about FM

1. FINANCIAL MANAGEMENT
UNIT 1

2. Meaning of Financial Management
Financial Management means planning,
organizing, directing and controlling the
financial activities such as procurement and
utilization of funds of the enterprise. It means
applying general management principles to
financial resources of the enterprise.

3. Scope/Elements
• Investment decisions includes investment in fixed
assets (called as capital budgeting).
• Financial decisions - They relate to the raising of
finance from various resources which will depend
upon decision on type of source, period of
financing, cost of financing and the returns
thereby.
• Dividend decision - The finance manager has to
take decision with regards to the net profit
distribution.

4. Objectives of Financial Management
The objectives can be-
• To ensure regular and adequate supply of funds to the
concern.
• To ensure adequate returns to the shareholders which will
depend upon the earning capacity, market price of the
share, expectations of the shareholders.
• To ensure optimum funds utilization.
• To ensure safety on investment, i.e, funds should be
invested in safe ventures so that adequate rate of return
can be achieved.
• To plan a sound capital structure-There should be sound
and fair composition of capital so that a balance is
maintained between debt and equity capital.

5. Functions of Financial Management
• Estimation of capital requirement
• Determination of capital composition
• Choice of sources of funds
• Investment of funds
• Disposal of surplus
• Management of cash
• Financial controls

6. Key activities of management
accounting
Key activities nclude budgeting, internal financial reporting,
cost analysis and monitoring of internal controls, systems
and procedures.
• Budgeting. ...
• Financial Reporting. ...
• Variance Analysis. ...
• Internal Controls Monitoring.

7. Financial Services
Financial Services are concerned with the design and delivery
of financial instruments, advisory services to individuals and
businesses within the area of banking and related institutions
• Banking Services Includes all the operations provided by
the banks including to the simple deposit and withdrawal of
money to the issue of loans, credit cards etc.
• Foreign Exchange services Includes currency exchange,
foreign exchange banking or the wire transfer.
• Investment Services: It generally includes the asset
management, hedge fund management and the custody
services.
• Insurance Services: It deals with the selling of insurance
policies, brokerages, insurance underwriting or the
reinsurance.

8. Financial Instrument
MEANING:
financial Instruments can be defined as a
market for short-term money and financial
assets that is a substitute for money. The term
short-term means generally a period of one year
substitutes for money is used to denote any
financial asset which can be quickly converted
into money.

9. Financial instruments
• Call /Notice-Money is the money borrowed on demand for
a very short period. When money is lent for a day it is
known as Call Money.
• Term Money deposits with maturity period beyond 14 days
is referred as the term money.
• Treasury Bills are short-term (up to one year) borrowing
instruments of the union government.
• Certificate of Deposits is a money market instrument
issued in dematerialised form or as a Promissory Note for
funds deposited at a bank, other eligible financial
institution for a specified period.
• Commercial Paper is a note in evidence of the debt
obligation of the issuer.

10. Financial market
 Capital market is an organised market which
provides long-term finance for business.
Corporate Securities Market
Government Securities Market
Long-Term Loans Market.
 Money market is the market for short-term
funds.
Unorganized Market.
Organized Money Market

11. Financial System In India
Indian Financial System aids in increasing the
national output of the country by providing funds to
corporate customers to expand their respective
business. It helps economic development and raising
the standard of living of people and promotes the
development of weaker section of the society through
rural development banks and co-operative societies.
These are the important facts about Indian Financial
system.

12. CAPITAL BUDGETIG
UNIT 2

13. Capital Budgeting Techniques
It such as:
• Payback Period.
• Discounted Payback Period.
• Net Present Value.
• Accounting Rate of Return.
• Internal Rate of Return.
• Profitability Index.

14. Principles
• Decisions are based on cash flow not accounting
income
• Timing of cash flow
• Opportunity cost should be considered
• Cash flow should be adjusted for taxes
• Financing Costs Should be Ignored

15. PAY BACK PERIOD
Payback period in capital budgeting refers to
the period of time required to recoup the funds
expended in an investment, or to reach
the break-even point
The payback period is the length of time
required to recover the cost of an investment.

16. Payback Period Formula
Payback Period = Investment Required/Net Annual
Cash Inflow
Payback Period = Number of years prior to full
recovery of investment + Unrecovered cost at start of
year/Cash flow during full recovery year

17. Discounted Cash Flow
discounted cash flow (DCF) analysis is a
method of valuing a project, company, or asset
using the concepts of the time value of money.
All future cash flows are estimated
and discounted by using cost of capital to give
their present values (PVs).

18. Risk and uncertainty
• It was assumed that those investment proposals
did not involve any kind of risk, i.e., whatever the
proposal is undertaken, there would not be any
change in the business risk which are
apprehended by the suppliers of capital.
• decisions are taken on the basis of forecast which
again depends on future events whose
happenings cannot be anticipated/predicted with
absolute certainly due to some factors.

19. NPV and IRR Methods
• It can be a conflict between the two methods
because of implicit assumptions with respect
to reinvestment of cash flows. The NPV
method is based on the assumption that all
cash inflows are reinvested at a rate equal to
the cost of capital (or whatever discount rate
is chosen as the cut-off rate).

20. Rate of Return and Decision Making
The rate of return on investment, defined by
equations (1) and (2) above, goes by the name,
marginal efficiency of capital or internal rate of
return. These two concepts are identical only for
a uniform series of cash flows. However, it is
very difficult to apply these concepts in practice
because the solution for r depends on both the
amounts and the timings of the cash flows, both
of which are estimates.

21. Risk- Adjusted Discount Rate
Approach
The decision maker must specify at the outset the
degree of risk in a particular investment decision. If the
risk exceeds the risk of an ‘average’ investment, a risk
premium has to be added into the ‘average’ discount
rate. This risk-adjusted discount rate is to be used to
calculate net present values. It follows quite logically
that investments with less than the average risk are
discounted at lower rates.

22. Probability Distribution Approach
• The probability distribution approach is slightly
better than the previous two methods. It calculates
an NPV amount for each possible outcome related to
an investment.
• Assume that these periods are possible with the
following probabilities:
(1) two year, p = .2,
(2) three years, p = .5; and four years, p = .3.

23. WORKING CAPITAL
UNIT -3

24. INTRODUCTION
• Working capital is the life blood of the
business funds required for the purchase of
raw materials payement of wages and other
day to day expenses are known as working
capital.
• It is part of the firms capital which is used for
financing shortterm operations.hence it is also
known as circulating capital or shortterm
capital

25. DEFINITION
• “Any acquisition of fund which the current
asset increases working capital for they are
one and the same”.
-Bonne ville

26. CONCEPT OF WORKING CAPITAL
• Working capital means excess of current asset
over current liabilities
• Funds invested in current asset is known as
“GROSS WORKING CAPITAL”.
• The difference between current asset and
current liabilities is known as “NET WORKING
CAPITAL”

27. TYPES OF WORKING CAPITAL
There are 2 components of working
capital namely
*** PERMANENT ( OR) FIXED WC
***TEMPORARY (OR) VARIABLE WC

28. PERMANENT (OR) FIXED WC
• It is a minimum amount of current assets
required for conducting a business operations
• This capital will remain permanent in current
assets and should be financed out of long-
term funds the amount varies from year to
year depending upon the growth of the
company

29. TEMPORARY (OR) VARIABLE WC
• It is a amount of additional current assets
required for a short period
• It is needed to meet the seasonal demands at
different time during the year
• The capital can be temporary and should be
financed out of short term funds
• The wc starts decreasing when the peak
season is over

30. FACTORS INFLUENCING WC
• Nature of business
• Credit policies
• Manufacturing process
• Changes in technology
• Rapidity of turnover
• Business cycle
• Seasonal variations
• Fluctuation of supply
• Dividend policy

31. NATURE OF BUSINESS
• Working capital depends upon the nature of
business.
• service oriented concern like electricity,water
supplies,need limited working capital.
• whereasvthe manufacturing concerns
required sufficient wc.
• since they have to maintain stocks and
debtors

32. CREDIT POLICIES
A company allows credit to its customer shall
need more amount of working capital like wise a
company enjoying credit facilities from its
supplieries will need lower amount of wc.

33. MANUFACTURING PROCESS
• Manufacturing process involves convention of
raw materials intoinfluencing wc requirement
finished product.
• Longer the proces higher the requirement of
wc. Therefore the length of manufacturing
period is one of the factor

34. CHANGES IN TECHNOLOGY
• Changes in technology affect the requirement
of wc
• If the firm adopt labour intensive process it
requires more working capital
• If the firm adopt automation then it improves
the raw material processing reducing the
wastages and make fast production hence the
requirement of wc is less

35. RAPIDITY OF TURNOVER
• High rate of turnover requires low amount of
wc and lower and slow moving stocks needs a
larger wc
• Examples- jewellary shop have to maintain
different types of jewellary which requires
high wc but high moving grossary shop
requires low wc

36. BUSINESS CYCLE
• Change in a economy also influences the wc.
when a business prosperous with requires
huge amount of capital also during depression
huge amount of wc required for unsold stock
and uncollected debtors.

37. SEASONAL VARIATIONS
Industries which are manufacturing and
selling goods seasonally requires large amount
of wc during the season.

38. FLUCTUATION OF SUPPLY
Firms have to maintain large reserves of raw
in stores to avoid unintrupted production
reqired large amount of wc

39. DIVIDEND POLICY
If a conservative dividend policy is followed by
an management the needs for wc can be met
with the retained earnings it consequently
drains of large amount of wc

40. ADVANTAGES OF WC
• Adequate wc make possible to receive cash
discount from the suppliers which reduce the
purchase price
• It creates and maintains the goodwill of the
firm
• It provides facilities to meet the crises during
the depression period
• It enable the credit worthyness of the
business

41. • It ensures regular supply of raw material and continueous
production
• It increases the morale of employees and their efficiency
• It can create favourable market condition by purchasing
material in bulk
• Materials in bulk when prizes are lower hold the stock to
realized better prize
• It generate high rate of return by using effictive utilisation
of fixed assests
• It enables the firms to pay regular dividend

42. LIMITATION OF INADEQUATE AND
EXCESSIVE WC
Every bussiness firm should maintains an
adequate wc.it should be neither excess nor
inadequate however out of the 2 inadequate is
more dangerous

43. DISADVANTAGE OF INADEQUATE WC
• It result in intruption of production which leads
to increase in cost and reduction in profit
• It leads to borrow loans at high rate of interest
• The firm cannot buy the raw materials in bulk
order and cannot take the advantages of cash
discount
• It may failed to pay dividend because of non-
availability of funds
• It leads to liquidation because of low liquidity
position
• It leads to under utilisation of fixed assests ,thus
the rate of return on investments falls

44. DISADVANTAGES OF EXCESSIVE WC
• It results in idle funds which earns no profit
• It makes an imbalance between liquidity and
profitability
• It leads to more production then the demand
• It indicates excessive debtors and incidence of
bad debts
• It may tempt to over trade and lose hevily

45. COST OF CAPITAL & CAPITAL STRUCTURE
IN FINANCIAL MANAGEMENT
UNIT-4

46. DEFINITION
• Cost of capital refers to the opportunity
cost of making a specific investment. It is the
rate of return that could have been earned by
putting the same money into a different
investment with equal risk.
• Thus, the cost of capital is the rate of return
required to persuade the investor to make a
given investment.

47. IMPORTANCE OF COST OF CAPITAL
• The cost of capital is very important concept in the financial
decision making.
• Designing the capital structure: The cost of capital is the significant
factor in designing a balanced and optimal capital structure of a
firm. While designing it, the management has to consider the
objective of maximizing the value of the firm and minimizing cost of
capital.
• Capital budgeting decisions: The cost of capital sources as a very
useful tool in the process of making capital budgeting decisions.
Acceptance or rejection of any investment proposal depends upon
the cost of capital. A proposal shall not be accepted till its rate of
return is greater than the cost of capital.
• Comparative study of sources of financing: There are
various sources of financing a project. Out of these, which source
should be used at a particular point of time is to be decided
by comparing costs of different sources of financing.

48. ASSUMPTION
• It is documented in theoretical studies that cost of capital is based
on some assumptions which are directly related while calculating
and measuring the cost of capital. There are three basic concepts:
• It is not a cost as such. It is merely a hurdle rate.
• It is the minimum rate of return.
• It consists of three important risks such as zero risk level, business
risk and financial risk.
• Cost of capital can be measured with the following equation:
• Where,
K = Cost of capital.
rj = The riskless cost of the particular type of finance.
b = The business risk premium.
f = The financial risk premium.

49. Explicit and Implicit Cost:
 The cost of capital may be explicit or implicit cost on the basis of the computation
of cost of capital. Explicit cost is the rate that the firm pays to procure financing. An
explicit cost is one that has occurred and is evidently reported as a separate cost. It
is defined as direct payment to others in doing business such as wage, rent and
materials.
This may be calculated with the following equation;
Where,
CIo = initial cash inflow
C = outflow in the period concerned
N = duration for which the funds are provided
T = tax rate
Implicit cost is the rate of return linked with the best investment opportunity for
the firm and its shareholders that will be inevitable if the projects presently under
consideration by the firm were accepted. It is the opportunity cost equal to what a
firm must give up in order to use factor of production which it already owns and
thus does not pay rent for.
Both implicit and explicit costs are actual business cost of firms (Barthwal, 2007).

50. COST OF RETAIN EARNINGS
• Equity finance may be obtained in two ways. Firstly by utilizing Retained Earnings
and secondly by issue of additional equity. The cost of equity or the return
required by equity shareholders is the same in both cases. There are no floatation
costs for retained earnings whereas there is a floatation cost of 2 to 10% or
sometimes even more for additional external equity.
• The companies do not generally distribute the entire profits earned by them by
way of dividend among their shareholders. The cost of retained earnings is the
earnings foregone by the shareholders. In other words, the opportunity cost of
retained earnings may be taken as the cost of retained earnings.
Accordingly, there could be two possible approaches to evaluate the cost of
retained earnings. The first of these criteria is based on what shareholders are
able to obtain on other investments, while second approach is expressed as
"external yield criterion".

51.  The cost of retained earnings can be measured as follows:
Where there are no taxes and brokerage fees:
Kr = Ke = D1 + g
P0
Where:
Kr = Cost of retained earnings
Ke = Cost of equity capital
D1 = Expected Dividend at the end of Year 1
P0 = Current price of the stock
g = Growth rate
 Where there are taxes and brokerage fees:
Kr = Ke (1 - T) (1 - B)
Where:
T = Marginal tax rate of shareholder and
B = Brokerage or commission to acquire new shares.
Example:
The cost of equity capital for Company X is 8.67%. The average tax rate of the shareholders is
25% and the brokerage costs amounts to 3%. Calculate the cost of retained earnings.
Kr = 0.0867 (1 - 0.25) (1 - 0.03) -> 0.0631 or 6.31%

52. COST OF PREFERENCE SHARE
• The cost of preference share capital is apparently the dividend
which is committed and paid by the company. This cost is not
relevant for project evaluation because this is not the cost at
which further capital can be obtained. To find out the cost of
acquiring the marginal cost, we will be finding the yield on the
preference share based on the current market value of the
preference share.
• The preference share is issued at a stated rate of dividend on
the face value of the share.

53. BASIC FACTORS INFLUENCING FINANCIAL
DECISIONS:
Factors influencing financial decision for 2 factors namely
1.External factors
2.Internal factors
External Factors:
External factors refer to environmental factors within which a business
enterprise has to operate. These factors are beyond the control and
influence of the management.
The following external factors enter into decision making process:
State of Economy:
• At a time when the entire economy is enveloped into state of uncertainty
and there is no ray of hope of recovery in the ensuing years, and
considerable amount of risk is associated with investment it would be
worthwhile on the part of a finance manager neither to take up new
investment activities nor to carry further the expansion programs.

54. INTERNAL FACTORS:
• Internal factors refer to those factors which are related with internal
conditions of the firm such as nature of business, size of business,
expected return, cost and risk, asset structure of business, structure of
ownership, expectations about regular and steady earnings, age of the
firm, liquidity in company funds and its working capital requirements,
restrictions in debt agreements, control factor and attitude of the
management.
• Nature of Business:
• Nature of business may influence the pattern of investment in a firm,
firm’s make-up of capitalisation and the firm’s dividend policy. In
manufacturing and public utility concerns bulk of the funds have to be
employed in acquiring fixed assets while in trading concerns substantially
large amount of funds is invested in current assets, and fixed assets claim
a nominal proportion.
• As among manufacturing industries, fixed assets requirements in capital
goods industries would always be higher than in consumer goods
industries.

55. FINANCIAL LEVERAGE
Meaning
• Financial leverage simply means the presence of debt in the capital structure of a
firm. In other words, we can also call it the existence of fixed-charge bearing capital
which may include preference shares along with debentures, term loans etc.
• Financial leverage deals with the profit magnification in general. It is also well known
as gearing or ‘trading on equity’. Measures of Financial Leverage
There are various measures of Financial Leverage
• Debt Ratio: It is the ratio of debt to total assets of the firm which means what
percentage of total assets is financed by debt.
• Debt Equity Ratio: It is the ratio of debt to equity which signifies how many dollars
of debt is taken per dollar of equity.
• Interest Coverage Ratio: It is the ratio of profits to interest. This ratio is also
represented in times. It represents how many times of the interest is the available
profit to pay it off. Higher such ratio, higher is the interest paying capacity. The
reciprocal of it is income gearing.

56. OPERATING LEVERAGE
'
• Operating leverage is a measurement of the degree to which a
firm or project incurs a combination of fixed and variable
costs. Operating Leverage = Contribution Margin / Net
Operating Income
• Next Up Variable Cost Ratio
• Operating Cost
• Leverage
• Degree Of Operating Leverage - ...
• BREAKING DOWN 'Operating Leverage'
• Operating leverage may be used for calculating a company’s
breakeven point and substantially affecting profits by
changing its pricing structure..

57. DIVIDAND AND DIVIDAND
POLICY
UNIT -5

58. Dividand
It is part of profits of a company which is distributed
by the company among its shareholders. It is the
reward of the shareholders for investments made by
them in the shares of the company. The investors are
interested in earning the maximum return on their
investments and to maximise their wealth.

59. Dividend policy
A dividend policy is a company's approach to
distributing profits back to its owners or stockholders. If
a company is in a growth mode, it may decide that it
will not pay dividends, but rather re-invest its profits
(retained earnings) in the business.

60. Types of Dividend Policy
• Regular Dividend Policy
Payment of dividend at the usual rate is termed as
regular dividend.
• Stable Dividend Policy
It means consistency or lack of variability in the
stream of dividend payments.
• Stable rupee dividend plus extra dividend
Some companies follow a policy of paying constant
low dividend per share plus an extra dividend in the
years of high profits.

61. Four External Factors Influencing The
Dividend Policy
I. General State of Economy
II. State of Capital Market
III. Legal Rules
IV. Tax Policy.