Description
financial management, what is the function the scope and function of finance. It also explains the financial system, Financial Markets , participants, financial institutions.
•An Introduction
“Money is an arm or a leg. You either use it or lose it.”…………….
Henry Ford
“Arthah Sachivah”…..”Finance reigns supreme
Business need money to make more money
Session Plan
Week No. 1 2 3 4 Topics Introduction of Financial Management, Function and scope. FM with other functional areas. Financial System: Financial Markets , participants, financial institutions Investment companies and institutions, Regulatory authorities. Time value of money QUIZ
5 6 7 8
Present value of single cash flow, multiple flow and annuity Financial statement analysis: Ratio Analysis Time series analysis, Du Point, Fund flow and cash flow analysis Sources of long term finance Mid Term
9
10
11
12
Cost of capital and capital structure: Cost of debentures, term loan, equity capital Factors affecting capital structure, capital structure theories Dividend policy: Waltor position, Gordon position
Estimation of working capital: composition of working capital Quiz Factors for
13 Management of working capital: Inventory management, Receivable management, Cash management 14 Capital budgeting process and investment criteria 15 Capital expenditure decisions: Appraisal criteria 16 Benefit cost ratio, Internal rate of return, ARR, IRR, NPV
• Accounting is the language of business. • Finance uses accounting information together with other information to make decisions that affect the market value of the firm. • There are three primary decision areas that are of concern.
Financial Management According to Van Horne and Wachowicz: FM is concerned with the Acquisition, financing, and management of assets with some overall Goals in mind. Scope of FM: 1. How large the firm should be and how fast should it grow 2. What should be the composition of firm?s assets 3. What should be the mix of firm?s financing 4. How should the firm analyze, plan and control its financial affairs
? 1. 2. 3.
The Traditional Phase: Arrangement of funds from FIs Arrangement of funds through financial instruments like shares, bonds Looking after the legal and accounting relationship between corporation and its sources
Limitations: 1. External Approach 2. Ignored routine problems 3. Ignored working capital financing 4. No emphasis on allocation of funds
Modern Approach: Covers both, acquisition of funds as well as their allocation
Four major decisions: 1. Investment decision 2. Financing decision 3. Dividend policy decision 4. Funds requirement
FM may be classified Liquidity: Forecasting cash flows Raising Funds Profitability Cost control Pricing Management: Mgt of long term funds Mgt of short term funds
Management of Long tern Funds •Capital Structure •Cost of Capital •Sources of funds •Dividend policy
Management of Long term assets •Capital budgeting •Operational leverage •Risk analysis
Financial Management
Working Capital Management
Management of Short term funds •Principle of working capital Mgt •Working capital policy •Mgt of short term liabilities
Mgt of short term assets Receivables management Cash Mgt
Financial Management Process Financial Control Financial Analysis
Financial Planning
Financial Decision Making
1. FA: Preliminary, diagnostic stage and will include a review to determine Current financial performance and conditions of the business; an identification Of any particular financial problem, risks, constraint and limitation. 2. FDM: Based on findings of the review stage, financial decisions and choices are made. This includes strategic investment decisions (investing in new production facilities) and strategic financing decisions (Decision to raise additional long term loan.)
3. Financial planning: To ensure that right amount of funds
are available at the right time and at the right cost. Budgeting will be the key financial Planning tool 4. Financial Control: This is to ensure that plans are properly implemented, progress is continually reported to the mgt., and any deviations from the plan should be clearly identified
Finance Functions
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Investment Decision
Financing Decision Dividend or Profit Allocation Decision Liquidity Decision
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• Investment decisions - What assets should the company hold? This determines the left-hand side of the balance sheet. • Financing decisions - How should the company pay for the investments it makes? This determines the right-hand side of the balance sheet.
Decision areas in finance:
•Dividend decisions - What should be done with the profits of the business? •Liquidity or Current asset Mgt: Investment in CA reduces the profitability of the firm, so while investing funds in CA, he must see that proper balance (trade off) is maintained between profitability and Liquidity
Finance Manager Maximization of share value Financial Decisions
Investment decision
Dividend decision
Financing decision
Funds requirement decision
Return Trade off
Risk
Board of Directors
President
VP: Sales
VP: Finance
VP: Operations
Treasurer
Controller
Credit Manager
Cost Accounting
Inventory Manager
Financial Accounting
Capital Budgeting Director
Tax Department
Treasurer To Look after cash and Bank Account Investments Tax and Insurance Credit and Collection Investor Relations
Finance Controller Accounting Budgeting Internal Audit Finance Planning Profit planning Investment decisions Economic Appraisal
•What should be the goal of the firm?
Objective of FM
Basic Objective 1. Maintenance of liquid assets 2. Profit maximization 3. Wealth Maximization Other Objectives
1. 2. 3. 4.
Ensuring fair return to shareholders Building up reserves for growth and expansion Ensuring max. operational efficiency Ensuring financial discipline in the mgt.
• Would this mean short-term profit, or longterm profit? Businesses are sometimes criticized for being overly concerned about short-term profits results rather than the long-term strategic positioning of the company.
• How would the stockholders of a small business react if they were told that their manager canceled all casualty and liability insurance policies so that the money spent on premiums could go to profit instead. • Even though the expected profits increased by this action, it is likely that stockholders would be dissatisfied because of the increased risk they would bear.
• Stockholders elect a board of directors who in turn hire managers to maximize the stockholders’ well being. • When stockholders perceive that management is not doing this, they might attempt to remove and replace the management, but this can be very difficult in a large corporation with many stockholders.
•This action by stockholders will cause the market price of the company’s stock to fall.
•Management is failing in their job to increase the welfare (or wealth) of the stockholders (the owners).
•Management is accomplishing their goal of increasing the welfare (or wealth) of the stockholders (the owners).
• This is equivalent to saying the goal is to maximize owners’ wealth. • Note that the stock price is affected by management’s decisions affecting both risk and profit. • Stock price can be maintained or increased only when stockholders perceive that they are receiving profits that fully compensate them for bearing the risk they perceive.
• Accounting and Finance often focus on different things • Finance is more focused on market values rather than book values. • Finance is more focused on cash flows rather than accounting income.
• Book values are often based on dated values. They consist of the original cost of the asset from some past time, minus accumulated depreciation (which may not represent the actual decline in the assets’ value). • Maximization of market value of the stockholders’ shares is the goal of the firm.
• Cash flow to stockholders (in the form of dividends) is the only basis for valuation of the common stock shares. Since the goal is to maximize stock price, cash flow is more directly related than accounting income. • Accounting methods recognize income at times other than when cash is actually received or spent.
• When cash is actually received is important, because it determines when cash can be invested to earn a return. [Also: When cash must be paid determines when we need to start paying interest on money borrowed.]
• Credit sales are recognized as accounting income, yet cash has not been received. • Depreciation expense is a legitimate accounting expense when calculating income, yet depreciation expense is not a cash outlay. • A loan brings cash into a business, but is not income.
• When new capital equipment is purchased, the entire cost is a cash outflow, but only the depreciation expense (a portion of the total cost) is an expense when computing accounting income. • When dividends are paid, cash is paid out, though dividends are not included in the calculation of accounting income.
• Operating income = earnings before interest and taxes (EBIT). This is the total income that the company earned by operating during the period. It is income available to pay interest to creditors, taxes to the government, and dividends to stockholders.
• Operating cash flow = EBIT + Depreciation - Taxes. This definition recognizes that depreciation expense is subtracted in computing EBIT, though it is not a cash outlay. • It also recognizes that taxes paid is a cash outlay.
Financial System
1. The economic development of any country depends upon
the existence of a well organized financial system.
2. It is the financial system which supplies the necessary financial inputs for the production of goods and services which in turn promotes the well being and standard of living of the people of a country.
Thus, the „financial system? is a broader term which brings under its fold the financial markets and the financial institutions which support the system. The major assets traded in the financial system are money and monetary assets.
Structure of Financial System
A set of complex and closely connected or interlinked institutions, agents, practices, markets, transactions, claims, and liabilities in the economy.
Functions of Financial System:
1. It provides a payment for the exchange of goods and services 2. It enables the pooling of funds for understanding large scale enterprises 3. It provides a mechanism for managing uncertainty and controlling risk. 4. It generates information for managing uncertainty and controlling risk.
Financial System Financial Institutions 1. Regulatory 2. Intermediaries 3. Non intermediaries Financial Markets Organized market Financial Instruments Unorganized Market Financial Services
Capital market
Money Market
Financial Institutions Financial institutions are classified as intermediaries and non Intermediaries. 1. Intermediaries lend money as well as mobilizes savings (banking institutions) 2. Non Intermediaries institutions do the loan business but their resources are not directly obtained from the savers like IDBI, IFC and NABARD 3. Many non banking intermediaries also act as an intermediaries like UTI, LIC etc.
1. The responsibility of the financial system is to mobilize
the savings in the form of money and monetary assets and invest them to productive ventures. 2. An efficient functioning of the financial system facilitates the free flow of funds to more productive activities and thus promotes investment. 3. Thus, the financial system provides the intermediation between savers and investors and promotes faster economic development.
Functions of Financial System 1 Promotion of Liquidity The major function of the financial system is the provision of money and monetary assets for the production of goods and services. There should not be any shortage of money for productive ventures. Hence, all activities in a financial system are related to liquidity – either provision of liquidity or trading in liquidity. 2 Mobilization of Savings Another important activity of the financial system is to mobilize savings and channelise them into productive activities. The financial system should offer appropriate incentives to attract savings and make them available for more productive ventures. Thus, the financial system facilitates the transformation of savings into investment and consumption. The financial intermediaries have to play a dominant role in this activity.
Functions of Financial System
Liquidity Function
Risk Function
Saving Function
Payment Function
Financial market is a mechanism that allows people to easily buy and sell (trade) financial securities (such as stocks and bonds), commodities (such as precious metals or agricultural goods), at low transaction costs and at prices that reflect the efficient-market hypothesis.
Financial Market can be defined as the market in which financial assets are created or transferred.
Types of Financial Markets
Money Market Treasury Bills Commercial Bill Commercial paper Certificate of Deposits Repos MMMFs Government Securities Capital Market
Primary
Secondary
FINANCIAL INTERMEDIATION Adequate information of the issue, issuer and the security should be passed on. Therefore their should be a proper channel within the financial system to ensure such transfer. To serve this purpose, Financial intermediaries came into existence. Some of the important intermediaries operating in the financial markets include; investment bankers, underwriters, stock exchanges, registrars, depositories, custodians, portfolio managers, mutual funds, financial advertisers financial consultants, primary dealers, satellite dealers, self regulatory organizations, etc
Intermediary Stock Exchange Investment Bankers
Market Capital Market Capital Market, Credit Market
Role Secondary Market to securities Corporate advisory services, Issue of securities
Underwriters Registrars, Depositories, Custodians Primary Dealers Satellite Dealers Forex Dealers
Capital Market, Money Market
Subscribe to unsubscribed portion of securities
Issue securities to the investors on behalf of the company and handle share transfer activity Market making in government securities Ensure exchange ink currencies
Capital Market
Money Market Forex Market
Money Market
Market for Short term securities, such as banker's acceptances, commercial paper, repos, negotiable certificates of deposit, and Treasury Bills with a maturity of one year or less and often 30 days or less. Money market securities are generally very safe investments which return a relatively low interest rate that is most appropriate for temporary cash storage or short-term time horizons.
Some of the important money market instruments are briefly discussed 1. Call/Notice Money 2. Treasury Bills 3. Term Money 4. Certificate of Deposit 5. Commercial Papers
1. Call /Notice-Money Market 1. Call/Notice money is the money borrowed or lent on demand for a very short period. When money is borrowed or lent for a day, it is known as Call (Overnight) Money. 2. Intervening holidays and/or Sunday are excluded for this purpose. 3. Thus money, borrowed on a day and repaid on the next working day, (irrespective of the number of intervening holidays) is "Call Money". 4. When money is borrowed or lent for more than a day and up to 14 days, it is "Notice Money". 5. No collateral security is required to cover these transactions.
6. Call Money Market: Call money loans are of very short term in nature and the maturity period of these loans vary from 1 to 15 days.
7. Purpose: Banks borrow in call market to:
a. Fill the temporary gaps, or mismatches that arise, as the banks normally lend out the deposits they mobilize b. Meet the CRR requirements which they should maintain with RBI c. Meet sudden demand for funds, which may arise due to large payments and remittances
1. T- Bills: This short term instruments issued by the government of India. 2. Treasury bills are available for a minimum amount of Rs.25,000 and in multiples of Rs. 25,000. 3. Treasury bills are issued at a discount and are redeemed at par. 4. Treasury bills are also issued under the Market Stabilization Scheme (MSS). 5. 91-day, 182-day and 364-day. There are no treasury bills issued by State Governments.
Treasury Bills (T-Bills)
• T-Bills is a way for governments to raise money from the public • T-Bills are short term securities that mature in 1 year or less from their issue date. They are usually issued with 3 months, 6 months and 9 months maturities
• They are sold to the public by the government of a country at a discount to face value.
• On maturity, the investor is paid the face value; so that he earns interest by way of a difference in purchase price and face value • T-Bills are usually considered the safest investment in the world because of government backing
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CP is a short-term unsecured loan issued by a corporation typically for financing day-to-day operations Corporate borrowers wishing to avoid the laborious task of applying for a bank loan resort to this avenue of financing CP is a very safe investment because the financial situation of a company can easily be predicted over a few months Only companies with high credit ratings issue CPs
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Commercial paper are short term, unsecured promissory notes issued at a discount to face value by well known companies that are financially strong and carry a high credit rating. Features: 1. They are negotiable by endorsement and delivery 2. They are issued in multiplies of Rs 5 lakhs 3. The Maturity varies between 1 month to a year. 4. They are purely unsecured as they are backed by the credit of the issuing company. 5. They normally have a bay back facility 6. No prior approval of RBI is needed for CP issues and underwriting of the issue is not mandatory.
• A CD is a time deposit with a bank
• Like most time deposits, funds cannot be withdrawn before maturity without paying a penalty
• CDs have specific maturity dates, interest rates and can be issued in any denomination • The main advantage of CDs is their safety • You will earn more than a savings account and you won?t be at the mercy of the stock market • But the disadvantage is that the returns are paltry compared to many other instruments
Certificate of Deposits: Its defined as short term deposits having short maturity of not less than 3 months and not more than one year. 1. All scheduled banks, are eligible to issue CDs 2. CDs can be issued to individuals, corporations, companies, trust, funds and associations. 3. They are issued at discount rate freely determined by the issuing bank and the market 4. They are issued in multiples of 5 lakhs 5. Banks can issue CDs ranging from 3 months to 1 year 6. CDs are freely transferable by endorsement on delivery but only after 30 days
Repurchase Agreements (Repos)
• Repo is a form of overnight borrowing and is used by those who deal in government securities • A holder of government securities usually sells the securities to a lender and agrees to buy them back (repurchase) at an agreed future date at an agreed price • They are usually very short term repurchase agreements, from overnight to 30 days or more • The short term maturity and government backing usually mean that repos provide lenders with extremely low risk. Repos are safe collateral for loans
Repurchase Agreements (Repos)
Whenever the banks have any shortage of funds they can borrow it from RBI. Repo rate is the rate at which our banks borrow rupees from RBI. A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases borrowing from RBI becomes more expensive.
Reverse Repos
1. Reverse Repo rate is the rate at which Reserve Bank of India (RBI) borrows money from banks. 2. Banks are always happy to lend money to RBI since their money are in safe hands with a good interest.
3. An increase in Reverse repo rate can cause the banks to transfer more funds to RBI due to this attractive interest rates.
Money Market Mutual Funds: These are MFs that invest primarily in Money market instruments of very high quality and of very short Maturity. 1. Set up by commercial banks, RBI and public financial institutions. 2. MMMF would be supervised and regulated by the RBI
Money Market Instruments thus provide the level of safety that even ambitious investors look out for, during stock market volatilities
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Money Market specializes in debt securities that mature in less than one year These securities are very liquid and very safe. As a result, they offer lower level of return than other securities The easiest route for individuals to this market is through money market mutual funds
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Capital Market: 1. Provide resources needed by medium and large scale industries for investment purposes
2. Deals with long term resources of funds whose maturity period is more than 1 year.
3. It functions as an institutional mechanism to channel long term funds those who save to those who need them for productive purposes. Primary Market Secondary Market
A. Primary Market or New issue market
1. Creates long term instruments through which corporate entities borrow from the capital market. 2. The depth of Secondary Market depends upon the activities of the Primary market b?cos it is only when more corporate entities enter into the market and raise funds through the market that more instruments are available in the secondary market for the purpose of improved activities. 3. Capital issue of the co?s were controlled by the capital issue control act, 1947 4. This has been substituted by the securities exchange board of India under SEBI act,1992
Functions and Power of SEBI 1. Promote fair dealings by the issues of securities and ensure a market place where funds can be raised at a relatively low cost.
2. Provide a degree of protection to the investors and safeguard their Rights and interests so that there is a steady flow of savings into the Market. 3. Regulate and develop a code of conduct and fair practices by Intermediaries in the capital market with a view to make them more Competitive and professional.
Types of issues
Public Issue
Right Issue Bonus Issue
Private Placement
1. Public Issue is the most popular method of raising capital and involves raising of funds direct from public
2. Right Issue: It is the method of raising additional finance from existing members by offering securities to them on pro rata basis
3. Bonus Issue: Some co?s distribute profits to existing shareholders by way of fully paid bonus shares in lieu of dividend. They are issued in ratio of existing shares held. The shareholders do not have to make any additional payment for the issue
4 Private placements: Direct sale by a public or private limited Company of its securities to a limited no. of sophisticated investors Like UTI, LIC, GIC In private placement no prospectus is issued Advantage of speed, low cost, confidentiality and accommodates Smaller debt financing It is possible to raise funds through private placements within 2 or 3 Months
5. Brought out deals: A co. initially places its equity shares, which are to be offered to the public at a later date, to a sponsor/merchant banker, who in turn offloads the share at the appropriate time.
The sale of securities directly to an institutional investor, such as a bank, mutual fund, insurance company, pension fund, or foundation. Does not require SEC registration, provided the securities are bought for investment purposes rather than resale, as specified in the investment letter
Government Securities Market
1. These securities are usually referred to as “gilt edged” securities as repayment 2. Depending upon the issuing body, such securities could be bifurcate a. Central gov. securities b. State gov. securities c. Treasury bills issued by RBI
Government securities could be held in three forme: 1. Stock certificates 2. Promissory notes 3. Bearer bonds
Stock Certificate:
When public debt is issued in the form of stock, the owner gets a certificate specifying that he is a registered holder in the books of Public debt office (PDO). It indicates the interest rate, interest due dates and face value of the stock. Interest payments are through interest warrants issued by PDO to the domicile of the holder or a specified local office of the RBI
Promissory Notes:
It contain promise by the president of India, or the governor of the state for payment to the holder in consideration along with interest.
These are negotiable instruments payable o the order of specified persons and transferable by endorsement
Bearer Bonds:
1. It certify the bearer for entitlement to the specified sum along with interest payable by interest warrants attached along with the bonds.
2. Such bonds are transferable by mere physical delivery
Secondary Market
Securities Market in India Thus the four important elements of securities markets are: • Investors • Issuers • Intermediaries • Regulators
History of Indian Stock Market • From Scattered and small beginning in the 19th Century, India?s stock market has risen to great heights. • By 1990, we had 19 stock exchanges in the country. • There were around 6,000 listed companies and the investors population stood around 15 Million.
Role & Functions of Stock Exchange A stock exchange, securities exchange or (in Europe) bourse is a corporation or mutual organization which provides "trading" facilities for stock brokers and traders, to trade stocks and other securities. Stock exchanges also provide facilities for the issue and redemption of securities as well as other financial instruments and capital events including the payment of income and dividends .
The initial offering of stocks and bonds to investors is by definition done in the primary market and subsequent trading is done in the secondary market. A stock exchange is often the most important component of a stock market.
Functions of Stock Exchange
1. 2. 3. 4. 5. 6.
Raising capital for business Mobilizing saving for investment Facilitating company growth Redistribution of wealth Corporate Governance Creating investment opportunities for small investor 7. Government capital raising for development project 8. Barometer for economy
Bombay Stock Exchange
Bombay Stock Exchange is the oldest stock exchange in Asia with a rich heritage, now spanning three centuries in its 133 years of existence. What is now popularly known as BSE was established as "The Native Share & Stock Brokers' Association" in 1875.
Over the past 133 years, BSE has facilitated the growth of the Indian corporate sector by providing it with an efficient access to resources. There is perhaps no major corporate in India which has not sourced BSE's services in raising resources from the capital market.
National Stock Exchange
1. The National Stock Exchange of India was promoted by leading Financial institutions at the behest of the Government of India, and was incorporated in November 1992 as a taxpaying company. 2. In April 1993, it was recognized as a stock exchange under the , 1956. 3. NSE commenced operations in the Wholesale segment in June 1994. 4. The (Equities) segment of the NSE commenced operations in November 1994, while operations in the Derivatives segment commenced in June 2000.
Objectives of NSE
1. Provide a nationwide trading facility for equities, debt instruments 2. Ensure equal access to investors all over the country through an appropriate communication network 3. Attain current international standards of securities market. 4. Provide fair, efficient and transparent standards of security market
Financial Institutions
1. 2. 3. 4. 5. 6. 7.
Industrial Development Bank of India (IDBI) Industrial Finance Cooperation of India (IFC) Industrial credit and Investment Corporation of India (ICICI) Industrial Investment Bank of India (IIBI) The Export Import Bank of India (EXIM Bank) State financial Corporations (SFC) State Industrial Development Corporations (SIDC)
IDBI
1. Established in 1964 2. Subsidiary of RBI 3. Wholly owned GOI undertaking Functions:
1. It serve as an apex financial institution to Co ordinate the functioning of all other financial institutions. 2. Planning, promoting and developing industries 3. Providing technical and administrative assistance 4. Undertaking market and investment research 5. Provide finance keeping in view the nations priori 6. Support SFC by providing refinance
IFCI
1. 1st Financial institution to be established in India 2. 1948 by the act of parliament 3. To provide medium and long term finance to industrial concern eligible for financing in the act
ICICI
1. 2. 3. 4. 5.
Established in 1955 Financing industries in Private sector Incorporated under Co?s Act Flexible approach in financing Ventured into leasing and performance guarantees
IIBI
1. Finance the reconstruction and rehabilitation of sick and closed industrial units. 2. Industrial reconstruction bank of India 3. In 1997 converted in full fledged development financial institution and incorporated under co?s act 1956 4. It provide finance for the establishment of new industrial projects as well as expansion, diversification and modernization of existing enterprises. 5. Active in merchant bankers
1. 1982 for trade finance 2. Help Indian exporters in extending credit to their overseas customers by providing long term finance 3. Provide advisory services and information to exporters
EXIM Bank
SFC’s
1. Separate institute for financing small and medium sector industries and 2. Develop industrial estates 3. Provide finance in form of term loan
SIDC
State Industrial Development Corporations 1. To facilitate rapid industrial growth in the respective states 2. Identify and sponsor project
Investment Institutions
1. 2. 3. 4.
Life Insurance Corporation Of India (LIC) General Insurance Corporation of India (GIC) Unit Trust of India (UTI) Mutual Funds
Reserve Bank Of India
Scheduled Banks
State Co op Banks
Non Scheduled banks
Commercial Banks Foreign Private sector Banks
Indian Public Sector Banks
SBI and subsidies
Other nationalized banks
The commercial banking structure in India consists of: 1. Scheduled Commercial Banks in India 2. Unscheduled Banks in India Scheduled Banks in India constitute those banks which have been included in the Second Schedule of Reserve Bank of India(RBI) Act, 1934. RBI in turn includes only those banks in this schedule which satisfy the criteria laid down vide section 42 (6) (a) of the Act. "Non-scheduled bank in India" means a banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949), which is not a scheduled bank".
The banks included in this schedule list should fulfill two conditions.
1. The paid capital and collected funds of bank should not be less than Rs. 5 lac. 2. Any activity of the bank will not adversely affect the interests of depositors.
Every Scheduled bank enjoys the following facilities. 1. Such bank becomes eligible for debts/loans on bank rate from the RBI 2. Such bank automatically acquire the membership of clearing house.
doc_276758379.pptx
financial management, what is the function the scope and function of finance. It also explains the financial system, Financial Markets , participants, financial institutions.
•An Introduction
“Money is an arm or a leg. You either use it or lose it.”…………….
Henry Ford
“Arthah Sachivah”…..”Finance reigns supreme
Business need money to make more money
Session Plan
Week No. 1 2 3 4 Topics Introduction of Financial Management, Function and scope. FM with other functional areas. Financial System: Financial Markets , participants, financial institutions Investment companies and institutions, Regulatory authorities. Time value of money QUIZ
5 6 7 8
Present value of single cash flow, multiple flow and annuity Financial statement analysis: Ratio Analysis Time series analysis, Du Point, Fund flow and cash flow analysis Sources of long term finance Mid Term
9
10
11
12
Cost of capital and capital structure: Cost of debentures, term loan, equity capital Factors affecting capital structure, capital structure theories Dividend policy: Waltor position, Gordon position
Estimation of working capital: composition of working capital Quiz Factors for
13 Management of working capital: Inventory management, Receivable management, Cash management 14 Capital budgeting process and investment criteria 15 Capital expenditure decisions: Appraisal criteria 16 Benefit cost ratio, Internal rate of return, ARR, IRR, NPV
• Accounting is the language of business. • Finance uses accounting information together with other information to make decisions that affect the market value of the firm. • There are three primary decision areas that are of concern.
Financial Management According to Van Horne and Wachowicz: FM is concerned with the Acquisition, financing, and management of assets with some overall Goals in mind. Scope of FM: 1. How large the firm should be and how fast should it grow 2. What should be the composition of firm?s assets 3. What should be the mix of firm?s financing 4. How should the firm analyze, plan and control its financial affairs
? 1. 2. 3.
The Traditional Phase: Arrangement of funds from FIs Arrangement of funds through financial instruments like shares, bonds Looking after the legal and accounting relationship between corporation and its sources
Limitations: 1. External Approach 2. Ignored routine problems 3. Ignored working capital financing 4. No emphasis on allocation of funds
Modern Approach: Covers both, acquisition of funds as well as their allocation
Four major decisions: 1. Investment decision 2. Financing decision 3. Dividend policy decision 4. Funds requirement
FM may be classified Liquidity: Forecasting cash flows Raising Funds Profitability Cost control Pricing Management: Mgt of long term funds Mgt of short term funds
Management of Long tern Funds •Capital Structure •Cost of Capital •Sources of funds •Dividend policy
Management of Long term assets •Capital budgeting •Operational leverage •Risk analysis
Financial Management
Working Capital Management
Management of Short term funds •Principle of working capital Mgt •Working capital policy •Mgt of short term liabilities
Mgt of short term assets Receivables management Cash Mgt
Financial Management Process Financial Control Financial Analysis
Financial Planning
Financial Decision Making
1. FA: Preliminary, diagnostic stage and will include a review to determine Current financial performance and conditions of the business; an identification Of any particular financial problem, risks, constraint and limitation. 2. FDM: Based on findings of the review stage, financial decisions and choices are made. This includes strategic investment decisions (investing in new production facilities) and strategic financing decisions (Decision to raise additional long term loan.)
3. Financial planning: To ensure that right amount of funds
are available at the right time and at the right cost. Budgeting will be the key financial Planning tool 4. Financial Control: This is to ensure that plans are properly implemented, progress is continually reported to the mgt., and any deviations from the plan should be clearly identified
Finance Functions
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Investment Decision
Financing Decision Dividend or Profit Allocation Decision Liquidity Decision
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• Investment decisions - What assets should the company hold? This determines the left-hand side of the balance sheet. • Financing decisions - How should the company pay for the investments it makes? This determines the right-hand side of the balance sheet.
Decision areas in finance:
•Dividend decisions - What should be done with the profits of the business? •Liquidity or Current asset Mgt: Investment in CA reduces the profitability of the firm, so while investing funds in CA, he must see that proper balance (trade off) is maintained between profitability and Liquidity
Finance Manager Maximization of share value Financial Decisions
Investment decision
Dividend decision
Financing decision
Funds requirement decision
Return Trade off
Risk
Board of Directors
President
VP: Sales
VP: Finance
VP: Operations
Treasurer
Controller
Credit Manager
Cost Accounting
Inventory Manager
Financial Accounting
Capital Budgeting Director
Tax Department
Treasurer To Look after cash and Bank Account Investments Tax and Insurance Credit and Collection Investor Relations
Finance Controller Accounting Budgeting Internal Audit Finance Planning Profit planning Investment decisions Economic Appraisal
•What should be the goal of the firm?
Objective of FM
Basic Objective 1. Maintenance of liquid assets 2. Profit maximization 3. Wealth Maximization Other Objectives
1. 2. 3. 4.
Ensuring fair return to shareholders Building up reserves for growth and expansion Ensuring max. operational efficiency Ensuring financial discipline in the mgt.
• Would this mean short-term profit, or longterm profit? Businesses are sometimes criticized for being overly concerned about short-term profits results rather than the long-term strategic positioning of the company.
• How would the stockholders of a small business react if they were told that their manager canceled all casualty and liability insurance policies so that the money spent on premiums could go to profit instead. • Even though the expected profits increased by this action, it is likely that stockholders would be dissatisfied because of the increased risk they would bear.
• Stockholders elect a board of directors who in turn hire managers to maximize the stockholders’ well being. • When stockholders perceive that management is not doing this, they might attempt to remove and replace the management, but this can be very difficult in a large corporation with many stockholders.
•This action by stockholders will cause the market price of the company’s stock to fall.
•Management is failing in their job to increase the welfare (or wealth) of the stockholders (the owners).
•Management is accomplishing their goal of increasing the welfare (or wealth) of the stockholders (the owners).
• This is equivalent to saying the goal is to maximize owners’ wealth. • Note that the stock price is affected by management’s decisions affecting both risk and profit. • Stock price can be maintained or increased only when stockholders perceive that they are receiving profits that fully compensate them for bearing the risk they perceive.
• Accounting and Finance often focus on different things • Finance is more focused on market values rather than book values. • Finance is more focused on cash flows rather than accounting income.
• Book values are often based on dated values. They consist of the original cost of the asset from some past time, minus accumulated depreciation (which may not represent the actual decline in the assets’ value). • Maximization of market value of the stockholders’ shares is the goal of the firm.
• Cash flow to stockholders (in the form of dividends) is the only basis for valuation of the common stock shares. Since the goal is to maximize stock price, cash flow is more directly related than accounting income. • Accounting methods recognize income at times other than when cash is actually received or spent.
• When cash is actually received is important, because it determines when cash can be invested to earn a return. [Also: When cash must be paid determines when we need to start paying interest on money borrowed.]
• Credit sales are recognized as accounting income, yet cash has not been received. • Depreciation expense is a legitimate accounting expense when calculating income, yet depreciation expense is not a cash outlay. • A loan brings cash into a business, but is not income.
• When new capital equipment is purchased, the entire cost is a cash outflow, but only the depreciation expense (a portion of the total cost) is an expense when computing accounting income. • When dividends are paid, cash is paid out, though dividends are not included in the calculation of accounting income.
• Operating income = earnings before interest and taxes (EBIT). This is the total income that the company earned by operating during the period. It is income available to pay interest to creditors, taxes to the government, and dividends to stockholders.
• Operating cash flow = EBIT + Depreciation - Taxes. This definition recognizes that depreciation expense is subtracted in computing EBIT, though it is not a cash outlay. • It also recognizes that taxes paid is a cash outlay.
Financial System
1. The economic development of any country depends upon
the existence of a well organized financial system.
2. It is the financial system which supplies the necessary financial inputs for the production of goods and services which in turn promotes the well being and standard of living of the people of a country.
Thus, the „financial system? is a broader term which brings under its fold the financial markets and the financial institutions which support the system. The major assets traded in the financial system are money and monetary assets.
Structure of Financial System
A set of complex and closely connected or interlinked institutions, agents, practices, markets, transactions, claims, and liabilities in the economy.
Functions of Financial System:
1. It provides a payment for the exchange of goods and services 2. It enables the pooling of funds for understanding large scale enterprises 3. It provides a mechanism for managing uncertainty and controlling risk. 4. It generates information for managing uncertainty and controlling risk.
Financial System Financial Institutions 1. Regulatory 2. Intermediaries 3. Non intermediaries Financial Markets Organized market Financial Instruments Unorganized Market Financial Services
Capital market
Money Market
Financial Institutions Financial institutions are classified as intermediaries and non Intermediaries. 1. Intermediaries lend money as well as mobilizes savings (banking institutions) 2. Non Intermediaries institutions do the loan business but their resources are not directly obtained from the savers like IDBI, IFC and NABARD 3. Many non banking intermediaries also act as an intermediaries like UTI, LIC etc.
1. The responsibility of the financial system is to mobilize
the savings in the form of money and monetary assets and invest them to productive ventures. 2. An efficient functioning of the financial system facilitates the free flow of funds to more productive activities and thus promotes investment. 3. Thus, the financial system provides the intermediation between savers and investors and promotes faster economic development.
Functions of Financial System 1 Promotion of Liquidity The major function of the financial system is the provision of money and monetary assets for the production of goods and services. There should not be any shortage of money for productive ventures. Hence, all activities in a financial system are related to liquidity – either provision of liquidity or trading in liquidity. 2 Mobilization of Savings Another important activity of the financial system is to mobilize savings and channelise them into productive activities. The financial system should offer appropriate incentives to attract savings and make them available for more productive ventures. Thus, the financial system facilitates the transformation of savings into investment and consumption. The financial intermediaries have to play a dominant role in this activity.
Functions of Financial System
Liquidity Function
Risk Function
Saving Function
Payment Function
Financial market is a mechanism that allows people to easily buy and sell (trade) financial securities (such as stocks and bonds), commodities (such as precious metals or agricultural goods), at low transaction costs and at prices that reflect the efficient-market hypothesis.
Financial Market can be defined as the market in which financial assets are created or transferred.
Types of Financial Markets
Money Market Treasury Bills Commercial Bill Commercial paper Certificate of Deposits Repos MMMFs Government Securities Capital Market
Primary
Secondary
FINANCIAL INTERMEDIATION Adequate information of the issue, issuer and the security should be passed on. Therefore their should be a proper channel within the financial system to ensure such transfer. To serve this purpose, Financial intermediaries came into existence. Some of the important intermediaries operating in the financial markets include; investment bankers, underwriters, stock exchanges, registrars, depositories, custodians, portfolio managers, mutual funds, financial advertisers financial consultants, primary dealers, satellite dealers, self regulatory organizations, etc
Intermediary Stock Exchange Investment Bankers
Market Capital Market Capital Market, Credit Market
Role Secondary Market to securities Corporate advisory services, Issue of securities
Underwriters Registrars, Depositories, Custodians Primary Dealers Satellite Dealers Forex Dealers
Capital Market, Money Market
Subscribe to unsubscribed portion of securities
Issue securities to the investors on behalf of the company and handle share transfer activity Market making in government securities Ensure exchange ink currencies
Capital Market
Money Market Forex Market
Money Market
Market for Short term securities, such as banker's acceptances, commercial paper, repos, negotiable certificates of deposit, and Treasury Bills with a maturity of one year or less and often 30 days or less. Money market securities are generally very safe investments which return a relatively low interest rate that is most appropriate for temporary cash storage or short-term time horizons.
Some of the important money market instruments are briefly discussed 1. Call/Notice Money 2. Treasury Bills 3. Term Money 4. Certificate of Deposit 5. Commercial Papers
1. Call /Notice-Money Market 1. Call/Notice money is the money borrowed or lent on demand for a very short period. When money is borrowed or lent for a day, it is known as Call (Overnight) Money. 2. Intervening holidays and/or Sunday are excluded for this purpose. 3. Thus money, borrowed on a day and repaid on the next working day, (irrespective of the number of intervening holidays) is "Call Money". 4. When money is borrowed or lent for more than a day and up to 14 days, it is "Notice Money". 5. No collateral security is required to cover these transactions.
6. Call Money Market: Call money loans are of very short term in nature and the maturity period of these loans vary from 1 to 15 days.
7. Purpose: Banks borrow in call market to:
a. Fill the temporary gaps, or mismatches that arise, as the banks normally lend out the deposits they mobilize b. Meet the CRR requirements which they should maintain with RBI c. Meet sudden demand for funds, which may arise due to large payments and remittances
1. T- Bills: This short term instruments issued by the government of India. 2. Treasury bills are available for a minimum amount of Rs.25,000 and in multiples of Rs. 25,000. 3. Treasury bills are issued at a discount and are redeemed at par. 4. Treasury bills are also issued under the Market Stabilization Scheme (MSS). 5. 91-day, 182-day and 364-day. There are no treasury bills issued by State Governments.
Treasury Bills (T-Bills)
• T-Bills is a way for governments to raise money from the public • T-Bills are short term securities that mature in 1 year or less from their issue date. They are usually issued with 3 months, 6 months and 9 months maturities
• They are sold to the public by the government of a country at a discount to face value.
• On maturity, the investor is paid the face value; so that he earns interest by way of a difference in purchase price and face value • T-Bills are usually considered the safest investment in the world because of government backing
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CP is a short-term unsecured loan issued by a corporation typically for financing day-to-day operations Corporate borrowers wishing to avoid the laborious task of applying for a bank loan resort to this avenue of financing CP is a very safe investment because the financial situation of a company can easily be predicted over a few months Only companies with high credit ratings issue CPs
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Commercial paper are short term, unsecured promissory notes issued at a discount to face value by well known companies that are financially strong and carry a high credit rating. Features: 1. They are negotiable by endorsement and delivery 2. They are issued in multiplies of Rs 5 lakhs 3. The Maturity varies between 1 month to a year. 4. They are purely unsecured as they are backed by the credit of the issuing company. 5. They normally have a bay back facility 6. No prior approval of RBI is needed for CP issues and underwriting of the issue is not mandatory.
• A CD is a time deposit with a bank
• Like most time deposits, funds cannot be withdrawn before maturity without paying a penalty
• CDs have specific maturity dates, interest rates and can be issued in any denomination • The main advantage of CDs is their safety • You will earn more than a savings account and you won?t be at the mercy of the stock market • But the disadvantage is that the returns are paltry compared to many other instruments
Certificate of Deposits: Its defined as short term deposits having short maturity of not less than 3 months and not more than one year. 1. All scheduled banks, are eligible to issue CDs 2. CDs can be issued to individuals, corporations, companies, trust, funds and associations. 3. They are issued at discount rate freely determined by the issuing bank and the market 4. They are issued in multiples of 5 lakhs 5. Banks can issue CDs ranging from 3 months to 1 year 6. CDs are freely transferable by endorsement on delivery but only after 30 days
Repurchase Agreements (Repos)
• Repo is a form of overnight borrowing and is used by those who deal in government securities • A holder of government securities usually sells the securities to a lender and agrees to buy them back (repurchase) at an agreed future date at an agreed price • They are usually very short term repurchase agreements, from overnight to 30 days or more • The short term maturity and government backing usually mean that repos provide lenders with extremely low risk. Repos are safe collateral for loans
Repurchase Agreements (Repos)
Whenever the banks have any shortage of funds they can borrow it from RBI. Repo rate is the rate at which our banks borrow rupees from RBI. A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases borrowing from RBI becomes more expensive.
Reverse Repos
1. Reverse Repo rate is the rate at which Reserve Bank of India (RBI) borrows money from banks. 2. Banks are always happy to lend money to RBI since their money are in safe hands with a good interest.
3. An increase in Reverse repo rate can cause the banks to transfer more funds to RBI due to this attractive interest rates.
Money Market Mutual Funds: These are MFs that invest primarily in Money market instruments of very high quality and of very short Maturity. 1. Set up by commercial banks, RBI and public financial institutions. 2. MMMF would be supervised and regulated by the RBI
Money Market Instruments thus provide the level of safety that even ambitious investors look out for, during stock market volatilities
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Money Market specializes in debt securities that mature in less than one year These securities are very liquid and very safe. As a result, they offer lower level of return than other securities The easiest route for individuals to this market is through money market mutual funds
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Capital Market: 1. Provide resources needed by medium and large scale industries for investment purposes
2. Deals with long term resources of funds whose maturity period is more than 1 year.
3. It functions as an institutional mechanism to channel long term funds those who save to those who need them for productive purposes. Primary Market Secondary Market
A. Primary Market or New issue market
1. Creates long term instruments through which corporate entities borrow from the capital market. 2. The depth of Secondary Market depends upon the activities of the Primary market b?cos it is only when more corporate entities enter into the market and raise funds through the market that more instruments are available in the secondary market for the purpose of improved activities. 3. Capital issue of the co?s were controlled by the capital issue control act, 1947 4. This has been substituted by the securities exchange board of India under SEBI act,1992
Functions and Power of SEBI 1. Promote fair dealings by the issues of securities and ensure a market place where funds can be raised at a relatively low cost.
2. Provide a degree of protection to the investors and safeguard their Rights and interests so that there is a steady flow of savings into the Market. 3. Regulate and develop a code of conduct and fair practices by Intermediaries in the capital market with a view to make them more Competitive and professional.
Types of issues
Public Issue
Right Issue Bonus Issue
Private Placement
1. Public Issue is the most popular method of raising capital and involves raising of funds direct from public
2. Right Issue: It is the method of raising additional finance from existing members by offering securities to them on pro rata basis
3. Bonus Issue: Some co?s distribute profits to existing shareholders by way of fully paid bonus shares in lieu of dividend. They are issued in ratio of existing shares held. The shareholders do not have to make any additional payment for the issue
4 Private placements: Direct sale by a public or private limited Company of its securities to a limited no. of sophisticated investors Like UTI, LIC, GIC In private placement no prospectus is issued Advantage of speed, low cost, confidentiality and accommodates Smaller debt financing It is possible to raise funds through private placements within 2 or 3 Months
5. Brought out deals: A co. initially places its equity shares, which are to be offered to the public at a later date, to a sponsor/merchant banker, who in turn offloads the share at the appropriate time.
The sale of securities directly to an institutional investor, such as a bank, mutual fund, insurance company, pension fund, or foundation. Does not require SEC registration, provided the securities are bought for investment purposes rather than resale, as specified in the investment letter
Government Securities Market
1. These securities are usually referred to as “gilt edged” securities as repayment 2. Depending upon the issuing body, such securities could be bifurcate a. Central gov. securities b. State gov. securities c. Treasury bills issued by RBI
Government securities could be held in three forme: 1. Stock certificates 2. Promissory notes 3. Bearer bonds
Stock Certificate:
When public debt is issued in the form of stock, the owner gets a certificate specifying that he is a registered holder in the books of Public debt office (PDO). It indicates the interest rate, interest due dates and face value of the stock. Interest payments are through interest warrants issued by PDO to the domicile of the holder or a specified local office of the RBI
Promissory Notes:
It contain promise by the president of India, or the governor of the state for payment to the holder in consideration along with interest.
These are negotiable instruments payable o the order of specified persons and transferable by endorsement
Bearer Bonds:
1. It certify the bearer for entitlement to the specified sum along with interest payable by interest warrants attached along with the bonds.
2. Such bonds are transferable by mere physical delivery
Secondary Market
Securities Market in India Thus the four important elements of securities markets are: • Investors • Issuers • Intermediaries • Regulators
History of Indian Stock Market • From Scattered and small beginning in the 19th Century, India?s stock market has risen to great heights. • By 1990, we had 19 stock exchanges in the country. • There were around 6,000 listed companies and the investors population stood around 15 Million.
Role & Functions of Stock Exchange A stock exchange, securities exchange or (in Europe) bourse is a corporation or mutual organization which provides "trading" facilities for stock brokers and traders, to trade stocks and other securities. Stock exchanges also provide facilities for the issue and redemption of securities as well as other financial instruments and capital events including the payment of income and dividends .
The initial offering of stocks and bonds to investors is by definition done in the primary market and subsequent trading is done in the secondary market. A stock exchange is often the most important component of a stock market.
Functions of Stock Exchange
1. 2. 3. 4. 5. 6.
Raising capital for business Mobilizing saving for investment Facilitating company growth Redistribution of wealth Corporate Governance Creating investment opportunities for small investor 7. Government capital raising for development project 8. Barometer for economy
Bombay Stock Exchange
Bombay Stock Exchange is the oldest stock exchange in Asia with a rich heritage, now spanning three centuries in its 133 years of existence. What is now popularly known as BSE was established as "The Native Share & Stock Brokers' Association" in 1875.
Over the past 133 years, BSE has facilitated the growth of the Indian corporate sector by providing it with an efficient access to resources. There is perhaps no major corporate in India which has not sourced BSE's services in raising resources from the capital market.
National Stock Exchange
1. The National Stock Exchange of India was promoted by leading Financial institutions at the behest of the Government of India, and was incorporated in November 1992 as a taxpaying company. 2. In April 1993, it was recognized as a stock exchange under the , 1956. 3. NSE commenced operations in the Wholesale segment in June 1994. 4. The (Equities) segment of the NSE commenced operations in November 1994, while operations in the Derivatives segment commenced in June 2000.
Objectives of NSE
1. Provide a nationwide trading facility for equities, debt instruments 2. Ensure equal access to investors all over the country through an appropriate communication network 3. Attain current international standards of securities market. 4. Provide fair, efficient and transparent standards of security market
Financial Institutions
1. 2. 3. 4. 5. 6. 7.
Industrial Development Bank of India (IDBI) Industrial Finance Cooperation of India (IFC) Industrial credit and Investment Corporation of India (ICICI) Industrial Investment Bank of India (IIBI) The Export Import Bank of India (EXIM Bank) State financial Corporations (SFC) State Industrial Development Corporations (SIDC)
IDBI
1. Established in 1964 2. Subsidiary of RBI 3. Wholly owned GOI undertaking Functions:
1. It serve as an apex financial institution to Co ordinate the functioning of all other financial institutions. 2. Planning, promoting and developing industries 3. Providing technical and administrative assistance 4. Undertaking market and investment research 5. Provide finance keeping in view the nations priori 6. Support SFC by providing refinance
IFCI
1. 1st Financial institution to be established in India 2. 1948 by the act of parliament 3. To provide medium and long term finance to industrial concern eligible for financing in the act
ICICI
1. 2. 3. 4. 5.
Established in 1955 Financing industries in Private sector Incorporated under Co?s Act Flexible approach in financing Ventured into leasing and performance guarantees
IIBI
1. Finance the reconstruction and rehabilitation of sick and closed industrial units. 2. Industrial reconstruction bank of India 3. In 1997 converted in full fledged development financial institution and incorporated under co?s act 1956 4. It provide finance for the establishment of new industrial projects as well as expansion, diversification and modernization of existing enterprises. 5. Active in merchant bankers
1. 1982 for trade finance 2. Help Indian exporters in extending credit to their overseas customers by providing long term finance 3. Provide advisory services and information to exporters
EXIM Bank
SFC’s
1. Separate institute for financing small and medium sector industries and 2. Develop industrial estates 3. Provide finance in form of term loan
SIDC
State Industrial Development Corporations 1. To facilitate rapid industrial growth in the respective states 2. Identify and sponsor project
Investment Institutions
1. 2. 3. 4.
Life Insurance Corporation Of India (LIC) General Insurance Corporation of India (GIC) Unit Trust of India (UTI) Mutual Funds
Reserve Bank Of India
Scheduled Banks
State Co op Banks
Non Scheduled banks
Commercial Banks Foreign Private sector Banks
Indian Public Sector Banks
SBI and subsidies
Other nationalized banks
The commercial banking structure in India consists of: 1. Scheduled Commercial Banks in India 2. Unscheduled Banks in India Scheduled Banks in India constitute those banks which have been included in the Second Schedule of Reserve Bank of India(RBI) Act, 1934. RBI in turn includes only those banks in this schedule which satisfy the criteria laid down vide section 42 (6) (a) of the Act. "Non-scheduled bank in India" means a banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949), which is not a scheduled bank".
The banks included in this schedule list should fulfill two conditions.
1. The paid capital and collected funds of bank should not be less than Rs. 5 lac. 2. Any activity of the bank will not adversely affect the interests of depositors.
Every Scheduled bank enjoys the following facilities. 1. Such bank becomes eligible for debts/loans on bank rate from the RBI 2. Such bank automatically acquire the membership of clearing house.
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