Financial Management BCOM 501-18 Synetic Business School

A sound capital structure enables management to increase the profits of a company in the form of higher return to the equity shareholders i.e., increase in earnings per share. This can be done by the mechanism of trading on equity i.e., it refers to increase in the proportion of debt capital in the capital structure which is the cheapest source of capital. If the rate of return on capital employed (i.e., shareholders’ fund + long- term borrowings) exceeds the fixed rate of interest paid to debt-holders, the company is said to be trading on equity.

  • Profit is the measuring techniques to understand the business efficiency of the concern.
  • Thus, it measures the period of time for the original cost of a project to be recovered from the additional earnings of the project itself.
  • The proposal is accepted if the profitability index is more than one and is rejected in case the profitability index is less than one.
  • Micro-economics points out to the finance manager techniques for profit maximisation, with the limited finances at the disposal of the enterprise.

Public deposits are the fixed deposits accepted by a business enterprise directly from the public. This source of raising short term and medium-term finance was very popular in the absence of banking facilities. In the past, generally, public deposits were accepted by textile industries in Ahmadabad and Bombay for periods of 6 months to 1 year. But now-a-days even long-term deposits for 5 to 7 years are accepted by the business houses. In labour intensive industries, larger working capital will be required than in the highly mechanized ones. It may be remembered, however, that to some extent the decision to use manual labour or machinery lies with the management.

Stage I: Initial Stage- Low to moderate use of debt capital

This policy is based on management’s belief that shareholders are entitled to dividend only when earning and liquidity position of the firm warrant. In this sense, Net Present Value method seems to be better as it assumes that the earnings are reinvested at the rate of firm’s cost of capital. According to this method, various projects are ranked in order of the rate of earnings or rate of return. The project with the higher rate of return is selected as compared to the one with lower rate of return. This method can also be used to make decision as to accepting or rejecting a proposal.

  • It gives a contradictory result where under different alternative financing plans new equity shares are not taken into consideration.
  • Create a personal debt-equity ratio that is equal to exactly 50% of the debt-equity ratio of the firm.
  • Bonus share is made out of free reserves built out of the genuine profits or share premium collected in cash only.
  • Thus, a 10% stock dividend would give a holder additional 10 shares, whereas a 250% stock dividend would give him 250 additional shares.

The various projects are ranked under this method in order of their profitability index, in such a manner that one with higher profitability index is ranked higher than the other with lower profitability index. The determination of cost of capital is not a pre-requisite for the use of this method and hence it is better than net present value method where the cost of capital cannot be determined easily. Find out the Net Present Value by deducting from the present value of total cash flows calculated in above the initial cost of the investment. In the same way as above, it may not give good results while comparing projects with unequal investment of funds. As this method is based upon accounting concept of profits, it can be readily calculated from the financial data. One of the limitations of the pay-back period method is that is it ignores the life of the project beyond the pay-back period.

Finance also is referred as the provision of money at the time when it is needed. The CICI hit a nine-quarter low of 58 out of 200, continuing a largely declining trend since its inception during the first quarter of FY19 when it recorded a score of 119. The quarterly index evaluates 47 industries based on six parameters covering financial performance, creditworthiness and outlook. CredAble recently raised $30 million in its Series B round and is using the funds to enhance the company’s reach as well as solutions for small businesses via UpScale.

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Let us assume that two financial courses of action provide equal benefits (i.e. profits) over a certain period of time. However, one alternative gives more profits in earlier years; while the other one gives more profits in later years. The utilization of profits or surpluses is also an important factor in financial management. An effective use of surplus is essential for expansion and diversification plans and also in protecting the interests of shareholders. Firm U is the Unlevered Firm and Firm L is the Levered Firm.

  • In exceptional cases where the operating cycle of a business is longer than one year, a current liability is described as being payable within the term of the operating cycle.
  • This situation is obviously more preferable than options with a BCR lower than 1.
  • We all know that a firm may enter into a variety of transactions to accomplish its objectives.
  • At the same time it is the ultimate output expected to be realized by selling goods and services A firm should hold sufficient cash, neither more, not less.
  • The capital structure decision should be examined from the view point of its impact on firm’s value.

Objectives of financial management may be multiple; as this branch of general management encompasses the entire organizational functioning. No production, purchases or marketing are possible without being duly supported by requisite finances. Hence, Financial Management commands a higher status vis-a-vis all other functional areas of general management.

Traditional Approach

Moreover, the need for this types of cash balance may be reduced if there is already borrowing power in order to meet the emergency cash outflows. Sometimes a portion of such cash balances may be held in marketable securities, i.e., near-money assets. Because, sometimes, it is cheaper to sell short-term securities while it may be wise to borrow from banks at times.

optimum credit term exists when

In the net present value method the net present value is determined by discounting the future cash flows of a project at a predetermined or specified rate called the cut-off rate. But under the internal rate of return method, the cash flows of a project are discounted at a suitable rate by hit and trial method, which equates the net present value so calculated to the amount of the investment. First of all determine an appropriate rate of interest that should be selected as the minimum required rate of return called ‘cut -off rate or discount rate. The rate should be a minimum rate of return below which the investor considers that it does not pay him to invest.

Cash Management of Working Capital:

If ROI is less than the interest on debt, debt financing decreases ROE. When the ROI is more than the interest on debt, debt financing increases ROE. On the other hand, large companies issue various types of securities despite the fact that they pay less interest because investors consider large companies less risky. Assets structure implies the composition of total assets used by a firm i.e., make-up of the assets side of Balance Sheet of a company.

optimum credit term exists when

Profit maximization is also the traditional and narrow approach, which aims at, maximizes the profit of the concern. Financial management “as an application of general managerial Principles to the area of financial decision-making. The two banks are conducting further due diligence, since all details of the book weren’t revealed in the initial rounds, said the people cited above. Kotak Mahindra’s bid may have gone further than that of Axis, which has a large retail book and credit card base, they said. We can pay incremental attention to how the management chooses to react when the going gets tough; note the timing of regulatory filings; observe whether insiders are buying or selling stock, and much more. Personal leverage is not a perfect substitute for corporate leverage.

In other words, it occurs when a firm has more acceptable proposals than it can finance. At this point, the firm ranks the projects from highest to lowest priority and, as such, a cut-off point is considered. The provision for future requirement of capital Everything you need to find out about commercial papers is also to be considered while planning the capital structure of a company. A cautious investor who wants his capital to grow will prefer equity shares. Investment in countries other than the home country has a bearing of exchange rate risk on them.

Financial activities of a firm are one of the most important and complex activities of a firm. Therefore, in order to take care of these activities a financial manager performs all the requisite financial activities. Attention to Irregular Events-It provides funds to irregular events like consolidation, incorporation, reorganization, and mergers, etc. and does not give attention to everyday business operations. Gives importance to the Financial Problems of Corporations-It only focuses on the financial problems of corporate enterprises, so it narrows the opportunity of the finance function. Accounting and legal relationship between the source of finance and business. Formulate plans for the most effective utilisation of funds, among channels of investment, which create most wealth for the company.

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