Financial Management. Sandeep Gokhale. References. Financial Management Authors : Khan & Jain Prasanna Chandra Myers Van Horne. Syllabus. Ratio Analysis Fund & Cash flow analysis Cost of Capital Working Capital Mgmt. Means of Financing Capital Budgeting Dividend Structuring
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Objective: Create share holder value
Methodology: Capturing of value at all Levels.
Business Process restructuring
Enterprise resource management.
Vertically integrated operations.
Customer relationship Management
Sustained up scaling of operations
Effectiveness: Proximity of gross profit to net profit
Maximisation of EVA
EV / EBIDTA multiple
Investor Wish List
( Audit & Taxation)
Convertibility of Local Currency
GDP / Industrial growth rate
Scalability of Operations
FDI – Incoming / outgoing
Inflation rate / Fiscal deficit
Balance of payment status
Emerging markets scenario
Gross national income distribution
Government programmes and projects
Subsidies, incentives and concessions
Exim policies / VAT
Lending considerations of financial institutions and commercial banks
Rating of Govt paper
Emergence of new technologies.
Access to technical Up gradation
Level of obsolescence.
Age shifts in population
Attitudes toward consumption and investment
Number of players in the industry and their market share.
Duty barrier and status of international cost and volume positioning.
Degree of homogeneity and differentiation among products.
Entry barriers for new capacities.
Comparison with substitute products.
Unorganised sector operations.
Marketing polices and practices.
Corp planning: Long term financial goals in terms of assets, sales,profits,dividends etc.
Expansion, new projects diversifications
takeovers , mergers,disinvestments.
Internal generation, tax planning.
Operations: Integrating functional plans.
Working capital management
Control:Budgetary control of all divisions
Marketing: Credit norms
Cost analysis of decisions like discounts , premium pricing,product promotion etc.
Manufacturing: Budgeting for manufacturing operations.
Product mix decisions.
Personnel: Budgeting for personnel & administrative function.
Working Capital Mgmt
Valuation of Assets
For the Period 1st April to March 31st
Gross sales from Goods & Services
Less: Excise Duty
Non operating Income
Raw materials consumed
WIP +FG adjustment
PBIDT (Gross Profit)
PBT (Operating Profit)
PAT (net profit)
Gross cash accruals : PAT + Depn
Net cash accruals : GCA - Dividend
For the year ended March 31st 200...
Equity share capital
Reserves & Surplus
Other unsecured loans
Commercial bank borrowings
Other current liabilities
Gross fixed assets
Less: Acc. Depn
Currents Assets: RM Stock
Cash in bank
Loans & Advances
Principal tool for analysis
Inter firm comparison
Intra firm comparison
Profitability / Valuation
Current Ratio: Current assets
Acid test ratio: C.A- Inventories
Cash position ratio: Cash in bank + hand
Inventory to G.W.C: Inventory
Debt / Equity ratio: Long term debt
Borrowing / Assets: 1 - Net worth
Fixed asset / Networth: Fixed Assets
Capital gearing ratio: Capital entitled to fixed return
Capital not entitled to fixed return
Debt. Service coverage ratio: PBDIT - Tax
Interest + Annual installment
Interest coverage ratio: PBDIT - Tax
F. Asset coverage ratio: Gross fixed asset - Acc. Depn
LT Secured liabilities
Total asset turnover: Net sales
Fixed asset turnover: Net sales
Inventory turnover: Net sales
Collection period: Avg. debtor * 365
Creditors Turnover: Credit purchase
Payment period: Avg. Creditor * 365
Gross profit ratio: PBDIT / Sales
EBITDA / Sales
RONW : PAT / Networth
ROSE: PAT - Pref. Div
Return on CAP. Employed: PBIT
Total Lia - Creditors – Provisions
Return on Investment : PBIT / Investments
NO of Equity Shares
EV / EBITDA: Enterprise value / Gross profit
Earning per share: PAT - Pref Div
No. of Equity shares
Price Earning ratio: Market price
Earnings per share
Pay out ratio: Dividend paid
Profit after Tax
Lenders of funds for appraising credit worthiness for long term / short term lending decisions.
Valuations in investment / disinvestment decisions.
Financial analyst / Mutual Funds / Investment Bankers.
Management for operational short / longterm planning.
Credit Rating Agencies
It is a statement indicating the methods by which a company has been financed and the uses to which it has applied its funds over a period of time.
It provide an insight into the movement of funds and helps in understanding the changes in the structure of asset & liabilities.
Provides information as to how funds are raised and utilised.
Determines need for funds and helps in deciding finance mix
Determines financial consequences of business decisions.
Free cash flow generation ability and Utilisation of the same.
Equity Buy back
Normal Capital expenditure
Funds from operations Loss from operations
Sale of fixed assets Increase in fixed assets
Increase in liabilities Redemption of liabilities
Sale of securities Purchase of securities
Decrease in W.C Increase In W.C
Cash Dividends, Equitybuy back
Assets Uses of funds
Liabilities Uses of funds
Assets Source of funds
Liabilities Source of funds
Comparison of balance sheets of consecutive years.
OVERALL FUND FLOW
OPERATIONAL FUND FLOW
WORKING CAPITAL BASED FUND FLOW
(ONLY STS/STU STATEMENT)
Aggregate of the liabilities raised by a company is the total capital employed in business.
Different sources have different cost and tax implications.
Cost of capital
It is a single rate (weighted average ) for a finance mix.
It is computed on a post - tax basis since cost of different sources have different tax implications
E.g.. Interest on debt capital enjoys tax shield while dividend paid on equity has no tax shield.
COC is used as a discounting rate in DCF analysis.
METHODS OF COMPUTATION OF COST OF EQUITY OF CAPITAL
Ke = PAT - pref. div + non tax shield portion of depn
Equity block (E + R +S + acc depn)
Market capitalisation approach
Ke = D/P + G
D = Dividend per share G = Growth rate = b*r
P = Market price per share
b= % Retained earnings = PAT - Dividends / PAT
r = % Return on “b” = PAT - Pref div / Net worth
Capital Asset Pricing model OF CAPITAL
Ke = Rf +beta ( Rf – Rm)
Rf = risk free rate of return
Beta = stock relationship with a index
Rm = Market expectations of return ( Bloomberg base )
WORKING CAPITAL MANAGEMENT be considered as weights.If market capitalization approach is used then market value to be considered as weights.
Objective: Optimise current asset deployment.
Advantages: Lower interest cost.
Inventory holding cost reduced.
Disadvantages: Interruption in production.
Stock out to customers.
ASSET STRUCTURE FOR VARIOUS INDUSTRIAL SEGMENTS be considered as weights.If market capitalization approach is used then market value to be considered as weights.
Power Generation 80% 20%
Chemical process plants 50% 50%
Engineering 40% 60%
Service 20% 80%
Trading 10% 90%
WORKING CAPITAL be considered as weights.If market capitalization approach is used then market value to be considered as weights.
Current assets comprise of stocks of raw materials, work in progress, finished goods, and receivables.
Gross working capital = total current assets.
Net working capital = CA - CL
Objective is to optimse asset requirement and funding the same at minimal cost.
CONSTITUENTS OF CURRENT ASSETS be considered as weights.If market capitalization approach is used then market value to be considered as weights.
Raw material stock
Work in progress
Finished goods stock
Cash in hand / bank
Debtors / Receivables
OPERATING CYCLE TIME be considered as weights.If market capitalization approach is used then market value to be considered as weights.
Time required for rolling or rotation of current assets.
Date of receipt RM issued to Throughput time
of RM production Dept
Collection of Despatched to consumers Converted to FG
CASH MANAGEMENT be considered as weights.If market capitalization approach is used then market value to be considered as weights.
Cash budgets : Quarterly / monthly / weekly
Operating cash inflow/ outflow items:
Cash inflowCash outflow
Cash sales Accounts payable
Collection of receivables R.M purchase
Taxes / Duties
Features: Interest rate is based upon the prime lending rate + project risk.
Basic interest rate linked to inflation rate
Linked to G-Sec rate or Sub - SBAR ( SBI PLR )
Security Hypothecation & mortgage
Door to Door tenure
EVALUATION OF ESC shareholder in the event foregin co has 10% stake in indian co.
Company’s point of view
Represents almost permanent capital
Does not involve any fixed obligation for servicing
Enhances credit worthiness of the company to secure additional debt.
High cost of capital
Dividends paid on profit after tax further subjected to dividend distribution tax of 15%
High flotation cost
Dilution of control (Treasury issue)
Investors point of view shareholder in the event foregin co has 10% stake in indian co.
Enjoy voting right in the company with limited liability.
Short term capital gains tax reduced to 10%
Long term Capital gains tax abolished. ( Exchange traded securities )
Indexation benefit available under 54E.
Controlling power could be notional
Turn over tax at 15 basis points on sale of the security on an exchange
Have residual claim to income / assets
Vide fluctuations in stock price
Dividend’s subjected to distribution tax of 15%
Retained earnings shareholder in the event foregin co has 10% stake in indian co.
Made up of Accumulated depreciationand retained profits.
Represent the internal sources of finance available to the company.
Availability : Level of profitability / payout ratio
Cost : Identical to ESC.
Flexibility : High
Advantages shareholder in the event foregin co has 10% stake in indian co.
Reinvestment of profit may be convenient to many shareholders.
No dilution of control since Co. Relies on retained earnings
No flotation cost/ Losses on account of underpricing.
Proceeds could be used in a subsequent buyback.
High opportunity cost
Limitation on amount
Bonus issue may capitalise reserves
Preference share capital shareholder in the event foregin co has 10% stake in indian co.
Fixed minimum dividend rate
No voting rights
Prior claim on income / assets
Redeemable at issuer’s & investor’s discretion
No dilution of control
Provision to skip dividend in absence of profits
CAPTAL BUDGETING shareholder in the event foregin co has 10% stake in indian co.
Non financial factors in project appraisal shareholder in the event foregin co has 10% stake in indian co.
Influence of non - financial factors
Life of project / Terminal value
NON FINANCIAL FACTORS DETERMINING shareholder in the event foregin co has 10% stake in indian co.
FINANCIAL VIABILITY OF PROJECTS
Present and future size of the market
Present and future demand and supply situation
Achievable market share
Selling & distribution channels
Level of Technological obsolence
Scales of operation
Raw material & utilities consumption norms
Ecological factors shareholder in the event foregin co has 10% stake in indian co.
Treatment of effluent
Environmental impact of the project
Social cost benefit analysis
Economic rate of protection
Domestic resource cost
Protection enjoyed by industry.
FINANCIAL TECHNIQUES IN CAPITAL BUDGETING shareholder in the event foregin co has 10% stake in indian co.
Return on investment
AVG ROI = PBIT
(over 10 yrs) Total Inv.
Simple to calculate and easy to understand
Maximisation of shareholders wealth and maximising the marketvalue of investments.
Time value of money not considered
It is a concept based on profit and not cash
No objective criterion for acceptance / Rejection decision.
Payback period shareholder in the event foregin co has 10% stake in indian co.
It is the time required to get back the original investment companies going through liquidity crisis /for small investments will use the pay back period method.
Cash inflows / Outflows after payback Period are ignored.
Time value for money is ignored
Discounted cash flow (DCF) shareholder in the event foregin co has 10% stake in indian co.
Cash inflow and outflow for the entire life of the project is considered.
It considers time value for money as a result earnings in earlier years have higher value than earned in later years.
IRR is that rate of discount at which the net present value of cash flows equals net present value of cash outflows.
If IRR > COC Investment is support worthy.
Using COC discount the netflows
If NPV is + VE investment is support worthy..
PROJECT COST COMPONENTS shareholder in the event foregin co has 10% stake in indian co.
Plant & Machinery
Misc Fixed Assets
Erection and commissioning
Technical Know how fees
Preliminary & preoperative expenses
Total Capital Cost
Margin money for working capital
Total project cost
PROJECT CASH FLOWS shareholder in the event foregin co has 10% stake in indian co.
Cash outflows Capital expenditure
Normal capital expenditure
Cash inflow Net cash accruals
Recovery of WC
DIVIDEND STRUCTURING shareholder in the event foregin co has 10% stake in indian co.
Appropriation of PAT towards Dividend pay out and Reserves
Payout ratio = Dividend paid / PAT
Retention ratio = PAT - Dividend paid / PAT
Dividend rate (%) could be high but payout could be low.
Dividend rate will be depended upon the PAT, Payout ratio and Equity base.
Dividend Structuring shareholder in the event foregin co has 10% stake in indian co.
100% retention scenario
For some shareholders dividend acts as a regular income source EX: investor’s for whom it is a regular source of income, mutual funds, investment companies.
Declaration of dividend is perceived as an indication that the companies operations are profitable.
100% payout scenario
Repeated raising of capital increases floatation cost
Companies requirement for expansion / margin money / new investment.
Tax inefficient due to 15% distribution tax.
GUIDELINES FOR ISSUE OF BONUS SHARES FI’s on on payment of dividend during the currency of the loan.
Issuer : Security exchange board of India
Bonus issue should be made from capitalisation of free reserves built out of genuine profits and share premium.Reserves created by revaluation of assets, statutory reserves etc. are not allowed for capitalisation
Bonus issue greater than 1:1 allowed
Residual reserve test: residual reserves after the proposed capitalisation should be at least 40% of the increased capital For computation all contingent liabilities, statutory reserves and revaluation reserves to be excluded.
Yield test: 30% of the average P.B.T for the last 3 years should give a return of at least 10% on the enhanced capital.
Bonus in lieu of dividend is not permitted
If R = Reserves before bonus issue FI’s on on payment of dividend during the currency of the loan.
S = Share capital before bonus issue
B = Bonus Quantum
PRT = Average PBT for last 3 years
RPT = .4 (S + B) > (R - B)
YIELD TEST = .3 (PBT) > (.1) (S+B)
Bonus issue also to be given to debenture holders if there is an impending conversion.