School of Management Studies Nagaland University

(A Central University Established by an Act of Parliament 1989)

DC Court Junction Dimapur-797112 Nagaland

MGT 203 FINANCIAL MANAGEMENT

(Class Notes)

Submitted by

Rokov N. Zhasa
NU/MN-22/11 rnzhasa@gmail.com

Semester II (February May 2012)

MGT 203 FINANCIAL MANAGEMENT

Course detail Course Instructor Course Code Course Title Student Detail Name Roll No. Course Contact Email

: : :

Ms. Imsuemla Imsong MGT 201 Human Resource Management

: : : : :

Rokov N. Zhasa NU/MN-22/11 MBA +91 9402716559 rnzhasa@gmail.com rnzhasaedu@gmail.com

Released under Creative Commons.

Class Notes

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MGT 203 FINANCIAL MANAGEMENT

Log Sl. No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51.

Date/Time

Coverage Unit 1 Introduction to Financial Management

Class Notes

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Introduction To Financial Management Business concern needs finance to meet their requirements in the economic world. Any kind of business activity depends on the finance. Hence, it is called as lifeblood of business organization. Whether the business concerns are big or small, they need finance to fulfil their business activities. Finance may be defined as the art and science of managing money. It includes financial service and financial instruments. According to Khan and Jain, Finance is the art and science of managing money.

TYPES OF FINANCE

Finance

Private Finance

Public Finance

Individual Finance

Partnership Finance

Business Finance

Central Government

State Government

Semi Government

Private Finance, which includes the Individual, Firms, Business or Corporate Financial activities to meet the requirements. Public Finance which concerns with revenue and disbursement of Government such as Central Government, State Government and Semi-Government Financial matters.

DEFINITION OF FINANCIAL MANAGEMENT

Class Notes

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Financial Management refers to that part of the Management activity which is concern with the planning and controlling of a firms financial resources. The most popular and acceptable definition of financial management as given by S.C. Kuchal is that Financial Management deals with procurement of funds and their effective utilization in the business. The evolution of financial management may be divided into three broad phases: EVOLUTION OF FINANCIAL MANAGEMENT i) The traditional phase ii) The transitional phase iii) The modern phase. The traditional phase In the traditional phase the focus of financial management was on certain events which required funds e.g., major expansion, merger, reorganisation etc. The traditional phase was also characterised by heavy emphasis on legal and procedural aspects as at that point of time the functioning of companies was regulated by a plethora of legislation. Another striking characteristic of the traditional phase was that, a financial management was designed and practiced from the outsiders point of view mainly those of investment bankers, lenders, regulatory agencies and other outside interests. The transitional phase During the transitional phase the nature of financial management was the same but more emphasis was laid on problems faced by finance managers in the areas of fund analysis planning and control.

The Modern phase The modern phase is characterised by the application of economic theories and the application of quantitative methods of analysis. The distinctive features of the modern phase are: Changes in macro economic situation that has broadened the scope of financial management. The core focus is how on the rational matching of funds to their uses in the light of the decision criteria. The advances in mathematics and statistics have been applied to financial management specially in the areas of financial modelling, demand forecasting and risk analysis.

Three major functions of financial decision Investment decision Financing decision Dividend decision Investment decision The firm has scarce resources that must be allocated among competing uses. On the one hand the funds may be used to create additional capacity which in turn generates additional revenue and profits Class Notes Page 5

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and on the other hand some investments results in lower costs. Investment decision can be classified under two broad categories: 1.Long term investment decision- is referred to as the capital budgeting 2.Short term investment decision- as the working capital management Financing decision Another important area where financial management plays an important role is in deciding when, where, from and how to acquire funds to meet the firms investment needs. These aspects of financial management have acquired greater importance in recent times due to the multiple avenues from which funds can be raised. Some of the widely used instruments for raising funds are equity, debts, ADRs, GDRs, Bonds, Loans, Banks, General deposit and Debentures etc. Dividend decision Dividend decisions is the third major financial decision. The share price of a firm is a function of the cash flows associated with the share. The share price at a given point of time is the present value of future cash flows associated with the holding of share. These cash flows are dividends. The finance manager has to decide what proportion of profits has to be distributed to the shareholders. The proportion of profits distributed as dividends is called the dividend pay out ratio and the retained proportion of profits is known as retention ratio. The dividend policy must be designed in a way, that it maximises the market value of the firms share. As far as dividend decisions are concerned the finance manager has to decide on the question of dividend stability, bonus shares, retention ratio and cash dividend. SCOPE OR CONTENT OF FINANCE FUNCTION/FINANCIAL MANAGEMENT Estimating financial requirement Deciding capital structure Selecting a source of finance Selecting a pattern of investment Proper cash management Implementing financial controls Proper use of surplus Objectives of the Firm The main objectives of the firm are: 1) Profit maximization 2) Return Maximization 2) Wealth maximization Profit maximization Maximization of profits is generally regarded as the main objective of a business enterprise. Each company collects its finance by way of issue of shares to the public. Investors in shares purchase these shares in the hope of getting medium profits from the company as dividend It is possible only when the company's goal is to earn maximum profits out of its available resources. If company fails to distribute higher dividend, the people will not be keen to invest their money in such firm and persons who have already invested will like to sell their stocks. On the other hand, higher profits are the barometer of its efficiency on all fronts, i.e., production, sales and management. A few replace the goal of 'maximization of profits' to 'fair profits'. 'Fair Profits' means general rate of profit earned by similar organisation in a particular area. Class Notes Page 6

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Return Maximization The second goal of financial management is to safeguard the economic interest of the persons who are directly or indirectly connected with the company, i.e.,shareholders, creditors and employees. All such interested parties must get the maximum return for their contributions. But this is possible only when the company earns higher profits or sufficient profits to discharge its obligations to them. Therefore, the goal of maximization of returns are inter-related. Wealth maximization Frequently, Maximization of profits is regarded a the proper objective of the firm but it is not as inclusive a goal as that of maximising its value to its shareholders. Value is represented by the market price of the ordinary share of the company over the long run which is certainly a reflection of company's investment and financing decisions. The log run means a considerably long period in order to work out a normalized market price. The management can make decision to maximize the value of its shares on the basis of day-today fluctuations in the market price in order to raise the market price of shares over the short run at the expense of the long run by temporarily diverting some of its funds to some other accounts or by cutting some of its expenditure to the minimum at the cost of future profits. This does not reflect the true worth of the share because it will result in the fall of the share price in the market in the long run. It is, therefore, the goal of the financial management to ensure its shareholders that the value of their shares will be maximized in the long-run. In fact, the performances of the company can well be evaluated by the value of its share. PROFIT VS WEALTH MAXIMIZATION Profit Maximization Main aim of any kind of economic activity is earning profit. A business concern is also functioning mainly for the purpose of earning profit. Profit is the measuring techniques to understand the business efficiency of the concern. Profit maximization is also the traditional and narrow approach, which aims at, maximizes the profit of the concern. Profit maximization consists of the following important features. Profit maximization is also called as cashing per share maximization. It leads to maximize the business operation for profit maximization. Ultimate aim of the business concern is earning profit, hence, it considers all the possible ways to increase the profitability of the concern. Profit is the parameter of measuring the efficiency of the business concern. So it shows the entire position of the business concern. Profit maximization objectives help to reduce the risk of the business. Favourable Arguments for Profit Maximization The following important points are in support of the profit maximization objectives of the business concern: (i) Main aim is earning profit. (ii) Profit is the parameter of the business operation. (iii) Profit reduces risk of the business concern. (iv) Profit is the main source of finance. (v) Profitability meets the social needs also. Unfavourable Arguments for Profit Maximization Class Notes Page 7

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The following important points are against the objectives of profit maximization: (i) Profit maximization leads to exploiting workers and consumers. (ii) Profit maximization creates immoral practices such as corrupt practice, unfair trade practice, etc. (iii) Profit maximization objectives leads to inequalities among the sake holders such as customers, suppliers, public shareholders, etc. Drawbacks of Profit Maximization Profit maximization objective consists of certain drawback also: (i) It is vague: In this objective, profit is not defined precisely or correctly. It creates some unnecessary opinion regarding earning habits of the business concern. (ii) It ignores the time value of money: Profit maximization does not consider the time value of money or the net present value of the cash inflow. It leads certain differences between the actual cash inflow and net present cash flow during a particular period. (iii) It ignores risk: Profit maximization does not consider risk of the business concern. Risks may be internal or external which will affect the overall operation of the business concern. Wealth Maximization Wealth maximization is one of the modern approaches, which involves latest innovations and improvements in the field of the business concern. The term wealth means shareholder wealth or the wealth of the persons those who are involved in the business concern. Wealth maximization is also known as value maximization or net present worth maximization. This objective is an universally accepted concept in the field of business. Favourable Arguments for Wealth Maximization (i) Wealth maximization is superior to the profit maximization because the main aim of the business concern under this concept is to improve the value or wealth of the shareholders. (ii) Wealth maximization considers the comparison of the value to cost associated with the business concern. Total value detected from the total cost incurred for the business operation. It provides extract value of the business concern. (iii) Wealth maximization considers both time and risk of the business concern. (iv) Wealth maximization provides efficient allocation of resources. (v) It ensures the economic interest of the society. Unfavourable Arguments for Wealth Maximization (i) Wealth maximization leads to prescriptive idea of the business concern but it may not be suitable to present day business activities. (ii) Wealth maximization is nothing, it is also profit maximization, it is the indirect name of the profit maximization. (iii) Wealth maximization creates ownership-management controversy. (iv) Management alone enjoy certain benefits. (v) The ultimate aim of the wealth maximization objectives is to maximize the profit. (vi) Wealth maximization can be activated only with the help of the profitable position of the business concern. Objective of public sector undertaking: (i) To promote rapid economic development by filing critical gaps in the industrial structure (ii) To provide basic infra-structural facilities for the growth of the economy;

Class Notes

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(iii) To undertake economic activity strategically important for the growth of the country, which, if left to private initiative, would distort the national objectives; (iv) To achieve balanced regional development and dispersal of economic activity through growth and diversification of economic activity in less developed areas by providing adequate infra-structure and undertaking programmes of conservation and development of national resources; (v) To reduce disparities in income; (vi) To avoid concentration of economic power in a few hands; (vii) To exercise social control and regulation of long-term finance through public financial institutions; (viii) To control over sensitive areas, i.e., allocation of scarce imported commodities; control over the distribution system in relation to essential goods in order to reduce the margin between prices obtained by the producers and those paid by the consumers; (ix) To attain self-reliance in different technologies through development of capacity for design and development of machinery, equipment and instruments and elimination of dependence of foreign agencies for these services; (x) To enhance the employment opportunities by heavy investment in industry and mining, transport and communication; and (xi) To increase exports and earn foreign exports and earn foreign exchange to ease the pressure of Balance of Payments. Public sector has come to assume the commanding heights of the economy. It was monopoly in railways, communication and air transport; virtual monopoly in coal mining, power generation and petroleum industry; a predominant share in banking, insurance, shipping, steel and other metals; machine tools, fertilizers, insecticides, and petrochemicals; and share in light engineering industries like drugs;textiles garbages industries; consumer goods form break of electronic new industries, it has also been taking over old opens which became sick. Public sector has played a significant role in the industrialization of the country. By establishing the basic and heavy industries and providing the infrastructure, it has enabled growth of innumerable light industries and also provided the virtual inputs of ushering the Green Revolution. It has also played a pioneering role in dispersing industries in various regions of the country particularly in the backward area. It is generally recognized as a model employer providing fair wages, good working conditions and amenities, and recognizing the rights of the workers. As a result, industrial relations, except in certain units and for some time past, are better and the man days lost are much less than in the private sector. In spite of its phenomenal growth and achievements, the public sector has come in for criticism for its major shortfalls. The most important defect in the public sector is the overall net loss incurred by it. The non-utilization of the rated capacity, by the public sector undertakings, is another major shortcoming. The shortfalls in core items in particular adversely affect the growth of the entire economy. Some of the other defects in the sector are: (i) lack of professional management; (ii) lack of autonomy for the mangers of undertakings; (iii) adoption of bureaucratic procedures which breed delay; (iv) appointment for surplus labour; (v) over stocking of inventories; (vi) unproductive expenditures; (vii) neglect in maintenance of equipment; (viii) taking over the burden of sick industries; Class Notes Page 9

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(ix) uneconomic pricing of products; and (x) lack of organic linkages between the big plants and small industries.

Date: 13.03.2012 Working note: 1. As payment for material is made in the month following the purchase, there is no payment for material in January, in February, material payment is calculated as 900units x 16 =14600, and in the same manner for the following months. 2. Cash sale as for January 900x 80 x 1/3=240000, and in the same for the other months. 3. Receipt form debtor is calculated as for January that is nil, because cash is collected month of the sale. 4. For February it is calculated as 900 x 80x 2/3= 48 000 and so on for the following months. NOTES: 1. Profit should be ignored while calculating working capital requirement for the following reasons; Profit may or may not be used as working capital Even if profits are to be used for Working Capital it has to be reduced by the amount of income tax, drawing , dividend paid, etc. 2. Calculation of work in progress depends upon to its degree of completion as regards to material, labour and overhead. However, if nothing is given in the question as regard to the degree of completion we suggest to take 100% cost of material, labour as well as over heads. Because in such a case the average period of work in progress must have been calculated as equivalent period of completed units. But some authers shave assumed in such a case, 100% consumption if raw material and 50% (1/2 on an average) in case of labour and over heads. 3. Calculation of stock of finished goods and debtors should be made at cost unless otherwise asked in the question. Q11. From the following information we are required to estimate the net working requirement: Cost per unit: (in Rs) Raw material= 400 Direct Labour = 150 Overhead (excluding depreciation)= 300 Total Cost=850 Additional information 1. Selling price=Rs. 1000/unit 2. O/P=Rs. 52000 units /annum 3. Raw material in stock= Average 4 weeks 4. Work in progress= (Assume 50% completion stage with 100% material consumption= Average 2 weeks 5. Finished goods in stock = Average 4 weeks 6. Credit allowed by supplier= Average 4 weeks 7. Credit allowed to debtor= Average 8 week 8. Cash at bank is expected= Rs. 50,000

Class Notes

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9. Assume that the production is sustained at an even pace, during the 52 weeks of the year. All sales are on credit basis. State any other assumption that you might have made while computing. Sol. Statement showing Working Capital Requirement A. Current Asset Stock of raw material [52000x 400 x(4/52)] Work in progress Raw material [52000x 400x (2/52)] Labour [52000x 150 x (2/52) x (50/100)] Stock of finished goods [52000x 850 x (4/52)] Overhead [52000x300x(2/52)x(50/100)] Debtors 52000x 850x (8/52) Cash at bank 50000 B. Current liabilities Creditors 52000x400x(4/52) Estimated Working Capital Requirement (A-B)

16,00,000 8,00,000 1,50,000 3,400,000 3,00,000 68,00,000 50000 1,31,00,000 16,00,000 11500000

Working note: Profit has been ignored and debtors has been taken at cost. Here profit It has been assumed that raw material has been introduced at the beginning of the process. Trade off between the various mix Tommorrow.

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Chapter 2 Working Capital management Date: 13.03.2012 Financing of working capital The working capital financing g policy of a firm is mainly concerned with the determination of a suitable mix between the long term and short term sources of finance. Usually this mix is guided by a. Trade-off between risk and return b. The cost of alternative combinations of short term and long term sources Approaches to working capital finance policy: a. Matching or hedging approach: With reference to financing policies, the term hedging refers to a process, of matching maturity of debt with the maturity of financial needs. Here, the effort is to match the life of assets with the term source of funds. Thus, this approach is also known as matching approach. b. The comparative approach: Under this approach, as far as possible investment in current assets should be financed by funds from long term sources. And the short term sources should be used only for emergency requirements. The unique features of this approach are 1. Liquidity is relatively greater 2. Risk is minimised 3. Cost of financing is relatively more c. The aggressive approach: this approach states that a major part of the total current asset requirements should be financed from short term sources and even a part of its asset requirement should be financed from short term sources. The aggressive approach makes finance mix more risky, less costly and more profitable. Comparative study of financial approach Financing Approach Cost Profitablity Risk Hedging Moderate Moderate Moderate Conservative High Low Low Aggressive Low High High Q1. The following is the summary of balance sheet of xyz co. under the three approaches Policy Hedging Conservative Aggressive Liabilities Current Liabilities 20,000 10,000 30,000 Long term loans 20,000 30,000 10,000 Equity 60,000 60,000 60,000 Total 100,000 100,000 100,000 Assets Current assets a) Permanent 25,000 25,000 25,000 Requirement b) Seasonal 20,000 20,000 20,000 Requirement Fixed Assets 55,000 55,000 55,000 Total 100,000 100,000 100,000 Additional information: 1. The company earns on an average 8% on investment in current assets and 20% on investments in fixed assets. Class Notes Page 12

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2. Average cost of current liabilities is 7% and average cost of long term funds is 14%. Compute the cost and returns under the three approaches and comment on the policies. Sol. Comparison of cost under the three approaches Policy Hedging Conservative Aggressive Liabilities Current Liabilities (7% on 20,000) (7% on 10,000) (7% on 30,000) 1400 700 2100 Long term loans 14% on 20,000 14% on 30,000 14% on 10,000 2800 4200 1400 Equity 14% on 60,000 14% on 60,000 14% on 60,000 8400 8400 8400 Total 12,600 13,300 11,900 Cost of financing is the greatest in Conservative approach =Rs. 13,300 and lowest in Aggressive Approach = Rs. 11, 900. The total fund being the same i.e., Rs. 1,00,000

Returns on Assets Hedging Current assets a) Permanent Requirement b) Seasonal Requirement Total Fixed Assets Conservative Aggressive

(8% of 25,000) (8% on 25,000) (8 % on 25,000) 2000 2000 2000 (8% on 20,000) (8% on 20,000) (8% on 20,000) 1600 1600 1600 3600 3600 3600 (20% on 55,000) (20% on 55,000) (20% on 55,000) 11,000 11000 11000 Total (2000+1600+11000) (2000+1600+11000) (2000+1600+11000) 14600 14600 14600 Net Return (Current Liabilities-Returns on Assets) 14600-12600 14600-13300 14600-11900 2000 1300 2700 Return on investment in conservative approach @Rs. 1300 and highest in aggressive approach @ Rs. 2700. Measurement of risk of technical insolvency under the three approaches Hedging Conservative Aggressive A. Net Working (45000-20000) 45000-10000 45000-30000 Capital 25000 35000 15000 B. Current Ratio (45000/20000) (45000/10000) (45000/30000) (Fixed assets/ 2.25:1 4.45:1 1.5:1 Current Assets) Risk is measured by the amount of net working capital . The lager the net working capital, the lesser the risk is. The newt working capital is comparatively larger in conservative approach and the hence the degree of risk is low. The net working capital is comparatively lower in aggressive approach and hence the degree of risk is high. Risk is measured by the amount of net working capital. The larger the net working capital the lesser the risk. The net working capital is comparatively larger in conservative approach and hence the degree of risk is low. The net working capital is comparatively lower in aggressive Class Notes Page 13

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approach and hence the degree o risk is comparatively larger. Risk is also measured by the degree of liquidity. However, liquidity can be measured the help of current ratio. The higher the current ratio, the greater the liquidity and lesser the risk. In conservative approach, current ratio is highest at 4.5:1, and in aggressive approach this ratio is lowest at 1.5:1. Hence, there is a low risk in conservative approach and high risk in aggressive approach. The following conclusions can be derived from the above analysis: 1. Hedging approach has moderate cost, risk and return. Its purpose is trade-off between profitability and risk. 2. In conservative approach, cost is low, risk is low and return is low. 3. In aggressive approach, cost is low, risk is high and return is high.

16.03.2012 Unit II Financial Management Cash Management Cash Narrow sense, it includes currency, coins, demand deposit, and bank draft. In broad sense, cash includes near cash assets such as marketable securities & time deposits with banks. RTGS=Real time gross settlement (replaced the bank draft, cheque) IFSC=Indian Financial Service Code Using this we can make transaction upto Rs. 1 crore no limit. But, we need a PAN card no. Need to know the RTGS/ IFSC code. Physical cash transaction has reduced a lot. Need to be careful when using internet banking. Never give username and password. Internet is volatile to risk. Therefore, banks are never going to ask me my user name and password. It somebody asks me, my PC has been hacked. Marketable security: Those security that can be converted to cash within a years e.g., Bonds Motives for holding cash 1. Transactional motive: Business needs cash to carry out transaction. 2. Precautionary motive: Having cash for unexpected moment or contingencies. E.g,, sharp incease in raw material price, cancellation of orders. Nagas do not have the culture of saving. Landlady of Zao in Gurgaon started to save money as soon her daughter was born. 3. Speculative motive: To take advantage of opportunities typically out of the normal course of business. E.g., purchase securities when prices are expected to decline. E.g., Reliance and Subiksha: These co. go to farmers and depending upon the area cultivated they go and fix a

Class Notes

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price for the produce at a future price. In this case, whatever the future price the farmers get the agreed price. 4. Instant cash payment at times also gets cash discount provided the payments are made on time. Objectives of cash management: 1. Minimise funds that remain idle. 2. Good relation with bank and prevent bankruptcy. 3. Good relation with suppliers 4. To meet unexpected cash expenditure 5. To maintain healthy cash balance

Models of cash management Vogel Model Ways to improve cash position 1. Reduce overhead 2. Increase prices especially to slow payer 3. Be more selective when taking credit 4. Reduce the period of giving credit 5. Make more cash sales Most co. have payment term of making payments after 6-9 months Improve cash management system Improve systems for billing and collection Improve the system to collect credit: e.g., BSNL and Airtel Sir had due. Airtel sent him notification from High Court so he paid up promptly. But no such notification came from then BSNL people. It is very important to be good at recollection. Add late payment charges or fees where possible. Use more pro-active collection techniques. E.g., in South India, CitiBank used hijiras to collect loaned amount from defaulters. Marketable securitites These consist of investment thata re both readily

Types of marketable securities 1. Term deposits with scheduled banks (banks registered with the RBI, and subject to meeting to certain criteria). Indigenous money lenders are not scheduled banks. In case of scheduled banks we can file a complaint to recover our money (baking ombudsman). 2. Treasury Bills (issued by govt) 3. Certificates of deposit (issued by corporates and govt. with certain amount of interest for a fixed period say 6-9 months) 4. Commercial papers 5. Bill discounting 6. Mutual fund scheme 7. Municipal bonds 8. Inter-corporate deposits Class Notes Page 15

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Cash budget Most important tools in cash management It is adevice to help a firm to plan and control the use of cash It may prepared annually, daily, monthly, weekly or quarterly. Purpose of cash budget Date: 19.03.2012 Managing cash collection and disbursement: Assignment: Methods and techniques of collecting cash (Likely to come in the exam) 1. Accelarating cash collection Decentralised collection: A no. Of collectio centres a Collection centres 2. Lock box system Collection centers aer established considering customer location and volume of remmittance At each centre the firm hires

Advantages: 3. Controlling disburemesnt Delay payments as much as possible. Disbursement or payment flot

The size of hte mnimum cash balance depends on How quickly

The organizations' maximum cash balance depends on

Models for Cash management Baumol Model Class Notes Page 16

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Bumol recognized the similaritie s between cash and inventory model

Find the ECQ

Assumptions The firm can prediuct its future cash requirement with certianiyt

Explanation

Oppurtunity Cost= Aftergraduation I go for MBA instead of a job. The oppurtunity cost is the lost earning.

Limitation of Baumol's model

Miller-Orr Model Assumes a constant

Allows daily cash variation

Provides two control limits Upper control limit Lower control limit

Formulae

Investing surplus cash in marketable securities: Selecting Investment oppurtunites: Safety: For short term people look for safety Matureity: It ranges for 1-90 days. If i want to get out cash then I should go for options like 30 days. Page 17

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MGT 203 FINANCIAL MANAGEMENT

Liquidity and marketability: Whether the marketabiltiy security can be converted in to cash as an d when needed especially immdeiate requirements. Return or yield

Assignment likely to come in the exam

Submission: 20/03/12 Methods of Accelerating Cash Inflows & Methods of slowing cash outflows

Q1. Only one question in cash management From the following forecast of income and expenditure, prepare a cash budget for a month January to april 2005.

Year Months

Sales Purchase Wages Manufacturing (Credit) (Credit) Rs. Expenses Rs. Rs. Rs. 30000 25000 35000 40000 15000 20000 15000 20000 22500 25000 3000 3200 2500 3000 2400 2600 1150 1225 990 1050 1100 1200

Adminsitrative Expenses Rs. 1060 1040 1100 1150 1220 1180

Selling expenses Rs. 500 550 600 620 570 710

2004 Nov 2005 January March April

December 35000 February 30000

Additional information is as follows: 1. The customers are allowed a credit period of two months. 2. A dividend to Rs. 10000 is payable in April. 3. Capital expenditure to be incurred. Planned purchased on 15 January for Rs. 5000, A building has been purchased on 1st March and the payments are to be made in monthly instalments of Rs. 2000 each. 4. 5. 6. 7. Sol. The creditors are allowed a credit period of two months. Wages are paid on the 1st of next month. Lag in payment of other expenses is one month Balance of cash in hand is Rs. 15000

Class Notes

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Cash budget for months For months from January to April, 2005 January February March Rs. Rs. Rs. 15000 30000 45000 15000 3200 1225 1040 550 5000 26015 18985 25190 28795 18985 35000 53985 20000 2500 990 1100 600 28795 25000 53795 15000 3000 1050 1150 620 2000 22820 30975

Details Receipts Opening balance Cash balance from debtors Cash available Payments Payments to customers Wages Manufacturing expenses Administrative expenses Selling expenses Dividend payable Instalment of building Total payments Closing balance

April Rs. 30975 30000 60975 20000 2400 1100 1220 570 10000 2000 37290 23685

Remark : The closing balance of January becomes the opening balance of February and the same continues into the other months.

Q3. From the following budget data, forecast the cash position at the end of April, May and June 2005 Month February March April May June Sales Rs. 120000 130000 80000 116000 88000 Purchase Rs. 84000 112000 104000 106000 80000 Wages Rs. 10000 12000 8000 10000 8000 Miscellaneous Rs. 7000 0 6000 12000 6000

Additional Information: Sales 20% released in the month of sales, discount allowed 2% Balance released equally in 2 subsequent months Purchases These are paid in the month following the month of supply Wages 25% paid in arrears in the following months Miscellaenous expenses Paid a month in arrears Rent Class Notes Page 19

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Rs. 1000 per month paid quarterly in advance due in April Income tax 1st instalment of advance tax = Rs 25000 due on or before 15 June Income from investment= Rs. 5000 received quarterly in April, July etc. Cash in hand Rs. 5000 on 1st April 2005 Sol. Cash budget for months For months from January to April, 2005 May June Rs. Rs. 18985 35000 53985 20000 2500 990 1100 600 28795 25000 53795 15000 3000 1050 1150 620 2000 25190 28795 22820 30975

Details Receipts Opening balance Cash balance from debtors Cash available Payments Payments to customers Wages Manufacturing expenses Administrative expenses Selling expenses Dividend payable Instalment of building Total payments Closing balance Working notes:

April Rs. 5000 15680 45000 15000 3200 1225 1040 550 5000 26015 18985

April Rs. 30975 30000 60975 20000 2400 1100 1220 570 10000 2000 37290 23685

April sales (20% on 80000) Less 2% discount on 16000 Total

=16000 =320 =15680

Balance released in 2 subsequent months Add 40% of Rs. 130000 (Sales of March) = 52000

40% of Rs. 120000 (Sales of February) = 48000 Total = 115680

May sales (20% on 116000) Class Notes

=23200 Page 20

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Less 2% discount on 16000 Total =464 =22736

Balance released in 2 subsequent months Add 40% of Rs. 80000 (Sales of April) 40% of Rs. 130000 (Sales of March) Total = 32000 = 52000 = 106736

(Repeat the procedure for the months of May and June)

Class Notes

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24.03.2012 Any fool can lend money, but

What are receivables? Sales made on credit basis Why do we need receovable? To reach sale potential To be competitive

Because of the lag between credit sale and realization of the cash, we need receivables. E.g., if Zao sells all 20 laptops in his

Basic Decision

1. To give credit or not

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Types of Cost: 1. 2. 3. 4. Collection Cost: Administrative cost incurred in the collect of cash Delinquency cost: Cost which arises of the customer fails to meet their commitment Capital Cost: The cost incurred in for arranging additional funds to support credit sale. Default Cost: Amount which have to be written off as bad debt.

Receivables Management Initiate collection proced

Steps in credit analyisis Character-Reputation, Track Record Capacity: Ability to repay (Earning capacity) Capital: Financial position of the Co. Collateral: The kind of assets pledged e.g., house or land. It may also be in the form of postal saving, mutual funds. Conditions: The economic conditions and competitive factors that may affect the profitability of the customer.

Steps in Credit Analysis Financial Statement: Long term, short term, solvency,etc. can be judged Bank reference: Information about the customer from another bank. Trade references: Information about customer obtained from firms based on their experience. Credit bureaus: To check the financial viability of the business. Third party guarantees: Field visit: To get information of the existence and general condition

Benefits Helps improve customer satisfaction Takes control of sales processes

Class Notes

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MGT 203 FINANCIAL MANAGEMENT

Collection Methods (Coming in the exam) (Discussed in the assignment) Del credere agent; They are registered under SEBI Act. Eg., I have a client in China. He asks me 100

De credere agent will pay on my behalf. And once the delivery is received, I will pay him the money along with the commission for covering the risk.

Daily sales outstanding (DSO) DSO= (accounts receivable/ Average sales)

ABC Analysis of Receivable

Performa Type A-If Fixed Cost is given Type B- If Fixed Cost is not given

Dimensions of Receivable Management 1. Forming of credit policy Quality of trade accounts or credit standards Length of credit

Class Notes

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MGT 203 FINANCIAL MANAGEMENT

Unit 3 Inventory Management Inventory: Finished goods, Work in P Introduction Stock items held to meet future demands. Effective is doing the right thing and efficient is doing the right thing right. Types of inventory Raw Materials Basic inputs that are converted into finished product through the manufacturing process Work-in-progress Semi-manufactured products need some more works before they become finished goods for sale Finished Goods Completely manufactured products ready for sale Supplies Office and plant cleaning materials not directly enter production but are necessary for production process and do not involve significant investment. Reasons To Hold Inventory Meet variations in customer demand: Meet unexpected demand Smooth seasonal or cyclical demand Pricing related: Temporary price discounts Hedge against price increases Take advantage of quantity discounts Process & supply surprises Internal upsets in parts of or our own processes External delays in incoming goods Objective of Inventory Management To maintain a optimum size of inventory for efficient and smooth production and sales operations To maintain a minimum investment in inventories to maximize the profitability Effort should be made to place an order at the right time with right source to acquire the right quantity at the right price and right quality

Class Notes

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MGT 203 FINANCIAL MANAGEMENT

An effective inventory management should Ensure a continuous supply of raw materials to facilitate uninterrupted production Maintain sufficient stocks of raw materials in periods of short supply and anticipate price changes Maintain sufficient finished goods inventory for smooth sales operation, and efficient customer service Minimize the carrying cost and time Control investment in inventories and keep it at an optimum level

An optimum inventory level involves three types of costs

Ordering costs: Quotation or tendering Requisitioning: Demanding the right/ required quantity Order placing Transportation Receiving, inspecting and storing Quality control Clerical and staff Stock-out cost Loss of sale Failure to meet delivery commitments: If the goods are not in stock so in such case he business will meet this situation. Carrying costs: Warehousing or storage Handling Clerical and staff Insurance Interest Deterioration, shrinkage, evaporation (petro chemicals, agricultural crops) and obsolescence Taxes

Class Notes

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MGT 203 FINANCIAL MANAGEMENT

Cost of capital Dangers of over investment Unnecessary tie-up of firms fund and loss of profit involves opportunity cost Excessive carrying cost Risk of liquidity- difficult to convert into cash Physical deterioration of inventories while in storage due to mishandling and improper storage facilities Dangers of under-investment Production hold-ups loss of labor hours: If there is insufficient raw material, labour and machine are idle. Therefore, there is loss of money. Failure to meet delivery commitments Customers may shift to competitors which will amount to a permanent loss to the firm May affect the goodwill and image of the firm Functions of Inventory Management Track inventory How much to order When to order Classification of inventory ABC Classification HML Classification XYZ Classification VED Classification FSN Classification SDF Classification GOLF Classification SOS Classification Discussion on the same: ABC Classification Almost Better Classification In most of the cases 10 to 20 % of the inventory account for 70 to 80% of the annual activity. Page 27

Class Notes

MGT 203 FINANCIAL MANAGEMENT

A typical manufacturing operation shows that the top 15% of the line items, in terms of annual rupees usage, represent 80% of total annual rupees usage. Next 15% of items reflect 15% of annual rupees Next 70% accounts only for 5% usage

XYZ Classification On the basis of value of inventory stored Whereas ABC was on the basis of value of consumption to value. X High Value Y Medium value Z Least value Aimed to identify items which are extensively stocked. HML Classification On the basis of unit value of item There is 1000 unit of Q @ Rs. 10 and 10,000 units of W @ Rs. 5. Aimed to control the purchase of raw materials. H High, M- Medium, L - Low VED Classification Mainly for spare parts because their consumption pattern is different from raw materials. Raw materials on market demand Spare parts on performance of plant and machinery. V Vital, E Essential, D Desirable

Therefore V items has to be stocked more and D Items has to be less stocked FSN Classification According to the consumption pattern To combat obsolete items F Fast moving S Slow moving N Non Moving SDF & GOLF Classification Class Notes Page 28

MGT 203 FINANCIAL MANAGEMENT

Based on source of procurement S Scarce, D- Difficult, E- Easy. GOLF G Government, O Ordinary, L Local, F Foreign. SOS Classification Raw materials especially for agriculture units S Seasonal OS Off seasonal

Different approaches Certainty approach Uncertain variables and risk are addressed separately Uncertainty approach Uncertain variables and risk are addressed simultaneously Deterministic approach Probabilistic approach

Basic EOQ Model Assumption Seasonal fluctuation in demand are ruled out Zero lead time Time lapsed between purchase order and inventory usage Cost of placing an order and receiving are same and independent of the units ordered Annual cost of carrying the inventory is constant Total inventory cost = Ordering cost + carrying cost Will be solving some question on the same Economic Order Quantity (EOQ Three Approaches) Trial and Error method Order-formula approach

Class Notes

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MGT 203 FINANCIAL MANAGEMENT

Graphical approach EOQ & Re-order point EOQ gives answer to question How much to Order Re-order point gives answer to question when to order Trial & Error Method Assumptions:Annual requirement (C)=1200 units Carrying cost (I) = Rs.1 Ordering cost (O) =Rs.37.5 Order size Q 1200 600 400 300 240

200

Average inventory Q/2

600

300

200

150

120

100

No. of orders C/Q

Annual carrying cost I* Q/2

600

300

200

150

120

100

Annual ordering cost O*C/Q

37.5

75

112.5

150

187.5

225

Total annual cost

637.5

375

312.5

300

307.5

325

Order- Formula approach 1/2 EOQ =(2CO/I) C = Annual demand Class Notes Page 30

MGT 203 FINANCIAL MANAGEMENT

O = Ordering cost per order I = Carrying cost per unit 1/2 EOQ =(2*1200*37.5/1) = 300 units EOQ is minimum when the total cost is the minimum

Reference:

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Class Notes

Page 31