FINANCIAL MANAGEMENT Unit I: Nature of Financial Management: Meaning – Nature – Objectives – Scope- Functions of Financial Management – Financial forecasting.

FINANCIAL MANAGEMENT

Unit I: Nature of Financial Management: Meaning – Nature – Objectives – Scope- Functions of Financial Management – Financial forecasting – Financial Planning – Time Value of Money (NP) Unit II: Financing Decisions: Sources of Finance - Cost of Different Sources of Finance - Cost of Debt - Cost of Preference Capital - Cost of Equity Share - Cost of Retained Earnings - Weighted Average Cost of Capital – Capital structure – financial and operational Leverage (NP) Unit III: Investment Decision: Basics of Capital Budgeting - Appraisal and Evaluation of Long Term Investment Proposals - Pay Back Method - Accounting Rate of Return - Internal Rate of Return - Net Present Value - Profitability Index. (NP)

Unit IV: Working Capital Management: Concept of Working Capital - Determinants of Working Capital - Operating Cycle – Computation of Working Capital Requirements (NP) Unit V: Dividend Policy: Stable Dividend – Dividend Theories - Factors Influencing Dividend Policy – Issues in Dividend Policy - Bonus Shares.

Working Capital Management

Definition of Working Capital

Working capital is the amount of funds necessary to cover the cost operating the enterprise

Circulating capital means current assets of a company that are changed in the ordinary course of business from one form to another.

Concepts of working capitalBalance sheet conceptOperating cycle or circular flow concept

Current Liabilities Current Assets Bank Overdraft Cash and Bank Balance Creditors Inventories: Raw-

Materials Outstanding Expenses Work-in-progress Bills Payable Finished Goods Short-term Loans Bills

Receivables Proposed Dividends Accrued

Income Provision for Taxation, etc. Prepaid

Expenses Accounts

Receivables Short-term

Investments

Balance sheets of a company as on 31 March 2007 as follows :Equity Share Capital 10,00,000 Goodwill 80,0008% P.S. Capital 2,00,000 Land andGeneral Reserve 1,20,000 Building 6,50,000 11% Debenture 5,00,000 Plant andProfit & Loss A/c 2,10,000 Machinery 6,60,000Bills Payable 30000 Investments 2,20,000

Creditors 2,15,000 Marketable securities 60,000Provisions for tax 80,000 Stock 3,85,000Proposed Dividend1,36,000 Debtors 4,15,000O/s expenses 20000 Bills Receivable

50,000 Cash and Bank 93,000

Prepaid Expenses 11,000

25,34,000 25,34,000

THE WORKING CAPITAL CYCLE

(OPERATING CYCLE)

Accounts Payable

Cash

RawMaterials

W I P

Finished Goods

Value Addition

AccountsReceivable

SALES

Operating CycleGross operating cycle = RMCP + WIPC +

FGCP + RCPNet operating cycle = Gross operating cycle –

Payable deferral period

FormulasRaw Material conversion = Average stock of

raw material /Raw material consumption per day*365

Work in process conversion period = Average stock of work in progress/Total cost of production per day*365

Finished goods conversion period = Average stock of finished goods/Total cost of goods sold per day*365

Receivables conversion period = Average receivables/Net credit sales per day*365

Payables deferral period = Average payables/ net credit purchases per day*365

ProblemPeriod covered 365 daysAverage period of credit allowed by suppliers 16 daysAverage total of debtors out standings Rs. 4,80,000Raw material consumption Rs. 44,00,000Total production cost 1,00,00,000Total cost of goods sold Rs. 1,05,00,000Sales for the year Rs. 1,60,00,000Value of average stock maintained- Raw material Rs. 3,20,000- WIP Rs. 3,50,000- Finished goods Rs. 2,60,000

Raw Material conversion = 320000/4400000 * 365 = 27 days

Work in process conversion period = 350000/10000000*365 = 13 days

Finished goods conversion period = 260000/10500000*365 = 9 days

Receivables conversion period = 480000/16000000*365 = 11 days

From the following data compute the duration of operating cycle for each of the two companies

Xltd Y ltd

Stock: Raw Materials 40000 60000

Work in process 30000 45000

Finished goods 25000 38000

Purchase of raw material

160000 270000

Cost of goods produced

300000 380000

Sale (credit basis) 360000 432000

Debtors 72000 108000

creditors 20000 27000

Assume 360 days per year for computational purposes

Classification of working capitalWorking capital may be classified in two waysOn the basis of conceptOn the basis of time

On the basis of time

Permanent or fixed working capitalTemporary or variable working capital

Difference between permanent & temporary working capital

Amount Variable Working Capitalof WorkingCapital

Permanent Working Capital

Time

Variable Working CapitalAmount of WorkingCapital

Permanent Working Capital

Time

PROFORMA - WORKING CAPTIAL ESTIMATES

1. TRADING CONCERNSTATEMENT OF WORKING CAPITAL REQUIREMENTS

Amount (Rs.)Current Assets(i) Cash ----(ii) Receivables ( For…..Month’s Sales)---- ----(iii) Stocks ( For……Month’s Sales)----- ----(iv)Advance Payments if any ----Less : Current Liabilities(i) Creditors (For….. Month’s Purchases)- ----(ii) Lag in payment of expenses -----_WORKING CAPITAL ( CA – CL ) xxxAdd : Provision / Margin for Contingencies -----

NET WORKING CAPITAL REQUIRED XXX

STATEMENT OF WORKING CAPITAL REQUIREMENTS Amount (Rs.)

Current Assets(i) Cash ----(ii) Receivables ( For…..Month’s Sales)---- ----(iii) Stocks ( For……Month’s Sales)----- ----(iv)Advance Payments if any ----Less : Current Liabilities(i) Creditors (For….. Month’s Purchases)- ----(ii) Lag in payment of expenses -----_WORKING CAPITAL ( CA – CL ) xxxAdd : Provision / Margin for Contingencies -----

NET WORKING CAPITAL REQUIRED XXX

1. MANUFACTURING CONCERN

STATEMENT OF WORKING CAPITAL REQUIREMENTSAmount (Rs.)

Current Assets(i) Stock of R M( for ….month’s consumption) -----(ii)Work-in-progress (for…months) (a) Raw Materials ----- (b) Direct Labour ----- (c) Overheads -----(iii) Stock of Finished Goods ( for …month’s sales) (a) Raw Materials ----- (b) Direct Labour ----- (c) Overheads -----(iv) Sundry Debtors ( for …month’s sales) (a) Raw Materials ----- (b) Direct Labour ----- (c) Overheads -----(v) Payments in Advance (if any) -----(iv) Balance of Cash for daily expenses -----(vii)Any other item -----

Less : Current Liabilities(i) Creditors (For….. Month’s Purchases) -----(ii) Lag in payment of expenses -----(iii) Any other -----WORKING CAPITAL ( CA – CL )xxxxAdd : Provision / Margin for Contingencies -----

NET WORKING CAPITAL REQUIRED XXX

Adequate working capitalSolvencyGoodwill Easy loansCash discount

Disadvantages of excess working capital IdleUnnecessary inventoryTheft waste & lossesDefective credit policy

Dangers of inadequate working capitalCannot meet its short term obligationsCannot buy requirements in bulk to avail

discountsCannot utilize fixed assts effectively

Factors determining working capital requirementsNature of the businessSize of the business Production policy Length of production cycleSeasonal variations Stock turnoverCredit policyBusiness cyclesDividend policy

Contd., Prices level changesOther factors – operating efficiency,

management ability, irregularities of supply, import policy, labour

Important working capital ratios Current Ratio = Current assets/Current

liabilitiesAcid-test ratio = Quick assets/Current

liabilitiesInventory turnover ratio= Cost of goods

sold/Average inventoryDebtors turnover ratio= Net credit

sales/Average debtorCreditors turnover ratio = Net Credit

purchase/Average Creditors