Title: CAIIB-Financial Management- MODULE B STUDY OF FINANCIAL STATEMENTS M Syed Kunmir email
1CAIIB-Financial Management- MODULE BSTUDY OF
FINANCIAL STATEMENTSM Syed Kunmiremail
kunmir_at_yahoo.co.uk
2- Financial management involves the application of
general management principles to particular
financial operation. - - Howard and Upton
3- 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.
4- 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.
5- 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.
6- Maximisation of the value of the company is also
known as maximisation of the wealth of the owners.
7- To achieve maximisation of value of the company,
finance manager has to take careful decisions in
respect of - -Financing
- -Investment
- -Dividend
- -Current asset management.
8- 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.
9- 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.
10- 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.
11- 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. -
12Wealth 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.
13- 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.
14Profit 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.
15State 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.
16- 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
17- 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
18CAPITAL 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
19- Difficulties
- -Measurement problems
- -Uncertainty
- -Temporal spread
20- 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.
21- 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
-
22- 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.
23- 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.
24- 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.
25- Internal rate of return method
- A selection method using the compounding rate of
return on the cash flow of the project.
26- 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.
27- 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
28- 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.
29Sources 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.
30Study of financial statements
- Who are the party interested in firms financial
condition? - - Shareholders
- - Creditors/suppliers
- - Financiers
- - Employees
- - Tax authorities.
31- Long term sources
- - Preference shares
- - Bonds
- - Debentures
- and
- - Long term loans from financial
institutions..
32- Various sources of short term finance-
- - Cash credit
- - Overdraft
- - Billsdiscounting
- - Commercial papers and
- - Trade credit.
33- Short term long term cash forecasts
- Time periods involved -
- - Yearly for long term forecasts
- - Monthly for short term forecasts.
34- 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.
35- 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.
36- 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.
37- 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.
38- 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.
39- Overdraft and bank loan-
- - Overdraft is a running account
- - whereas bank loan instalment are fixed.
40- 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.
41- 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.
42- 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)
43- 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)
44- 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
45- Data for analyzing the situations of the firm
- Balance Sheet
- Income Statement
- Fund flow statement
46- 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
47- 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.
48Elements of financial statements
- Main financial statements
- Balance Sheet
- Income statement
- Statement of Sources of funds and Uses of funds
49Balance Sheet
50Income Statement
51Sources and Uses of Funds
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53- 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.
54- 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.
55- 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).
56- 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)
57- 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
-
58Tools of Analysis
Horizontal Analysis
Comparing a companys financial condition and
performance across time
Time
59Horizontal 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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61Comparative Statements
- Calculate Change in Dollar Amount
Dollar Change
Analysis Period Amount
Base Period Amount
62Comparative Statements
- Calculate Change as a Percent
Percent Change
Dollar Change Base Period Amount
100
6312,000 23,500 (11,500)
(11,500 23,500) 100 48.9
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65Now, lets review the dollar and percent changes
for the liabilities and shareholders equity
accounts.
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67Now, lets look at trend analysis!
68Trend Analysis
- Also called trend percent analysis or index
number trend analysis.
Trend analysis is used to reveal patterns in data
covering successive periods.
69Trend Analysis
- Berry Products
- Income Information
- For the Years Ended 31 December
2000 is the base period so its amounts will equal
100.
70Trend Analysis
- Berry Products
- Income Information
- For the Years Ended 31 December
71Trend Analysis
- Berry Products
- Income Information
- For the Years Ended 31 December
How would this trend analysis look on a line
graph?
72Trend Analysis
73Vertical 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.
74Common-Size Statements
- Calculate Common-size Percent
Common-size Percent
Analysis Amount Base Amount
100
75(12,000 315,000) 100 3.8
(23,500 289,700) 100 8.1
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79- 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
-
80- Profit maximization is a
- Short term concept
- long term concept
- both
- none of the above
81- Wealth maximization is a
- Short term concept
- long term concept
- either a or b
- both a b.
82- Criterion for payback period
- Accept PBPgttarget period
- Accept PBPlttarget period
- Accept PBPtarget period
- d) none of the above
83- Criterion for accounting rate of return
- Accept ARRgttarget rate
- Accept ARRlt target rate
- Accept ARRtarget rate.
- none of the above
84- Criterion for Net Present Value
- a)Accept NPVgt0
- b) Accept NPVlt0
- c) Accept NPV0
- d) none of the above
85- 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
86- Criterion for benefit cost ratio
- Accept BCR gt1
- Accept BCRlt1
- Accept BCR1
- none of the above
87- 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.
88- 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.
89- Fund Flow is
- a) Sources Uses statement
- b) Sources Statement
- c) Uses Statement
- d) none of the above.
90- Economic Income is defined as
- a) Change in wealth
- b) Change in income
- c) Change in profit
- d) none of the above
91 THANK YOU Email kunmir_at_yahoo.co.uk