CAIIB-Financial Management- MODULE B STUDY OF FINANCIAL STATEMENTS M Syed Kunmir email

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CAIIB-Financial Management- MODULE BSTUDY OF
FINANCIAL STATEMENTSM Syed Kunmiremail
kunmir_at_yahoo.co.uk
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• Financial management involves the application of
  general management principles to particular
  financial operation.
• - Howard and Upton

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• Attending to investment decisions
• - as to when and
• - how to acquire and allocate funds
• - for short-term and long-term assets keeping
  
• - in view the profit generation of the
  business
• - through which repayment obligation can be
  met.

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• Objectives and basic consideration of
• Financial management.
• Though profit maximisation is the objective of
  financial management
• The long-term goal of the business entity is to
  achieve maximising the shareholder value of the
  firm
• Because the principle of maximisation of
  shareholder wealth provides a rational guide for
  running a business and for efficient allocation
  of resources in society.

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• The key objective of Financial Management is to
  maximise the value of the company.
• This could be possible by
• good investment decisions
• prudent financing decisions and
• well thought-out financial planning and control.

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• Maximisation of the value of the company is also
  known as maximisation of the wealth of the owners.

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• To achieve maximisation of value of the company,
  finance manager has to take careful decisions in
  respect of
• -Financing
• -Investment
• -Dividend
• -Current asset management.

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• Financing decision-
• Has to decide on sources of funds for business.
• It is to be decided whether entire capital should
  be raised from equity capital or a part is to be
  raised from loan.
• Hence Debt/Equity ratio or Leverage are important
  since each source has in them associated risk
  factors involved.

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• Investment decision
• It relates to acquisition of assets.
• Assets are classified into
• real assets such as
• - land
• - building
• - plant
• - equipment etc.
• and
• - the financial assets are
• - shares and
• - debentures etc.
• It indicates available mix of financing to fund
  companys activities.
• Such decisions on investment in projects come
  within the field of capital budgeting which is
  derived from net present value of assets.

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• Dividend decision-
• - It is basically a financing decision.
• - This is because profit is a source of fund.
• - By not paying dividend, the retained
  earningsor reserve can be increased which
  could be otherwise available for investment.
• This ultimately lead to maximisation of wealth
  of the organisation provided decisions on
  investments are correct.

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• Current Asset Management-
• This is necessary to maintain balance between
  current assets and current liability,
• The liquidity of the business is interrupted
  because of holding too much fund in current
  assets.

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Wealth maximisation value maximisation

• The goal of financial management is to maximise
  the value of companies.
• This is generally expressed in terms of
  maximising the value of the ownership shares of
  the company
• In short,maximising share price.
• Thus,better performing companies can raise
  additional funds under more favourable terms.
• This basic objective of maximising the price of
  the companys shares is called value
  maximisation.

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• Social responsibility is also an important goal
  of
• a company which requires
• -Maximising share-price by efficient,well-
• managed operations related to consumer
• demand parameters.
• -Efficiency innovation leads to value
• maximisation which leads to new
• products,new technologies and better
• employment.
• -External factors like pollution,product
  safety and
• job safety have achieved added dimensions
  in
• relation to value maximisation.

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Profit maximisation vs.Wealth maximisation

• Long run vs.Short run Profits.
• Convert total corporate profits to earning per
  share(EPS).
• EPS is total profits divided by number of shares
  outstanding.
• Assume the firm earns Rs.10 mn.and has 1mn.shares
  outstanding.The EPS will work out to Rs.10.
• Profit maximisation is a short-term concept,
• while wealth maximisation emphasises the
  long-term view point.

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State whether true or false

• The income statement depicts the financial
  position of the firm at a given point of time
• The balance sheet gives the financial performance
  of the firm over a given period of time.
• These statements are prepared every week.
• Funds Flow statement gives the liquidity position
  of the firm.

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• Cash Flow statement tells from where the money
  comes and where it is used.
• The prime objective of financial management is
  wealth maximisation,and not profit maximisation.
• What is earnings per share?
• a)Net Profit
• b)Profit before interest and tax
• c)Total earnings divided by investment
• d)Net profit divided by equity

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• What is the difference between long term funds
  and short term funds?
• -Difference in interest rates
• -Difference in time of repayment
• -Difference in the size of loan
• -No difference

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CAPITAL EXPENDITURE DECISIONS AND PROFITABILITY
STUDY

• It represents the important decisions taken by
  the firm.
• Importance due to the following issues
• -Long-term effects
• -Irreversibility
• -Substantial outlays

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• Difficulties
• -Measurement problems
• -Uncertainty
• -Temporal spread

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• Phases of capital budgeting
• -Capital budgeting is a complex process which
  
• may be divided into five broad phases.
• 1) Planning
• 2) Analysis
• 3) Selection
• 4) Implementation
• 5) Review.

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• Levels of Decision Making
• -Operating decisions
• -Administrative decisions
• -Strategic decisions
• Profitability Study important facets are
• -Market analysis
• -Technical analysis
• -Financial analysis
• -Economic analysis
• -Ecological analysis

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• The basic characteristic of a capital project is
  that it typically involves
• - A current outlay(or current and future
  outlays)of funds
• - In expectation of a stream of benefits
• - Extending far into future.

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• Accounting rate of return method
• - A selection criterion using average net
  income and investment outlay to compute a rate
  of return for a project.
• - This method ignores the time value of money
  cash flows.

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• Net Present Value method
• - A selection method using the difference
  between the present value of the cash inflows
  of the project and the investment outlay.
• - The method evaluates the differential cash
  flow between proposals.

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• Internal rate of return method
• A selection method using the compounding rate of
  return on the cash flow of the project.

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• Payback method
• - A selection method in which a firm sets a
  maximum payback period during which cash inflow
  must be sufficient to recover the initial
  outlay.
• - This method ignores the time value of money
  and cash flow beyond the pay back period.

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• What are the three important factors which arise
  from capital expenditure decisions?
• a)Long-term effects e)Debt
• b)Profitability f)Substantial
  outlays
• c)Irreversibility g)Short-term
  effects.
• d)Risk
• Why are capital expenditure decisions difficult?
• i)Uncertainity in predicting costsbenefits
• ii)Difficulty in measurement of
  costsbenefits
• iii)Risk involved
• iv)Problems in estimating discount rates
• v)All the above

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• If the IRR of the project is 7 and the cost of
  capital is (11.4 should we reject or accept the
  project). Yes/No.
• The firm should always make an ecological
  analysis to know the likely damage that may be
  caused by the project to the environment.
• a)Must do b)No need.

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Sources of finance and cost of capital

• For what purposes a firm needs a finance?
• - Since the cash receipts lag behind cash
• payments necessitating
• - loans,bonds,overdrafts etc.
• - the firm needs finance for short term and
  long term requirements-
• - fixed assets and working capital.
• Permanent sources of finance Share capital
  and retained profits.

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Study of financial statements

• Who are the party interested in firms financial
  condition?
• - Shareholders
• - Creditors/suppliers
• - Financiers
• - Employees
• - Tax authorities.

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• Long term sources
• - Preference shares
• - Bonds
• - Debentures
• and
• - Long term loans from financial
  institutions..

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• Various sources of short term finance-
• - Cash credit
• - Overdraft
• - Billsdiscounting
• - Commercial papers and
• - Trade credit.

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• Short term long term cash forecasts
• Time periods involved -
• - Yearly for long term forecasts
• - Monthly for short term forecasts.

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• Factors considered in equity financing
• - Issue costs
• - servicing costs such as paying out
• dividends
• - when there is retained earnings
• there will be capital appreciation of
  sharevalues.

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• Preference Shares
• - These shareholders get a fixed return
  and their risk is less than the equity
  Shareholders.
• - They have a right to the first slice
• of dividend.
• - Obligation to redeem the preference
• shares after its time period.
• - They do not have a right to vote.

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• Debentures or loan financing
• - the firm will have to pay fixed
  interest every year.
• - There is an obligation to
  redeem it at the end of the period.
• - There is also an advantage of tax
  deductibility of interest paid which
  makes it cheaper.

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• Bills rediscounting
• - The buyer can repay in a long period
  of time
• - while seller gets his money back by
  discounting the bills.
• - For the seller, this helps him to go
  ahead with production and increase the
  turnover.

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• Working capital term loan
• A part of working capital has to be with the
  manufacturer since there is a time lag between
  ordering and procuring.
• This particular portion (say25)can be financed
  by long term funds.
• When firm is not able to infuse its own funds for
  this purpose,it gets a long term loan from the
  bank.
• This carries fixed interest and for a fixed
  period.

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• Overdraft and bank loan-
• - Overdraft is a running account
• - whereas bank loan instalment are fixed.

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• Trade credit
• - When materials are bought from
  suppliers,the trade credit is extended
  for few days or a couple of months.
• - The supplier is willing to wait to
  collect money.
• - This also depends on the suppliers
  financial position and
• - The buyers credit worthiness.

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• Commercial paper
• - These are short term promissory notes
  with fixed maturity period.
• - They are issued by very large companies
  
• - Who are reputed and
• - Have high credit worthiness.
• - Credit rating agencies certify their
  credit rating.

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• Firmscost of capital-A firms is the average
  cost of capital is the weighted average
  arithmetic mean of the cost of resources from
  various sources.
• Questions
• a)Long term sources are banks and financial
• institutions (T/F)
• b)Current liabilities should be repaid
  within a
• financial year(T/F)
• c)Fixed assets are generally financed with
• current liabilities(T/F)

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• Equity Shareholders bear the greatest risk(T/F)
• Bills discounting scheme has been introduced to
  ease flow of funds in the economy(T/F)
• Trade creditors are suppliers of goods and
  services to whom the firm is yet to pay.(T/F)
• Accounts Receivables should be less than trade
  creditors(T/F).
• Bills of Exchange is same as cash credit(T/F).
• Equity and Preference shares are one and the
  same(T/F)
• A part of working capital can be financed by long
  term sources(T/F)

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• A firm borrows Rs.20,000 from bank _at_8 and floats
  a debenture for Rs.60,000 _at_6,for a special
  project,what is the cost of capital of the
  project?
• a)5.5 b)6.5 c)7.5 d)8.5
• If a firm borrows Rs.2 lac _at_10 and has a tax
  rate of 40.What is the cost of capital?
• a)5 b)6 c)7 d)8

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• Data for analyzing the situations of the firm
• Balance Sheet
• Income Statement
• Fund flow statement

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• Basic concepts while preparing balance sheet
• - Entity concept
• - Money measurement concept
• - Going concern concept
• - Cost concept
• - Consevatism concept
• - Dual aspect concept
• - Accounting period concept
• - Accrual concept
• - Realisation concept
• - Matching concept

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• What is revenue reserve capital reserve?
• Revenue reserves are accumulated earnings
  from profits and normal business operations.
• Capital reserves arise due to capital gains
  from revaluation of assets or due to premium on
  issue of shares.

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Elements of financial statements

• Main financial statements
• Balance Sheet
• Income statement
• Statement of Sources of funds and Uses of funds

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Balance Sheet
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Income Statement
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Sources and Uses of Funds
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• Accounts payable-These are current liabilities
  payable within one year from date of balance
  sheet.
• Fund Flow Statement-It shows the sources and uses
  of funds during a given accounting period.
• Horizontal analysis and Vertical analysis-
• Horizontal analysis is comparing the
  operations over a time period ie.comparing past
  performance with current position for predicting
  the future performance.

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• In vertical analysis we use percentages to show
• the relationship between various items in the
• balance sheet.
• a)X contributes Rs.10,000 to his properietory
  concern and the amount is deposited in the
  bank.What is the nature of liability?
• i)Owners equity
• ii)Loan
• iii)Short term finance
• iv)Fixed Asset.

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• Cost of goods sold and Cost of production refer
  to the same amount(T/F)
• Net profit is calculated before tax(T/F)
• Balance sheet and Income statement can be
  prepared every quarter for internal use(T/F)
• A loss is shown as asset in the balance
  sheet(T/F).

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• Provisions for taxes and accrued expenses to be
  paid within a year are current assets(T/F)
• Debtors(also known as accounts receivable)represen
  t the amount of money to be paid by the firm to
  the suppliers(T/F)
• Fund Flow statements can be prepared without the
  basis of balance sheets(T/F).
• Fund flow statements represent only bank
  borrowing and trade credit(T/F)

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• State whether following are sources or uses
• -Buying materials
• -Payment of dividend to shareholders
• -Advance received from buyer of goods
• -Investment in machinery
• -Issue of debentures
• -Retained earnings
• -Increase in Inventories
• -Sale of old machinery

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Tools of Analysis
Horizontal Analysis
Comparing a companys financial condition and
performance across time
Time
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Horizontal Analysis
Now, lets look at some ways to use horizontal
analysis.
Time
The term horizontal analysis arises from
left-to-right (or right-to-left) movement of our
eyes as we review comparative financial
statements across time.
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Comparative Statements

• Calculate Change in Dollar Amount

Dollar Change
Analysis Period Amount
Base Period Amount


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Comparative Statements

• Calculate Change as a Percent

Percent Change
Dollar Change Base Period Amount

100

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12,000 23,500 (11,500)
(11,500 23,500) 100 48.9
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Now, lets review the dollar and percent changes
for the liabilities and shareholders equity
accounts.
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Now, lets look at trend analysis!
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Trend Analysis

• Also called trend percent analysis or index
  number trend analysis.

Trend analysis is used to reveal patterns in data
covering successive periods.
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Trend Analysis

• Berry Products
• Income Information
• For the Years Ended 31 December

2000 is the base period so its amounts will equal
100.
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Trend Analysis

• Berry Products
• Income Information
• For the Years Ended 31 December

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Trend Analysis

• Berry Products
• Income Information
• For the Years Ended 31 December

How would this trend analysis look on a line
graph?
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Trend Analysis
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Vertical Analysis
V e r t i c a l A n a l y s i s
Vertical Analysis is also called as common-size
analysis
The term vertical analysis arises from the
up-down (down-up) movement of our eyes as we
review common-size financial statements.
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Common-Size Statements

• Calculate Common-size Percent

Common-size Percent
Analysis Amount Base Amount


100
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(12,000 315,000) 100 3.8
(23,500 289,700) 100 8.1
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• ABC co.paid Rs.30,000 as deposit to the suppliers
  for a period of 3 months.
• i)Liability
• ii)Current Asset
• iii)Trade Credit
• iv)Debenture
• Materials costing Rs.2000 destroyed by fire
• i) Reduction in Asset
• ii)Reduction in liability

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• Profit maximization is a
• Short term concept
• long term concept
• both
• none of the above

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• Wealth maximization is a
• Short term concept
• long term concept
• either a or b
• both a b.

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• Criterion for payback period
• Accept PBPgttarget period
• Accept PBPlttarget period
• Accept PBPtarget period
• d) none of the above

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• Criterion for accounting rate of return
• Accept ARRgttarget rate
• Accept ARRlt target rate
• Accept ARRtarget rate.
• none of the above

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• Criterion for Net Present Value
• a)Accept NPVgt0
• b) Accept NPVlt0
• c) Accept NPV0
• d) none of the above

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• Criterion for IRR(Internal Rate of Return)
• Accept IRRgtCost of capital
• Accept IRR ltCost of capital
• Accept IRR Cost of capital
• none of the above

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• Criterion for benefit cost ratio
• Accept BCR gt1
• Accept BCRlt1
• Accept BCR1
• none of the above

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• Common size statements are
• Financial Statements that depict financial data
  in the form of verticle percentages
• Financial Statements that depict financial data
  in the form of horizontal percentages
• Both a b
• none of the above.

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• Horizontal Analysis is
• a)Changes in financial statements
• b) percentage analysis of increase decrease in
  corresponding items in comparative financial
  statements.
• c) Financial statements which depict financial
  data.
• d)none of the above.

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• Fund Flow is
• a) Sources Uses statement
• b) Sources Statement
• c) Uses Statement
• d) none of the above.

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• Economic Income is defined as
• a) Change in wealth
• b) Change in income
• c) Change in profit
• d) none of the above

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THANK YOU Email kunmir_at_yahoo.co.uk