Important Business Activities

• Production• Marketing • Finance

Finance is defined as the provision of money at the time when it is required.

DEFINITION-FINANCE

FINANCE• PUBLIC FINANCE PRIVATE FINANCE

– GOVERNMENT INSTITUTIONS PERSONAL FINANCE– STATE & CENTRAL GOVT. BUSINES S FINANCE– LOCAL SELF-GOVT. FINANCE OF NON-PROFIT ORGN.

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Financial Management-definition

Financial management is that managerial activity which is concerned with the planning and controlling of the firm’s financial resources

Scope of Finance Function/Financial Management

Estimating Financial RequirementsDeciding Capital StructureSelecting a Source of Finance Selecting a Pattern of InvestmentProper Cash ManagementImplementing Financial ControlProper use of Surpluses

Who is the Finance Manager

• A person responsible for the supervision and handling of the financial affairs of an organization.

• A financial manager is responsible for providing financial advice and support to colleagues and clients to enable them to make sound business decisions.

• Financial managers must understand all aspects of the business so that they are able to adequately advise and support the chief executive officer in decision-making and ensuring company growth and profitability.

The Role of The Financial Manager

Financial

Manager

Firm's

operations Investors

(1) Cash raised from investors

(1)

(2) Cash invested in firm

(2)

(3) Cash generated by operations

(3)

(4a) Cash reinvested

(4a)

(4b) Cash returned to investors

(4b)Real assets

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Financial management, in the modern sense of the term, divided into four major decisions

The investment decision

The financing decision

The dividend policy decision

The funds requirement decision or Liquidity or short-term

asset-mix decision

Investment decision or capital budgeting involves the decision

allocation of capital or commitment of funds to long-term assets

that would yield benefits in the future .

Two important aspects of the investment decision are:

(a) The evaluation of the prospective profitability of new investments.

(b) The measurement of a cut-off rate against that the prospective return of new

investments could be compared.

INVESTMENT DECISION

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FINANCING DECISION

Here the point is to decide where and how to acquire funds to meet the firm’s investment needs .

The central issue is to determine the proportion of equity and debt . The mix of debt and equity is known as the firms capital structure

The financial manager must strive to obtain the best financing mix or the optimum capital structure .

The use of debt affects the return and risk of shareholders; it may increase the return on equity funds but it always increases risk.

• The finance manager must decide whether the firm should distribute all profits , or retain them, or distribute a portion and retain the balance .

• The financial manager should also consider the questions of dividend stability, bonus shares and cash dividends in practice.

• Most profitable companies pay cash dividends regularly.

• Sometime additional shares, called bonus share are also issued to the existing shareholders in addition to the cash dividend.

DIVIDEND DECISION

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Liquidity Decision

It is ascertained on the basis of three important considerations.

Forecasting cash flows i.e., matching the inflows against cash outflows

Raising funds i.e., financial manager will have to ascertain the sources from which funds may be raised and the time when these funds are needed.

Managing the flow of internal funds.

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APPROACHES TO FINANCE FUNCTION/FINANCIAL MANAGEMENT

The approach to the scope and functions of financial management is divided , in order to have a better exposition, into two broad categories.

Traditional Approach

Modern Approach

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Traditional Approach

The traditional approach, which was popular in the early stage, deals with the following aspects:

Arrangement of funds from financial institutions Arrangement of funds through financial instruments like share, bonds etc. Looking after the legal and accounting relationship between a corporation and its sources

of funds.

Main limitations of Traditional Approach

Ignored working capital financing No Emphasis on allocation of funds Time value of money is not considered

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Modern Approach

According to modern approach the term financial management provides that

the the finance function covers both acquisition of funds as well as their allocation.

The main contents of this approach are: What is the total volume of funds an enterprise should commit?

What specific assets should an enterprise acquire.

How should the funds required be financed.

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OBJECTIVE OF FINANCIAL MANAGEMENT

The objectives of financial management can be broadly classified into two categories.

Profit Maximization

Wealth MaximizationMaximization of Profit : “Profit maximization” is a term which denotes the maximum profit to be earned by an organization in a given time period. The profit- maximization goal implies that the investment, financing and dividend policy decision of the enterprise should be oriented to profit maximization.

Arguments in favour of Profit MaximizationIt is barometer for measuring efficiency and economic prosperity.Able to survive at the time of adverse business condition due to profit maximization.Profit is the main source of finance for the growth.Profitability is essential for fulfilling social goals.

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Drawbacks of Profit maximization

it is Vague The Term ‘Maximum’ is also ambiguous It Ignores Time Value it Ignores the Risk Factor Dividend policy

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Wealth Maximization

• This is also known as Value Maximisation or Net Present Worth Maximization.

• Value is represented by the market price of the company’s Equity Shares.

• Shareholders Wealth can be calculated by the following formula:Shareholders Wealth=No. of equity shares outstanding X Market Price of Shares

Hence , the higher the share price per share the greater will be the shareholders wealth.

Thus, a firm should aim at maximizing its current share price.

Sources of Finance

SHORT TERM LONG TERM

SHARES RETAINED EARNING

LONG TERM FINANCE

Issue of debenture

Loans from financial institutions

SHARES

• SHARE REFERES TO THE SMALLEST SEGMENT OF CAPITAL OF A COMPANY.

•A SHARE HAS BEEN DEFINED BY THE INDIAN COMPANIES ACT, 1956 , “SHARE MEANS SHARE IN THE SHARE CAPITAL OF THE COMPANY & INCLUDES STOCK EXCEPT WHERE A DISTINCTION BETWEEN STOCK & SHARE IS EXPRESSED OR IMPLIED”.

• THE LIABILITY OF THE SHAREHOLDER IS LIMITED TO THE EXTENT OF THE FACE VALUE OF THE SHARES.

SHARES

EQUITY SHARES PREFERENCE SHARES

EQUITY SHARES • Equity shares, also known as ordinary shares

or common shares, represent the owners capital in a company .

Characteristics of Equity Share • Permanent capital• Residual claim to asset & income • Right to control or voting rights and Limited

liability .

PREFERENCE SHARES :

Preference share capital gives certain privilege to its holders on the equity shareholders.

A preferential privilege in payment of a fixed dividend .

Preferential right as to repayment of capital in case of liquidation

FEATURES OF PREFERENCE SHARES

•HYBRID SECURITY•PREFERENCIAL RIGHTS•PREFERENCIAL RIGHT ON FIXED DIVIDENDS.•DEMAND UNPAID ARREARS• VOTING RIGHTS•CONVERSION OF SHARES•RIGHT TO SHARE SURPLUS PROFITS

Types of Preference shares :

• Cumulative preference shares• Non-cumulative preference share• Redeemable Preference share• Irredeemable Preference Share• Participating Preference share• Non-participating preference share• Convertible preference share• Non-convertible preference shares.

RETAINED EARNINGSINSTEAD OF DISRTIBUTING THE ENTIRE PROFITS TO THE SHAREHOLERS, COMPANY RETAINS SOME PROFITS FOR THE PURPOSE OF:

1. ACCUMULATIONS OF EARNINGS2. INVESTMENT IN FIXED ASSETS3. TO MEET WORKING CAPITAL NEEDS

DEBENTURES : A company may raise long-term finance through public borrowings.

These loans are raised by the issue of debentures.

A debenture is an acknowledgement of a debt.

Definition: A debenture is a document under the company’s seal which provides for the payment of a principal sum and interest thereon at regular intervals, which is usually secured by a fixed charges on the company’s property and which acknowledge a loan to the company .

A debenture holder is a creditor of the company.

Types of debenture

Simple or unsecured debentures Secured or mortgaged debentures Bearer debentures(Easily transferable) Registered debentures(not easily transferable ) Redeemable debentures Irredeemable debentures Convertible debentures Non-Convertible debentures First debentures and Second Debentures

Bonds Zero coupon bonds Deep discount bonds Floating rate bonds Inflation adjusted bonds

Term Loans

Term loans represent long-term debt with a maturity of more than one year .

Features of term loans :• Fixed maturity period• Term loans are secured• Restrictive contracts

Sources of Short term Financing• Bank credit

• Customer advance

• Trade credit

• Factoring

• Commercial paper

• Installment credit

• Bill discounting

• Leasing

Questions to be asked before deciding the sources of finance

• How much is required?

• What is the finance is needed for?

• How soon is the finance required?

• How long finance is needed?

• What is the cost of finance?

• What are the risks involved?

• What are the tax implications?

• What is the nature of business?

Tips for Choosing Sources of Finance

• The sources of finance should be matched to its purpose.

• Capital investment should be finance by long term loans or equity.

• Working capital should be finance by short term loans or overdrafts.

Case Study 1A medium-sized engineering firm with an annual return of over Rs. 25 lakhs before interest and tax has decided to install a new piece of machinery to help improve its productivity. The equipment needs to be housed in a new building to be construed on the site.

The forecast of the building is Rs. 50 lakhs and the equipment Rs. 40 lakhs. Firm already issued 12 % Debentures of Rs. 50 lakhs and Equity Shares Rs. 100 lakhs Face Value Rs. 100 each.

As a manger of finance decide the sources of finance with appropriate reasons.

Solution-Case 1

• The appropriate source of finance for this case would be to take 50% from the retained earnings and 50% from the bank loan.

• This approach will reduce the number of years to pay back in installment and will result in less amount of interest to pay from the amount borrowed.

CASE STUDY-2An individual has been made redundant after 20 years with a major organization and has received a lump sum redundancy payment of Rs. 70,000. The individual is planning to set up a bookmakers and has identified a suitable premises valued at Rs. 180,000 near to a major town centre shopping zone. As a financial consultant advise the person to take appropriate steps.

Case 2- Solution• Joint venture will be ideal for this case, as the individual has a

capital sum of Rs. 70,000 and another partner will put in a capital and will be able to borrow a smaller amount of money from the bank.

• The advantage for joint venture is that the risk is spread, advice will be bought in through experience and the company will be able to bring expertise for higher growth and for long term basis.

• And the disadvantage for is that profits will be shared with a shareholder.

• On the other hand the disadvantage of the bank loan will be that the bank may not be able to provide a loan due to the redundancy; unless the owner provides good business strategy plan which will forecast to give a good return and also owns an assets or security i.e. Property, land etc.

Case 3A rugby club is anticipating turning fully professional after the team secured promotion to the Zurich premiership. To take its place in the league, the league committee have insisted that it also improves facilities at the ground. It has been estimated that the cost of these two measures will be Rs. 550,000. Find out the appropriate sources of finance with explanations.

• A small news agent in a rural village centre has decided to purchase a new freezer cabinet and oven/roasting unit to provide hot meals for village workers and for students at the secondary school which serves the surrounding area which is located half a mile from the village centre. The cost of the units is £3,500. As a owner of this business, how and from which sources you should arrange the finance?

CASE 4

Case 5Following the construction of a new housing estate on the outskirts of a major city, a group of 10 ambitious young professionals has decided to try to exploit the type of resident moving into the area by setting up a gym and health centre on earmarked land within the development. The building has been bought by the group for £800,000 but needs to be furnished and fitted out for the purpose intended. The cost of the bar, restaurant and gym facilities is estimated at £95,000 but the other major cost is the swimming pool, spa and sauna area. This could be utilized on a separate project to the fitness centre as the local council want to secure use for local school children and elderly residents - this being part of the purchase arrangements associated with the new housing development.

Case 6• A large Public Limited Company is planning on

moving a major part of its production facility to Pune. It has identified a site near industrial estate at Pune that is now not used. The estimated cost of the facility is Rs. 45 lakhs.

Case 6-Solution• A long term bank loan will be suitable to for a large

company planning to move as the estimated cost is Rs. 45 lakhs and share issue will also be ideal as this can raise capital that can be used for the move, this is a long term source of finance.

• Shareholders will have to share the control of business, each share gives the shareholder a vote on the direction of the company and will spread the risk to the number of shareholders, and this will also reduce the amount of loan to borrow from the bank which will also result to fewer installments and less interest to pay.