FINANCE

THE LIFEBLOOD OF BUSINESS

How to manage it?

Entrepreneurial Decision Making
Business
Situation I
Human
Resources

Marketing
Go for Feasibility
Finance Study and either
Product
/Service accept or reject
the project
Business
Situation II
Human
Resources

Marketing
Product
Rank the Projects
/Service on the basis of
Finance profitability
 Either case Determine…

Fixed Capital Needs

&
Working Capital Needs
 CAPITAL BUDGETING
Project A Project B
Initial Investment Initial Investment
Rs 20000 Rs 40000
Year Returns Year Returns
I 2000 I 20000
II 3000 II 15000
III 7000 III 5000
IV 7000 IV 4000
V 4000 V 1000
Total returns 23000 Total returns 45000
Profit 3000 Profit 5000
 Return on Investment (ROI)

PR
OF
IT

ROI = 100

INV
EST
ME
NT
 Return on Investment (ROI)
30
00

ROI = 100

20
00
0
 Return on Investment (ROI)
50
00

ROI = 100

40
00
0
 Initial Investment Initial Investment
Rs 20000 Rs 40000
Year Returns Year Returns
I 2000 I 20000
II 3000 II 15000
III 7000 III 5000
IV 7000 IV 4000
V 4000 V 1000
Total returns 23000 Total returns 45000
Profit 3000 Profit 5000

ROI of A = 15% ROI of B = 12.5%

TIME VALUE OF MONEY
 Year 2009- Rs 100 : 100 KMs
Year 2010-Rs 100 : 95 KMs
Year 2009- Rs 1 : 1 KM
Year 2010- Rs 1 : 0.95 KM
Year 2009- Rs 0.95 : 0.95 KM
Year 2010- Rs 1 : 0.95 KM

Value of Rs.1 in 2010 has the

same value as that of 95 p in
2009
 Year 2009- Rs 100 : 100 KMs
Year 2011-Rs 100 : 90 KMs
Year 2009- Rs 1 : 1 KM
Year 2011- Rs 1 : 0.90 KM
Year 2009- Rs 0.90 : 0.90 KM
Year 2011- Rs 1 : 0.90 KM

Value of Rs.1 in 2011 has the

same value as that of 90 p in
2009
Rs 1.00 in the appropriate years equivalent to
2009(Current year)
2010 ●
95 p.

2011 ●
90 p.

2012 ●
85 p.

2013 ●
80 p.

2014 ●
75 p.
 Rs. 1.00 in 2010 = 0.95 in 2009
Therefore

Rs. 100 in 2010 = 100 * 0.95 = Rs. 95 in 2009

Rs. 2000 in 2010 = 2000 * 0.95 = Rs.1900 in 2009

 Net Present Value (NPV)
Year Returns NPV Year Returns NPV
I 2000 * 0.95 1900 I 20000 * 0.95 19000
II 3000 *0.90 2700 II 15000 *0.90 13500
III 7000 * 0.85 5950 III 5000 * 0.85 4250
IV 7000 * 0.80 5600 IV 4000 * 0.80 3200
V 4000 * 0.75 3000 V 1000 * 0.75 750
Total returns 19150 Total returns 40700
Loss 850 Profit 700

ROI of A =
Negative ROI of B = 1.75%
Operating Cycle
Cash
Accounts
Receivable

Raw
Materials

Finished
Goods

Work in
Process
 Working Capital = Current Assets – Current Liabilities

Current Assets Current Liabilities

 Raw materials  Creditors

 Work in Process  Bills Payable
 Finished Goods
 Debtors
 Bills Receivables
WORKING CAPITAL MANAGEMENT

• Management of Receivables

• Management of Payables

• Management of Inventories

• Management of Cash
Cash Management

Liquidity
Cost
and
Benefit

Profitability

Optimum cash balance

Cash Balance
 Sources of Finance

Long Term Sources

Debe
Sha nture
Term Lea
res Loans sing
s
Sources of Finance
(another classification)

Own Capital

Share Retained
Earnings
Capital
Share Debenture
 The Problem of Finance MIX(Capital Structure)
Mr. . X needs Rs. 100000 to start a business
He has Rs 50000 only and has two options available to him …

Own Capital 50000 + Rs 50000 share

Own Capital 50000 + Rs 50000 Debt at 10%

interest

Best Option ?
 The Problem of Finance Mix
Own Capital 50000 + Rs 50000 Debt at 10%
Own Capital 50000 + Rs 50000 share
interest

Particulars Amount Particulars Amount

Operating Profit 20000 Operating Profit 20000
Interest Nil Interest 5000
PBT 20000 PBT 15000
Tax 10000 Tax 7500
Net Profit 10000 Net Profit 7500
Mr. X’s earning 5000 Mr. X’s earning 7500

Calculate ROI
 Effect on Mr. X’s earnings when
Profit Increases by 10%
Financial Leverage

Own Capital 50000 + Rs 50000 Debt at 10%

Own Capital 50000 + Rs 50000 share
interest

Particulars Amount Particulars Amount

Operating Profit 22000 Operating Profit 22000
Interest Nil Interest 5000
PBT 22000 PBT 17000
Tax 11000 Tax 8500
Net Profit 11000 Net Profit 8500
Mr. X’s earning 5500 Mr. X’s earning 8500
Previous case 5000 Previous case 7500
Increase in profit 1% Increase in profit 2%
 Effect on Mr. X’s earnings when
Profit Decreases
Own Capital 50000 + Rs 50000 Debt at 10%
Own Capital 50000 + Rs 50000 share
interest

Particulars Amount Particulars Amount

Operating Profit 4000 Operating Profit 4000
Interest Nil Interest 5000
PBT 4000 PBT
Tax 2000 Tax
Net Profit 2000 Net Profit
Mr. X’s earning 1000 Mr. X’s earning Negative
 The Mantra of Finance

LESS RISK LESS RETURNS

MORE RISK MORE RETURNS

 COST DECISIONS

Fixed Vs Variable
 Break-Even Point
Fixed
Cost

BEP

Contr
ibutio
n
 Break-Even Point
500

1000

0.5
0
 Break-Even Point
&
Economies of Scale

No. of Planes Fixed Cost Variable Cost Total Cost Average Cost
1 500 2.50 502.50 502.5
2 500 5.00 505.00 252.50
3 500 7.50 507.50 169.17
4 500 10.00 510 127.5
5 500 12.50 512.50 102.5
- - - - -
100 500 250 750 7.5
- - - - -
500 500 1250 1750 3.5
- - - - -
1000 500 2500 3000 3
 Graphical representation of BEP
Sales Line

Profit
Total Cost Line

Cost & Revenue

Fixed Cost line(500)
Loss

BEP=1000 units

Production/Sales
 IMPACT OF FIXED COST ON PROFIT

Number of units produced = 2000

Situation I Situation II
Sales(3*2000) 6000 6000
Variable Cost(2.5*2000) 5000 5000
Contribution (6000-5000) 1000 1000
Fixed Cost 500 800
Operating Profit 500 200
 IMPACT OF FIXED COST ON PROFIT
Operating Leverage
Number of units produced = 3000
Situation I Situation II
Sales 9000 6900
Variable Cost 7500 7500
Contribution 1500 1500
Fixed Cost 500 800
Operating Profit 1000 700
Operating Profit (when 500 200
sales = 2000)
Increase in Profit 200% 350%
 IMPACT OF FIXED COST ON PROFIT
when sales reduces
Number of units produced = 1500
Situation I Situation II
Sales 4500 4500
Variable Cost 3750 3750
Contribution 750 750
Fixed Cost 500 800
Operating Profit 250 -50
Operating Profit (Sales = 2000) 500 200
Operating Profit (Sales=3000) 1000 700
 PRICING
on the basis of Elasticity of Demand…

Law of Demand

Price Increases : Demand Decreases

Price Decreases : Demand Increases
 Classification of Products on the basis of
Elasticity of demand
Relatively Elastic Demand
Small increase in Price : Heavy Decrease in Demand
Price cannot be increased without affecting demand

Relatively Inelastic Demand

Heavy increase in Price: Very small reduction in Demand

Price can be increased without affecting demand

 Factors Determining Elasticity
Relatively Elastic Demand Relatively Inelastic Demand
• Luxury goods • Necessities
• Products with • Without Substitutes
substitutes
• Frequently Purchased • Not Frequently purchased
Goods
• Durables • Non Durables
• Non urgent • Urgent
• Low income Customers • High Income Customers
 Social Cost Benefit
Costs Benefits
All costs the society will All benefits whether
have to pay whether in economic or non
momentary terms or economic which the
otherwise society is likely to receive
• Pollution • Employment
• Displacement • Foreign exchange
• Etc. earnings
• Etc.
 Thank you
by

Herald M. Dhas M.Sc. (Agri.), MBA, M.Phil.

Head , Dept. of Business Studies
Scott Christian College