A 4.

5: Financial Management 2021 I

Unit-I: Financial Management

Financial Management: Meaning

Financial management is one of the most important aspects in business. In order to start up or even
rim a successful business, owner or management of business will need excellent knowledge in
financial management. Practically finance management is such important function in any business
that it comes first of the any other functional area.
What is financial management?

— Financial management refers to the strategic planning, organizing, directing, and controlling of
financial undertakings in an organization or an institute.
- It also includes applying management principles to the financial assets of an organization, while
also playing an important part in fiscal management [1].
Financial management, is that branch of general management, which has grown to provide
specialized and efficient financial services to the whole enterprise; involving, in particular, the timely
supplies of requisite finances and ensuring their most effective utilization-contributing to the most
effective and efficient attainment of the common objectives of the enterprise.
Some prominent definitions of financial management are cited below:

— “Financial management is an area of financial decision-making harmonizing individual motives

and enterprise goals.” -Weston and Brigham

- “Financial management is concerned with managerial decisions that result in acquisition and
financing of long-term and short-term credits for the firm. As such, it deals with situations that
require selection of specific assets and liabilities as well as problems of size and growth of an
enterprise. Analysis of these decisions is based on expected inflows and outflow of funds and

—
their effects on managerial objectives.” Philppatus
The above definitions of financial management could be analyzed, in terms of the following points:
a) Financial management is a specialized branch of general management.
b) The basic operational aim of financial management is to provide financial services to the whole
enterprise.
c) One most important financial service by financial management to the enterprise is to make
available requisite (i.e. required) finances at the needed time. If requisite funds are not made
available at the needed time; significance of finance is lost.
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d) Another equally important financial service by financial management to the enterprise is to
ensure the most effective utilization of finances; but for which finance would become a liability
rather than being an asset.
e) Through providing financial services to the enterprise, financial management helps in the most
effective and efficient attainment of the common objectives of the enterprise [2].
Nature of Finance Management:
Finance management is a long term decision making process which involves lot of planning,
allocation of funds, discipline and much more. Let us understand the nature of financial management
with reference of this discipline.
1) Primary nature of financial management focus towards valuation of company. That is the reason
where all the financial decisions are directly linked with optimizing / maximization the value of a
company. Finance functionality like investment, distribution of profit earnings, rising of capital,
etc. are the part of management activities.
2) Nature of financial management basically involves decision where risk and return are linked with
investment. Generally high risk investment yield high returns on investments. So, role of financial
manager is to effectively calculate the level of risk company is involve and take the appropriate
decision which can satisfy shareholders, investors or founder of the company.
3) Finance is a foundation of economic activities. The person who Manages finance is called as
financial manager. Important role of financial manager is to control finance and implement the
plans. For any company financial manager plays a crucial role in it. Many times it happens that
lack of skills or wr ong decisions can lead to heavy losses to an organization.
4) Financial Management is an important function in company’s management. Financial factors are
considered in all the company’s decisions and all the departments of an organization. It affects
success, growth and volatility of a company. Finance is said to end up being the lifeline of a
business.
5) Finance management is realized as important education word wide. Now a day’s people are
undergoing through various specialization courses of financial management. Many people have
chosen financial management as their profession.
6) The nature of financial management is never a separate entity. Even as an operational manager or
functional manager one has to take responsibility of financial management.
7) Nature of financial management is multi-disciplinary. Financial management depends upon
various other factors like: accounting, banking, inflation, economy, etc. for the better utilization
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8) Approach of financial management is not limited to business functions but it is a backbone of
commerce, economic and industry
Objectives of Financial Management:
Objectives of financial management may be multiple; as this branch of general management
encompasses the entire organizational functioning.
For sake of analysis and better comprehension, the objectives of financial management might be
classified into certain categories-as depicted in form of the following chart:
Basic Objectives Operational Objectives
Profit Maximization Timely availability of requisite finances
Wealth Maximization Most effective utilization of finance
Safety of investment
Growth of the enterprise

Following is a brief account of each one of the above objectives of financial management:
Basic Objectives:
Profit-Maximization:
Since time immemorial, the primary objective of financial management has been held to be profit-
maximization. That is to say, that financial management ought to take financial decisions and
implement them in a way so as to lead the enterprise along lines of profit maximization. The support
for these objectives could be derived from the philosophy, that ‘profit is a test of economic
efficiency’.
Though, there could be little controversy over profit maximization, as the basic objective of financial
management - yet, in the modem times, several authorities on financial management criticizes this
objective, on the following grounds:
(i) Profit is a vague concept, in that; it is not clear whether. ..
- Profit means - short-run or long-run profits. Or
- Profit before tax or profits after tax Or
- Rate of profits or the amount of profits .
(ii) The profit maximization objective ignores, what financial experts call the time value of money’.
To illustrate, this concept, let us assume that two financial courses of action provide equal benefits
(i.e. profits) over a certain period of time. However, one alternative gives more profits in earlier
years; while the other one gives more profits in later years.
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Based on profit maximization criterion, both alternatives are equally well. However, the first
alternative i.e. the one which gives more profits in earlier years is better; as some part of the profits
received earlier could be reinvested also.
Modem financial experts call this philosophy, the earlier the better principle’. The second alternative
which gives more profits only in later years is inferior; as the time-value of profits is more in the case
of the first alternative.
(iii) The profit maximization objective ignores the quality of benefits (i.e. profits). The factor implicit
here, is the risk element associated with profits. Quality of benefits (profits) is the most when risk
associated with their occurrence is the least. According to modem financial experts, less profit with
less risk are superior to more profits with more risk.
(iv) Profit-maximization objective is lop-sided. This objective considers or rather over-emphasizes
only on the interests of owners. Interests of other parties like, workers, consumers, the Government
and the society as a whole are ignored, under this concept of profit-maximization.
Wealth-Maximization:
Discarding the profit-maximization objective; the real basic objective of financial management, now-
a-days, is considered to be wealth maximization. Wealth maximization is also known as value-
maximization or the net present worth maximization.
Since wealth of owners is reflected in the market-value of shares; wealth maximization means the
maximization of the market price of shares. Accordingly, wealth maximization is measured, by the
market value of shares.
According to wealth maximization objective, financial management must select those decisions,
which create most wealth for the owners. If two or more financial courses of action are mutually
exclusive (i.e. only one can be undertaken at a time); then that decision-which creates most wealth,
must be selected.
The wealth arising from a financial course of action could be stated as follows:
Wealth = Gross present value of a financial course of action minus amount of capital invested which
is required to achieve the benefits ie. cash flows.
Operational Objectives:
(i) Timely Availability of Requisite Finances:
A very important operational objective of financial management is to ensure that requisite funds are
made available to all the departments, sections or units of the enteiprise at the needed time; so that the
operational life of the enterprise goes smoothly.
(ii) Most Effective Utilization of Finances:
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Throughout the enterprise, the finances must be utilized most effectively. This is yet another
important operational objective of the financial, management.
To ensure the attainment of this objective, the financial management must:

— Formulate plans for the most effective utilization of funds, among channels of investment, which
create most wealth for the company.
- Exercise and enforce ‘financial discipline’ to prevent wasteful expenditure, by any department, or
branch or section of the enterprise.
(iii) Safety of Investment:
The financial management must primarily look to the safety of investment i.e. the channels of
investment might bring in less returns; but investment must be safe. Loss of investment, in any one
line, might lead to capital depletion; and ultimately tell upon the financial health of the enterprise.
(iv) Grow th of the Enterprise:
The financial management must plan for the long-term stability and growth of the enterprise. The
limited finances of the enterprise must be so utilized that not only short run benefits are available; but
the enterprise grows slow and steady, in the long run also [4].
Scope of Financial Management:
The introduction to financial management also requires you to understand the scope of financial
management. It is important that financial decisions take care of the shareholders‘interests.
Further, they are upheld by the maximization of the wealth of the shareholders, which depends on the
increase in net worth, capital invested in the business, and plowed-back profits for the growth and
prosperity of the organization.
The scope of financial management is explained in the diagram below:

Financial Management

Financing Investment Dividend

Decision Decision Decision

Fig. 1 - The scope of Financial Management

Investment Decisions: Managers need to decide on the amount of investment available out of the
existing finance, on a long-term and short-term basis. They are of two types:
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- Long-Term Investment Derisions or Capital Budgeting mean committing funds for a long
period of time like fixed assets. These decisions are irreversible and usually include the ones
pertaining to investing in a building and/or land, acquiring new plants/machinery or replacing the
old ones, etc. These decisions determine the financial pursuits and performance of a business.
- Short-Term Investment Decisions or Working Capital Management means committing funds
for a short period of time like current assets. These involve decisions pertaining to the investment
of funds in the inventory, cash, bank deposits, and other short-term investments. They directly
affect the liquidity and performance of the business.
Financing Decisions: Managers also make decisions pertaining to raising finance from long-term
sources (called Capital Structure) and short-term sources (called Working Capital). They are of two
types:
- Financial Planning decisions which relate to estimating the sources and application of funds. It
means pre-estiuiating financial needs of an organization to ensure the avaiiability of adequate
finance, the primary objective of financial planning is to plan and ensure that the funds are
available as and when required.
- Capital Structure decisions which involve identifying sources of funds. They also involve
decisions with respect to choosing external sources like issuing shares, bonds, borrowing from
banks or internal sources like retained earnings for raising funds.
Dividend Decisions: These involve decisions related to die portion of profits that will be distributed
as dividend. Shareholders always demand a higher dividend, while the management would want to
retain profits for business needs. Hence, this is a complex managerial decision

1.2 Relationship of Finance Function with other disciplines:

Financial management is interrelated with other areas. The relation between financial management
with other areas discipline can be defined as follow':
Finance and Economics
Economic concept like micro and macro economics are directly applied with the Finance
management approaches. Investment decisions, micro and macro environmental factors are closely
associated with the functions of financial manager. Finance management also uses the economic
equations like money value discount factor; economic order quantity etc. financial economics is one
of the emerging areas, which provides immense Opportunities to finance and economical areas.
Finance and Accounting
Accounting records includes the financial information of the business concern. Hence, we can easily
understand the relationship between the Finance management and accounting. In the olden periods
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both finance management and accounting are treated as a same discipline and then it has been merged
as management accounting because this part is very much helpful to finance manager to take
decisions. But nowadays Finance management and Accounting discipline are separate and
interrelated.
Finance and Production .Management
Production management is the operational part of the business concern, which helps to multiply the
money into profit. Profit of the concern depends upon the production performance. It needs finance
because production department requires raw material, machinery, wages and operating expenses etc.
these expenditures are decided and estimated by the financial department and the finance manager
allocates the appropriate finance to production.
Finance and Human Resource
Finance management is also related with Human Resource department, which provides manpower to
all the functional areas of the management. Financial manager should carefully evaluate the
requirement of manpower to each department and allocate the finance to the Human Resource
department as wages, salary, remuneration, commission, bonus, pension and other monetary benefits
to the Human Resource department. Hence, Finance management is directly related with Human
Resource management.
Finance and Marketing
Produced goods are sold in the market with innovative and modem approaches. For this, the
marketing department needs finance to meet their requirements. The financial manager or finance
department is responsible to allocate the adequate finance to the marketing department. Hence,
marketing and FM are interrelated and depends on each other.
Finance and Mathematics
Modem approaches of the Finance management applied lar ge number of mathematical and statistical
tools and techniques. They are also called as econometrics. Economic order quantity, discount factor,
tune value of money, cost of capital, capital structure theories, dividend theories, ratio analysis and
working capital analysis are used as mathematical and statistical tools and techniques in the field of
Finance management [6].
13 Functional Areas of Finance:
The responsibilities for financial management are spread throughout the organization in the sense that
financial management is, to an extent, an integral part of the job for the managers involved in
planning, allocation of resources and control. For example, the production manager shapes the
investment policy in terms of proposal of a new plant, the marketing manager provides inputs in
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forecasting and planning, the purchase manager influences the level of investment in inventories, and
the sales manager has a say in the determination of receivables policy.
The ultimate responsibility for carrying out financial management functions lies with the top
management, that is, board of directors/managing director/chief executive or the committee of the
board. However, the exact nature of the organization of the financial management function differs
from firm to finn depending upon factors such as size of the firm, nature of its business, type of
financing operations, ability of financial officers and the financial philosophy, and so on. Similarly,
the designation of the chief executive of the finance department also differs widely in case of
different finns. Following figure indicates the different functional areas of the finance m.
I Board of Directors

| Managing
I
Director/Chairman|

I Vice-President/DIrector (Finance)/Chief Finance Officer (CFO) I

l
:
| Treasurer |
1
|Controller |
I
T
Financial Cash
I
Credit
I ~TForeign
r
Tax
\
Cost
planning and manager manager exchange manager accounting
fund-raising manager manager
manager

Capital Pension Corporate Financial

expenditure fund accounting accounting
manager manager manager manager

Figure 1.1: Pg. 1.21, Finance Management, M Y Khan, P K Jain

1.4 Time Value of Money:
The concept of “Time Value of Money” indicates the value / worth of money. It indicates value /
worth of 1 unit of money i.e. Rs 1 is different in two different time period. The value of a sum of
money received today is more than its value received after some time. Conversely, the sumo of
money received in future is less valuable than it is today.
Eg. Value of Rs 1 today is more than value of Rs 1 after 1 year. This difference between values of Rs
1 for two different time period is due to preference of the money in present as compared to preference
of money in future period. Rs 1 received today can be re-invested in any asset and earn profit on it.
This would result in higher value than Rs 1 after 1 year [8l
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1.4 Concept of Risk & Return:
Return:
Return is the actual income received plus any change in market price of an asset / investment.
Generally this is expressed in terms of percent of the opening marketing price. Symbolically, the one
period actual return is indicated by following equation.
R = Df + (P,— P,.,)/Pt.!
Where, D, = Annual Income / Cash dividend at the end of the time period, t
P, = security price at time period, t (closing / ending security price)
P t-1- security price at time period.
t-1 = (opening/beginning security price)
Example
If the price of a share on April 1 (Current Year) is Rs 25, the annual dividend received at the end of
the year is Rs 1 and the year end price on March 31 is Rs 30, the rate of return
= [Rs 1 + (Rs 30 - Rs 25)] / Rs 25 = 0.24 = 24 %, the rate of return of 24 % has two components.
1] Current Yield i.e. Annual Income + beginning price = Rs 1 / Rs 25 =0.04 or 4 per cent and
2] Capital gains / loss = (ending price - beginning price) / beginning price = (Rs 30 - Rs 25) /25 =
0.20 = 20 per cent.
Risk:
The variability of the actual return from the expected returns associated with a given asset /
investment is defined as risk. The greater the variability, the riskier the security is said to be. The
more certain the return from an asset, the less the variability and, therefore, the less the risk.
There are many techniques to measure the risk associated with an asset. Range, standard deviation
and coefficient of variation are the most preferred techniques [9].
1.5 Role of Finance Manager:
Financial activities of a firm is one of the most important and complex activities of a firm. Therefore
in order to take care of these activities a financial manager performs all the requisite financial
activities.
A financial manger is a person who takes care of all the important financial functions of an
organization. The person in charge should maintain a far sightedness in order to ensure that the funds
are utilized in the most efficient manner. His actions directly affect the Profitability, growth and
goodwill of the firm.
Following are the main functions of a Financial Manager:
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Raising of Funds
In order to meet the obligation of the business it is important to have enough cash and liquidity. A
firm can raise funds by the way of equity and debt. It is the responsibility of a financial manager to
decide the ratio between debt and equity. It is important to maintain a good balance between equity
and debt.
Allocation of Funds
Once the funds are raised through different channels the next important function is to allocate the
funds. The funds should be allocated in such a manner that they are optimally used. In order to
allocate funds in the best possible maimer the following point must be considered
- The size of the firm and its growth capability
- Status of assets whether they are long-term or short-term
— Mode by which the funds are raised
These financial decisions directly and indirectly influence other managerial activities. Hence
formation of a good asset mix and proper allocation of funds is one most important activity.
Profit Planning
Profit earning is one of the prime functions of any business organization. Profit earning is important
for survival and sustenance of any organization. Profit planning refers to proper usage of the profit
generated by the firm.
Profit arises due to many factors such as pricing, industry competition, state of the economy,
mechanism of demand and supply, cost and output. A healthy mix of variable and fixed factors of
production can lead to an increase in the profitability of the firm.
Fixed costs are incurred by the use of fixed factors of production such as land and machinery. In order
to maintain a tandem it is important to continuously value the depreciation cost of fixed cost of
production. An opportunity cost must be calculated in order to replace those factors of production
which has gone thrown wear and tear. If this is not noted then these fixed cost can cause huge
fluctuations in profit.
Understanding Capital Markets
Shares of a company are traded on stock exchange and there is a continuous sale and purchase of
securities. Hence a clear understanding of capital market is an important function of a financial
manager. When securities are traded on stock maricet there involves a huge amount of risk involved.
Therefore a financial manger understands and calculates the risk involved in this trading of shares and
debentures.
It’s on the discretion of a financial manager as to how to distribute the profits. Many investors do not
like the firm to distribute the profits amongst share holders as dividend instead invest in the business
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itself to enhance growth. The practices of a financial manager directly impact the operation in capital
market -10'.

Unit-II: Financial Statements and Financial Analysis

2.1 Concept of Financial Statement:

Financial statements are reports prepared by a company’s management to present the financial
performance and position at a point in time. A general-purpose set of financial statements usually
includes a balance sheet, income statements, statement of owner’s equity, and statement of cash
flows. These statements are prepared to give users outside of the company, like investors and
creditors, more information about the company’s financial positions. Publicly traded companies are
also required to present these statements along with others to regulatory agencies in a timely manner.
Financial statements are the main source of financial information for most decision makers. That is
why financial accounting and reporting places such a high emphasis on the accuracy, reliability, and
relevance of the information on these financial statements.
Example
The balance sheet a summary of the company position on one day at a certain point in time. The
balance sheet lists the assets, liabilities, and owners' equity on one specific date. In a sense, the
balance sheet is a picture of the company on that date. Investors and creditors can use the balance
sheet to analyze how companies are funding capital assets and operations as well as current investor
information.
The income statement shows the revenue and expenses of the company over a period of time. Most
companies issue annual income statement, but quarterly and semi-annual income statements aie also
common. Users can analyze the income statement to see if companies are operating efficiently and
producing enough profit to fiuid their current operations and growth.
The statement of owner’s capital summarizes all owner investments and withdrawals from the
company during a period. It also reports the current income or loss recorded in retained earnings [1l
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/ \

Figure 2.1: Components of Financial Statements, https://biisinessiargons.com/

2.2 Importance & Objectives of Financial Statements

Importance:
The importance of financial statements lies in their utility to satisfy the varied interest of different
categories of parties such as management, creditors, public, etc.
1. Importance to Management:
Increase in size and complexities of factors aifecting the business operations necessitate a scientific
and analytical approach in the management of modem business enterprises.
The management team requires up to date, accurate and systematic financial information for the
puiposes. Financial statements help the management to understand the position, progress and
prospects of business vis-a-vis the industry.
By providing the management with the causes of business results, they enable them to formulate
appropriate policies and courses of action for the future. The management communicates only
through these financial statements, their performance to various parties and justify their activities and
thereby their existence.
A comparative analysis of financial statements reveals the trend in the progress and position of
enterprise and enables the management to make suitable changes in the policies to avert unfavorable
situations.
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2. Importance to the Shareholders:
Management is separated from ownership in the case of companies. Shareholders cannot, directly,
take part in the day-to-day activities of business. However, the results of these activities should be
reported to shareholders at the annual general body meeting in the form of financial statements.
These statements enable the shareholders to know about the efficiency and effectiveness of the
management and also the earning capacity and financial strength of the company.
By analyzing the financial statements, the prospective shareholders could ascertain the profit earning
capacity, present position and future prospects of the company and decide about making their
investments in this company.
Published financial statements are the main source of information for the prospective investors.
3. Importance to LendeiVCreditors:
The financial statements serve as a useful guide for the present and future suppliers and probable
lenders of a company.
It is through a critical examination of the financial statements that these groups can come to know
about the liquidity, profitability and long-term solvency position of a company. This would help them
to decide about their future course of action.
4. Importance to Labor:
Workers are entitled to bonus depending upon the size of profit as disclosed by audited profit and loss
account. Thus, P&La/c becomes greatly important to the workers. In wrages negotiations also, the
size of profits and profitability achieved are greatly relevant.
5. Importance to the Public:
Business is a social entity. Various groups of society, though directly not connected with business, are
interested in knowing the position, progress and prospects of a business enterprise.
They are financial analysts, lawyers, trade associations, hade unions, financial press, research
scholars and teachers, etc. It is only through these published financial statements these people can
analyze, judge and comment upon business enterprise [2].
Objectives of Financial Statements:
To identify Profitability of Business:
Financial statements are required to ascertain whether the enterprise is earning adequate profit and to
know whether the profits have increased or decreased as compared to the previous year(s), so that
corrective steps can be taken well in advance.
To identify- the Solvency of the Business:
Financial statements help to analyze the position of the business as regards to the capacity of the
entity to repay its shoit as well as long term liabilities.
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Judging the Growth of the Business:
Through comparison of data of two or more years of business entity, we can draw a meaningful
conclusion as regard to growth of the business. For example, increase in sales with simultaneous
increase in the profits of the business, indicates a healthy sign for the growth of the business.
Judging Financial Strength of Business:
Financial statements help the entity in determining solvency of the business and help to answer
various aspects viz., whether it is capable to purchase assets from its own resources and/or whether
the entity can repay its outside liabilities as and when they become due.
Making Comparison and Selection of Appropriate Policy:
To make a comparative study of the profitability of the entity with other entities engaged in the same
trade, financial statements help the management to adopt sound business policy by making intra firm
comparison.
Forecasting and Preparing Budgets:
Financial statement provides information regarding the weak-spots of the business so that the
management can take corrective measures to remove these short comings. Financial statements help
the management to make forecast and prepare budgets.
Communicating with Different Parties:
Financial statements are prepared by the entities to communicate with different parties about their
financial position. Hence, it can be concluded that understanding the basic financial statements is a
necessary step towards the successful management of a commercial enterprise [3).

2.3 Types of Financial Statements- For Public and For Management

Financial statements provide a picture of the performance, financial position, and cash flows of a
business. These documents are used by the investment community, lenders, creditors, and
management to evaluate an entity. There are four main types of financial statements, which are as
follows:
Income Statement: This report reveals the financial performance of an organization for the entire
reporting period. It begins with sales, and then subtracts out all expenses incurred dining the period to
arrive at a net profit or loss. Earnings per share figure may also be added if the financial statements
are being issued by a publicly-held company. This is usually considered the most important financial
statement, since it describes performance.
Balance Sheet: This report shows the financial position of a business as of the report date (so it
covers a specific point in time). The information is aggregated into the general classifications of
assets, liabilities, and equity. Line items within the asset and liability classification are presented in
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their order of liquidity, so that the most liquid items are stated first. This is a key document, and so is
included in most issuances of the financial statements.
Statement of Cash Flows: This report reveals the cash inflows and outflows experienced by an
organization during the reporting period. These cash flows are broken down into three classifications,
which are operating activities, investing activities, and financing activities. This document can be
difficult to assemble, and so is more commonly issued only to outside parties.
Statement of Changes In Equity: This report documents all changes in equity during the reporting
period. These changes include the issuance or purchase of shares, dividends issued, and profits or
losses. This document is not usually included when the financial statements are issued internally, as
the information in it is not overly useful to the management team.
When issued to users, the preceding types of financial statements may have a number of footnote
disclosures attached to them. These additional notes clarify certain summary-level information
presented in the financial statements, and may be quite extensive. Their exact contents are defined by
the applicable accounting standards

2.4 Statutory Provisions Regarding Financial Statements:

1. Section 129 of companies act 2013, provides for preparation of financial statements.
2 . 2(40) to include balance sheet profit and loss account/income and expenditure account, cash flow
statement, statement of changes in equity and any explanatory note annexed to the above.
3. New section 129 corresponds to existing section 210. It provides that the financial statements
shall give a true and fair' view of the state of affairs of the company and shall comply with the
accounting standards notified under new section 133.
4. It is also provided that the financial statements shall be prepared in the form provided in new
schedule HI of Companies Act, 2013.
5. It may be noted that in the new schedule in the provisions for preparation of balance sheet and
statement of profit and loss have been given which are on the same lines as in the existing
schedule VI.
6. Further, in the new Schedule III detailed instructions have been given for preparation of
consolidated financial statements as consolidation of accounts of subsidiary companies is now
made mandatory in section 129.
7. It may be noted that for the first time a provision has been made in the new section 129(3)that if a
company has one or more subsidiaries it will have to prepare a consolidated financial statement of
the company and of all the subsidiaries in the form provided in the new schedule III of
Companies Act, 2013.
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8. The company has also to attach along with its financial statement, a separate statement containing
the salient features of the financials of the subsidiary companies in such form as may prescribed
by the rales.
9. It is also provided that if the company has interest in any associate company or a joint venture the
accounts of that company as well as joint venture shall be consolidated.
10. For this purpose associate company has been defined in new section 2(6) companies has
significant influence i.e. it has. 20% of the total share capital of the company or has control on the
business decision under an agreement.
11. The Central Government has power to exempt any companies from complying with any of the
requirements made under the section [5l
Pro-forma of Balance Sheet as per Schedule-TIT - Companies Art, 2013
PART I: BALANCE SHEET
Name of the Company :
Balance sheet as at :

Figures as at the Figures as at the

Particulars Note No. end of current end of previous
reporting period reporting period
L EQUITY AND LIABILITIES
1) Shareholder’s Funds
(a) Share Capital
(b) Reserves and Surplus
(c) Money received against share warrants
(2) Share application money pending allotment
(3) Non-Current Liabilities
(a) Long-term borrowings
(b) Deferred tax liabilities (Net)
(c) Other Long term liabilities
(d) Long term provisions
(4) Current Liabilities
(a) Short-term borrowings
(b) Trade payables
(c) Other curr ent liabilities
(d) Short-term provisions
Total
IIAssets
(1) Non-current assets(a) Fixed assets
(i) Tangible assets
(ii) Intangible assets
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(iii) Capita] work-in-progress

(iv) Intangible assets under development
(b) Non-current investments
(c) Defened tax assets (net)
(d) Long term loans and advances
(e) Other non-current assets
(2) Current Assets
(a) Current investments
(b) Inventories
(c) Trade receivables
(d) Cash and cash equivalents
(e) Short-term loans and advances
(f) Other current assets
Total

PART II - PROFIT & LOSS STATEMENT

Name of the Company
Profit and Loss statement for the year ended
Figures as
Figures as
at the end
at the end
of the
Particulars Note No. of current
previous
reporting
reporting
period
period
CONTINUING OPERATIONS(l)
I Revenue from operations (Gross)
n Other income
in Total revenue (1+2)
Expenses
(a) Cost of materials consumed
(b) Purchases of stock-in-trade
(c) Changes in inventories of finished goods, work-in
progress and stock-in-trade
VI
(d) Employee benefits expense
(e) Finance costs
(f) Depreciation and amortization expense
(g) Other expenses
Total expenses
Profit before exceptional and extraordinary items and
v tax (IIMV)
VI Extraordinary items
vn Profit / (Loss) before extraordinary items and tax (V+VI)
Mil Extraordinary items
 A 4.5: Financial Management 2021 I
IX Profit before tax (VI (-/4-)\TIT)
Tax expense:
X (I) Current tax expense for current year
(II) Deferred tax
XI Profit / (Loss) from continuing operations (IX+X)
XU Profit V (loss) ftom discontinuing operations
XIII Tax expense of discontinuing operations
Profit/floss) from Discontinuing operations (after tax)
XIV
(xnxni)
XV Profit (Loss) for the period (XI + XTV)
Earnings per equity share:
XVI (1) Basic
(2) Diluted

2.5 Technique of Financial Statement Analysis:

Following are the most popular methods of financial statement analysis:
Hoiizontal and Vertical Analysis:
hi Horizontal Analysis, the analysts compare the financial information of one period with the
previous years. In this, we compare a line item with the same line item in another period (a year or
quarter). The objective is to find any significant change in any line item. For instance, if the cost of
goods sold (COGS) rises much more than the increase in sales or gross profit rises but net profit
drops.
In the Vertical Analysis, every line item in the financial statement is calculated as a proportion of
another prominent item. Usually, in the income statement, each line item is calculated as a proportion
of revenue or sales. On the balance sheet, each line item is represented as a proportion of total assets.
After die calculation of ratios, one can compare them with the past years to identify any usual
happenings.
Ratio Analysis:
It is among the most popular methods of financial statement analysis. There are different types of
ratios that help management and analysts to dig out meaningful information. There are four categories
of ratios - profitability ratios, liquidity ratios, leverage ratios, and activity ratios. Some of the popular
ratios are the current ratio, PE ratio, debt ratios, and more.
After analysts calculate a ratio (or ratios), they can compare it with the same ratio of previous years.
Or, they can also compare it with the industry average or with the competitors. Also, one can compare
the ratios with the set standards or the ideal ratio. For instance, the cuirent ratio of 1 is excellent.
However, the benchmark or ideal ratios vaiy from industry to industry.
 A 4.5: Financial Management 2021 I
Trend Analysis:
This method of financial analysis is similar to the horizontal analysis. In this method, also we
compare and review the financial statements of three or more years. Under this, the earliest year
becomes the base year. The objective is to find any pattern in the financial numbers. These patterns
could be rising (or falling) sales, any seasonal trend, fluctuations in expenses, and more. An analyst
can also use ratios to identify trends (if any) in the financial numbers.
Fund Flow / Cash Flow Analysis:
This method helps to study the inflow and outflow of cash and bank balances. Under this method, we
examine the movement of cash, rather than changes in the working capital. The study of cash flow
tells the purpose - investing, operations, and more - for which the company is using its funds.
Moreover, it also shows the source of those funds M.
Common Size Analysis:
In this balance sheet, the total assets figures are assumed to be 100 and all figures are expressed as a
per centage of this total [7J.

Unit-111: Management of W orking Capital

1.1 Meaning, Significance and Sources of Working Capital:

Working capital is the capital needed by the firm to finance current assets. It is the fund to
finance regular operations, i.e. day to day business activities, effectively. It is helpful in
gauging the operating liquidity of the company, i.e. how efficiently the company is able to
cover the short-term debt with short-term assets [1]. It can be calculated as:
• Working Capital = Current Assets - Current Liabilities
It is the difference between a company's current assets and current liabilities. It is a financial
measure, which calculates whether a company has enough liquid assets to pay its bills that
will be due within a year. When a company has excess current assets, that amount can then
be used to spend on its day-to-day operations [2].

The funds invested in current assets are termed as working capital. It is the fund that is
needed to run the day-to-day operations. It circulates in the business like the blood circulates
in a living body. Generally, working capital refers to the current assets of a company that are
changed from one form to another in the ordinary course of business, i.e. from cash to
inventory, inventory to work in progress (WIP), WIP to finished goods, finished goods to
receivables and from receivables to cash.
 A 4.5: Financial Management 2021 I
Classification of Working Capital:
Working capital may be of different types as follows:
Gross Working Capital:
Gross working capital refers to the amount of funds invested in vari-ous components of
current assets. It consists of raw materials, work in progr ess, debtors, finished goods, etc.
Net Working Capital:
The excess of current assets over current liabilities is known as Net working capital. The
principal objective here is to learn the composition and magnitude of current assets requir ed
to meet current liabilities.
Positive Working Capital:
This refers to the surplus of current assets over current liabilities.
Negative Working Capital:
Negative working capital refers to the excess of current liabilities over current assets.
Permanent Working Capital:
The minimum amount of working capital which even required dur-ing the dullest season of
the year is known as Permanent working capital.
Temporary or Variable Working Capital:
It represents the additional current assets required at different times during the operating year
to meet additional inventory, extra cash, etc.
It can be said that Permanent working capital represents minimum amount of the current
assets required throughout the year for normal production whereas Temporary working
capital is the addi-tional capital required at different time of the year to finance the
fluctuations in production due to seasonal change. A firm having constant annual production
will also have constant Permanent work-ing capital and only Variable working capital
changes due to change in production caused by seasonal changes. (See Figure 3.1.)
 A 4.5: Financial Management 2021

. Variable Working
Capital
Amount

I’cmiancnl Working
Capital

Period

Figure 3.1: Variable & Permanent Working Capital for Firm haying constant sales.

Similarly, a growth firm is the firm having unutilized capacity, however, production and
operation continues to grow naturally. As its volume of production rises with the passage of
time so also does the quantum of the Permanent working capital. (See Figure 3.2.)

A y
'
Variable Working
Capital

/
\ I J
/

Amount
N/
V Permanent Working
( tpiul

J
Figure 3.2: Variable & Permanent Working Capital for Growth Firm

Components of Working Capital:

Working capital is composed of various current assets and current liabilities, which are as
follows:
Current Assets:
These assets are generally realized within a short period of time, i.e. within one year. Current
assets include:
- Inventories or Stocks
- Raw materials
 A 4.5: Financial Management 2021 I
Work in progress
Consumable Stores
Finished goods
Sundry Debtors
Bills Receivable
- Pre-payments
- Short-term Investments

- Accrued Income and

- Cash and Bank Balances
Current Liabilities;
Current liabilities are those which are generally paid in the ordinary course of business within
a short period of tune, i.e. one year. Current liabilities include:
- Sundry Creditors

Bills Payable
- Accrued Expenses
- Bank Overdrafts
- Bank Loans (short-term)
Proposed Dividends
- Short-term Loans
- Tax Payments Due
Significance of Working Capital:
Working capital plays a vital role in business. This capital remains blocked in raw materials,
work in progress, finished products and with customers. The needs for working capital are as
given below:
1. Adequate working capital is needed to maintain a regular supply of raw materials, which
hi turn facilitates smoother running of production process.
2. Working capital ensures the regular and timely payment of wages and salaries, thereby
improving the morale and efficiency of employees.
3. Working capital is needed for the efficient use of fixed assets.
 A 4.5: Financial Management 2021 I
4. In order to enhance goodwill a healthy level of working capital is needed. It is necessary
to build a good reputation and to make payments to creditors in time.
5. Working capital helps avoid the possibility of under-capitalization.
6. It is needed to pick up stock of raw materials even during economic depression.
7. Working capital is needed in order to pay fair rate of dividend and interest in time, which
increases the confidence of the investors in the firm.
8. It helps measure profitability of an enterprise. In its absence, there would be neither
production nor profit.
9. Without adequate working capital an entity cannot meet its sliort-tenn liabilities in time.
10. A firm having a healthy working capital position can get loans easily from the market due
to its high reputation or goodwill.
11. Sufficient working capital helps maintain an uninterrupted flow of production by
supplying raw materials and payment of wages.
12. Sound working capital helps maintain optimum level of investment in current assets.
13. It enhances liquidity, solvency, credit worthiness and reputation of enterprise.
14. It provides necessary funds to meet unforeseen contingencies and thus helps the
enterprise run successfully during periods of crisis C3l
Sources of Working Capital:
1. Bank Overdraft / Cash Credit:
Bank overdraft or cash credit is the most useful as well as right sources of working capital
finance used by all the small as well as larger businesses. It’s offered by banks by which your
borrower is sanctioned a specified amount that can be utilized for his business repayments.
Borrower has to ensure that he does not exceed the lnnrt sanctioned. The greatest advantage
is that the interest is actually billed towards level the funds utilized rather than the sanctioned
amount.
2. Trade Credit:
This really is only by way of extending credit period by your creditor associated with your
business. Mostly trade credit is extended by creditors based on the creditworthiness
associated with the company. This can be reflected by its liquidity position, earning records
and more.
 A 4.5: Financial Management 2021 I
3. Working Capital Loan:
Working capital loan are best for short term requirement. These types of working capital
finance can be paid back at monthly installment payments or even as a lumpsum amount. The
debtor / borrowers should definitely opt for such financing to finance permanent working
capital needs.
4. Factoring:
Factoring is actually excellent arrangement for the companies to raise funds simply by selling
his or her invoices to third party at a lower price or discounted price. That the thir d party the
following is known as the factor who provides factoring provider s in order to business. Your
factor would offer you financing by buying your invoices.
5. Bank Guarantee:
It is recognized as non-fund structured sources of working capital finance. Bank guarantee is
actually acquired with a buyer or seller towards reduce the threat of loss towards other party
task that might be repaying or offering services. Working capital finance example: A buyer
can opt for bank guarantee when purchasing products from sellers against risk of poor quality
or late delivery of goods. Bank charges some commission as well as ask for security deposit
as well.
Loan-Term Sources of Working Capital Finance / Loan:
6. Equity Capital:
Equity capital refers to the portion of the company’s equity that has been received or are
going to be acquired simply by investing in stock as a shareholder for cash or perhaps
equivalent capital worth. Equity comprises their nominal values of all of the equity granted,
which is known as par values. Stock capital defined as their amount of capital received by the
company from investors when investing in stocks.
7. Long Term Working Capital Loan:
A loan is a type of finance which it involves their redistribution of assets over time,
anywhere between the lender as well as the debtor. When opting for loan, you initially gets or
bonows an amount of cash through the lender, and is obligated to repay an equal money of
cash along with interest to your lender. For the most part, the money is paid back in monthly
installments, where every installment is the same. Lender can be either non-fmancial
organizations or banking institutions. Secured loan is a loan where borrower pledges an asset
 A 4.5: Financial Management 2021 I
(Working capital finance example: Car, House, Land, etc.) as collateral. Unsecured loans is
financial loans that does not require borrower to pledge any assets but such loans have higher
interest rates [4].
1.2 Factors Affecting to Working Capital:
Length of Operating Cycle:
The amount of working capital directly depends upon the length of operating cycle.
Operating cycle refers to the time period involved in production. It starts right from
acquisition of raw material and ends till payment is received after sale.
The working capital is very important for the smooth flow of operating cycle. If operating
cycle is long then more working capital is required whereas for companies having short
operating cycle, the working capital requirement is less.
Nature of Business:
The type of business, film is involved in, is the next consideration while deciding the
working capital. In case of trading concern or retail shop the requirement of working capital
is less because length of operating cycle is small.
The wholesalers as compared to retail shop require more working capital as they have to
maintain large stock and generally sell goods on credit which increases the length of
operating cycle. The manufacturing company requires huge amount of working capital
because they have to convert raw material into finished goods, sell on credit, maintain the
inventory of raw material as well as finished goods.
The firms operating at large scale need to maintain more inventory, debtors, etc. So they
generally require large working capital whereas firms operating at small scale require less
workmg capital.
Business Cycle Fluctuation:
During boom period the market is flourishing so more demand, more production, more stock,
and more debtors which mean more amount of working capital is required. Whereas during
depression period low demand less inventories to be maintained, less debtors, so less
working capital will be required.
Seasonal Factors:
The working capital requirement is constant for the companies which are selling goods
throughout the season whereas the companies which are selling seasonal goods require huge
 A 4.5: Financial Management 2021 I
amount during season as more demand, more stock has to be maintained and fast supply is
needed whereas during off season or slack season demand is very low so less working capital
is needed.
Technology and Production Cycle:
If a company is using labour intensive technique of production then more working capital is
required because company needs to maintain enough cash flow for making payments to
labour' whereas if company is using machine-intensive technique of production then less
working capital is required because investment in machinery is fixed capital requirement and
there will be less operative expenses.
In case of production cycle, if production cycle is long then more working capital will be
required because it will take long time for converting raw material into finished goods
whereas when production cycle is small lesser funds are tied up in inventory and raw
materials so less working capital is required.
Credit Allowed:
Credit policy refers to average period for collection of sale proceeds. It depends on number
of factors such as creditworthiness, of clients, industry norms etc. If company is following
liberal credit policy then it will require more working capital whereas if company is
following strict or short term credit policy, then it can manage with less working capital also.
Credit Avail:
Another factor related to credit policy is how much and for how long period company is
getting credit from its suppliers. If suppliers of raw materials are giving long term credit then
company can manage with less amount of working capital whereas if suppliers are giving
only short period credit then company will require more working capital to make payments to
creditors.
Operating Efficiency:
The fhm having high degree of operating efficiency requires less amount of working capital
as compared to firm having low degree of efficiency which requir es more working capital.
Firms with high degree of efficiency have low wastage and can manage with low level of
inventory also and during operating cycle also these firms bear less expense so they can
manage with less working capital also.
 A 4.5: Financial Management 2021 I
Availability of Raw Materials:
If raw materials are easily available and there is ready supply of raw materials and inputs
then firnis can manage with less amount of working capital also as they need not maintain
any stock of raw materials or they can manage with very less stock, hi case, the supply of
raw materials is not smooth then films may require more working capital.
Inflation:
If there is increase or rise in price then the price of raw materials and cost of labor will rise, it
will result in an increase in working capital requirement.
But if company is able to increase the price of its own goods as well, then there will be less
problem of working capital. The effect of rise in price on working capital will be different for
different businessmen.
Level of Competition:
If the market is competitive then company will have to adopt liberal credit policy and to
supply goods on time. Higher inventories have to be maintained so more working capital is
requited. A business with less competition or with monopoly position will require less
working capital as it can dictate terms according to its own requirements.
Growth Prospects:
Firms planning to expand their activities will require more amount of working capital as for
expansion they need to increase scale of production which means more raw materials, more
inputs etc. so more working capital also [5].
Manufacturing Cost
The manufacturing cost is another factor that determines how much working capital is
needed.
For example, if production cost of a product is high then working capital required is also
more and vice versa.
Rate of Turnover
The working capital requirements of a business depend on the rate of turnover or sales. If the
sales are very fast, then less working capital is required and vice versa [6).

1.3 Disadvantages of insufficient Working Capital:

Major drawbacks or disadvantages of inadequate working capital can be highlighted as
follows:
 A 4.5: Financial Management 2021 I
Lack of Solvency
Inadequate working capital creates problem for making payment of salary, wages and short¬
term liabilities of a firm. It weakens the solvency position of the company.
Opportunity Loss
A business finn may lose new opportunities due to insufficient amount of working capital.
Business expansion is also impossible.
Damage Goodw ill
A firm fails to meet its financial obligations due to inadequate working capital. It affects or
damages the goodwill of the firm.
Inefficiency
A firm cannot utilize its fixed assets and other production facilities effectively because of the
shortage of fund. So, production process will be disturbed and leads to inefficiency.
No Discount
It is impossible to purchase raw materials and other requir ements in bulk quantity because of
poor liquidity. So, opportunity of trade discount and cash discount cannot be availed.
No Attraction of Investors
A film cannot attract investors and lenders due to poor liquidity and solvency position.
Low' Rate of Return
Due to inadequate amount of working capital, a firm cannot function properly. It leads to low
rate of return on investment [7l
Unit IV: Fund Flow' and Cash Flow

Introduction:
The objectives of preparing Income statement / Profit and Loss Account and Balance Sheet
are to supply the financial information to the users. The Balance Sheet exhibits the financial
position at the end of the period through the assets (which show the development of
resources in various types of properties) and liabilities (which present how these resources
were taken).
Hie Income Statement, on the other hand, measures the results of the operation at the end of
the period, i.e., the change in the owner’s equity as a result of the productive and commercial
activities for the period.