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Name Amit Gupte

Registration / Roll No. 511023366

Course Master of Business Administration (MBA)

Subject Financial Management

Semester Semester 2

Subject Number MB0045

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Sign of Center Head

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Sign of Evaluator

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Sign of Coordinator

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Short Notes

1. Financial ManagementFinancial Management is Planning, directing, monitoring, organizing,

and controlling of the monetary resources of an organization. Themanagement of the finances of a business / organization in order toachieve financial objectives. Financial Management is the efficient andeffective planning and controlling of financial resources so as tomaximize profitability and ensuring liquidity for an individual(calledpersonal finance), government(called public finance) and for profit andnon-profit organization/firm (called corporate or managerial finance).Generally, it involves balancing risks and profitability.

The decision function of financial management can be divided into thefollowing 3 major areas:

INVESTMENT DECISION

1. Determine the total amount of assets needed by a firm henceclosely tied to the allocation of funds

2. Two type of investment decisions namely:

Capital Investment decisions re: large sums, non routine, longerterm, critical to the business like purchase of plant andmachinery or factory

Working Capital Investment decisions re: more routine in nature,

short term but are also very critical decisions like how much andhow long to invest in inventories or receivables

FINANCING DECISION

1. After deciding on the amount and type of assets to buy, thefinancial manager needs to decide on HOW TO FINANCE theseassets with the sources of fund

2. Financing decisions for example:

Whether to use external borrowings/debts or share capital or

retained earnings

Whether to borrow short, medium or long term

What sort of mix all borrowings or part debts part share capitalor 100% share capital

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The needs to determine how much dividend to pay out as thiswill directly affects the financial decision.

Financial PlanningFinancial Planning is an exercise aimed to ensure availability of rightamount of money at the right time to meet the individuals financialgoalsConcept of Financial PlanningFinancial Goals refer to the dreams of the investor articulated infinancial terms. Each dream implies a purpose, and a schedule of fundsrequirements for realising the purposeAsset Allocation refers to the distribution of the investors wealthbetween different asset classes (gold, property, equity, debt etc.)

Portfolio Re-balancing is the process of changing the investors assetallocationRisk Tolerance / Risk Preference refers to the appetite of the investorfor investment risk viz. risk of loss

Financial Plan Is a road map, a blue print that lists the investorsfinancial goals and outlines a strategy for realising themQuality of the Financial Plan is a function of how much information theprospect shares, which in turn depends on comfort that the plannerinspires

Capital Structure

Capital structure of a firm is a reflection of the overall investment andfinancing strategy of the firm.

Capital structure can be of various kinds as described below:

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- Horizontal capital structure: the firm has zero debt componentin the structure mix. Expansion of the firm takes throughequity or retained earnings only.

- Vertical capital structure: the base of the structure is formed

by a small amount of equity share capital. This base serves asthe foundation on which the super structure of preferenceshare capital and debt is built.

- Pyramid shaped capital structure: this has a large proportionconsisting of equity capita; and retained earnings.

- Inverted pyramid shaped capital structure: this has a smallcomponent of equity capital, reasonable level of retainedearnings but an ever-increasing component of debt.

SIGNIFICANCE OF CAPITAL STRUCTURE:

- Reflects the firms strategy- Indicator of the risk profile of the firm- Acts as a tax management tool- Helps to brighten the image of the firm.

FACTORS INFLUENCING CAPITAL STRUCTURE:

- Corporate strategy- Nature of the industry

- Current and past capital structure

Cost of Capital

Cost of capital is the rate of return the firm requires from investment inorder to increase the value of the firm in the market place. In economicsense, it is the costof raising funds required to finance the proposed project, the borrowingrate of the firm. Thus under economic terms, the cost of capital may bedefined as the weighted average cost of each type of capital.There are three basic aspects about the concept of cost

1. It is not a cost as such: The cost of capital of a firm is the rate ofreturn which it requires on the projects. That is why; it is a hurdlerate.2. It is the minimum rate of return: A firms cost of capital representsthe minimum rate of return which is required to maintain at least themarket value of equity shares.3. It consists of three components. A firms cost of capital includesthree components

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a. Return at Zero Risk Level: It relates to the expected rate of returnwhen a project involves no financial or business risks.b. Business Risk Premium: Business risk relates to the variability inoperating profit (earnings before interest and taxes) by virtue ofchanges in sales. Business risk premium is determined by the capital

budgeting decisions for investment proposals.c. Financial Risk Premium: Financial risk relates to the pattern of capitalstructure (i.e., debt-equity mix) of the firm, In general, a firm which hashigher debt content in its capital structure should have more risk thana firm which has comparatively low debt content. This is because theformer should have a greater operating profit with a view to coveringthe periodic interest payment and repayment of principal at the time ofmaturity than the latter.

Trading on Equity

When a co. uses fixed interest bearing capital along with owned capitalin raising finance, is said Trading on Equity.

(Owned Capital = Equity Share Capital + Free Reserves )

Trading on equity represents an arrangement under which a company uses fundscarrying fixed interest or dividend in such a way as to increase the rate of return onequity shares.

It is possible to raise the rate of dividend on equity capital only when the

rate of interest on fixed interest bearing security is less than therate of return earned in business.

Two other terms:

Trading on Thick Equity :- When borrowed capital is less than

owned capitalTrading on Thin Equity :- When borrowed capital is more thanowned capital, it is called Trading on thin Equity.

ASSETS MANAGEMENT DECISION

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1. Once assets have been purchased and appropriate financing arsecured, it now involve the efficient and effective managementof current assets like cash, inventories & receivables so as tomaximize returns and minimize the risk of liquidity.

2. Example of assets management decision like.

Extension of credit term to increase sales

To hold more stocks or on a longer term

The Goal Of The Firm

a. Maximization of profits.b. Maximization of shareholder wealth.c. Maximization of consumer satisfaction.d. Maximization of sales.

PROFIT MAXIMIZATION:

Simply a single-period or a short-term goal to be achieved withinone year

Management mainly focuses on efficient utilization of capitalresources to maximize profits WITHOUT considering the

consequences of its actions towards the companys futureperformance.

Drawbacks/disadvantages of Profit Maximization Goal:

a. It is only a SHORT TERM concept

b. It does NOT consider the timing of returns

c. It IGNORES risk

SHAREHOLDERS WEALTH MAXIMIZATION:

Shareholders wealth is regarding the maximizing of the totalmarket /market price of the existing shareholders common stock

It can be achieved by considering many factors whether short orlong term pertaining to decisions/actions made affecting thepresent and future earnings per share, timing of returns,

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dividend policy and other factors that can affect the market priceof the company stock

Unlike profit maximization, it has the following advantages:

Its applies to the principle of time value of money wherein adollar received today is worth more hand it is to be received say1 year later. By considering time value of money, this will lead toan overall increase in the companys earning

To achieve shareholders wealth maximization, managementneeds to consider the uncertainty or risk factor. It accept acertain degree of risk when it is compensated with the samelevel of return

Increase in shareholders wealth will directly lead to increase in

cash flows. It is not concern only with accounting earnings/profitsbut CASH FLOWS.

To achieve shareholders wealth maximization, the firm has toachieve all the short-term target like sales/earnings growth anddividend payout targets. Only when these short term targetsbeing achieved, the firm will then be attractive to the potentialinvestors which might raise the stock price.

Corporate Governance:

Corporate governance is the set of processes, customs, policies, laws,and institutions affecting the way a corporation (or company) isdirected, administered or controlled. Corporate governance alsoincludes the relationships among the many stakeholders involved andthe goals for which the corporation is governed. The principalstakeholders are the shareholders, management, and the board ofdirectors. Other stakeholders include employees, customers, creditors,suppliers, regulators, and the community at large.

Board of Director:

A board of directors is a body of elected or appointed members whojointly oversee the activities of a company or organization. The bodysometimes has a different name, such as board of trustees, board ofgovernors, board of managers, or executive board. It is often simplyreferred to as "the board."

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A board's activities are determined by the powers, duties, andresponsibilities delegated to it or conferred on it by an authorityoutside itself. These matters are typically detailed in the organization'sbylaws. The bylaws commonly also specify the number of members ofthe board, how they are to be chosen, and when they are to meet.

Typical duties of boards of directors include.

Governing the organization by establishing broad policies andobjectives;

Selecting, appointing, supporting and reviewing the performanceof the chief executive;

Ensuring the availability of adequate financial resources; Approving annual budgets; Accounting to the stakeholders for the organization's

performance.

Role of Management:

The success of the business depends primarily upon the skill andabilities of managementwhich skills can vary widely among differentmanagers. The business is not completely at the mercy of marketforces. Management can through its actions (decisions) influence andcontrol events within limits. In order to achieve desired results,management makes use of specific planning and control concepts andtechniques. Planning and control techniques which management mayuse include business budgeting, cost, volume, profit analysis,

incremental analysis, flexible budgeting, segmental contributionreporting, inventory models, and capital budgeting models.Management, in order to improve decision making and operatingresults, will evaluate performance through the use of flexible budgetsand variance analysis.

Finance Department of Organization:The Finance Department is responsible for the systems and proceduresthat assure the sound and efficient functioning of the organizationfinancial activities. The flow of financial activities begins with a plan

(budget). The plan is then implemented and the transactions recorded(accounting); and finally, the results are reported (financialstatements). The Finance Department also keeps an accurate record ofall financial transactions, generates interim financial reports, andproduces audited financial statements at the end of each year.

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Capital Market:A capital market is a market for securities (debt or equity), wherebusiness enterprises (companies) and governments can raise long-term funds. It is defined as a market in which money is provided forperiods longer than a year, as the raising of short-term funds takesplace on other markets (e.g., the money market). The capital marketincludes the stock market (equity securities) and the bond market(debt).Capital markets may be classified as primary markets and secondarymarkets. In primary markets, new stock or bond issues are sold toinvestors via a mechanism known as underwriting. In the secondarymarkets, existing securities are sold and bought among investors ortraders, usually on a securities exchange, over-the-counter, orelsewhere.

Public Issue.With a public issue, securities are sold to hundreds, and oftenthousands, of investors under formal contract overseen by federal and

state regulatory authorities.

Privileged Subscription:The sale of new securities in which existing shareholders are given apreference in purchasing these securities up to the proportion ofcommon shares that they already own; also known as a RIGHTSOFFERING.

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Regulation of Security Offering:Both the federal and state governments regulate the sale of newsecurities to the public, but federal authority is far more encompassingin its influence.

Private Placement:Private placement is made to a limited number of investors, sometimesonly one, and considerably less regulation. An example of a privateplacement might be a loan by a small group of insurance companies toa corporation.Private or direct placement the sale of an entire issue of unregisteredsecurities (usually bonds) directly to one purchaser or a group ofpurchasers (usually financially intermediaries).

Initial Public Offering:An initial public stock offering (IPO) referred to simply as an "offering"

or "flotation," is when a company issues common stock or shares to thepublic for the first time. They are often issued by smaller, youngercompanies seeking capital to expand, but can also be done by largeprivately-owned companies looking to become publicly traded.An IPO can be a risky investment. For the individual investor, it is toughto predict what the stock or shares will do on its initial day of tradingand in the near future since there is often little historical data withwhich to analyze the company.

Signaling Effect:Through signaling effect we get the signal of surrounding environment.

Primary Market:The primary market is that part of the capital markets that deals withthe issuance of new securities. Companies, governments or publicsector institutions can obtain funding through the sale of a new stockor bond issue. This is typically done through a syndicate of securitiesdealers. The process of selling new issues to investors is calledunderwriting. In the case of a new stock issue, this sale is an initialpublic offering (IPO). Dealers earn a commission that is built into the

price of the security offering, though it can be found in the prospectus.

Features of primary markets are:

This is the market for new long term equity capital. The primarymarket is the market where the securities are sold for the firsttime. Therefore it is also called the new issue market (NIM).

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In a primary issue, the securities are issued by the companydirectly to investors.

The company receives the money and issues new securitycertificates to the investors.

Primary issues are used by companies for the purpose of setting

up new business or for expanding or modernizing the existingbusiness. The primary market performs the crucial function of facilitating

capital formation in the economy. The new issue market does not include certain other sources of

new long term external finance, such as loans from financialinstitutions. Borrowers in the new issue market may be raisingcapital for converting private capital into public capital; this isknown as "going public."

The financial assets sold can only be redeemed by the originalholder.

Secondary Market:The secondary market, also known as the aftermarket, is the financialmarket where previously issued securities and financial instrumentssuch as stock, bonds, options, and futures are bought and sold.

Financial intermediary:Financial intermediation consists of channeling funds between surplusand deficit agentsA financial intermediary is an entity that connects surplus and deficitagents. The classic example of a financial intermediary is a bank that

transforms bank deposits into bank loans. Through the process offinancial intermediation, certain assets or liabilities are transformedinto different assets or liabilities.As such, financial intermediaries channel funds from people who haveextra money (savers) to those who do not have enough money to carryout a desired activity (borrowers).

Types of financial intermediaries:

Banks Building societies Credit unions Financial advisers or brokers Insurance companies Collective investment schemes Pension funds

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Investment Banker:

A financial institution that underwrites (purchases at a fixed price on afixed date) new securities for resale.

Traditional Underwriting:Underwriting bearing the risk of not being able to sell a security at theestablished price by virtue of purchasing the security for resale to thepublic; also known as FIRM COMMITMENT UNDERWRITING.If the security issue does not sell well, either because of an adverseturn in the market of because it is overpriced, the underwriter, not thecompany, takes the loss.

Underwriting syndicate:A temporary combination of investment banking firms formed to sell anew security issue.

(A): Competitive-bid:

The issuing company specifies the date that sealed bids will bereceived.

Competing syndicates submit bids.

The syndicate with the highest bid wins the security issue.

(B): Negotiated offering:

The issuing company selected an investment banking firm andworks directly with the firm to determine the essential features ofthe issue.

Together they discuss and negotiate a price for the security andthe timing of the issue.

Depending on the size of the issue, the investment banker mayinvite other firms to join in sharing the risk and selling the issue.

Generally used in corporate stock and most corporate bondissues.

Best Effort Offering:

A security offering in which the investment bankers agree to use onlytheir best effort to sell the issuers securities. The investment bankersdo not commit to purchases any unsold securities.

Shelf Registration:A procedure whereby a company is permitted to register securities itplans to sell over the next two years. These securities can be soldpiecemeal whenever the company chooses.

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Balance Sheet:In financial accounting, a balance sheet or statement of financialposition is a summary of the financial balances of a sole proprietorship,a business partnership or a company. Assets, liabilities and ownership

equity are listed as of a specific date, such as the end of its financialyear. A balance sheet is often described as a "snapshot of a company'sfinancial condition" Of the four basic financial statements; the balancesheet is the only statement which applies to a single point in time. Acompany balance sheet has three parts: assets, liabilities andownership equity.

Income Statement:Income statement, also referred as profit and loss statement (P&L),earnings statement, operating statement or statement of operations, isa company's financial statement that indicates how the revenue

(money received from the sale of products and services beforeexpenses are taken out, also known as the "top line") is transformedinto the net income (the result after all revenues and expenses havebeen accounted for, also known as the "bottom line"). It displays therevenues recognized for a specific period, and the cost and expensescharged against these revenues, including write-offs (e.g., depreciationand amortization of various assets) and taxes. The purpose of theincome statement is to show managers and investors whether thecompany made or lost money during the period being reported. Theimportant thing to remember about an income statement is that itrepresents a period of time. This contrasts with the balance sheet,

which represents a single moment in time.

Ratio Analysis:A tool used by individuals to conduct a quantitative analysis ofinformation in a company's financial statements. Ratios are calculatedfrom current year numbers and are then compared to previous years,other companies, the industry, or even the economy to judge theperformance of the company. Ratio analysis is predominately used byproponents of fundamental analysis.

Liquidity Ratios:

These ratios indicate the ease of turning assets into cash. It which givea picture of a company's short term financial situation or solvency.They include the Current Ratio, Quick Ratio, and Working Capital.

Current Ratios: The Current Ratio is one of the best known measures of financialstrength. It is figured as shown below:

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Total Current AssetsCurrent Ratio = ____________________

Total Current Liabilities

Quick Ratios:The Quick Ratio is sometimes called the "acid-test" ratio and is one ofthe best measures of liquidity. It is figured as shown below:

Cash + Government Securities + ReceivablesQuick Ratio = _________________________________________

Total Current Liabilities

Working Capital:Working Capital is more a measure of cash flow than a ratio. The resultof this calculation must be a positive number. It is calculated as shownbelow:

Working Capital = Total Current Assets - Total Current Liabilities

Leverage Ratios:Any ratio used to calculate the financial leverage of a company to getan idea of the company's methods of financing or to measure its abilityto meet financial obligations. There are several different ratios, but the

main factors looked at include debt, equity, assets and interestexpenses.This Debt/Worth or Leverage Ratio indicates the extent to which thebusiness is reliant on debt financing (creditor money versus owner'sequity):

Total LiabilitiesDebt/Worth Ratio = _______________

Net Worth

Generally, the higher this ratio, the more risky a creditor will perceive

its exposure in your business, making it correspondingly harder toobtain credit.

Debt Ratios:

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A ratio that indicates what proportion of debt a company has relativeto its assets. The measure gives an idea to the leverage of thecompany along with the potential risks the company faces in terms ofits debt-load.

Capitalization Ratios:The capitalization ratio measures the debt component of a company'scapital structure, or capitalization (i.e., the sum of long-termdebt liabilities and shareholders' equity) to support a company'soperations and growth.Long-term debt is divided by the sum of long-term debt andshareholders' equity. This ratio is considered to be one of the moremeaningful of the "debt" ratios - it delivers the key insight into a

company's use of leverage.

Coverage Ratios:Measure of a corporation's ability to meet a certain type of expense. Ingeneral, a high coverage ratio indicates a better ability to meet theexpense in question.

Activities Ratios:Accounting ratios that measure a firm's ability to convert differentaccounts within their balance sheets into cash or sales.Such ratios are frequently used when performing fundamental analysison different companies. The asset turnover ratio and inventoryturnover ratio are good examples of activity ratios.

Account Receivable Ratios:An accounting measure used to quantify a firm's effectiveness inextending credit as well as collecting debts. The receivablesturnover ratio is an activity ratio, measuring how efficiently a firm usesits assets.

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Ratio analysis can be used to tell how well you are managing youraccounts receivable. The two most common ratios for accountsreceivable are turnover and number of days in receivables.

Time Value of Money:

The time value of money is the value of money figuring in a givenamount of interest earned over a given amount of time. The idea thatmoney available today is worth more than the same amount of moneyin the future, based on its earnings potential.

Present value of a future sum:

The present value formula is the core formula for the time value ofmoney; each of the other formulae is derived from this formula. Forexample, the annuity formula is the sum of a series of present value

calculations.

The present value (PV) formula has four variables, each of which canbe solved for:

1. PV is the value at time=02. FV is the value at time=n3. it is the rate at which the amount will be compounded each

period4. n is the number of periods (not necessarily an integer)

Future value of a present sum:

The future value (FV) formula is similar and uses the same variables.

Interest:The fee charged by a lender to a borrower for the use of borrowedmoney, usually expressed as an annual percentage of the principal; therate is dependent upon the time value of money, the credit risk of theborrower, and the inflation rate. Here, interest per year divided byprincipal amount, expressed as a percentage. Also called interest rate.

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Types of Interest:

A: Simple Interest:

Simple interest is earned on the principal only.

Formula:

Interest = Principal Rate Time

B: Compound Interest:

Compound interest is paid on the original principal and on theaccumulated past interest.

Formula:

P is the principal (the initial amount you borrow or deposit)

r is the annual rate of interest (percentage)

n is the number of years the amount is deposited or borrowed for.

A is the amount of money accumulated after n years, includinginterest.

When the interest is compounded once a year:

A = P (1 + r) n

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Annuity:

A financial product sold by financial institutions that is designed toaccept and grow funds from an individual and then, uponannuitization, pay out a stream of payments to the individual at a laterpoint in time. Annuities are primarily used as a means of securing asteady cash flow for an individual during their retirement years.

Types of Annuity:

Ordinary Annuity:

A series of fixed payments made at the end of each period over a fixedamount of time. An ordinary annuity is essentially a level stream ofcash flows for a fixed period of time. Straight bond coupon paymentsare normally referred to as ordinary annuities.

Formula: (future value)

C = Cash flow per periodi = interest raten = number of payments

Annuity Due:

An annuity due requires payments to be made at the beginning of theperiod. For example, in many lease arrangements, the first payment isdue immediately and each successive payment must be made at thebeginning of the month.

I have a formula for an annuity due calculationfv = p * (((1 + i) ^ n - 1) / i) * (1 + i)

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Wherefv = future valuep = paymentsi = interest raten = term