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.
• 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.

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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.

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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

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IMPORTANT BUSINESS ACTIVITIES

• Major Business Activities in a Firm is
  categorized as-
• PRODUCTION
• MARKETING
• FINANCE

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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
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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

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FOCUSES IN WEALTH MAXIMIZATION GOAL/ENHANCING
FIRMS VALUE -The process of value creation
VALUE
CREATION
Economic Risk Operational
Risk Financial Risk
Business Risk
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RISK-RETURN PARADOX
Contradictory
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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
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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
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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
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ALSO REFERRED AS CORPORATE FINANCE OR
MANAGERIAL FINANCE The Role of The Financial
Manager
Financial
Firm's
Financial
managers
operations
markets
(5)
Government
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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.

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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
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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)

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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.

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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.

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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

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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

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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

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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).

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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.

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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
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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.

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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.

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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

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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.

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