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CONCEPT OF FINANCIAL MANAGEMENT

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concept of financial management what is finance sub-set of economics and in essence is also termed as applied micro-economics. important business activity. – PowerPoint PPT presentation

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Title: CONCEPT OF FINANCIAL MANAGEMENT


1
CONCEPT OF FINANCIAL MANAGEMENT
  • What is Finance
  • SUB-SET OF ECONOMICS AND IN ESSENCE IS ALSO
    TERMED AS APPLIED MICRO-ECONOMICS.
  • IMPORTANT BUSINESS ACTIVITY.
  • FUND MANAGEMENT SCIENCE.
  • FOCUSES IN WEALTH MAXIMIZATION GOAL/ENHANCING
    FIRMS VALUE.
  • FOCUSES ON FUTURE DECISION BASED ON ACCOUNTING
    FINANCIAL STATEMENTS.
  • ALSO REFERRED AS CORPORATE FINANCE OR MANAGERIAL
    FINANCE.

2
BASIC CONCEPT OF NATIONAL INCOME AND ECONOMIC
INDICATORS
  1. GDP A measure of the final goods and services,
    produced by the residents of the country with
    resources located in that country.
    GDP(CIG)(X-M) Domestic Economy 5.3
    Indias GDP growth during Jan-March 2011-12,
    slowest in 9 years.
  2. GNP The value measured at market prices, of all
    final goods and services produced by an economy
    in one year. GNP(CIG)(X-M)(RP) Open
    Economy
  3. IIP Index of Industrial production, released
    monthly, is a measure of capturing production
    across factories in India. It records output in
    factories across three categories-mining,
    electricity, manufacturing, IIP was flat at 0.1
    in April.
  4. WPI Wholesale price Index This is Indias most
    watched cost of living index. Calculated on a
    monthly basis, the index gives trends in
    inflation rate or the rate at which wholesale
    prices of goods such as vegetables, fuel,
    manufactured items and food grains are changing.
    It rose to worrisome 7.55 in May.
  5. CPI Consumer Price Index released monthly,
    gives retail prices of almost all everyday
    products and services from food to footwear and
    movie tickets to medicine. It is more realistic
    cost-of-living index because it captures shop-end
    prices. It rose 10.36 in May, showing government
    inability to cool prices.
  6. Sensex The Bombay Stock Exchanges (BSE)
    benchmark 30-share index (reflects the weighted
    arithmetic average of price relatives of 30
    sensitive shares) is a barometer for equity
    markets, perhaps the first indicator (base year
    for calculation of sensex is 1978-79 value 100)
    about the health of the economy and investor
    sentiments. The Sensex closed up 76 pts. at
    17,538.67 on Thursday (5th July), a three-month
    high, amid strong expectations about reformist
    moves in the coming weeks.

3
SUB-SET OF ECONOMICS
The fundamental Approach says
  • Economics Focuses on optimization of Valued
    Goals.
  • Finance Focuses on Wealth Maximization
  • To Sum up, a basic knowledge of macro-economics
    is necessary for understanding the environment in
    which company/firm operates.
  • Good grasp of micro-economic principles is
    helpful in sharpening the tools of financial
    decision making

4
IMPORTANT BUSINESS ACTIVITIES
  • Major Business Activities in a Firm is
    categorized as-
  • PRODUCTION
  • MARKETING
  • FINANCE

5
FUND MANAGEMENT SCIENCE
  1. CHOICE OF FINANCIAL MARKET
  2. CHOICE OF FINANCIAL INSTRUMENT---FINANCING
    DECISION
  3. OPTIMUM CAPITAL STRUCTURE DECISION
  4. OPTIMIZATION OF COST OF CAPITAL

The Business Proposal
6
FUND MANAGEMENT SCIENCE
FINANCE FUNCTION
  1. Investment or Long Term Asset Mix Decision
  2. Financing or Capital Mix Decision
  3. Dividend or Profit Allocation Decision
  4. Liquidity or Short Term Asset Mix Decision

7
FOCUSES IN WEALTH MAXIMIZATION GOAL/ENHANCING
FIRMS VALUE -The process of value creation
VALUE
CREATION
Economic Risk Operational
Risk Financial Risk
Business Risk
8
RISK-RETURN PARADOX
Contradictory
9
FOCUSES ON FUTURE DECISION BASED ON ACCOUNTING
FINANCIAL STATEMENTS
  • Share Capital
  • Equity
  • Preference
  • Reserve Surplus
  • Secured Loans
  • Debentures
  • Loans and advances
  • Unsecured Loans
  • Current Liabilities and Provisions
  • Trade Creditors
  • Provisions
  • Fixed Assets (net)
  • Gross block
  • Less depreciation
  • Investments
  • Current Assets, loans and advances
  • Cash and bank
  • Receivables

Working Capital financing policy
Capital Budgeting
Portfolio Management
Cash Management
Credit Management
Inventory Management
10
ALSO REFERRED AS CORPORATE FINANCE OR MANAGERIAL
FINANCE The Role of The Financial Manager
  • The Balance-Sheet Model of the Firm-Traditional
    Approach

The Net Working Capital Investment Decisions
Current Liabilities
Current Assets
Net Working Capital
Long-Term Debt
  • Investment Decisions
  • Capital
  • Budgeting
  • Financing Decisions
  • Capital Structure

Fixed Assets 1 Tangible 2 Intangible
Shareholders Equity
11
FOCUSES ON FUTURE DECISION BASED ON ACCOUNTING
FINANCIAL STATEMENTS
Revenue Risk
  • Net Sales
  • Cost of goods sold
  • stocks
  • Wages and salaries
  • Other manufacturing expenses
  • Gross Profit
  • Operating expenses
  • Selling Administration expenses
  • Depreciation
  • Operating Profit
  • Non-operating surplus/deficit
  • Earnings before income and tax
  • Interest
  • Profit before tax
  • Tax
  • Profit after Tax
  • Dividends
  • Retained earnings

Gross Profit Margin
Depreciation Policy
Business Risk
Financial Risk
Tax Planning

Return on Equity
Dividend Policy
12
ALSO REFERRED AS CORPORATE FINANCE OR
MANAGERIAL FINANCE The Role of The Financial
Manager
Financial
Firm's
Financial
managers
operations
markets
(5)
Government
13
ALSO REFERRED AS CORPORATE FINANCE OR MANAGERIAL
FINANCE The Role of The Financial Manager
  • Contemporary Approach
  • Concern on Institutional Imperatives referred as
    the focus which lead to divergence between the
    goals of Managers and Shareholders. Instead of
    merely focusing on the efficient allocation of
    funds among various assets and the acquisition of
    funds on favorable terms.
  • A fundamental change in financial management is
    the direct result of two recent trends the
    Globalization of Competition and the Integration
    of World financial markets facilitated by
    Improved ability to collect and analyze
    information.
  • A common element, which distinguishes the recent
    Financial Management tools from the earlier ones
    have emerged predominantly from practice and from
    consultants. The modern approaches also have
    developed concerning the pursuit of shareholder
    value.

14
ALSO REFERRED AS CORPORATE FINANCE OR MANAGERIAL
FINANCE The Role of The Financial Manager
Competencies
Business Knowledge

Effective Costing, Planning Evaluation

Risk Management

Standards Compliance

Effective Communication

Performance Management

Forecasting, Planning and Budgeting

Accounting/ Financial Knowledge
Value- for- Money
Strategic Focus
Valued-added Advice
15
CONCEPT OF ECONOMIC VALUE ADDED
  • Traditional approaches to measuring
    Shareholders Value Creation used parameters
    such as earnings capitalisation, market
    capitalisation and present value of estimated
    future cash flows.
  • Extensive equity research has now established
    that it is not earnings per se, but value which
    is important.
  • A new measure called Economic Value Added (EVA)
    is increasingly being applied to understand and
    evaluate financial performance.
  • EVA NOPAT COCE (Net operating profit after
    taxes Cost of Capital Employed)
  • NPOAT Profits after depreciation and taxes but
    before interest costs. NOPAT thus represents the
    total pool of profits available on an ungeared
    basis to provide a return to lenders and
    shareholders
  • COCE Weighted average cost of capital (WACC x
    Average capital employed)

16
CONCEPT OF ECONOMIC VALUE ADDED
  • What does EVA show ?
  • EVA is residual income after charging the Company
    for the cost of capital provided by lenders and
    shareholders. It represents the value added to
    the shareholders by generating operating profits
    in excess of the cost of capital employed in the
    business.
  • When will EVA increase ?
  • Operating profits can be made to grow without
    employing more capital, i.e. greater efficiency.
  • Additional capital is invested in projects that
    return more than the cost of obtaining new
    capital, i.e., profitable growth.
  • Capital is curtailed in activities that do not
    cover the cost of capital, i.e., liquidate
    unproductive capital.
  • Utility of EVA
  • (i) EVA represents the value added to the
    shareholders by generating operating profits over
    and above the cost of capital employed in the
    business. Hence it is a measure of financial
    performance.

17
CONCEPT OF ECONOMIC VALUE ADDED
  • Utility of EVA Continued
  • (ii) EVA is a management tool that discloses the
    impact of both strategic as well as operational
    decision of the management. The examples of
    strategic decisions are what investment to make,
    which business to exist, which financial
    structure is optimal, etc. While operational
    decision include, whether to make in house or out
    source, repair or replace equipment or, make
    short or long production runs, etc.
  • (iii) EVA can prove as an effective tool for
    increasing shareholders wealth, through
    integrating EVA framework in four key areas,
    viz., to measuring business performance, guiding
    managerial decision-making, aligning managerial
    incentives with shareholder interests and
    improving the financial and business literacy
    throughout the organisation.

18
The Foreign Exchange Market
  • The foreign exchange market is the market where
    the currency of one country is exchanged for the
    currency of another country. Most currency
    transactions are channelled through the
    world-wide interbank market. Interbank market is
    the wholesale market in which major banks trade
    with each other.
  • Participants
  • Speculators
  • Arbitrageurs
  • Traders
  • Hedgers

19
Foreign Exchange Rates
  • A foreign exchange rate is the price of one
    currency quoted in terms of another currency.
  • When the rate is quoted per unit of the domestic
    currency, it is referred to as direct quote.
    Thus, the US and INR exchange rate would be
    written as US 0.02538/INR.
  • When the rate is quoted as units of domestic
    currency per unit of the foreign currency, it is
    referred to as indirect quote.
  • A cross rate is an exchange rate between the
    currencies of two countries that are not quoted
    against each other, but are quoted against one
    common currency.
  • Suppose that German DM is selling for 0.62 and
    the buying rate for the French franc (FF) is
    0.17, what is the DM/FF cross-rate? It is

20
Foreign Exchange Rates
  • The spot exchange rate is the rate at which a
    currency can be bought or sold for immediate
    delivery which is within two business days after
    the day of the trade.
  • Bid-ask spread is the difference between the bid
    and ask rates of a currency.
  • The forward exchange rate is the rate that is
    currently paid for the delivery of a currency at
    some future date.
  • The forward rate may be at a premium or at a
    discount.
  • For a direct quote, the annualised forward
    discount or premium can be calculated as follows

21
International Parity Relationships
  • There are the following four international parity
    relationships
  • Interest rate parity (IRP)
  • Purchasing power parity (PPP)
  • Forward rates and future spot rates parity
  • International Fisher effect (IFE).

22
Currency Appreciation and Depreciation
  • We frequently hear things like the dollar
    strengthened (or weakened) in financial Markets
    today or the dollar is expected to appreciate
    (or depreciate) relative to the Rupee. When we
    say that the dollar strengthens or appreciates,
    we mean that the value of a dollar rises, so that
    it takes more foreign currency to buy a dollar.
  • What happens to the exchange rates as currencies
    fluctuate in value depends on how exchange rates
    are quoted. Since we are quoting them as units
    of foreign currency per Rupee, the exchange rate
    move in the same direction as the value of the
    Rupee it rises as the rupee strengthens, and it
    falls as the rupee weakens.
  • Relative PPP tells that the exchange rate will
    rise if the Indias inflation rate is lower than
    the foreign countrys. This happens because the
    foreign currency depreciates in value and
    therefore weakens relative to the Rupee.

23
Depreciation of Rupee against US Dollar
  1. Rupee has depreciated a record low of Rs. 57.32
    on June 22-2012 against US dollar.
  2. Loss of potential European export market. Due to
    Euro-zone debt crises. Financial crunch and
    insolvency. The main countries are Greece,
    Ireland, Portugal, Spain and Italy and France.
  3. Export leads to foreign exchange inflow.
  4. Huge oil bills due to import of crude oil.
  5. FIIs turned bearish due to implementation of
    GAAR retroactively.
  6. The above mentioned reasons lead to scarcity of
    US dollar and depreciated partially convertible
    rupee to a record low.
  7. Gradual strengthening of Rupee started form 4th
    July 2012.
  8. Offloading of dollars by banks and exporters.
  9. The government increased foreign investment
    limits in government debt by 5 billion to 20
    billion.
  10. FIIs turned bullish due to announcement that
    application of GAAR will not be retrospectively.

General Anti Avoidance Rule aimed at preventing
deals or incomes that are structured to avoid
taxes
24
GAAR jarrs
  1. What is GAAR? General Anti Avoidance Rule is
    aimed at preventing deals or incomes that are
    structured only to avoid paying taxes.
  2. Why is GAAR Required? Isnt Tax Planning and Tax
    Savings Legitimate In India the courts have
    ruled that savings of taxes through permissible
    instruments of Tax planning is legitimate. But
    Tax Avoidance is illegal.
  3. Why are Anti-Avoidance measures necessary?
    According to some expert in an environment of
    moderate rates of tax, it is necessary that the
    correct tax base be used for calculating taxes in
    the face of aggressive planning and use of opaque
    low tax jurisdictions for residents as well as
    for sourcing capital.
  4. Whom does GAAR Affect ? Almost anybody and
    everybody. Corporations may be forced to
    re-structure salaries of employees if Taxmen
    conclude that these were structured only to avoid
    Taxes. (FIIs) who invest through countries such
    as Mauritius to exploit bilateral Tax Treaties
    will be effected after GARR comes into force.
    Its feared that once GAAR is invoked FIIs will
    have to pay capital gain tax for their investment
    in Indian equities.
  5. The committee has proposed to implement GARR on
    P-Notes. (Participatory Notes are offshore
    derivative instruments issued by foreign broking
    houses to overseas investors who wish to invest
    in the Indian stock market without registering
    themselves with the market regulator, SEBI.

25
Critical Policies Awaiting Approval
  1. Indias is suffering from stagflation of its own
    version Morgen and Stanley
  2. P.M. is rated as under-achiever Times Magazine.
  3. Indian economy downgraded from stable to
    negative Standard Poors.
  4. Raising FDI Limit in insurance sector from 29 to
    49.
  5. Introduce the Direct Tax Code (DTC) to overhaul
    archaic income tax laws.
  6. Banking laws (Amendment) Bill to empower RBI to
    supersede banks boards grant license to new
    private sector banks.
  7. Introduce a uniform Goods and Services (GST).
  8. Legislate the Pension Fund Regulatory and
    Development Authority (PFRDA) Bill to ensure
    social security for employees.
  9. Allow FDI in multi-brand retail.

26
PERPLEXING FACTS
  1. PM promises in G20 summit at Los Cabos, Mexico,
    to provide 10 billlion (Appx Rs 56,000 crore)
    under deficit economy when the people are
    subjected to growing economic burdens.
  2. The three major rating agencies forced India to
    allow International Capital flows by the recent
    reform witnessed. There is a strong suspicions
    that these agencies promote agenda of
    international finance capital by manipulating
    their ratings.
  3. These agencies had earlier given AAA rating to
    mortgage-based debt of companies like Enron.
  4. In 2008, on the eve of the global financial
    meltdown, they had given a similar rating to
    Lehman Brothers and the insurance giant AIG-the
    main players in the Wall street collapse.
  5. Reforms undertaken opening Retail trade sector,
    reducing subsidy, decontrolling fuel prices,
    increase foreign investment ceiling in thr
    insurance sector, allowing foreign banks to take
    over Indian private banks, allowing foreign
    investment in pension funds to go in for maeket
    investment i.e., speculation

27
PERPLEXING FACTS
  1. The retail sector in India conservatively
    contributes 11 of the GDP and employs over 40
    million people. According to the 4th Economic
    census, 38.2 of rural and 46.4 of urban
    employment is generated in this sector.
  2. Permitting multinational giants in retail will
    only displace these millions into poverty and
    misery.
  3. India to a large extent protected itself from the
    global financial meltdown because it did not
    allowed its financial sector to be open to
    international speculation.
  4. After the proposed reforms, India may subject
    itself to international volatility and thus,
    become extremely vulnerable.
  5. Allowing international speculation in pension
    funds and the insurance sector will ruin the
    lives of millions of working people.

28
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