Intermediate Course

Study Material
(Modules 1 to 2)

PAPER 6A

Financial
Management
MODULE – 2

BOARD OF STUDIES
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA
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This Study Material has been prepared by the faculty of the Board of Studies
(Academic). The objective of the Study Material is to provide teaching material to
the students to enable them to obtain knowledge in the subject. In case students
need any clarification or have any suggestion for further improvement of the
material contained herein, they may write to the Director of Studies.
All care has been taken to provide interpretations and discussions in a manner
useful for the students. However, the Study Material has not been specifically
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expressed herein may not be taken to necessarily represent the views of the
Council or any of its Committees.
Permission of the Institute is essential for reproduction of any portion of this
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© THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

All rights reserved. No part of this book may be reproduced, stored in a retrieval
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Basic draft of this publication was prepared by CA. Vandana D Nagpal.

Edition : April, 2023

Reprint : April, 2024

Committee/Department : Board of Studies

E-mail : [email protected]

Website : www.icai.org

Price : ` /- (For All Modules)

ISBN No. : 978-81-19472-03-1

Published by : The Publication & CDS Directorate on behalf of

The Institute of Chartered Accountants of India,
ICAI Bhawan, Post Box No. 7100,
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Printed by :
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CONTENTS

MODULE – 1
Chapter-1: Scope and Objectives of Financial Management
Chapter-2: Types of Financing
Chapter-3: Financial Analysis and Planning-Ratio Analysis
Chapter-4: Cost of Capital
Chapter-5: Financing Decisions-Capital Structure
Chapter-6: Financing Decisions-Leverages

MODULE - 2

Chapter-7: Investment Decisions

Chapter-8: Dividend Decisions

Chapter-9: Management of Working Capital

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DETAILED CONTENTS: MODULE – 2

CHAPTER 7 : INVESTMENT DECISIONS ....................................................... 7.1-7.102

Learning Outcomes ................................................................................................................. 7.1

Chapter Overview .................................................................................................................... 7.2

1. Introduction .................................................................................................................. 7.2

2. Purpose of Capital Budgeting .................................................................................. 7.3

3. Capital Budgeting Process ........................................................................................ 7.4

4. Types of Capital Investment Decisions................................................................... 7.5

4.1 On the basis of firm’s existence ................................................................... 7.5

4.2 On the basis of situations .............................................................................. 7.6

4.3 Steps of Capital Budgeting Procedure ....................................................... 7.7

5. Estimation of Project Cash Flows ............................................................................ 7.7

6. Basic Principles for Measuring Project Cash Flows .......................................... 7.12

6.1 Block of Assets and Depreciation .............................................................. 7.12

6.2 Exclusion of Financing Costs Principle ..................................................... 7.14

6.3 Post-tax Principle ........................................................................................... 7.16

7. Capital Budgeting Techniques ............................................................................................ 7.17

8. Traditional or Non-Discounting Techniques ............................................................... 7.18

8.1 Payback Period ............................................................................................... 7.18

8.1.1 Payback Reciprocal ........................................................................................ 7.21

8.2 Accounting (Book) Rate of Return (ARR) or Average Rate of

Return (ARR) .................................................................................................... 7.22
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9. Discounting Techniques ......................................................................................................... 7.26

9.1 Net Present Value Technique (NPV) ......................................................... 7.27

9.2 Profitability Index/ Desirability Factor/Present Value Index

Method (PI) ...................................................................................................... 7.31

9.3 Internal Rate of Return Method (IRR)....................................................... 7.32

9.3.1 Acceptance Rule ............................................................................................. 7.37

9.3.2 Internal Rate of Return (IRR) and Mutually Exclusive

Projects ............................................................................................................. 7.38

9.3.3 The Reinvestment Assumption................................................................... 7.40

9.3.4 Multiple Internal Rate of Return ................................................................ 7.41

9.4 Discounted Payback Period Method ........................................................ 7.42

9.5 Modified Internal Rate of Return (MIRR) ................................................. 7.43

9.6 Comparison of Net Present Value and Internal Rate of Return

Methods............................................................................................................ 7.45

9.7 Different conclusion in the following scenarios .................................... 7.45

10. Summary of Decision Criteria of Capital Budgeting Techniques ..................... 7.52

11. Special Cases of Capital Budgeting ...................................................................... 7.53

11.1 Capital Budgeting under Capital Rationing ............................................ 7.53

11.2 Projects with unequal lives .......................................................................... 7.54

Summary .................................................................................................................................. 7.71

Test Your Knowledge ............................................................................................................ 7.72

Multiple Choice Questions (MCQs)................................................................................... 7.72

Theoretical Questions ........................................................................................................... 7.75

Practical Problems ................................................................................................................. 7.76

Answers to the MCQs ........................................................................................................... 7.85

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Answers to Theoretical Questions ..................................................................................... 7.85

Answers to Practical Problems ........................................................................................... 7.85

CHAPTER 8 : DIVIDEND DECISION .................................................................8.1-8.52

Learning Outcomes ................................................................................................................. 8.1

Chapter Overview .................................................................................................................... 8.1

1. Introduction .................................................................................................................. 8.2

2. Meaning of Dividend .................................................................................................. 8.3

3. Forms of dividend ....................................................................................................... 8.3

4. Significance of Dividend Policy ............................................................................... 8.6

5. Relationship between Retained Earnings and Growth ...................................... 8.8

6. Determinants of Dividend Decisions ..................................................................... 8.9

7. Practical Considerations in Dividend Policy ....................................................... 8.10

8. Theories of Dividend ................................................................................................ 8.14

8.1 Dividend’s Irrelevance Theory .................................................................... 8.14

8.2 Dividend’s Relevance Theory ...................................................................... 8.21

9. Stock Splits .................................................................................................................. 8.33

9.1 Meaning of Stock Split ................................................................................. 8.33

9.2 Advantages of Stock Splits .......................................................................... 8.33

9.3 Limitations of Stock Splits ........................................................................... 8.33

10 Share Buyback ............................................................................................................ 8.33

10.1 Meaning of Share Buyback.......................................................................... 8.33

Summary ............................................................................................................................ 8.39

Test Your Knowledge ............................................................................................................ 8.39

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Multiple Choice Questions (MCQs)................................................................................... 8.39

Theoretical Questions ........................................................................................................... 8.42

Practical Problems ................................................................................................................. 8.42

Answers to the MCQs ........................................................................................................... 8.45

Answers to Theoretical Questions ..................................................................................... 8.45

Answers to Practical Problems ........................................................................................... 8.45

CHAPTER 9 : MANAGEMENT OF WORKING CAPITAL ............................... 9.1-9.156

Learning Outcomes ................................................................................................................. 9.1

Chapter Overview .................................................................................................................... 9.2

UNIT I : INTRODUCTION TO WORKING CAPITAL MANAGEMENT .................9.3

1. Meaning and Concept of Working Capital........................................................... 9.3

2. Significance of Working Capital .............................................................................. 9.6

2.1 Importance of Adequate Working Capital ................................................ 9.6

2.2 Optimum Working Capital ............................................................................ 9.7

3. Determinants of Working Capital ........................................................................... 9.8

4. Management of Working Capital ......................................................................... 9.10

4.1 Liquidity and Profitability ............................................................................ 9.11

4.2 Investment and Financing ........................................................................... 9.12

4.3 Approaches of working capital investment ............................................ 9.13

4.4 Current Assets to Fixed Assets Ratio ........................................................ 9.15

5. Estimating Working Capital Needs ....................................................................... 9.16

6. Operating or Working Capital Cycle .................................................................... 9.17

6.1 Working Capital Based on Operating Cycle ........................................... 9.20

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6.2 Estimation of amount of Different Components of Current Assets

and Current Liabilities ................................................................................... 9.22

6.3 Working Capital Requirement Estimation

based on Cash Cost ....................................................................................... 9.28

6.4 Effect of Double Shift Working on Working

Capital Requirements .................................................................................... 9.31

UNIT II : TREASURY AND CASH MANAGEMENT ..................................................... 9.37

7. Treasury Management: Meaning .......................................................................... 9.37

8. Functions of Treasury Department ....................................................................... 9.38

9. Management of Cash ............................................................................................... 9.39

9.1 The Need for Cash ......................................................................................... 9.39

9.2 Cash Planning ................................................................................................. 9.40

9.3 Cash Budget .................................................................................................... 9.40

10. Methods of Cash Flow Budgeting ........................................................................ 9.42

10.1 Cash budget for short period ..................................................................... 9.41

10.2 Cash Budget for long period ...................................................................... 9.50

10.3 Managing Cash Collection and Disbursements ..................................... 9.53

10.4 Accelerating Cash Collections .................................................................... 9.53

10.5 Controlling Payments ................................................................................... 9.55

10.6 Determining the Optimum Cash Balance ................................................ 9.59

11. Cash Management Models ..................................................................................... 9.59

11.1 William J. Baumol’s Economic Order Quantity Model, (1952) ........... 9.59

11.2 Miller-Orr Cash Management Model (1966) .......................................... 9.61

12. Recent Developments in Cash Management..................................................... 9.62

12.1 Electronic Fund Transfer .............................................................................. 9.63

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12.2 Zero Balance Account ................................................................................... 9.63

12.3 Money Market Operations .......................................................................... 9.63

12.4 Petty Cash Imprest System .......................................................................... 9.64

12.5 Management of Temporary Cash Surplus............................................... 9.64

12.6 Electronic Cash Management System ...................................................... 9.64

12.7 Virtual Banking ............................................................................................... 9.65

13. Management of Marketable Securities ............................................................... 9.67

UNIT III : MANAGEMENT OF INVENTORY ................................................................ 9.69

14. Inventory Management ........................................................................................... 9.69

UNIT IV : MANAGEMENT OF RECEIVABLES ............................................................... 9.70

15. Meaning and Objective ........................................................................................... 9.70

16. Aspects of Management of Debtors .................................................................... 9.70

17. Factors Determining Credit Policy ........................................................................ 9.71

18. Factors under the Control of the Finance Manager ........................................ 9.72

19. Approaches to Evaluation of Credit Policies ...................................................... 9.73

20. Financing Receivables .............................................................................................. 9.82

20.1 Pledging and Factoring ................................................................................ 9.82

20.2 Forfaiting .......................................................................................................... 9.86

21. Innovations in Receivable Management ............................................................. 9.89

22. Monitoring of Receivables ...................................................................................... 9.94

UNIT V : MANAGEMENT OF PAYABLES (CREDITORS)........................................... 9.98

23. Introduction ................................................................................................................ 9.98

24. Cost and Benefits of Trade Credit......................................................................... 9.98

25. Computation of Cost of Payables ......................................................................... 9.99

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UNIT VI : FINANCING OF WORKING CAPITAL ...................................................... 9.102

26. Introduction ............................................................................................................. 9.102

27. Sources of Finance ................................................................................................. 9.103

27.1 Spontaneous Sources of Finance............................................................ 9.103

27.2 Inter-corporate Loans and Deposits ...................................................... 9.104

27.3 Commercial Papers ..................................................................................... 9.104

27.4 Funds Generated from Operations ........................................................ 9.105

27.5 Public Deposits ............................................................................................ 9.105

27.6 Bills Discounting .......................................................................................... 9.105

27.7 Bill Rediscounting Scheme ....................................................................... 9.105

27.8 Factoring........................................................................................................ 9.105

28. Working Capital Finance from Banks ................................................................ 9.106

28.1 Instructions on Working Capital Finance by Banks ........................... 9.106

29. Forms of Bank Credit ............................................................................................. 9.107

Summary ......................................................................................................................... 9.108

Test Your Knowledge ......................................................................................................... 9.110

Multiple Choice Questions (MCQs)................................................................................ 9.110

Theoretical Questions ........................................................................................................ 9.115

Practical Problems .............................................................................................................. 9.116

Answers to the MCQs ........................................................................................................ 9.126

Answers to Theoretical Questions .................................................................................. 9.126

Answers to Practical Problems ........................................................................................ 9.127

APPENDIX

Financial Tables ................................................................................................................ A.1-A.8