the company which is called equity funds. | |- Debenture: is a medium-to long term debt instrument used by large companies to borrow money at a fixed rate of interest. + Loans from commercial banks: is adept based funding arrangement between a business and a financial institution such as a bank. It's used to fund major capital expenditures or cover operational cost. A loan may be secured by collateral such as mortgage or it may be unsecured, such as a credit card. Public deposits: are those deposits made directly to an institution by the general public. On deposits of the general public, companies pay higher interest rates than bank. Public deposit s is an unsecured deposit. There is usually no charge on the company's assets when it comes to public deposits Trade credit: a customer is allowed to purchase goods or services and pay the supplier at a later scheduled late.1/2/3 Based on Sources of Generation: Sources of Finance may be classified into internal source or external source of finance (@/ Internal source of finanee : are those that are generated inside the business. Internal source of finance includes + Retained earnings Debt collection + owners capital owners investment = selling assets Sales of stocks and financial assets The internal source of funds has the same characteristics of owned capital. (The best part of the internal sourcing of capital is that the business grows by itself and does not depend on outside parties. (o) External sources of finanee: are the sources that lie outside an organization, such as suppliers, lenders, and investors. When a large amount of money is needed finance may be include: Suppliers, lenders, and investors - Share capital - Debenture/ Bonds - Public deposits - Loans from Banks and Financial institutionsLease financing is one of the popular and common methods of assets based finance, which is the alternative Lease is contractual agreement between the owner of the assets and user of the assets for a specific period by a periodical rent. 1/2/4/1 DEFINATION OF LEASING Lease may be defined as a contractual arrangement in which a party owning an asset provides the asset for use to another, the right to use the assets to the user over a certain period of time, for consideration in form of periodic payment, with or without a further payment. According to the equipment leasing association of UK definition, leasing is a contract between the lesser and the leaser for hire of a specific asset selected from a manufacturers or vender of such assets by the lessee. The leaser retains the ownership of the asset. The lessee pass possession and uses the asset on payment for the specified period. Leasing is one of the important and popular parts of asset based finance. It consists of the following essentialelements. One should understand these elements before they are going to study on leasing. Leasers may be individual partnership, joint stock companies, corporation or financial institutions. » He acts as an intermediary in arranging the lease deals. divisions of foreign banks, &é af Sg. .o oO a8 28 & eg c ees 5 q ia . 3 8 a a a. Sg a S g. TQ 5 lo Be 3 8 implied or in perpetuity. The lease should commence either in the present or on some date in future or on the happening of some contingency, which is bound to happen. Though the lease can commence from a past day, but that is for the purpose of computation of lease 4cag ges ges Gok om 2 oe ag @ 824 a Box aa POs Be Ze Ba = 2 gS gS ae a “ § 3 BG ge & g = 0 ss _ = op 3 as Goo o> oa . The premium is the consideration paid of being let in possession, such as Salami, even if it is to be paid in a a & 5 & 3 e Leasing, as a financing concept, is an arrangement s 2 3 8 8 6 3 3 a 5 g s g 2 a sg 3 a. oh e a 3 & e 3 a Finance leases offer companies both advantages and disadvantages as far as costs, liabilities, and accounting.+ The Lessee is able to use a needed asset without purchasing it + Lease financing is usually less expensive than other types of financing options + A lessee is able to spread payments out over several years + There is no burden of a lump-sum cost for an asset + The lessee claims depreciation on the leased asset reducing tax liability + Even if the asset rises in price, the lessee only has to pay the installments already agreed upon + The lessee retains the right to purchase the asset at the end of the lease period, usually at a bargain rate Some limitations or disadvantages of a bargain lease include the following: + The lessee is responsible for all maintenance or repairs on the asset + The lessee is liable for all risks involved with the asset + The lessee cannot cancel a finance lease b. Operating Lease: Operating lease is also called as service lease. An operating lease is a contract that allows a business to use an asset for a specified period of time, usually shorter than its useful life, in exchange for periodic payments to the owner or lessor. The business does not own the asset, nor does it assume the risks and benefits of ownership, such as depreciation, maintenance, or disposal. The lessor retains the ownership and control of the asset, and can lease it to another party or sell the equipment secondhand after the contract expires. 16e Enhancing the flexibility and efficiency of the business, and ownership. This is because operating leases reduce the amount of debt and assets on the balance sheet, increase cash flow from operations, ownership, and enable adjustment to changing market conditions and customer demands. 1/2/4/4 The Impact of Operating and Financing Leases on Financial Statement: Financing leases A financing lease is a type of lease that transfers the ownership or the risks and rewards of the asset to the lessee. The lessee effectively purchases the asset and pays for it over time. such as thedebt-to-equity ratio, the asset turnover ratio, and the return on assets ratio, because they increase your debt and decrease your asset efficiency. An operating lease: An operating lease is a type of lease that does not transfer the ownership or the risks and rewards of the asset to the lessee. The lessee only pays for the use of the asset and returns it at the end of the lease term. Operating leases are treated as expenses on the income statement and do not affect the balance sheet. Therefore, operating leases reduce net income and operating cash flow, but they do not affect your assets, liabilities, or equity. Operating leases also improve some of financial ratios, such as the debt-to-equity ratio, the asset turnover ratio, and the return on assets ratio, because they lower your debt and increase your asset efficiency. 1/2/4/5 Evaluation of lease: Example: A company is evaluating the lease of a new computer (cost: 150). « The computer‘s economic life is 5 years after which it is obsolete.1/2/4/5 Leasing finance is one of the modern sources of finance, which plays a major role in the part of the asset based financing of the company. It has the following important advantages. equipment's for the company. Hence, it plays a important and additional source of finance. without purchasing. This type of finance is suitable where the company uses the assets only for a particular period or particular purpose. 20Lease rent is fixed by the lease agreement and it is based on the assets which are used by the business concern. o = a om $ D g 2 g 3 8 B Ss use the assets or fixed equipment's by the lessee, the leasing arrangement is mostly finished. 6. Transaction cost When the company mobilizes finance through debt or equity, they have to pay some amount as transaction cost. But in case of leasing finance, transaction cost or floating cost is very less when compared to other sources of Leasing finance reduces the financial risk of the lessee. Hence, he need not buy the assets and if there is any price 21Now a day, most of the commercial banks and financial institutions are providing lease finance to the industrial concern. Some of them have specialized lease finance company. They are established to provide faster and speedy arrangement of lease finance. Finally, having known that there are many alternatives to finance or capital, a company can choose from, Choosing right source and the right mix of finance is a key challenge for every finance manager. The process of selecting right source of finance involves in-depth analysis of each and every source of fund. For analyzing and comparing the sources, it needs the understanding of all the characteristics of the financing sources It is helpful to keep the following financing. Firms do not just pick one source — the goal is to You combine debt and equity to maximize your rate of return to investors. 2equity is interested in the company‘s management as the goods or services the company sells. Next Lecture... An essential component of general management is financial management. It is focused on the responsibilities of the business firm's financial management. Business finance is that business activity which concerns with the acquisition and conversation of capital funds in meeting financial needs and overall objectives of a business enterprise. According to the Guthumann and Dougall, “Business finance can broadly be defined as the activity concerned with planning, organizing, coordinating and controlling of the funds used in the business”. if the finance not being properly arranged, the business system will stop. Arrangement of the required finance to each department of business concern is highly a complex one and it needs careful decision. Quantum of finance may be depending upon the nature and situation of the business concern.