FINance MGT-1 Asma

8/4/2019 FINance MGT-1 Asma

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Finance Management

Hospital: - WHO Definition:A hospital is an integral part of a social and medicalorganization, the function of which is to provide for thepopulation complete health care, both curative and preventive,and whose out patient services reach out to the family and its

home environment, the hospital is also a center for thetraining of health workers and bio-social research.

Management:Art and science of organizational goals and objectives

through people, by making the best utilization of (available)resources. Saving, payment and credit facilities of moneyManagement of cash flows.


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Resources: Men Machines

Material Money - Finance

Finance: Normally means money

Wider meaning Study of money management

Goals and objectives of hospital:

Preventive Curative Rehabilitative Education and training Research


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Types of Hospital:A. - Primary

- Secondary- Tertiary

B. - Multispeciality- Specilaity

Hospitals - Classification based on ownershipA. - Government

- Semi- government- Industrial

B. - Proprietorship- Partnership- Trust charitable- Co-operative- Corporate


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Hospitals

- For Profit

- Not for Profit

Proprietorship -

Advantages - Ownership of all profits

- Easy to create and to dissolve-Tax savings

Disadvantages - Unlimited liability

- Small size

- Difficulty in acquiring newfunds


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Partnership :

It is an organization of two or more persons engaging in same

line of business.

Advantages -Easy to attract talent and wealth

-Incentives of future ownership tooutstanding employees

-Easy to grow and expand

-Chance for better credit standing

Advantages - Dissolves with the death of a partner

- Hard to withdraw wealth

- Opportunity for dispute and ill willamong partners.


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Corporation:

It is a business that is owned by shareholders and has a legalstatus, similar to that of a person, it can make contracts, own

property sue, and be sued. A corporation, has a legal existence that is separate from its

owners.

Advantages - Limited liability

- Potentially long life- Easy transfer ability of ownership

- Easy of attracting new capital

- Ability to grow

Disadvantages - More expensive form of organization

- Increased regulatory burden

- Lack of secrecy

- Double taxation.


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Trust

Advantages - A separate legal entity

- Limited liability- Potentially long life

- Ability to grow

- Public contributions

- Tax and other benefits- Service to the community at an

affordable cost (since profit is not the

motive)

Disadvantages - Regulatory burden

- Control from government agency

- Lack of accountability

- Since profitability is not motive, there

may not be incentive for growth.


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Meaning and Definition of Book Keeping

Book-keeping is defined as the process of analysing, classifying and recordingtransactions in a systematic manner to provide information about the financial

affairs of the business concern. Following are some of the important definitionsgiven by eminent authorities on the subject :

J.R.Batliboi : Book-keeping is the art of recording business dealings in a set ofbooks.

R.N. Carter : The science and art of correctly recording in the books of accountsall those business transactions that result in the transfer of money or moneys worth.

Richard E. Stranhelm : The art of analysing and recording business transactions,reporting results of business operations through periodic statements and interpretingsuch results for purposes of effective control of future operations.

Northcott : Book-keeping is the art of recording in the books of account themonetary aspect of commercial or financial transactions.

Book-keeping is the art of recording, classifying and summarising the financialtransactions and events in a business. It is a systematic recording in terms of

money in a set of books.


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Features

Birds Eye View

Features

1. Art

2. Documentary support

3. Universal system

4. Recording monetary transactions

5. Own transactions with others

6. Process of recording

7. Recording in a given set of books

Analysis of the above definitions brings out the following features of Book-Keeping :

It is an art of recording transactions scientifically.

There must be a documentary support for each and every transaction.

The system of recording should be universal.

The recording is made of monetary transactions only. It means the transaction must involve money

or moneys worth. Non-monetary transactions cannot be recorded.

The business house records its own transactions with others.

It is the process of recording data relating to accounting transactions in the books of accounts.

Recording of transactions is made in a given set of books only.


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Objects of Book-Keeping at a glance

Primary Objects Sub-Objects Ancillary Objects

To know To know To review the

Profit / loss creditors progress

To know To know To prevent errorsfinancial position debtors & frauds

To have a To know capital To keep a check onsystematic invested property

recordTo understand To provide valuablecash and stock information for

decision-making


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Rules for Different Accounts for Passing Entries

Under Double Entry System of accounting, both the aspects of thetransaction are recorded. The two aspects involve, receiving of valuesand giving of values of each transaction. The two aspects aredistinguished in terms of Debit and Credit. Dr. stands for debit and Cr.stands for credit. Every account is capable of receiving and givingvalues. It is debited when it receives benefit and it is credited when itgives benefit. Hence, the rule is : it receives benefit and it is credited

when it gives benefit. Hence, the rule is :

Debit the Account that receives the benefit and Credit the Accountthat gives the benefit.

Every transaction affects at least two accounts. When one accountreceives the benefit of certain value, another account gives the benefitof the same value. Hence the rule is :

Every debit must have a corresponding credit and every credit

must have corresponding debit.


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While recording business transactions, the accounts are either to be debited orcredited. Therefore, a book-keeper must be fully aware of the rules of debitingand crediting different types of accounts. The rules of Debit and Credit are asgiven below :

Chart Showing Rules of Debit and Credit :

Account

Personal Account Real Account Nominal Account

Debit Credit Debit Credit Debit Credit

Receiver Giver What What Expenses & Incomes &

comes in goes out Losses Gains


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Financial Principles of Accounting

A debit denotes:(a) in the case of a person, that he has received some benefit against which he has

already rendered some service or will render service in future. When a personbecomes liable to do something in favour of the firm, the fact is recorded bydebiting that persons account;

(b) in the case of goods or properties, that the stock and value of such goodsproperties has increased, and

(c) in the case of other accounts like salary or rent, that the firm has incurred someexpense or has lost money.

A credit denotes:(a) in the case of a person, that some benefit has been received from him, entitling

him to claim from the firm a return benefit in the form of cash or goods orservice. When a person becomes entitled to money or moneys worth for anyreason, the fact is recorded by crediting him;

(b) in the case of goods or properties, that the stock and value of such goods orproperties has diminished; and

(c) in the case of other accounts (e.g., commission), that the firm has made a gain.


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Dual Aspect Rules

A. Debit the receiver and credit the giver.(Personal transactions)If A buys ticket for B

B has been under obligation or debtA has done a creditable thing and therefore entitled to credit.So B will be debited. A will be credited.

B. Debit what comes in and credit what goes out.When business receives cash - Debit cash Account

When good received - Debit stock AccountWhen cash is paid - Credit cash AccountWhen goods sent out - Credit goods Account

C. Debit all expenses (losses) and credit all incomes (and gains)e.g. Salary - Paid to Clerk (Service already rendered)

Debit clerk (not practical)So debit Salaries Account (expense)Same Rent Account (Expense) - not landlord

Instead of crediting the person from whom income is received, it is

credited to an account (say) commission account or interest account.


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Assets

Increase on the Lt. Hand (Debit side)

Decreases on the credit (Rt. Hand side)(When cash is received, cash account is debited when it ispaid the account should be credited i.e. the amount put oncredit side.)

Liabilities - Increases on the credit side and decreases on thedebit side.

Capital : The same as for liabilities.

Expenses - Increases on the debit side and decreases on the

credit side.

Incomes or Gains - Increases on the credit side and decreaseson the debit side.


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A debit balance shows that :

money is owing to the firm; or

the firm owns some property (cash, goods,

furniture, etc.); or

the firm has lost money or has incurred some

expense.

A credit balance shows that :

money is owing to some person; or

the firm has given up so much property; or

the firm has earned an income.


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Finance Management

Hospital: - WHO Definition:A hospital is an integral part of a social and medicalorganization, the function of which is to provide for thepopulation complete health care, both curative and preventive,and whose out patient services reach out to the family and itshome environment, the hospital is also a center for thetraining of health workers and bio-social research.

Management:Art and science of organizational goals and objectives

through people, by making the best utilization of (available)resources. Saving, payment and credit facilities of moneyManagement of cash flows.


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Resources: Men Machines

Material Money - Finance

Finance: Normally means money

Wider meaning Study of money management

Goals and objectives of hospital: Preventive Curative Rehabilitative Education and training Research


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Types of Hospital:A. - Primary

- Secondary

- Tertiary

B. - Multispeciality- Specilaity

Hospitals - Classification based on ownershipA. - Government

- Semi- government- Industrial

B. - Proprietorship- Partnership- Trust charitable- Co-operative- Corporate


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Hospitals

- For Profit

- Not for Profit

Proprietorship -

Advantages - Ownership of all profits

- Easy to create and to dissolve

-Tax savings

Disadvantages - Unlimited liability

- Small size

- Difficulty in acquiring newfunds


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Partnership :

It is an organization of two or more persons engaging in same

line of business.

Advantages -Easy to attract talent and wealth

-Incentives of future ownership tooutstanding employees

-Easy to grow and expand

-Chance for better credit standing

Advantages - Dissolves with the death of a partner

- Hard to withdraw wealth

- Opportunity for dispute and ill willamong partners.


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Corporation:

It is a business that is owned by shareholders and has a legalstatus, similar to that of a person, it can make contracts, ownproperty sue, and be sued.

A corporation, has a legal existence that is separate from its

owners.

Advantages - Limited liability

- Potentially long life- Easy transfer ability of ownership

- Easy of attracting new capital

- Ability to grow

Disadvantages - More expensive form of organization

- Increased regulatory burden

- Lack of secrecy

- Double taxation.


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Trust

Advantages - A separate legal entity

- Limited liability- Potentially long life

- Ability to grow

- Public contributions

- Tax and other benefits

- Service to the community at anaffordable cost (since profit is not themotive)

Disadvantages - Regulatory burden

- Control from government agency- Lack of accountability

- Since profitability is not motive, there

may not be incentive for growth.


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Goals of organization :

Role of finance:General objective of the organisation is to maximise its value.

This is accomplished by making decisions in which the benefitsexceed the costs. This is accomplished by

i. Maximizing size :

Every organization strives to grow in size. Of course size itself

may not mean increase in value of organization.

ii. Maximizing Profits :

The basic objective of every business enterprise is the welfare

of its owners. It can be achieved by maximization of profits.Financial decisions (investment / financing and dividend) ofa firm should be oriented to maximisation of profits i.e. selectthose assets projects and decisions which are profitable. Inother words, actions that increase profits be undertaken and

those, that decrease profits are to be avoided. Contd.


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Goals of organization . (contd.)

iii. Maximising wealth:

Organization should be managed to maximize the price ofshare, which is equivalent to maximizing shareholderswealth. It means value of the firm should be maximised.

Investors focus mostly on the cash flows generated by a

firm. If they perceive that the organization will generatesubstantial cash flow in the future, they will demand theshares in greater quantities, thus increasing it price.

iv. Social obligations:

Other objectives (especially in health care in not for profitorganizations)To provide the best possible quality health care, at the mostaffordable cost to the community.


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Financial Management

Definition:

It involves the application of general management principles toa particular financial operation.

An integrated and composite subject, which welds together,accounting economics, mathematics management andbehavioral sciences and other disciplines as its tools.

Financial management, as an integral part of over allmanagement, is not a totally independent area. It draws heavilyon related disciplines and fields of study, such as economics,accounting, marketing production and quantitative methods.

Financial management optimises the output from the giveninput of funds. Financial management is the planning,organizing, directing and controlling and procurement andutilization of funds and safe disposal of profit, to the end thatindividual organizational and social objectives areaccomplished.


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Financial Decision Areas- Investment Analysis- Working Capital Management- Sources and cost of funds

- Determination of capital structure support- Dividend Policy- Analysis of risks and returns

Functions of finance: - Executive or Administrative-

- Incidental or Routine1. Finance planning

- Fore casting of resources of income and expenditure.

2. Control / Managing funds

3. Financial Decision makinga. Financial decisionb. Investment decisionc. Dividend decision

d. Methods of raising funds


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4. Liquidity function

5. Profitability function

6. Evaluation of financial performance

7. Co-ordination with other departments

8. Bringing performance closer to targets

Application of Financial Management in Hospitals:- Financial planning- Budgeting- Reduction in cost- Proper utilization of funds- Financial analysis- Fixed Asset Management

- Working Capital Decision- Pricing of services- Investments- Tax planning- Arranging funds including donations

- Control and monitoring


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Fields of finance

Public Finance - Government- State- Local Government

Institutional Finance - Banks- Financial Institution

Personal Finance

Securities and Investment Analysis

International Finance

Corporate Finance :

- Sources of funds

- Cost of capital

- Capital investment decisions

- Working Capital Management

- Dividend Decisions


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Role of Finance Manager

Planning for financial needs

Estimating the requirements of funds

Arrangement of financial resources and maintenance of financial liquidity

Decision regarding capital structure

Supply of funds to all parts of the organization or cash management

Set up financial policies

Implement the policies

Adverse and educate management on financial matters

Control land monitor expenses and income

To see that the organization flourishes financially Evaluating financial performance

Policies

Economic purchases

Financial negotiations

Inventory control

Programme Investment decisions

Dividend decisions

To increase income

Cost control

Cost reduction

Increase efficiency


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Status and Role of Finance Manager

1. Line officer - A member of higher management

2. Functional Head of finance

3. Specialist of finance

4. Co-ordinator

5. Overall manager of financial function

6. Guide and representative of employees

7. Guide and patron of investors

8. Liaison officer with statutory agencies


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Normally the functions of the finance department are divided between

Treasurer - Obtaining finance

- Banking relationship- Investor relationship

- Short term financing

- Cash Management

- Credit Administration

- Investments-Insurance

Controller :

Accounting and

control

- Financial Accounting

- Internal Audit

- Taxation

- Management Accounting and control

- Budgeting, planning and control

-Economic Appraisal


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Parties interested in financial status/performance of the institution

People at the helm (Management)

Share holders Investors

Creditors Banks

Employees

Customers

Government

Research

F d t l f A ti


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Fundamentals of Accounting

Accounting :

A system for collecting, summarizing, analyzing, presenting andreporting in monetary terms, information about the enterprise.

Accounting is a business language

Main purpose is to communicate about the business enterprise.

American Institute of Certified Accountants

The art of recording, classifying and summarizing in a significantmanner and in terms of money transactions and events which are in part

at least of a financial character, and interpreting the results thereof:

Parties interested in financial status/ performance of the institution :

People at the helm

Share holders

Investors Creditors

Employees

Customers

Government

Research


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Accounting Concepts :

Business Entity Concept

Money Measurement Concept

Cost Concept

Going Concern Concept

Dual Aspect Concept

Realization Concept

Accrual Concept

Conventions regarding financial statement :

Consistency

Disclosure

Conservation

Systems :

Cash

Mercantile


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Dual Aspect Rules

A. Debit the receiver and credit the giver.(Personal transactions)If A buys ticket for B

B has been under obligation or debtA has done a creditable thing and therefore entitled to credit.So B will be debited. A will be credited.

B. Debit what comes in and credit what goes out.When business receives cash - Debit cash Account

When good received - Debit stock AccountWhen cash is paid - Credit cash AccountWhen goods sent out - Credit goods Account

C. Debit all expenses (losses) and credit all incomes (and gains)e.g. Salary - Paid to Clerk (Service already rendered)

Debit clerk (not practical)So debit Salaries Account (expense)Same Rent Account (Expense) - not landlord

Instead of crediting the person from whom income is received, it iscredited to an account (say) commission account or interest account.


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Assets

Increase on the Lt. Hand (Debit side)

Decreases on the credit (Rt. Hand side)(When cash is received, cash account is debited when it ispaid the account should be credited i.e. the amount put oncredit side.)

Liabilities - Increases on the credit side and decreases on thedebit side.

Capital : The same as for liabilities.

Expenses - Increases on the debit side and decreases on the

credit side.

Incomes or Gains - Increases on the credit side and decreaseson the debit side.


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Financial Principles of Accounting

A debit denotes:(a) in the case of a person, that he has received some benefit against which he has

already rendered some service or will render service in future. When a person

becomes liable to do something in favour of the firm, the fact is recorded bydebiting that persons account;

(b) in the case of goods or properties, that the stock and value of such goodsproperties has increased, and

(c) in the case of other accounts like salary or rent, that the firm has incurred someexpense or has lost money.

A credit denotes:(a) in the case of a person, that some benefit has been received from him, entitling

him to claim from the firm a return benefit in the form of cash or goods orservice. When a person becomes entitled to money or moneys worth for any

reason, the fact is recorded by crediting him;

(b) in the case of goods or properties, that the stock and value of such goods orproperties has diminished; and

(c) in the case of other accounts (e.g., commission), that the firm has made a gain.


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A debit balance shows that :

money is owing to the firm; or

the firm owns some property (cash, goods,furniture, etc.); or

the firm has lost money or has incurred some

expense.

A credit balance shows that :

money is owing to some person; or

the firm has given up so much property; or

the firm has earned an income.

B h f A i


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Branches of Accounting :

Financial Accounting

- Developed originally

- Concerned only with the financial state of affairs andfinancial results of operations

Management Accounting

- Data collected from financial accounting- It enables management to discharge its functions properly,

chiefly in respect of forecasting and budgeting, control over

costs and revenues and decisions, both routine and strategic.

Cost Accounting

- It involves estimating cost in advance and detailed analyses.

- It is used for making numerous decisions and for exercising

control over the costs being incurred.

Fi i l A ti M t A ti


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Financial Accounting Management Accounting

Primary Users

External Users- Owners- Tax authorities- Lending Institutions

Freedom of choiceGoverned by generallyaccepted principles

Behavioural ImplicationsAlmost noneSince it is statutoryrequirement

Time Focus

Records are historicalTime SpanUsually one yearStatements prepared at fixedtime intervals

CoveragePrimarily concerned withentire organization

ExactitudeAccuracy to the last digitdesired

PurposeAccounts at periodical intervals asprescribed by the authorities.

Justification for useStatutory requirementsCompulsory

Managers within the organisation.

Can be subjected to varied interpretations andtreatment depending upon individual circumstances.

Its effectiveness depends on involvement ofoperating personnel and how they react to variousreports.

Emphasis on planning for future

Flexible varying

Frequency and timings depend upon the need andurgency even 15 years

Parts could be covered

Less emphasis on precision

Has several objectives.

Some data could be interpreted differently.

Benefits derived from use optional.

B i Fi i l C t


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Basic Financial Concepts

Time Value of money

Value of money changes with time

Understanding of future value and present value is necessary for effective

financial decision making.

Conceptually time value of money means that the value of unit of money is

different in different time periods.

The value of a sum of money received today is more than its value received after

some time. Conversely the sum of money received in future is less valuable than it is today

Since a rupee received today has more value, rational investors would prefer

current receipts to future receipts

The time value of money can also be referred as Time preference for money.

The main reason for time preference for money is to be in the reinvestopportunities for funds which are received early.

The funds so invested will earn a rate of return; this would not be possible if the

funds are received at a later time.

T h i t t th f t


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Techniques to convert the sums of money to acommon point of time

Compounding Technique :

Interest is compounded, when the amount earned on an initial deposit

(the initial principle) becomes part of the principle at the end of the first

compounding period. The term principal refers to the amount of money

on which interest is received.

Discounting or Present Value Technique :The concept of present values is the exact opposite of that of

compound value. While in the latter approach money invested now

appreciates in value, because compound interest is added, in the

former approach (present value approach) money is received at some

future date and will be worthless because the corresponding interest islost during the period. In other words, the present value of a rupee that

will be received in the future will be less than the value of a rupee in

hand today.


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Valuation of Long Term Securities : Debenture / Bond is a security acknowledging long term debt issued by a

corporate, firm or government to investors with the undertaking of paying interest,period a flow period till the security matures.They have - Face value

Maturity periodAnnual rate of interestPaying pattern

Based on the above it is possible to calculate the valuation of the bond by applyingthe appropriate formula.

Valuation of Equities :

Preferential Shares: They carry fixed rate of return / dividend.. In case of nostated maturity

their valuation is similar to that of perpetual bonds.Valuation is done, as is done with bonds.

Equity Shares: Value of equity shares is the discounted based on the value of allexpected future dividends to be paid by the company to its equity shareholders.The discounted value represents the investors required rate of return on suchinvestment.It is calculated based on the assumptions:

i. Constant growth

ii. No growth

iii. Varied growth


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Risk and Return : Compounding and discounting techniques of time value of money are

applied to determine the value of different securities. The value of asecurity is viewed as the present value of the cash flow stream provided tothe investor, discounted at a required rate of return appropriate for the risk

involved.

Return: The (rate of) return on an asset/investment for a given period, saya year, is the annual income received plus any change in market price,usually expressed as a per cent of the opening market price.

Symbolically, the one-period factual (expected) return, RDt + (Pt Pt-1 )= ------------------

Pt-1 Where Dt = annual income/cash dividend at the end of time

period, t

Pt = security price at time period, t (closing/endingsecurity price)

Pt-1= security price at time period, t-1(opening/beginning security price)


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Risk : The variability of the actual return from the expected returnsassociated with a given asset/investment is defined as risk. Thegreater the variability, the riskier the security (shares) is said to be.The more certain of the return from an asset, the less the variabilityand, therefore, less the risk.Measurement of Risk : The risk associated with a single asset isassessed from both a behavioural and a quantitative/statistical pointof view.The behavioural view of risk can be obtained by using (i) sensitivityanalysis and (ii) probability (distribution). The statistical measures ofrisk of an asset are (1) standard deviation and (2) coefficient of

variation.Portfolio Risk : Conceptually, the risk of a portfolio can bemeasured in much the same way as the risk of a single asset. Buttheir computation is to be differentiated as portfolio holdings confercertain benefits to investors as compared to holding of single assets.Portfolio investments provide an opportunity to diversify

investments. Successful diversification may make the risk of aportfolio investment less than the risk of the individual assets.Therefore, the portfolio standard deviation, as a measure of risk, isnot the simple weighted average of individual security standarddeviations mainly because of the correlation/covariance between thereturn on different securities constituting the portfolio.

Diversification : Diversification through combination of securities can be


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Diversification : Diversification through combination of securities can beused to reduce overall risk of a portfolio. By combining assets that have anegative (or low positive) correlation which ;existing assets, overall risk ofthe portfolio can be reduced. By combining negatively correlated assets,the overall variability of returns (risk) can be reduced. Even if the assetsare not negatively correlated, the lower the positive correlation between

them, the lower the resulting risk.

Risk Return Trade-off:

The relationship between the risk and the required rate of return.

Diversification through a combination of securities that are not perfectlypositively correlated helps to lessen the risk of portfolio.

Total portfolio risk has two components:

systematic/ non-diversifiable /unavoidable risk and (ii) unsystematic/diversifiable /avoidable.

The systematic risk is caused by risk factors that affect the overall market /all securities. Even an investor who holds a well-diversified portfolio isexposed to this type of risk.

The unsystematic risk is unique to a particular company/industry/security.This kind of risk can be reduced by diversification and through efficientdiversification can be even eliminated. Therefore, the important risk is thesystematic risk. Investors can expect compensation for bearing this typeof risk, but not for bearing unsystematic risk.

There is, thus, a trade-off between risk and return.

Legal and Tax Environment of financial decision making


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Legal and Tax Environment of financial decision makingDepends on the legal status of the institution

- Individual - Personal

- Partnership - Law of Partnership

- Company - Company act

- Co-operative - Co-operative Act

- Charitable - Indian Trust

- Bombay Trust

- Income Tax - Income Tax Act gives details about Income Tax liability exemptions

available on depending on the legal status- Sales Tax - For goods sold

- Excise Duty - For manufacturing industry

- Octroi - For bringing the goods into a particular area

- Customs Duty - For importing goods

- Import/ Export rules -

- Double Taxation - e.g. Taxation of the company

- Taxation of the Share holder on dividend

- Exemptions - e.g. 80 G of IT for charitable organizations

- Laws relating to Foreign Exchange

- Laws relating to Stock Markets

Financial Markets :


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Origin and development of money currency : Barter system Currency Plastic cards

Electronic transactions Gold eternal and universal currency.Money :Received for variety of purposes:

i. Self requirements - Personal- Business

ii. Asset creation

iii. For future requirementiv. For security andPaid for variety of Purposes :1. As commitment in exchange for product service2. Repay the debts.3. As investment to earn more money4. As a security

- Private Lenders- Concept of Interest- Concept of Security

- Hypothecation- Pledge- Mortgage- Lease

- Individual / collectoral securities


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Mutual Funds Concept


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Mutual Funds - Concept- UTI- LIC- Pvt. Mutual Fund

Pension Schemes - PPF, Gratuity etc.

- Government Securities- Bonds- Kisan Vikas Patra- RBI Bonds- Post Office Schemes- NSC

- Insurance - Concept

- Need

Different types of Insurance- e.g. Life- Fire and Accident- Loss

- Professional Indemnity- Property Liability- Health insurance

- Reinsurance

Assets :


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Assets :- Property and possessions of the company- Represent how funds are utilized in the business

Defined as valuable resources owned and controlled by a businessand are acquired at a measurable cost.

Characteristics :- Valuable resources- Owned and controlled by the company- Acquired at a measurable money cost

Types Current AssetsRepresent facilities or assets acquired with an intention of sale orconversion into finished goods to be marketed in the near future.

e.g. InventorySunday debtorsCashBankLoans

Advances

Fixed Assets :


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Fixed Assets : Represent facilities or assets acquired for carrying on business

operations. These are required with an intention to use in businessoperations (which cover, manufacture administration and marketing)and not to market these in the normal course of business.

e..g. LandBuilding Have longer useful economic lifeMachineryFurniture

Fixed Current

To use them Intention To market themLonger life Shorter life (Less than a year)Security Liquidity

Other Assets :- Intangible Assets e.g. Goodwill

Patents- Deferred charges


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Short Term Loans


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OR- Account payable - Claims of vendors of business

All credit purchases of goods and services.- Accrued liabilities

Represent the payment received in advance for services to be rendered in futuree.g. Rent received in advance

Expenses of salaries and wagesDividends payable

Estimated Liabilities :

They represent obligations for which the amount can not be determined withsubstantial accuracy (Termed as Provisions)e.g Tax liability

Warranty for goods

Long Term Liabilities : These are obligations which will mature after a period longer than year

- Secured- Unsecured

e.g. - Public DepositsLong term loans from financial institutionsDebentures or bonds.

However, installment due on long term loans during that year is current liability

Working Capital Management


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Working Capital Management

Working capital management is concerned with problems that arise inattempting to manage the current assets, the current liabilities and the

interrelationship that exists between them.

Current Assets: The assets, in the ordinary course of business canbe or will be, converted into cash within one year, without undergoinga diminution in value, and without disrupting the operations of the firm.

e.g. CashMarketable SecuritiesInventory

Current Liabilities: The liabilities, which are intended at theirinception to be paid in the ordinary course of business, within a year,out of the current assets or earnings of the concern.

e.g. Accounts payableBills payableBank overdraftOutstanding expenses

Th l f ki it l t i t th


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The goal of working capital management is to manage thefirms current assets and liabilities in such a way that asatisfactory level of working capital is maintained.

This is so because if the firm cannot maintain a satisfactorylevel of working capital it is likely to become insolvent andforced into bankruptcy.

The current assets should be large enough to cover its currentliabilities in order to reasonable margin of safety. Each of the

current assets must be managed efficiently in order tomaintain the liquidity of firm, while not keeping too high alevel of any of them. Each of the short term sources offinancing must be continuously managed to ensure that theyare obtained and used in the best possible way.

The interaction between current assets and current liabilitiesis therefore, the main theme of the theory of working capitalmanagement.

Working capital


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g pGross working capital - Total current AssetsNet working capital - Difference between Current assets

And Current liabilities.

i.e. Working capital (WC) - Current Assets (CA) -Current Liabilities (CL)

Thus working capital is represented by the excess of current assetsover current liabilities and identifies the relatively liquid portion of thetotal enterprise capital which constitutes a margin or buffer for

maturing obligations, within the ordinary operating cycle of business.

Working capital is the amount of funds required to finance day to dayoperations of a business.

A circulating or floating capital.

Used to obtain and retain the factors of production, which arenecessary to make fixed assets productive.

Working capital changes from day to day depending on the income

and expenditure or cash inflow and cash outflow.

Transactions affecting working capital


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CA WC

CA WC

CL WC

CL WC

Transactions not affecting WC

Simultaneous increase in CA and CL

Simultaneous decrease in CA and CL

Trade off between Profitability and Risk

The term profitability used in this context is measured by profits after expense. The term risk is defined as the probability that a firm will become technically insolvent

so that it will not be able to meet its obligations, when they become due for payment.

Greater the WC the less risk prone the organization and lesser profit.

Lesser the WC more risk prone and more profit.

Current Assets have a cost which include -

Financial cost - e.g.Storage costPilferageObsolenceBad Debt

This cost is also known as cost of liquidity.

Low Current Assets :


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May result in orders from customers

Technical bankruptcy

Loss of credibility and reputation

Also known as cost of liquidity or shortage cost

Cost of liquidity Profitability

Risk of Insolvency

The organization decides its policy of working capital management taking intoaccount the above principles.

- Sources of Working Capital- Funds from business operations

- Other incomes

- Sales of non current assets

- Long term borrowings

- Issues of additional equity capital or preference share capital- (Uses) ?

- Losses from business operations

- Purchase of non current assets

- Redemption of debentures and or preference

- Dividends to shareholders


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Components - Normally - Cash- Bank Balance- Raw material- Work in process

- Inventory- Receivable

Determining the financing mix - (Approaches to working capital management)

It is an important decision. Broadly speaking two sources from which funds can

be raised for current financing.

i. Short term sources

ii. Long term sources e..g. Share capitalLong term borrowingsInternally generated resources likeRetained Earnings

What proportion of current assets should be financed by current liabilities and howmuch by long term resources is the decision which determines the financial mix.

There are three approaches :


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e e a e t ee app oac es1. Matching approach (Hedging approach) Permanent funds required - Financed with long term funds e.g.

- Equity- Long term

- Debt.

Seasonal (Fluctuating) - With short Term funds.Funds required

2. Conservative approach:

A relative high proportion of long term funds are utilized to reduce the risk.

Use of short term funds is restricted to only emergency situations, or whenthere is an unexpected outflow of funds.

The conservative plan for financing is more expensive because the availablefunds are not fully utilized during certain periods.

Interest has to be paid for funds, which are not actually needed.

3. Aggressive Approach:

Permanent and fluctuating working capital are financed by Short Term Funds.

Higher profits but there are higher risks.

Operating of Cash Cycle :


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Operating cycle can be said to be at the heart of the need for workingcapital.

The continuing flow from cash to supplies to inventory, to accountsreceivable and back into what is called the operating cycle.

Operating cycle refers to the length of time necessary to complete thefollowing cycle of events :

i. Conversion of cash into inventory (raw materials)

ii. Conversion of raw materials into work in progress

iii. Conversion of work in progress into finished stock

iv. Conversion of finished tock into accounts

receivable through sales

v. Conversion of account receivable into cash.

Operation cycle of Manufacturing Concern

Cash

Debtors Raw Materials

(Receivables)

Finished

Stock Work in progress

Working capital cycle Hospital


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Working capital cycle Hospital

Inflow Cash Out flow

Collection Purchase of

From patients consumables

Billing of patients Payment of Salaries

Generation of Payment of General

Medical services expenses

Working Capital Long Term Funds


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- Investment in current assets

e.g. Cash

Marketable securitiesAccount receivable

Inventions

- Investment in fixed assets

Land, Building, Machinery,

Equipment, FurnitureFixtures

- Held for short term - For longer terms

- Can be converted into cash easily

(Liquid assets)

- Cannot be easily converted into cash

ordinarily not meant to be converted into

cash

- Fluctuating in nature

WC changes

Cash Inventory Debtors

Cash

- Static in nature

- Required in smaller quantity to carry out

routine functions

- Required in huge amounts to acquire

fixed assets

Types of working capital


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yp g p

Permanent working capital

Also known regular working capital or hard core

Minimum amount of investment in current assets that is deemed

necessary ;for carrying out operations for a period.

Fluctuating working capital (Variable working capital)

Additional assets required at different times to cover any change orvariability from normal operations

- Seasonal e.g. Sugar IndustryTypes

- Special e.g. Inflationary

RecessionStrikeTo take advantage of bulk discount

Factors (determinants) influencing the working capital needs.

Factors (determinants) influencing the working capital needs.


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(1) General Nature of Business(A) Manufacturing

- Trading(B) Seasonal

- Perennial(C) Cash sale

- Credit sale(D) Size of Business

- Volume of sales

(2) Production CycleIt refers to the time involved in the manufacture of goods. It covers the time-spanbetween the procurement of raw materials and the completion of the manufacturingprocess, leading to production of finished goods. Funds are to be tied up during theprocess of manufacture.

(3) Business cycle:

Business fluctuations lead to cyclical and seasonal, changes which in turn cause ashift in the working capital position, particularly for temporary capital requirements.

(4) Production Policy:

Policy of the company about volume of production to meet the requirement of seasonaland cyclical fluctuations in demand.

(5) Credit Policy:

The credit policy relating to sales and purchase affects the working policyContd..

(6) Growth and Expansion :As the company grows working capital requirement also grows Advance planning


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As the company grows, working capital requirement also grows. Advance planningis required to meet this demand.

(7) Vagaries in the availability of Raw material :The availability or otherwise of certain raw materials on a continuous basis without

interruption, affect the requirement of working capital.

(8) Profit Level :Expected profit policy determines the working capital mix and volume.It in turn depends on

i. Level of Taxesii. Dividend Policyiii. Depreciation Policy

(9) Price Level Changes :Changes in the price level affect the requirements of working capital e.g. rising pricesrequire more funds for maintaining an existing level of activity.

(10) Operating Efficiency :Operating efficiency of the management is also an important determinant of the levelof working capital.

Thus, the level of working capital is determined by a wide variety of factors, whichare partly internal to the firm and partly external (environmental) to it. Efficientworking capital management require efficient planning and a constant review of theneeds for an appropriate working capital strategy.

Computation of Working Capital:Two components of working capital (WC) are :


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Two components of working capital (WC) are :(i) Current Assets (CA)(ii) Current liabilities (CL)

In order to calculate we need -

(i) Holding periods of various types of inventories(ii) Credit Collection period(iii) Credit payment period to be known in advance.

Also one should know- Budgeted level of activity in terms of production and sales.

Estimation of CA :- Raw Materials Inventory- Work in Process (W/F) Inventory- Finished Goods inventory- Debtors- Cash and Bank Balances

Estimation of CL :- Trade creditors- Direct Wags- Overheads (other than depreciation and amortization) + Add contingency

CA CL = Working Capital

Estimation of Working Capital


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Estimation of Working Capital

Components of the operating cycle

- Input stock level

Materials and servicesStock level for safety period and Recording period

Production Process :

Wages, overheads

Input Output

Warehouse Stock -

Finished goods, normally valued at the cost of goods sold

Collection Period -

Credit Period - Receivable

Following steps :


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Determine level of activity during the period

Determine the type and quantity of inputs required for one unit of output

Ascertain the price of various inputs required for outputs

Ascertain the production stage at which the various inputs are added to theproduction process.

Ascertain the length of the production process (This is to ascertain the stockof work in process)

Ascertain the policies regardinga. input storage

b. finished goods stockc. credit to customersd. credit allowed by supplierse. cash balance to be retained.

Working Capital Management Technique

1. Ratio analysis

2. Fund flow and cash flow analysis

3. Schedules of changes in working capital

4. Management of various components of working capital

Working Capital Financing :

Aft d t i i th l l f ki it l th fi h t d id h it i t b


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After determining the level of working capital the firm has to decide, how it is to befinanced. The need arises because the investment in working capital/current assets, i.e.raw materials work/stock in process, finished goods and receivables fluctuate during theyear.

Financing of Working Capital

Long Term sources of Funds :- Retained earning- Fresh issues of shares- Raising of long term debts- Proceeds from sale of fixed assets

- Right debentures

Short Term Sources of Funds:- Credit from suppliers- Public deposits- Bank borrowings - Loans

OverdraftCash credit- Inter corporate deposits- Short term loans from financial institutions

A sound business principle is at least part of the working needs should be financed out of

the long term sources.

Trade Credit :


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Trade Credit :Credit extended by the supplier of goods and services inthe normal course of transaction / business / sale of the firm.Usually cash is not paid immediately for purchases, but after

agreed period of time. This, deferral of payment (trade credit)represents a source of finance.

Advantages:

i. It is an important source of financeii. Almost always automatic

iii. Flexible and spontaneous source of finance

iv. Negotiable

Disadvantages:

i. There is always a cost (although not stated)

ii. Not to fulfill the terms may prove very expensive (High rate of interest)

Bank Credit :


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1. Cash credit / overdraft

2. Loans

3. Bills purchased / discounted

4. Term loans for working capital upto 3-7 years

5. Letter of Credit

It is an indirect form of working capital financing and banks assumeonly the risk. The credit being provided by the supplier himself. Thebank undertakes the responsibility to make payment to the supplierin case the buyer fails to meet his obligations.

Mode of Security :

Hypothecation - movable property e.g. inventory of goods

- custody in the possessions of the owners (not thebank)

Pledge - custody in the possession of the bank

Lien - Lien refers to the right of the party to retain goods

belonging to another party until debt due is paid.

Mortgage :

It i th t f f l l/ it bl i t t i ifi i bl t f


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It is the transfer of legal/equitable interest in specific immovable property forsecuring the payment of debt. Possession is with the owner (not the bank).

Charge :

Where immovable property of one person is by the fact of parties or by theoperation of law made security for payment of money to another and thetransaction, does not amount to mortgage, the latter person is said to havecharge on the property.

Commercial Papers :

Commercial paper is a short term unsecured negotiable instrument,

consisting of usance promissory notes with a fixed maturity. It is issued ona discount on face value basis, but it can also be issued in interesting from.

Factoring :

It is an agreement in which receivables arising out of sale of goods/servicesare sold by a firm (client) to the factor (a financial intermediary) as a result

of which the title of goods/services represented by the said receivablespasses, on to the factor. Henceforth, the factor becomes responsible for allcredit control, sales accounting and debt collection from the buyer(s)

The factorer becomes responsible to absorb losses (if it happens).

Cash and marketable Securities management :

- Cash most liquid current asset


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Cash most liquid current asset

- Cash management is a major area of working capital management.

- Cash management - Cash - Cash- Cheques

- Drafts- Demand depositsNear - Marketable SecuritiesCash - Time Deposits in banks

Motives for holding cash :1. Transaction motive:

To meet routine cash requirements ti finance the transactions which a firm carries on in theordinary course of business.

2. Precautionary Motive:To meet the demands, which cannot be predicted or anticipated.

3. Speculative motive:To take advantage of opportunities which present themselves at unexpected moments andwhich are outside the normal course of business.

4. Compensating motive:To hold cash balance is to compensate banks for providing certain services and loans.

Documents

FINance MGT-1 Asma