Corporate Finance, Funds Statament,Agency Problem 52

8/8/2019 Corporate Finance, Funds Statament,Agency Problem 52

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Hi!!!! I am a

financeman!!!

What this man does???

FINANCEMANAGER


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31-03-2002 31-03-2003 31-07-2002 31-03-2003

3589.816 3577.043

343.379 305.879 1338.768 1522.166

5525.162 4922.769 2251.048 2054.8775868.541 5228.648 620.517 1019.248

2871.565 3074.125

212.891 285.119

2012.431 2317.769

594.333 833.333

122.000 238.800

152.079 545.441 28.862 28.098

868.412 1617.574 275.862 336.930

127.069 152.137

28.290 7.383 483.668 359.037

10.476 88.239 4.998 7.228

316.512 322.492 2.039 1.212

355.278 418.114 4.323 4.635

926.821 889.277

1254.779 594.979

376.834 290.362 1.237 1.132

290.094 278.168 55.119 91.974

666.928 568.530 1.225 3.325

265.888 112.596 57.581 96.431

1114.761 1243.934

3353.942 2824.621

14.066

8237.938 8230.581 8237.938 8230.581

Fixed Assets (Net)

Packing Material

Provisions

(vi) Loans and Advances

Non-Convertible Debentures

Working Capital Borrowings from Banks

Fixed Deposits

Acceptances (Short-Term)

Deferred Sales Tax Loan

Goods Traded in

Particulars

NET WORTH

Miscellaneous Expenses

Total AssetsTotal Liabilities

Total Current Assets

Semi-Finished Goods

Sundry Creditors

Other Current Liabilities

Finished Goods

Debts Considered Good

Cash in hand

Cash in Fixed Deposits Account

Scrap

Stores, Spares & Consumables

Current Liabilities:

(ii) Sundry Debtors

(iii) Cash and Bank Balnces

Raw Materials

Loans Funds:

Secured Loans

Unsecured Loans

Investments

Current Assets, Loans and Advances:

(i) Inventories

Particulars

Reserves and Surplus

Deferred Tax (Net)

Gross Block

ASSETS

Less: Depreciation

Capital Work-in-ProgressNet Block

FINOLEX Cables LimitedBALANCE SHEET as at 31st March (Rs. in millions)

Foreign Currency Demand Loan (Short-

Term)

Cash in Current Account

LIABILITIESShareholders' Fund:

Share Capital

READ &

THINK!!!


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HAVE YOU EVER WONDEREDHAVE YOU EVER WONDERED

WHAT DECISIONS OF AWHAT DECISIONS OF AFIRM DETERMINEFIRM DETERMINE THETHE

STRUCTURE OF A BALANCE SHEET?STRUCTURE OF A BALANCE SHEET?


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2002 2003

724.460 282.230

221.954 235.245

(70.059) (72.658)

9.056 21.017

(50.741) (50.570)

7.033

103.458 123.446

938.128 54 5.743

340.857 558.581

(120.318) (303.046)

1158.667 801.278

(49.700) (24.500)

1108.967 776.778

70.059 72.658

10.327 44.100

325.405 104.279

(1 064.053) (502.922)

279.805 1.703

(223.467)

(601.924 ) (280.182)

(92.833) 239.00010.476 77.763

(4.957) (20.907)

(37.500)

(712.500)

28.125

4.467 5.981

7.077 6.390

(1 03.458) (1 23.446)

(257.534) (1 03.521 )

(4 36.762) (64 0.615)

70.281 (144 .019)116.167 186.448

186.448 42.429

CASH FLOW STATEMENT OF FINOLEX Cables LIMITED FOR THE YEAR ENDING ON 31ST

MARCH

Adjustments for :

Depreciation (Net)

Income from Investments

A) CASH FLOW FROM OPERATING ACTIVITIESNet Profit/ (Loss) Before Tax and Extraordinary Items

Operating Profit before Working Capital Changes

Adjustments for Changes in Working Capital

Current Assets

Buy-Back of Shares

Taxation

Net Cash Flow from Operating Activities

Current Liabilities

Cash Generated from Operations

Sales of Fixed Assets

Sales of Investments

Amalgamation of Subsidiary

Net Cash used in Investing Activities

Proposed Dividend including tax thereon

Short Term Acceptances

Fixed Deposits

Premium on Buy-back of Shares

Unclaimed Dividend

Interest on Fixed Period Loans

Closing Balance - Cash and Cash Equivalents

Particulars

Loss/ (Profit) on Sale of Fixed Assets

Loss/ (Profit) on Sale of Investments

Amortisation of Miscellaneous Expenditure

Interest on Fixed Period Loans

Net Cash used in Financing Activities

Sales Tax Deferral Loan

Net increase/ (decrease) in Cash and Cash EquivalentsOpening Balance - Cash and Cash Equivalents

(Rs. in mill ions)

Purchase of Fixed Assets

Investments in Subsidiary

Excess appropriation for Dividend written back

C) CASH FLOW FROM FINANCING ACTIVITIES

Debentures (Net of Redemption)

B) CASH FLOW FROM INVESTING ACTIVITIESIncome from Investments

Cash

FlowStatemen

t


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Identify anyfourimportantfinancial decisionsIdentify anyfourimportantfinancial decisions

taken bythe Companyduringtheyear.taken bythe Companyduringtheyear.

1 Buy Back of Shares Issue of Non-Convertible Shares

Payment of dividends

Sale of Investments

Purchase of Fixed Assets

Redemption of Fixed Deposits

Reduction in Net Working Capital


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AnalyzeAnalyze variousvarious consequencesconsequences andand impactsimpacts ofof thethe financialfinancial

decisionsdecisions identifiedidentified aboveabove onon thethe BalanceBalance SheetSheet andand thethe

ProfitProfit andand LossLoss AccountAccount ofof thethe CompanyCompany.. Also,Also, classifyclassify thetheimpactsimpacts specifiedspecified intointo shortshort--termterm onesones andand longlong--termterm onesones..

2 Buy Back of Shares..???

Issue of Non-Convertible Shares ..???

Payment of dividends ..???

Sale of Investments ..???

Purchase of Fixed Assets ..???

Redemption of Fixed Deposits ..???

Reduction in Net Working Capital ..???


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Identify WHO is behindtheimportantdecisionsIdentify WHO is behindtheimportantdecisions

identified above.identified above.

3 ?


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WHO IS RESPONSIBLE TO MAKE DECISIONS

THAT DETERMINE ASSETS SIDE AND THE

LIABILITIES SIDE OF A BALANCE SHEET??


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This man!!!

FINANCEMANAGER


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Identify anytwoimportantfinancial decisionswhichwereIdentify anytwoimportantfinancial decisionswhichwere

taken bythemanagementofthe Companyinpast buttheirtaken bythemanagementofthe Companyinpast buttheir

effectcanstill beseeninthe Balance Sheetoftheyear 2002effectcanstill beseeninthe Balance Sheetoftheyear 2002--03.03.

4 Purchase/creation of Fixed Assets

Raising funds through share capital, long-term loans etc.

Miscellaneous Expenditure

Purchase of investments


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Inyouropinion,whatmust betheobjective(s)Inyouropinion,whatmust betheobjective(s)

behindthefinancial decisionsdiscussed above?behindthefinancial decisionsdiscussed above?

5 Profit Maximization??? Sales Maximization..???

Wealth Maximization ..???

.


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Listdownsomeoftheimportantissues,which,youthink, areListdownsomeoftheimportantissues,which,youthink, are

involved/before,themanagementofthe Company.involved/before,themanagementofthe Company.

6


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PutinsimplewordsPutinsimplewords whatisthe basicfunctionwhatisthe basicfunction

ofa Finance Managerin a businessfirm?ofa Finance Managerin a businessfirm?

7 Manage theBalance Sheet of

the Company.

How should a finance managermanage the Balance Sheet of a

Company is a subject matter of

FINANCIAL MANAGEMENT!!!


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FinancialFinancialManagement...Management...


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FINANCIAL MANAGEMENT???

ThetheoryofFinancial Managementor CorporateFinanceisthe theory of financial decision making by

business firms.

Itcan bedescribed asthestudyofthedecisionsthateveryfirmhastomakerelatedtofinancial matters.

Itisthatmanagerial activitywhichisconcernedwiththeplanning andcontrollingofthefirmsfinancial resources.

It can be viewed as proper management of flowsof funds in a firm.


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ToTo bebe preciseprecise-- thethe mainmain tasktask ofof

FinancialFinancial ManagementManagement isis toto

MANAGEMANAGE FLOWSFLOWS OFOF FUNDS/CASHFUNDS/CASHTHROUGHTHROUGH OUTOUT THETHE

ORGANIZAT

IONORGANIZAT

IONT

OT

O ENHANCEENHANCET

HET

HEVALUEVALUE OFOF AA FIRMFIRM..


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Why Should a studentofmanagementstudyFinancial Management...???

Management Students areinterestedinthesubjectbecause amongthemostcrucial decisionsofa firm arethosewhichrelatetofinance, and anunderstandingofthetheoryoffinancial managementprovidesthemwith

conceptual and analytical insightstomakethosedecisionsskillfully.

They should study Financial Management because it

provides necessary tools to appreciate the financialdimensions of managerial decisions. Its study helps intraining the minds of managers so that they can handleskillfully financial implications of managerial decisions.


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FOCUS/NATURE OF FINANCIAL MANAGEMENT

It focuses basically on corporate that is, thevehicle to achieve objectives of anentity. It isassumed to be Joint Stock Company; and hence, it issometimes is known as CORPORATE FINANCE.

Implicationofitis- all managerial decisionswill be assumedto bemade bytheMANAGEMENTwhichis anagentofshareholders.

It is all-pervasive managerial function in a firm. It

has to be integrated with Production, Marketing andPersonnel functions of the management.

Implicationofitis- financial decision-makingshould beintegratedwithothermanagerial functions.


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FOCUS/NATURE OF FINANCIAL

MANAGEMENT(continued)

It is all decision-making; nothing except

decision-making.

Implicationofitis- onehastomakebest possibledecisions andforthatuse all thatisneeded andthis

makesit a multi-dimensional subject.


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Whatisexpectedfrom a financemanager?

Toprovidenecessaryfundssothatnoproductive and

beneficial activityshould besacrificedforwantoffunds.

Toensurethatscarcefundsofthefirmshould beoptimally

utilised.

Toplan andcontrol in a coordinatedmannersothatthe

requirementsofall thedepartmentscould bemet

effectively.

Donot act as a bull-dog but as a watch-dog.

Donot act as a strictcontroller and auditor but as a

facilitator andmotivator.


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Whatisexpectedfrom a financemanager?(continued)

Donot allowthefundsofa firmtoremainunutilised.

Donot let anyoneinthefirmtowastefunds.

Donot let anyonetocommit anyfraudonfunds.

Donot letthesystemto berigidenoughso astosacrifice

profitable activities/opportunitiesofthefirm.

Act as aneffectivechannel betweenfinancial marketson

oneside andthecompanyontheotherside.

Ensurethatnecessary legal requirements aresatisfiedwhile

taking anyfinancial decision.


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FINANCEFINANCEMANAGERMANAGER


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BasicnatureofFinancial Managementas a

Course of study

Itis a decision-makingcourse that is to say, each topicin it is concerned with a managerial decision problem.

All decision problems dealt in it are having finance(money or funds) as an important dimension.

Its approachtodecision-makingisquantitative innature. Thatstosay,itmakeuseofnumbersheavily.

Itisprimarilynormative innature.


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BasicnatureofFinancial Managementas a Course of

study(continuation)

Tounderstanditproperly,oneshould becomfortablewiththefollowing:

Decision-making

Quantitative Methodsofdecisionmaking Behaviouroffinancial andeconomicvariables

Impactoffinancial variablesontheperformanceofa firm

Impactofenvironmental variablesonfinancial variablesofafirm

To take better financial decisions, one must be awareof necessary legal, economic and financialenvironment.


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MAIN DECISIONS to be madeMAIN DECISIONS to be made

by a finance managerby a finance manager

Investment Decisions: Long-term Decisions

Financing Decisions: Capital Structure

Decisions

Dividend Decisions: Profit Distribution

Decisions

Liquidity Decisions: Working Capital or Short-

term Decisions


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OBJECTIVES BEFORE A FINANCEOBJECTIVES BEFORE A FINANCE

MANAGER???MANAGER???

Profit Maximisation

Profit after tax (PAT) Maximisation

Earning per share (EPS) Maximisation

Sales Maximisation

Market Share Maximisation

Firms Wealth Maximisation

Shareholders Wealth/Value Maximisation


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PROFIT MAXIMISATIONPROFIT MAXIMISATION

For any business firm, the natural objective is Profit Maximisation

and as such can be pursued to guide financial decisions of a financemanager. This objective has the following advantages:

It is a well understood objective.

It achieves sustainability for a firm as without profits, none can sustain itself for

long. Profit is also considered as a yardstick of efficiency.

In a free and competitive market, profit is the best driving and motivating force

behind all economic decisions.

The theory of Invisible Hand that ensures optimum allocation of resources for

a society in a free and competitive market also depends upon the objective of

Profit Maximisation.

It is an objective that is compatible with societys objective as well as firms

objective.


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Disadvantages of ProfitDisadvantages of ProfitMaximisationMaximisation as an objectiveas an objective

It works perfectly well when markets are perfectly competitive and free. But,

in real life, markets are full of a number of imperfections and as a

consequence, profit can not be used as a yardstick of efficiency and hence,

can guide various economic decisions to ensure best utilisation of resourcesfor the firm as well as for the society.

Profit is a vague term as it means so many things to different people that

finance manager fails to appreciate which profit should be maximised. Should

it be profit to all stakeholders or profit to only owners; before tax or after tax;

short-term profits or long-term profits; total profits or per share profits;

operating profit or net profit; Accounting profit or Economic profit; and profit

reported to shareholders or profit reported to tax authorities?


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This objective ignores risk and uncertainty attached with profit. If a firm is

earning huge profits at a very high degree of risk, then it may be dangerous

for the very existence of the firm in the periods to come? For instance, should

a finance manager divert funds to speculative activities and maximise the

profits of a firm?

It ignores the time value of money as it does not make a distinction between

profits received in future and at present. Also, it ignores the timings when the

costs are incurred and when the profits are earned.

Profit Maximisation objective concentrates only on the profitability aspects of

various decisions but ignores the financing decisions that are involved in

them. As such, it fails to ignore the costs and the risks involved in financing

decisions that are important.

Disadvantages of Profit MaximisationDisadvantages of Profit Maximisation as an objectiveas an objective ((continuedcontinued))


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OTHER OBJECTIVES...

Profit after tax (PAT) Maximisation

Earning per share (EPS) Maximisation

These two are having more or less same disadvantages as the objective

of Profit Maximization has.

Sales Maximisation

Market Share Maximisation

??????????


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Firms Wealth Maximisation

Thisobjective alsomeanstomaximizetheSTAKEHOLDERSWEALTH.

Accordingtoit,thefinancemanagershould

decidedthethingsinsuch a mannerthatthewealththatwould beclaimed by all thestakeholders- creditors, lenders,employees,society,shareholders,etc.- should bemaximum.

....?????

...\.?????


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Shareholders Wealth/ Value

Maximisation Creationofshareholders Valueinfacttakescareof

PROFIT, SUCCESSFUL MARKETING STRATEGIES, HAPPYCREDITORS and LENDERS.

Ensuring balances amongtheobjectivesofthevariousstakeholdersisnot a practical objectiveto be achieved.

Sincemanagers are accountabletotheshareholders andtheyemploythem,managersshouldwork forthe

maximum benefitsoftheshareholders.

Shareholdersvalueconsistsofdividendpayments andthemarketvalueofshares. They both are accuratelyobservableincaseoflistedcompanies.


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Shareholders Wealth/ Value

Maximisation(continued)

Ifwe assumethatstock markets areefficientthenthevaluationofthesharesreflects the fundamentals andrisk involved ofa company. Thus,marketprovides a

suitablemeasureto judgetheperformance andhence, anobjectiveworthpursuing.

Also,themarkettakesinto accountthe long-termviewtodeterminetheshareprices.

Thisobjectivetakescareofthetimevalueofmoney.

Thisobjectiveprovides anobjective andwell definedqu

antit

ative

ya

rdstick

forev

alu

ating

fin

anci

aldecisions.


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FINANCIAL ASSETS vs

REAL ASSETS

??????


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BASIC AXIOMS OF FINANCIALBASIC AXIOMS OF FINANCIAL

MANAGEMENTMANAGEMENT

Money has time value/opportunity cost.

Every financial decision involves a trade-off

between RISK and RETURN.

Financial markets are EFFICIENT.

Accounting Profit is not relevant profit concept forfinancial decisions. Profits based on cashflows aremore relevant for Financial Decision-Making.

Options have a VALUE.

Incremental/differential cashflows are important for

financial decision-making.


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Remember that ...


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LLETS NOW UNDERSTANDETS NOW UNDERSTAND --WHAT ISWHAT IS RETURNRETURN??


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RETURN IS


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RETURN...

RETURN presents-

benefits

gains profits

interest

yield theextra wegetwhenweinvestsomemoney.

Itis a positiveparameterinthesensethatmoreofit

ismoredesirable.


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LLETS NOW UNDERSTANDETS NOW UNDERSTAND --WHAT ISWHAT IS RISKRISK??


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RISK IS


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RISK IS UNDERSTOOD AS A NEGATIVE PARAMETER HAVINGRISK IS UNDERSTOOD AS A NEGATIVE PARAMETER HAVING

DIFFERENTDIFFERENT SSHHAADDEESS!!!!!!

Risk is a threat.

Risk prevents the project to realise its expected

goals.

Risk is a fear.

Risk is pessimism.

Risk is expected loss.

Risk is a chance of loss.

Risk comes out from unexpected undesirable

events.

Risk is unwanted.

Risk is variation, fluctuation and volatility.

Risk is dynamic.

Risk arises due to uncertainty.

Risk is because of change.

Risk is an odd thing out.


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RISK IS USUALLY MEASUREDRISK IS USUALLY MEASURED

AS ...AS ...

thePROBABILITY OF LOSS

the EXPECTED LOSS

VARIATIONS & FLUCTUATIONS: Range

Mean Absolute Deviation

Standard Deviation/Variance/Coefficient ofVariation

Semi-Variance Variance from Subjective Expected Value

Co-variance

the SENSITIVITY OF RETURN TO

POSSIBLE CHANGES - percentage


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TYPES OF RISK Systematic Risk

Unsystematic Risk Market Risk

Interest Rate Risk

Purchasing Power Risk or Inflation Risk

Foreign Exchange Risk

Business Risk - Operating Leverage

Financial Risk - Financial Leverage

Management Risk

Industry Risk

Economy/Country Risk

Credit Risk/Default Risk

System Risk


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IS THERE ANY RELATION

BETWEEN RISK AND

RETURN?


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HOW MAXIMIZATIONHOW MAXIMIZATION

OF SHAREHOLDERSOF SHAREHOLDERS

WEALTH TAKES INTOWEALTH TAKES INTO

ACCOUNT THE RISK OFACCOUNT THE RISK OF

A COMPANY?A COMPANY?


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FORMS OF BUSINESS

ORGANISATION SOLEPROPRIETORSHIP

PARTNERSHIP

JOINT STOCKCOMPANY

PRIVATE COMPANY:it has a minimum paid-up capital of one

lakh rupees; minimum two members; maximum 50members and by its articles, restricts the right to transfer its

shares; prohibits any invitation to the public to subscribe for

any shares in, or debentures of, the company; prohibits any


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FORMS OF BUSINESS

ORGANISATION(continued)

JOINT STOCKCOMPANY

PUBLIC COMPANY:It is not a private company; it has

minimum number of members 7 and maximum no limit; has

a minimum paid-up capital of five lakh rupees; and is a

private company which is a subsidiary of a company which

is not a private company.

CO-OPERATIVE


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AGENCY PROBLEM

Inproprietorship,partnership andcooperatives,

theowners are activelyinvolved butnormally,in

jointstock companies,owners(shareholders) and

management aretwodifferententities.

Thisseparation leadstoAGENCYPROBLEM. It

meansthatthemanagementwhichissupposed

to act as an agentoftheownersstarts acting as

aprincipal. Themanagementmaydecidethe

thingsforitsown benefitsratherthanforthe

benefitofthecompanysowners. Some


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AGENCY PROBLEM(CONTINUED...)

Lack ofperfect alignment betweenthe

objectivesofthemanagement andthoseofthe

ownersresultsinAGENCYCOST.

AgencyProblemisoneoftheseriousproblems.

Itmaycausesub-optimumdecisions;itmay

forcethemanagersto adoptedunfair andfraudulentpractices. Thefirmmayhavetoincur

a costtomitigatetheill effectsofit andthus,it

may lowerdownthevalueofshareholders.


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AGENCY PROBLEM(CONTINUED...)

Tomitigatethe agencycost,effectivemonitoringis

to bedone alongwith appropriateincentivesthat

haveto beofferedtothemanagement.

Someexamplesofthewaystomitigatethecostof

AgencyProblem are-

Moretransparency andfrequentreportingofimportantdecisions andtheir

effects.

Morepowerstoshareholders.

Havemoreinstitutional investors.

Performance linked bonus

Corporate Finance, Funds Statament,Agency Problem 52

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