Name Amit Gupte

Registration / Roll No. 511023366

Course Master of Business Administration (MBA)

Subject Financial Management

Semester Semester 2

Subject Number MB0045

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Short Notes

1. Financial Management
Financial Management is Planning, directing, monitoring, organizing,
and controlling of the monetary resources of an organization. The
management of the finances of a business / organization in order to
achieve financial objectives. Financial Management is the efficient and
effective planning and controlling of financial resources so as to
maximize profitability and ensuring liquidity for an individual(called
personal finance), government(called public finance) and for profit and
non-profit organization/firm (called corporate or managerial finance).
Generally, it involves balancing risks and profitability.

The decision function of financial management can be divided into the

following 3 major areas:

INVESTMENT DECISION

1. Determine the total amount of assets needed by a firm hence

closely tied to the allocation of funds
2. Two type of investment decisions namely:

• Capital Investment decisions re: large sums, non routine, longer

term, critical to the business like purchase of plant and
machinery or factory
• Working Capital Investment decisions re: more routine in nature,
short term but are also very critical decisions like how much and
how long to invest in inventories or receivables

FINANCING DECISION

1. After deciding on the amount and type of assets to buy, the

financial manager needs to decide on HOW TO FINANCE these
assets with the sources of fund
2. Financing decisions for example:

• Whether to use external borrowings/debts or share capital or

retained earnings

• Whether to borrow short, medium or long term

• What sort of mix – all borrowings or part debts part share capital
or 100% share capital
 • The needs to determine how much dividend to pay out as this
will directly affects the financial decision.

Financial Planning
Financial Planning is an exercise aimed to ensure availability of right
amount of money at the right time to meet the individual’s financial
goals
Concept of Financial Planning
Financial Goals refer to the dreams of the investor articulated in
financial terms. Each dream implies a purpose, and a schedule of funds
requirements for realising the purpose
Asset Allocation refers to the distribution of the investor’s wealth
between different asset classes (gold, property, equity, debt etc.)
Portfolio Re-balancing is the process of changing the investor’s asset
allocation
Risk Tolerance / Risk Preference refers to the appetite of the investor
for investment risk viz. risk of loss

Financial Plan Is a road map, a blue print that lists the investors’
financial goals and outlines a strategy for realising them
Quality of the Financial Plan is a function of how much information the
prospect shares, which in turn depends on comfort that the planner
inspires

Capital Structure

Capital structure of a firm is a reflection of the overall investment and

financing strategy of the firm.

Capital structure can be of various kinds as described below:

 - Horizontal capital structure: the firm has zero debt component
in the structure mix. Expansion of the firm takes through
equity or retained earnings only.

- Vertical capital structure: the base of the structure is formed

by a small amount of equity share capital. This base serves as
the foundation on which the super structure of preference
share capital and debt is built.

- Pyramid shaped capital structure: this has a large proportion

consisting of equity capita; and retained earnings.

- Inverted pyramid shaped capital structure: this has a small

component of equity capital, reasonable level of retained
earnings but an ever-increasing component of debt.

SIGNIFICANCE OF CAPITAL STRUCTURE:

- Reflects the firm’s strategy

- Indicator of the risk profile of the firm
- Acts as a tax management tool
- Helps to brighten the image of the firm.

FACTORS INFLUENCING CAPITAL STRUCTURE:

- Corporate strategy
- Nature of the industry
- Current and past capital structure

Cost of Capital

Cost of capital is the rate of return the firm requires from investment in
order to increase the value of the firm in the market place. In economic
sense, it is the cost
of raising funds required to finance the proposed project, the borrowing
rate of the firm. Thus under economic terms, the cost of capital may be
defined as the weighted average cost of each type of capital.
There are three basic aspects about the concept of cost
1. It is not a cost as such: The cost of capital of a firm is the rate of
return which it requires on the projects. That is why; it is a ‘hurdle’
rate.
2. It is the minimum rate of return: A firm’s cost of capital represents
the minimum rate of return which is required to maintain at least the
market value of equity shares.
3. It consists of three components. A firm’s cost of capital includes
three components
 a. Return at Zero Risk Level: It relates to the expected rate of return
when a project involves no financial or business risks.
b. Business Risk Premium: Business risk relates to the variability in
operating profit (earnings before interest and taxes) by virtue of
changes in sales. Business risk premium is determined by the capital
budgeting decisions for investment proposals.
c. Financial Risk Premium: Financial risk relates to the pattern of capital
structure (i.e., debt-equity mix) of the firm, In general, a firm which has
higher debt content in its capital structure should have more risk than
a firm which has comparatively low debt content. This is because the
former should have a greater operating profit with a view to covering
the periodic interest payment and repayment of principal at the time of
maturity than the latter.

Trading on Equity

When a co. uses fixed interest bearing capital along with owned capital
in raising finance, is said “Trading on Equity”.

(Owned Capital = Equity Share Capital + Free Reserves )

Trading on equity represents an arrangement under which a company uses funds

carrying fixed interest or dividend in such a way as to increase the rate of return on
equity shares.
It is possible to raise the rate of dividend on equity capital only when the
rate of interest on fixed – interest – bearing – security is less than the
rate of return earned in business.
•Two other terms:
•Trading on Thick Equity :- When borrowed capital is less than
owned capital
•Trading on Thin Equity :- When borrowed capital is more than
owned capital, it is called Trading on thin Equity.

ASSETS MANAGEMENT DECISION

 1. Once assets have been purchased and appropriate financing ar
secured, it now involve the efficient and effective management
of current assets like cash, inventories & receivables so as to
maximize returns and minimize the risk of liquidity.
2. Example of assets management decision like.

• Extension of credit term to increase sales

• To hold more stocks or on a longer term

The Goal Of The Firm

a. Maximization of profits.
b. Maximization of shareholder wealth.
c. Maximization of consumer satisfaction.
d. Maximization of sales.

PROFIT MAXIMIZATION:

• Simply a single-period or a short-term goal to be achieved within

one year
• Management mainly focuses on efficient utilization of capital
resources to maximize profits WITHOUT considering the
consequences of its actions towards the company’s future
performance.

Drawbacks/disadvantages of Profit Maximization Goal:

a. It is only a SHORT TERM concept

b. It does NOT consider the timing of returns

c. It IGNORES risk

SHAREHOLDERS’ WEALTH MAXIMIZATION:

• Shareholders’ wealth is regarding the maximizing of the total

market /market price of the existing shareholders’ common stock
• It can be achieved by considering many factors whether short or
long term pertaining to decisions/actions made affecting the
present and future earnings per share, timing of returns,
 dividend policy and other factors that can affect the market price
of the company stock

Unlike profit maximization, it has the following advantages:

• Its applies to the principle of time value of money wherein a

dollar received today is worth more hand it is to be received say
1 year later. By considering time value of money, this will lead to
an overall increase in the company’s earning

• To achieve shareholder’s wealth maximization, management

needs to consider the uncertainty or risk factor. It accept a
certain degree of risk when it is compensated with the same
level of return

• Increase in shareholders’ wealth will directly lead to increase in

cash flows. It is not concern only with accounting earnings/profits
but CASH FLOWS.

• To achieve shareholders’ wealth maximization, the firm has to

achieve all the short-term target like sales/earnings growth and
dividend payout targets. Only when these short term targets
being achieved, the firm will then be attractive to the potential
investors which might raise the stock price.

Corporate Governance:

Corporate governance is the set of processes, customs, policies, laws,

and institutions affecting the way a corporation (or company) is
directed, administered or controlled. Corporate governance also
includes the relationships among the many stakeholders involved and
the goals for which the corporation is governed. The principal
stakeholders are the shareholders, management, and the board of
directors. Other stakeholders include employees, customers, creditors,
suppliers, regulators, and the community at large.

Board of Director:

A board of directors is a body of elected or appointed members who

jointly oversee the activities of a company or organization. The body
sometimes has a different name, such as board of trustees, board of
governors, board of managers, or executive board. It is often simply
referred to as "the board."
A board's activities are determined by the powers, duties, and
responsibilities delegated to it or conferred on it by an authority
outside itself. These matters are typically detailed in the organization's
bylaws. The bylaws commonly also specify the number of members of
the board, how they are to be chosen, and when they are to meet.

Typical duties of boards of directors include.

• Governing the organization by establishing broad policies and

objectives;
• Selecting, appointing, supporting and reviewing the performance
of the chief executive;
• Ensuring the availability of adequate financial resources;
• Approving annual budgets;
• Accounting to the stakeholders for the organization's
performance.

Role of Management:

The success of the business depends primarily upon the skill and
abilities of management–which skills can vary widely among different
managers. The business is not completely at the mercy of market
forces. Management can through its actions (decisions) influence and
control events within limits. In order to achieve desired results,
management makes use of specific planning and control concepts and
techniques. Planning and control techniques which management may
use include business budgeting, cost, volume, profit analysis,
incremental analysis, flexible budgeting, segmental contribution
reporting, inventory models, and capital budgeting models.
Management, in order to improve decision making and operating
results, will evaluate performance through the use of flexible budgets
and variance analysis.

Finance Department of Organization:

The Finance Department is responsible for the systems and procedures
that assure the sound and efficient functioning of the organization
financial activities. The flow of financial activities begins with a plan
(budget). The plan is then implemented and the transactions recorded
(accounting); and finally, the results are reported (financial
statements). The Finance Department also keeps an accurate record of
all financial transactions, generates interim financial reports, and
produces audited financial statements at the end of each year.
Capital Market:
A capital market is a market for securities (debt or equity), where
business enterprises (companies) and governments can raise long-
term funds. It is defined as a market in which money is provided for
periods longer than a year, as the raising of short-term funds takes
place on other markets (e.g., the money market). The capital market
includes the stock market (equity securities) and the bond market
(debt).
Capital markets may be classified as primary markets and secondary
markets. In primary markets, new stock or bond issues are sold to
investors via a mechanism known as underwriting. In the secondary
markets, existing securities are sold and bought among investors or
traders, usually on a securities exchange, over-the-counter, or
elsewhere.

Public Issue.
With a public issue, securities are sold to hundreds, and often
thousands, of investors under formal contract overseen by federal and
state regulatory authorities.

Privileged Subscription:
The sale of new securities in which existing shareholders are given a
preference in purchasing these securities up to the proportion of
common shares that they already own; also known as a RIGHTS
OFFERING.
Regulation of Security Offering:
Both the federal and state governments regulate the sale of new
securities to the public, but federal authority is far more encompassing
in its influence.

Private Placement:
Private placement is made to a limited number of investors, sometimes
only one, and considerably less regulation. An example of a private
placement might be a loan by a small group of insurance companies to
a corporation.
Private or direct placement the sale of an entire issue of unregistered
securities (usually bonds) directly to one purchaser or a group of
purchasers (usually financially intermediaries).

Initial Public Offering:

An initial public stock offering (IPO) referred to simply as an "offering"
or "flotation," is when a company issues common stock or shares to the
public for the first time. They are often issued by smaller, younger
companies seeking capital to expand, but can also be done by large
privately-owned companies looking to become publicly traded.
An IPO can be a risky investment. For the individual investor, it is tough
to predict what the stock or shares will do on its initial day of trading
and in the near future since there is often little historical data with
which to analyze the company.

Signaling Effect:
Through signaling effect we get the signal of surrounding environment.

Primary Market:
The primary market is that part of the capital markets that deals with
the issuance of new securities. Companies, governments or public
sector institutions can obtain funding through the sale of a new stock
or bond issue. This is typically done through a syndicate of securities
dealers. The process of selling new issues to investors is called
underwriting. In the case of a new stock issue, this sale is an initial
public offering (IPO). Dealers earn a commission that is built into the
price of the security offering, though it can be found in the prospectus.

Features of primary markets are:

• This is the market for new long term equity capital. The primary
market is the market where the securities are sold for the first
time. Therefore it is also called the new issue market (NIM).
 • In a primary issue, the securities are issued by the company
directly to investors.
• The company receives the money and issues new security
certificates to the investors.
• Primary issues are used by companies for the purpose of setting
up new business or for expanding or modernizing the existing
business.
• The primary market performs the crucial function of facilitating
capital formation in the economy.
• The new issue market does not include certain other sources of
new long term external finance, such as loans from financial
institutions. Borrowers in the new issue market may be raising
capital for converting private capital into public capital; this is
known as "going public."
• The financial assets sold can only be redeemed by the original
holder.

Secondary Market:
The secondary market, also known as the aftermarket, is the financial
market where previously issued securities and financial instruments
such as stock, bonds, options, and futures are bought and sold.

Financial intermediary:
Financial intermediation consists of “channeling funds between surplus
and deficit agents”
A financial intermediary is an entity that connects surplus and deficit
agents. The classic example of a financial intermediary is a bank that
transforms bank deposits into bank loans. Through the process of
financial intermediation, certain assets or liabilities are transformed
into different assets or liabilities.
As such, financial intermediaries channel funds from people who have
extra money (savers) to those who do not have enough money to carry
out a desired activity (borrowers).

Types of financial intermediaries:

• Banks
• Building societies
• Credit unions
• Financial advisers or brokers
• Insurance companies
• Collective investment schemes
• Pension funds
Investment Banker:

A financial institution that underwrites (purchases at a fixed price on a

fixed date) new securities for resale.

Traditional Underwriting:
Underwriting bearing the risk of not being able to sell a security at the
established price by virtue of purchasing the security for resale to the
public; also known as FIRM COMMITMENT UNDERWRITING.
If the security issue does not sell well, either because of an adverse
turn in the market of because it is overpriced, the underwriter, not the
company, takes the loss.

Underwriting syndicate:
A temporary combination of investment banking firms formed to sell a
new security issue.

(A): Competitive-bid:
• The issuing company specifies the date that sealed bids will be
received.
• Competing syndicates submit bids.
• The syndicate with the highest bid wins the security issue.

(B): Negotiated offering:

• The issuing company selected an investment banking firm and
works directly with the firm to determine the essential features of
the issue.
• Together they discuss and negotiate a price for the security and
the timing of the issue.
• Depending on the size of the issue, the investment banker may
invite other firms to join in sharing the risk and selling the issue.
• Generally used in corporate stock and most corporate bond
issues.

Best Effort Offering:

A security offering in which the investment bankers agree to use only
their best effort to sell the issuer’s securities. The investment bankers
do not commit to purchases any unsold securities.

Shelf Registration:
A procedure whereby a company is permitted to register securities it
plans to sell over the next two years. These securities can be sold
piecemeal whenever the company chooses.
Balance Sheet:
In financial accounting, a balance sheet or statement of financial
position is a summary of the financial balances of a sole proprietorship,
a business partnership or a company. Assets, liabilities and ownership
equity are listed as of a specific date, such as the end of its financial
year. A balance sheet is often described as a "snapshot of a company's
financial condition" Of the four basic financial statements; the balance
sheet is the only statement which applies to a single point in time. A
company balance sheet has three parts: assets, liabilities and
ownership equity.

Income Statement:
Income statement, also referred as profit and loss statement (P&L),
earnings statement, operating statement or statement of operations, is
a company's financial statement that indicates how the revenue
(money received from the sale of products and services before
expenses are taken out, also known as the "top line") is transformed
into the net income (the result after all revenues and expenses have
been accounted for, also known as the "bottom line"). It displays the
revenues recognized for a specific period, and the cost and expenses
charged against these revenues, including write-offs (e.g., depreciation
and amortization of various assets) and taxes. The purpose of the
income statement is to show managers and investors whether the
company made or lost money during the period being reported. The
important thing to remember about an income statement is that it
represents a period of time. This contrasts with the balance sheet,
which represents a single moment in time.

Ratio Analysis:
A tool used by individuals to conduct a quantitative analysis of
information in a company's financial statements. Ratios are calculated
from current year numbers and are then compared to previous years,
other companies, the industry, or even the economy to judge the
performance of the company. Ratio analysis is predominately used by
proponents of fundamental analysis.

Liquidity Ratios:
These ratios indicate the ease of turning assets into cash. It which give
a picture of a company's short term financial situation or solvency.
They include the Current Ratio, Quick Ratio, and Working Capital.

Current Ratios:
The Current Ratio is one of the best known measures of financial
strength. It is figured as shown below:
 Total Current Assets
Current Ratio = ____________________
Total Current Liabilities

Quick Ratios:
The Quick Ratio is sometimes called the "acid-test" ratio and is one of
the best measures of liquidity. It is figured as shown below:

Cash + Government Securities + Receivables

Quick Ratio = _________________________________________
Total Current Liabilities

Working Capital:
Working Capital is more a measure of cash flow than a ratio. The result
of this calculation must be a positive number. It is calculated as shown
below:

Working Capital = Total Current Assets - Total Current Liabilities

Leverage Ratios:
Any ratio used to calculate the financial leverage of a company to get
an idea of the company's methods of financing or to measure its ability
to meet financial obligations. There are several different ratios, but the
main factors looked at include debt, equity, assets and interest
expenses.
This Debt/Worth or Leverage Ratio indicates the extent to which the
business is reliant on debt financing (creditor money versus owner's
equity):

Total Liabilities
Debt/Worth Ratio = _______________
Net Worth

Generally, the higher this ratio, the more risky a creditor will perceive
its exposure in your business, making it correspondingly harder to
obtain credit.

Debt Ratios:
A ratio that indicates what proportion of debt a company has relative
to its assets. The measure gives an idea to the leverage of the
company along with the potential risks the company faces in terms of
its debt-load.

Capitalization Ratios:
The capitalization ratio measures the debt component of a company's
capital structure, or capitalization (i.e., the sum of long-term
debt liabilities and shareholders' equity) to support a company's
operations and growth.
Long-term debt is divided by the sum of long-term debt and
shareholders' equity. This ratio is considered to be one of the more
meaningful of the "debt" ratios - it delivers the key insight into a
company's use of leverage.

Coverage Ratios:
Measure of a corporation's ability to meet a certain type of expense. In
general, a high coverage ratio indicates a better ability to meet the
expense in question.

Activities Ratios:
Accounting ratios that measure a firm's ability to convert different
accounts within their balance sheets into cash or sales.
Such ratios are frequently used when performing fundamental analysis
on different companies. The asset turnover ratio and inventory
turnover ratio are good examples of activity ratios.

Account Receivable Ratios:

An accounting measure used to quantify a firm's effectiveness in
extending credit as well as collecting debts. The receivables
turnover ratio is an activity ratio, measuring how efficiently a firm uses
its assets.
Ratio analysis can be used to tell how well you are managing your
accounts receivable. The two most common ratios for accounts
receivable are turnover and number of days in receivables.

Time Value of Money:

The time value of money is the value of money figuring in a given

amount of interest earned over a given amount of time. The idea that
money available today is worth more than the same amount of money
in the future, based on its earnings potential.

Present value of a future sum:

The present value formula is the core formula for the time value of
money; each of the other formulae is derived from this formula. For
example, the annuity formula is the sum of a series of present value
calculations.

The present value (PV) formula has four variables, each of which can
be solved for:

1. PV is the value at time=0

2. FV is the value at time=n
3. it is the rate at which the amount will be compounded each
period
4. n is the number of periods (not necessarily an integer)

Future value of a present sum:

The future value (FV) formula is similar and uses the same variables.

Interest:
The fee charged by a lender to a borrower for the use of borrowed
money, usually expressed as an annual percentage of the principal; the
rate is dependent upon the time value of money, the credit risk of the
borrower, and the inflation rate. Here, interest per year divided by
principal amount, expressed as a percentage. Also called interest rate.
Types of Interest:

A: Simple Interest:

Simple interest is earned on the principal only.

Formula:

Interest = Principal × Rate × Time

B: Compound Interest:

Compound interest is paid on the original principal and on the

accumulated past interest.

Formula:

P is the principal (the initial amount you borrow or deposit)

r is the annual rate of interest (percentage)

n is the number of years the amount is deposited or borrowed for.

A is the amount of money accumulated after n years, including

interest.

When the interest is compounded once a year:

A = P (1 + r) n
Annuity:

A financial product sold by financial institutions that is designed to

accept and grow funds from an individual and then, upon
annuitization, pay out a stream of payments to the individual at a later
point in time. Annuities are primarily used as a means of securing a
steady cash flow for an individual during their retirement years.

Types of Annuity:

Ordinary Annuity:

A series of fixed payments made at the end of each period over a fixed
amount of time. An ordinary annuity is essentially a level stream of
cash flows for a fixed period of time. Straight bond coupon payments
are normally referred to as ordinary annuities.

Formula: (future value)

C = Cash flow per period

i = interest rate
n = number of payments

Annuity Due:

An annuity due requires payments to be made at the beginning of the

period. For example, in many lease arrangements, the first payment is
due immediately and each successive payment must be made at the
beginning of the month.

I have a formula for an annuity due calculation

fv = p * (((1 + i) ^ n - 1) / i) * (1 + i)
Where
fv = future value
p = payments
i = interest rate
n = term