FINANCIAL MANAGEMENT Mehernosh Randeria.

FINANCIAL MANAGEMENT Mehernosh Randeria

REVISION CLASS April 19, 2015

FINANCIAL MANAGEMENT

What is 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.

Decisions taken by Finance
Investment Decision Financing Decision Dividend Decision

Investment Decision Investment decision relates to the selection of assets in which funds will be invested by a firm. Decision with regard to long term assets is called Capital Budgeting. Decision with regard to short term or current assets is called Working Capital Management.

Capital Budgeting Capital budgeting relates to selection of an asset or investment proposal which would yield benefit in future. It involves three elements: The measurement of the worth of the proposal Evaluation of the investment proposal in terms of risk associated with it Evaluation of the worth of the investment proposal against certain norms or standard. The standard is broadly known as cost of capital

Working Capital Management
Proper management of working capital ensures firm’s liquidity and solvency. The financial manager should develop proper techniques to ensure that neither insufficient nor excess funds are invested in current assets. The management of working capital involves the efficient management of individual current assets such as cash, receivable and inventory.

Financing Decision Financing Decision relates to acquiring the optimum finance to meet financial objectives and seeing that fixed and working capital needs are effectively managed. Financing decision is concerned with the determination of the Source of Financing, viz. the proportion of equity and debt. The mix of debt and equity is known as the Financing Mix or Capital Structure.

Dividend Decision Dividend Decision relates to the determination as to how much and how frequently cash can be paid out of the organization as income for its owners or shareholders. Dividend Decision is concerned with the firm’s policy of distributing profits to the shareholders as dividend vis-à-vis retaining the profits for further growth. The optimum dividend policy is one which maximizes the value of shares and wealth of the shareholders.

Objectives Profit Maximization Wealth Maximization
The 2 Key Goals for Financial Management are Profit Maximization Wealth Maximization

Profit Maximization The firm should undertake those actions that would increase profits and drop those actions that would decrease profit. The financial decisions should be oriented to the maximization of profits. Profit provides the yardstick for measuring performance of firms.

Wealth Maximization Wealth maximization or net present value maximization provides an appropriate and operationally feasible decision criterion for financial management decisions.

Some questions Which objective is more superior – Profit Maximization or Wealth Maximization? Is there a conflict between the two objectives? If yes, which one should be followed? What is the inter-relationship between investment, financing and dividend decisions? How do each of these 3 decisions help to achieve the objectives of profit maximization and wealth maximization? What is the difference between Financial Management and Financial Accounting?

RATIO ANALYSIS

Applications / Uses Principal tool for analysis Inter firm comparison
Intra firm comparison Industry analysis Responsibility accounting

Types of Financial Ratios
A. Liquidity B. Leverage C. Turnover D. Profitability / Valuation

A. Liquidity Ratios Current Ratio: Current assets Current liabilities
Acid test / Quick ratio: Current Assets - Inventories Cash position ratio: Cash in bank + hand Inventory to G.W.C: Inventory Current assets

B. Leverage Ratios Debt / Equity ratio: Long term debt Net worth
Borrowing / Assets: Net worth Total Assets 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 Interest F. Asset coverage ratio: Gross fixed asset - Accumulated Depn LongTerm Secured liabilities

C. Turnover Ratios Total asset turnover: Net sales Total assets
Fixed asset turnover: Net sales Fixed assets Inventory turnover: Cost of Goods Sold Average Inventory Inventory holding period: Average Inventory * 365 Cost of Goods Sold

Debtors turnover: Net Credit sales
Average Debtors Collection period: Average debtor * 365 Net Credit Sales Creditors Turnover: Net Credit purchase Average Creditors Payment period: Average Creditor * 365 Net Credit Purchases

D. Profitability Ratios
Operating profit ratio: PBDIT Sales OR EBITDA Sales ROSE: PAT - Pref. Div Net worth Return on Capital Employed: PBIT Equity + Debt

Book value per share: Net Worth
No. of Equity Shares Earning per share: PAT - Pref Dividend No. of Equity shares Price Earning ratio: Market price Earnings per share Pay out ratio: Dividend paid PAT – Pref Dividend

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 / long term planning. Credit Rating Agencies Tax authorities Users of Ratios

Limitations of Ratios A ratio in absolute terms has no meaning. It has to be compared. Inter firm comparison. Companies resort to window dressing of Balance sheets. Operating and accounting practices differ from company to company. Consolidation of group / subsidiary companies figures. E.G. Changes in Depreciation methods Inventory Valuation Treatment of contingent liabilities. Valuation of investments. Conversion or transaction of foreign exchange items.

CAPITAL BUDGETING

Introduction Capital Budgeting is the process of making investment decision in capital expenditure. It involves the planning and control of capital expenditure. It is the process of deciding whether or not to commit resources to particular long-term projects whose benefits are to be realized over a period of time. According To Charles T Horngreen: “Capital Budgeting is the long term planning for making and financing proposed capital outlays” According To Lynch: “Capital Budgeting consists in planning development of available capital for the purpose of maximizing the long term profitability of the concern” From the above definition, it may be concluded that it is the process by which the companies allocate funds to various investment projects designs to ensure profitability and growth.

Features of Capital Budgeting
Exchange of funds for future benefits. The future benefits are expected to be realized over a period of time. The funds are invested in long-term activities. They have a long term and significant effect on the profitability of the concern, They involve huge funds.

Importance of Capital Budgeting
Large Investment Long Term Commitment of Funds Irreversible in nature Long term effect on profitability National importance

Evaluation Techniques
Traditional Method Pay backs period method or pay out or pay off method Rate of return Method or Accounting Method Time adjusted Method or discounted method Net present value method Internal rate of return method Profitability Index

Payback Techniques It represents the period in which the total investments in permanent asset pay backs itself. This method is based on the principal that every capital expenditures pays itself back within a certain period out of the additional earnings generated from the capital assets. Thus it measures the period of time for the original cost of a project to be recovered from the additional earnings of the project itself. In case of evaluation of a single project, it is adopted if it pays back itself within a period specified by the management. If the project does not pay back itself within the period specified by the management than it is rejected.

Steps in Payback Calculate annual net earning (profit) before depreciation and after taxes; these are called the annual cash flows. Where the annual cash inflows are equal, Divide the initial outlay (cost) of the project by annual cash flows, where the project generates constant annual cash inflows. Payback period = Cash outlay of the project or original cost of the asset Annual cash Inflows Where the annual cash inflows are unequal, the pay back period can be found by adding up the cash inflows until the total is equal to the initial cash outlay of project or original cost of the asset.

Illustration A project costs Rs
Illustration A project costs Rs. 1, 00,000 and yields annual cash inflow of Rs. 20,000 for 8 years. Calculate its pay back period. Payback period = Cash outlay of the project or original cost of the asset Annual cash Inflows = 1,00,000 / 20,000 = 5 years

Advantages of Pay Back Period
It is simple to understand and easy to calculate. It saves in cost; it requires lesser time and labor as compared to other methods of capital budgeting. This method is particularly suited to firm, which has shortage of cash or whose liquidity position is not particularly good.

Disadvantages of Pay Back Period
It does not take into account the cash inflows earned after the pay back period and hence the true profitability of the project cannot be correctly assessed. It ignores the time value of money and does not consider the magnitude and timing of cash inflows. it treats all cash flows as equal though they occur in different time periods. It does not take into consideration the cost of capital, which is very important; factor in making sound investment decision. It treats each asset individually in isolation with other asset, which is not feasible in real practice. It does not measure the true profitability of the project, as the period considered under this method is limited to a short period only and not the full life of the asset.

Rate of Return This method take into account the earnings expected from the investment over their whole life. It is known as Accounting Rate of Return method for the reasons that under this method, the accounting concept of profit is used rather than cash inflows. According to this method, various projects are ranked in order of the rate of earnings or rate of return. The project with the higher rate of return is selected as compared to the one with the lower rate of return. This method can be used to make decisions as to accepting or rejecting a proposal. The expected return is determined and the project with a higher rate of return than the minimum rate specified by the firm called cut-off rate, is accepted and the one which gives a lower expected rate of return than the minimum rate is rejected.

Accounting Rate of Return
Average Accounting Rate Return Method = Total Profits (after dep. & tax) / No. of years x 100 Net investment in the project Return per Unit of Investment Method = Total Profits (after dep. & tax) x 100

Accounting Rate of Return
A project requires an investment of Rs.5, 00,000 and has a scrap value of Rs.20,000 After 5 years. It is expected to yield profits after depreciation and taxes during the 5 years amounting to Rs. 40,000. Rs. 60,000, Rs. 70,000, Rs. 50,000 and Rs.20,000. Calculate the accounting rate of return on the investment.

Advantages of Rate of Return Method
It is very simple to understand and easy to operate. This method is based upon the accounting concept of profits; it can be readily calculated from the financial data. It uses the entire earnings of the projects in calculating rate of return. Disadvantages of Rate of Return Method It does not take into consideration the cash flows, which are more important than the accounting profits. It ignores the time value of money as the profits earned at different points of time are given the equal weighs.

Net Present Value Method
This method is the modern method of evaluating the investment proposals. This method takes into consideration the time value of money and attempts to calculate the return in investments by introducing the factor of time element. It recognizes the fact that a rupee earned today is more valuable earned tomorrow. The net present value of all inflows and outflows of cash occurring during the entire life of the project is determined separately for each year by discounting these flows by the firm’s cost of capital.

Net Present Value Method - Steps
Determine appropriate rate of interest that should be selected as the minimum required rate of return called discount rate. Compute the present value of total investment outlay. Compute the present value of total investment proceeds. Calculate the net present value of each project by subtracting the present value of cash inflows from the present value of cash outflows for each project. If the net present value is positive or zero, the proposal may be accepted otherwise rejected.

Advantages of Net Present Value
It recognizes the time value of money and is suitable to be applied in situations with uniform cash outflows and cash flows at different period of time. It takes into account the earnings over the entire life of the projects and the true profitability of the investment proposal can be evaluated. It takes into consideration the on\objective of maximum profitability. Disadvantages of Net Present Value This method is more difficult to understand and operate. It is not easy to determine an appropriate discount rate. It may not give good results while comparing projects with unequal lives and investment of funds.

Internal Rate of Return
It is a modern technique of capital budgeting that takes into account the time value of money. It is also known as “time adjusted rate of return discounted cash flows” “yield method” “trial and error yield method” The cash flows of the project are discounted at a suitable rate by hit and trial method, which equates the net present value so calculated to the amount of the investment. Under this method, since the discount rate is determined internally, this method is called as the internal rate of return method. It can be defined as the rate of discount at which the present value of cash inflows is equal to the present value of cash outflows.

Internal Rate of Return - Steps
Determine the future net cash flows during the entire economic life of the project. The cash inflows are estimated for future profits before depreciation and after taxes. Determine the rate of discount at which the value of cash inflows is equal to the present value of cash outflows. Accept the proposal if the internal rate of return is higher than or equal to the minimum required rate of return. In case of alternative proposals select the proposals with the highest rate of return as long as the rates are higher than the cost of capital.

Advantages of Internal Rate of Return Method
It takes into account the time value of money and can be usefully applied in situations with even as well as uneven cash flows at different periods of time. It considers the profitability of the project for its entire economic life. It provides for uniform ranking of various proposals due to the % rate of return. Disadvantages of Internal Rate of Return Method It is difficult to understand. This method is based upon the assumption that the earnings are reinvested at the internal rate of return for the remaining life of the project, which is not a justified assumption particularly when the rate of return earned by the firm is not close to the internal rate of return. The result of NPV and IRR method may differ when the project under evaluation differ their size.

Profitability Index This is also known as Benefit Cost Ratio.
This is similar to NPV method. The major drawback of NPV method that not does not give satisfactory results while evaluating the projects requiring different initial investments. PI = Present value of cash Inflows Present value of cash outflows If PI > 1, project will be accepted If PI<1 then project is rejected If PI= 1 then decision is based on non-financial consideration.

Advantages of PI method
It considers Time value of money It considers all cash flow during life time of project. More reliable than NPV method when evaluating the projects requiring different initial investments. Disadvantages of PI method This method is difficult to understand. Calculations under this method arte complex

A Ltd. is considering the purchase of a machine
A Ltd. is considering the purchase of a machine. Machines X and Y are alternative models. The following information is furnished : Depreciation will be charged on straight line basis. Tax rate 30%. Evaluate the alternatives according to – a. Accounting rate of return on original investment b. Profitability index assuming cost of capital being 10%. Present value of Re. 10% p.a. for 5 years is 3.79 and for 6 years is Machine X Rs. Machine Y Cost of machine 75,000 2,40,000 Estimated life of machine 5 years 6 years Estimated cost of maintenance p.a. 3,500 5,500 Estimated cost of indirect material p.a. 3,000 4,000 Estimated cost of supervision p.a. 6,000 8,000 Estimated savings in scrap p.a. 5,000 7,500 Estimated savings in wages p.a. 45,000 60,000

One of the two machines A and B is to be purchased
One of the two machines A and B is to be purchased. Form the following information find out which of the two will be more profitable? The average rate of tax may be taken at 50%. Cost of capital is 10%. Use NPV Method and PI Method. Machine A (Rs.) Machine B (Rs.) Cost of machine Machine Life 4 years 6 years Earnings Before Tax 1st year nd year rd year th year th year th year 13000

COST OF CAPITAL

Cost of Capital The cost of capital of a firm is the minimum rate of return expected by its investors. It is the weighted average cost of various sources of finance used by the firm. The capital used by the firm may be in the form of debt, preference capital, retained earnings and equity shares. The concept of cost of capital is very important in the financial management. Cost of capital for a firm may be defined as the cost of obtaining funds i.e., the average rate of return that the investors in a firm would expect for supplying funds to the firm. According to Solomin Ezra: “Cost of capital is the minimum required rate of earning or the cutoff rate of capital expenditure.” According to Jhon J: “The rate of return the firm requires from investment in order to increase the value of the firm in then market place.”

Significance of Cost of Capital
As Acceptance Criteria in Capital Budgeting As a Determinant of Capital Mix in Capital Structure Decisions As a Basis for Evaluating the Financial Performance As the Basis for taking other Financial decisions

Computation of Cost of Capital
Computation of cost of Specific source of finance 1. Cost of Debt 2. Cost of Preference Capital 3. Cost of Equity Capital 4. Cost of Retained earnings 5. Weighted average cost of capital

Cost of Debt The cost of debt to the firm is the effective yield to maturity (or interest rate) paid to its bondholders Since interest is tax deductible to the firm, the actual cost of debt is less than the yield to maturity: After-tax cost of debt = yield x (1 - tax rate) The cost of debt should also be adjusted for flotation costs (associated with issuing new bonds)

Example: Tax effects of financing with debt
with stock with debt EBIT , ,000 - interest expense (50,000) EBT , ,000 - taxes (34%) (136,000) (119,000) EAT , ,000 Now, suppose the firm pays 50,000 in dividends to the shareholders

Example: Tax effects of financing with debt
with stock with debt EBIT , ,000 - interest expense (50,000) EBT , ,000 - taxes (34%) (136,000) (119,000) EAT , ,000 - dividends (50,000) Retained earnings , ,000

Cost of Debt = - OR 33,000 = 50,000 ( 1 - .34) of Debt of Debt Savings
After-tax cost Before-tax cost Tax of Debt of Debt Savings 33, = , ,000 OR 33, = ,000 ( ) Or, if we want to look at percentage costs: = -

1 Cost of Debt .066 = .10 (1 - .34) - = % cost of % cost of x tax
After-tax Before-tax Marginal % cost of % cost of x tax Debt Debt rate Kd = kd (1 - T) = ( ) 1 - =

Illustration X Ltd. issues Rs. 50,000 8% debenture. The tax rate applicable is 50%. Compute the cost of debt capital, if debentures are issued at par at Premium of 10% at discount of 10%

Irredeemable Debt Kd = Interest amount* (1-t) * 100 NP Kd = Cost of debt T = Tax rate NP = Net proceeds = Face value + premium – discount – flotation cost Alternatively If rate of interest is given and the debentures are issued at par (i.e. at face value), then: Kd = Interest rate * (1-t)

Redeemable Debt Kd = Interest + FV – NP N * (1-t) * 100 FV + NP 2 Kp = Cost of debt FV = Face Value NP = Net proceeds = Face value + premium – discount – flotation cost N = Number of years after which redeemable T = Tax rate

Cost of Preference Shares
Preference Share Capital: has a fixed dividend (similar to debt) has no maturity date dividends are not tax deductible and are expected to be perpetual or infinite

Irredeemable Preference Shares
Kp = Preference dividend * 100 Net proceeds Kp = Cost of preference share capital Net proceeds = Face value + premium – discount – flotation cost Alternatively If rate of dividend is given and the shares are issued at par (i.e. at face value), the rate of dividend = cost of preference share capital.

Redeemable Preference Shares
Kp = Pref. Div. + FV – NP N * 100 FV + NP 2 Kp = Cost of preference share capital FV = Face Value NP = Net proceeds = Face value + premium – discount – flotation cost N = Number of years after which redeemable

Cost of Preferred stock: Example

Cost of Equity The cost of the equity is the “maximum rate of return that the company must earn on equity financed portion of its investments in order to leave unchanged the market price of its stock.” The cost of equity capital is a function of the expected return by its investors. 3 Methods: Total Yield Method Dividend Growth Method Earnings per Share Method

Total Yield Method Ke = D1 + (P1-P0) * 100 P0 Ke = Cost of equity D1 = Dividend after 1 year P0 = Current price P1 = Price after 1 year

Dividend Growth Method
Ke = D1 * G ---- P0 Ke = Cost of equity D1 = Dividend after 1 year P0 = Current price G = Growth rate of dividend

Earnings per share Method
Ke = EPS1 * P0 Ke = Cost of equity EPS1 = PAT – Pref. Div No. of equity shares P0 = Current price

Illustration The shares of a company are selling at Rs. 40 per share and it had paid a dividend of Rs. 4 per share last year. The investor’s market expects a growth rate of 5% per year. a) Compute the company’s equity cost of capital; b) If the anticipated growth rate is 7% per annum, calculate the indicated market price per share.

Cost of Retained Earnings
The cost of retained earnings may be considered as the rate of return which the existing shareholders can obtain by investing the after tax dividends in alternatives opportunity of equal qualities. It is thus the opportunity cost of dividends foregone by the shareholders.

Cost of Retained Earnings
Kr = ( D + G ) (1 – t) (1 – b) NP Where, Kr = Ke (1-t) (1-b) D = Expected Dividends G = Growth Rate NP = Net Proceeds of equity issue t = Tax rate b = Dividend payout rate Ke = Rate of return available to shareholders.

Weighted Average Cost of Capital
Weighted average cost of capital is the average cost of various sources of financing. It is also known as Composite Cost of Capital, Overall Cost of capital, average cost of capital. Once the cost of specific source of capital is determined, weighted average cost of capital can be computed by putting weights to the specific costs of capital in proportion of the various sources of funds to the total. The CIMA defines the weighted average cost of capital “ as the average cost of company’s finance (equity, debentures, bank loans) weighted according to the proportion each elements bears to the total pool of capital, weighting is usually based on market valuation current yields and costs after tax.”

Weighted Average Cost of Capital (WACC)
WACC weighs the cost of equity and the cost of debt by the percentage of each used in a firm’s capital structure WACC=(E/ V) x KE + (D/ V) x KD (E/V)= Equity % of total value (D/V)=Debt % of total value Weights can be given in the following way: Historical or existing weights Book value weights Market value weights Marginal weights

Cost of capital * Weights
WACC Format Particulars Amount Weights Cost of capital Cost of capital * Weights Total WACC xxxxxx

Market value as weights
Following are the details regarding the capital structure of a company : You are required to determine the weighted average cost of capital, using – Book value as weights Market value as weights Types of capital Book value Market value After tax cost Debentures 40,000 38,000 5% Preference capital 10,000 11,000 8% Equity capital 60,000 1,20,000 13% Retained earnings 20,000 - 9% Total 1,30,000 1,69,000

Hook Ltd. is financed solely by debt and equity
Hook Ltd. is financed solely by debt and equity. The company’s pre-tax cost of debt (Kd) is 11%. The company currently pays a dividend of Rs. 2 per share. The dividend is expected to grow at a constant rate of 7%. The share is selling for Rs on the stock market. Tax rate 30%. The company has estimated its WACC to be 13.95%. What is the proportion of debt in the company’s capital structure?

The capital structure of ABC Ltd
The capital structure of ABC Ltd. as on March 31, 2011 is given below : Equity share capital (Par value Rs.10) Rs. 50,00,000 Preference share capital (Par value Rs.100) Rs. 5,00,000 Debentures (secured) (Par value Rs.1,000) Rs. 10,00,000 Bonds (unsecured) (Par value Rs.10,000) Rs. 25,00,000 Term loans (secured) Rs. 10,00,000 Total Rs.100,00,000 The current market price of the company’s equity share is Rs.36. Equity shareholders expect to get a dividend of Rs.9 next year. The holders of preference shares get a fixed dividend of Rs.15 every year. Debentureholders get 12%, whereas bondholders get it at the rate of 14%. The company pays interest Rs.1,10,000 per year on term loans. The company is liable to pay tax at the rate of 30% on its pre-tax profit. Calculate the company’s WACC.

WORKING CAPITAL

Working Capital According to Shubin: “Working Capital is the amount of funds necessary to cover the cost of operating the enterprises.” According to Genestenberg: “Working Capital means current assets of a company that are changed in the ordinary course of business from one form to another as for example Cash to inventories, inventories to receivables and receivables to cash”.

Classification of Working Capital
(A) On the basis of concept (i) Gross working capital concept: According to this concept, working capital means total of all current assets of business. Gross working capital = Total current assets. (ii) Net working capital concept: According to this concept, working capital means excess of current assets over current liabilities. Net Working capital = Current Assets – current Liabilities As per the general practice net working capital is referred to simply as working capital. (B) On the basis of time (i) Fixed or permanent working capital: There is always a minimum level of current assets which is continuously required by the enterprise to carry out normal business operation. For example: Every firm has to maintain a minimum level of stock and cash balance. This minimum level of current assets is called fixed working capital as this amount is permanently blocked in currant assets (ii) Temporary or variable working capital: It is that amount of working capital which is required to meet the seasonal demand and some special needs. Any amount over and above the permanent level of working capital is called as Temporary or variable working capital.

Operating Cycle Every business needs some amount of working capital. The need for working capital arises due to the time gap between the production and realization of cash from sales. Thus working capital is needed for the following purposes: 1. For the purchase of raw material, components and spares parts. 2. To pay wages and salaries 3. To incur day-to-day expenses. 4. To meet the selling costs s packing, advertising. 5. To provide the credit facilities to the customers. 6. To maintain the inventories of Raw material, work in progress, finished stock

Components of Operating Cycle
There is an operating cycle involved in the sales and realization of cash. The cycle starts with the purchase of raw material and ends with the realization of cash from sales of finished foods. It involves purchase of raw material and stores, it conversion in to stock of finished goods through work-in- progress, conversion of finished stock in to sales, debtors and receivables and ultimately in cash and this cycle continues again from cash to purchase of raw material and so on. The gross operating cycle of the firm = RMCP +WIPCP + FGCP+RCP Where, RMCP = Raw material conversion period WIPCP = Work in progress conversion period FGCP = Finished goods conversion period RCP = Receivables conversion period However a firm may acquire some resources of credit and thus defer payments fro certain period. Net operating cycle period = Gross operating cycle period - Payable deferral period.

Cash Raw Material Work In Progress Finished Goods Receivables

Factors determining Working Capital
Nature or Character of Business Size of Business Production Policy Seasonal Variations Rate of Stock Turnover Credit Policy Business Cycle Rate of Growth of Business

Estimation of Working Capital Requirements
Factors requiring consideration while estimating working capital Total costs incurred on material, wages and overheads. The length of the time for which materials are to remain in stores before they are issued for production. The length of the production cycle or work in progress. The length of the sales cycle during which finished goods are to be kept waiting for sales. The average period of credit allowed to customers. The amount of cash required to pay day to day expenses of the business. The average amount of cash required to make the payments. The average credit period expected to be allowed by suppliers. Time lag in the payment of wages and other expenses.

From the following data, prepare a statement showing working capital requirements for the year a. Estimated activity / operations for the year 1,30,000 units (52 weeks). b. Stock of raw materials 2 weeks, and material in process for 2 weeks, 50% of wages and overheads are incurred. c. Finished goods 2 weeks’ storage. d. Creditors 2 weeks. e. Debtors 4 weeks. f. Outstanding wages and overheads 2 weeks each. g. Selling price per unit Rs.15. h. Analysis of cost per unit is as follows : i. Raw materials 33 1/3% of sales. ii. Labour and overheads in the ratio of 6 : 4 per unit. iii. Profit is at Rs.5 per unit. Assume that operations are evenly spread throughout the year.

Estimate the working capital requirements of a business firm on the basis of the following information : Raw materials cost Rs.75 per unit Labour Rs per unit Overheads Rs.15,00,000 p.a. Output and sales 10,000 units per month Selling price Rs.150 per unit Stock to be carried : Raw materials – 2 weeks’ production Finished goods – 3 weeks’ supply The debtors on an average take 2 ¼ month’s credit. Raw materials is received in uniform deliveries daily and suppliers have to be paid at the end of the month the goods are received. Other trade creditors allow an average of 1 ½ month’s credit. Estimate the working capital for the month of March. Assume that a month is a four weeks’ period.

FUNDFLOW STATEMENT

Fund Fund means Working Capital. Current Assets Working Capital
Current Liabilities

Fund Flow Statement Fund flow statement is –
a statement shows the changes in funds between two balance sheet of two different dates.

Format: Fund Flow Statement (As on…………..)
Sources of Funds Amount Application of Funds Issue of share capital ……. Redemption of pref. share …….. Issue of debenture Redemption of debenture Raising of long term loan Payment of long term loan Sales of fixed assets Purchase of fixed assets Interest received Interest paid Dividend received Dividend paid .……. Refund of Taxes Payment of Taxes Decrease in working capital Increase in working capital Fund from operation Fund lost in operation TOTAL

Importance of Fund Flow Statement
Identification & Analysis of changes in working capital Evaluation of firm’s financing Knowing the overall creditworthiness of a firm An instrument for allocation of resources

Preparation of Fund Flow Statement
Statement of Changes in Working Capital Increase in Working Capital Decrease in working Capital Adjusted Profit & Loss A/c Funds from Operation (Profit) Funds lost in operation (Loss) Fund Flow Statement Sources of Funds Application of Funds

Balance sheets of ABC Ltd. on 31-3-2014 and 31-3-2015 are as follows :
Additional information : New machinery of Rs.3,00,000 was purchased but an old machinery costing Rs.1,45,000 was sold for Rs.50,000 and accumulated depreciation thereon was Rs.75,000. 10% debentures were redeemed at 20% premium. Investments (long term) were sold for Rs.45,000 and its profit was transferred to General Reserve. Income tax paid during was Rs.80,000. An interim dividend of Rs.1,20,000 was paid during Prepare funds flow statement based on the above information. Liabilities Rs. Assets Share capital 20,00,000 Land & building 15,00,000 14,00,000 General Reserve 4,00,000 4,50,000 Plant and machinery 18,00,000 17,50,000 Profit and Loss A/c 2,50,000 3,60,000 Investments (long term) 3,72,000 10% debentures 10,00,000 8,00,000 Stock 4,80,000 8,50,000 Bank loan (Long term) 5,00,000 6,00,000 Debtors 7,98,000 Creditors 5,80,000 Prepaid expenses 50,000 40,000 Outstanding expenses 20,000 25,000 Cash and bank 1,40,000 85,000 Proposed dividends 3,00,000 Provision for taxation 1,00,000 1,20,000 49,70,000 52,95,000

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