1. What do you mean by working capital? Explain its importance for Nepalese organizations.

(Chapter
12: Working capital management)
Definition

• Working capital is the amount of available capital that a company can readily use for day-to-day
operations.
• It measures a company's liquidity, operational efficiency, and short-term financial health.

• Working capital represents the difference between a company’s current assets and current liabilities.

Components of Working Capital

➢ Current Assets

This is what a company currently owns—both tangible and intangible—that it can easily turn into
cash within one year or one business cycle, whichever is less. examples of current assets; cash and
cash equivalents, accounts receivable, inventory, and other shorter-term prepaid expenses. current
assets are resources that can be converted into cash fairly quickly and, therefore, do not include long-
term investments

➢ Current Liabilities

current liabilities are all the debts and expenses the company expects to pay within a year or one
business cycle, whichever is less. This typically includes the normal costs of running the business
such as rent, utilities, materials and supplies; interest or principal payments on debt; accounts
payable; accrued liabilities; and accrued income taxes.

Calculation of Working Capital

Working capital is calculated by using the current ratio, which is current assets divided by current
liabilities. A ratio above 1 means current assets exceed liabilities, and, generally, the higher the ratio,
the better. A higher ratio also means the company can easily fund its day-to-day operations. The
more working capital a company has, the less it’s likely to have to take on debt to fund the growth
of its business.

Current Ratio= Current Assets

Current Liabilities
 Working capital should be assessed periodically over time to ensure no devaluation occurs and that
there's enough of it left to fund continuous operations.

The Benefit of Working Capital on any Business

Working capital is an essential component of the business that doesn’t depend on the size and scale of
operation. The benefits of the working capital include –

• It allows a smooth production flow

• Helps in boosting the liquidity
• Also ensures proper use of the fixed assets
• It aids a project in getting a positive image of the firm
• Also enables the firms for availing benefits for the cash discounts
• Aids in availing financial assistance such as loans easily
• It also allows meeting the contingencies very effectively
Working capital can help smooth out fluctuations in revenue. Many businesses experience some
seasonality in sales, selling more during some months than others, for example. With adequate
working capital, a company can make extra purchases from suppliers to prepare for busy months while
meeting its financial obligations during periods where it generates less revenue.

For example, a retailer may generate 70% of its revenue in November and December — but it needs to
cover expenses, such as rent and payroll, all year. By analyzing its working capital needs and
maintaining an adequate buffer, the retailer can ensure it has enough funds to stock up on supplies
before November and hire temps for the busy season while planning how many permanent staff it can
support.
 2.State and explain the dividend payment schemes of the firms with suitable examples. (Chapter 13:
Management of surplus)
Dividend refers to the portion of net income paid to shareholders. It is paid to shareholders in cash and
or in stock. The percentage of earnings paid out in the form of cash dividend is known as Dividend
Payout Ratio. A company may retain some portion of its earning to finance new investment. The
percentage of earnings retained in the firm is called Retention Ratio.

When dividends are paid to stockholders the firm’s cash is reduced. A company may decrease its
dividend payout and use the retained funds to pay off some its debt, increase investment or expand its

Capacity. Hence, firm’s dividend policy is closely related with the firm’s investment and financing
decisions.

Dividend Payout Schemes

Firms can pay dividends using either residual dividend policy or stable dividend policy.

1. Residual Dividend Policy

This policy suggests that firm should retain its earnings as long as it has investment opportunities that
promise higher rate of return than shareholders required rate of return. Under this policy firm pays
dividend only after meeting its investment needs at desired debt-equity ratio.

This policy is based on assumptions that

▪ Firm wishes to minimize the need of external equity.

▪ Firm wishes to maintain the current capital structure.

If net income exceeds the portion of equity financing, then the excess of income over equity is paid as
dividend. The company does not pay any dividend when net income is less than or equal to equity need
for financing the investment proposals. Thus in case of residual policy, dividend payments will vary from
year to year, depending of investment opportunities and debt equity ratio. If net income is not sufficient to
finance new project, then dividend is not paid and deficit amount is raised from external equity.

Eg- A firm has Rs.18 lakhs in available earnings. It needs 15 lakhs to fund new investment and
target equity ratio is 70%. Calculation will be as-

Net Income-Rs. 18,00,000/(a)

Needed of Investment-Rs.15,00,000/
Equity Needed@ 70%-Rs.10,50,000/(b)
Dividend(NI-Equity Needed)- Rs. 7,50,000/(Rs.18lacs-Rs.10.50lacs) [a-b]
Dividend Payout Ratio=Dividend/N.I
=7.5lacs/18lacs
=41.67%

2.Stable Dividend Policy

A stable dividend policy is the easiest and most commonly used. The goal of the policy is a steady
and predictable dividend payout each year, which is what most investors seek. Whether earnings
are up or down, investors receive a dividend. This approach gives the shareholder more certainty
concerning the amount and timing of the dividend.

Under stable dividend per share, a constant Rs. Per share dividend is paid. The policy may be
stated as Rs. 2 dividends per share. This fixed amount of dividend per share is paid on an annual
basis irrespective of earnings for the year. Earnings may fluctuate from year to year but dividends
per share remain the stable.

3. Constant Dividend Policy

Under constant dividend policy ratio of dividends per share to the earnings per share is fixed.
Under this policy a firm tries to maintain constant dividend payout ratio over the years. Eg.

If Dividend payout ratio of a company is set at 60%, firm will always pay 60% of its annual
earnings as dividends. Because of fixed payout ratio, dividends per share under this policy will
fluctuate from year to year as earnings fluctuate. If firm suffers loss in any year, then the dividend
becomes zero.

Short Question Set-1

1. What do you mean by financial management? Explain the role and responsibilities of financial
manager in the Nepalese context. (Chapter 1: Financial management)
➢ Financial Management is used to refer to the management of funds in the context of a business
firm. Thus finance as a discipline is categorized into three domains: Public Finance, Personal
Finance and Financial Management. Public finance is the management of funds for
governments-both local government units and central government. It deals with management of
 Revenue and Expenditures of governments. Personal Finance refers to the management of funds
of an individual.
➢ Financial Management refers to the decision making process of various managerial decisions
such as-Investment Decision, Financing Decision and Asset Management Decision. Financial
management today is more concerned with the total funds employed by the business firm with
their allocation to different activities and projects.

The role of Financial Mangers

Financial managers perform data analysis and advise senior managers on profit-maximizing ideas.
Financial managers are responsible for the financial health of an organization. They produce
financial reports, direct investment activities, and develop strategies and plans for the long-term
financial goals of their organization. Financial managers typically:

▪ Prepare financial statements, business activity reports, and forecasts,

▪ Monitor financial details to ensure that legal requirements are met,
▪ Supervise employees who do financial reporting and budgeting,
▪ Review company financial reports and seek ways to reduce costs,
▪ Analyze market trends to find opportunities for expansion or for acquiring other companies,
▪ Help management make financial decisions.

Responsibilities of Financial Managers.

Financial managers have an extensive range of responsibilities, and what financial managers do
largely depend on the type of organization. In a small business, a financial manager may be
responsible for the entire financial operation, while in a large corporation, a financial manager may
be more likely to specialize in a particular aspect of finance, such as financial reporting or cash
management.

Common responsibilities of a financial manager include:

▪ Producing accurate financial reports and information

▪ Developing cash flow statements
▪ Projecting profit
▪ Managing credit
▪ Providing advice in making financial decisions
▪ Directing investments
▪ Making financial forecasts
▪ Budgeting
 ▪ Managing risk of financial loss

2. Write short notes (Any two)

a) Portfolio (Chapter 6: Risk and return)
A portfolio’s meaning can be defined as a collection of financial assets and investment tools
that are held by an individual, a financial institution or an investment firm. It is a collection
of a wide range of assets that are owned by investors. The said collection of financial assets
may also be valuables ranging from gold, stocks, funds, derivatives, property, cash
equivalents, bonds, etc
Based on investment strategies, these following are some common types of portfolios-
▪ Income Portfolio
This type of portfolio emphasizes more on securing a steady flow of income from
investment avenues. In other words, it is not entirely focused on potential capital
appreciation. Income-driven investors may invest in stocks that generate regular
dividends instead of those who show a track of price appreciation.
▪ Growth Portfolio
A growth-oriented portfolio mostly parks money into growth stocks of a company who
are in their active growth stage. Typically, growth portfolios are subject to greater risks.
This type of portfolio is known for presenting high risk and reward aspects.

▪ Value Portfolio
Such a portfolio puts money into cheap assets in valuation and focuses on securing
bargains in the investment market. When the economy is struggling, and companies are
barely surviving, value-oriented investors look for profitable companies whose shares
are priced lower than their fair value. When the market revives, value portfolio holders
generate substantial earnings.

b) Stock repurchase (Chapter 13: Management of surplus)

Stock buybacks refer to the repurchasing of shares of stock by the company that issued them.
A buyback occurs when the issuing company pays shareholders the market value per share and
re-absorbs that portion of its ownership that was previously distributed among public and
private investors. A company might choose to repurchase shares for many different reasons, but
the main reason is that its stock is undervalued, and the company wants to increase demand.
Share buybacks reduce the number of shares in circulation, which can increase the share value
and the earnings per share (EPS).
c) PBP (Chapter 11: Capital budgeting)
 • Pay Back Period is the expected number of years required to recover the investment of the
project. Pay Back Period is the length of time an investment reaches a break-even point. People
and corporations invest their money mainly to get paid back, which is why the payback period
is so important. Shorter paybacks mean more attractive investments, while longer payback
periods are less desirable. Account and fund managers use the payback period to determine
whether to go through with an investment.
• There is one problem with the payback period calculation. Unlike other methods of capital
budgeting, the payback period ignores the time value of money (TVM). This is the idea that
money today is worth more than the same amount in the future because of the present money's
earning potential.
• The payback period disregards the time value of money.1 It is determined by counting the
number of years it takes to recover the funds invested. For example, if it takes five years to
recover the cost of an investment, the payback period is five years.
• It ignores an investment's overall profitability. Many managers and investors thus prefer to use
NPV as a tool for making investment decisions. The NPV is the difference between the present
value of cash coming in and the current value of cash going out over a period of time.

Short Question -Set B

1. Wealth maximization is superior to profit maximization. Comment this statement. (Chapter 1:

Financial management)

The process through which the company is capable of increasing earning capacity is known as profit
maximization, on the other hand the ability of the company in increasing the value of stock is known
as wealth maximization.

According to financial management, profit maximization is the approach or process which increases
the profit or Earnings per Share (EPS) of the business. More specifically, profit maximization to
optimum levels is the focal point of investment or financing decisions.

The following two steps can be applied to achieve profit maximization

▪ Increasing Sales Revenue-applying better marketing strategies, motivating employees,

Educating all customers both existing and potential.
▪ Cost Cutting-using technologies that saves time and expands production, outsourcing,
better negotiation with suppliers
Wealth maximization is a modern approach to financial management. Maximization of profit used to
be the main aim of a business and financial management till the concept of wealth maximization came
into being. It is a superior goal compared to profit maximization as it takes broader arena into
consideration. Wealth or Value of a business is defined as the market price of the capital invested
by shareholders. It simply means maximization of shareholder’s wealth. a shareholder holds share in
the company/business and his wealth will improve if the share price in the market increases which in
turn is a function of net worth. This is because wealth maximization is also known as net worth
maximization.

Wealth maximization is a better operative criterion then profit maximization on following ground:

▪ Profit maximization avoids time value of money but wealth maximization

recognizes it. It is important as we all know that a dollar today and a dollar one-
year latter do not have the same value. In wealth maximization, the future cash
flows are discounted at an appropriate discounted rate to represent their present
value.
▪ Profit maximization is a short term objective where wealth maximization is long
term objective
▪ The wealth-maximization criterion considers the risk and uncertainty
factor while considering the discounting rate. The discounting rate reflects both
time and risk. Higher the uncertainty, the discounting rate is higher and vice-versa.
▪ Profit maximization acts as a yardstick for completing the operational efficiency of
the entity, on the other hand wealth maximization aims at gaining a large market
share
▪ Firstly, the wealth maximization is based on cash flows and not on profits. Unlike
the profits, cash flows are exact and definite and therefore avoid any ambiguity
associated with accounting profits. Profit can easily be manipulative, if there is a
change in accounting assumption/policy, there is a change in profit

Conclusion: Though profit maximization necessary for the survival and growth of the enterprises but
whereas wealth maximization accelerates the growth rate of enterprises and aims at attaining the
maximum market share of the economy.

2. Write shorts notes (Any two)

a) Cash conversion cycle (Chapter 12 : Working capital management)
The cash conversion cycle (CCC) is a metric that expresses the time (measured in days) it takes
for a company to convert its investments in inventory and other resources into cash flows from
sales. The CCC is one of several quantitative measures that help evaluate the efficiency of a
 company's operations and management. A trend of decreasing or steady CCC values over
multiple periods is a good sign while rising ones should lead to more investigation and analysis
based on other factors

The Formula for CCC

CCC=DIO+DSO−DPO
where:
DIO=Days of inventory outstanding (also known as days’ sales of inventory)
DSO=Days sales outstanding
DPO=Days payables outstanding

CCC traces the lifecycle of cash used for business activity. It follows the cash as its first
converted into inventory and accounts payable, then into expenses for product or service
development, through to sales and accounts receivable, and then back into cash in hand.
Essentially, CCC represents how fast a company can convert the invested cash from start
(investment)to end (returns). The Lower the CCC, the better.

In addition to other financial measures, the CCC value indicates how efficiently a company’s
management is using the short-term assets and liabilities to generate and redeploy the cash and
gives a peek into the company’s financial health with respect to cash management.

b) Stock dividend versus cash dividend (Chapter 13: Management of surplus)

A stock dividend is a dividend paid to shareholders in the form of additional shares in the
company, rather than as cash. Stock dividends have a tax advantage for the investor. The share
dividend, like any stock share, is not taxed until the investor sells it. stock dividend will grant a
shareholder a fraction of shares in relation to their currently held shares. A company may issue
a stock dividend if it has a limited supply of liquid cash reserves. It may also choose to issue a
stock dividend if it is trying to preserve its existing supply of cash.

Cash Dividend

A cash dividend is a payment made by a company out of its earnings to investors in the form of
cash (check or electronic transfer). This transfers economic value from the company to the
shareholders instead of the company using the money for operations. However, this does cause
the company's share price to drop by roughly the same amount as the dividend.

Another consequence of cash dividends is that receivers of cash dividends must pay tax on the
value of the distribution, lowering its final value. Cash dividends are beneficial, however, in
 that they provide shareholders with regular income on their investment along with exposure
to capital appreciation.

c) Net present value (Chapter 11 : Capital budgeting)

Net present value (NPV) is a method used to determine the current value of all future cash
flows generated by a project, including the initial capital investment. It is widely used in capital
budgeting to establish which projects are likely to turn the greatest profit.Net Present Value of
the project is the difference between Present Value of cash inflow and Outflow.
In case of NPV following decision and ranking rules are applied
• If NPV is zero or more the project is accepted
• If NPV is less than zero, reject the project
• Assign higher rank to project with the higher NPV and lower rank with lower NPV.

Merits of NPV

• This method considers time value of money.

• This method takes into account of all cash flows occurred during the life of the project
• This is based on estimated cash flow of the project rather than on the accounting income
• This method is consistent with the objective of maximizing the shareholder’s wealth.