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Production
Marketing
Finance
All
business activities involve acquisition and use of funds. Finance function makes money available to meet the costs of production and marketing operations.
represent ownership rights of their holders. Shareholders are owners of the company. Shares can of two types:
Loans,
Bonds or Debts: represent liability of the firm towards outsiders. Lenders are not owners of the company. These provide interest tax shield.
Equity
Do not have fixed rate of dividend. There is no legal obligation to pay dividends to equity shareholders.
Preference
They get fixed rate of dividends. They also have preference of repayment at the time of liquidation.
Finance Functions
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Long-term asset-mix or investment decision or capital budgeting decisions. Capital-mix or financing decision or capital structure and leverage decisions. Profit allocation or dividend decision Short-term asset-mix or liquidity decision or working capital management.
Raising
Financial Goals
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Profit maximization
Financial Statements
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Financial
statements provide information about the financial activities and position of a firm. are:
Important financial statements Balance sheet Profit & Loss statement Cash flow statement
Balance Sheet
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Balance
sheet indicates the financial condition of a firm at a specific point of time. It contains information about the firms: assets, liabilities and equity. Assets are always equal to equity and liabilities: Assets = Equity + Liabilities
Assets
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Assets
are economic resources or properties owned by the firm. There are two types of assets:
Current Assets
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Current
assets (liquid assets) are those which can be converted into cash within a year i.e. accounting period or operating cycle of the business (time taken to convert raw material into finished goods, sell them and convert debtors into cash). Current assets include:
Cash Tradable (marketable) securities Debtors (account receivables) Stock of raw material Work-in-process Finished goods
Fixed Assets
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Fixed
Liabilities
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Liability
is a firms obligation to pay cash or provide goods or services in the future. types of liabilities are:
Two
Current Liabilities
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Current
liabilities are payable within a year in the normal course of business. They include:
Accounts payable (creditors) Outstanding expenses Advances from customers Provision for tax Provision for dividend
Long-term Liabilities
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Long-term
liabilities are the obligations or debts payable in a period of time greater than the accounting period. They include - Debentures, bonds, and secured long-term loans from financial institutions.
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(i) paid-up share capital, and (ii) reserves and surplus (retained representing undistributed profits.
earnings)
Paid-up
share capital and reserve and surplus together are called net worth.
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Sources of Funds
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It is the sum of net worth or equity (E) and borrowing/debt (D), both long and short term. This is also called as Capital Employed. It do not include current liabilities.
CE = Net Worth + Borrowing = E + D
Net
current assets (NCA) is the difference between current assets (CA) and current liabilities (CL):
NCA = CA CL
Application of Funds
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It
includes Net fixed assets, net current assets, investment and other assets. Net current assets (NCA) is the difference between current assets (CA) and current liabilities (CL):
NCA = CA CL
Sources
of Funds are equal to application of funds. It means capital employed finances its net assets.
Capital Employed = Net Assets
Note:
Contingent liabilities are written as a note to the balance sheet as they are not the actual liabilities.
Profit &
It
Nature of Revenues
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Revenue
is the amount received or receivable within the accounting period from the sale of the firms goods or services. Operating revenue is the one that arises from main operations of the firm i.e. sale of finished goods, and the revenue arising from other activities is called non-operating revenue i.e. sale of old equipment.
Nature of Expenses
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Expense
is the amount paid or payable within the accounting period for generating revenue.
Examples: raw material consumed, salary and wages, power and fuel, repairs and maintenance, rent, selling and marketing expenses, administrative expenses.
Expenses
are expired costs and capital expenditures represent un-expired costs and appear as assets in balance sheet.
Concepts of Profit
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Gross profit = sales cost of goods sold (CGS) CGS = raw material consumed + manufacturing expenses of goods that have been sold PBDIT = Profit before dep., interest and tax = sales expenses, except dep., interest and tax Operating profit (OP), OP = GP OEXP DEP. It is also known as PBIT. It measures firms operative performance without regard to firms sources of financing. PBIT= Profit before interest and tax= PBDIT DEP PBT= Profit before tax = PBIT Interest PAT = Profit after tax = PBT Tax Net operating profit after tax (NOPAT)=PBIT (1 Tax rate)
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Gujarat Narmada Valley Fertilizers Company Ltd Profit & Loss Account for the year ended on 31 March
LEARNING OBJECTIVES
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We
will see how financial ratios helps in getting useful information from the financial statements Recognize the diagnostic role of financial ratios Highlight the utility of financial ratios in credit analysis and competitive analysis as well as in determining the financial capability of the firm Understand the limitations of financial ratios
Financial Analysis
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Financial analysis is the process of identifying the financial strengths and weaknesses of the firm by property establishing relationships between the item of the balance sheet and the profit and loss account.
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analysis is a powerful tool used for financial analysis A financial ratio is a relationship between two accounting numbers. Ratios help to make a qualitative judgement about the firms financial performance.
Standards of Comparison
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Time
series analysis Inter-firm analysis Industry analysis Proforma financial statement analysis
Liquidity
LIQUIDITY RATIOS
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Liquidity
Cont
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LEVERAGE RATIOS
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To
judge the long-term financial position of the firm, financial leverage, or capital structure ratios are calculated. These ratios indicate mix of funds provided by owners and lenders.
Cont
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ACTIVITY RATIOS
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Activity
ratios are employed to evaluate the efficiency with which the firm manages and utilizes its assets. These ratios are also called turnover ratios because they indicate the speed with which assets are being converted or turned over into sales. ratios, thus, involve a relationship between sales and assets.
Activity
PROFITABILITY RATIOS
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The
profitability ratios are calculated to measure the operating efficiency of the company. two major types of profitability ratios are calculated:
1. 2.
Generally,
Cont
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Cont
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Cont
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Cont
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Cont
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simple method of tracing periodic changes in the financial performance of a company is to prepare comparative statements. Comparative financial statements will contain items at least for two periods. Changesincreases and decreasesin income statement and balance sheet over a period can be shown in two ways:
TREND ANALYSIS
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In
financial analysis the direction of changes over a period of years is of crucial importance. Time series or trend analysis of ratios indicates the direction of change. This kind of analysis is particularly applicable to the items of profit and loss account.
Cont
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For
trend analysis, the use of index numbers is generally advocated. The procedure followed is to assign the number 100 to items of the base year and to calculate percentage changes in each items of other years in relation to the base year. This procedure may be called as trend-percentage method.
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INTER-FIRM ANALYSIS
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The
analysis of the financial performance of all firms in an industry and their comparison at a given point of time is referred to the cross-section analysis or the inter-firm analysis. To ascertain the relative financial standing of a firm, its financial ratios are compared either with its immediate competitors or with the industry average.
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the
ability of the firm to meet its current obligations; the extent to which the firm capital structure has been financed by borrowed funds; the efficiency with which the firm is utilizing its assets in generating sales revenue the overall operating efficiency and performance of the firm.
Profitability analysis
Assets
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comparison Company differences Different definitions of variables Changing situations Historical data
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preference for money is an individuals preference for possession of a given amount of money now, rather than the same amount at some future time. Three reasons may be attributed to the individuals time preference for money:
Time
risk...uncertainty abt future cash receipts preference for present consumption over future...becoz of risk of not enjoying future consumption that may be caused by death or illness or inflation investment opportunities...they can put present cash to earn additional cash
The
time preference for money is generally expressed by an interest rate. An individual will require a rate of return which compensates him for time and is called as risk-free rate. He would also demand compensation for assuming risk, which is called risk premium. The investors required rate of return is: Risk-free rate + Risk premium.
Would an investor want Rs. 100 today or after one year? Cash flows occurring in different time periods are not comparable. It is necessary to adjust cash flows for their differences in timing and risk. Example : If preference rate =10 percent
An investor can invest if Rs. 100 if he is offered Rs 110 after one year. Rs 110 is the future value of Rs 100 today at 10% interest rate. Also, Rs 100 today is the present value of Rs 110 after a year at 10% interest rate.
If the investor gets less than Rs. 110 then he will not invest. Anything above Rs. 110 is favourable.
Two
most common methods of adjusting cash flows for time value of money:
Compoundingthe process of calculating future values of cash flows and Discountingthe process of calculating present values of cash flows.
Future Value
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Compounding
is the process of finding the future values of cash flows by applying the concept of compound interest. Compound interest is the interest that is received on the original amount (principal) as well as on any interest earned but not withdrawn during earlier periods. Simple interest is the interest that is calculated only on the original amount (principal), and thus, no compounding of interest takes place.
Future Value
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Sinking Fund
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Example
Present Value
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Present
value of a future cash flow (inflow or outflow) is the amount of current cash that is of equivalent value to the decision-maker. Discounting is the process of determining present value of a series of future cash flows. The interest rate used for discounting cash flows is also called the discount rate.
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Example
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Example
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End of Year 0 1 2 3
Payment
Interest Principal Outstanding Repayment Balance 900 625 326 3,051 3,326 3,625* 10,000 6,949 3,623 0
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most instances the firm receives a stream of uneven cash flows. Thus the present value factors for an annuity cannot be used. The procedure is to calculate the present value of each cash flow and aggregate all present values.
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Example
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Example
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Example
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The
present value of Re 1 paid at the beginning of each year for 4 years is 1 3.170 1.10 = Rs 3.487
Multi-Period Compounding
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