BBA 301

SECTION A

Q.1.

i.

Objectives of Financial Management

 To ensure regular and adequate supply of funds to the concern.

 To ensure adequate returns to the shareholders which will depend upon
the earning capacity, market price of the share, expectations of the
shareholders.
 To ensure optimum funds utilization. Once the funds are procured, they
should be utilized in maximum possible way at least cost.
 To ensure safety on investment, i.e, funds should be invested in safe
ventures so that adequate rate of return can be achieved.
 To plan a sound capital structure-There should be sound and fair
composition of capital so that a balance is maintained between debt and
equity capital.

iv.

factors determine the need of working capital:

 Cash Requirements

• Volume of Sales

• Terms of Purchase and Sales

• Inventory Turnover

• Business Turnover

• Current Assets Requirements

• Profit Planning and Control

• Repayment Ability

• Cash Reserves
• Operation Efficiency

• Change in Technology

• Firm’s Finance and Dividend Policy

• Attitude towards Risk

v.

Safety stock is the stock held by a company in excess of its requirement for the
lead time. Companies hold safety stock to guard against stock-out.

Safety stock is calculated using the following formula:

Safety Stock = (Maximum Daily Usage − Average Daily Usage) × Lead Time

Lead time is the time which supplier takes in ordering the items

formula of EOQ:

EOQ = √(2SD / H), or the square root of (2 x S x D / H).

S = Setup costs (per order, generally includes shipping and handling)

D = Demand rate (quantity sold per year)

H = Holding costs (per year, per unit)

vii.

The payback period is the length of time required to recover the cost of an
investment. The payback period of a given investment or project is an
important determinant of whether to undertake the position or project, as
longer payback periods are typically not desirable for investment positions.
The payback period ignores the time value of money (TVM), unlike other
methods of capital budgeting such as net present value (NPV), internal rate of
return (IRR), and discounted cash flow.

viii.

Horizontal analysis – Also known as trend analysis, horizontal analysis of a

balance sheet is a financial statement analysis technique that shows changes in
the amounts of financial statement items over a period of time. The earliest
period is usually used as the base period and the items on the statements for
all later periods are compared with the same items on the statements of the
base period. The changes are generally shown both in dollars and as a
percentage.

Vertical analysis – Vertical analysis is a financial statement technique that

reports each amount on a financial statement as a percentage of another item.
The vertical analysis of the balance sheet restates every amount on the
balance sheet as a percentage of total assets. Results from vertical analysis of a
balance sheet are presented as a common-size financial balance sheet.
Common-size balance sheets are useful for comparing a company to other
companies or to industry averages.

x.

Factoring, receivables factoring or debtor financing, is when a company buys a

debt or invoice from another company. Factoring is also seen as a form of
invoice discounting in many markets and is very similar but just within a
different context. In this purchase, accounts receivable are discounted in order
to allow the buyer to make a profit upon the settlement of the debt. Essentially
factoring transfers the ownership of accounts to another party that then
chases up the debt.

Factoring therefore relieves the first party of a debt for less than the total
amount providing them with working capital to continue trading, while the
buyer, or factor, chases up the debt for the full amount and profits when it is
paid. The factor is required to pay additional fees, typically a small percentage,
once the debt has been settled. The factor may also offer a discount to the
indebted party.

SECTION B

Q.2.

Financial management refers to the efficient and effective management of

money (funds) in such a manner as to accomplish the objectives of the
organization. It is the specialized function directly associated with the top
management. The significance of this function is not seen in the 'Line' but also
in the capacity of the 'Staff' in overall of a company. It has been defined
differently by different experts in the field.

Importance of Financial Management:

1. Investment Opportunities: As a person, if you are good at managing your

finance and saving then you get opportunities to explorer investment.
Investment opportunities will assist you in creating wealth so that you can
enjoy your retirement period. There are various investment opportunities you
can explorer like investing in stocks, gold, mutual funds, property, lands, etc.
You can study about investing in detail to know the risk and return of
investment. Depending upon your risk ability you can then choose the
appropriate investment options.

2. Economic Growth and Stability: Proper financial planning will ensure your
economic growth. Gradually you will expand your wealth creation which will
help you to grow financially. Important thing in someone’s life is financially
stability. Only way to ensure your financial stability is through economic
growth and only option to ensure the same is through financial management.

3. Improve Standard of Living: Once you have learned and taken good
knowledge on financial management, this will not only provide you financial
stability and peace of mind but also it will improve your standard of living. Your
economic growth will transform into better standard of living.

4. Tax Planning: Your financial planning should also include your tax planning.
When failing to plan your taxes appropriately, it will lead you spend more out
of your pocket. For example: If you can analyze that current fiscal year you will
be spending less on taxes but in next year you are more likely to pay heavy
taxes then you should manage your budget and saving accordingly. This will
help you towards economic growth else you may run out of cash and may lead
in disturbance in your investment decisions.
Objectives of Financial Management

1. To ensure regular and adequate supply of funds to the concern.

2. To ensure adequate returns to the shareholders which will depend upon

the earning capacity, market price of the share, expectations of the
shareholders.

3. To ensure optimum funds utilization. Once the funds are procured, they
should be utilized in maximum possible way at least cost.

4. To ensure safety on investment, i.e, funds should be invested in safe

ventures so that adequate rate of return can be achieved.

5. To plan a sound capital structure-There should be sound and fair

composition of capital so that a balance is maintained between debt and
equity capital.

Q.3.

A ratio analysis is a quantitative analysis of information contained in a

company’s financial statements. Ratio analysis is used to evaluate various
aspects of a company’s operating and financial performance such as its
efficiency, liquidity, profitability and solvency.

Ratio analysis is a cornerstone of fundamental analysis.

Utility of the Ratio Analysis are:

1. Easy to understand the financial position of the firm:  The ratio analysis
facilitates the parties to read the changes taken place in the financial
performance of the firm from one time period to another.

2. Measure of expressing the financial performance and position:  It acts

as a measure of financial position through Liquidity ratios and Leverage
ratios and also a measure of financial performance through Profitability
ratios and Turnover Ratios.

3. Intra-firm analysis on the financial information over many number of

years:The financial performance and position of the firm can be
analysed and interpreted with in the firm in between the available
 financial information of many number of years; which portrays either
increase or decrease in the financial performance.

4. Inter-firm analysis on the financial information within the industry: The

financial performance of the firm is studied and interpreted along with
the similar firms in the industry to identify the presence and status of
the respective firm among others.

5. Possibility for Financial planning and control:  It not only guides the firm
to earn in accordance with the financial forecasting but also facilitates
the firm to identify the major source of expense which drastically has
greater influence on the earnings.

Limitations of the Ratio Analysis are:

1. It is dependant tool of analysis: The perfection and effectiveness of the

analysis mainly depends upon the preparation of accurate and
effectiveness of the financial statements. It is subject to the availability
of fair presentation of data in the financial statements.

2. Ambiguity in the handling of terms: If the tool of analysis taken for the
study of inter firm analysis on the profitability of the firms lead to
various complications. To study the profitability among the firms, most
required financial information are profits of the enterprise. The profit of
one enterprise is taken for analysis is Profit After Taxes (PAT) and
another is considering Profit Before Interest and Taxes (PBIT) and third
one is taking Net profit for study consideration. The term profit among
the firms for the inter firm analysis is getting complicated due to
ambiguity or poor clarity on the terminology.

3. Qualitative factors are not considered:  Under the ratio analysis, the
quantitative factors only taken into consideration rather than qualitative
factors of the enterprise. The qualitative aspects of the customers and
consumers are not considered at the moment of preparing the financial
statements but while granting credit on sales is normally considered.

4. Not ideal for the future forecasts: Ratio analysis is an outcome of

analysis of historical transactions known as Postmortem Analysis. The
analysis is mainly based on the yester performance which influences
 directly on the future planning and forecasting ; it means that the
analysis is mainly constructed on the past information which will also
resemble the same during the future analysis.

5. Time value of money is not considered: It does not give any room for
time value of money for future planning or forecasting of financial
performance; the main reason is that the fundamental base for
forecasting is taken from the yester periods which never denominate the
timing of the benefits.

Q.7.

Capital structure means the proportion of debt and equity used for financing
the operations of business.

Capital structure = Debt / Equity

capital structure represents the proportion of debt capital and equity capital in
the capital structure. What kind of capital structure is best for a firm is very
difficult to define. The capital structure should be such which increases the
value of equity share or maximizes the wealth of equity shareholders.

Debt and equity differ in cost and risk. As debt involves less cost but it is very
risky securities whereas equity is expensive securities but these are safe
securities from companies’ point of view.

Debt is risky because payment of regular interest on debt is a legal obligation

of the business. In case they fail to pay debt security holders can claim over the
assets of the company and if firm fails to meet return of principal amount it
can even go to liquidation and stage of insolvency.

Equity securities are safe securities from company’s point of view as company
has no legal obligation to pay dividend to equity shareholders if it is running in
loss but these are expensive securities.

Capital structure of the business affects the profitability and financial risk. A
best capital structure is the one which results in maximizing the value of equity
shareholder or which brings rise in the price of equity shares. Generally
companies use the concept of financial leverage to set up capital structure.
the types of leverages:

1. Operating Leverage:

Operating leverage is concerned with the investment activities of the firm. It

relates to the incurrence of fixed operating costs in the firm’s income stream.
The operating cost of a firm is classified into three types: Fixed cost, variable
cost and semi-variable or semi-fixed cost. Fixed cost is a contractual cost and is
a function of time. So it does not change with the change in sales and is paid
regardless of the sales volume.

2. Financial Leverage:

Financial leverage is mainly related to the mix of debt and equity in the capital
structure of a firm. It exists due to the existence of fixed financial charges that
do not depend on the operating profits of the firm. Various sources from which
funds are used in financing of a business can be categorized into funds having
fixed financial charges and funds with no fixed financial charges. Debentures,
bonds, long-term loans and preference shares are included in the first category
and equity shares are included in the second category.

3. Combined Leverage:

A firm incurs total fixed charges in the form of fixed operating cost and fixed
financial charges. Operating leverage is concerned with operating risk and is
expressed quantitatively by DOL. Financial leverage is associated with financial
risk and is expressed quantitatively by DFL. Both the leverages are concerned
with fixed charges. If we combine these two we will get the total risk of a firm
that is associated with total leverage or combined leverage of the firm.
Combined leverage is mainly related with the risk of not being able to cover
total fixed charges.

4. Working Capital Leverage:

Investment in working capital has a significant impact on the profitability and

risk of a business. A decrease in investment in current assets will lead to an
increase in the profitability of the firm and vice versa. This is due to the fact
that current assets are less profitable in comparison to fixed assets. Decrease
in investment in current assets also increases the volume of risk. Risk and
returns are directly related.

Q.8.

a) Fund flow statement

Fund flow is the net of all cash inflows and outflows in and out of various
financial assets. Fund flow is usually measured on a monthly or quarterly basis;
the performance of an asset or fund is not taken into account, only share
redemptions, or outflows, and share purchases, or inflows. Net inflows create
excess cash for managers to invest, which theoretically creates demand for
securities such as stocks and bonds.

Example of Fund Flows

A roaring bull market attracted investors from the sidelines into the fray in the
early part of 2018, as was evidenced by the direction of fund flows. Investors
poured $58 billion into mutual funds and exchange-traded funds (ETFs) in the
four weeks ended Jan. 17, the fastest pace of all time. Passively managed
equity ETFs recorded $38.2 billion in outflows for the first several weeks of
January, while a net four-year peak of $5.6 billion flowed into mutual funds,
suggesting a return of positive sentiment toward active management after
years of outflows as managers underperformed the market but expected
higher fees than passive management.

b) Cost of capitat

Cost of capital is the required return necessary to make a capital budgeting

project, such as building a new factory, worthwhile. Cost of capital includes the
cost of debt and the cost of equity. Another way to describe cost of capital is
the cost of funds used for financing a business. Cost of capital depends on the
mode of financing used — it refers to the cost of equity if the business is
financed solely through equity, or to the cost of debt if it is financed solely
through debt. Many companies use a combination of debt and equity to
finance their businesses and, for such companies, the overall cost of capital is
derived from a weighted average of all capital sources, widely known as the
weighted average cost of capital (WACC). Since the cost of capital represents a
hurdle rate that a company must overcome before it can generate value, it is
extensively used in the capital budgeting process to determine whether the
company should proceed with a project.