Blog address For important updates, course outline, slide as well as assignment uploads keep on regularly checking this blog: www.financialmanagement502.wordpress.com

First session

What is Finance? As a term ‘Finance’ is defined in various ways, However a more comprehensive definition of finance could be: Finance is the set of administrative functions in an organization which manage the flow of cash within an organization so that the organization will have the means to carry out its objectives as easily as possible and in the meantime also meet the obligations as they become due.

Main subdivisions of Finance Finance is traditionally sub-divided into 3 interrelated segments: Finance Financial Management Investments Financial Markets and Institutions

1. Financial Management Specialty area of finance. Financial Decision Making Investment Decision Making Managerial Decision Making Specialty area of finance. Financial management is known by different names. Interrelated decision making process. Three main types of financial management decisions. Important for financial managers to evaluate these decision on an interrelated basis.

i. Investment Decisions Assets are any item owned by an individual or company which has value (i.e. they could be sold). Long term in nature. ‘Capital budgeting’ decisions. Example: Sale of a division or business, change in method of advertising, expansion, acquisition, modernization and replacement of long term assets all have potential to impact firm’s expenditures and benefits in the long run and are known as capital budgeting decisions. Involves determining the type and amount of assets the firm wants to buy and hold. Example: Spinning machine for a textile unit, setting up an electric power generating facility for a sugar mill.

i. Investment Decisions Involve finding a right balance between long-term and short-term goals. Explained through example.

i. Investment Decisions Asset side of balance sheet (left-hand side) is related to investment decisions. Investment decision

i. Investment Decisions Common investment decisions to be undertaken by the financial manager: In what lines of business should the firm engage? Should the firm acquire other companies? Should the firm modernize or sell an old production facility? Note.

ii. Financing Decisions The second question that a financial manager faces. Concerned with the ways and sources through which firm obtains and manages long term financing it needs to support long term investments. A firm’s capital structure refers to the specific mixture of debt and equity the firm uses to finance its investments.

ii. Financing Decisions An important part of manager’s financing decisions is to answer the question, ‘How to raise cash for meeting firm’s capital expenditures? The answer to this questions involves the right side of the balance sheet, the firm’s capital structure. Stockholders’ equity representing owner investment into assets of the company.  Financing decision

ii. Financing Decisions Types of Financing: Equity financing Debt Financing

ii. Financing Decisions Common Financing decisions to be undertaken by the financial manager: How to finance? Short-term or long-term? People or banks? Wait or to invest now?

iii. Managerial Decisions Concerned with day-to-day decision making Making investing and financing decisions that improve the firms value for its owners. What should be the growth rate of the firm? Does a firm need external (debt) financing? If Yes, then work to improve credibility so that financial institutions would grant loans.

Functions of Financial Manager Financial analysis Discovering full meaning contained within F.S. Unlock activity pattern. Financial planning Deciding how much and where to invest Financial forecasting Primary function, estimate financial requirement Financial control Tracking performance and evaluating org. progress towards achieving organizational goals Interrelation with other departments Very important to regularly interact and maintain relationship

Goals of Financial Manager F.M. makes decisions for stockholders of firm From stockholders P.O.V what would be a good F.M. decision? The goal of maximizing stock value avoids a number of problems. Stockholders are residual owners of a firm. The goal of financial manager of a corporation is to increase the value per share of the corporation’s stock.

Agency Relationships Goal of a financial manager is to act in best interest of stockholders. However, in large corporations extreme diversity of ownership. Dispersion in ownership Greater managerial control Agency relationship Two main players The relationship between stockholder and manager is called agency relationship.

1. Between shareholders and management Within the financial management context the primary agency relationships are of 2 types: 1. Between shareholders and management 2. Between shareholders and creditors

1. Stockholders versus managers Stockholders delegate decision making authority to managers to run the business. This relationship between stockholder and manager is called agency relationship. Several problems may exist with this agency relationship: Managerial abuse of benefits putting cost on firm and its stockholders Managers acting in their own self interest (behavior towards risk)

1. Stockholders versus managers Firms incur cost to reduce the conflict. Agency cost Direct agency cost Corp. exp. at the expense of shareholders, Monitoring cost Indirect agency cost Result from managers’ failure to make a profitable investment because of its aversion to risk

1. Stockholders versus managers Different mechanisms to reduce conflict between shareholders and managers How to make managers work in stockholder’s best interest? By using a mixture of reward and punishment strategies: Managerial Compensation Direct intervention by stockholders Threat of firing Threat of takeover

Managerial Compensation Managerial compensation package must meet two objectives: Attract and retain able managers Offer executives incentives to motivate them to take actions that will enhance shareholder wealth(stock price maximization) Bonus Performance shares Executive stock option

ii. Direct intervention by stockholders iii. Threat of takeover Occurs when: A firm's stock is undervalued relative to its potential because of inadequate management Acts as a check on manager performance because: In a hostile takeover, the senior managers of the acquired firm are typically dismissed. iv. Threat of dismissal ii. Direct intervention by stockholders Today institutional investors hold a large portion of company’s stock and can intervene to nominate members to BOD who’d represent their interest.

2. Stockholders (through managers) versus creditors Conflict of interest may also exist between stockholders and creditors. Stockholders through managers may take steps that tend to maximize shareholder value but works against the cause of creditors Invest in risky projects – if successful all benefits go to stockholders if unsuccessful creditors bear the risk.

Practical Illustration >

2. Stockholders versus creditors Different mechanisms to reduce conflict between shareholders and creditors Creditors may charge higher rate upfront Writing detailed debt agreements/covenants

Second session

What are Financial Statements? Financial statements are records that outline the financial activities of a business. Presentation of financial information in a clear manner. Aiding creditors and investors in making effective credit and investment decisions.

Basic Financial Statements used in Financial Analysis Two basic financial statements that are used in financial analysis: Balance sheet (statement of financial position) Income statement (profit and loss statement)

Balance Sheet Financial snapshot of a company at a particular point in time. Components: Assets Liabilities and owner’s equity

Income Statement Income statement reports the primary performance measure of a company i.e. revenue less expenses during an accounting period.

Significance/need for the analysis of Financial Statements It is important to analyze financial statements as this analysis aids in getting information about a company’s: Liquidity position Growth rate Profitability Capacity to borrow Credit worthiness Assessing market risk Financial strengths and weaknesses

1. Liquidity position “The ease or convenience with which we can convert a current asset into cash” Speed Convenience Fair price

2. Growth rate 3. Profitability Financial analysis involving growth rate focuses on whether a company is growing in sales, stock price, profitability etc. 3. Profitability Taking help from profitability ratios to make important financial decisions

4. Capacity to borrow Using debt ratios to determine portion of firms total assets financed with creditor’s funds Long term creditors most interested in firm’s debt ratio High debt ratio sends warning signal to firms’ creditors

6. Credit worthiness 7. Strengths and weaknesses Capacity to meet debt obligations in full and on time Credit ratings help determine CW. 5. Assessing market risk Analyzing past financial statements to determine trends w.r.t. elements that control market risk 7. Strengths and weaknesses

Users of Financial Statements Internal users - Management - Investing public -Creditors External users - Government - Auditors - Potential investors

Ratio Analysis “Ratio is the mathematical relationship of one number to another number”. Financial ration analysis is a valuable tool helping small business owners and managers measure their progress against: A competing firm/s Industry average Previously defined internal goal

5 main categories of Financial Statement ratios Liquidity ratios Asset Management Ratio Debt utilization ratio Profitability ratio Market value ratio