Financial Management - Importance

Financial management is indispensable to any

organization as it helps in:
Financial planning and successful promotion of an
enterprise
Acquisition of funds as and when required at the
minimum possible cost
Proper use and allocation of fund
Taking sound financial decisions
Improving the profitability through financial controls
Increasing the wealth of the investors and the nation; and
Promoting and mobilizing individual and corporate
savings.
 Financial Management - Scope
Estimating Financial Requirements
Deciding Capital Structure
Selecting a Source of Finance
Selecting a Pattern of investment
Proper Cash Management
Implementing Financial Controls
Proper use of Surpluses
 Finance Functions
Financing Decisions
How much funds are required?
From where should the funds be procured?
At what costs should the funds be procured?
Investment Decisions
Liquidity Decisions
Dividend Decisions
Decisions regarding reporting, monitoring and
controlling of funds
 Finance Manager - Functions
Forecasting and planning
Analyzing and evaluating the investment activities
Coordination and control
Understanding the finance market
Risk management
Performance measurement
 Financial Planning - Steps
Setting the financial goals
Establishing the financial policies related to various
financial activities
Establishing the financial procedures for attainment of
financial goals
Monitoring the financial plan
 Forms of Business Organizations
Sole Proprietorship
Partnership
Corporation
 Types of Business Operations
Service business
Merchandising business
Manufacturers
 Sources of Finance
Equity (Shareholders funds)
Equity capital, retained earnings, preference capital
Debt (loan funds)
Term loans, debentures, short-term borrowings
 Debt and Equity Capital
Debt Capital Equity Capital
1. Investors are entitled to a 1. Investors have a claim on the
contractual set of cash flows (interest residual cash flows of the firm, after
and principal) it has satisfied all other claims and
liabilities.
2. Debt has a fixed maturity 2. Equity has an infinite life

3. Interest paid to debt investors 3. Dividend paid to equity investors

represents a tax-deductible expense. has to come out of profit after tax.

4. Debt investors play a passive role - 4. Equity investors enjoy the

often impose certain restrictions to prerogative to control the affairs of
protect their interests. the firm.
 Sources of Finance
Preference Share Capital
Retained Earnings
Term Loans
Setting up of projects
Expansion
Modernization
Renovation of projects etc.
Debentures
Short-term
Medium-term
Long-term
Fixed interest rate
Floating interest rate
Zero interest rate
 Sources of Finance
Venture Capital Financing
Lease Financing
Trade Credit
Advances from Customers
 Working Capital
Working capital refers to that part of the firms capital
which is required for financing short-term or current
assets.
The current assets include; cash, marketable securities,
short-term investments, accounts receivables, inventory
etc.
Funds invested in current assets is also known as
revolving or circulating capital.
 Working Capital Management
Management of the current assets held by a firm is
known as working capital management.
It involves
administration,
control,
procurement and
financing of current assets.
 Need of Working Capital
The need of working capital vary from organization to
organization
The amount of working capital in new concern depends
primarily upon its size and ambitions of its promoters
For the purchase of raw materials, components and spares
To pay wages and salaries
To incur day-to-day expenses and overhead costs such as
fuel, power and office expenses
To meet the selling costs as packaging, advertising etc.
To provide credit facilities to the customers
To maintain the inventories of raw material, work-in-
progress, stores and spares and finished stock
 Advantages of Adequate WC
Solvency of the business
Goodwill
Easy loans
Cash discounts
Regular supply of raw materials
Regular payment of salaries, wages and other day-
to-day commitments
Exploitation of favorable market conditions
Ability to face crisis
Quick and regular return on investments
High morale
 Disadvantages of Excessive WC
Excessive working capital means idle funds which earn no
profits for the business.
It may lead to unnecessary purchasing and accumulation of
inventories causing more chances of theft, waste and losses.
It implies excessive debtors and defective credit policy which
may cause higher incidence of bad debts.
It may result into overall inefficiency in the organization.
When there is excessive working capital, relations with
banks and other financial institutions may not be
maintained.
It may give rise to speculative transactions.
Due to low rate of return on investments, the value of shares
may also fall.
 Disadvantages of Inadequate WC
A concern having inadequate working capital can not pay
its short-term liabilities in time. Thus it will lose its
reputation and shall not be able to get good credit
facilities.
It can not buy its requirements in bulk and cannot avail of
discounts etc.
It becomes difficult for the firm to exploit favorable
market conditions and undertake profitable projects due
to lack of working capital.
It becomes impossible to utilize efficiently the fixed assets
due to non-availability of liquid funds
The rate of return on investments also falls with the
shortage of working capital.
 Factors Determining WC Requirements
Nature or character of Business
Size of Business/Scale of Operations
Production Policy
Manufacturing Process/Length of Production Cycle
Seasonal Variations
Working Capital Cycle
Rate of Stock Turnover
Credit Policy
Business Cycle
Rate of Growth of Business
Earning Capacity and Dividend Policy
Price Level Changes
 Financing of Permanent/Fixed WC
Shares
Debentures
Public Deposits
Ploughing back of profits
Loans from Financial Institutions
 Financing of Temporary/Variable WC
Commercial banks
Indigenous bankers
Trade creditors
Installment credit
Advances
Accrued expenses
Commercial papers
 Operating Cycle
The speed/time duration required to complete one
cycle determines the requirement of working capital.

The longer the period, larger is the requirement of

working capital.

Gross Operating Cycle = Raw material conversion

period (RMCP) + work-in-process conversion period
(WIPCP)+ Finished goods conversion period (FGCP) +
Receivable conversion period (RCP)
 Operating Cycle
Raw Material Conversion Period = Average stock of
raw material / Average daily consumption of raw
material
Work-in-Process Conversion Period = Average Stock
of WIP / Average daily Cost of Production
Average cost of production = Annual cost or production / 360
Annual cost of production = Opening stock of WIP +
consumption of raw material + other manufacturing cost
closing WIP.
Finished goods Conversion Period = Average stock of
finished goods / Average daily cost of sales
 Operating Cycle
Average Collection Period= Average Debtors / Credit
sales
Average Payment period = Average creditors/Credit
purchase
 Budget
In the words of Crown and Howard, A budget is a pre-
determined statement of management policy during a
given period which provides a standard for
comparison with the results actually achieved.

A budget is a financial and/or quantitative statement

prepared prior to a defined period of time, of the
policy to be pursued during that period for the
purpose of attaining a given objective.
 Characteristics of Good Budgeting
A good budgeting system should involve persons at different
levels while preparing the budgets.
There should be a proper fixation of authority and
responsibility.
The targets of the budgets should be realistic.
A good system of accounting is essential.
It should have a whole-hearted support of the top
management.
There should be meetings and discussions and the targets
should be explained to the employees concerned.
A proper reporting system should be introduced, the actual
results should be promptly reported so that performance
appraisal is undertaken.
 Classification and Types of Budget
Classification According to Time
Long-term budget
Short-term budget
Current budget
Classification on the basis of Functions
Operating budget
Financial budget
Master budget
Classification on the basis of flexibility
Fixed budget
Flexible budget
 Operating Budgets
Sales budget
Production budget
Production cost budget
Purchase budget
Raw materials budget
Labor budget
Plant utilization budget
Manufacturing expenses or works overhead budget
Administrative and selling expenses budget
 Cash Budget
A cash budget is an estimate of cash receipts and
disbursements during a future period of time.
It is an analysis of flow of cash in a business over a future, short
or long period of time.
It is a forecast of expected cash intake and outlay.
Cash forecasts will include all possible sources from which cash
will be received and the channels in which payments are to be
made so that a consolidated cash position is determined.
The estimated cash collections for sales, debts, bills receivables,
interests, dividends and other incomes and sale of investments
and other assets will be taken into account.
 Sales Budget
A sales budget is an estimate of expected sales during a
budget period.
It lays down a comprehensive plan and program for sales
department.
The sales manager is made responsible for preparing sales
budget.

Factors to be considered while preparing sales budget

Past sales figures
Assessment and reports by salesmen
Availability of raw materials
Seasonal fluctuations
Availability of finances
Plant capacity
 Production Budget
It is a forecast of the production for the budget period.
It is prepared for the number of units to be produced and
also for the cost to be incurred on materials, labor and
factory overhead.

The preparation of production budget involves the

following steps:
Production planning
Consideration of plant capacity
Stock quantity to be held
Considering sales budget
 Capital Budgeting/Expenditure Decisions
Financial Decisions of the firm
Financing decisions
Dividend decisions
Investment decisions
Long-term investments
Capital Budgeting decisions
Short-term investments
 Capital Budgeting/Expenditure Decisions
Most important strategic decisions affecting firms
long-term value.
It deals with acquisition or generation of assets.
Expansion of existing capacity and purchase of new
assets.
It deals with corporate restructuring initiatives.
 Capital Budgeting/Expenditure Decisions
Importance:
Large investments
Long-term commitment of funds
Irreversible nature
Long-term effect on profitability
Difficulties of investment decisions
National importance
 Capital Budgeting Process
Identification investment proposals
Screening the proposals
Evaluation of various proposals
Fixing priorities
Final approval and preparation of capital expenditure
budget
Implementing proposal
Performance review
 Capital Budgeting
Methods
Pay-back period method
Average rate of return method
Net present value method
Internal rate of return method
 Project Finance: Participants
Government
Project sponsors or owners
Project company
Contractor
Operator
Supplier
Customer
Commercial Banks
Capital Markets
Multilateral agencies
Export credit agency
Insurers, Legal advisors, Financial advisors
 Project Financing Risks
Country (civil unrest, guerrilla sabotage of projects, work stoppages)
Political
Industry
Project (adequacy and track-record of the concerned tech & exp)
Customer (demand for the product declines or widely fluctuates)
Supplier (quality, quantity and availability of supply for the project)
Sponsor (experience, mgt ability, ability to contribute equity)
Contractor (schedule delays and budget overruns)
Operating risk (maintaining the quality of asset)
Product (product liability, design problems)
Competitor
Funding
Currency
Interest rate
Risk allocation