Financial Management

Chart Book for Revision

 1.SCOPE & OBJECTIVES OF FINANCIAL MANAGEMENT

1.Introduction 2.Meaning 3.Aspects of FM

4 Stages of New It is a A.Procurement of B. Use of Funds

Business Managerial funds
Activity a) Keeping in mind
• How many concerned with 1. R->Risk For Fixed For Working capital
Assets/PPE to effective 2. C ->Control assets [FA] Management
buy procurement & 3. C-> Cost
• cost Required utilization of b) Sound knowledge a) Adequate FA to a) Maintain
for above Funds of Various ensure optimum optimum level.
assets. sources of Operation b) Don’t block too
• cash for day to Finance. capacity much funds in
day operations. c) knowledge on b) Without Inventory,
• sources of Risk Coverage Endangering Debtors, cash
Finance [Hedging] Financial
Insolvency.
c) Through capital
Budgeting
Technique
 1.SCOPE & OBJECTIVES OF FINANCIAL MANAGEMENT

4.Tasks of FM 5.Objectives of FM 6.PM 7.WM

Advantages Advantages
S  Setting Sales A. Profit B. Wealth • Easy to • It’s long term
Target Maximization Maximization Calculate Nature
T  Tax Planning (PM) (WM) • Easy to link • It considers Time
to Minimizing PM Value of Money
tax a) Traditional objective • It Considers risk
a) Wealth = PV of
O  Avoid Over Approach with Factor
Benefits – PV
Investment in b) Over Emphasis Financial Disadvantages
of Cost
FA of profit Decision • Not Easy to link
b) Ascertaining
B  Balancing Cash Objective can Disadvantages WM to Financial
wealth
Inflows & lead to problems • Refer 5A decision
outflows • Cash flow • Might leads to
:  Narrow
N
S  Ensure approach & Not Management
Sufficient T  Ignore Time a/c profit Distress
short term Value of • Cost benefit
working Money analysis
capital R  Ignores Risk • Apply Time
Factor Value of money
V  Vague
 1.SCOPE & OBJECTIVES OF FINANCIAL MANAGEMENT

8.Role of Finance 9.Financial Distress (FD) 11.Agency Agency

Executive / CFO Problem (AP) & Cost (AC)

B  Budgeting Cash Inflow not

I  Overseeing Sufficient to pay a) Principal & Agent relationships exists b/w Manager
IT Function off Current & Providers of Funds
M  Manage obligations b) Mangers should keep interest of Provides of funds
Mergers& & Make financial decisions
Acquisitions c) If Interest of Manager ≠ Interest of providers of
O  Outsourcing 10. Insolvency finance
decisions Then it Creates AP
R  Risk Mgmt. d) AC is incurred by company to Control & Monitor
Inability to pay Manager behaviour and actions
P  Pricing off debts due to
Analysis continuous FD Negative Covenants
H  Oversee HR
(Borrowing Restrictions)
Functions
e) SORT OUT
Link Manager compensation
with overall objectives of
the company & Profits
 2.TYPES OF FINANCE

1.Financial Needs 2.Equity Shares 3.Preference Shares 4.Retained Earnings

a) Long Term [PPE] Ploughing back of

A.Advantages Preference
b) Medium Term Profits
i. Permanent
[Ad Campaign] Capital Dividends Repayment Of
c) Short Term ii. No Capital a) Profits are
[Working Capital] Obligation retained in the
To pay Business to fund
A. Advantages
Dividend Future Growth
i. Relatively
B.Disadvantages b) No Floatation
Cheaper
i. No tax Cost
ii. No Control
benefit on c) No Control
Dilution
dividend Dilution
B. Disadvantages d) No EPS
ii. Control i. Not a
Dilution permanent
iii. EPS Capital
iv. Relatively ii. Obligation to
Costly pay dividend
Exists
 2.TYPES OF FINANCE

5.Debentures 6.Bonds 7.Indian Bonds

Documents Types
A. Masala B. Municipal C. Govt
acknowledging the
Bonds Bonds Bonds
debt taken by the Callable Puttable
company
a) Denoted in
Company Has a) For Issued by
Investor has a INR
Advantages: right to redeem Infrastructure Central Govt/
right to sell b) Issued by
a) Tax Benefit On bonds before bonds back to a projects State Govt /
Indian
Interest maturity at a b) Ahmedabad RBI / Govt
company at a Companies
b) Relatively predetermined predetermined c) Issued to Municipal Dept.
Cheaper price corporation
price Investors
Disadvantages: raised 100 Cr
Outside
a) It is Not a By issuing
India
permanent Municipal
d) NTPC
Capital bonds in Asia
raised
b) Obligation to 2000 Cr.
pay Interest at By Masala
Regular Bonds
Intervals
 2. TYPES OF FINANCE

8.Foreign Bonds 9.Bridge Finance

A. Plain B. Drop Lock C. Yankee D. Samurai E. Bulldog a) Short term loan taken
Vanilla Bonds Bonds Bonds Bonds when original Loan is
sanctioned but yet to
a) Only a) Has floating disbursed
a) Denoted in a) Japanese a) In UK b) Bridge Finance gets
Interest rate of
US $ Yen pound repaid when original
and Interest
b) Issued in b) Issued In b) Issued in loan get disbursed
Principal b) If Interest
USA Japan UK c) Interest rate is Higher
repaid rate falls
c) Issued by c) By Non c) Issued when Compared to
b) No Other below
non US Japanese by Non original loan
features certain limit
companies Company UK
Attached then
d) To access d) To Access company
company Funds of
Funds of d) To
needs to pay Japanese
US access
fixed Market
markets funds of
Interest
UK
market
 2. TYPES OF FINANCE

10. Venture Capital Financing (VCF) 11. Debt Securitization

a) Funding of new risky projects promoted by qualified a) It is a process through which liquid
entrepreneurs who lack fund & Experience assets are Converted into Marketable
b) Types of VCF Securities & sold to Investors
i. Equity Financing: Eq Share given to VC firms but b) Financier pools finance given to
note more than 49% Borrower
ii. Conditional Loan: Interest free, But royalty B/W 2 – c) SPV act as a trustee for Investors
15% on sales Guaranteed d) The financier pool of assets is
iii. Income Note: Interest & Royalty on sales paid but transferred to Special Purpose Vehicle
at lower rate (SPV)
iv. Participation Debenture e) Investors are paid when Borrowers pays
 Start up phase = No Interest the Instalment
 Up to Certain level of operation = Low Interest f) It is Non Recourse Arrangement &
 Beyond that level = High Interest Investors bears the default risk
 2.TYPES OF FINANCE

12.Lease Financing 13.Other Types of Lease 14.Short Term Creditors

A. Sale & Lease Back:

Particulars OL FL a) Trade Creditors
 Seller = L’E
Cancellable Yes No  Buyer = L’R b) Accrued
Expenses
Term Short Long B. Leverage Lease: c) Advance From
 3 Parties Financier,L’R,L’E Customers
Repairs Lessor Lessee  L’E pays Financier,L’R d) Bank Advance:
Risk & Reward Lessor Lessee C. Sale Aid Lease: i. Short term
Obsolescence Risk Lessor Lessee  3 Parties = Manufacturer, loans
L’R & L’E ii. Overdraft
Single Pay-out Lease No Yes  L’R earn from Both Parties iii. Cash credit
 L’R gets Commission or iv. Bill
Option To Buy Asset No Yes
Credit from Manufacturer Discounting
PV of LP  L’R get lease rent from L’E
Approximately = Fair No Yes D. Open Ended & Close Ended:
Value of Asset
L’E has Option to Asset goes
Purchase the Asset back to L’R
 2. TYPES OF FINANCE

15. Export Finance From Banks 16. Seed Capital Assistance 17. Other Bonds

Pre Shipment Post Shipment a) Scheme of IDBI A. DEEP DISCOUNT /

b) Interest free ZERO COUPEN
Packing Credit (PC) BONDS
a) Discounting c) Service charge at 1%
PC is loan given by Bills for first 5 years  Issued at Discount
bank for b) Advance d) Moratorium period for  Redeemed at Face
Purchasing, against export first 5 years (No EMI Value
Manufacturing bill sent for required)  No Interest is paid
,processing, collection B. INFLATION BONDS
packing goods to c) Advance  Projects Investors
be sold to overseas against Duty against inflation
buyer drawback,  Interest rate is
Subsidy Adjusted with
Types of PC Inflation rate
a) Clean PC = Only Personnel
guarantee of borrower
b) PC against Hypothecation of goods
(goods are pledged for Security)
c) ECGC guarantee
 2.TYPES OF FINANCE

18. International Finance 19.EURO issues 20.ADR,GDR & IDR

a) Commercial Banks (Foreign Euro Commercial Paper: American Depositary Receipt:

Currency loans) • Less than 1 year  offered by Non US companies
b) Discounting of trade bills • Denoted in US $  To Investors In US
c) External Commercial Euro Convertible Bonds  Non US companies deposit their Company share with
Borrowing (ECB) • Get Converted into Eq. US banks
 Commercial loans taken from Share  Which inturn is converted into ADR & Sold to
non-residential lenders • May have call/put Investor
 Lenders are foreign banks or option Global Depositary Receipts
international financial Euro Convertible Zero  They are negotiable certificated held in the bank of
institutions like AOB etc. Bonds one country representing a specific No of shares
 Minimum Term of Loan = 3 • No Interest traded on Stock exchange of another country
years • Get Converted into Eq.
 Automatic (No approval Share Indian Depositary Receipts
necessary) • May have call/put  Issued By Non Indian Companies
 Approval Route (RBI/Govt option  Issued to Indian Investors
approval is required  To Access Indian Capital Market
 2.TYPES OF FINANCE

21.Comtemporary Sources of Funding

Crowd Funding Equity Funding Peer to Peer Start – Up Donation Based

Lending (P2P) funding Crowd funding
a) Raising money for an
Investor
Individual or
invest in In this types Through crowd Where large
organisation from a
organisation where lender funding a start group of people
group of a people to
and receive matched with up company can donate money as
fund a project
securities borrowers in raise money a charity for
typically via Internet
of the order to provide from large group some cause with
b) Helps Start ups to
organisation Unsecured loans of people no expectation
Substantiate demand
in return through Online of any ownership
for their product
before enter into platform It includes in the or debt
Production form of equity
c) Parties Involved funding and P2P
i. Fund Raiser lending
ii. Mediator
iii. Fund Investor
 3. Ratio Analysis

1.Liquid Ratios 3.Coverage Ratios 4.Efficiency Ratios

Interest 𝐸𝐵𝐼𝑇 Total Asset = 𝑆𝑎𝑙𝑒𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 (𝐶𝐴)
Current Ratio = coverage = Turnover Ratio 𝐴𝑣𝑔. 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 (𝐶𝐿) Ratio
𝐶𝐴 − 𝑆𝑡𝑜𝑐𝑘 Inventory 𝐶𝑂𝐺𝑆
Quick Ratio = Preference 𝐸𝐴𝑇 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 (𝐶𝐿) Turnover Ratio 𝐴𝑣𝑔. 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
Dividend coverage = 𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒
Ratio 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 Debtor 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠
=
2. Capital Structure Ratios Turnover Ratio 𝐴𝑣𝑔. 𝐷𝑒𝑏𝑡𝑜𝑟𝑠
Equity 𝐸𝐴𝐸𝑆𝐻
Dividend coverage = 𝐸𝑞𝑢𝑖𝑡𝑦 12𝑀 𝑜𝑟 365 𝐷𝐴𝑌𝑆
Debtor
Debt to Equity Ratio =
𝑇𝑜𝑡𝑎𝑙 𝑂𝑢𝑡𝑠𝑖𝑑𝑒 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 Ratio 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 =
𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝐸𝑞𝑢𝑖𝑡𝑦 Collection Period 𝐷𝑒𝑏𝑡𝑜𝑟𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜

Proprietary 𝐹𝑢𝑛𝑑 (𝑃𝐹) Creditor's = 𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠

Proprietary Ratio = Turnover Ratio 𝐴𝑣𝑔. 𝐶𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
Creditor =
12𝑀 𝑜𝑟 365 𝐷𝐴𝑌𝑆
PF = Equity Share Preference Payment Period
+ Reserves &
𝐶𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜
+ Share Capital
Capital Surplus
 3. Ratio Analysis

5.Profitability Ratios 6. Limitation of Ratios

Return on 𝐸𝐴𝐸𝑆𝐻
= 𝑥 100
Equity 𝑁𝑒𝑡𝑤𝑜𝑟𝑡ℎ
𝐺𝑃 a) Impacted by Inflation
GP Ratio = 𝑥 100 Net worth = Eq. Sh. Capital b) Impacted by seasonal nature of
𝑆𝑎𝑙𝑒𝑠
+ Reserves and Surplus Business
NP Ratio =
𝑁𝑃 c) Affected by accounting Policies
𝑥 100 Dividend
𝑆𝑎𝑙𝑒𝑠 =
𝐷𝑃𝑆 d) Can be manipulated by year end
Pay-out Ratio 𝐸𝑃𝑆 Adjustments
Operating Profit 𝐸𝐵𝐼𝑇
= 𝑥 100 𝑀𝑃𝑆 e) Difficult to generalize whether
Ratio 𝑆𝑎𝑙𝑒𝑠 PE ratio =
𝐸𝑃𝑆 particular ratio is good or bad
Operating Cost = COGS + Operating Expenses
Dividend 𝐷𝑃𝑆
= 𝑥100
Return on 𝐸𝐵𝐼𝑇(1 − 𝑇) Yield ratio 𝑀𝑃𝑆
Assets = 𝑥 100
𝐴𝑣𝑔. 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
Equity = Eq. Sh. Capital + Pref.
Return on 𝐸𝐵𝐼𝑇 Sh. Capital + R&S
Capital employed = 𝑥 100
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑
(ROCE ) Pre Tax Capital Employed = Eq. Sh. Capital
+ Pref. Sh. Capital + R&S
𝐸𝐵𝐼𝑇 (1 − 𝑇) +Long term debt
(ROCE ) Post Tax = 𝑥 100
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑
 4. Cost Of Capital

1.Meaning 2. Importance 3.Long Term Debt (kd)

Expected 1. Investing Decisions Redeemable Irredeemable

Return of 2. Financing Decisions
Providers 3. Optimum Credit 𝑹𝑽 − 𝑵𝑷
of Finance limit for Debtors 𝑰 𝟏−𝑻 +
𝒏 kd =
𝑰 𝟏−𝑻
kd = 𝑵𝑷
𝑹𝑽 + 𝑵𝑷
𝟐

1. Known as Approximation Method

2. If Difference B/w Redeemable Value & Net Proceeds is
Higher then use IRR method
3. IRR 
i. Select any 2 discount factors & Find out NPV
𝑵𝑷𝑽 𝑳
ii. IRR = L + 𝒙 (𝑯 − 𝑳)
𝑵𝑷𝑽𝑳 − 𝑵𝑷𝑽𝑯
New Debts = Issue Proceeds – Floatation Cost
iii. Net Proceeds
Existing = MPS – Floatation Cost
 4. Cost Of Capital

4. Cost of Convertible 5.Cost of Preference Shares(Kp) 6.Cost of Equity Shares(Ke)

Debentures
𝑫
Redeemable Irredeemable A. Dividend Approach (Ke) =
a) RV at Cash 𝑷
Value 𝑹𝑽 − 𝑵𝑷 𝑬𝑷𝑺
𝑷𝑫 + B. Earnings Approach (Ke) =
b) RV at Equity 𝒏 𝑷𝑫
kp = kp = 𝑴𝑷𝑺
𝑹𝑽 + 𝑵𝑷 𝑷𝟎
𝟐
Choose a or b C. Growth (Ke) =
𝑫𝟎(𝟏 + 𝒈)
+ 𝐠 (g = b X r)
whichever is 𝑷𝟎 − 𝑭
higher b= retention ration
D. CAPM (Ke)= 𝐑𝐟 + 𝜷 (𝐑𝐦 − 𝐑𝐟) r= return on equity
Then go for Growth
Approx. E. Realized Yield i. Find out Current Dividend
method or ii. Find out Dividend nth year
i. Find out cash flow
IRR for Kd iii. Step i / Step ii
ii. Use IRR method to
iv. Look for step iii answer in RV annuity table for
get Ke
nth year
 4. Cost Of Capital

7. Cost of 9.Marginal cost of Capital 8.WACC

Retained Earnings

Without A. Overall Cost of Capital

Kr = Apply 6A,6B,6C floatation B. Weights can be either Book/Market Value
Cost C. Format
(NP = MPS)
After
𝐊𝐫 = 𝐊𝐞 𝐗 𝟏 − 𝐭𝐩 𝐗(𝟏 − 𝐟) Source of MV/B tax cost
Weights Ko
finance V of
(3) 5=(4)x(3)
(1) (2) Capital
(4)
A. Cost of Raising Additional Funds
B. Limit beyond which new Equity shares are to be
sold by company
a) Find out RE
b) Find out % of RE on Total Capital
𝑹𝑬 𝒙𝟏𝟎𝟎
c) Total Capital =
% 𝒂𝒔 𝒑𝒆𝒓 (𝒃)
 4. Cost Of Capital

10.Debenture 11.Others
Interest rate from
Expected Rate
A. If Preference Shares / Debentures
are issued & redeemed at Par then
𝑨𝒄𝒕𝒖𝒂𝒍 𝑫𝒆𝒃𝒆𝒏𝒕𝒖𝒓𝒆 𝑰𝒏𝒕𝒆𝒓𝒆𝒔𝒕
NP = 𝒙𝟏𝟎𝟎 Kd = I (1-T)
𝑬𝒙𝒑𝒆𝒄𝒕𝒆𝒅 𝑫𝒆𝒃𝒆𝒏𝒕𝒖𝒓𝒆 𝑰𝒏𝒕𝒆𝒓𝒆𝒔𝒕 𝑹𝒂𝒕𝒆

Kp = Preference dividend %
 5. Capital Structure Theories

1.Objectives 2.Theories

Find out Capital Relevance Theories Irrelevance Theories

Structure (CS)
which Maximizes
Value of Firm Net Income Approach Traditional Approach

a) Use Debt as much Possible a) Use Debt & Equity Judiciously

b) Debt is Cheaper b) Though Debt is Cheaper &
 Ko , V Initially Ko later on Kd , Ke  ,
Ko & V

𝑬𝑩𝑰𝑻
V=
𝑲𝒐
Or
S = MV of Equity 𝑁𝐼 𝑜𝑟 𝐸𝐴𝐸𝑆𝐻
D = MV of Debt V = S + D S=
𝐾𝑒
 5. Capital Structure Theories

2.Irrelevance Theory 3.Trade off Theory

Net Operating MM Approach a) Get Balance of D & E right

Income (NOI) b) By cost Benefit analysis
No Tax c) Cost
a) Use of Debt has a) Ko of ‘U’ firm = Ko of ‘L’ firm 1. Kd
no Impact on b) V of ‘U’ firm = V of ‘L’ firm 2. Financial Distress
Value of Firm Tax 3. Financial Insolvency
b) Debt is cheaper Value of ‘L’ firm = Value of ‘U’ firm + Tax Advantage 4. Non Bankruptcy cost
= Ke  = Both of (Debt x Tax Rate) d) Benefits
Will get set off Arbitrage 1. Cheaper
hence no Impact 2. Tax Advantage
a) Find out the Value of U&L firm
on value b) Sells shares of that firm whose value is higher & Buys
other firm’s share
c) LU UL  L
• Borrowings • No Borrowings
•  returns or get • Invest in Debt & Equity of L firm in D:E Ratio
surplus with •  returns or keep surplus with same equity %
same equity %
 5. Capital Structure Theories

4.Pecking Order Theory 5.Factors Affecting 6.Financial Breakeven

Capital Structure Point (FBP)
a) Different Persons has
access to different
levels of Information S  Stability in sales & A. Point At which EPS = 0
b) Choice of Source of Growth (EBIT)
Finance is based on L  Leverage
that source which R  Risk B. FBP
reveals highest Info. F  Flexibility
c) Priority C  Cost
C  Control Equity Debt Preference
Shares
Retained Debt Equity
Earning 0 Interest
Earnings Least Charges 𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑
Outlook Priority (1 − 𝑇)
=
Positive
 5. Capital Structure Theories

7.Indifference Point (IP) 8.Over Capitalization 9.Under Capitalization

a) EBIT at which both alternatives gives a) Scenario where firm has lesser Capital
Same EPS when it compared to its earning Capacity
𝐸𝐵𝐼𝑇 −𝐼1 1−𝑇 −𝑃𝐷 𝐸𝐵𝐼𝑇−𝐼2 1−𝑇 −𝑃𝐷 b) Dividend Pay-out Ratio is 
b) 𝐸1
=
𝐸2 c) Entrance of Competitors
c) No IP for Debt Plan & Pref Share only. d) Remedy
(Debt plan will dominate pref. Share Plan) i. Bonus
ii. Share Split up

a) Scenario where firm has more Capital

when it compared to its earning Capacity
/Returned
b) Causes
i. Too Much of Borrowings
ii. Higher Rate
c) Remedy
i. Reorganisation
ii. Buyback of Equity Shares
 6. LEVERAGES

1.Meaning 2.Types of Leverages 3.FL = Double Edge Sword

Influence of One
financial Variable Operating Leverage Financial Leverage Combined
OL Leverage Advantages Disadvantages
with Another FL
Financial Variable CL
a) Debt is a) Financial
a) Firm is using fixed cost cheaper Distress
Instruments to maximise EPS b) Tax b) Insolvency
a) OL is relationship b/w b) FL is relationship b/w EBIT & Advantage c) Bankruptcy or
EBIT & Sales EPS Non
b) OL = Business Risk 𝑬𝑩𝑰𝑻 % 𝒊𝒏 𝑬𝑷𝑺 Bankruptcy
c) FL = or
𝑪 𝑬𝑩𝑻 % 𝒊𝒏 𝑬𝑩𝑰𝑻 cost
c) OL = or
𝑬𝑩𝑰𝑻
% 𝒊𝒏 𝑬𝑩𝑰𝑻 𝟏
𝒐𝒓 a) If ROI > Kd =Favourable Leverage
% 𝒊𝒏 𝑺𝒂𝒍𝒆𝒔 𝑴𝑶𝑺 a) CL measures relationship between
b) If ROI < Kd = Unfavourable Leverage
Sales & EPS c) ROI = Return on Investment
d) If OL = 2 then if Sales 
b) CL = Total Risk
by 10% then EBIT  by 𝑪
20% c) CL = 𝒐𝒓 OL X FL
𝑬𝑩𝑻
 6. LEVERAGES

4.Trading On equity 5. Others

Using Debt
Along with a) Contribution = Sales (-) Variable Cost
Equity &
percentage of b) Break even Point =
Fixed Cost
or
FC
Debts is higher Contribution Per Unit PV ratio (Value)
when compared
to Equity % = c) Margin of Safety =
Actual Sales −Break Even Sales
Trading On Actual Sales
Equity Contribution
d) PV Ratio = X100
Sales
e) Relationship
i. FC  => BEP  => OL
ii. If MOS  => Risk => OL
f) EBT = EBIT – Interest

g) If EBIT & FL are given in problem then check if there is any

interest Charges
 7. INVESTMENT DECISIONS

1. Capital 2.Purpose of CB 3.CB process 4.Types of 5. Estimation of

Budgeting (CB) Capital Cash flow
Investment
a) Huge a) Planning Decision A. Depreciation -> Tax Shield
Techniques which b) Evaluate
Expenditure B. Opportunity cost -> Outflow
determines c) Selection
b) Impacts C. Sunk cost -> Ignore
proposals are d) Implementation
Business for D. Working Capital
providing desired e) Review
Longer period • Initially = Outflow
rate of return f) control
Time • End = Inflow
c) Irreversible R  Replacement
d) Complex &Modernization
Decision E  Expansion
D  Diversification
C  Contingent Decision
A  Accept/Reject
M  Mutually Exclusive
 7. INVESTMENT DECISIONS

6.Payback Period 7.Pay back 8.ARR

(PP) Reciprocal (PR)

𝐀𝐯𝐠.𝐍𝐞𝐭 𝐈𝐧𝐜𝐨𝐦𝐞
a) PP is a period by 𝟏 a) ARR =
which investment a) PR = 𝐈𝐧𝐢𝐭𝐢𝐚𝐥 𝐈𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭 𝐨𝐫 𝐀𝐯𝐠.𝐈𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭
𝐏𝐏
will be recovered b) PR =IRR (Approximates)
if 𝐓𝐂𝐈𝐅 −𝐓𝐂𝐎𝐅
b) Net cash flow b) Avg.Net Income =
[NCF] is constant life of Project = 2 x PP 𝐧

𝐈𝐧𝐢𝐭𝐢𝐚𝐥 𝐈𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭+𝑺𝒂𝒍𝒗𝒂𝒈𝒆 𝑽𝒂𝒍𝒆

c) Avg.Investment =
Yes No 𝟐
𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡𝑠 Cumulative d) TCIF = Total Cash Inflow
PP=
𝐴𝑛𝑛𝑢𝑎𝑙 𝑁𝐶𝐹 Approach
e) TCOF = Total Cash Outflow
Advantages:
Easy to Calculate &
Understand
Disadvantages
Ignores Time Value of
Money
Ignore Cash flow after PP
 7. INVESTMENT DECISIONS

9.NPV 10.PI 11.IRR 12.MIRR

a) NPV = PV of NCIF- 𝐏𝐕 𝐨𝐟 𝐂𝐚𝐬𝐡 𝐢𝐧𝐟𝐥𝐨𝐰 a) Rate at which PV of CIF = PV

PI =
PV of COF 𝐏𝐕 𝐨𝐟 𝐂𝐚𝐬𝐡 𝐎𝐮𝐭𝐟𝐥𝐨𝐰 of COF
b) Advantages b) IRR = L +
𝑵𝑷𝑽 𝑳
𝒙 (𝑯 − 𝑳)
i. Time Value of 𝑵𝑷𝑽𝑳 −𝑵𝑷𝑽𝑯

Money
ii. Full Stream of
Cash flow is Same
Considered
c) Disadvantages a) Consider Reinvestment Element
i. Forecasting b) Find out cash outflow
Problem c) Find out terminal Cash flow (TCF) for each year & Total
TCF
TCF = NCF x (1+i)n
𝑃𝑉 𝑜𝑓 𝐶𝑎𝑠ℎ 𝑂𝑢𝑡𝑓𝑙𝑜𝑤
d) PV at ‘x’ % nth year =
𝑇𝐶𝐹
e) Look for closest PVIF at ‘x’ % nth year in PVIF table (OR)
f) MIRR is rate at which PV of TCF = PV of COF
 7. INVESTMENT DECISIONS

13.CB under 14.Projects with 15.Decision Rule for Project Acceptance

Capital Rationing Unequal Life

Individual Multiple
Technique
a) Find out NPV a) Equivalent Project Project
for RS 1 of Annualized
Capital criteria [EAC] Lower than
PP Lower PP
Invested NPV Expected Period
b) EAC =
PVAF
𝐍𝐏𝐕 EAC Higher than
ARR Higher ARR
𝐂𝐚𝐬𝐡 𝐎𝐮𝐭𝐟𝐥𝐨𝐰 Expected Return
b) Assign Ranks Inflow Cost
based on NPV NPV > 0 Higher NPV
above &
Select Select
select the
Project Project
project with PI PI >1 Higher PI
with with
Higher rank
Higher Lower
EAC EAC
IRR IRR > Ko Higher IRR
 7. INVESTMENT DECISIONS

16.Others

a) Find out Incremental inflow & Incremental Outflow for Replacement of Old Asset with new
assets Decisions:
i. Consider Incremental Salvage Value (SV) [ New Asset SV (-) Old Asset SV ]
ii. Tax on sale of old asset should be considered for Incremental outflow Calculations
b) If Earnings before Tax (EBT) is (loss)
i. Loss Cannot be Carried forward = Tax in the year of loss is zero
ii. Loss can be set off in next 2 or 3 years = Tax in the Year of loss is Zero. Tax in 2 or 3
years should be calculated After adjusting loss of Previous year
c) Depreciation on written down Value Basis
i. No depreciation in the Last year of project
ii. WDV of Last year (-) Salvage Value = Short term Capital Loss (STCL)
iii. First deduct STCL from earnings & add back STCL at end to get Net cash flow (Same
like depreciation)
 8. DIVIDEND DECISIONS

1.Types of Dividend 2.Advantages of 3.Factors Affecting 4.Stability in

Stock Dividend Dividend Decision Dividend

a) Cash Dividend
b) Stock Divided a) Non Taxable for A Availability of Funds a) Constant Dividend
(Bonus Shares) Shareholders S Stock Price per Share (DPS)
b) No Cash flow C Cost of Capital b) Constant % on
E Expectation of SH. earnings
T Trend In Industry c) Small constant
I Investment Opportunities DPS & Extra
C Capital Structure Dividend in case
of prosperity
 8. DIVIDEND DECISIONS

5.Dividend Theory

Irrelevance Theory Relevance Theory

MM Theory
Walter Gordon
𝐏𝟏 + 𝐃𝟏
𝐏𝟎 = 𝐫 𝑬𝟏 (𝟏 − 𝐛)
𝟏 + 𝐊𝐞 𝐃+ (𝐄 − 𝐃) 𝐏=
𝐏𝟎 = 𝐤𝐞 𝐊𝐞 − 𝐛𝐫
𝐧 + 𝒏 𝑷𝟏 − 𝑰 + 𝑬 𝐊𝐞
𝐕𝐟 𝐨𝐫 𝐧𝐏𝟎 =
𝟏 + 𝐊𝐞 𝑫𝟎 (𝟏 + 𝐠)
𝐏=
𝐒𝐡𝐨𝐫𝐭𝐚𝐠𝐞 𝐢𝐧 𝐟𝐮𝐧𝐝𝐬 𝐊𝐞 − 𝐠
𝒏 =
𝐏𝟏

Assumptions:
i. Perfect Capital Market
(Information Freely available)
ii. No Tax
iii. No Transaction Cost
 8. DIVIDEND DECISIONS

6.Stock Split 7.Optimum Dividend Pay-out (GORDON & WALTER)

a) Once share get split into OPTIMUM

many shares CASE DIVIDEND
b) It is done to regulate price PAYMENT RATIO
shares
c) It makes share affordable
d) It has certain Compliance &
Additional Cost
r > Ke 0%

r < Ke 100%

No optimum
Ratio/whatever is
r = Ke
paid is optimum
ratio
 9. WORKING CAPITAL MANAGEMENT (WCM)

1.WCM 2.WCM  2 Angles 3.Factors

Affecting WC

CA - CL Value Time
M  Market & Demand
a) Get balance
I  Inventory
of CA & CL Gross Net Permanent Temporary
C Cash
Right WC WC WC WC
R Receivables
b) WCM is a
O Operationally Efficiency
trade of WC portion Other N Nature of Business
Liquidity & Net CA - CL that is fixed is
than S Short term Finance
profitability Investments buffer stock, Permanent
in Current Minimum cash working
Assets etc. capital

CA = Current Assets
CL = Current Liabilities
 9. WORKING CAPITAL MANAGEMENT (WCM)

4.Inventory Increases  5.Debtors  6.Creditors 

Advantages (A) Disadvantages (D) (A) (D) (A) (D)

a) Keep up with a) Funds Blocked a) Higher a) Bad Debts  a) Sources of a) Goodwill loss
demand b) Storage Cost  Sales b) Funds Blocked Finance b) Creditor may
b) Take price c) Inventory Risk  b) Higher c) Liquidity risk  stop supplying
advantage d) Liquidity risk  Profits the goods
inflationary 7.Cash  c) Creditor May
condition increase the
c) Discount price of the
(A) (D) goods
d) Creditor may
stop supplying
a) Day today Exp. Are met a) Less goods on credit
b) Precautionary needs Returns basis
c) Encash Investment
Opportunities
 9. WORKING CAPITAL MANAGEMENT (WCM)

8.Operating Cycle (OC) 9.Factors Affecting 11.Things to Keep in mind for WC

Investment in WC Requirement Calculation Problems

a) Time gap b/w payment a) Old/New Company

a) Nature of
for purchase of b) New Company
Business
materials & till date i. Consider Closing stock of RM for
b) Types of Products
goods are sold & Creditors Calculation
/ Services
money is collected ii. Consider Closing stock of FG for cost of
c) Manufacturer/
b) OC indicates Number sales (Debtor’s Calculation)
Traders
of days for which iii. Calculate on cash cost basis
d) Volume of Sales
funds are getting
blocked 10.Approach to WC
c) OC = R+W+F+D-C Investment

a) Aggressive  CA  => OC 
Return on Assets 
Liquidity 
b) Conservative  CA  => OC 
Return on Assets 
Liquidity 
c) Moderate  In b/w (a) & (b)
 9. WORKING CAPITAL MANAGEMENT (WCM)

12.Treasury Management 13.Accelarating Cash 15.Cash Management Model

Collection

Functions William Baumol Model Miller Orr Model

a) Concentration
a) Cash Mgmt.
banking
b) Currency Mgmt.
b) Lock Box System a) Transaction Cost a) Upper Limit (UL)
c) Funds Mgmt.
d) Point of Contract & Opportunity b) Return Point (RP)
of Banker Cost @ Minimum c) Lower Limit (LL)
Calculation of Cash b) Minimum Cash
Budget 2𝐴𝑇
14. Different Kind of Balance =√ a) Cash goes to UL Make
a) Receipts & Payment 𝐼
Float c) A = Annual Cash Investment
Method
Requirement b) Cash Balance goes to LL
b) Adjusted Income
a) Billing float = Billing delay d) T =Transaction  Sell Investment
Method
b) Mail Fail = Cheque Receipt Cost per c) Maintain Cash balance at
c) Adjusted B/S
delay/courier Time e) I = Interest Rate RP
method
c) Change Processing Float = per Rs.
Deposit delay
d) Bank processing Float =
Clearance Delay
 9. WORKING CAPITAL MANAGEMENT (WCM)

16.Virtual Banking 17.Recievables Management 18.Financing Receivables

Banking a) Pledging
a) Assessing Credit
Transaction Done b) Factoring
worthiness of
Without Vising • Credit collection process outsourced
Customer
the bank • Factor gives Advance (charges
b) Setting Credit Limit
a) Process Time commission)
c) Invoicing & Prompt
reduce • With recourse & Without recourse
Collection
b) Reduction of
• Reminder
Transaction
Emails
Cost Bad debt risk Factor has
• Phone Calls
c) Operation with seller / Bad debt risk
• Withholding
Cost reduction supplier
Supply
• Factoring
• Legal Action
d) Review  Agewise
Analysis Report
 9. WORKING CAPITAL MANAGEMENT (WCM)

19.Working Capital 20. Maximum Possible Banking 21.Other

finance Finance (Tandon Committee)
𝑁𝑜 𝑜𝑓 𝐷𝑎𝑦𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟
i. No of WC cycles =
Permanent Temporary Methods 𝑂𝐶

Portion Portion ii. WC under OC =

Annual Operating Cost
i. 75% of (CL-CL) No of WC cycles
Fund through Fund Thorough ii. (75% of CA) – CL
iii. 75% (CA – CCA) - CL iii. Cash OC = I + D - C
Long sources like Short term
debts & Equity Source No of days in a year
iv. Cash Turnover ratio =
Cash Operating Cycle
Source
Annual Cash Outlay
v. Cash Requirement =
Cash Turnover ratio
Spontaneous
Negotiated
Source: No of Days in a year
Source: vi. Receivables Credit Period =
Arising in Course Recievables Turnover Ratio
Arising though
of Business
negotiations with
(Creditors credit
banker, FI,Public
Period)
 9. WORKING CAPITAL MANAGEMENT (WCM)

22.Factoring Format 23.Other

Opportunity Cost of Investment in Receivables

i. Cost of Credit Sales X 𝑪𝒐𝒍𝒍𝒆𝒄𝒕𝒊𝒐𝒏 𝒑𝒆𝒓𝒊𝒐𝒅 𝒊𝒏 𝒅𝒂𝒚𝒔÷

𝟑𝟔𝟓 𝒅𝒂𝒚𝒔 X Required rate of return
ii. Bad Debts will not be consider as a part of Cost of
Credit Sales for calculation of Opportunity cost
iii. Cash discount also not be consider for the
Opportunity cost calculation
 9. WORKING CAPITAL MANAGEMENT (WCM)

24.Working Capital Requirement 25.Other

Current Asset
RM XXX
WIP XXX Avg Stock of RM
Material xxx RM holding Period =
Avg cost of RM consumption per day
Labour xxx
OH xxx XXX Avg Stock of WIP
WIP holding Period =
FG XXX Avg cost of WIP per day
Drs XXX
Prepaid , Cash and bank XXX Cost of WIP = Material + Labour + Factory OH
Other CA XXX
Avg Stock of FG
Total (A) XXX FG holding Period =
Current Liabilities Avg cost of goods produced per day
Crs XXX Cost of FG = Material + Labour + FOH + AOH + S&D OH
O/S labour/OH XXX
Other CL XXX Avg total Drs
Drs Collection Period =
Total (B) XXX Avg cost of Credit sales per day
WC before Safety Margin (A-B) XXX
Safety Margin XXX Avg Creditor Expenses
Crs Payment Period =
WC after Safety Margin XXX Avg cost of Creditor payment per day