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Sandeep Gokhale

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Title: Sandeep Gokhale


1
Financial Management
  • Sandeep Gokhale

2
References
  • Financial Management
  • Authors
  • Khan Jain
  • Prasanna Chandra
  • Myers
  • Van Horne

3
Syllabus
  • Ratio Analysis
  • Fund Cash flow analysis
  • Cost of Capital
  • Working Capital Mgmt.
  • Means of Financing
  • Capital Budgeting
  • Dividend Structuring
  • Bonus Shares
  • Share Holder Value Measurement

4
FINANCIAL MANAGEMENT Objective
Create share holder value Methodology
Capturing of value at all Levels.
Business Process restructuring Enterprise
resource management.
Vertically integrated operations.
Customer relationship Management
Sustained up scaling
of operations Effectiveness Proximity of
gross profit to net profit
Maximisation of EVA
EV / EBIDTA multiple
5
Financial Management an Overview
Business environment
Planning PoliciesDecisions (Management
Accounting)
Restructuring Resource Mobilisation Treasury
Financial Markets
Investor Wish List
ControlInformation ( Audit Taxation)
Valuation Technique
6
Environmental scan
Economy
Convertibility of Local Currency GDP / Industrial
growth rate Scalability of Operations FDI
Incoming / outgoing Inflation rate / Fiscal
deficit Trade surplus/deficits Balance of payment
status WTO Implications Emerging markets
scenario Gross national income distribution
7
Government Policy
Industrial policy Government programmes and
projects Tax regime Subsidies, incentives and
concessions Exim policies / VAT Government
Expenditure Lending considerations of financial
institutions and commercial banks Infrastructure
Development Rating of Govt paper Agricultural
policies
8
Technology
Emergence of new technologies. Access to
technical Up gradation Level of obsolescence.
Socio Demographic
Population trends Age shifts in
population Educational profile. Attitudes toward
consumption and investment
9
Competition
Number of players in the industry and their
market share. Duty barrier and status of
international cost and volume positioning. Degree
of homogeneity and differentiation among
products. Entry barriers for new
capacities. Comparison with substitute
products. Unorganised sector operations.
Marketing polices and practices.
10
ORGANISATIONAL INTERFACE OF FINANCE
Areas Interface Corp planning Long term
financial goals in terms of assets,
sales,profits,dividends etc. Expansion, new
projects diversifications takeovers ,
mergers,disinvestments. Internal generation,
tax planning. Operations Integrating
functional plans. Working capital management
11
Areas Interface Control Budgetary control of
all divisions Variance analysis Marketing Cre
dit norms Cost analysis of decisions like
discounts , premium
pricing,product promotion etc. Manufacturing Bud
geting for manufacturing operations. Product
mix decisions. Personnel Budgeting for
personnel administrative
function.
12
FINANCIAL FUNCTION
Money Mgmt
Accounting
Control
Advisory Role
Financial Accounting
Project Financing
Resource Mobilisation
Budgets
Working Capital Mgmt
Cost Accounting
Variance Analysis
Pricing
Investment Mgmt
Mgmt Accounting
Profit Center
Div. Policy
Valuation of Assets
Cost Center
13
Financial Decision Areas
  • Investment analysis
  • Working capital management
  • Sources and cost of funds
  • Determination of capital structure
  • Dividend policy
  • Analysis of risks returns
  • Treasury - interest / exchange rate swaps
  • Restructuring of operations / term debt profile
  • Equity buyback / Bonus / Capitalisation
  • To result in shareholder wealth maximisation

14
PROFIT AND LOSS ACCOUNT
For the Period 1st April to March 31st
Income
Gross sales from Goods Services Less Excise
Duty Net Sales Other Income Non operating
Income Total Income
15
Expenditure
Raw materials consumed Manufacturing
expenses Administrative expenses Selling
expenses WIP FG adjustment PBIDT (Gross
Profit) Less Interest Less Depreciation PBT
(Operating Profit) Less Tax PAT (net
profit) Gross cash accruals PAT Depn Net cash
accruals GCA - Dividend
16
THE BALANCE SHEET
For the year ended March 31st 200...
Liabilities
Equity share capital Reserves Surplus Term
loan Debentures Fixed deposits Other unsecured
loans Commercial bank borrowings Creditors Other
current liabilities
17
Assets
Gross fixed assets Less Acc. Depn Net
Block Investments Currents Assets RM Stock
WIP F.G.Stock Debtors Cash in
bank Loans Advances Misc.. expenditure Deferred
expenditure
18
RATIO ANALYSIS
Principal tool for analysis Inter firm
comparison Intra firm comparison Industry
analysis Responsibility accounting
19
TYPES OF FINANCIAL RATIOS

Liquidity
Leverage Turnover
Profitability /
Valuation
20
LIQUIDITY RATIOS
Current Ratio Current
assets Current liabilities Acid test
ratio C.A- Inventories Current
liabilities Cash position ratio Cash in bank
hand Current liabilities Inventory to
G.W.C Inventory Current assets
21
LEVERAGE RATIOS
Debt / Equity ratio Long term debt Net
worth Borrowing / Assets 1 -
Net worth Total Assets Fixed
asset / Networth Fixed Assets Net worth
22
Capital gearing ratio Capital entitled to
fixed return Capital not entitled to
fixed return Debt. Service coverage ratio
PBDIT - Tax Interest Annual
installment Interest coverage ratio
PBDIT - Tax Interest F. Asset coverage
ratio Gross fixed asset - Acc. Depn LT
Secured liabilities
23
ACTIVITY RATIOS Total asset turnover
Net sales Total assets Fixed asset
turnover Net sales Fixed
assets Inventory turnover Net
sales Inventory
24
Debtors turnover Credit sales Avg.
debtor Collection period Avg. debtor
365 CR. Sales Creditors Turnover Credit
purchase Avg.. Creditors Payment
period Avg. Creditor 365 Net Purchases
25
PROFITABILITY / VALUATION RATIOS Gross profit
ratio PBDIT / Sales EBITDA /
Sales RONW PAT / Networth
ROSE
PAT - Pref. Div Net worth Return
on CAP. Employed PBIT Total
Lia - Creditors Provisions Return on Investment
PBIT / Investments
26
Book value per share Net Worth NO of
Equity Shares EV / EBITDA
Enterprise value / Gross profit
Earning per share PAT - Pref Div No. of
Equity shares Price Earning ratio Market
price Earnings per share Pay out
ratio Dividend paid Profit after Tax
27
USERS OF FINANCIAL RATIOS Lenders of funds for
appraising credit worthiness for long term /
short term lending decisions. Valuations in
investment / disinvestment decisions. Financial
analyst / Mutual Funds / Investment
Bankers. Management for operational short / long
term planning. Credit Rating Agencies Tax
authorities
28
  • LIMITATIONS OF RATIO ANALYSIS
  • A ratio in absolute terms has no meaning. It has
    to be compared.
  • Inter firm comparison.
  • Companies resort to window dressing of Balance
    sheets.
  • Operating and accounting practices differ from
    company to company.
  • Consolidation of group / subsidiary companies
    figures.
  • E.G. Changes in Depreciation methods
  • Inventory Valuation
  • Treatment of contingent liabilities.
  • Valuation of investments.
  • Conversion or transaction of foreign exchange
    items.

29
FUND FLOW ANALYSIS It is a statement indicating
the methods by which a company has been financed
and the uses to which it has applied its funds
over a period of time. It provide an insight
into the movement of funds and helps in
understanding the changes in the structure of
asset liabilities. Provides information as to
how funds are raised and utilised. Determines
need for funds and helps in deciding finance
mix Determines financial consequences of
business decisions. Free cash flow generation
ability and Utilisation of the same.
30
FUND MANAGEMENT
Requirement
Mobilisation
Quantum
Source
Cost
Equity Buy back
Normal Capital expenditure
IncrementalWorking capital
New Investments
31
FUND FLOW OCCASIONS Sources Uses Funds from
operations Loss from operations Sale of fixed
assets Increase in fixed assets Increase in
liabilities Redemption of liabilities Sale of
securities Purchase of securities Decrease in
W.C Increase In W.C Cash Dividends, Equity
buy back
32
FUND FLOW Assets Uses of
funds Liabilities Uses of funds Assets Source
of funds Liabilities Source of
funds Comparison of balance sheets of
consecutive years.
33
TYPES OF FUND FLOW STATEMENTS OVERALL FUND
FLOW OPERATIONAL FUND FLOW WORKING CAPITAL
BASED FUND FLOW (ONLY STS/STU STATEMENT)
34
COST OF CAPITAL Aggregate of the liabilities
raised by a company is the total capital employed
in business. Different sources have different
cost and tax implications. Cost of capital It is
a single rate (weighted average ) for a finance
mix. It is computed on a post - tax basis since
cost of different sources have different tax
implications E.g.. Interest on debt capital
enjoys tax shield while dividend paid on equity
has no tax shield. COC is used as a discounting
rate in DCF analysis.
35
  • RELEVANCE OF COC
  • Used as a hurdle rate in DCF analysis.
  • Wt. Average cost of capital
  • Marginal cost of capital
  • K0 Ki Ke
  • K0 WT. Average cost of capital
  • Ki Cost of debt capital
  • Ke Cost of equity capital

36
  • COST OF CAPITAL
  • Consists of three components
  • Risk less cost of a particular type of finance
    (rj)
  • Business risk premium(b)
  • Finance risk premium(f)
  • K0 rj b f

37
  • RELATIONSHIP BETWEEN WEIGHTED AVERAGE COST AND
    MARGINAL COST OF CAPITAL
  • Degree of leverage
  • Cost of instruments
  • Tax Rate / Treatment
  • WACOC K0 Ki1 Ke1
  • MCOC K0 Ki2 Ke1

38
METHODS OF COMPUTATION OF COST OF EQUITY ROI
approach Ke PAT - pref. div non tax
shield portion of depn Equity block (E R S
acc depn) Market capitalisation approach Ke
D/P G D Dividend per share G Growth rate
br P Market price per share b Retained
earnings PAT - Dividends / PAT r Return on
b PAT - Pref div / Net worth
39
  • Capital Asset Pricing model
  • Ke Rf beta ( Rf Rm)
  • Rf risk free rate of return
  • Beta stock relationship with a index
  • Rm Market expectations of return ( Bloomberg
    base )

40
  • If ROI approach is used to determine Ke then book
    value to be considered as weights.If market
    capitalization approach is used then market value
    to be considered as weights.
  • All cost to be considered on a post tax basis.
  • The market capitalization approach is superior to
    the ROI approach since the parameters are market
    determined and futuristic as compared to the ROI
    approach.
  • The CAPM approach is a further refinement which
    also includes premium for risk
  • In loss making companies minimum cash flow
    approach is used.
  • Cost of equity could be benchmarked with return
    on guilts,market risk and portfolio risk ( Asset
    Beta )

41
WORKING CAPITAL MANAGEMENT Objective Optimise
current asset deployment. Advantages Lower
interest cost. Inventory holding cost
reduced. Disadvantages Interruption in
production. Stock out to customers.
42
ASSET STRUCTURE FOR VARIOUS INDUSTRIAL
SEGMENTS FA CA Power Generation 80 20 Ch
emical process plants 50 50 Engineering 40
60 Service 20 80 Trading 10 90
43
WORKING CAPITAL Current assets comprise of stocks
of raw materials, work in progress, finished
goods, and receivables. Gross working capital
total current assets. Net working capital
CA - CL Objective is to optimse asset
requirement and funding the same at minimal
cost. Working capital requirement
Permanent component
Variable component)
44
CONSTITUENTS OF CURRENT ASSETS Raw material
stock Work in progress Finished goods stock Cash
in hand / bank Debtors / Receivables
45
OPERATING CYCLE TIME Time required for rolling or
rotation of current assets. Date of receipt
RM issued to Throughput time of RM
production Dept Collection of Despatched to
consumers Converted to FG Receivables
46
  • FACTORS INFLUENCING WORKING CAPITAL REQUIREMENTS
  • Nature of business
  • Manufacturing process
  • Competitive forces in raw material finished
    goods segment.
  • Infrastructural support.
  • Through put time
  • Seasonality in demand
  • Shelf life of RM / Finished product
  • Customer relationship management

47
  • CREDIT MANAGEMENT
  • Terms of payment Cash against delivery
  • Consignee basis
  • Proforma invoice
  • Letter of credit
  • Advances
  • Suppliers / Buyers LOC
  • Credit policy variables Credit standards
  • Credit period
  • Cash Discounts

48
  • Credit evaluation Character
  • Capacity
  • Capital
  • Collateral
  • Macro conditions
  • Control of accounts Days sales outstanding
  • receivables Ageing schedule (in days)
  • Collection matrix
  • Average collection period

49
  • RECEIVABLES MANAGEMENT
  • Credit standards Collection cost
  • Average collection period
  • Bad debts
  • Level of incremental sale
  • Credit terms
  • Collection policies
  • Factoring

50
CASH MANAGEMENT Cash budgets Quarterly /
monthly / weekly Operating cash inflow/
outflow items Cash inflow Cash outflow Cash
sales Accounts payable Collection of
receivables R.M purchase
Salary factory
expense Administration/selling
exp. Taxes / Duties
51
  • WORKING CAPITAL FINANCING
  • Cash accruals
  • Trade credit
  • Commercial bank borrowings
  • Cash credit limit
  • WCTL
  • Bill discounting
  • Letter of credit
  • Bank guarantee
  • Public deposits

52
  • Short term / medium term loans from FIs Banks
  • Debentures for working capital
  • Commercial Paper.
  • Euro Commercial Borrowings
  • Inter Corporate deposits
  • Trade credit notes ( commodity exchanges )
  • Factors

53
  • Long Term Financing
  • Basis of evaluation
  • Availability
  • Flexibility
  • Cost
  • Availability should be available at the point
    / time when required
  • Flexibility certain instruments are user/
    application specific
  • Cost to be evaluated on a post tax
    basis

54
  • SOURCES OF TERM FINANCE
  • Term loans from Financial institutions Banks
  • State level financial institutions
  • Debentures NCD
  • PCD
  • OFCD
  • Fixed Deposits
  • Equity share capital
  • Equity share capital with differential rights
  • Non voting shares
  • Preference share capital
  • Mutual Funds

55
  • Retained earnings
  • Exchangeables
  • Venture Capital
  • Deferred payment gurantees
  • Leasing
  • External commercial borrowings
  • Depository receipts
  • Floating interest rate Debt.
  • Securitisation of future receivables
  • Derivative linked bonds

56
  • FINANCIAL / INVESTMENT INSTITUTIONS
  • They are major source of long term debt funds for
    financing
  • Fixed Assets
  • Margin money for working capital
  • Indian FIs
  • IDBI / ICICI / IFCI / IIBI
  • Foreign Institutions
  • Sectoral Institutions
  • HDFC / ILFS / HUDCO / IDFC
  • Universal Banks
  • ICICI Bank

57
  • Investment institutions
  • GIC Subsidiaries
  • UTI
  • LIC
  • Investment Banks
  • 23 State level financial institutions (IDCs)
  • 23 State level financial institutions (MSFC)
  • Scheduled Commercial Banks

58
Features Interest rate is based upon the prime
lending rate project risk.
Basic interest rate linked to inflation
rate Linked to G-Sec rate or Sub - SBAR ( SBI
PLR ) Security
Hypothecation mortgage Collateral Covena
nts Moratorium period Amortisation schedule Door
to Door tenure
59
  • GUIDE LINES FOR KEY RATIOS
  • DCSR gt 1.8 TIMES
  • D/E 151
  • Promoters contribution 20 - 25
  • CR gt 1.33
  • ADDITIONAL FEATURES
  • Interest rate re-set clause
  • Tapering of interest rate post project risk

60
  • Debentures
  • Approval from SEBI mandatory if public issue is
    proposed
  • Debentures used to finance margin money not to
    exceed more than 20 of N.W.C
  • Convertibility clause terms to be specified at
    issuance time.
  • Credit rating mandatory

61
  • Types of Debentures
  • NCD
  • FCD
  • PCD
  • OCD
  • Coupon rate depends on terms of issue.
  • Other features
  • No TDS for interest paid upto Rs 2500 per annum
  • Redemption premium
  • Listing on stock exchanges
  • Fully secured
  • Call and put options

62
  • Advantages from Issuers point of view
  • Lower cost due to low risk and tax deductibility
    of interest payment.
  • No / limited dilution of control
  • Offer stable return to investors having fixed
    maturity
  • and subsequently redemption/ conversion to
    equity
  • No increase in equity base during non conversion
    period
  • Fixed deposits
  • Limit on quantum 25 of networth
  • Cost 8-10 depending on maturity period
    risk
  • unsecured

63
  • EQUITY SHARE CAPITAL
  • Authorised , issued, subscribed and paid up
  • Par value, issue price, book value, market value
  • Residual claims on Income /Assets
  • No upper limit
  • Costliest sources of finance
  • Entails permanent servicing by way of dividends
    without tax shield
  • Voting rights/ Control in management/ Limited
    liability
  • Under preview of SEBI and SEB guidelines
  • Buy Back allowed

64
  • Equity investments in foreign cos allowed to
    resident indian shareholder in the event foregin
    co has 10 stake in indian co.
  • For Listing on exchanges atleast 10 to be
    offered to the public by way of a prospectus
  • Issuance of Non-Voting differential rights
    shares allowed
  • Debentures on conversion becomes equity share
    capital.
  • Listed / Unlisted shares
  • Sweat Equity / Employee Stock Options

65
EVALUATION OF ESC Companys point of
view Advantages Represents almost permanent
capital Does not involve any fixed obligation for
servicing Enhances credit worthiness of the
company to secure additional debt. Disadvantages
High cost of capital Dividends paid on profit
after tax further subjected to dividend
distribution tax of 15 High flotation
cost Dilution of control (Treasury issue)
66
Investors point of view Advantages Enjoy voting
right in the company with limited
liability. Short term capital gains tax reduced
to 10 Long term Capital gains tax abolished. (
Exchange traded securities ) Indexation benefit
available under 54E. Disadvantages Controlling
power could be notional Turn over tax at 15 basis
points on sale of the security on an
exchange Have residual claim to income /
assets Vide fluctuations in stock
price Dividends subjected to distribution tax of
15
67
Retained earnings Made up of Accumulated
depreciation and retained profits. Represent the
internal sources of finance available to the
company. Availability Level of profitability /
payout ratio Cost Identical to
ESC. Flexibility High
68

Advantages Reinvestment of profit may be
convenient to many shareholders. No dilution of
control since Co. Relies on retained earnings No
flotation cost/ Losses on account of
underpricing. Proceeds could be used in a
subsequent buyback.
Disadvantages High opportunity cost Limitation on
amount Bonus issue may capitalise reserves
.
69
Preference share capital Fixed minimum dividend
rate No voting rights Prior claim on income /
assets Redeemable at issuers investors
discretion Features No dilution of
control Provision to skip dividend in absence of
profits
70
CAPTAL BUDGETING
71
  • Capital investment decision
  • Capital investments involve increase in the fixed
    assets of a company.
  • (Expansion / diversification / Green field /
    takeover / merger)
  • Characteristics of investments
  • Capital outlay needs to be made up front returns
    come later
  • Certain amount of risk is involved
  • Capital investment tend to be indivisible.
    (difficult to phase out).
  • Financial techniques
  • The purpose of financial techniques is to enable
    the making of investment acceptance / rejection
    decisions.

72
Non financial factors in project
appraisal Market Technical Infrastructure Ecologic
al Economic Influence of non - financial
factors Financial projections Gestation
period Profitability Life of project / Terminal
value Sensitivity analysis
73
NON FINANCIAL FACTORS DETERMINING FINANCIAL
VIABILITY OF PROJECTS Market factors Present and
future size of the market Present and future
demand and supply situation Achievable market
share Selling distribution channels Technical
factors Level of Technological obsolence Plant
location Scales of operation Raw material
utilities consumption norms
74
Ecological factors Pollutant levels Treatment of
effluent Environmental impact of the
project Economic factors Social cost benefit
analysis Economic rate of protection Domestic
resource cost Protection enjoyed by industry.
75
FINANCIAL TECHNIQUES IN CAPITAL BUDGETING Return
on investment AVG ROI PBIT (over 10 yrs)
Total Inv. Advantages Simple to calculate and
easy to understand Maximisation of shareholders
wealth and maximising the market value of
investments. .Disadvantages Time value of money
not considered It is a concept based on profit
and not cash No objective criterion for
acceptance / Rejection decision.
76
Payback period It is the time required to get
back the original investment companies going
through liquidity crisis /for small investments
will use the pay back period method. Disadvantag
es Cash inflows / Outflows after payback Period
are ignored. Time value for money is ignored
77
Discounted cash flow (DCF) Cash inflow and
outflow for the entire life of the project is
considered. It considers time value for money as
a result earnings in earlier years have higher
value than earned in later years. IRR Method IRR
is that rate of discount at which the net present
value of cash flows equals net present value of
cash outflows. If IRR gt COC Investment is support
worthy. NPV method Using COC discount the
netflows If NPV is VE investment is support
worthy..
78
Comparison of elements
79
Comparison of elements
80
  • CONCEPTS IN CAPITAL BUDGETING
  • Life of project
  • Physical
  • Market
  • Techno efficient
  • Incremental principle
  • Sunk / Allocated costs to be ignored
  • Only incremental cash flows to be considered
  • Evaluation of post tax basis since COC is on a
    post tax basis
  • Principle of separation of Finance from
    Investment decision.
  • Financing cost (interest) to be ignored.
  • Effect of tax shield on the company as a whole
    to be considered

81
PROJECT COST COMPONENTS Land Civil
Construction Plant Machinery Misc Fixed
Assets Erection and commissioning Technical Know
how fees Preliminary preoperative
expenses Contingencies Total Capital Cost Margin
money for working capital Total project cost
82
PROJECT CASH FLOWS Cash outflows Capital
expenditure Margin money Normal
capital expenditure Cash inflow Net cash
accruals Salvage value Recovery of WC
83
NPV vs IRR conflict
  • NPV is technically superior to IRR and is also
    able to handle selection of mutually exclusive
    projects.
  • The decision rule for the NPV assumes that cash
    flows resulting during the life cycle of the
    project have an opportunity cost equal to the
    discount rate used.
  • The decision rule for the IRR assumes that such
    resulting cash flows have an opportunity cost
    equal to IRR which generated them.
  • NPV approach provides an absolute measure that
    fully represents the value from the project to a
    company.
  • IRR by contrast provides a figure from which
    the benefits in terms of wealth creation cannot
    be grasped.

84
Capital Budgeting Sensitivity Analysis
  • Monte Carlo Simulation
  • Break even analysis
  • Decision tree analysis
  • Expected value Criterion
  • Alternate buisness plans

85
Share holder value creation
  • Cash Dividends
  • Stock Dividends
  • Bonus Shares
  • Bonus Debentures-issued from free reserves
  • Equity Buy back / Secondary Listing
  • Stock Split
  • Synergic Investments
  • Synergic Acquisitions
  • Disinvest out of unrelated businesses
  • Shares of holding co. with fungibility

86
DIVIDEND
STRUCTURING Appropriation of PAT towards
Dividend pay out and Reserves Payout ratio
Dividend paid / PAT Retention ratio
PAT - Dividend paid / PAT
Dividend rate () could be high but payout could
be low. Dividend rate will be depended upon
the PAT, Payout ratio and Equity base.
87
Dividend Structuring 100 retention scenario For
some shareholders dividend acts as a regular
income source EX investors for whom it is a
regular source of income, mutual funds,
investment companies. Declaration of dividend is
perceived as an indication that the companies
operations are profitable. 100 payout
scenario Repeated raising of capital increases
floatation cost Companies requirement for
expansion / margin money / new investment. Tax
inefficient due to 15 distribution tax.
88
  • Factors influencing dividend policy
  • If the appetite for funds is high due to increase
    in level of exsisting operation or due to major
    capital investment plan then a high retention
    policy will be adopted.
  • A closely held company having major capital
    investment plans will follow a low pay out policy
    so that internal accruals could act as a major
    source of finance in the future thereby reducing
    dependence on infusion of fresh equity.
  • Tax implications
  • Company has to pay 12.5 distribution
    tax.Recipient of dividend tax exempted in the
    shareholders hands..
  • Section 80-M exemption at 100

89
  • Restriction in loan agreement / government
    regulations / FIs on on payment of dividend
    during the currency of the loan.
  • Legal requirement under Companies act.
  • Liquidity position Higher PAT does not
    necessarily mean healthy liquidity. A strained
    liquidity position would force a policy of low
    payout.
  • Stability in the rate of dividend companies
    usually follow a policy of gradually rising or
    stable dividend policy and not directly link it
    with PAT.
  • Generally the Indian corporate sector follows a
    payout policy of 30 . The retention ratio keeps
    increasing so as to counter inflation, floatation
    cost, help in Equity buyback etc.

90
  • BONUS SHARES
  • Bonus share are issued to existing share holders
    as a result of capitalization of reserves.
  • In the wake of a bonus issue
  • The shareholders proportional ownership remains
    unchanged
  • The book value, market price, E.P.S decreases.
  • Fallout of a bonus issue
  • Normally the Ex-bonus price comes down by the
    proportion of bonus given with a mark up of
    approximately 30 - 35
  • More active trading in stock exchanges.
  • The nominal rate of dividend tends to decline
    this may dispel the impression of profiteering.
  • Shareholders regard a bonus issue as a firm
    indication that the prospects for the company are
    good.
  • Capital gains tax exemptions with indexation
    available for bonus issue

91
GUIDELINES FOR ISSUE OF BONUS SHARES Issuer
Security exchange board of India Bonus issue
should be made from capitalisation of free
reserves built out of genuine profits and share
premium.Reserves created by revaluation of
assets, statutory reserves etc. are not allowed
for capitalisation Bonus issue greater than 11
allowed Residual reserve test residual reserves
after the proposed capitalisation should be at
least 40 of the increased capital For
computation all contingent liabilities,
statutory reserves and revaluation reserves to be
excluded. Yield test 30 of the average P.B.T
for the last 3 years should give a return of at
least 10 on the enhanced capital. Bonus in lieu
of dividend is not permitted
92
If R Reserves before bonus issue
S Share capital before bonus issue B
Bonus Quantum PRT Average
PBT for last 3 years RPT .4 (S B)
gt (R - B) YIELD TEST .3 (PBT) gt
(.1) (SB) Bonus issue also to be given to
debenture holders if there is an impending
conversion.
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