Overview of financial management:-

• According to Van Horne and Wachowicz, “Financial Management is concerned with the acquisition,
financing and management of assets with some overall goal in mind.”(1)

• Financial management deals with the ways in which an organization can raise funds for the various projects,
allocation of those funds in the most productive and efficient way, how to exercise control over those funds
and how to distribute the returns of those funds to the various stakeholders.

• It generally deals with planning, controlling, organizing, and directing the financial activities of a firm.

• Financial Management ensures that the organization meets its primary objectives such as maximizing the
shareholders’ wealth, cutting down the finance cost and other non-financial objectives which are to other
stakeholders such as the government, employees, and suppliers.

Goals of financial management:-

Two main goal:-
• Profit maximization happens when marginal cost is equal to marginal revenue. This is the main objective of Financial
Management.
• Shareholders wealth maximization

Apart from these 2 following are goals of financial mgmt.:

• Management of reserves for growth and expansion.
• Maintaining proper cash flow
• To pay day to day expenses
• To ensure adequate returns of the stakeholders based on market price of the share, earning capacity ,
expectations of the stakeholders
• To ensure optimum fund utilization.
• Wealth maximization means maximization of shareholders' wealth. It is an advanced goal compared to profit
maximization.
• Survival of company is an important consideration when the financial manager makes any financial decisions. One
incorrect decision may lead company to be bankrupt.
• Maintaining proper cash flow is a short run objective of financial management. It is necessary for operations to pay
the day-to-day expenses e.g. raw material, electricity bills, wages, rent etc. A good cash flow ensures the survival of
company.
• Minimization on capital cost in financial management can help operations gain more profit.

Fundamental principles of finance:-

There are six core principles of finance you should know
1. The Principle of Risk and Return
The principle of Risk and Return indicates that investors have to conscious both risk and return, because
higher the risk higher the rates of return and lower the risk, lower the rates of return. For business financing,
we have to compare the return with risk. To ensure optimum rates of return investors need to measure risk
and return by both direct measurement and relative measurement.

2. Time Value of Money Principle

This principle is concerned with the value of money, that value of money is decreased when time passes. The
value of dollar 1 of the present time is more than the value of dollar 1 after some time or years. So before
investing or taking funds, we have to think about the inflation rate of the economy and the required rate of
return must be more than the inflation rate so that return can compensate for the loss incurred by the
inflation.

3. Cash Flow Principle

The cash flow principle mainly discusses the cash inflow and outflow, more cash inflow in the earlier period
is preferable than later cash flow by the investors. This principle also follows the time value principle that’s
why it prefers earlier more benefits rather than later years benefits.

4. The Principle of Profitability and liquidity

The principle of profitability and liquidity is very important from the investor’s perspective because the
investor has to ensure both profitability and liquidity. Liquidity indicates the marketability of the investment
i.e. how much easy to get cash by selling the investment. On the other hand, investors have to invest in a way
that can ensure the maximization of profit with a moderate or lower level of risk.

5. Principles of diversity and

This principle helps to minimize the risk by building an optimum portfolio. The idea of a portfolio is, never
put all your eggs in the same basket because if it falls then all of your eggs will break, so put eggs by
separating in a different basket so that your risk can be minimized. To ensure this principle investors have to
invest in risk-free investment and some risky investment so that ultimately risk can be lower. Diversification
of investment ensures minimization of risk.

6. The Hedging Principle of Finance

Hedging principle indicates us that we have to take a loan from appropriate sources, for short-term fund
requirement we have to finance from short-term sources and for long-term fun requirement we have to
manage fund from long-term sources. For fixed asset financing is to be done from long-term sources.

Finally, if you have a basic understanding of finance and its principles then you will be able to take financial
decisions effectively. And there is a higher possibility to become financially gainer.
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Financial manager’s responsibilities:
- Forecasting and planning
- Coordination and control
- Dealing with financial markets
- Major investments and financing decisions
- Obtain and use funds in a way that will maximize the value of the firm

Financial Decisions:
Forms of business organization:
Choosing a form of business organizations depends on following factors:
- The nature of business is the most important factor.
- Scale of operations i.e. volume of business (large, small, medium) and the size of the market area (local,
national, international)
- Amount of capital required for the establishment and operations of a business.
- The volume of risks and liabilities as well as the willingness of the owners to bear it.
Forms of business organizations:
1. Sole Proprietorship:
- Single person owns, manages and controls the entire firm
- Owner is the only source of capital
- Sole recipient of all profits and losses
- Eg. Shops in our locality like shop of sweets, vegetable store, chemist shop, paanwala, stationary store
etc comes under sole proprietorship.
Advantages:
- Easy to start
- Better control
- Ownership of all profits
- Easy decision making
- Easy to windup
- Secrets (information about business techniques)
- No corporate taxes
Disadvantages:
- Unlimited liability-personal assets are also involved in paying the liabilities
- Difficult to raise capital
- Business has Limited Life
- Undivided risk
- Difficult to do business beyond certain size

2. Partnership
- Owned by two or more persons who contribute resources into the entity
- Agreed to share profit and losses predefined by mutual consent
- Members-Minimum 2 and maximum 100 members
- Each member of such a group is individually known as ‘Partner’ and collectively the members are
known as a ‘Partnership Firm’
- Formed in accordance to the provisions of the Indian Partnership Act, 1932
- Generally, the partnership agreement or partnership Deed is prepared. Partnership Deed lays down the
terms and conditions of partnership and the rights, duties and obligations of partners
Advantages:
- Relatively easy to start
- Easy to raise funds
- More skilled persons
- Loss sharing/risk bearing
- Better Management and Flexibility of Operation
- No corporate income tax

Disadvantages:
- Unlimited liability of all partners
 - Profit sharing
- Chances of conflicts
- Limited life
- Transferability is difficult

3. Joint Stock Company

- A voluntary association of persons who contribute money to carry on business
- Artificial person-official signature in the form of stamp (common seal)
- Members of a joint stock company are known as shareholders (part of owners) and the capital of the
company is known as share capital
- Representatives in the form of Board of directors- take the major decisions of the company
- The companies are governed by the Indian Companies Act, 1956
- E.g. Tata Iron & Steel Co. Limited, Hindustan Lever Limited, Reliance Industries Limited
Advantages:
- Limited Liability-limited to the amount of capital contributed
- Continuity of existence
- Risk bearing-less as it is spread amongst all the shareholders
- Benefits of large scale operation
- Professional Management
- Transferability of shares
Disadvantages:
- Formation is not easy
- Controlled by a group
- Excessive government control
- Delay in Policy Decisions

4. Co-operative Society
- It is a voluntary association of people or business to achieve an economic goal with a social perspective
- Mutual welfare of members
- Minimum membership requirement is 10 and there is no maximum limit
- Registration of Co-Operative is must under the “Co-Operative Societies Act”
- Separate legal entity
Advantages:
- Easy formation
- Limited Liability –Limited to the extent of the capital contributed
- Democratic Management i.e. one man- one vote irrespective to the amount of capital they contributed to
the society
- Support from Government- Low taxes, Low subsidy, Low interest rates on loans
- Stable existence/continuity in existence
Disadvantages:
- Possibility of conflicts due to differences in opinion
- Long decision making process
- Limited financial resources
- Inefficiency in Management.

Risk Return Trade off:

 • Risk is present in every decision, whether it is corporate decision or personal decision
• Risk refers, ‘threat or damage, injury or liability or loss of other negative occurrence caused by external or
internal vulnerabilities’

• The risk-return trade-off is an investment principle that indicates that the higher the risk, the higher
the potential reward.
• To calculate an appropriate risk-return trade-off, investors must consider many factors, including
overall risk tolerance, the potential to replace lost funds and more.
• Investors consider the risk-return trade-off on individual investments and across portfolios when
making investment decisions.
• Increasing risk does not guarantee higher return; it just raises the possibility of it.
• From business point of view risk is the variability in an expected return
• They see risk in the business when they realise less return than expected
• Actual return may be less than the expected, because of risks like, business risk, financial risk, default risk,
delivery risk, interest rate risk, exchange rate risk, liquidity risk, investment risk, and political risk.

The objective of measuring risk is not to eliminate or avoid it – because it is not feasible to do so. But it helps us in
assessing and determining whether the proposed investment is worth or not.

There is a relation between the risk and return. Any decision that involves more risk generally we can expect more
returns from taking that decision, and vice-versa. (Fig 1.4)

risk free return : In some decisions we do not assume any risk or assume zero risk, but we get some return. Return on
this type of investment/decision is known as risk free return (Rf).

Mergers and Acquisitions:

Mergers:
 - A merger is an agreement that unites two existing companies into one new company.
• Done to expand a company’s reach, expand into new segments, or gain market share. All of
these are done to increase shareholder value. Often, during a merger, companies have a no-
shop clause to prevent purchases or mergers by additional companies.
• A merger is the voluntary fusion of two companies on broadly equal terms into one new legal
entity.
• The firms that agree to merge are roughly equal in terms of size, customers, scale of
operations, etc. For this reason, the term "merger of equals" is sometimes used.
• Mergers are most commonly done to gain market share, reduce costs of operations, expand to
new territories, unite common products, grow revenues, and increase profits—all of which
should benefit the firms' shareholders.
• After a merger, shares of the new company are distributed to existing shareholders of both
original businesses.
• Due to a large number of mergers, a mutual fund was created, giving investors a chance to
profit from merger deals.
• The fund captures the spread or amount left between the offer price and trading price.
• Eg. Vodafone - Idea Merger, Tata Teleservices and Telenor – Airtel, Axis Bank-Freecharge
• Ola- foodpanda: Uber has launched its food ordering application “UberEats” in India. In
order to competete with it Ola decided to acquire Foodpanda which was 3rd largest food
ordering application after Zomato and Swiggy.

Types of Mergers

Conglomerate

A merger between firms that are involved in totally unrelated business activities. There are two types of
conglomerate mergers: pure and mixed. Pure conglomerate mergers involve firms with nothing in common,
while mixed conglomerate mergers involve firms that are looking for product extensions or market
extensions.

Example

A leading manufacturer of athletic shoes, merges with a soft drink firm. The resulting company is faced with
the same competition in each of its two markets after the merger as the individual firms were before the
merger. One example of a conglomerate merger was the merger between the Walt Disney Company and the
American Broadcasting Company.

Benefits of a Merger or Acquisition

Horizontal Merger

A merger occurring between companies in the same industry. Horizontal merger is a business consolidation
that occurs between firms who operate in the same space, often as competitors offering the same good or
service. Horizontal mergers are common in industries with fewer firms, as competition tends to be higher and
the synergies and potential gains in market share are much greater for merging firms in such an industry.

Example

A merger between Coca-Cola and the Pepsi beverage division, for example, would be horizontal in nature.
The goal of a horizontal merger is to create a new, larger organization with more market share. Because the
merging companies' business operations may be very similar, there may be opportunities to join certain
operations, such as manufacturing, and reduce costs.
Market Extension Mergers

A market extension merger takes place between two companies that deal in the same products but in separate
markets. The main purpose of the market extension merger is to make sure that the merging companies can
get access to a bigger market and that ensures a bigger client base.

Example

A very good example of market extension merger is the acquisition of Eagle Bancshares Inc by the RBC
Centura. Eagle Bancshares is headquartered at Atlanta, Georgia and has 283 workers. It has almost 90,000
accounts and looks after assets worth US $1.1 billion.

Eagle Bancshares also holds the Tucker Federal Bank, which is one of the ten biggest banks in the
metropolitan Atlanta region as far as deposit market share is concerned. One of the major benefits of this
acquisition is that this acquisition enables the RBC to go ahead with its growth operations in the North
American market.

With the help of this acquisition RBC has got a chance to deal in the financial market of Atlanta , which is
among the leading upcoming financial markets in the USA. This move would allow RBC to diversify its base
of operations.

Product Extension Mergers

A product extension merger takes place between two business organizations that deal in products that are
related to each other and operate in the same market. The product extension merger allows the merging
companies to group together their products and get access to a bigger set of consumers. This ensures that they
earn higher profits.

Example

The acquisition of Mobilink Telecom Inc. by Broadcom is a proper example of product extension merger.
Broadcom deals in the manufacturing Bluetooth personal area network hardware systems and chips for IEEE
802.11b wireless LAN.

Vertical Merger

A merger between two companies producing different goods or services for one specific finished product. A
vertical merger occurs when two or more firms, operating at different levels within an industry's supply
chain, merge operations. Most often the logic behind the merger is to increase synergies created by merging
firms that would be more efficient operating as one.

Example

A vertical merger joins two companies that may not compete with each other, but exist in the same supply
chain. An automobile company joining with a parts supplier would be an example of a vertical merger. Such
a deal would allow the automobile division to obtain better pricing on parts and have better control over the
manufacturing process. The parts division, in turn, would be guaranteed a steady stream of business.

Synergy, the idea that the value and performance of two companies combined will be greater than the sum of
the separate individual parts is one of the reasons companies merger.

Acquisitions:

• An acquisition occurs when one company buys most or all of another company's shares.
 • If a firm buys more than 50% of a target company's shares, it effectively gains control of that
company.
• An acquisition is often friendly, while a takeover can be hostile; a merger creates a brand new entity
from two separate companies.
• Acquisitions, which are very common in business, may occur with the target company's approval, or
in spite of its disapproval. With approval, there is often a no-shop clause during the process.
Eg. Flipkart and Myntra (may 2014), Zomato and Urbanspoon,

Myntra and Jabong: Despite having raised $250 million in funding, online fashion portal Jabong was
facing a severe cash crunch when it was acquired by Flipkart-owned Myntra for $70 million in July 2016

Why Make an Acquisition?

Companies acquire other companies for various reasons. They may seek economies of scale, diversification,
greater market share, increased synergy, cost reductions, or new niche offerings. Other reasons for
acquisitions include those listed below.

As a Way to Enter a Foreign Market

If a company wants to expand its operations to another country, buying an existing company in that country
could be the easiest way to enter a foreign market. The purchased business will already have its own
personnel, a brand name, and other intangible assets, which could help to ensure that the acquiring company
will start off in a new market with a solid base.

As a Growth Strategy
Perhaps a company met with physical or logistical constraints or depleted its resources. If a company is
encumbered in this way, then it's often sounder to acquire another firm than to expand its own. Such a
company might look for promising young companies to acquire and incorporate into its revenue stream as a
new way to profit.

To Reduce Excess Capacity and Decrease Competition

If there is too much competition or supply, companies may look to acquisitions to reduce excess capacity,
eliminate the competition, and focus on the most productive providers.

To Gain New Technology

Sometimes it can be more cost-efficient for a company to purchase another company that already has
implemented a new technology successfully than to spend the time and money to develop the new
technology itself.
Takeover :
- A takeover is the purchase of one company by another.
- A takeover occurs when one company makes a bid to assume control of or acquire another, often by
purchasing a majority stake in the target firm.
- In the takeover process, the company making the bid is the acquirer while the company it wishes to take
control of is called the target.
- typically initiated by a larger company for a smaller one
- A takeover, which merges two companies into one, can bring major operational advantages and
improvements to performance and for shareholders.
- Takeovers are similar to mergers in that both processes combine two companies into one. Where they
differ is that a merger involves two equal companies while a takeover generally involves unequals—a
larger company that targets a smaller one.
- If the takeover goes through, the acquiring company becomes responsible for all of the target company’s
operations, holdings, and debt.
- There are many reasons why companies may initiate a takeover. An acquiring company may pursue an
opportunistic takeover, where it believes the target is well priced. By buying the target, the acquirer may
feel there is long-term value.
- Some companies may opt for a strategic takeover. This allows the acquirer to enter a new market without
taking on any extra time, money, or risk. The acquirer may also be able to eliminate competition by going
through a strategic takeover.
Reasons for the takeovers:
• Those with a unique niche in a particular product or service
• Small companies with viable products or services but insufficient financing
• Similar companies in close geographic proximity where combining forces could improve efficiency
• Otherwise viable companies that pay too much for debt that could be refinanced at a lower cost if a
larger company with better credit took over
Types of takeovers:
1. Friendly Takeover
- A friendly takeover bid occurs when the board of directors from both companies (the target and acquirer)
negotiate and approve the bid.
- The board from the target company will approve the buyout terms and shareholders will get the opportunity
to vote in favour of, or against, the takeover.
2. Hostile takeovers:
- A hostile takeover allows a bidder to take over a target company whose management is unwilling to
agree to a merger or takeover.
- A takeover is considered hostile if the target company's board rejects the offer, and if the bidder
continues to pursue it, or the bidder makes the offer directly after having announced its firm intention to
make an offer.
3. Reverse Takeovers:
A reverse takeover is a type of takeover where a private company acquires a public company.
4. Backflip takeovers:
A backflip takeover is any sort of takeover in which the acquiring company turns itself into a subsidiary of
the purchased company. This type of takeover can occur when a larger but less well-known company
purchases a struggling company with a very well-known brand.
Privatization:
- Privatization occurs when a government-owned business, operation, or property becomes owned by a
private, non-government party.
- Privatization also describes the transition of a company from being publicly traded to becoming privately
held.
How Privatization Works
- Privatization of specific government operations happens in a number of ways, though generally, the
government transfers ownership of specific facilities or business processes to a private, for-profit
company.
- Privatization generally helps governments save money and increase efficiency. In general, two main
sectors compose an economy—the public sector and the private sector.
- Government agencies generally run operations and industries within the public sector. In the U.S., the
public sector includes the U.S. Postal Service, public schools, and university systems, as well as the
National Park Service. Enterprises not run by the government comprise the private sector.
- Private companies include the majority of firms in the consumer discretionary, consumer staples,
finance, information technology, industrial, real estate, materials, and health care sectors.
Advantages and Disadvantages of Privatization
- privately-owned companies run businesses more economically and efficiently because they are profit
incentivized to eliminate wasteful spending.
- Furthermore, private entities don’t have to contend with the bureaucratic red tape that can plague
government entities.
- On the other hand, privatization naysayers believe necessities like electricity, water, and schools
shouldn’t be vulnerable to market forces or driven by profit.
- In certain states and municipalities, liquor stores and other non-essential businesses are run by public
sectors, as revenue-generating operations.
Divestiture
- A divestiture is the partial or full disposal of a business unit through sale, exchange, closure, or
bankruptcy.
- A divestiture may also occur if a business unit is deemed to be redundant after a merger or acquisition, if
the disposal of a unit increases the resale value of the firm, or if a court requires the sale of a business
unit to improve market competition.
- divestiture is the disposition or sale of an asset by a company.
- Divestitures are essentially a way for a company to manage its portfolio of assets.
- As companies grow, they may find they are trying to focus on too many lines of business and they must
close some operational units to focus on more profitable lines. Many conglomerates face this problem.
- Companies may also sell off business lines if they are under financial duress.
- Divested business units may be spun off into their own companies rather than closed in bankruptcy or a
similar outcome.
- Companies may be required to divest some of their assets as part of the terms of a merger before the deal
goes through.
- Governments may divest some of their interests in order to give the private sector a chance to profit.
- By divesting some of its assets, a company may be able to cut down on its costs, repay its outstanding
debt, reinvest, and focus on its core business(es) and streamline its operations.
- This, in turn, can enhance shareholder value. This is especially important when there is volatility in the
markets or if the company experiences unstable conditions.
Divesting Assets:
- There are many different reasons why a company may decide to sell off or divest itself of its assets.
Here are some of the most prevalent reasons why:
1. Bankruptcy: Companies that are going through the process of bankruptcy will need to sell off parts
of the business.
2. Cutting back on locations: A company may find it has too many locations. When consumers just
aren't coming through the doors, the company may be forced to close or sell down some of their
locations. This is especially true in the retail sector.
3. Selling losing assets: If the demand for a product or service is lower than expected, a company may
need to sell it off. Continuing to produce and sell an underperforming asset can cut into the company's
bottom line when it can concentrate on those that are performing.
Corporate Security:
Shares:
- A share or the proportion of interest of a shareholder is equal to the proportion of the amount paid to the total
capital payable to the company.

- According to Companies Act, 2013, Section 2(84), a share in the share capital of the company,
including stock, is the definition of the term ‘Share’.

- In other words, a share is a measure of the interest in the company’s assets held by a shareholder.

- Companies Act, 2013, Sec 44, states that shares or debentures or other interests of any member in a company
are movable properties. Also, they are transferable in the manner prescribed in the Articles of the company.

According to Section 43 of the Companies Act, 2013, the share capital of a company is of two types:
1. Preferential Share Capital

- The preferential share capital is that part of the Issued share capital of the company carrying a preferential
right for:
- Dividend Payment – A fixed amount or amount calculated at a fixed rate. This might/might not be
subject to income tax.
- Repayment – In case of a winding up or repayment of the amount of paid-up share capital, there is a
preferential right to the payment of any fixed premium or premium on any fixed scale. The
Memorandum or Articles of the company specifies the same.

2. Equity Share Capital – Equity Shares

- All share capital which is NOT preferential share capital is Equity Share Capital. Equity shares are of two
types:
- With voting rights
- With differential rights to voting, dividends, etc., in accordance with the rules.

Debentures:
- A certificate or voucher acknowledging a debt.
- Ability of a customer to obtain goods or services before payments, based on the trust that payments will be
made in the future.
- Debentures are a debt instrument used by companies and government to issue the loan.

- The loan is issued to corporates based on their reputation at a fixed rate of interest.

- Companies use debentures when they need to borrow the money at a fixed rate of interest for its expansion.
Secured and Unsecured, Registered and Bearer, Convertible and Non-Convertible, First and Second are
four types of Debentures.

- The debenture issued by a company is an acknowledgment that the company has borrowed an amount of
money from the public, which it promises to repay at a future date. Debenture holders are, therefore,
creditors of the company.
Characteristic of a Debenture The characteristic features of a debenture are as follows :

• It is a movable property.
• It is issued by the company and is in the form of a certificate of indebtedness.
• It usually specifies the date of redemption. It also provides for the re payment of principal and interest at
specified date or dates.
• It generally creates a charge on the undertaking or undertakings of the company.

Advantages of Debentures

• Investors who want fixed income at lesser risk prefer them.

• As a debenture does not carry voting rights, financing through them does not dilute control of equity
shareholders on management.

• Financing through them is less costly as compared to the cost of preference or equity capital as the
interest payment on debentures is tax deductible.

• The company does not involve its profits in a debenture.

• The issue of debentures is appropriate in the situation when the sales and earnings are relatively stable.
Disadvantages of Debentures
• Each company has certain borrowing capacity. With the issue of debentures, the capacity of a company to
further borrow funds reduces.

• With redeemable debenture, the company has to make provisions for repayment on the specified date,
even during periods of financial strain on the company.

• Debenture put a permanent burden on the earnings of a company. Therefore, there is a greater risk when
the earnings of the company fluctuate.
Types of Debenture
1. Secured and Unsecured:
Secured debenture creates a charge on the assets of the company, thereby mortgaging the assets of the company.
Unsecured debenture does not carry any charge or security on the assets of the company.

2. Registered and Bearer:

A registered debenture is recorded in the register of debenture holders of the company. A regular instrument of
transfer is required for their transfer. In contrast, the debenture which is transferable by mere delivery is called
bearer debenture.

3. Convertible and Non-Convertible:

Convertible debenture can be converted into equity shares after the expiry of a specified period. On the other
hand, a non-convertible debenture is those which cannot be converted into equity shares.

4. First and Second:

A debenture which is repaid before the other debenture is known as the first debenture. The second debenture is
that which is paid after the first debenture has been paid back
Financial statements :
balance sheet:

- Summary or snapshot of the financial position of a company at a particular date.

- Also referred to as the statement of financial position.
- Summarizes a company’s assets, liabilities and shareholders’ equity at a specific point in time.
- It includes: Assets, liabilities, owners’ equity.
- Assets (What the company has?):Cash, accounts receivable, inventory, land, buildings, equipment
- Liabilities (From where the money comes): accounts payable, notes payable and mortgages payable,
bank loan.
- Owners’ Equity (Own share): net assets after all obligations have been satisfied.
- Balance sheet is divided into 3 sections: Assets = Liabilities + Equity

Sample balance sheet:-

Assets
Cash $ 40 Liabilities
Accounts receivable $100 Accounts payable $ 50
Land $200 Bank Loan $150
Total Assets $340 $200

Owners’ Equity
Capital stock $100
Retained earnings $ 40
Total liabilities and ------------------------
owners’ equity $340
Must Equal

profit and loss statement:

- also called as statement of income and expenses or income statement.

- Says how much a company earned in a given period( can be made annually, monthly or for 6 months)
- It contains: revenues, expenses, net income or net loss
- Revenues= assets or cash created through business operations.
- Expenses= assets or cash consumed through business operations
- Net income or net loss= revenues - expenses

Cash flow statement:

- a report showing how things affect the balance sheet and
- income statement will affect the firm’s cash flows
- Cash flow statement has four sections: operating, long-term investing, financing activities, and
summary on cash flows over an accounting period
Free cash flow
- Accounting profit vs. cash flow
- Accounting profit is a firm’s net income reported on its income statement.
- Net cash flow is the actual net cash that a firm generates during a specified period.
- Net cash flow = NI + depreciation and amortization
- Free cash flow: amount of cash available for payments to all investors, including
- stockholders and debt-holders after investments to sustain on-going operations
 - FCF = EBIT*(1-T) + depreciation and amortization – (capital expenditures + Δ in net operating
working capital)

Taxes:

- A tax is a compulsory charge or payment imposed by Government on individuals or business activity.

- The act of levying taxes is called taxation.
- Most important source of revenue of the Government is taxes.
- The people who are taxed have to pay the taxes irrespective of any corresponding return from the goods
or services by the Government.
- The taxes may be imposed on the personal income, wealth of a person, business profits or added to the
cost of some goods, services and transactions.
- The rate of taxes may vary.

Objectives of taxes:

- Raising revenue
- Regulation of consumption and production’
- Encouraging domestic industries
- Stimulating investment
- Promoting economic growth
- Development of backward regions
- Ensuring price stability

What is tax money used for?

- Construction of bridges
- Road maintenance
- Research
- Education
- Armed services. National defense
- Retirement income for elders
- Social programs
- Physical, human and community development
- Law enforcement
- Interest on the national debt

Classification of Taxes:

- Taxes can be classified into various types on the basis of form, nature, aim and method of taxation.
- The most common and traditional classification is:
i) Direct Tax
ii) Indirect Tax
i) Direct Tax:-
- It is a tax levied on the income or profit of person who pays it rather than on goods or services.
- It is based on the income and property of a person.
- Examples of direct taxes: income tax, corporate tax on company’s profits, property tax, capital
gain tax, wealth tax, etc.
ii) Indirect Tax:-
- It is a tax levied on goods and services rather than on income or profit.
- Person paying this taxes can recover form another persons.
- It is levied on the expenditure of a person.
- Examples:- Excise duty, sales tax, custom duties, etc.
- Other classifications of taxes:

Income Tax:

- It is a tax levied directly on personal income

Value-Added Tax (VAT):

- It is type of consumption tax that is placed on a product whenever value is added at a stage of
production and at final sale.

Excise duty tax:

- It is an indirect tax levied on those goods which are manufactured in India.

Corporate tax:

- It is a direct tax levied on profits / net earnings of firms or business.

Custom duty:

- It is a type of indirect tax levied on goods imported into India as well as goods exported from India.

Sales Tax:

- A sales tax is a consumption tax imposed by the Government on the sale of goods and services.

Goods and Service Tax (GST):

- GST is a tax on goods and services with value addition at each stage having comprehensive and
continuous chain of set of benefits from the producer’s/ service provider’s point up to the retailer’s
level where only the final consumer should bear the tax.
- It is an indirect tax which is levy on manufacture, sale and consumption of all goods and services.
- It substitute mostly all the indirect taxes like excise tax, VAT, service Tax, Entertainment Tax,
Luxury Tax.

- Classification of taxes on the basis of degree of progression of tax:

- On the basis of degree of propagation of tax, it may be classified into:
i) Proportional tax
ii) Progressive Tax
iii) Regressive Tax
iv) Digressive Tax
i) Proportional tax: (Fixed rate of tax for every level of income or production)
- A tax is called proportional when the rate of taxation remains constant as the income of the tax
payer increases.
- In this system all incomes are taxed at a single uniform rate, irrespective of whether tax
payer’s income is high or low.
ii) Progressive Tax: ( Increasing rate of tax for increasing value or volume)
- When the rate of taxation increases as the tax payer’s income increases, it is called a
progressive tax.
- In this system, the rate of tax goes on increasing with every increase in income.
iii) Regressive Tax: ( Decreasing rate tax for increasing values or volume)
 - A regressive tax is one in which the rate of taxation decreases as the tax payer’s income
increases.
- Lower income is taxed at a higher rate, whereas higher income is taxed at a lower rate.
iv) Digressive Tax:
- A tax is called digressive when the rate of progression in taxation does not increase in the
same proportion as the increase in income. In this case, the rate of tax increases up to a certain
limit, after that a uniform rate is charged.
- Thus digressive tax is combination of progressive and proportional taxation.
- This type of taxation id often used in case of income tax. This is the case of income tax in
India as well.

Time value of money:

The time value of money draws from the idea that rational investors prefer to receive
money today rather than the same amount of money in the future because of money's
potential to grow in value over a given period of time.

Time lines and Notations:

- Dealing with cash flows that are at different points in time is made easier using a time line that shows
both the timing and the amount of each cash flow in a stream.
- Thus a cash flow stream of $100 at the end of each of the next four years can be depicted on a time line
like the one depicted in Figure.

Fig. A Time Line for Cash Flows: $ 100 in Cash Flows Received at the End of Each of Next 4 years

- 0 refers to right now.

- A cash flow that occurs at time 0 is therefore already in present value terms and does not need to be
adjusted for time value.
- A distinction must be made here between a period of time and a point in time.
- The portion of the time line between 0 and 1 refers to period 1, which in this example is the first year.
- The cash flow that occurs at the point in time 1 refers to the cash flow that occurs at the end of period 1.
- Finally, the discount rate, which is 10 per cent in this example, is specified for each period on the time
line and may be different for each period.
- Had the cash flows been at the beginning of each year instead of at the end of each year, the time line
would have been redrawn as it appears in next Figure:

Fig. A Time Line for Cash Flows: $ 100 in Cash Received at the Beginning of Each Year for Next 4 years
- Note that in present value terms, a cash flow that occurs at the beginning of year two is the equivalent of
a cash flow that occurs at the end of year one.
- Cash flows can be either positive or negative;
- positive cash flows are called cash inflows.
- negative cash flows are called cash outflows.
- For notational purposes, we will assume the following for the chapter that follows: