FINANCE ACCOUNTINGFINANCE IS THE AGENT THAT DIRECTS THE FLOW OF ECONOMIC ACTIVITY AND

FACILITATES ITS SMOOTH OPERATION. THE TASK FOR PROVIDING FUNDS NEEDED BY THE ENTERPRISE AT RESONABLE TERMS. IT CAN ALSO BE SAID THAT FINANCE FUNCTION IS TO COMMITY AND RECOMMIT THE SCARCE RESOURCES.

OBJECTIVES OF FINANCIAL MANAGEMENT

THE OBJECTIVES OF FINANCIAL MANAGEMENT ARE CONSIDERED USUALLY AT TWO LEVELS: AT MACRO AND AT MICRO LEVEL.

AT MACRO LEVEL THE CHIEF OBJECTIVE OF FINANCIAL MANAGEMENT IS TO MAKE AN INTENSIVE AND ECONOMICAL USE OF SCARCE CAPITAL RESOURCES. IT IS AN INDIRECT SOCIAL RESPONSIBILITY OF FINANCIAL MANAGEMENT, WHICH IS READILY DEFINED ALTHROUGH NOT EASILY PUT INTO PRACTICE.

AT MICRO LEVEL THE OBJECTIVES ARE CONSIDERED AT FIRM LEVEL. THE GOALS OF FINANCE CAN BE REASONABLY ASSOCIATED WITH THE OVER ALL GOALS OF BUSINESS. A SUCCESSFULLY BUSINESS ENTERPRISE OFTEN USES A GOAL ORIENTED FINANCIAL STRUCTURE. THE FINANCIAL MANAGER PERFORMS CERTAIN TASKS THAT HELP TO ACHIEVE THE GOALS OF THE FINANCE DEPARTMENT. THESE GOALS IN TURN HELP THE FIRM IN ACHIEVING ITS OVER ALL OPERATING OBJECTIVES.

3 PRIMARY OBJECTIVES ARE GENERALLY ENCOUNTERED

PROFIT MAXIMISATION

MERITS

1. RATIONAL TO ACCEPT PROFIT AS STANDARD MEASURE SUCCESS OF EFFICIENCY

2. SURVIVE WITHOUT PROFIT MAXIMIZATION

3. ATTAINMENT OF SOCIO ECONOMIC WELFARE PROFIT MAXIMIZATION HAS ACHIEVE

4. HIGH LEVEL OF PROFITABILITY WILL GENERATE HIGH LEVEL OF FUNDS

5. IN ABSENCE OF PROFIT, BUSINESS ACTIVITY WOULD BE STATIC LEVEL

FINANCE ACCOUNTING (CONTD.)WEAKNESS

1. IT IS AN INCOMPLETE CONCEPT. DOES NOT IDENTIFY WHICH RETURNS TO BE FOCUSED ON.

2. IT GIVES NO GUIDE ON LEVEL OF RISK AND UNCERTAINTY THAT MIGHT APPROPRIATELY BE ACCEPTED ALONG WITH THE PROFIT FORECAST. NO POSSIBLE TO MAXIMISE WHAT CAN NOT BE KNOWN.

3. THIS APPROACH IS COMPLETELY SILENT ON THE TIMINGS OF PROFITS TO BE MAXIMISED. IT DOES NOT TELL MANAGEMENT IF ITS WORTH THE WAIT

4. IT IS A NARROW CONCEPT, WHICH DOES NOT TAKE INTO ACCOUNT THE INTERESTS OF OTHER INTERESTED PARTIES SUCH AS GOVERNMENT AND WORKERS, ETC.

MAXIMISATION OF RETURN

SOME AUTHORITIES ON FIN. MANAGE. CONCLUDE THAT MAXIMIZATION OF RETURN PROVIDES A BASIC GUIDELINE BY WHICH FINANCIAL DECISIONS SHOULD BE EVALUATED. BUT RETURNS ARE MAINLY BASED ON PROFITS. HENCE THERE IS NO BASIC DIFFERENCE BETWEEN PROFIT MAX AND RETURN MAN.

WEALTH MAXIMISATION

IT MEANS MAXIMIZTION OF RETURNS TO SHAREHOLDERS AND ENSUING GROWTH TO THE SHAREHOLDER’S CAPITAL. OTHERS SUCH AS EMPLOYEES, PUBLIC, WORKERS, CREDITORS, BANKERS ARE WELL PROTECTED THROUGH PROPER LEGISLATION. WEALTH MAXIMIZATION MEANS MAXIMIZING THE NET PRESENT VALUE OF FUTURE RETURNS, TO SHAREHOLDERS FOR THE INVESTMENT THEY MAKE TODAY. THE OWNERS INVEST TODAY AND EXPECT RETURNS IN THE FUTURE. THAT MEANS ANY COURSE OF THE FINANCIAL ACTION WILL NECESSITATE THE OWNERS TO INVEST AGAINST CERTAIN BENEFITS TO COME.

FUNCTIONS OF FINANCIAL MANAGEMENT

EXECUTIVE FUNCTIONS : OR MANAGERIAL FINANCE FUNCTIONS ARE SO CALLED BECAUSE REQUIRE SKILLFULL PLANNING, CONTROL AND EXECUTION OF FINANCIAL ACTIVITIES

• FINANCIAL FORECASTING

• INVESTMENT DECISIONS

• MANAGEMENT OF CORPORATE ASSET STRUCTURE

• THE MANAGEMENT OF INCOME

• MANAGEMENT OF CASH

• DECIDING ABOUT NEW SOURCES OF FINANCE

• TO CONTACT AND CARRY NEGOTATION FOR NEW FINANCE

• ANALYSIS AND APPRASIAL OF FIANANCIAL PERFORMANCE

• ADVISING THE TOP MANAGEMENT

INCIDENTAL OR ROUTINE FUNCTIONS: DO NOT REQUIRE A GREAT MANAGERIAL ABILITY TO CARRY THEM OUT. THEY ARE CHIEFLY CLERICAL AND ARE INCIDENTAL TO EFFECTIVE HANDLING OF MANAGERIAL FINANCE FUNCTIONS.

• CAPITAL BUDGETING DECISION

• FINANCING DECISIONS

• DIVIDEND DECISION

• CURRENT ASSET MANAGEMENT

FUNCTIONAL ASPECTS OF FINANCE

INCOME STATEMENT

MOST USEFUL FINANCIAL STATEMENT.EXPLAINS WHAT HAPPENED IN BUSINESS BETWEEN 2 DATES. IT MATCHES REVENUES AND COSTS DURING THE PERIOD. SHOWS NET PROFIT EARNED OR LOSS.

BALANCE SHEET STATEMENT OF FINANCIAL POSITION OF BUSINESS AT POINT OF TIME. REPRESENTS ALL ASSETS OWNED AT

A TIME AND THE CLAIMS OF OWNERS AND OUTSIDERS AGAINST ASSETS. SNAPSHOT OF THE BUSINESS.

1. LIQUIDITY ORDER

2. PERMANENCY ORDER

NATURE OF FINANCIAL STATEMENTS

• RECORDED FACTS

• ACCOUNTING CONVENTIONS

• PERSONAL JUDGEMENTS

LIMITATIONS OF FINANCIAL STATEMENTS

1. FINANCIAL STATEMENTS ARE ESSENTIALLY INTERM REPORTS

2. ACCOUNTING CONCEPTS AND CONVENTIONS

3. INFLUENCE OF PERSONAL JUDGEMENT

4. DISCLOSE ONLY MONETARY FACTS

FINANCIAL ANALYSIS

TYPES OF FINANCIAL ANALYSIS

EXTERNAL ANALYSIS OF FINANCIAL STATEMENT MADE BY DON’T HAVE ACCESS TO DETAILED ACCOUNT RECORDS (BANKS, CREDITORS, &GENERAL PUBLIC). BASED ENTIRELY ON PUBLISHED FINANCIAL STATEMENTS. OBJECTIVE VARIES FROM PARTY TO PARTY

INTERNAL ANALYSIS – IS MADE BY FINANCE & ACCOUNTING DEPARTMENT TO HELP TOP MANAGEMENT. THEY HAVE FULL ACCESS TO FIN. STATE. (BS & INCOME STATE). FOR PERFORMANCE APPRAISAL AND ASSESSING PROFITABLILTY OF ACTIVITIES.

SHORT-TERM ANALYSIS OF FIN. STATE. IS MAINLY CONCERNED WITH THE WORKING CAPITAL ANALYSIS. SHORT RUN COMPANY MUST HAVE SAMPLE FUNDS READILY AVAILABLE TO MEET CURRENT NEEDS AND BORROWING CAPACITY FOR CONTINGENCIES. CURRENT ASSETS AND LIABILITIES ARE ANALYSED & CASH POSITION (LIQUIDITY) DETERMINED.

LONG -TERM ANALYSIS THE COMPANY MUST EARN MIN. AMOUNT TO MAINTAIN SUITABLE R.O.I TO PROVIDE FOR NECESSARY GROWTH AND DEVELOPMENT & MEET COST OF CAPITAL. STRESS ON STABILITY AND EARNING POTENTIAL. FIXED ASSETS, LONG TERM DEBT STRUCTURE & OWNERSHIP INTEREST ARE ANALYSED.

HORIZONTAL ANALYSIS IS WHEN FIN. STATE. FOR A NUMBER OF YEARS IS REVIEWED AND ANALYSED. BASED ON DATA FROM YEAR TO YEAR NOT ON ONE DATE AS A WHOLE. IT IS A COMPARATIVE STUDY BASED ON DATA FROM YEAR TO YEAR, RAHTHER THAN ON ONE DATE, THIS IS ALSO KNOWN AS DYNAMIC ANALYSIS.

VERTICAL ANAYSIS IS ALSO KNOWN AS STATIC ANALYSIS. WHEN RATIOS ARE CALCULATED FROM BALANCE SHEED OF ONE YEAR IT IS CALLED VERTICAL ANALYSIS. IT IS NOT VERY USEFUL FOR LONG TERM PLANNING AS IT DOES NOT INCLUDE THE TREND STUDY FOR FUTURE.

FINANCIAL ANALYSIS (CONTD.)

IT IS METHOD BY WHICH WE STUDY THE NET FUNDS FLOW BETWEEN TWO POINTS OF TIME. THE POINTS CONFIRM TO BEGINNING AND ENDING FIN. STATE. DATES FOR PERIOD OF EXAMINATION IS RELEVANT, A QUARTER OF A YEAR. IT IS A FLEXIBLE DEVICE DESIGNED TO DISCLOSE AND EMPHASIZE ALL SIGNIFICANT CHANGES AND TRANSACTIONS WITHIN CURRENT ASSET OR LIABILITY GROUP. IT IS A REPORT ON FIN. OPERATION CHANGES.

USES

• ANALYSIS OF FINANCIAL OPERATIONS

• EVALUATION OF THE FIRM’S FINANCE

• A TOOL OF COMMUNICATION

• FUTURE GUIDANCE

• PROFITABLE BUT LESS LIQUID

• MEANS OF PLANNING

• SHAREHOLDERS BE MOTIVATED

FUNDS-FLOW ANALYSIS

SOURCES OF FUNDS

1. FUNDS FROM OPERATION

• DEPRECIATION AND DEPLETION

• AMORTIZATION OF NON-FUND ITEMS

• PROVISION OF TAXATION

• APPROPRIATION OF RETAINED EARNINGS

2. ISSUE OF SHARE CAPITAL

3. ISSUE OF DEBENTURES OR LONG TERM LOANS

4. SALE OF FIXED ASSETS

5. NON-TRADING RECEIPTS

USES OF FUNDS

1. PURCHASE OF ANY FIXED ASSETS

2. PAYMENT OF LOANS

3. PAYMENT OF DIVIDEND

4. INCREASE IN WORKING CAPITAL

FUNDS-FLOW ANALYSIS (CONTD.)

SOME USE IT TO REFER TO THE MOVEMENT OF CASH IN AND OUT OF THE BUSINESS OTHERS USE THIS TERM TO REPRESENT FUNDS PROVIDED FROM OPERATIONS.

DIFFERENCE BETWEEN FUNDS FLOW AND CASH FLOW

1. A CASH FLOW STATEMENT IS CONCERNED ONLY WITH CHANGE IN CASH POSITION WHILE A FUND FLOW ANALYSIS IS CONCERNED WITH CHANGE IN WORKING CAPITAL POSITION, BETWEEN TWO BALANCE SHEET DATES.

2. CASH FLOW STATEMENT IS MERELY A RECORD OF CASH RECEIPTS AND DISBURSEMENTS. IT FAILS TO ENLIGHTEN MANY IMPORTANT CHANGES INVOLVING THE DISPOSITION OF RESOURCES SHORT TERM SOLVENCY OF A BUSINESS

3. CASH FLOW ANALYSIS IS MORE USEFUL TO MANAGEMENT AS A TOOL OF FINANCIAL ANALYSIS IN SHORT PERIODS AS COMPARED TO FUNDS FLOW ANALYSIS.

4. CASH IS PART OF WORKING CAPITAL SO AN IMPROVEMENT IN CASH POSITION RESULTS IN IMPROVEMENT IN FUNDS POSITION BUT REVERSE IS NOT TRUE. MEANING INFLOW OF CASH RESULTS INFLOW IN FUNDS BUT INFLOW OF FUNDS MAY NOT RESULT IN INFLOW OF CASH.

5. AN INCREASE IN CURRENT LIABILITIES OR DECREASE IN CURRENT ASSET RESULTS IN DECREASE IN WORKING CAPITAL AND VICE VERSA. WHILE THE SAME WILL RESULT IN INCREASE IN CASH AND VICE VERSA.

CASH FLOW ANALYSIS

LIMITATIONS OF CASH FLOW ANALYSISCASH FLOW ANALYSIS IS A USEFUL TOOL OF FINANCIAL ANALYSIS. HOWEVER IS HAS ITS OWN

LIMITATIONS. THESE LIMITATIONS ARE AS UNDER.

1. CASH FLOW STATEMENT CANNOT BE EQUATED WITH THE INCOME STATEMENT. AN INCOME STATEMENT TAKES INTO ACCOUNT BOTH CASH AS WELL AS NON-CASH ITEMS AND, THEREFORE, NET CASH FLOW DOES NOT NECESSARY MEAN NET INCOME OF BUSINESS

2. THE CASH BALANCE AS DISCLOSED BY THE CASH FLOW STATEMENT MAY NOT REPRESENT THE REAL LIQUID POSITION OF THE BUSINESS ONCE IT CAN BE EASILY INFLUENCED BY POSTPONING PURCHASES AND OTHER PAYMENTS

3. CASH FLOW STATEMENT CAN NOT REPLACE THE INCOME STATEMENT OR THE FUNDS FLOW STATEMENT. EACH OF THEM AS A SEPARATE FUNCTION TO PERFORM,

APPLICATIONS OF CASH

• PURCHASE OF FIXED ASSETS

• PAYMENT OF LONG TERM LOANS

• DECREASE IN DEFERRED PAYMENT LIABILITIES

• LOSS ON ACCOUNT OF OPERATIONS

• PAYMENT OF TAX

• PAYMENT OF DIVIDEND

• DECREASE IN UNSECURED LOANS, DEPOSITS, ETC.

RATIO ANALYSISTO EVALUATE FINANCIAL CONDITION AND PERFORMANCE OF A FIRM THE FINANCIAL

EXECUTIVE NEEDS CERTAIN YARD STICKS. THE YARDSTICK FREQUENTLY USED IS RATIO ANALYSIS. THE CONSTRUCTION OF RATIO IS A MAJOR ANALYTICAL TOOL IN THE HANDS OF FINANCIAL EXECUTIVES

Uses

• AID IN FINANCIAL FORECASTING : RATIO RELATING TO PAST SALES, PROFIT, FIN. POSITION ARE BASED FOR FUTURE TREND

• AID IN COMPARISON : OF PARTICULAR FIRM’S PROGRESS & PERFORMANCE

• AID IN COST CONTROL : BY MEASURING THE PERFORMANCE AND COSTS INVOLVED

• COMMUNICATION VALUE :COMUN. THE STRENGTH/FINANCIAL STANDING TO INT/EXT

• OTHER USES : HIGHLIGHT LIQUIDITY, SOLVENCY, PROFITABILITY, CAPITAL GEARING & FINANCIAL STANDING OF THE FIRM

IMPORTANCE

• LIQUID POSITION

• LONG TERM SOLVENCY

• OPERATION EFFICIENCY

• OVER ALL PROFITABILITY

• INTER-FIRM COMPARISON

• TREND ANALYSIS

ADVANTAGES OF RATIO ANALYSIS

• SIMPLIFIES FINANCIAL STATEMENTS

• FACILITATES INTER-FIRM COMPARISON

• MAKES INTRA-FIRM COMPARISON POSSIBLE

• HELPS IN PLANNING

LIMITATIONS RATIO ANALYSISDIFFICULT TO DECIDE PROPER BASIS FOR COMPARISON

RATIOS OF A COMPANY HAVE MEANING ONLY WHEN THEY ARE COMPARED WITH SOME STANDARDS. USUALLY RECOMMENDED THAT RATIOS COMPARED WITH INDUSTRY AVERAGES

COMPARISON BECOMES DIFFICULT BECAUSE OF DIFFERENT SITUATIONS

THE SITUATION BETWEEN 2 COMPANIES ARE NEVER THE SAME.

PRICE CHANGES

THE INTERPRETATION AND COMPARISON OF RATIOS ARE MADE INVALID BY THE CHANGING VALUE OF CURRENCY. ACCOUNT FIGURES ARE EXPRESSED IN MONETARY VALUE.

DEFINITIONAL DIFFERENCES

IN PRACTICE, DIFFERENCES EXIST AS TO THE MEANING OF CERTAIN ITEMS. DIVERSITY EXISTS AS TO WHAT SHOULD BE INCLUDED AND METHODS IN CALCULATING NET WORTH OF SHAREHOLDER’S EQUITY, CURRENT ASSETS OR CURRENT LIABILITIES.

SHORT TERM CHANGES

THE RATIOS DO NOT HAVE MUCH USE IF THEY ARE NOT ANALYSED OVER YEARS.

NO INDICATORS OF FUTURE

THE BASIS OF RATIOS IS FIN. STATEMENT. FINANCIAL ANALYST IS MORE INTERESTED IN WHAT HAPPENS IN FUTURE BUT RATIOS ONLY SHOW WHAT HAS ALREADY HAPPENED. THEY OFFER NO INDICATIONS OF WHAT IS GOING TO HAPPEN.

APPLICATION OF RATIOSTYPES OF RATIOS

MEASURE OF LIQUIDITY

• NET WORKING CAPITAL = CURRENT ASSETS – CURRENT LIABILITIES

• CURRENT RATIO = CURRENT ASSETS / CURRENT LIABILITIES

• ACID TEST RATIO = CURRENT ASSETS(LESS INVENTORY)/CURRENT LIABILITIES

• CASH POSITION RATIO = (CASH+MARKETABLE SECURITIES)/CURRENT LIABILITIES

FINANCIAL FORECASTINGFINANCIAL FORECASTING INVOLVES SYSTEMATIC PROJECTION OF EXPECTED ACTIONS OF

MANAGEMENT IS THE FORM OF FINANCIAL STATEMENTS BUDGETS ETC, THE PROCESS OF FINANCIAL FORECASTING INVOLVES USE OF PAST RECORDS, FUNDS FLOW BEHAVIOUR, FINANCIAL RATIOS, AND EXPECTED ECONOMIC CONDITIONS IN INDUSTRY AS WELL AS IN THE FIRM. IT IS A SORT OF WORKING PLAN FORMULATED FOR SPECIFIC PERIOD BY ARRANGING FUTURE ACTIVITIES.

ADVANTAGES

• FINANCIAL FORECASTING FORMS BASIS OF COORDINATED THINKING FOR OPTIMUM UTILIZATION OF FUNFS AND EXCESS CASH CAN BE INVESTED PROFITABLY.

• IT IS USEFUL TO ANTICIPATE THE FINANCIAL NEEDS AND EFFECTS OF NEW POLICIES AND REDUCE EMERGENCY DECISIONS

• IT IS USEFUL TO FIX STANDARDS FOR MEASURING PERFORMANCE AND EVALUATING RESULTS.

• IT SERVES AS A BASIS FOR ESTIMATING FUNDS REQUIREMENTS WITHIN THE COMPANY

• IT HELPS THE CORPORATE MANAGERS FOR NEGOTIATING CONFIDENTLY WITH THE SUPPLIERS OF FUNDS

• IT IS USED TO PROTEST THE FINANCIAL FEASABILITY OF VARIOUS PROGRAMMES.

PROFORMA FINANCIAL STATEMENTS

FIN. STATE. WHICH DISPLAY THE EFFECTS OF FUTURE CIRCUMSTANCES ARE DESCRIBED AS PROFORMA STATEMENTS. PREPARED BY ASSUPTIONS, ESTIMATES REVENUE, TAXES, DIVIDENDS, PROFITS, COSTS, USES AND SOURCES.

• PROJECTED INCOME STATEMENT

• PROJECTED BALANCE SHEET

• PROJECTED CASH BUDGET

• PROJECTED SOURCES AND USES STATEMENT

FINANCIAL FORECASTING (CONTD.)CASH BUDGET

THE PROJECTED CASH BUDGET REFLECTS THE CASH INFLOWS AND OUT FLOWS EXPECTED IN THE FUTURE. THE MAJOR SOURCES OF CASH FLOWS ARE CASH SALES, COLLECTION OF ACCOUNTS RECEIVABLES, DISPOSBALE ASSETS, SHORT TERM BORROWINGS, LONG TERM DEBTS & EQUITY CAPITAL.

ADDITIONAL METHODS OF FINANCIAL FORECASTING

• PERCENT OF SALES :THIS METHOD ASSUMES THAT CERTAIN ITEMS OF BALANCE SHEET VARY WITH SALES. IN THIS APPROACH THE FIRM’S NEEDS IN TERMS OF PERCENTAGE OF ANNUAL SALES ENVISAGED IN EACH INDIVIDUAL BALANCE SHEET ITEMS ARE EXPRESSED.

• SIMPLE REGRESSION OR SCATTER DIAGRAM METHOD :IT IS A GRAPHIC PRESERNTATION OF JOINT RELATIONS.

• CURVILINEAR SIMPLE REGRESSION METHOD : LINEAR REGRESSION METHOD ASSUMES THAT THE SLOPES OF THE REGRESSION LINE IS CONSTANT. THIS IS THE NORM BUT NOT ALWAYS TRUE. HENCE APPLICATION OF CURVILINEAR SIMPLE REGRESSION OF FORECASTING FINANCIAL RELATIONSHIPS IS NECESSARY.

• MULTIPLE REGRESSION METHOD : IT IS MORE MEANINGFUL. IN PREVIOUS METHODS SALES ARE ASSUMED TO DEPEND ON ONE VARIABLE. BUT IN THIS METHOD SALES ARE RECOGNIZED TO DEPND ON A NUMBER OF VARIABLES AND THUS THIS TAKES INTO ACCOUNT ADDITIONAL VARIABLES INTO THE ANALYSIS TO IMPROVE FINANCIAL FORECASTING.

MANAGEMENT OF RECEIVABLESGOALS OF CREDIT MANAGEMENT

TO MAXIMISE VALUE OF THE FIRM BY ACHIEVING A TRADE OFF BETWEEN LIQUIDITY(RISK) AND PROFITABILITY. THE PURPOSE OF CREDIT IS NOT TO MAX SALE, NOR TO MIN THE RISK OF BAD DEBT. IF THE OBJECTIVE WERE TO MAX SALES THEN WE WOULD GIVE CREDIT TO ALL. IF IT WAS TO MIN BAD DEBT THEN WE WOULDN’T GIVE OUT ANY CREDIT. THE FIRM SHOULD MANAGE ITS CREDIT IN SUCH A WAY THAT SALES EXPANDED TO AN EXTENT TO WHICH RISK REMAINS WITHIN AN ACCEPTABLE LIMIT. THUS THE GOALS CAN BE SAID AS

1. TO OBTAIN OPTIMUM (NOT MAXIMUM) VOLUME OF SALES

2. TO CONTROL THE COST OF CREDIT AND KEEP IT AT MINIMUM

3. TO MAINTAIN INVESTMENT IN DEBTORS AT OPTIMUM LEVEL.

CREDIT INFORMATION

IN EXTENDING CREDIT TO CUSTOMERS, THE FIRM WOULD ENSURE THAT RECEIVABLES ARE COLLECTED IN FULL AND ON DUE DATE. AS DISCUSSED EARLIER, INVESTMENT IN RECEIVABLES INVOLVES COSTS. IF THE FIRM FAILS TO COLLECT ITS RECEIVABLES, THERE IS A GREATER LOSS TO THE FIRM LOSS OF BAD DEBT AND COST OF INVESTMENT. THEREFORE CREDIT SHOULD BE GRANTED TO THOSE CUSTOMERS WHO HAVE THE ABILITY TO MAKE THE DUE DATES. TO ENSURE THIS, THE FIRM SHOULD HAVE CREDIT INFORMATION CONCERNING EACH CUSTOMER WHOM THE CREDIT IS GRANTED

• FINANCIAL STATEMENT

• BANK REFERENCES

• TRADE REFERENCES

• CREDIT BUREAU REPORTS

• CREDIT ANALYSIS

WORKING CAPITAL MANAGEMENTOPERATING CYCLE

THE DURATION OF TIME REQUIRED TO COMPLETE THE FOLLOWING SEQUENCE OF EVENTS, IS CALLED OPERATING CYCLE.

• CONVERSION OF CASH INTO RAW MATERIALS

• CONVERSION OF RAW MATERIALS INTO WORK IN PROGRESS

• CONVERSION OF FINISHED GOODS INTO DEBTORS AND BILLS RECEIVABLE

• CONVERSION OF BILLS RECEIVABLE AND DEBTORS INTO CASH

THE DANGERS OF EXCESSIVE WORKING CAPITAL ARE

1. UNNECESSARY ACCUMULATION OF INVENTORIES SO MISHANDLING IS POSSIBLE

2. DEFECTIVE CREDIT POLICY AND SLACK COLLECTION PERIOD SO HIGHER INCIDENCE OF BAD DEBTS IS POSSIBLE

3. IT LEADS TO COMPLACENCY ON PART OF MANAGEMENT

4. IT MAY LEAD TO A LIBERAL DIVIDEND POLICY WHICH COULD BE DIFFICULT TO COPE.

INADEQUATE WORKING CAPITAL COULD LEAD TO

1. STAGNATION OF GROWTH OF THE FIRM

2. IT BECOMES DIFFICULT TO IMPLEMENT OPERATING PLANS AND ACHIEVE THE PROFIT TARGETS

3. OPERATING INEFFICIENCIES

4. AS FIXED ASSETS ARE NOT EFFICIENTLY UTILIZED, THE RBI SLUMPS.

5. PAUCITY RENDERS THE FIRM UNABLE TO ATTRACT CREDIT OPPORTUNITIES

6. LOSS OF REPUTATION AS THE FIRM MAY NOT MEET ITS COMMITMENTS.

WORKING CAPITAL MANAGEMENT (CONTD.)FINANCING CURRENT ASSETS

3 TYPES OF FINANCING POLICIES LONG TERM, SHORT TERM & SPONTANEOUS FINANCING.

LONG TERM REFERS TO SHARES, DEBENTURE PREFERENCE SHARES, RETAINED EARNINGS AND DEBTS FROM FINANCIAL INSTITUTIONS. SHORT TERM FINANCING REFERS TO SOURCES OF SHORT TERM CREDIT THAT THE FIRM MUST ARRANGE IN ADVANCE. THESE SOURCES INCLUDE SHORT TERM BANK LOANS COMMERCIAL PAPERS AND FACTORING RECEIVABLES. SPONTANEOUS FINANCING REFERS TO THE AUTOMATIC SOURCES OF SHORT TERM FUNDS. THE MAJOR SOURCES OF SUCH FINANCES ARE CREDITORS, BILLS PAYABLE AND OUTSTANDING EXPENSES. A FIRM WOULD LIKE TO FINANCE ITS CURRENT ASSETS WITH SPONTANEOUS SOURCES AS MUCH AS POSSIBLE, BECAUSE THIS SOURCES OF FINANCING ARE COST FREE.

SHORT TERM VS LONG TERM

FACTORS FOR CHOOSING FINANCING

1. THE COST ADVANTAGE :SHORT TERM FINANCING SHOULD GENERALLY BE LESS COSTLY THAN LONG TERM. THE RATE OF INTEREST IS GENERALLY REALTED TO MATURITY OF DEBT. RELATIONSHIP BETWEEN MATURITY OF DEBT AND ITS COST IS CALLED TERM STRUCTURE OF INTEREST RATES. THE COST OF FINANCING HAS AN IMPACT ON FIRMS RETURN. AS SHORT TERM FINANCING COSTS LESS, THE RETURN WOULD BE HIGHER.LONG TERM NOT ONLY HAS HIGHER COSTS BUT ALSO MAKES THE EQUITY HIGHER.

2. FLEXIBILITY : SHORT TERM= EASY TO REFUND, LONG TERM=CONNOT BE REFUNDED BEFORE TIME.

3. RISK OF FINANCING :SHORT TERM=MORE RISKY SINCE IT MAY NEED RENEWING AGAIN & AGAIN, LONG TERM=LESS RISKY. THIS IS PARTICULARLY THE CASE IN CURRENT ASSETS. PERMANENT CURRENT ASSETS ARE TO MINIMUM LEVEL OF CURRENT ASSETS WHICH A COMPANY SHOULD MAINTAIN.

DETERMINANTS OF WORKING CAPITALNATURE AND SIZE OF BUSINESS

THE WORKING CAPITAL REQUIREMENTS OF A FIRM ARE BASICALLY INFLUENCED BY THE NATURE OF ITS BUSINESS.

• MANUFACTURING CYCLE

• BUSINESS FLUCTUATIONS

• PRODUCTION POLICY

• FIRM’S CREDIT POLICY

• AVAILABILITY OF CREDIT

PRICE LEVEL CHANGES

THE INCREASING SHIFTS IN PRICE LEVELS MAKE THE FUNCTIONS OF FINANCIAL MANAGER DIFFICULT. HE SHOULD ANTICIPATE THE EFFECT OF PRICE LEVEL CHANGES ON WORKING CAPITAL REQUIREMENTS OF THE FIRM.

OPERATING EFFICIENCY

THE OPERATING EFFICIENCY OF A FIRM RELATES TO THE OPTIMUM UTILIZATION OF RESOURCES AT MINIMUM COSTS.

CAPITAL STRUCTURE PLANNINGFEATURES OF A SOUND AND APPROPRIATE CAPITAL STRUCTURE

1. PROFITABILITY: THE CAPITAL STRUCTURE OF THE COMPANY SHOULD BE MORE ADVANTAGEOUS. WITHIN THE CONTRAINTS, MAXIMUM USE OF LEVERAGE AT A MINIMUM COST SHOULD BE MADE.

2. SOLVENCY: THE USE OF EXCESSIVE DEBT THREATENS THE SOLVENCY OF THE COMPANY. TO THE POINT DEBT DOES NOT ADD SIGNIFICANT RISK IT SHOULD BE USED, OTHERWISE ITS USE SHOULD BE AVOIDED

3. FLEXIBILITY: THE CAPITAL STRUCTURE SHOULD NOT BE IN FLEXIBLE TO MEET THE CHANGING CONDITIONS. IT SHOULD BE POSSIBLE FOR A COMPANY TO ADAPT ITS CAPITAL STRUCTURE WITH A MINIMUM COST AND DELAY IF WARRANTED BY A CHANGED SITUATION.

4. CONSERVATISM: THE CAPITAL STRUCTURE SHOULD BE CONSERVATIVE IN THE SENCE THAT THE DEBT CAPACITY OF THE COMPANY SHOULD NOT BE EXCEEDED. THE DEBT CAPACITY OF A COMPANY DEPENDS ON ITS ABILITY TO GENERATE FUTURE CASH FLOWS.

5. CONTROL: THE CAPITAL STRUCTURE SHOULD INVOLVE MINIMUM RISK OF LOSS OF CONTROL OF THE COMPANY.