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FINANCE FUNCTION : Finance is the management of monetary affairs of a company. It includes determining what has to be paid for & when; raising the money on the best terms available & devoting the available funds to the best uses. Finance functions : 1. Routine financial matters : these matters are looked after by the Treasurer. 2. Special financial functions : these functions are looked after by the Controller of finance.
Finance committee Chief Finance Officer [ CFO] Treasurer Cash & bank a/c Investments work to Tax & Insurances be Credit & collection performed Reconciliations Investor relations Controller of finance Accounting Budgeting Internal Audit Finance planning Profit planning Economies
Finance functions
Technique of acquiring & utilizing the funds Integral part of over all management Deals with financial forecasting Financial planning & control Co-related with production, marketing & accounting Deals with budgeting, reporting & accounting Contributes to the decision making
financing
1. Forecasting :
1. 2. 3. 4. 5.
Analyzing economic trends Anticipating industrial trends Estimating financial requirements Profit planning Estimating ROI
2. financing:
1. 2. 3. 4.
Ensuring the availability of the funds Allocating funds Investing funds Raising funds
4. Costing :
Measuring & Controlling cost of capital 2. Measuring & Controlling company costs
1.
5. Decision making :
1. 2. 3. 4. 5.
Financial decisions Investment decisions Mgt of income & div function Meeting special or contingent problems Working capital decisions
6. Miscellaneous :
1. 2. 3. 4. 5. 6.
Tax mgt Fixed assets & investment mgt Computer operations Insurance Credit & collections Pensions & welfare
4.
5. 6.
Responsible for dept of finance In charge of planning, developing strategies & guiding the mgt for financial decisions Responsible for maintaining good repo with baker, & other financial institutions timely submission of documents, stock statements, pymt of intt & principle sum, cash flow & fund flow statements, etc. Guiding the BOD in certain key decision making like allocation & utilization of funds, anticipation of financial need Contributes to overall progress of the business by putting his/her professional knowledge, experience. It is the primary objective to maximize the value of the firm to its stock holders.
AGENCY PROBLEM :
Ratio analysis
This one of the popular tools of FSA. It mean, the indicated quotient of two mathematical expressions & the relationship between 2 or more things. Interpretation of ratios is another most important task. It is based on certain factors like :
1. 2. 3. 4. 5.
General economic condition Opportunities Risk acceptance Accounting system Comparison with peers
Inter firm as well as intra firm comparison Inter period comparison To help in decision making To analyze the performance of the firm To check the liquidity, solvency, operational efficiency, overall profitability, capital gearing, etc. Provide effective control For forecasting, budgeting, planning, co-ordination To check the personnel efficiency To point out the financial condition of the business like very strong, good, questionable or poor & by that way enables the mgt to take proper steps
It guides mgt in formulating financial planning & policies It throws light on the efficiency of the business organisation Comparison with similar firms, segment & industry is possible Ensures effective cost control It provides greater clarity, perspective & meaning to the data It measures profitability & solvency of the concern It helps in investment decisions
Statement of changes in WC :
Particulars Current assets Inventories Debtors Cash Bank Prepaid exps,etc Total : A : Current liabilities Creditors Outstanding exps Bills payable Bank o/d Total :B: Net WC [A-B] Increase / decrease in WC previous yr current yr increase decrease
CAPITAL BUDGETING
Capital budgeting refers to planning the deployment of available capital for the purpose of maximizing long term profitability of a firm. This includes to take various decisions like, investing in long term objectives, acquiring fixed assets, implementation of projects, set aside the funds. It involves : 1. Idea generation 2. Evaluation / analysis 3. Selection 4. Financing the selected projects 5. Implementation 6. Review of the project
5. 6. 7.
It involves investment of current funds for future benefits These decisions have long term implications for a firm It is one of the main tool of financial mgt. It gives sufficient scope to the financial manager to evaluate different proposals & only viable projects must be taken up for investments. It has gained importance as it offers effective control on cost of capital expenditure on the projects. Helps the mgt to avoid over / under involvement of funds It guides the mgt for essential & objective oriented investments are to be made
8. Capital budgeting decisions are exposed to risk & uncertainty 9. CB decisions are irreversible in nature ie once made cant be taken back or changed. It affects the liquidity & marketability; so to be made carefully.
Decision rule : acceptance or rejection of the project is decided on the comparison of calculated PBP with standard PBP.
Amounts
ARR
3. It takes into account all profits of the projects life period. Limitations : 1. It ignores the time value of money 2. It does not allow the fact that profit can be reinvested 3. It doesnt take in to consideration any benefits, which can be accrued to the firm by selling the equipments which are replaced by the new investments 4. It never take in to account the size of the investments required for different types of projects
ARR
Decision rule : Accept : calculated ARR > predetermined ARR Reject : calculated ARR < predetermined ARR
NPV:
Advantages : 1. It takes into account the time value of money 2. It uses all cash inflows occurring over the entire life period of the project, including scrape value of the old project Limitations : 1. It is difficult to under when compared with PBP & ARR 2. Difficult calculations
IRR :
This is defined as that discounting factor at which the present value of cash inflow equals to the present value of cash outflows. IRR = LDF% + [PVLDF Cash outflow] [PVLDF PVHDF ] LDF = lower discount factor HDF = higher discount factor PVLDF = present value of cash inflow at lower disc factor PVHDF = present value of cash inflow at high disc factor Decision Rule : Accept : IRR> cost of capital Reject : IRR < cost of capital
debtor
cash
sales
Raw materials
Finished goods
WIP
receivables
cash
Operating cycle
OC can be computed with the following formula : Inventory conversion period + Accounts receivable period Inventory conversion period = avg. inventory cost of goods sold/365 days Accounts receivable period = avg. accounts receivable sales /365 days
Estimation of WC requirement : WC means current assets less current liabilities. Hence, following steps to be done : 1. Estimation of current assets 2. Estimation of current liabilities 3. Calculation estimated WC 4. Add certain % as contingency to estimated WC Factors influencing WC : 1. Nature of business 2. Size of business 3. Production cycle process 4. Production policy 5. Terms of purchase & sale 6. Business cycle
Estimation of WC requirement : 7. Growth & expansion 8. Availability of raw materials 9. Profit level 10. Taxes 11. Operating efficiency 12. Availability of credit 13. Price level changes
Financing of WC requirement :
1.
Short term financing : for a period of less than 1 year from a. loan from banks, b. short term deposits from public, c. commercial papers d. factoring of receivables e. bills discounting f. retention of profits 2. Long term financing :for a period above 5 years from a. ordinary share capital b. preference share capital c. loan from banks
Financing of WC requirement :
3.
Spontaneous financing : this refers to the automatic sources of short term funds arising in the normal course of a business. It includes trade credits [ suppliers] & out standing exps. All these spontaneous sources of finance are available at free of costs.
Factoring :
From 1994, banks are allowed to enter in factoring services. Banks provide WC finance through financing receivables, which is known as factoring. a factor is a financial institution, which renders services relating to the mgt & financing of sundry debtors that arises from credit sales. There are only 4 PSBs which are permitted to offer factoring related services in India. SBI, Canara Bank, Allahabad Bank, & PNB.
Buyer approaches to the seller to provide goods on credit The seller that has factoring option approaches the factor for credit limit, factor fixes credit limit Once the factor sets limit for credit, then seller sends goods & invoice to the buyer After receiving invoice from the buyer, seller sends the same to the factor. Factor pays up to 80% of invoice Factor sends monthly statements to seller Factor allow for collection of credit so the buyer pays the amounts to the factor. Factor settles after paying balance 20% & deducting commission to the seller.
CAPITALIZATION :
Capitalization means total amount of long term funds available to the company. It includes shares, debentures, long term loans, reserves & surplus. The assessment of the funds needed by the co should be done in such a way that the total amount of funds available should be neither too large nor less. Over capitalization : It means existence of excess capital as compared to the level of activity & requirements. It doesnt mean that there is excess funds. It may mean that the co is having more funds & still the earning capacity is low.
Causes of Over capitalization : Eg. If the earning of a co is Rs.50k & the rate of return is 10%; then the expected capital of the co is 50k/10% = Rs. 5 lakh. If the actual capital is more than this expected capital then there is the situation of over capitalization. Some of the reasons of over capitalization are : 1. Assets might have been purchased in the inflationary situation. 2. Adequate provision of depreciation is not made so that the picture of earnings is not real & affects the capitalization position. 3. The requirement of the funds might not have been properly planned by the co, as a result, the co may realise shortage of funds & borrow from the market
Over capitalization : At higher interest rate; resulting in reduction of earnings of the co. 4. Retained earnings of the co is not sufficient to cope up with the requirement of funds. Effects of over capitalization :