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FINA NCI AL

MANAGEM EN T

Obj ecti ves and


functi ons

Refer university reference


book page no 124-131
Meaning

• Every business needs finance


(funds) to carry out carry out
its activities and accomplish
business objectives

• Life blood of the organization


Financial management
• The economic objectives of the
business are
• Profitability
• Growth
• Survival
• Efficient management of finance
is required to achieve the above
objectives
Financial management
• Finance function is concerned
with the process of acquiring and
efficiently utilizing the funds with
the objective of maximizing the
value of the firm
• Finance management involves the
application of general
management principles to the
finance function
Financial management

• Financial management deals with


how the corporation obtains the
funds and how it uses them
• Refers the application of skills in
the manipulation, use and control
of funds
Func tio
ns
1 DETE RMININ G F INA NCIA L
NE ED S
• It means determining the total
financial requirements – long
term and short terms.
This is called the
capitalization decisions

• Avoid over capitalization and


under capitalization
2. Determining capital
structure and source of funds.
• The capital structure decides
the blending of the owned and
borrowed funds in the total
financial requirements.
• The funds may be raised by
different types of securities,
debentures, financial
institutions or banks.
3. INVES TM ENT
DECISI ONS
• Allocating funds between
different components of
fixed and current assets.
• The return from business
operations should be high
to meet the cost of rising
funds.
4. Management of fixed
assets
• The investment in fixed assets
like land, building, machinery,
equipment, furniture etc
constitute 60% to 80%.
• Top management decision like
owning the assets, to hire, lease
it, make or buy components
5. Working capital
management
• It is the life blood of the
organization
• The important components
of the working capital are
inventories, receivables,
and cash balances which
keeps on circulating
6.Control over financial
activities
• Standard costing (actual Vs std)
• Budget control (capital, cash,
operating budgets)
• Financial analysis (various financial
ratios)
• Break even analysis (c-v-p- analysis)
7.Management of earnings
• Out of the total earnings for equity
share holders, how much should be
retained in the business for
reinvestment – dividend policies.
• Formulate dividend policy in such a
manner so as to formulate the value of
the firm such as profitability, share
holders reactions, requirement of
additional capital, investment
opportunities, accumulated profits etc.
Routine financial functions
• Del egated to subordi nat es
• Record keepin g
Custody and s afe guard of
documents.
Manageme nt report ing
Control on cash
OBJECTIVES
OBJECTIVES

• PROFIT MAXIMIZATION
• WEALTH MAXIMIZATION
PROFIT MAXIMIZATION

• Main aim of every economic


activity
• Profit is a measure of
efficiency
• Protection against risk
• Essential for fulfilling social
goals.
Wealth maximization
• Objective of the organization
• Firm should aim at maximizing its
current stock price.
• Market price of the share serves as a
performance index or report card of its
progress
• When the share price is increased, the
individual share holder can use the
increase towards better utility
Financial management and
profit maximization

•Increase in revenue
•Controlling costs
•Minimizing risks
Basics of financial
accounting

refer university book


page nos 165-169
Financial accounting -
meaning
• Concerned with record
keeping directed towards the
preparation of Profit and Loss
Account and Balance Sheet.
• It provides information
regarding profit and Loss
account that enterprise is
making and also financial
position on a particular date.
Financia l accountin g -
Limita tio ns
• No clear idea of operating efficiency
• Weakness not spotted out by collecting
results
• Not helpful in price fixation
• No data for comparison and decision
making
• No control on costs, no analysis on
losses
• Provides only historical information
Basic concepts
• Separate Entity Concept
• Going concern concept
• Money measurement concept
• Dual aspect concept
• Accounting period concept
• Periodic matching concept
• Realization concept
Separate Entity Concept
• Owner is treated as a separate person, ie
owner is different and business is different
• If the owner invests Rs 10,000 in the
business, the amount will be treated as
capital for the business and business has to
repay that amount to the owner.
• If the owner takes Rs 2000/- from the
business, it will be treated as a withdrawal
from his account, ie the business has repaid
Rs 2000/- to the owner, so net balance will be
Rs 8000/-on owner’s account.
Going concern concept

• Business will continue


for a very long period .
Even if the owner dies,
the business continues
to live.
Money measurement concept

• All transactions will be recorded


in the books of accounts, only if
they are in terms of money.
• Transactions which are not in
terms of money cannot be
recorded. For eg- 5 trucks, 1000
kgs of raw materials.
Cost concept
• The assets are entered in the books at
the purchase (cost price) only.
• From the purchase price (cost price)
depreciation is deducted to find the
book value.
• If the assets are shown on market
value, it may depend upon the
subjective views of the persons and
may lead to misleading results.
Dual aspect concept
• This dual aspect (debit and credit) is
the foundation of accounting principle.
(give and take) Every transaction has
two aspects- when you buy a book, you
get the book (take) and pay money
(give).
• For instance, when there is increase in
one asset, there is corresponding
decrease in other assets or increase in
liabilities
Accounting period
concept

• Life of the business (indefinite


period) will be divided into
small segments, say a year.
Every small segment is called
an Accounting year.
Matching concept

• After deciding about the


accounting period, the
revenues (income) are
matched with
expenditures to find out
profit or loss.
Realization concept.
• Revenue is considered only when the
ownership is transferred and the buyer
becomes legally liable to pay.
• For eg, a producer receives an order on
Jan 1st and delivers goods on Feb 1st
and receives the payment on March 1st.
In this case, revenue is realized as on
date of delivery ie Feb 1st when buyer
becomes liable to pay
FINANCIAL STATEMENTS
• BALANCE SHEET (Refer
Prasanna Chandras Financial
Management - page nos 41-48)
• PROFIT AND LOSS ACOUNT
(Refer Prasanna Chandras
Financial Management - page
nos 48-52)
Financial statements
• The accountants prepares two
principal statements ie Balance sheet
and Profit and loss statements to
answer the following questions to
Managers, shareholders, creditors
• What is the financial position of the
firm at a given point of time?
• How was the firm performed financially
over a given period of time?
• What have been the sources and uses
of cash over a given period of time?
BALANCE SHEET
Balance sheet
• Balance sheet shows the
assets of the firm and how the
assets are financed by
different types of capital.
• The assets are shown in one
side and the sources of the
assets or liabilities are
displayed on the other.
Balance sheet
• The balance sheet shows the
financial condition of the
business at a given point of
time.
• As per companies act, the
balance sheet can be either
account form or the report
form
Account form
LIABILITIES ASSETS
Share capital Fixed assets
Reserves and Investments
surplus
Secured loans Current assets,
loans and advances
Unsecured loans Miscellaneous
expenditure and
losses
Current liabilities
and provisions
Report form
• I SOURCES OF FUNDS
• 1 shareholder’s funds
a) share capital
b) reserves and surplus
• 2 Loans funds
a) secured loans
b) unsecured loans
• II APPLICATION OF FUNDS
• 1 fixed assets
• 2 investments
• 3 current assets, loans and advances
less current liabilities and provisions
net current assets
• 4 Miscellaneous expenditure and losses
Balance sheet of ABC Ltd as
on 31st March 2007
2006 2007 ASSETS 2006 2007
Liabilities
Share capital 150 150 Fixed assets 330 322
Equity-150
Prefer-0

Reserves /surplus 112 106 investments 15 15

Secured loans (term 143 131 Current assets, loans, 234 156
loans, cash credit) 69 25 and advances( cash
Unsecured loans &bank, debtors,
( bank credit, inter- inventories &advances)
corporate deposits)
Current liabilities and 105 81
provision

579 493 579 493


Liabilities
• Liabilities represent what the business
owes to others. These constitute
source for assets for the firm through
borrowing.
• These obligations must be settled in
future.
• Liabilities may be classified into
current and long term liabilities
Liabilities - classifications
• Companies act classifies
liabilities as follows
• Share capital
• Reserves and surplus
• Secured loans
• Unsecured loans
• Current liabilities and provisions
Share capital
• Divided into two-equity capital and
preference capital
• EQUITY CAPITAL- Contributions of
equity shareholders who are
theoretically the owners to the firm
• Equity capital, being risk capital,
carries no fixed rate of interest.
• PREFERENCE CAPITAL- Contributions
of preference shareholders and
dividend is payable on it is fixed.
Types of capital
• Authorized capital- the amount of
capital that a company can potentially
issue as per its memorandum
• Issued capital
• The amount offered by the company to
the investors is called issued capital.
• Subscribed capital
• The part of issued capital which has
been subscribed to by the investors is
called subscribed capital
Reserves and surplus
• Reserves and surplus are Profits retained by
the firm
• There are two kinds of reserves ie capital
reserves and revenue reserves
• Revenue reserves represent accumulated
retained earnings from profits of business.
• Capital reserves arise out of gains from
premium on issue on shares or gain in
revaluation of assets. A capital reserve
cannot be distributed as dividend
• Reserves and surplus along with paid up
capital represent owner’s equity which is also
called share holder’s equity or net worth.
Owners equity

• Reserves and surplus along


with equity capital
represent owner’s equity.
Secured loans
• Borrowings of the firm against
which specific collateral have
been provided.
• Eg, debentures, loans from
financial institutions /
commercial banks
Unsecured loans
• Not secured by a charge on
the assets of the firm
• Fixed deposits, loans and
advances from promoters,
corporate borrowings and
unsecured loans from
banks
Current Liabilities and
provisions
• CURRENT LIABILITIES
• include bills payable ie amounts due to
suppliers of goods and services bought
on credit sundry creditors, advance
payments received, interest accrued
but not due on loans
• Also include loans which are repayable
within a year from the date of balance
sheet
Provisions

• Provisions include items


such as provision for
taxes, provision for
dividend, provident fund,
gratuity, superannuation
and leave encashment
Assets

• Assets are classified as under


• Fixed assets
• Investments
• Current assets, loans and
advances
• Miscellaneous expenditure
and losses
FIXED ASSETS
• Assets that produce benefits for more
than one year
• May be tangible or intangible
• Land, building, plant, machinery,
furniture and computers are tangible
fixed asset.
• Patents, copyrights, trademarks &
goodwill are intangible fixed assets
• Tangible fixed assets are reported in
the balance sheet at their net book
value, which is simply the gross value
less accumulated depreciation
Investments
• Financial securities owned by the firm
• Divided into long term and current
investments
• Long term - equity / preference shares,
debentures of other companies, most
of which are likely associate and
subsidiary companies.
• current – short term holdings of units/
shares, mutual funds to generate
income from short term cash surplus.
Current assets, loans and
advances
• Inventories (RM, work in process, finished
goods, packing materials, stores and spares)
• Sundry debtors (amount owned to the firm by
customers who have bought goods and
services on credit and others.)
• Cash and bank balance (comprise cash on
hand and balance with scheduled and non-
scheduled banks)
• Other current assets (interest on
investments, dividends, deposits with govt
authorities)
• Loans and advances- comprise of items such
as advances and loans to subsidiaries,
advances recoverable etc
Profit and
loss account
Profit and loss account
• Prepared to show the income
or loss, the management has
generated over a period,
usually one year
• The purpose is to indicate
how successful the business
is
Profit and loss account
• Profit is the primary importance to
the board of directors in
evaluating the management of the
company.
• To share holders in making
investment decisions
• To banks and creditors for loan
decisions
Profit and loss account
• A profitable company is a
good company to invest in.
• An unprofitable company will
go out of business
• Therefore, income statements
are carefully scrutinized by all
interested parties
Profit and loss account

• May be presented in
account form or report
form.
• Usually use report form
P&L Account of ABC Ltd as
on 31/3/2007
2007 2006
Net sales 701 623
Cost of goods sold 552 475
Stocks 421
Wages/sal 68
Other manu ex 63
Gross profit 149 148
Operating expenses 60 49
Depreciation 30
Gen admn 12
Selling 18
Operating profit 89 99
Non-operating gain/loss - 6
Profit before interest and taxes 89 105
Interest and taxes 56 63
Profit after tax 34 42
FACTORS – P& L ACCOUNT
• NET SALES
• COST OF GOODS SOLD
• GROSS PROFIT
• OPERATING EXPENSES
• OPERATING PROFIT
• NON-OPERATING SURPLUS/DEFICIT
• PROFIT BEFORE INTEREST AND TAX
• INTEREST
• PROFIT BEFORE TAX
• TAX
• PROFIT AFTER TAX
• PRIOR PERIOD ADJUSTMENTS
• AMOUNT AVAILABLE FOR APPROPRIATIONS
• APPROPRIATIONS
• BALANCE ACRRIED FORWARD
Net sale
• NET SALE IS DEFINED AS-
Sales-sales return-excise
duty.
• SALES= SUM OF INVOICE PRICE AND
SERVICES RENDERED DURING THE PERIOD
• SALES RETURN= INVOICE VALUE OF GOODS
RETURNED BY CUSTOMERS
• ED= AMOUNT PAID TO EXCISE DEPT
Cost of goods sold
• Includes
• Direct material cost
• Direct labor cost
• Manufacturing overhead
Gross profit

•Is the difference


between net sales and
cost of goods sold
Operating expenses
• Expenses incurred for
running its business
• General admn expenses
• Selling and distribution
• Depreciation
Non operating gains/losses

• Arising from transactions


not related to normal
operating activities
• Profit and losses from sale
of fixed assets and
investments.
• Restructuring expenses
Profit before interest and
taxes(PBIT)
• Earnings before interest
and taxes
• Operating profit of the firm
plus non operating surplus
less any non operating
losses
Interest and taxes
• Interest for borrowing
loans, debentures, working
capital loan etc
• Tax-income tax payable
and other taxes
FINANCE MANAGEMENT-
SYLABBUS
Financial mgmt – objectives Uni ref 124/131 All
/functions branches

Time value of money chandra 161/182 All


branches

Basic financial accounting (no Uni ref 165/169 All


problems) branches

Profit and loss a/c chandra 48/52 All


branches

Balance sheet (only introduction) chandra 41/58 All


branches

Sources of indl finance, shares, chandra 461/475 All


debentures, public deposits, bank branches
loans, financial institutions except BT

Costing, elements of cost, cost NOTES Only For


sheet, allocation of overheads, break GIVEN BT
even analysis