1. 1 FINANCE December 7 th 2012

2. What is Financial Management? Art & Science of managing money 2

3. Primary Activities Financing Decision Raising of funds; amount, sources Investment Decision Buy assets; fixed assets/projects Current Assets/Working Capital Correlate with risk and uncertainty Dividend Decision Retain profits (reinvest)/give dividends 3

4. Controlling and Monitoring Stakeholders in a business (Owners, Managers, Regulators, Creditors) are interested in knowing – current status of the business – results of business carried out during a specific period 4

5. Basic Accounting Concepts Business Entity Money Measurement Cost; Acquisition cost Going Concern Conservative nature Accounting Period Matching; revenues and expenses Materiality Consistency 5

6. Tools for Controlling / Monitoring Annual Reports - Financial Statements Balance Sheet – Summary of Financial position at a given point of time. – Like a snapshot; list of assets and liabilities Profit & Loss Statement – Summary of operating results during a period. Cash Flow Statement – Summary of firms operating, investment and financing cash flows during a period 6

7. Working Capital Investment in various forms of Current Assets Necessary for smooth and uninterrupted functions of business operations of the firm Current Assets include: Inventory (Raw Material, Work in Process & Finished Goods), Debtors (Receivables), Advances, Cash Tradeoff between profitability and liquidity Gross Working Capital = ∑ (Current Assets) Net Working Capital = ∑ Sum (Current Assets) - ∑ Sum (Current Liabilities)

8. Receivables Inventory Cash Operating Cycle

9. It is sum of 1.Inventory Conversion Period (ICP) Total Time required for producing and selling the product; includes 1.Raw Material Storage Period (RMSP) 2.Work in Process Conversion Period (WIPCP) 3.Finished Goods Storage Period (FGSP) 2.Debtors Conversion Period (DCP) Time required to collect outstanding amount from customers Operating Cycle Constituents

10. Gross Operating Cycle (GOC) = ICP + DCP Actually purchase of Raw Materials on Credit leads to temporarily postponing payments, source of finance. Payment Deferral Period (PDP) Time firm is able to delay payments on purchase of various resources Net Operating Cycle(NOC) = GOC – PDP NOC is also called as Cash Cycle Operating Cycle Calculation

11. Analysis of Financial Statements Ratio Analysis - widely used tool Makes related information comparable e.g. Net Profit in relation to what? Standards of Comparison Cross sectional Analysis; competitors ratio or industry ratio Time series Analysis evaluation of performance over time Classification of Ratios Liquidity Activity Leverage Profitability 11

12. Liquidity Ratios Indicate ability to meet current obligations Current Ratio Current Assets / Current Liabilities It is a test of quantity not quality 12

13. Liquidity Ratios Quick (Acid Test) Ratio (Current Assets – Inventories - Loans & Advances) Current Liabilities Select only Current Assets that can be converted to cash without loss of value Measure of liquidity when inventory cannot be easily converted to cash 13

14. Activity Ratios Measure firm’s operating efficiency; Indicates speed with which assets are converted into sales Fixed Assets Turnover Ratio Sales Average Net Fixed Assets High is better, means better utilization of assets 14

15. Inventory Turnover Ratio Sales Average Inventory Average Collection Period 365 days Inventory Turnover Ratio

16. Debtors Turnover Ratio Credit Sales / Average Debtors Average Collection Period 365 days / Debtors Turnover Ratio Measures speed with which debtors are converted to cash High means better management of credit, quality of debtors good Debtors Turnover Ratio

17. Indicates financial risk and firms ability to use debt to shareholders advantage Ability to service debts or degree of indebtedness Indicates mix of funds provided by owners and lenders The process of magnifying shareholder return through use of debt is called “Financial Leverage”, “Financial Gearing” or “Trading on Equity ” Leverage Ratios

18. Debt Equity Ratio Total Debt Net Worth High means Risky Investment Interest Coverage Ratio EBIT Interest Charges Measures ability to meet contractual payments Leverage Ratios

19. Profitability in relation to Sales and in relation to Investment Operating Profit Margin Operating Profit (EBIT) Sales Measure for operating efficiency of the company Net Profit Margin Profit after Tax(PAT) Sales Profitability Ratios

20. Return on Capital (ROC) Profit before Interest & Taxes (PBIT) Capital Capital= Debt +Equity Return on Equity (ROE) Profit After Tax Net Worth Profitability Ratios

21. Earnings Per Share (EPS) Profit after Tax/Number of shares Profit earned by firm on a per share basis Price/Earnings Ratio(P/E) Market Price of Equity Share/EPS Measures the amount investors are ready to pay for every rupee of current day earnings Higher P/E – indicates higher investor confidence Some other Measures

22. Capital Budgeting –investment in Long Term Assets (Fixed Assets) in anticipation of future benefits over a series of years e.g.. Expansion, Diversification, Modernization, Cost Reduction Proposal Investment in Short Term Assets (Current Assets) - Working Capital Management Capital Budgeting

23. Related to long term survival of the business e.g.. investment in technology Large amount of funds Assessment of future events and cash flows makes it difficult Typically Irreversible Importance

24. Types of Projects-Independent or Mutually Exclusive Steps in Project Evaluation and Management Project/Proposal Generation Project Evaluation – Congruence with objectives of firm Project Selection Project Execution Monitoring Project Management Process

25.  Some ignore Time Value of Money  Some consider Time Value of Money Payback Period Time taken for the Cash benefits to recover the original cost of an investment Very basic measure of feasibility, has its limitations Better metric is Discounted Payback Period Project Evaluation Techniques

26. Present Values of Cash Inflows and Outflows are calculated using cost of capital NPV = ∑ PV (Cash Flows) in - ∑ PV (Cash Flows) out NPV>0May accept NPV<0Reject Net Present Value (NPV)

27. It is the rate of return that the project gives independent of any external rate Depends solely on cash inflows and cash outflows It is the rate at which, ∑ PV (Cash Flows) in = ∑ PV (Cash Flows) out or NPV = 0 IRR>Cost of Capital (k)may accept IRR<Cost of Capital (k)reject Internal Rate of Return (IRR)