Financial Management Free Essays

I believe that the code of ethics would be effective in an organization particularly when it comes to decentralization of the decision making authority. Employees are the most important assets of an organization and in order to maximize the utilization of these assets companies are focusing on building organizational cultures based on ownership, responsibility and accountability. The managements in companies are focusing on this objective because it enhances employee motivation. We will write a custom essay sample on Financial Management or any similar topic only for you Order Now As employees are empowered to make decisions, they begin to develop a sense of ownership over the operational processes and thus take the responsibility to improve effectiveness on their own. In this respect, organizational interests must be aligned to employee interests and this alignment is facilitated with the code of ethics. The code enables employees to take initiatives on their own in alignment with organizational interests. This alignment maximizes the strategic focus of the company and in that respect the code of ethics is an essential part of an effective organizational structure. Question 2 I was surprised by the contradiction between integrity and confidentiality. In the integrity section, employees are advised to apprise all parties of any potential conflicts. However I think that would violate the laws of confidentiality because certain information cannot be disclosed to all the parties in the company. Therefore I think the code should be modified to address this conflict between integrity and confidentiality. In the event that there is a breach in the code of conduct, then it should be treated strictly on a departmental basis in order to preserve confidentiality. However, according to the code, no such limitations are required.   In the event that the conflict cannot be resolved within the department, then it should be taken up to the next level. However, according to the points covered in the section of integrity, employees do not have to worry about who to pick in communicating the issues of the conflict. This would violate confidentiality which is the one of the critical success factors in any organization (cited in Brigham Ehrhardt, 2007). Therefore there is a gap here which should be addressed in the code. Comments I don’t think that it should be surprising that there should be a code of ethics in accounting discussion. This is particularly so in the current business environment in which the management is increasingly decentralizing the decision making process. As a result, a lot of the decisions have to be taken by the employees by themselves. In a lot of areas they do not have the luxury of supervision. It is in this respect that the code of ethics becomes a critical success factor. It guides the employees in making effective decisions if they should find themselves in situations which are difficult to resolve. Therefore this is a critical consideration for the management. If they are to effectively empower their employees, then they should provide the necessary framework in which employees can take decisions in alignment with the strategic focus of the organization. In this respect, the code of ethics can guide the employees. It must be remembered that in an organization there will be conflicts of interests between different departments. In such situations, it is absolutely essential that there should be a code of ethics to address the relevant issues without delay. Particularly when it comes to the dissemination of accounting information, the employees are frequently unsure of which information to communicate and which not to (cited in Higgins, 2007). In this respect, it is the duty of the management to develop a code of ethics which will enable the employers to make decisions without requiring supervision. In this respect, the management needs to communicate frequently with the employees in order to promote the use of the code of ethics in arriving at effective decisions. Employees may not bother to check with the guidelines before making their decisions. This is the issue that the management needs to address in creating a code of ethics for its organization. References Brigham, Eugene F., and Michael C. Ehrhardt. (2007). Financial Management: Theory Practice. South western college pub. Higgins, Robert C. (2007). Analysis of Financial Management. McGraw-Hill/Irwin. How to cite Financial Management, Essays Financial Management Free Essays Financial Management WORKBOOK The ICFAI University # 52, Nagarjuna Hills, Hyderabad – 500 082  © 2005 The Icfai University Press. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means – electronic, mechanical, photocopying or otherwise – without prior permission in writing from The Icfai University Press. We will write a custom essay sample on Financial Management or any similar topic only for you Order Now ISBN : 81-7881-969-4 Ref. No. FMWB 11200502 For any clarification regarding this book, the students may please write to us giving the above reference number of this book specifying chapter and page number. Financial Statements iframe class="wp-embedded-content" sandbox="allow-scripts" security="restricted" style="position: absolute; clip: rect(1px, 1px, 1px, 1px);" src="https://phdessay.com/financial-statements-2/embed/#?secret=ZB0sgqMct4" data-secret="ZB0sgqMct4" width="500" height="282" title="#8220;Financial Statements#8221; #8212; Free Essays - PhDessay.com" frameborder="0" marginwidth="0" marginheight="0" scrolling="no"/iframe While every possible care has been taken in type-setting and printing this book, we welcome suggestions from students for improvement in future editions. Preface The ICFAI University has been upgrading its study material to make it more beneficial to the students for self-study through the Distance Learning mode. We are delighted to publish a workbook for the benefit of the students preparing for the examinations. The workbook is divided into three parts. Effective from April, 2003, the examinations for all the subjects of DBF/CFA (Level-I) consist of only multiple choice questions. Brief Summaries of Chapters A brief summary for each of the chapters in the textbook is given for easy recollection of the topics studied. Part I: Questions on Basic Concepts and Answers (with Explanatory Notes) Students are advised to go through the relevant textbook carefully and understand the subject thoroughly before attempting Part I. In no circumstances should the students attempt Part I without fully grasping the subject material provided in the textbook. Frequently used Formulae Similarly the formulae used in the various topics have been given here for easy recollection while working out the problems. Part II: Problems and Solutions The students should attempt Part II only after carefully going through all the solved examples in the textbook. A few repetitive problems are provided for the students to have sufficient practice. Part III: Model Question Papers (with Suggested Answers) The Model Question Papers are included in Part III of this workbook. The students should attempt all model question papers under simulated examination environment. They should self score their answers by comparing them with the model answers. Each paper consists of Part A and Part B. Part A is intended to test the conceptual understanding of the students. It contains 40 questions carrying one point each. Part B contains problems with an aggregate weightage of 60 points. Please remember that the ICFAI University examinations follow high standards that demand rigorous preparation. Students have to prepare well to meet these standards. There are no shortcuts to success. We hope that the students will find this workbook useful in preparing for the ICFAI University examinations. Work Hard. Work Smart. Work Regularly. You have every chance to succeed. All the best. You can read also Portfolio Management Quizzes   Contents PAPER I Brief Summaries of Chapters Part I: Questions on Basic Concepts and Answers (with Explanatory Notes) 1 10 Frequently Used Formulae 101 Part II: Problems and Solutions 108 Part III: Model Question Papers (with Suggested Answers) 333 PAPER II Brief Summaries of Chapters 467 Part I: Questions on Basic Concepts and Answers (with Explanatory Notes) 480 Frequently Used Formulae 560 Part II: Problems and Solutions 570 Part III: Model Question Papers (with Suggested Answers) 749 Detailed Curriculum Paper I Introduction to Financial Management: Objectives, Functions and Scope, Evolution, Interface of Financial Management with Other Functional Areas, Environment of Corporate Finance. Indian Financial System: a. Financial Markets: Money Market, Forex Market, Government Securities Market, Capital Market, Derivatives Market, International Capital Markets. b. Participants: i. Financial Institutions: IDBI, IFCI, ICICI, IIBI, EXIM Bank, SFCs, SIDCs ii. Insurance Companies: LIC, GIC iii. Investment Institutions: UTI, Mutual Funds, Commercial Banks; Non-Banking Financial Companies; Housing Finance Companies; Foreign Institutional Investors. c. Regulatory Authorities: RBI, SEBI, IRA. Time Value of Money: Introduction; Future Value of a Single Cash Flow, Multiple Flows and Annuity, Present Value of a Single Cash Flow, Multiple Flows and Annuity. Risk and Return: Risk and Return Concepts, Risk in a Portfolio Context, Relationship between Risk and Return. Leverage: Concept of Leverage, Operating Leverage, Financial Leverage, Total Leverage. Valuation of Securities: Concept of Valuation, Bond Valuation, Equity Valuation: Dividend Capitalization Approach and Ratio Approach, Valuation of Warrants and Convertibles. Financial Statement Analysis: Ratio Analysis, Time Series Analysis, Common Size Analysis, Du Pont Analysis, Funds Flow Analysis, Difficulties associated with Financial Statement Analysis. Financial Forecasting: Sales Forecast, Preparation of Pro forma Income Statement and Balance Sheet, Growth and External Funds Requirement. Paper II Sources of Long-Term Finance: Equity Capital and Preference Capital, Debenture Capital, Term Loans and Deferred Credit, Government Subsidies, Sales Tax Deferments and Exceptions, Leasing and Hire Purchase. Cost of Capital and Capital Structure Theories: Cost of Debentures, Term Loans, Equity Capital and Retained Earnings, Weighted Average Cost of Capital, Systems of Weighting, Introduction to Capital Structure, Factors affecting Capital Structure, Features of an Optimal Capital Structure, Capital Structure Theories: Traditional Position, MM Position and its Critique Imperfections. Dividend Policy: Traditional Position, Walter Model, Gordon Model, Miller Modigliani Position, Rational Expectations Model. Estimation of Working Capital Needs: Objectives of Working Capital (Conservative vs. Aggressive Policies), Static vs. Dynamic View of Working Capital, Factors affecting the Composition of Working Capital, Interdependence among Components of Working Capital, Operating Cycle Approach to Working Capital. Financing Current Assets: Behavior of Current Assets and Pattern of Financing, Accruals, Trade Credit, Provisions, Short-Term Bank Finance, Public Deposits, Commercial Paper, Factoring, Regulation of Bank Credit. Management of Working Capital: a. Inventory Management: Nature of Inventory and its Role in Working Capital, Purpose of Inventories, Types and Costs of Inventory, Inventory Management Techniques, Pricing of Investments, Inventory Planning and Control; b. Receivables Management: Purpose of Receivables, Cost of Maintaining Receivables, Credit Policy Variables (Credit Standard, Credit Period, Cash Discount, Collection Program), Credit Evaluation, Monitoring Receivables; c. Treasury Management and Control; d. Cash Management: Meaning of Cash, Need for and Objectives of Cash Management, Cash Forecasting and Budgets, Cash Reports, Factors and Efficient Cash Management. Capital Expenditure Decisions: The Process of Capital Budgeting, Basic Principles in Estimating Costs and Benefits of Investments, Appraisal Criteria: Payback Period, Average Rate of Return, Net Present Value, Benefit-Cost Ratio, Internal Rate of Return, Annual Capital Charge, Infrastructure Decisions and Financing. Current Developments. Brief Summaries of Chapters Introduction to Financial Management †¢ The financial goal of any firm including public sector firms is to maximize the wealth of the shareholders by maximizing the value of the firm. †¢ The objective of financial manager is to increase or maximize the wealth of owners by increasing the value of the firm which is reflected in its earning per share and market value of the firm. †¢ Function of finance manager includes mobilization of funds, deployment of funds, control over the use of fund, and balancing the trade-off between risk and return. †¢ The advantages of sole proprietorship are (i) easy and inexpensive set up. (ii) few governmental regulations and (iii) no firm tax. Partnership firm is a business owned by two or more persons. They are partners in business and they bear the risks and reap the rewards of the business. A partnership firm is governed by the Indian Partnership Act, 1932. Hence it is relatively free from governmental regulations as compared to the joint stock companies. A group of persons working towards a common objective is a company. It represents different kinds of associations, be it business or non-business. †¢ Corporate investment and financing decisions are circumscribed by a government regulatory framework. The important elements of these framework re: (i) Industrials policy (ii) Industrial licensing provisions and procedure (iii) Regulation of Foreign Collaborations and Investment (iv) Foreign Exchange Management Act (v) Companies Act and (vi) SEBI. Indian Financial System †¢ The economic development of a country depends on the progress of its various economic units, namely the Corporate Sector, Government Sector and the Household Sector. †¢ The role of the financial se ctor can be broadly classified into the savings function, policy function and credit function. †¢ The main types of financial markets are: money market, capital market, forex market and credit market. †¢ The financial markets are further sub-divided into the Primary market and the Secondary market. †¢ A market is considered perfect if all the players are price takers, there are no significant regulations on the transfer of funds and transaction costs, if any, are very low. †¢ The accounting equation: Assets = Liabilities, can be altered as Financial Assets + Real Assets = Financial Liabilities + Savings. †¢ The main types of financial assets are deposits, stocks and debt. †¢ While designing a financial instrument, the issuer must keep the following in mind: cash flows required, taxation rules, leverage expected, dilution of control facts, transaction costs to be incurred, quantum of funds sought, maturity of plan required, prevalent market conditions, investor profile targeted, past performance of issues, cost of funds to be borne, regulatory aspects to abide by. †¢ While investing in a financial instrument, the investor must keep the following in mind: risk involved, liquidity of the instrument, returns expected, possible tax planning, cash flows required and simplicity of investment. †¢ Various financial intermediaries came into existence to facilitate a proper channel for investment. The main ones are: stock exchanges, investment bankers, underwriters, registrars, depositories, custodians, primary dealers, satellite dealers and forex dealers. Time Value of Money †¢ †¢ †¢ †¢ †¢ †¢ †¢ Additional compensation required for parting with say Rs. 1,000 now is called ‘interest’. There are two methods by which the time value of money can be taken care of compounding and discounting. Under the method of compounding, we find the Future Values (FV) of all the cash flows at the end of the time horizon at a particular rate of interest. Under the method of discounting, we reckon the time value of money now i. e. at time zero on the time line. So, we will be comparing the initial outflow with the sum of the Present Values (PV) of the future inflows at a given rate of interest. To determine the accumulation of multiple flows as at the end of a specified time horizon, we have to find out the accumulations of each of these flows using the appropriate FVIF and sum up these accumulations. Annuity is the term used to describe a series of periodic flows of equal amounts. To determine the present value, we have to first define the relevant rate of interest. Risk and Return †¢ The risk associated with a common stock is interpreted in terms of the variability of its return. The most common measures of riskiness of security are standard deviation and variance of returns. †¢ Unsystematic risk is the extent of the variability in the security’s return on account of the firm specific risk factors. This is also called diversifiable or avoidable risk factors. †¢ Systematic risk refers to factors which affect the entire market and hence the firm too. This is also called non-diversifiable risk. †¢ If a portfolio is well diversified, the unsystematic risk gets almost eliminated. The non-diversifiable risk arising from the wide movements of security prices in the market is very important to an investor. The modern portfolio theory defines the riskiness of a security as its vulnerability to market risk. This vulnerability is measured by the sensitivity of the return of the security vis-a-vis the market return and is called beta. †¢ The concept of security market line is developed by the modern portfolio theory. SML represents the average or normal trade-off between risk and return for a group of securities. Here the risk is measured typically in terms of the beta values. Application of Security Market Lines: The ex post SML is used to evaluate the performance of portfolio manager; tests of asset-pricing theories, such as the CAPM and to conduct tests of market efficiency. The ex ante SML is used to identify undervalued securities and determine the consensus, price of risk implicit in the current market prices. Depending upon the value of alpha, using SML it is possible to estimate whether the scrip is underpriced (it is then eligible to be purchased) or overpriced (it is then eligible to be sold). Valuation of Securities †¢ Value of any security can be defined as the present value of the future cash streams i. e. , the intrinsic value of an asset should be equated to the present value of the benefits associated with it. †¢ Book value is an accounting concept. Assets are recorded at historical costs and they are depreciated over years. Book value includes intangible assets at acquisition cost minus amortized value. The book value of debt is stated at the outstanding amount. The difference between the book value of assets and liabilities is equal to shareholder’s funds or net worth (which is equal to paid-up equity capital plus reserves and surplus). Replacement Value is the amount that a company would be required to spend if it were to replace its existing assets in the current condition. 2 †¢ Liquidation Value is the amount that a company could realize if it sells its assets after having terminated its business. It is generally a minimum value which a company might accept if it sells it s business. †¢ Going Concern Value is the amount that a company could realize if it sells its business as an operating one. Its value would always be higher than the liquidation value, the difference accounting for the usefulness of assets and value of intangibles. Market Value of an asset or security is the current price at which the asset or the security is being sold or bought in the market. †¢ Face Value: This is the value stated on the face of the bond and is also known as par value. It represents the amount of borrowing by the firm which it specifies to repay after a specific period of time i. e. , at the time of maturity. A bond is generally issued at face value or par value which is usually Rs. 100 and may sometimes be Rs. 1,000. †¢ Coupon Rate or Interest: A bond carries a specific rate of interest which is also called as the coupon rate. The interest payable is simply the par value of the bond ? Coupon Rate. Interest paid on a bond is tax deductible for the issuer. †¢ Maturity: A bond is issued for a specific period of time. It is repaid on maturity. Typically corporate bonds have a maturity period of 7-10 years whereas government bonds have a maturity period up to 20-25 years. †¢ Redemption Value: The value which a bondholder gets on maturity is called redemption value. A bond may be redeemed at par, at premium (more than par value) or at discount (less than par value). †¢ Market Value: A bond may be traded in a stock exchange. Market value is the price at which the bond is usually bought or sold in the market. Market value may be different from Par Value or redemption value. †¢ One Period Rate of Return: If a bond is purchased and then sold one year later, its rate of return over this single holding period can be defined as rate of return. †¢ Current Yield measures the rate of return earned on a bond if it is purchased at its current market price and if the coupon interest is received. †¢ Coupon rate and current yield are two different measures. Coupon rate and current yield will be equal if the bond’s market price equals its face value. †¢ Yield-to-Maturity (YTM): It is the rate of return earned by an investor who purchases a bond and holds it till maturity. The YTM is the discount rate which equals the present value of promised cash flows to the current market price/purchase price. †¢ Based on the bond valuation model, several bond value theorems have been derived which state the effect of the following factors on bond values: I. Relationship between the required rate of return and the coupon rate. II. Number of years to maturity. III. Yield-to-maturity. When the required rate of return (kd) is equal to the coupon rate, the value of the bond is equal to its Par Value. . e. , If kd = Coupon Rate; then value of a bond = Par Value. When the required rate of return (kd) is greater than the coupon rate, the value of the bond is less than its par value. If kd coupon rate; then value of a bond par value. When the required rate of return (kd) is less than the coupon rate, the value of the bond is greater than its par v alue. i. e. , if kd coupon rate; then value of a bond par value. †¢ †¢ †¢ 3 †¢ When the required rate of return (kd) is greater than the coupon rate, the discount on the bond declines as maturity approaches. †¢ When the required rate of return (kd) is less than the coupon rate, the premium on the bond declines as maturity approaches. †¢ A bond’s price is inversely proportional to its yield to maturity. †¢ For a given difference between YTM and coupon rate of the bonds, the longer the term to maturity, the greater will be the change in price with change in YTM. †¢ Given the maturity, the change in bond price will be greater with a decrease in the bond’s YTM than the change in bond price with an equal increase in the bond’s YTM. That is, for equal sized increases and decreases in the YTM, price movements are not symmetrical. For any given change in YTM, the percentage price change in case of bonds of high coupon rate will be smaller than in the case of bonds of low coupon rate, other things remaining the same. †¢ A change in the YTM affects the bonds with a higher YTM more than its does bonds with a lower YTM. A warrant is a call option to buy a stated number of shares. †¢ The exercise price of a warrant is what the holder must pay to purchase the stated number of shares. †¢ A convertible debenture, as the name indicates, is a debenture which is convertible partly or fully, into equity shares. If it is partially converted, it is referred to as ‘partly convertible debenture’ and if the debentures are converted into equity shares at the end of maturity fully, it is referred to as ‘fully convertible debentures’. The option of conversion is either at the discretion of the investor, i. e. , (optional) or compulsory (if it is specified). †¢ The conversion ratio gives the number of shares of stock received for each convertible security. If only the conversion ratio is given, the par conversion price can be obtained by dividing the conversion ratio multiplied by the face or par value of the convertible security. †¢ The conversion value represents the market value of the convertible if it were converted into stock; this is the minimum value of the convertible based on the current price of the issuer’s stock. †¢ Intrinsic value is the value of a stock which is justified by assets, earnings, dividends, definite prospects and the factor of the management of the issuing company. †¢ According to the dividend capitalization approach, which is a conceptually sound approach, the value of an equity share is the discounted present value of dividends received plus the present value of the resale price expected when the equity share is sold. The E(P/E) ratio is formed by dividing the present value of the share by the expected earnings per share denoted by E(EPS). Financial Statement Analysis †¢ A financial statement is a compilation of data, which is logically and consistently organized according to accounting principles. †¢ Financial Statement Analysis consists of the application of analytical tools and techniques to the data in financial statements in order to derive from them measurements and relationships that are significant and useful for decision making. †¢ The financial data needed in the financial analysis come from many sources. The important tools of analysis: 1. Ratio Analysis – Comparative Analysis – Du Pont Analysis 2. 4 Funds flow Analysis. †¢ The analysis of a ratio can disclose relationships as well as bases of comparison that reveal conditions and trends that cannot be detected by going through the individual components of the ratio. The usefulness of ratios is ultimately dependent on their intelligent and skillful interpretation. †¢ Financial ratios fall into three groups: 1. Liquidity Ratios 2. Profitability or Efficiency Ratios 3. Ownership Ratios – – – †¢ Earnings Ratios Dividend Ratios Leverage Ratios a. Capital Structure Ratios b. Coverage Ratios. Liquidity implies a firm’s ability to pay its debts in the short run. †¢ Current Ratio: The liquidity ratio is defined as: †¢ Current assets include cash, marketable securities, debtors, inventories, loans and advances, and pre-paid expenses. Current liabilities include loans and advances taken, trade creditors, accrued expenses and provisions. Quick Ratio Quick-test (also acid-test ratio) is defined as: = †¢ Current Assets Current Liabilities Quick Assets Quick Assets ? Inventories = Current Liabilities Current Liabilities Bank Finance to Working Capital Gap Ratio = Short ? term bank borrowings Working capital gap where Working capital gap is equal to current assets less current liabilities other than bank borrowings. †¢ Accounts receivable turnover ratio = †¢ Average collection period = = Net credit sales Average accounts receivable 360 Average accounts receivable turnover Average accounts receivable Average daily sales Cost of goods sold Average inventory †¢ Inventory turnover = †¢ The Gross Profit Margin Ratio (GPM) is defined as: Gross Pr ofit Net Sales Where net sales = Sales – Excise duty. †¢ The Net Profit Margin ratio (NPM) is defined as: †¢ Asset turnover ratio is defined as: Net Pr ofit Net Sales Sales Average assets 5 †¢ Earning power is a measure of operating profitability and it is defined as: Earning before interest and taxes Average total assets †¢ Return on Equity The Return on Equity (ROE) is an important profit indicator to shareholders of the firm. It is Net income calculated by the formula: Average equity †¢ Ownership ratios are divided into three main groups. They are: 1. 2. †¢ Earnings Ratios Leverage Ratios – Capital Structure Ratios – Coverage Ratios 3. Dividend Ratios. The earnings ratios are Earnings Per Share (EPS), price-earnings ratio (P/E ratio), and capitalization ratio. From earnings ratios we can get information on earnings of the firm and their effect on price of common stock. Net income (PAT) Number of outstanding shares †¢ Earning Per Share (EPS) = †¢ Price earnings multiple = †¢ Capitalization rate = †¢ Debt equity ratio = Debt Equity †¢ Debt-Asset ratio = Debt Assets †¢ Interest coverage ratio = †¢ Fixed charges coverage ratio Earning = †¢ Earnings per share Market price of the share EBIT Interest expense before depreciation, debt interest and lease rentals and taxes Debt interest + Lease rentals + Loan repayment installment + Preference dividends (1? tax rate) (1? tax rate) Debt Service Coverage Ratio = †¢ Market price of theshare Earnings per share PAT + Depreciation + Other non ? cash charges + Interest on term loan Interest on term loan + Repayment of the term loan Dividend Pay-out Ratio This is the ratio of Dividend Per Share (DPS) to Earnings Per Share (EPS) Dividend per share Market price of theshare †¢ Divident yield = †¢ Different types of comparative analysis are: 1. 2. 3. 6 Cross-sectional analysis Time-series analysis a. Year-to-year change b. Index analysis Common-size analysis. †¢ Cross-sectional analysis is used to assess whether the financial ratios are within the limits, they are compared with the industry averages or with a good player in normal business conditions if an organized industry is not there. †¢ A comparison of financial statements over two to three years can be undertaken by computing the year-to-year change in absolute amounts and in terms of percentage changes. †¢ When a comparison of financial statements covering more than three years is undertaken, the year-to-year method of comparison may become too cumbersome. In the analysis of financial statements, it is often instructive to find out the proportion that a single item represents of a total group or subgroup. In a balance sheet, the assets, the liabilities and the capital are each expressed as 100%, and each item in these categories is expressed as a percentage of the respective totals. Similarly, in the income statement, net sales ar e set at 100% and every other item in the statement is expressed as a percentage of net sales. †¢ Analyzing return ratios in terms of profit margin and turnover ratios, referred to as the Du Pont System. Funds Flow Analysis †¢ A funds flow statement is a statement which explains the various sources from which funds are raised and the uses to which these funds are put. †¢ The major difference, however, between a true funds flow statement and a balance sheet lies in the fact that the former captures the movements in funds, while the latter merely presents a static picture of the sources and uses of funds. †¢ A funds flow statement would enable one to see how the business financed its fixed assets, built up the inventory, discharged its liabilities, paid its dividends and taxes and so on. Similarly, it would enable one to see how the business managed to meet the above capital or revenue expenditure. †¢ The simplest funds flow statement for a period is the difference between the corresponding balance sheet items at the beginning and the end of the period, such that all increases in liabilities and decreases in assets are shown as sources of funds and all decreases in liabilities and increases in assets are shown as applications of funds. †¢ FFS can also be prepared with the help of the two balance sheets (opening and closing) and the profit and loss statement of the intervening period. Such a funds flow statement defines funds as â€Å"total resources† and the sources of funds will always be equal to the uses of funds. 7 †¢ A funds flow statement may be so prepared as to explain only the change in the working capital (current assets and current liabilities) from the beginning of a period to the end of the period. †¢ Sources of funds that increase cash are: – A net decrease in any asset other than cash or fixed assets. – A gross decrease in fixed assets. – A net increase in any liability. – †¢ Proceeds from the sale of equity or preference stock. – Funds from operations. Uses of funds which decrease cash include: – A net increase in any asset other than cash or fixed assets. – A gross increase in fixed assets. – A net decrease in any liability. – A retirement or purchase of stock. – Cash dividends. †¢ Gross changes in fixed assets is calculated by adding depreciation for the period to net fixed assets at the ending financial statement date. From this figure, the net fixed assets at the beginning of financial statement date is deducted. †¢ An increase in a current asset results in an increase in working capital. A decrease in a current asset results in a decrease in working capital. †¢ An increase in a current liability results in a decrease in working capital. †¢ A decrease in a current liability results in an increase in working capital. Leverage †¢ †¢ Leverage is the influence which an independent financial variable has over a dependent/ related financial variab le. Operating leverage examines the effect of the change in the quantity produced on the EBIT of the company and is measured by calculating the Degree of Operating Leverage (DOL). †¢ A large DOL indicates that small fluctuations in the level of output will produce large fluctuations in the level of operating income. †¢ DOL is a measure of the firm’s business risk. Business risk refers to the uncertainty or variability of the firm’s EBIT. So, every thing else being equal, a higher DOL means higher business risk and vice-versa. †¢ The financial leverage measures the effect of the change in EBIT on the EPS of the company. Financial leverage refers to the mix of debt and equity in the capital structure of the company. The measure of financial leverage is the Degree of Financial Leverage (DFL) †¢ If the management decides to finance a part of the total investment required of through debt financing, the following two factors are important: The proportion of total investment which the management decides to finance through debt (Debt Equity Ratio the firm aspires to) and the interest rate on borrowed funds. †¢ The greater the tax rate, the more is the tax shield available to a company which is financially leveraged. †¢ As the company becomes more financially leveraged, it becomes riskier, i. e. increased use of debt financing will lead to increased financial risk which leads to: Increased fluctuations in the return on equity and increase in the interest rate on debts. †¢ The greater the use of financial leverage, the greater the potential fluctuation in return on equity. 8 †¢ As the interest rate increases, the return on equity decreases. Even though the rate of return diminis hes, it might still exceed the rate of return obtained when no debt was used, in which case financial leverage would still be favorable. †¢ A combination of the operating and financial leverages is the total or combined leverage. Thus, the Degree of Total Leverage (DTL) is the measure of the output and EPS of the company. DTL is the product of DOL and DFL †¢ There is a unique DTL for every level of output. At the overall break-even point of output the DTL is undefined. If the level of output is less than the overall break-even point, then the DTL will be negative. If the level of output is greater than the overall break-even point, then the DTL will be positive. DTL decreases as the quantity of sales increases and reaches a limit of one. †¢ DTL measures the changes in EPS to a percentage change in quantity of sales. †¢ DTL measures the total risk of the company since it is a measure of both operating risk and total risk. Financial Forecasting †¢ Financial forecasting is a planning process with which the company’s management positions the firm’s future activities relative to the expected economic, technical, competitive and social environment. †¢ There are three main techniques of financial projections. They are proforma financial statements, cash budgets and operating budgets. †¢ Proforma statements are projected financial statements embodying a set of assumptions about a company’s future performance and funding requirements. Cash budgets are detailed projections of the specific incidence of cash moving in and out of the business. †¢ Operating budgets are detailed projections of departmental revenue and/or expense patterns, and they are subsidiary to both proforma statements and cash flow statements. †¢ Sales Budget can be prepared by making a sales for ecast, sales forecast can be made from subjective and objective methods. †¢ Subjective methods use the judgments or opinions of knowledgeable individuals within the company, ranging from sales representatives to executives. †¢ Objective methods are statistical methods which range in sophistication from relatively simple trend extrapolations to the use of complicated mathematical models. More and more companies are relying on computers to predict causal relationships. 9 Part I: Questions on Basic Concepts Introduction to Financial Management 1. 2. 3. 4. 5. 6. 7. The financial goal of a public sector firm fully owned by the government is to a Maximize the book value per share b. Maximize the profits earned by the firm c. Maximize the present value of stream of equity returns d. Maximize the return on equity e. Both (a) and (d) above. Which of the following is not an objective of financial management? a. Maximization of wealth of shareholders. b. Maximization of profits. c. Mobilization of funds at an acceptable cost. d. Efficient allocation of funds. e. Ensuring discipline in the organization. Which of the following is not a function of a finance manager? a. Mobilization of funds. b. Deployment of funds. c. Control over use of funds. d. Manipulate share price of the company. e. Maintain a balance between risk and return. The market value of the firm is the result of a. Dividend decisions b. Working capital decisions c. Capital budgeting decisions d. Trade-off between cost and risk e. Trade-off between risk and return. Which of the following is related to the control function of the financial manager? a. Interaction with the bankers for arranging a short-term loan. b. Comparing the costs and benefits of different sources of finance. c. Analysis of variance between the targeted costs and actual costs incurred. d. Assessing the costs and benefits of a project under consideration. e. Deciding the optimum quantity of raw materials to be ordered for procurement. The minimum number of persons required to form a private limited company and a public limited company respectively are a. and 5 b. 5 and 7 c. 2 and 7 d. 7 and 2 e. None of the above. Which of the following is an advantage of a sole proprietorship? a. Life of a firm is limited to the life of the owner. b. Fund raising from outside is easy. c. Limited personal liabilities. d. Easy and inexpensive to set-up. e. Expansion of Business is possible. Part I 8. Which of the following i s an advantage of partnership firms? a. The life of the firm is perpetual. b. Personal liabilities of the partners are limited. c. Its ability to raise funds is virtually unlimited. d. It is relatively free from Governmental regulations as compared to joint stock companies. . None of the above. 9. The objective of financial management is to a. Generate the maximum net profit b. Generate the maximum retained earnings c. Generate the maximum wealth for its shareholders d. Generate maximum funds for the firm at the least cost e. All of the above. 10. Which of the following statements represents the financing decision of a company? a. Procuring new machineries for the RD activities. b. Spending heavily for the advertisement of the product of the company. c. Adopting state of the art technology to reduce the cost of production. d. Purchasing a new building at Delhi to open a regional office. e. Designing an optimal capital structure by using suitable financial instruments. 11. The amount that can be realized by a company when it sells its business as an operating one is termed as a. Going concern value b. Market value c. Book value d. Replacement value e. Liquidation value. 12. Which of the following functions of the financial system facilitates conversion of investments in stocks, bonds, debentures etc. , into money? a. Savings function. b. Liquidity function. c. Payment function. d. Risk function. e. Policy function. 13. The objective of financial management to increase the wealth of the shareholders means to a. Increase the physical assets owned by the firm b. Increase the market value of the shares of the firm c. Increase the current assets of the firm d. Increase the cash balance of the company e. Increase the total number of outstanding shares of the company. 14. Which of the following is a function of the finance manager? a. Mobilizing funds. b. Risk return trade off. c. Deployment of funds. d. Control over the uses of funds. e. All of the above. 11 Financial Management Indian Financial System 15. A financial asset should necessarily have a. A claim to a payment in the form of an instrument b. An underlying asset, with a charge over it c. Parting of money today with an expectation that it will be returned in future with some addition to it d. Both (a) and (c) above e. All of (a), (b) and (c) above. 16. Which is/are the essential feature(s) of a Call Money Market? a. Maturity periods of 1-15 days. b. Market determined interest rates. c. Low liquidity. d. High agency costs. e. Both (a) and (b) above. 17. The apex financial institution in India that promotes housing finance is a. Housing Urban Development Corporation (HUDCO) b. Housing Development Finance Corporation Ltd. (HDFC) c. Cooperative Housing Finance Society d. National Housing Bank (NHB) e. LIC Housing Finance Limited. 18. â€Å"Single Window Lending† refers to a. An arrangement by which the lead bank in a consortium of banks releases the initial requirements of the borrower b. Loans given by commercial banks to the agricultural sector, which are subject to efinance from NABARD c. A specialized cell set up in scheduled banks exclusively for the purpose of industrial loans d. Priority sector lending by nationalized banks e. Loans given by NBFCs to some sectors to which nationalized banks are not allowed to give. 19. The difference(s) between Commercial Paper (CP) and Certificate of Deposit (CD) is/are a. CP is secured while CD is unsecured b. CPs can be issued by private sector companies while CDs can be issued by scheduled banks c. CP is sold at a discount and redeemed at face value whereas for CD the principal and interest are payable upon maturity d. Both (b) and (c) above e. All of (a), (b) and (c) above. 20. The money lent in money market for a period of 2 to 15 days is referred to as a. b. Demand loan c. Term loan d. Notice money e. 12 Call money None of the above. Part I 21. Which of the following are feature(s) of Gilt-edged securities? . Only repayment of principal is secured. b. They are issued by non-governmental service organizations. c. They are issued by government entities. d. The repayments of both principal and interest are secured. e. Both (c) and (d) above. 22. Which of the following provides liquidity to money market instruments by creating a secondary market where they can b e traded? a. Discount and Finance House of India. b. National Securities Depository Limited. c. State Bank of India. d. Reserve Bank of India. e. Over the Counter Exchange of India. 23. Which of the following is an example of non-fund based activity of an NBFC? . Bill discounting. b. Leasing. c. Issue management. d. Hire purchase. e. Inter-corporate loans. 24. The minimum maturity period for a Certificate of Deposit is a. Fifteen days b. One month c. Three months d. Six months e. No specific time limit is prescribed. 25. Statutory Liquidity Ratio (SLR) refers to the a. Percentage of secret reserves which acts as a cushion for nationalized banks b. Percentage of reserves banks are required to park with instruments approved by RBI c. Ratio between current account and fixed account deposits of banks d. Percentage of reserves banks are required to utilize only for forex ransactions e. Percentage of reserves meant for priority sector lending. 26. Public debt in the Indian economy is bein g managed by a. SBI on behalf of Government of India b. Ministry of Finance c. RBI d. All nationalized banks and term lending institutions e. Ministry of Commerce and Trade. 27. In which of the following instances bought-out deal is more appropriate? a. Companies do not wish to disclose information by way of public issue. b. Promoters do not want to dilute their stake by going public. c. Small projects require funds but costs of public issue are substantially high. d. Foreign Institutional Investors offload their shares when market is down. e. Board for Industrial and Financial Reconstruction (BIFR) offers a sick unit to existing blue chips in that industry. 13 Financial Management 28. Which of the following is/are not a feature(s) of National Stock Exchange? a. NSE was promoted by FIs at the bentest of GOI. b. The trading is on-line in national network. c. The volume of trading in it is less than that of BSE. d. It has a debt market segment. e. The weights to the stocks on NIFTY are based on total share holding. 29. Which of the following is/are not true in respect of PSU bonds? . There is no secondary market. b. Market lot for trading purposes is minimum of Rs. 10 crore. c. They come under â€Å"approved investments† by RBI. d. Both (a) and (b) above. e. All of (a), (b) and (c) above. 30. Unit banking refers to the system a. With a single bank having units at different places b. With the overall operations of a bank conducted from a singl e office c. Which deals with the units of UTI d. Which deals with the units in small-scale sector e. Either (a) or (b) above. 31. Which of the following is not a function performed by a financial system? a. Savings function. b. Liquidity function. . Risk function. d. Social function. e. Policy function. 32. The maturity period of a Certificate of Deposit (CD) issued by a bank is a. Not less than 1 month and not more than 6 months b. Not less than 2 months and not more than 9 months c. Not less than 15 days and not more than 12 months d. Not less than 4 months and not more than 12 months e. Not less than 1 month and not more than 12 months 33. If in an order to buy/sell shares from a stock exchange is limited by a fixed price it is called a. Limit order b. Limited discretionary order c. Stop loss order d. Best rate order e. None of the above. 4. ‘Gilt edged’ securities are the bonds issued by a. b. Multinational corporates c. Global corporations d. Central government e. 14 Big corporates Financial institutions. Part I 35. Medium dated government securities have maturities ranging from a. 1 to 3 years b. 1 to 5 years c. 3 to 5 years d. 3 to 10 years e. 5 to 10 years. 36. Which of the following maturity of T-Bills does not have a provision? a. 30-day. b. 91-day. c. 182-day. d. 364-day. e. None of the above. 37. In secondary spot capital market, the delivery and payment is completed a. On the same day of the date of contract b. How to cite Financial Management, Papers