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Semester 3: B.B.A., INTERNATIONAL BUSINESS
Meaning, objectives and Importance of Finance, Sources of finance, Functions of financial management, Role of financial manager in Financial Management
Meaning, Objectives and Importance of Finance, Sources of Finance, Functions of Financial Management, Role of Financial Manager in Financial Management
Meaning of Finance
Finance refers to the management, creation, and study of money, investments, and other financial instruments. It encompasses various aspects including budgeting, forecasting, and investment analysis.
Objectives of Finance
The primary objectives of finance include maximizing shareholder wealth, ensuring business liquidity, providing necessary funds for operations and expansion, and managing financial risks.
Importance of Finance
Finance is crucial for the functioning of any organization as it supports decision making, facilitates growth and expansion, enables effective resource allocation, and maintains business sustainability.
Sources of Finance
Sources of finance can be classified into: 1. Internal Sources: Retained earnings, personal savings, etc. 2. External Sources: Loans, equity financing, grants, and bonds.
Functions of Financial Management
Key functions include financial planning and forecasting, resource allocation, managing working capital, financial reporting, and budgeting.
Role of Financial Manager in Financial Management
The financial manager is responsible for financial planning, maintaining optimal capital structure, investment decisions, financial risk management, and ensuring compliance with financial regulations.
Capital structures planning: Factors affecting capital structures, Determining Debt and Equity proportion, Theories of capital structures, Leverage concept, Cost of capital (equity, preference share, debt, retained earnings), Weighted Average Cost of Capital (WACC)
Capital Structures Planning
Factors Affecting Capital Structures
1. Business Risk: Higher business risk leads to lower debt capacity. 2. Financial Flexibility: Firms with greater flexibility prefer less debt. 3. Tax Considerations: Interest expense is tax-deductible, encouraging debt. 4. Market Conditions: Economic climate impacts investor sentiment toward equity and debt. 5. Company Size: Larger firms often have easier access to capital markets. 6. Growth Opportunities: Companies with high growth prefer equity to avoid financial constraints.
Determining Debt and Equity Proportion
1. Target Capital Structure: Establish a long-term plan for debt equity ratio. 2. Industry Norms: Align with industry benchmarks for financial structure. 3. Cost of Capital: Aim for the lowest overall cost of capital while managing risk. 4. Growth Prospects: Consider future funding needs and their implications. 5. Current Market Conditions: Evaluate interest rates and investor demand.
Theories of Capital Structures
1. Modigliani-Miller Theorem: Suggests that under certain conditions, capital structure does not affect firm value. 2. Trade-off Theory: Companies balance tax advantages of debt against bankruptcy costs. 3. Pecking Order Theory: Firms prefer internal financing, then debt, and finally equity if external funds are needed.
Leverage Concept
1. Financial Leverage: Use of debt to increase the potential return on equity. 2. Operating Leverage: Impact of fixed costs on operational profits. 3. Risk: Higher leverage increases both potential returns and business risk.
Cost of Capital
1. Equity: Returns expected by shareholders based on risk. 2. Preference Shares: Fixed dividends, treated as debt in WACC calculations. 3. Debt: Interest costs that are tax-shielded, impacting overall capital cost. 4. Retained Earnings: Internal source of financing, calculated using equity cost.
Weighted Average Cost of Capital (WACC)
1. Definition: WACC is the average rate of return a company must earn on its capital. 2. Calculation: Based on the proportion of debt and equity in the capital structure. 3. Importance: Used as a hurdle rate for investment decisions, guiding financing strategies.
Capital Budgeting: ARR, Pay back period, Net present value, IRR, Capital rationing, simple problems on capital budgeting methods
Capital Budgeting
Introduction to Capital Budgeting
Capital budgeting is the process of planning and evaluating investments in long-term assets. It involves analyzing potential projects to determine their feasibility and profitability.
Average Rate of Return (ARR)
ARR is a financial ratio used to measure the profitability of an investment. It is calculated by dividing the average annual profit by the initial investment cost. A higher ARR indicates a more attractive investment.
Payback Period
The payback period is the time it takes for an investment to generate enough cash flows to recover the initial investment cost. Shorter payback periods are generally preferred, as they indicate quicker returns.
Net Present Value (NPV)
NPV is the difference between the present value of cash inflows and the present value of cash outflows over the investment's lifespan. A positive NPV indicates that the investment is expected to generate value.
Internal Rate of Return (IRR)
IRR is the discount rate at which the net present value of an investment becomes zero. It represents the expected annual rate of return. If the IRR exceeds the required rate of return, the investment is considered acceptable.
Capital Rationing
Capital rationing occurs when a company has limited funds for investments and must prioritize projects. This may lead to selecting projects that offer the highest returns within the available budget.
Simple Problems on Capital Budgeting Methods
Examples of simple problems can include calculating ARR, payback period, NPV, and IRR for various projects. These examples help illustrate the application of each method in decision-making processes.
Dividend policies: Factors affecting dividend payment, Company Law provision on dividend payment, Various Dividend Models
Dividend policies
Factors affecting dividend payment
1. Earnings: Higher profitability often leads to higher dividends. 2. Cash Flow: Sufficient cash flow is crucial for paying dividends. 3. Debt Levels: High debt may restrict dividend payments. 4. Retained Earnings: Companies may retain earnings for growth instead of paying them out. 5. Market Expectations: Investors' expectations can influence dividend announcements. 6. Tax Considerations: Tax treatment on dividends might affect decisions.
Company Law provision on dividend payment
1. Legal Framework: Company laws define the conditions under which dividends may be declared. 2. Declaration: Dividends must be declared by the board before being paid. 3. Solvency Test: Companies may need to prove they are solvent before paying dividends. 4. Preference Shareholders: Certain classes of shares may have preferential rights to dividends. 5. Payment Method: Laws may dictate how dividends can be paid (cash, stock, etc.).
Various Dividend Models
1. Dividend Discount Model (DDM): Values a stock based on predicted dividends discounted to present value. 2. Gordon Growth Model: A version of DDM assuming constant growth in dividends. 3. Residual Dividend Model: Dividends are based on earnings left after all profitable opportunities are funded. 4. Stable Dividend Model: Companies aim to maintain a steady dividend payment over time, regardless of earnings.
Working capital: Components, operating cycle, Factors influencing working capital, Determining or Forecasting of working capital requirements
Working capital
Components of Working Capital
Working capital consists of current assets and current liabilities. Key components include cash, inventory, accounts receivable, and accounts payable. The formula for calculating working capital is Current Assets minus Current Liabilities.
Operating Cycle
The operating cycle refers to the time taken to convert raw materials into cash through the sale of finished goods. It includes the inventory period and the accounts receivable period. A shorter operating cycle generally indicates more efficient working capital management.
Factors Influencing Working Capital
Factors affecting working capital include the nature of the business, production cycle duration, credit policies, operational efficiency, seasonality, and inflation. Understanding these factors helps businesses manage and optimize their working capital effectively.
Determining or Forecasting Working Capital Requirements
Forecasting working capital requirements involves analyzing past financial data, estimating future sales and production needs, and considering industry trends. Techniques like the cash conversion cycle and ratio analysis can aid in accurate forecasting.
