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

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


1
CAIIB-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.

12
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.

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.

14
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.

15
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.

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

18
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

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.

29
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.

30
Study 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.

48
Elements of financial statements
  • Main financial statements
  • Balance Sheet
  • Income statement
  • Statement of Sources of funds and Uses of funds

49
Balance Sheet
50
Income Statement
51
Sources and Uses of Funds
52
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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

58
Tools of Analysis
Horizontal Analysis
Comparing a companys financial condition and
performance across time
Time
59
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.
60
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61
Comparative Statements
  • Calculate Change in Dollar Amount

Dollar Change
Analysis Period Amount
Base Period Amount


62
Comparative Statements
  • Calculate Change as a Percent

Percent Change
Dollar Change Base Period Amount

100

63
12,000 23,500 (11,500)
(11,500 23,500) 100 48.9
64
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65
Now, lets review the dollar and percent changes
for the liabilities and shareholders equity
accounts.
66
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67
Now, lets look at trend analysis!
68
Trend Analysis
  • Also called trend percent analysis or index
    number trend analysis.

Trend analysis is used to reveal patterns in data
covering successive periods.
69
Trend Analysis
  • Berry Products
  • Income Information
  • For the Years Ended 31 December

2000 is the base period so its amounts will equal
100.
70
Trend Analysis
  • Berry Products
  • Income Information
  • For the Years Ended 31 December

71
Trend Analysis
  • Berry Products
  • Income Information
  • For the Years Ended 31 December

How would this trend analysis look on a line
graph?
72
Trend Analysis
73
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.
74
Common-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
76
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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
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