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Financial Management
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Financial Management Definitions
Financial management is the operation activity of abusiness that is responsible for obtaining and effectively
utilizing the funds necessary for efficient operations.
-- Joseph and Massie
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Financial management is the area of business
management devoted to a judicious use of capital and a
careful selection of sources of capital in order to enable a
business firm to move in the direction of reaching its
goals.
J.F.Bradlery
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Financial management may be defined as that area or
set of administrative functions in an organization which
relate with arrangement of cash and credit so that
organization may have the means to carryout its
objective as satisfactorily as possible.
Howard and Opton
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Introduction to financial management
Financial management is concerned with : Raising of funds in a most economic and suitable manner
Using these funds profitably.
Planning future operations.
Controlling current performances.
Controlling future developments
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Introduction to financial management
Objectives of financial management
- Maximisation of the profits of the firm
- Maximisation of the shareholders wealth
- Maximisation of cash flow
- Maximising return on capital employed
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Introduction to financial management
EVA : is emerging as a popular measure to understand and
evaluate financial performance of the company.
- EVA compares the return on capital employed with cost of
the capital. i.e, returns earned by the company in excess of
the minimum expected return of the shareholder
- EVA will increase if
Operating profits grow without additional capital
If additional capital invested gives higher returns
Unproductive capital is liquidated
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Introduction to financial management
Theory of financial management is based on the following- Time value of money
- Risk - return trade off- Cash flows and accounting profits
- Incremental cash flows- Tax implications incorporated before a decision is made
- Market price of a share is right and reflects all
information available with the public
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Long-term funds procurement
Long-term funds are necessary for
- The initial setting up of a business organization,- Its expansion and also
- Meeting a part of its operational requirements
Long term funds may be in the form of owner participation
bonds, debentures or loans from institutions Accurate assessment of the requirements of LT funds is
necessary to avoid distress through either short-fall or
unnecessary payment of interest-charges.
Availability, cost, existing capital structure and repayment termsare to be taken into consideration while making decisions for L
funds.
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Capital Structure
Funds, the life blood of every enterprise, are required for
the financing of fixed assets and current assets. Following
are the sources of long term finance commonly employed
by business firms:-
Retained earnings
Equity Capital
Preference Capital
Debenture capital Term loans
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Retained Earnings
Firms Point of View -Retained earnings are viewedvery favourably by most corporate managements for
the following reasons:
1. Readily available internally.
2. Effectively represent infusion of additional equity
in the firm.
3. No dilution of control.
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Retained Earnings
Disadvantages of retaining earnings are
The amount that can be raised by way of retained
earnings may be limited. The quantum of retained
earnings tends to be highly variable.
The opportunity cost of retained earnings is quite high.
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Equity Capital
Equity capital presents ownership capital as equityshareholders collectively own the company. They enjoy
the rewards and bear the risk of ownership.
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Equity Capital
The most important source of long-term funds, equitycapital offers the following advantages:-
1. It represents permanent capital. Hence, there is
no liability for repayment.
2. It does not involve any fixed obligation for
payment of dividends.
3. It enhances the creditworthiness of the
company.
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Preference Capital
Preference capital represents a hybrid form of financing -it partakes some characteristics of equity and some
attributes of debentures.
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Preference Capital
There are some advantages in issuing preference
capital from the companys point of view :
1. There is no legal obligation to pay preference
dividend. A company does not face bankruptcy,or legal action if it skips preference dividend.
2. There is no dilution of control.
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Debenture Capital
Debentures are instruments for raising long term debt
capital. Debenture holders are creditors of the company.
The obligation of the company towards its debenture
holders is similar to that of a borrower who promises to
pay interest and capital at a specified times.
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Debenture Capital
Debenture offer the following advantages to theissuing company -
1. Cost of debt capital , represented by debentures,
is lower than the cost of preference or equity
capital.
2. Debenture financing does not result in dilution ofcontrol.
3. The fixed monetary burden associated withdebenture financing , irrespective of changes in
price level, has appeal to many companies.
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Term Loan
Term loans, also referred to as term finance, represent asource of debt finance which is generally repayable in
more than one year but less than 10 years. They are
employed to finance acquisition of fixed assets and
working capital margin. Term loan differ from short term
bank loans which are employed to finance short term
working capital and liquidated over a period of time,
usually less than one year.
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Term Loan
Term loans offer the following advantages to the
borrower:-
In post-tax terms, the cost of term loans is lower
than the cost of equity capital or preference
capital.
Term loan do not result in dilution of control, as
lenders do not have the right to vote.
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Comparison of Long-term Sources of Financing
Instrument Cost Dilution of Risk Restraint on
control Mgmt.
Retained High No Nil No
Earnings
Eq.Capital High Yes Nil No
Pref. Cap HighNo Negligible No
DebentureLow No High Some
Term loans LowNo High
Moderate
C it l St t Pl i
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Capital Structure Planning
Issues relating to Capital Structure Planning
There is no one optimum capital structure which is
suited to all the enterprises.
External forces and regulations influence the capital
structure. Such regulations relate to the fiscal and
monetary policies of the Government.
Management Policies regarding their reliance on
various sources.
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Capital Market
The Capital market can be looked as :-
a) A market for new securities issued by
companies, known as the Primary Market, or b) A
market for trading securities already issued,
known as the Secondary Market
For internal circulation of BSNL only
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Long term investment decision
Key considerations in making investment decisions are:
1. What is the scale of the investment - can the
company afford it?
2. How long will it be before the investment starts toyield returns?
3. How long will it take to pay back the investment?
4. What are the expected profits from the investment?
5. Could the money that is being ploughed into theinvestment yield higher returns elsewhere?
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Nature of CAPEX Decisions
Cost: Huge investments Time: When to Invest? Consequences in uncertain future
Irreversibility: Irreversible or reversible at a substantial
cost or at heavy loss
Consequence extend over a long period of time
Nature of CAPEX Decisions
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Nature of CAPEX Decisions
Complexity:
- Forecasting future cash outflows and inflows are
difficult
- Constantly changing technologies
- Constantly changing customer preferences
- Severe Competition in Telecom sector
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Steps in CAPEX Decisions
Identification of potential Investment Opportunities bycarefully screening the :
New / emerging technologies
New uses for existing technologies / infrastructure
Customer needs perceived through market surveys
and customer feedback
Need to spread to different / New locations New
opportunities indicated by the growth path ofcompetitors
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Steps in CAPEX Decisions
Preliminary Screening of Opportunities
Criteria typically applied are Compatibility with the companys existing technology
Existing and potential skill
Organizational environment
Lead time
Easy availability of technology / equipment and their
potential sources
Reasonableness of costs
Associated risks (like obsolescence)
Competition in the segments
Steps in CAPEX Decisions
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Steps in CAPEX Decisions
Feasibility Studies Involves :
Preparation of detailed Project Report
Examining the marketing, technical, financial and
economic feasibility aspects
Specific estimates of cost and benefits Means of raising funds
Schedules of implementation
Profitability estimates
Social benefits
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Steps in CAPEX Decisions
Implementation :
Equipment selection And procurement
Construction
Training
Trial run Commissioning
Equipment maintenance planning
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Steps in CAPEX Decisions
Dealing with implementation delays : PERT (Project evaluation review technique)
CPM (critical path method)
Assigning specific time bound responsibilities to the
nominated project managers for different
implementation stages in clear terms
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Steps in CAPEX Decisions
Performance review :
After implementation the project must bereviewed To
see whether it matches the revenue and
performance projections made in the project report
Reasons for variations
Appropriate remedial action
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Appraisal of CAPEX Decision
Market Appraisal
Size of the market in the area
Expected share of the project
Past trends
Expected future trends Results of market surveys
Assessment of specific customer requirements in the
area
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Appraisal of CAPEX Decision
Technical Appraisal :
Technical feasibility
Required scale of operations
Existing infrastructure of power, land and buildings
etc., Required technology to support anticipated custome
requirements
Appraisal of CAPEX Decision
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Appraisal of CAPEX Decision
Economic appraisal
Social cost benefit analysis
Especially in respect of government supported
projects and Government specified targets
Indicates the impact of the project on the society itserves
Appraisal of CAPEX Decision
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Appraisal of CAPEX Decision
Financial appraisal The investment analysis must estimate the cash outflows
(on investments and working capital outflows) and the
cash inflows (Revenue) and apply the standard decision
rules to determine whether the investment satisfies therequisite decision criteria .
As OF FINANCIAL MANAGEMENT
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A s OF FINANCIAL MANAGEMENT
Anticipating financial needs.
Acquiring financial resources.
Allocating funds in business
Administering the allocation of funds.
Analyzing the performance of funds.
Accounting and reporting to managers.
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