Caiib Fm Modb

7/28/2019 Caiib Fm Modb

1/39

CAIIB-Financial Management-

MODULE B

STUDY OF FINANCIAL STATEMENTSC.S.BALAKRISHNAN

FACULTY MEMBER

SPBT COLLEGE


2/39

Scope,Functions and objective

Scope isDesigning and implementing certain plans.

Ensuring effective funds utilisation by directing

funds flow according to some plan.

Serving as a necessary tool and technique for

resources allocation to various projects of the

business and providing the best guide for existing

and prospective resource allocation.


3/39

According to Howard and Upton Financial

management involves the application of

general management principles to particularfinancial operation.

Attending to investment decisions as to when

and how to acquire and allocate funds forshort-term and long-term assets keeping in

view the profit generation of the business

through which repayment obligation can be

met.


4/39

Objectives and basic consideration of

Financialmanagement.

Although profit maximisation is the objectiveof financial management,the long-term goalof

the business entity is to achieve maximising

the shareholder value of the firm,since theprinciple of maximisation of shareholder

wealth provides a rational guide for running a

business and for efficient allocation ofresources in society.


5/39

The key objective of Financial Management is to

maximise the value of the company.This is the result

of good investment decisions,prudent financingdecisions and well thought-out financial planning

and control.

Maximisation of the value of the company is also

known as maximisation of the wealth of the

owners.To achieve this,finance manager has to take

careful decisions in respect of

-Financing -Dividend-Investment -Current asset management.


6/39

Financing decision-Has to decide on sources offunds for business.It is to be decided whetherentire capital should be raised from equity capital

or a part is to be raised from loan.HenceDebt/Equity ratio or Leverage are important sinceeach source has in them associated risk factorsinvolved.

Investment decision-It relates to acquisition ofassets.Assets are classified into real assets suchas land,building,plant,equipment etc.and thefinancial assets are shares and debentures etc.Itindicates available mix of financing to fundcompanys activities.Such decisions oninvestment in projects come within the field ofcapital budgeting which is derived from netpresent value of assets.


7/39

Dividend decision-It is basically a financingdecision.This is because profit is a source offund.By not paying dividend,the retained

earningsorreservecan be increased whichcould be otherwise available for investment.

This ultimately lead to maximisation of wealth

of the organisation provided decisions on

investments are correct. Current Asset Management-This is necessary to

maintain balance between current assets andcurrent liability,if the liquidity of the business is

interrupted because of holding too much fund incurrent assets.


8/39

Wealth maximisation &value maximisation

The goal of financial management is to maximisethe value of companies.This is generallyexpressed in terms of maximising the value of theownership shares of the company,inshort,maximising share price.Thus,betterperforming companies can raise additional fundsunder more favourable terms.When funds go thesuch companies the economys resources are

directed to more efficient use.This basic objectiveof maximisingthe price of the companys shares iscalled value maximisation.


9/39

Social responsibility is also an important goal of

a company which requires

-Maximising share-price by efficient,well-managed operations related to consumer

demand parameters.

-Efficiency & innovation leads to value

maximisation which leads to newproducts,new technologies and better

employment.

-External factors like pollution,product safety and

job safety have acieved added dimensions inrelation to value maximisation.


10/39

Profit maximisation vs.Wealth

maximisation

Long run vs.Short run Profits.

Convert total corporate profits to earning pershare(EPS).

EPS is total profits divided by number of sharesoutstanding.

Assume the firm earns Rs.10 mn.and has1mn.shares outstanding.The EPS will work out toRs.10.

Profit maximisation is a short-term concept,whilewealth maximisation emphasises the long-termview point.


11/39

State whether true or false

The income statement depicts the financialposition of the firm at a given point of time

The balance sheet gives the financial

performance of the firm over a given period oftime.

These statements are prepared every week.

Funds Flow statement gives the liquidityposition of the firm.


12/39

Cash Flow statement tells from where the

money comes and where it is used.

The prime objective of financial managementis wealth maximisation,and not profit

maximisation.

What is earnings per share?a)Net Profit

b)Profit before interest and tax

c)Total earnings divided by investment

d)Net profit divided by equity


13/39

What is the difference between long term

funds and short term funds?

-Difference in interest rates

-Difference in time of repayment

-Difference in the size of loan

-No difference


14/39

CAPITAL EXPENDITURE DECISIONS AND

PROFITABILITY STUDY

It represents the important decisions taken by

the firm.Importance due to the following issues

-Long-term effects

-Irreversibility-Substantial outlays


15/39

Difficulties

-Measurement problems

-Uncertainty

-Temporal spread

o Phases of capital budgeting

-Capital budgeting is a complex process which

may be divided into five broad phases.

Planning ImplementationAnalysis Review.

Selection


16/39

Levels of Decision Making

-Operating decisions

-Administrative decisions-Strategic decisions

o Profitability Study important facets are

-Market analysis-Technical analysis

-Financial analysis

-Economic analysis-Ecological analysis


17/39

The basic characteristic of a capital project is thatit typically involves a current outlay(or currentand future outlays)of funds in expectation of astream of benefits extending far into future.

Accounting rate of return method-A selectioncriterion using average net income and

investment outlay to compute a rate of return fora project.This method ignores the time value ofmoney & cash flows.

Internal rate of return method-A selection

method using the compounding rate of return onthe cash flow of the project.


18/39

Net Present Value method-A selection method

using the difference between the present

value of the cash inflows of the project andthe investment outlay.The method evaluates

the differential cash flow between proposals.

Payback method-A selection method in whicha firm sets a maximum payback period during

which cash inflow must be sufficient to

recover the initial outlay.This method ignores

the time value of money and cash flow

beyond the pay back period.


19/39

What are the three important factors which arise

from capital expenditure decisions?

a)Long-term effects e)Debt

b)Profitability f)Substantial outlays

c)Irreversibility g)Short-term effects.

d)Risk

Why are capital expenditure decisions difficult?

i)Uncertainity in predicting costs&benefits

ii)Difficulty in measurement of costs&benefits

iii)Risk involved

iv)Problems in estimating discount rates

v)All the above


20/39

If the IRR of the project is 7% and the cost of

capital is (11.4% should we reject or accept

the project). Yes/No. The firm should always make an ecological

analysis to know the likely damage that may

be caused by the project to the environment.a)Must do b)No need.


21/39

Sources of finance and

cost of capital

For what purposes a firm needs a finance?

Since the cash receipts lag behind cash

payments necessitating loans,bonds,overdrafts

etc.the firm needs finance for short term and long

term requirements-fixed assets and working

capital.Permanent sources of finance

Share capital and retained profits.


22/39

Depreciation is not a real expenditure.It is a

non-cash expenditure(T/F)

Depreciation amount increases the liquidity ofthe firm(T/F)

Cost of goods sold and Cost of production refer

to the same amount(T/F)Net profit is calculated before tax(T/F)

Balance sheet and Income statement can be

prepared every quarter for internal use(T/F)

A loss is shown as asset in the balance

sheet(T/F).


23/39

Provisions for taxes and accrued expenses to

be paid within a year are current assets(T/F)

Debtors(also known as accountsreceivable)represent the amount of money to

be paid by the firm to the suppliers(T/F)

Fund Flow statements can be preparedwithout the basis of balance sheets(T/F).

Fund flow statements represent only bank

borrowing and trade credit(T/F)


24/39

State whether following are sources or uses

-Buying materials

-Payment of dividend to shareholders

-Advance received from buyer of goods

-Investment in machinery

-Issue of debentures

-Retained earnings

-Increase in Inventories

-Sale of old machinery

-Depreciation amount


25/39

Study of financial statements

Who are the party interested in firms financial

condition?

Shareholders,creditors/suppliers,managers,tax

authorities.

Different types of concerns of stakeholders

Profitability and earning capacity,liquidity and

repaying loan instalments and interest.


26/39

Long term sources

Preferenceshares,bonds,debentures and long

term loans from financial institutions.

Various sources of short term finance-

Cash credit,overdraft,billsdiscounting,commercial

papers and trade credit.

Short term & long term cash forecasts-

Time periods involved-Yearly for long term

forecasts,monthly for short term forecasts.


27/39

Factors considered in equity financing

Issue costs,servicing costs such as paying out

dividends, and when there is retained earningsthere will be capital appreciation of sharevalues.

Preference Shares-These shareholders get a

fixed return and their risk is less than the equityShareholders.They have a right to the first slice

of dividend.Obligation to redeem the preference

shares after its time period.They do not have a

right to vote.


28/39

Debentures or loan financing-the firm will have

to pay fixed interest very year.There is an

obligation to redeem it at the end of theperiod.There is also an advantage of tax

deductibility of interest paid which makes it

cheaper.

Bills rediscountingThe buyer can repay in a

long period of time,while seller gets his money

back by discounting the bills.For the seller,this

helps him to go ahead with production and

increase the turnover.


29/39

Working capital term loan-A part of working

capital has to be with the manufacturer,since

there is a time lag between ordering andprocuring.This particular portion (say25%)can

be financed by long term funds.When firm is

not able to infuse its own funds for thispurpose,it gets a long term loan from the

bank.This carries fixed interest and for a fixed

period.

Overdraft and bank loan-Overdraft is a running

account whereas bank loan instalment are

fixed.


30/39

Trade credit-When materials are bought from

suppliers,the trade credit is extended for few

days or a couple of months.The supplier iswilling to wait to collect money.This also

depends on the suppliersfinancial position

and the buyers credit worthiness.

Commercial paper-These are short term

promissory notes with fixed maturity

period.They are issued by very large

companies who are reputed and have high

credit worthiness.Credit rating agencies certify

their credit rating.


31/39

Firmscost of capital-A firms is the average cost of

capital is the weighted average arithmetic mean

of the cost of resources from various sources.

Questions:

a)Long term sources are banks and financial

institutions (T/F)

b)Current liabilities should be repaid within a

financial year(T/F)

c)Fixed assets are generally financed withcurrent liabilities(T/F)


32/39

Equity Shareholders bear the greatest risk(T/F)

Bills discounting scheme has been introduced to ease

flow of funds in the economy(T/F) Trade creditors are suppliers of goods and services to

whom the firm is yet to pay.(T/F)

Accounts Receivables should be less than trade

creditors(T/F).

Bills of Exchange is same as cash credit(T/F).

Equity and Preference shares are one and the

same(T/F)A part of working capital can be financed by long

term sources(T/F)


33/39

A firm borrows Rs.20,000 from bank @8% and

floats a debenture for Rs.60,000 @6%,for a

special project,what is the cost of capital of the

project?

a)5.5% b)6.5% c)7.5% d)8.5%

If a firm borrows Rs.2 lac @10% and has a tax

rate of 40%.What is the cost of capital?

a)5% b)6% c)7% d)8%

A company has issued preference share of Rs.100

face value carrying 14% dividend repayable atpar after 12 years.Cost of capital after tax of

40%?a)21.22% b)23.33%c)24.23%


34/39

Data for analyzing the situations of the firm

Balance Sheet,Income Statement,fund flow

statement.Basic concepts while preparing balance sheet

-Entity concept

-Money measurement concept

-Going concern concept

-Cost concept

-Consevatism concept

-Dual aspect concept


35/39

Accounting period concept

Accrual concept

Realisation conceptMatching concept

Materiality concept.

What is revenue reserve & capital reserve?

Revenue reserves are accumulated earnings

from profits and normal business

operations.Capital reserves arise due to

capital gains from revaluation of assets or due

to premium on issue of shares.


36/39

Accounts payable-These are current liabilities

payable within one year from date of balance

sheet.

Fund Flow Statement-It shows the sources

and uses of funds during a given accounting

period.

Horizontal analysis and Vertical analysis-

Horizontal analysis is comparing the

operations over a time period ie.comparing

past performance with current position for

predicting the future performance.


37/39

In vertical analysis we use percentages to show

the relationship between various items in the

balance sheet.a)X contributes Rs.10,000 to his properietory

concern and the amount is deposited in the

bank.What is the nature of liability?i)Owners equity

ii)Loan

iii)Short term financeiv)Fixed Asset.


38/39

b)ABC co.paid Rs.30,000 as deposit to the

suppliers for a period of 3 months.

i)Liabilityii)Current Asset

iii)Trade Credit

iv)Debenture

c)Materials costing Rs.2000 destroyed by fire

i)Asset

ii)Liability


39/39

Moving over to other questions.

Caiib Fm Modb

Documents

Transcript of Caiib Fm Modb