Unit I: Introduction to Business Finance and Financial Management

Concept Of Finance Finance = Funds or Money (Life Blood of any business Organisation) Finance = Monetary resources comprising debt or ownership funds of either The State, Company or Person Finance = The activity by which claims to resources are either assembled from those released by domestic savings, obtained from abroad, or specially created usually bank deposits or notes and then placed in the hands of investors

Fields of Finance Business Finance Corporate Finance International Finance Public Finance Private Finance

Concept Of Financial Management Financial Management can be defined as the management of flow of funds and it deals with the financial decision making. It encompasses the procurement of funds in the most economic and prudent manner and employment of these funds in the most optimum way to maximize the returns for the owner

Finance Functions/ Decisions (Management of Cash Flows) Long Term Functions Financing Decision Investment Decision Dividend Decision Short Term Functions Liquidity Function (Management of Cash Flows)

Finance Functions or Scope of Financial Management Financing Decision Investment Decision Dividend Decision How large should an enterprise be, or How much funds are required for enterprise? What are various sources for acquiring funds? What should be composition of the Liabilities or sources of funds? Investment in Fixed Assets (Capital Budgeting) Investment in Current Assets (Working Capital Management) Dividend Pay out Retained Earnings

Financing Decision (Capital Structure) 1.What is the mix of various forms of capital used by the firms? 2. What is the optimal mix of the various sources of capital? 3. How do the expectations of suppliers of each source of capital changes with alteration in the capital mix. Value Recedes Value Enhances

Financing Decision (Capital Structure) How large should an enterprise be, or How much funds are required for enterprise? Manufacturing Organisation Trading Organisation What are various sources for acquiring funds? Long term sources Short term sources What should be composition of the Liabilities or sources of funds? Optimal Capital structure Debt Equity Ratio Capital Gearing Ratio

Investment Decision Acquisition of Fixed Assets Land, Building, Machinery, Intangibles Long Term Assets (What & When to Buy) Survival and Growth

Investment Decision Investment in Fixed Assets (Capital Budgeting) Acquisition of old or new asset Risk or Uncertainty factor Evaluation of assets Investment in Current Assets (Working Capital Management) Profitability vs. Liquidity Management of individual current assets

Dividend Decision Dividend Pay out i. Increase in marketability ii. Earning for shareholders iii. Alternative Investment options to shareholders iv. Legal Restrictions Retained Earnings i. Prospective projects ii. Internal Financing iii. Taxation iv. Repayment of Debt

Functional Areas or Responsibilities of Financial Manager Deciding the Financial Needs Raising the Funds Allocation of Funds Allocation of Income Control of Funds Evaluation of Performance Corporate Taxation

Organization of Finance Function Managing Director/ President Board of Directors Managing Director/ President Finance Director/ CFO Financial Controller Internal Auditor Treasurer Manager Accounts Management Accountant Manager Credit Manager Taxation Cash Manager Corporate Finance & Funding Manager Foreign Exchange Manager Salaries Financial Accounts Statutory Accounts Debtor Ledger Creditor Ledger Cost Accounting Management Accounting Budgeting Credit Assessment Setting credit limits Monitoring credit Chasing overdue balances Assessment of Duties/Taxes Payment of Duties/Taxes Claming Refunds Tax Planning Compliance with tax laws Banking Arrangements Cash Transmission Banking Cost Working Capital Control Investing Surplus Funds Export Finance Project Finance Interest rates exposure management Buying/Selling Foreign Currency Currency Exposure Management

Goals / Objectives of Financial Management Profit Maximisation Wealth Maximisation Sales Maximisation Growth Maximisation Maximisation of ROI (Return on Investment)

Profit Maximisation Meaning of Profit Owner Oriented Concept: Amount and share of national income which is paid to the shareholders or the supplier of equity capital i.e., the owners of the business. Operational Concept: Profitability Profitability = Economic Efficiency Problems in Profit Maximisation Ambiguity Timing of Benefits (Time value of Money) Quality of Benefits

(Monitoring &Control) Wealth Maximisation Time value of Money EVA (Economic Value Added) Stakeholders view Government (Tax) Shareholders (Profit/ /Dividend) Lenders (Interest) Regulatory Bodies (Monitoring &Control) Supplier (Sale of RM) Firm Firm Society (Standard of living ) Employees (Salary, Growth) Customers (Price & Quality)

Time Value of Money Compounding Technique Future Value of a single cash flow A = P(1+i)n FV = PV(1+i)n Here P=Principal amount A= Amount to be received after n years i= Rate of interest (i= r/100) n= Number of years PV= Present Value of Principal FV= Future Value of Principal

Time Value of Money Discounting Technique Present Value of a single cash flow P = A / (1+i)n PV = FV / (1+i)n Here P=Principal amount A= Amount to be received after n years i= Rate of interest (i= r/100) n= Number of years PV= Present Value of Principal FV= Future Value of Principal

Compounding Technique Time Value of Money Annuity: An Annuity is a finite series of equal cash flows made at regular intervals. Compounding Technique Future Value of a equal cash flows for a definite period Interest being paid at the end of the year FV = Annuity[ (1 + i )n – 1] / i i= Rate of interest (i= r/100) n= Number of years Annuity= Equal cash flow FV= Future Value of Annuity

Compounding Technique Time Value of Money Compounding Technique Future Value of a equal cash flows for a definite period Interest being paid at the beginning of the year FV = Annuity [{ (1 + i )n – 1} / i] x (1 +i ) i= Rate of interest (i= r/100) n= Number of years Annuity= Equal cash flow FV= Future Value of Annuity

Discounting Technique Time Value of Money Discounting Technique Present Value of a equal cash flows for a definite period Interest being paid at the end of the year PV = Annuity [{ (1 + i )n – 1} / i(1 + i ) n] i= Rate of interest (i= r/100) n= Number of years Annuity= Equal cash flow PV= Present Value of Annuity

Discounting Technique Time Value of Money Discounting Technique Present Value of a equal cash flows for a definite period Interest being paid at the beginning of the year PV = Annuity [{ (1 + i )n – 1} / i(1 + i ) n] x (1 + i ) i = Rate of interest (i= r/100) n= Number of years Annuity= Equal cash flow PV= Present Value of Annuity

Time Value of Money Numerical Examples: Find out the present values of the following: a. Rs. 1500 receivable in 7 years at a discount rate of 15%. b. An annuity of Rs. 760 starting after 1 year for 6 years at an interest rate of 12% c. An annuity of Rs. 1,000 starting immediately and lasting until 9th year at a discounting rate of 20%.

Time Value of Money Numerical Examples: 2. A co. has issued debentures of Rs. 50,00,000 to be repaid after 7 years. How much should the company invest in a sinking fund earning 12% in order to be able to repay debentures? Novelty industries is establishing a sinking fund to redeem Rs. 50,00,000 bond issue which matures in 15 years. How much do they have to put into the fund at the end of each year to accumulate the Rs. 50,00,000 assuming the funds are compounded at 7% annually. Mr. X borrows Rs. 1,00,000 at 8% compounded annually. Equal annual installment are to be made for 6 years. How much is the installment amount?