Professional Documents
Culture Documents
Fm-1
Fm-1
Fm-1
Sydenham Institute
Of
Management Studies
University of Mumbai
1
References
Financial Management
Authors :
• Khan & Jain
• Prasanna Chandra
• I.M.Pandey
• S.C.Kuchhal
• Maheshwari
2
Syllabus
• Ratio Analysis
• Fund & Cash flow analysis
• Cost of Capital
• Working Capital Mgmt.
• Means of Financing
• Capital Budgeting
• Dividend Structuring
• Bonus Shares
• Share Holder Value
Creation
3
FINANCIAL MANAGEMENT
Objective: Create share holder value
Methodology: Capturing of value at all Levels.
Business Process restructuring
Enterprise resource management.
Vertically integrated operations.
Customer relationship Management
Sustained up scaling of operations
Effectiveness: Proximity of gross profit to net profit
Maximisation of EVA
4
EV / EBIDTA multiple
Financial Management – an Overview
Business environment
Planning Policies&Decisions
(Management Accounting)
Restructuring
Financial Investor Wish
Markets Resource Mobilisation List
Treasury
Control&Information
( Audit & Taxation)
5
Valuation Technique
6
Economic Trinity
• Relationship between Interest rates,Inflation and Deficit
financing.
7
POST 1991 SCENERIO
FINANCIAL
INSTITUTIONS
AND BANKS
INDUSTRIAL
SECTOR
(DEFICIT)
8
Business Environmental scan
11
Competition: Number of players in the industry and their
market share.
Duty barrier and status of international cost
and volume positioning.
Degree of homogeneity and differentiation
among products.
Entry barriers for new capacities.
Comparison with substitute products.
Unorganised sector operations.
Marketing polices and practices.
12
ORGANISATIONAL INTERFACE OF FINANCE
Areas Interface
Corp planning: Long term financial goals in terms of
assets, sales,profits,dividends etc.
Expansion, new projects diversifications
takeovers , mergers,disinvestments.
Internal generation, tax planning.
13
Areas Interface
Control: Budgetary control of all divisions
Variance analysis
Marketing: Credit norms
Cost analysis of decisions like discounts ,
premium pricing,product promotion etc.
Competitive
Position
18
Expenditure: Raw materials consumed
Manufacturing expenses
Administrative expenses
Selling expenses
WIP +FG adjustment
PBIDT (Gross Profit)
Less: Interest
Less Depreciation
PBT (Operating Profit)
Less: Tax
PAT (net profit)
Gross cash accruals : PAT + Depn
19
Net cash accruals : GCA - Dividend
THE BALANCE SHEET
For the year ended March 31st 200...
Industry analysis
Responsibility accounting
22
TYPES OF FINANCIAL RATIOS
Liquidity
Leverage
Turnover
Profitability / Valuation
23
LIQUIDITY RATIOS
25
Capital gearing ratio: Capital entitled to fixed return
Capital not entitled to fixed return
27
Debtors turnover: Credit sales
Avg. debtor
Tax
ROSE: PAT - Pref. Div
Net worth
Lenders of funds for appraising credit worthiness for long term / short
term lending decisions.
Tax authorities 31
LIMITATIONS OF RATIO ANALYSIS
A ratio in absolute terms has no meaning. It has to be compared.
•Inter firm comparison.
•Companies resort to window dressing of Balance sheets.
•Operating and accounting practices differ from company to
company.
•Consolidation of group / subsidiary companies figures.
E.G. Changes in Depreciation methods
Inventory Valuation
Treatment of contingent liabilities.
Valuation of investments.
Conversion or transaction of foreign exchange items.
32
FUND FLOW ANALYSIS
It is a statement indicating the methods by which a company has been
financed and the uses to which it has applied its funds over a period of
time.
Mobilisation Requirement
Equity Buy
Normal Incremental New
back
Capital Working Investments 34
expenditure capital
FUND FLOW OCCASIONS
Sources Uses
Funds from operations Loss from operations
37
COST OF CAPITAL
Aggregate of the liabilities raised by a company is the total capital
employed in business.
Cost of capital
E.g.. Interest on debt capital enjoys tax shield while dividend paid
on equity has no tax shield.
K0 = Ki + Ke
40
K0 = rj + b + f
RELATIONSHIP BETWEEN WEIGHTED AVERAGE
COST AND MARGINAL COST OF CAPITAL
•Degree of leverage
•Cost of instruments
41
METHODS OF COMPUTATION OF COST OF
EQUITY
ROI approach
Ke = Rf +beta ( Rf – Rm)
43
•If ROI approach is used to determine Ke then book value to be
considered as weights.If market capitalization approach is used
then market value to be considered as weights.
•All cost to be considered on a post tax basis.
•The market capitalization approach is superior to the ROI
approach since the parameters are market determined and
futuristic as compared to the ROI approach.
•The CAPM approach is a further refinement which also includes
premium for risk
•In loss making companies minimum cash flow approach is used.
•Cost of equity could be benchmarked with return on
44
guilts,market risk and portfolio risk ( Asset Beta )
WORKING CAPITAL MANAGEMENT
45
ASSET STRUCTURE FOR VARIOUS
INDUSTRIAL SEGMENTS
FA CA
46
WORKING CAPITAL
Current assets comprise of stocks of raw materials, work in progress,
finished goods, and receivables.
Gross working capital = total current assets.
Net working capital = CA - CL
Objective is to optimse asset requirement and funding the same at
minimal cost.
Working capital
Permanent
requirement component
Variable
component) 47
CONSTITUENTS OF CURRENT ASSETS
Work in progress
Debtors / Receivables
48
OPERATING CYCLE TIME
Time required for rolling or rotation of current assets.
•Manufacturing process
•Infrastructural support.
•Seasonality in demand
Credit period
Cash Discounts
51
•Credit evaluation Character
Capacity
Capital
Collateral
Macro conditions
•Collection policies
•Factoring 53
CASH MANAGEMENT
Cash budgets : Quarterly / monthly / weekly
•Cash accruals
•Trade credit
•Commercial bank borrowings
Cash credit limit
WCTL
Bill discounting
Letter of credit
Bank guarantee
•Public deposits 55
•Short term / medium term loans from FI’s Banks
•Debentures for working capital
•Commercial Paper.
•Euro Commercial Borrowings
•Inter Corporate deposits
•Trade credit notes ( commodity exchanges )
•Factors
56
RBI CREDIT AUTHORISATION SCHEME
1969 Dahejia committee .
. recommended nationalisation of
banks
58
1979: Chore committee
Norms:
•Prior approval of RBI not required to be taken by
commercial banks provided :
•Borrowers follow CA norms.
•Method 2 of lending (CR > 1.33)
•Regular / timely submission of information.
60
•Most companies could not meet the CA norms.
FAST TRACK APPROCH
62
RBI Guidelines
• Working capital credit to be determined by banks according to
their perception of the borrower and the credit needs.Methods
followed are :
64
Projected Balance Sheet Method
• Form 1 : Particulars of existing Long / short term
debts,borrowings from NBFC’S ,ICD’,Leasing etc
ICD’s taken CL CL
69
Long Term Financing
Basis of evaluation
Availability
•Flexibility
•Cost
74
Features: Interest rate is based upon the prime
lending rate + project risk.
Basic interest rate linked to inflation rate
Project risk / company risk depends on the credit-
rating.
Banks
Participate in Long term financing on conditions similar to FI’s
however are able to offer funds at lower cupon rates.
76
Debentures:
77
•Types of Debentures:
NCD
FCD
PCD
OCD
•Coupon rate depends on terms of issue.
Other features
•No TDS for interest paid upto Rs 2500 per annum
•Redemption premium
•Listing on stock exchanges
•Fully secured
•Call and put options
78
Advantages from Issuer’s point of view:
•Lower cost due to low risk and tax deductibility of interest
payment.
•No / limited dilution of control
•Offer stable return to investors having fixed maturity
and subsequently redemption/ conversion to equity
•No increase in equity base during non conversion period
Fixed deposits
•Limit on quantum : 25% of networth
•Cost : 11 - 14% depending on maturity period & risk
•unsecured 79
EQUITY SHARE CAPITAL
80
•Listing on stock exchanges in demat / non demat forms
•Companies with paid up Equity capital Less than Rs. 5 Crs. Can
be Listed on the OTC exchange.
•For Listing on exchanges atleast 10% to be offered to the public
by way of a prospectus
Issuance of Non-Voting & differential rights shares allowed
•Debentures on conversion becomes equity share capital.
81
EVALUATION OF ESC
Company’s point of view
Advantages
Represents almost permanent capital
Does not involve any fixed obligation for servicing
Enhances credit worthiness of the company to secure additional
debt.
Disadvantages
High cost of capital
Dividends paid on profit after tax further subjected to tax at the
hands of the share holder leading to double taxation.
High flotation cost
82
Dilution of control (Treasury issue)
Investors point of view
Advantages
Enjoy voting right in the company
Liability is limited to the extent of participation
Eligible for LTCG benefits U / S 54.
.
Disadvantages
Controlling power could be notional
Cannot contest dividend decision of the board
Have residual claim to income / assets
Vide fluctuations in stock price
Dividend’s subjected to double taxation 83
Retained earnings
. Limitation on amount
Bonus issue may capitalise
reserves 85
Preference share capital
Features:
No dilution of control
Provision to skip dividend in absence of profits
86
Leasing
87
CAPITAL BUDGETING
88
•Capital investment decision
Capital investments involve increase in the fixed assets of a
company.
(Expansion / diversification / Green field / takeover / merger)
•Characteristics of investments
Capital outlay needs to be made up front returns come later
Certain amount of risk is involved
Capital investment tend to be indivisible. (difficult to phase out).
•Financial techniques
The purpose of financial techniques is to enable the making of
investment acceptance / rejection decisions.
89
Non financial factors in project appraisal
Market
Technical
Infrastructure
Ecological
Economic
Influence of non - financial factors
Financial projections
Gestation period
Profitability
Life of project / Terminal value
Sensitivity analysis 90
NON FINANCIAL FACTORS DETERMINING
FINANCIAL VIABILITY OF PROJECTS
Market factors
Present and future size of the market
Present and future demand and supply situation
Achievable market share
Selling & distribution channels
Technical factors
Level of Technological obsolence
Plant location
Scales of operation 91
Ecological factors
Pollutant levels
Treatment of effluent
Environmental impact of the project
Economic factors
Social cost benefit analysis
Economic rate of protection
Domestic resource cost
Protection enjoyed by industry.
92
FINANCIAL TECHNIQUES IN CAPITAL
BUDGETING
Return on investment
AVG ROI = PBIT
(over 10 yrs) Total Inv.
Advantages
Simple to calculate and easy to understand
Maximisation of shareholders wealth and maximising the market
value of investments.
.Disadvantages
Time value of money not considered
It is a concept based on profit and not cash
93
No objective criterion for acceptance / Rejection decision.
Payback period
Disadvantages
Cash inflows / Outflows after payback Period are ignored.
Time value for money is ignored
94
Discounted cash flow (DCF)
Cash inflow and outflow for the entire life of the project is
considered.
It considers time value for money as a result earnings in earlier
years have higher value than earned in later years.
IRR Method
IRR is that rate of discount at which the net present value of cash
flows equals net present value of cash outflows.
If IRR > COC Investment is support worthy.
NPV method
Using COC discount the netflows
If NPV is + VE investment is support worthy..
95
Comparison of elements
Elements Payback NPV IRR
97
CONCEPTS IN CAPITAL BUDGETING
•Life of project
Physical
Market
Techno efficient
•Incremental principle
Sunk / Allocated costs to be ignored
Only incremental cash flows to be considered
•Evaluation of post tax basis since COC is on a post tax basis
•Principle of separation of “Finance” from “Investment “ decision.
Financing cost (interest) to be ignored.
•Effect of tax shield on the company as a whole to be considered
98
Cash flow term profile
99
PROJECT COST COMPONENTS
Land
Civil Construction
Plant & Machinery
Misc Fixed Assets
Erection and commissioning
Technical Know how fees
Preliminary & preoperative expenses
Contingencies
Total Capital Cost
Margin money for working capital
Total project cost 100
PROJECT CASH FLOWS
Cash outflows Capital expenditure
Margin money
Normal capital expenditure
101
NPV vs IRR conflict
• NPV is technically superior to IRR and is also able to handle
selection of mutually exclusive projects.
• The decision rule for the NPV assumes that cash flows resulting
during the life cycle of the project have an opportunity cost equal
to the discount rate used.
• The decision rule for the IRR assumes that such resulting cash
flows have an opportunity cost equal to IRR which generated
them.
• NPV approach provides an absolute measure that fully represents
the value from the project to a company.
• IRR by contrast provides a % figure from which the benefits in
terms of wealth creation cannot be grasped.
102
Capital Budgeting Sensitivity Analysis
103
Share holder value creation
• Cash Dividends
• Stock Dividends
• Bonus Shares
• Bonus Debentures-issued from free reserves
• Equity Buy back / Secondary Listing
• Stock Split
• Synergic Investments
• Synergic Acquisitions
• Disinvest out of unrelated businesses
104
DIVIDEND STRUCTURING
Dividend rate will be depended upon the PAT, Payout ratio and 105
Equity base.
Dividend Structuring
•If the appetite for funds is high due to increase in level of exsisting
operation or due to major capital investment plan then a high
retention policy will be adopted.
111