This document discusses various key concepts in financial management. It begins by defining financial management and its scope/elements, which include investment decisions, financial decisions, and dividend decisions. It then discusses three elements of financial management: financial planning, financial control, and financial decision-making. Other topics covered include functions of financial management, importance of financial management, types of finance, financial goals of organizations, financial forecasting, financial planning, break-even analysis, fixed costs, and variable costs.
2. Meaning of Financial Management
• Financial Management means planning, organizing, directing and
controlling the financial activities such as procurement and utilization of
funds of the enterprise. It means applying general management
principles to financial resources of the enterprise.
Scope/Elements
• Investment decisions includes investment in fixed assets (called as
capital budgeting). Investment in current assets are also a part of
investment decisions called as working capital decisions.
• Financial decisions - They relate to the raising of finance from various
resources which will depend upon decision on type of source, period of
financing, cost of financing and the returns thereby.
• Dividend decision - The finance manager has to take decision with
regards to the net profit distribution. Net profits are generally divided
into two:
– Dividend for shareholders- Dividend and the rate of it has to be decided.
– Retained profits- Amount of retained profits has to be finalized which will
depend upon expansion and diversification plans of the enterprise.
R'tist@Tourism, Pondicherry University 2
3. • There are three key elements to the process of financial management:
(1) Financial Planning
• Management need to ensure that enough funding is available at the right time to meet
the needs of the business. In the short term, funding may be needed to invest in
equipment and stocks, pay employees and fund sales made on credit.
• In the medium and long term, funding may be required for significant additions to the
productive capacity of the business or to make acquisitions.
(2) Financial Control
• Financial control is a critically important activity to help the business ensure that the
business is meeting its objectives. Financial control addresses questions such as:
– Are assets being used efficiently?
– Are the businesses assets secure?
– Do management act in the best interest of shareholders and in accordance with business rules?
(3) Financial Decision-making
• The key aspects of financial decision-making relate to investment, financing and
dividends:
– Investments must be financed in some way – however there are always financing alternatives that
can be considered. For example it is possible to raise finance from selling new shares, borrowing
from banks or taking credit from suppliers
– A key financing decision is whether profits earned by the business should be retained rather than
distributed to shareholders via dividends. If dividends are too high, the business may be starved of
funding to reinvest in growing revenues and profits further.
R'tist@Tourism, Pondicherry University 3
4. Functions of Financial Management
Estimation of capital requirements: A finance manager has to make estimation with regards to capital
requirements of the company. This will depend upon expected costs and profits and future programmes
and policies of a concern. Estimations have to be made in an adequate manner which increases earning
capacity of enterprise.
Determination of capital composition: Once the estimation have been made, the capital structure have to be
decided. This involves short- term and long- term debt equity analysis. This will depend upon the
proportion of equity capital a company is possessing and additional funds which have to be raised from
outside parties.
Choice of sources of funds: For additional funds to be procured, a company has many choices like-
– Issue of shares and debentures
– Loans to be taken from banks and financial institutions
– Public deposits to be drawn like in form of bonds.
• Choice of factor will depend on relative merits and demerits of each source and period of financing.
Investment of funds: The finance manager has to decide to allocate funds into profitable ventures so that
there is safety on investment and regular returns is possible.
Disposal of surplus: The net profits decision have to be made by the finance manager. This can be done in two
ways:
– Dividend declaration - It includes identifying the rate of dividends and other benefits like bonus.
– Retained profits - The volume has to be decided which will depend upon expansional, innovational, diversification
plans of the company.
Management of cash: Finance manager has to make decisions with regards to cash management. Cash is
required for many purposes like payment of wages and salaries, payment of electricity and water bills,
payment to creditors, meeting current liabilities, maintainance of enough stock, purchase of raw
materials, etc.
Financial controls: The finance manager has not only to plan, procure and utilize the funds but he also has to
exercise control over finances. This can be done through many techniques like ratio analysis, financial
forecasting, cost and profit control, etc.
R'tist@Tourism, Pondicherry University 4
5. Importance
• (i) success of Promotion Depends on Financial
Administration. One of the most important
reasons of failures of business promotions is a
defective financial plan. If the plan adopted fails
to provide sufficient capital to meet the
requirement of fixed and fluctuating capital an
particularly, the latter, or it fails to assume the
obligations by the corporations without
establishing earning power, the business cannot
be carried on successfully. Hence sound
financial plan is very necessary for the success
of business enterprise.
• (ii) Smooth Running of an Enterprise. Sound
Financial planning is necessary for the smooth
running of an enterprise. Money is to an
enterprise, what oil is to an engine. As, Finance
is required at each stage f an enterprise, i.e.,
promotion, incorporation, development,
expansion and administration of day-to-day
working etc., proper administration of finance is
very necessary. Proper financial administration
means the study, analysis and evaluation of all
financial problems to be faced by the
management and to take proper decision with
reference to the present circumstances in
regard to the procurement and utilisation of
funds.
• (iii) Financial Administration Co-ordinates
Various Functional Activities. Financial
administration provides complete co-ordination
between various functional areas such as
marketing, production etc. to achieve the
organisational goals. If financial management is
defective, the efficiency of all other
departments can, in no way, be maintained. For
example, it is very necessary for the finance-
department to provide finance for the purchase
of raw materials and meting the other day-to-
day expenses for the smooth running of the
production unit. If financial department fails in
its obligations, the Production and the sales will
suffer and consequently, the income of the
concern and the rate of profit on investment
will also suffer. Thus Financial administration
occupies a central place in the business
organisation which controls and co-ordinates all
other activities in the concern.
• (iv) Focal Point of Decision Making. Almost,
every decision in the business is take in the light
of its profitability. Financial administration
provides scientific analysis of all facts and
figures through various financial tools, such as
different financial statements, budgets etc.,
which help in evaluating the profitability of the
plan in the given circumstances, so that a
proper decision can be taken to minimise the
risk involved in the plan.R'tist@Tourism, Pondicherry University 5
6. • (v) Determinant of Business Success. It has
been recognised, even in India that the financial
manger splay a very important role in the
success of business organisation by advising the
top management the solutions of the various
financial problems as experts. They present
important facts and figures regarding financial
position an the performance of various
functions of the company in a given period
before the top management in such a way so as
to make it easier for the top management to
evaluate the progress of the company to amend
suitably the principles and policies of the
company. The financial manges assist the top
management in its decision making process by
suggesting the best possible alternative out of
the various alternatives of the problem
available. Hence, financial management helps
the management at different level in taking
financial decisions.
(vi) Measure of Performance. The performance
of the firm can be measured by its financial
results, i.e, by its size of earnings Riskiness and
profitability are two major factors which jointly
determine the value of the concern. Financial
decisions which increase risks will decrease the
value of the firm and on the to the hand,
financial decisions which increase the
profitability will increase value of the firm. Risk
an profitability are two essential ingredients of a
business concern.
• importance of financial management can
be summarized as follows:
• It brings economic growth and
development through investments ,
financing, dividend and risk management
decision which help companies to
undertake better projects.
• When there is good growth and
development of the economy it will
ultimately improve the standard of living
of all people.
• Improved standard of living will lead to
good health and financial stress will
reduce considerably.
• It enables the individual to take better
financial decision which will reduce
poverty, reduce debts and increase
savings and investments.
• Better financial ability will lead to
profitability which will create new jobs
and in turn lead to more development ,
expansion and will promote efficiency.
R'tist@Tourism, Pondicherry University 6
7. Types of Finance
• Overdraft
A popular form of finance because it has the
advantages of availability, convenience and
flexibility. However, because interest rates are high,
it should only be used for short-term requirements
such as funding working capital. Find out more
about Overdraft.
Bank term loans
These provide fixed-term finance for longer
periods. They are often secured by a charge against
company assets and require you to sign legally
binding covenants. Find out more about our Loans
and Finance products
Asset-based finance
This describes financing an asset over its estimated
life span using the asset as security for the loan. It
can be structured so that the borrower has the
sole right to use the asset and ownership transfers
to the borrower at the end of the loan period. Find
out more about our Asset Finance products
Receivables Finance
This form of finance uses outstanding customer
invoices as security. Find out more
about Receivables Finance.
• Invoice discounting
Similar to Receivables Finance, this is usually only
offered to larger companies with strong credit
management systems.
Angel funding
An individual invests in a company in return for
shares in the company.
Venture capital
There are organisations that specialise in investing
in unquoted companies which they believe will
offer high returns to investors. There is strong
competition for this type of finance and you
should only consider it after assessing all the
alternatives.
Personal resources
These include personal savings, money borrowed
from family and friends, or profits generated by
the business.
R'tist@Tourism, Pondicherry University 7
8. Financial goals of organisation
• Financial Goals of Organization
• The two important financial goals of
organization can be
– profit maximization and
– wealth maximization.
• Out of this wealth maximization is most
important because it is based on cash flows of
the organizations.
• On the other profit maximization can be vague
as there can be multiple interpretations of
profits.
• Moreover profits do not take care of time value
of money and ignore risk attached to the
returns.
• Also profit maximization focus on short term
profitability which may not lead to long term
wealth creation.
• Hence financial management is concerned with
value maximization.
• Management's efforts are for increasing the
value of the company for the shareholders.
• This requires investing in projects that are likely
to provide positive returns to the company.
• Hence wealth maximization accounts for the
timing and risk of the expected benefits.
• Earnings are valued by deducting the total costs
from total income.
• Hence Net Earnings = Total Income - Total costs.
• Cash flows will only take cash inflows and cash
outflows.
• Increase in cash flows can lead to improvement in
wealth maximization.
• Management decisions affect the stockholder
wealth greatly. They can affect the wealth by
following decisions:
– Present and future earnings per share
– Investment decision: This is related to deciding
about the composition of fixed assets
– Financing decision: This is deciding about the mix
of sources of funds
– Working capital managements
– Profit allocation decisions
• We must understand that the firms' primary
objective is maximizing the welfare of owners,
but, in operational terms, they focus on the
satisfaction of its customers through the
production of goods and services needed by
them.
• Firms state their vision, mission and values in
broad terms. Wealth maximization is more
appropriately a decision criterion, rather than an
objective or a goal.
R'tist@Tourism, Pondicherry University 8
9. Financial Forecasting
• Financial Forecasting describes the process by which firms think about and
prepare for the future. The forecasting process provides the means for a firm
to express its goals and priorities and to ensure that they are internally
consistent. It also assists the firm in identifying the asset requirements and
needs for external financing.
• For example, the principal driver of the forecasting process is generally the
sales forecast. Since most Balance Sheet and Income Statement accounts are
related to sales, the forecasting process can help the firm assess the increase
in Current and Fixed Assets which will be needed to support the forecasted
sales level. Similarly, the external financing which will be needed to pay for the
forecasted increase in assets can be determined.
• Firms also have goals related to Capital Structure (the mix of debt and equity
used to finance the firms assets), Dividend Policy, and Working Capital
Management. Therefore, the forecasting process allows the firm to determine
if its forecasted sales growth rate is consistent with its desired Capital
Structure and Dividend Policy.
• The forecasting approach presented in this section is the Percentage of Sales
method. It forecasts the Balance Sheet and Income Statement by assuming
that most accounts maintain a fixed proportion of Sales. This approach,
although fairly simple, illustrates many of the issues related to forecasting and
can readily be extended to allow for a more flexible technique, such as
forecasting items on an individual basis.R'tist@Tourism, Pondicherry University 9
10. Financial plan
• a financial plan is a series of steps which are carried out, or goals that are
accomplished, which relate to an individual's or a business's financial affairs.
• This often includes a budget which organizes an individual's finances and
sometimes includes a series of steps or specific goals for spending
and saving future income.
• This plan allocates future income to various types of expenses, such as rent or
utilities, and also reserves some income for short-term and long-term savings.
• A financial plan sometimes refers to an investment plan, which allocates savings to
various assets or projects expected to produce future income, such as a new
business or product line, shares in an existing business, or real estate.
• In business, a financial plan can refer to the three primary financial
statements (balance sheet, income statement, and cash flow statement) created
within a business plan.
• Financial forecast or financial plan can also refer to an annual projection of
income and expenses for a company, division or department.
• A financial plan can also be an estimation of cash needs and a decision on how to
raise the cash, such as through borrowing or issuing additional shares in a
company.
R'tist@Tourism, Pondicherry University 10
11. Break Even analysis
• Break-even analysis is a technique
widely used by production
management and management
accountants. It is based on
categorising production costs
between those which are "variable"
(costs that change when the
production output changes) and
those that are "fixed" (costs not
directly related to the volume of
production).
• Total variable and fixed costs are
compared with sales revenue in
order to determine the level of
sales volume, sales value or
production at which the business
makes neither a profit nor a loss
(the "break-even point").
• The Break-Even Chart
• In its simplest form, the break-even
chart is a graphical representation of
costs at various levels of activity
shown on the same chart as the
variation of income (or sales,
revenue) with the same variation in
activity. The point at which neither
profit nor loss is made is known as
the "break-even point“
• the line OA represents the variation
of income at varying levels of
production activity ("output"). OB
represents the total fixed costs in
the business. As output increases,
variable costs are incurred, meaning
that total costs (fixed + variable) also
increase. At low levels of output,
Costs are greater than Income. At
the point of intersection, P, costs are
exactly equal to income, and hence
neither profit nor loss is made.
R'tist@Tourism, Pondicherry University 11
12. • Fixed Costs
• Fixed costs are those business
costs that are not directly related
to the level of production or
output. In other words, even if
the business has a zero output or
high output, the level of fixed
costs will remain broadly the
same. In the long term fixed
costs can alter - perhaps as a
result of investment in
production capacity (e.g. adding
a new factory unit) or through
the growth in overheads
required to support a larger,
more complex business.
• Examples of fixed costs:
- Rent and rates
- Depreciation
- Research and development
- Marketing costs (non- revenue
related)
- Administration costs
R'tist@Tourism, Pondicherry University 12
13. • Variable Costs
• Variable costs are those costs which vary directly with the level of output. They
represent payment output-related inputs such as raw materials, direct labour, fuel and
revenue-related costs such as commission.
• A distinction is often made between "Direct" variable costs and "Indirect" variable
costs.
• Direct variable costs are those which can be directly attributable to the production of a
particular product or service and allocated to a particular cost centre. Raw materials
and the wages those working on the production line are good examples.
• Indirect variable costs cannot be directly attributable to production but they do vary
with output. These include depreciation (where it is calculated related to output - e.g.
machine hours), maintenance and certain labour costs.
• Semi-Variable Costs
• Whilst the distinction between fixed and variable costs is a convenient way of
categorising business costs, in reality there are some costs which are fixed in nature but
which increase when output reaches certain levels. These are largely related to the
overall "scale" and/or complexity of the business. For example, when a business has
relatively low levels of output or sales, it may not require costs associated with
functions such as human resource management or a fully-resourced finance
department. However, as the scale of the business grows (e.g. output, number people
employed, number and complexity of transactions) then more resources are required. If
production rises suddenly then some short-term increase in warehousing and/or
transport may be required. In these circumstances, we say that part of the cost is
variable and part fixed.
R'tist@Tourism, Pondicherry University 13
14. Break-Even Analysis
• Study of
interrelationships
among a firm’s sales,
costs, and operating
profit at various levels
of output
• Break-even point is
the Q where TR = TC
(Q1 to Q2 on graph)
TR
TC
Q
$’s
Profit
Q1 Q2
14R'tist@Tourism, Pondicherry University
15. Management of current Assets
• Working capital (abbreviated WC) is
a financial metric which
represents operating
liquidity available to a business,
organization or other entity,
including governmental entity.
• Along with fixed assets such as
plant and equipment, working
capital is considered a part of
operating capital.
• Net working capital is calculated
as current assets minus current
liabilities.
• It is a derivation of working capital,
that is commonly used in valuation
techniques such as DCFs
(Discounted cash flows).
• If current assets are less than
current liabilities, an entity has
a working capital deficiency, also
called a working capital deficit.
• Net Working Capital = Current
Assets − Current Liabilities
• Net Operating Working Capital =
Current Assets − Non Interest-
bearing Current Liabilities
• Equity Working Capital = Current
Assets − Current Liabilities − Long-
term Debt
• A company can be endowed
with assets and profitability but
short of liquidity if its assets cannot
readily be converted into cash.
• Positive working capital is required
to ensure that a firm is able to
continue its operations and that it
has sufficient funds to satisfy both
maturing short-term debt and
upcoming operational expenses.
• The management of working capital
involves managing inventories,
accounts receivable and payable,
and cash.R'tist@Tourism, Pondicherry University 15
16. Calculation
• Current assets and current liabilities include three accounts which are of
special importance. These accounts represent the areas of the business where
managers have the most direct impact:
– accounts receivable (current asset)
– inventory (current assets), and
– accounts payable (current liability)
• The current portion of debt (payable within 12 months) is critical, because it
represents a short-term claim to current assets and is often secured by long
term assets. Common types of short-term debt are bank loans and lines of
credit.
• An increase in working capital indicates that the business has either
increased current assets (that is has increased its receivables, or other current
assets) or has decreased current liabilities, for example has paid off some
short-term creditors.
• Implications on M&A: The common commercial definition of working capital
for the purpose of a working capital adjustment in an M&A transaction (i.e.
for a working capital adjustment mechanism in a sale and purchase
agreement) is equal to:
– Current Assets – Current Liabilities excluding deferred tax assets/liabilities, excess
cash, surplus assets and/or deposit balances.
– Cash balance items often attract a one-for-one purchase price adjustment.
R'tist@Tourism, Pondicherry University 16
17. Management of working capital
• Guided by the above criteria, management will use a combination of policies
and techniques for the management of working capital.
• These policies aim at managing the current assets (generally cash and cash
equivalents, inventories and debtors) and the short term financing, such that
cash flows and returns are acceptable.
– Cash management. Identify the cash balance which allows for the business to meet
day to day expenses, but reduces cash holding costs.
– Inventory management. Identify the level of inventory which allows for
uninterrupted production but reduces the investment in raw materials - and
minimizes reordering costs - and hence increases cash flow. Besides this, the lead
times in production should be lowered to reduce Work in Progress (WIP) and
similarly, the Finished Goods should be kept on as low level as possible to avoid
over production
– Debtors management. Identify the appropriate credit policy, i.e. credit terms which
will attract customers, such that any impact on cash flows and the cash conversion
cycle will be offset by increased revenue and hence Return on Capital (or vice
versa);
– Short term financing. Identify the appropriate source of financing, given the cash
conversion cycle: the inventory is ideally financed by credit granted by the supplier;
however, it may be necessary to utilize a bank loan (or overdraft), or to "convert
debtors to cash" through "factoring".
R'tist@Tourism, Pondicherry University 17
18. • Characteristics of Working Capital
• Needs that are Short Term: Working
capital is being utilized in acquiring
current assets which will be converted to
cash for a short period only.
• Circular Movement: Working capital is
being converted to cash constantly
which will just be turned as a working
capital all over again.
• Permanency: Although it is just a kind of
short term capital, working capital is
needed by a business forever and
always.
• Fluctuation: Working still fluctuates
every now and then even it is something
permanent.
• Liquidity: It is very liquid for it can be
converted as cash any time without
losing anything.
• Less Risky: Investments in current assets
such as working capital comes with less
risk for it is just for short term.
• No Need for Special Accounting System:
Since working capital is a short term
asset that will last for a year only, there
will be no need for adoption of a special
accounting system.
• Sources of Working Capital
– Operational funds
– Sales of assets that are non-current
– Long term investments’ sales
– Physical fixed assets’ sales
– Intangible fixed assets’ sales
– Financing for longer term
– Borrowings that are long term
– Issuance of preference and equity shares
Operating cycle and cash cycle:
• The investment in working capital is
influenced by four key events in the
production and sales cycle of the firm:
– 1. Purchase of raw materials
2. Payment of raw materials
3. Sale of finished goods
4. Collection of cash for sales
R'tist@Tourism, Pondicherry University 18
19. • Several strategies are available to a firm for
financing its capital requirements. Three strategies
are illustrated by lines A,B, and C below.
– Strategy A: Long term financing is used to meet fixed
asset requirement as well as peak working capital
requirement. When the working capital requirement is
less than its peak level, the surplus is invested in liquid
assets (cash and marketable securities).
– Strategy B: Long term financing is used to meet fixed
assets requirement, permanent working capital
requirement, and a portion of fluctuating working capital
requirement. During seasonal swings, short-term
financing is used during seasonal down swing surplus is
invested in liquid assets.
– Strategy C: Long term financing is used to meet fixed
asset requirement and permanent working capital
requirement. Short term financing is used to meet
fluctuating working capital requirement.
R'tist@Tourism, Pondicherry University 19
20. Cash Management
• cash management,
or treasury management, is
a marketing term for certain
services offered primarily to
larger business customers.
• It may be used to describe all
bank accounts (such
as checking accounts)
provided to businesses of a
certain size, but it is more
often used to describe
specific services such as cash
concentration, zero balance
accounting, and automated
clearing house facilities.
• Sometimes, private
banking customers are given
cash management services.
• Cash management services
generally offered
– Account Reconcilement Services
– Advanced Web Services
– Armored Car Services (Cash
Collection Services)
– Automated Clearing House
– Balance Reporting Services
– Cash Concentration Services
– Lockbox – Retail
– Lockbox – Wholesale
– Positive Pay
– Reverse Positive Pay
– Sweep accounts
– Zero Balance Accounting
– Wire Transfer
– Controlled Disbursement
R'tist@Tourism, Pondicherry University 20
21. Receivables Management
Managing and collecting commercial receivables (unpaid receivables between
companies or organisations) is linked to the credit insurance business and the
information business.
• reducing claims expenses by setting up efficient receivables management
processes, developing excellent knowledge of local payment and collection
regulations and practices, accurately predicting the commercial and financial
behaviour of buyers throughout the world and closely monitoring changes in
their behaviour.
• You can benefit from our experience and recognition in this field:
• - Better manage your amount of outstandings,
- Maintain your trading relationship with a valued customer either on domestic
or international level
- Be fully informed of progress,
- Get liquidity and cash flow
- Increase own company financial attractiveness
- Save personal resources
R'tist@Tourism, Pondicherry University 21
22. Inventory Management and Inventory Control
• must be designed to meet the dictates of the marketplace and support the company's
strategic plan. The many changes in market demand, new opportunities due to
worldwide marketing, global sourcing of materials, and new manufacturing technology,
means many companies need to change their Inventory Management approach and
change the process for Inventory Control.
• Despite the many changes that companies go through, the basic principles of Inventory
Management and Inventory Control remain the same. Some of the new approaches and
techniques are wrapped in new terminology, but the underlying principles for
accomplishing good Inventory Management and Inventory activities have not changed.
• The Inventory Management system and the Inventory Control Process provides
information to efficiently manage the flow of materials, effectively utilize people and
equipment, coordinate internal activities, and communicate with customers. Inventory
Management and the activities of Inventory Control do not make decisions or manage
operations; they provide the information to Managers who makemore accurate and
timely decisions to manage their operations.
• The basic building blocks for the Inventory Management system and Inventory Control
activities are:
Sales Forecasting or Demand Management
Sales and Operations Planning
Production Planning
Material Requirements Planning
Inventory Reduction
• The emphases on each area will vary depending on the company and how it operates,
and what requirements are placed on it due to market demands. Each of the areas
above will need to be addressed in some form or another to have a successful
program of Inventory Management and Inventory Control.R'tist@Tourism, Pondicherry University 22
23. Fixed assets management
• Fixed assets management is an accounting process that seeks to
track fixed assets for the purposes of financial accounting, preventive
maintenance, and theft deterrence.
•
Many organizations face a significant challenge to track the location,
quantity, condition, maintenance and depreciation status of their fixed
assets. A popular approach to tracking fixed assets utilizes serial
numbered Asset Tags, often with bar codes for easy and accurate
reading. Periodically, the owner of the assets can take inventory with a
mobile barcode reader and then produce a report.
• Off-the-shelf software packages for fixed asset management are
marketed to businesses small and large. Some Enterprise Resource
Planning systems are available with fixed assets modules.
• Some tracking methods automate the process, such as by using fixed
scanners to read bar codes on railway freight cars or by attaching
a radio-frequency identification(RFID) tag to an asset.
R'tist@Tourism, Pondicherry University 23
24. Importance of capital budgeting
• Capital budgeting decisions are of paramount importance in financial decision.
So it needs special care on account of the following reasons:
– 1. Long-term Implications: A capital budgeting decision has its effect over a long
time span and inevitably affects the company’s future cost structure and growth. A
wrong decision can prove disastrous for the long-term survival of firm. On the other
hand, lack of investment in asset would influence the competitive position of the
firm. So the capital budgeting decisions determine the future destiny of the
company.
– 2. Involvement of large amount of funds: Capital budgeting decisions need
substantial amount of capital outlay. This underlines the need for thoughtful, wise
and correct decisions as an incorrect decision would not only result in losses but
also prevent the firm from earning profit from other investments which could not
be undertaken.
– 3. Irreversible decisions: Capital budgeting decisions in most of the cases are
irreversible because it is difficult to find a market for such assets. The only way out
will be scrap the capital assets so acquired and incur heavy losses.
– 4. Risk and uncertainty: Capital budgeting decision is surrounded by great number
of uncertainties. Investment is present and investment is future. The future is
uncertain and full of risks. Longer the period of project, greater may be the risk and
uncertainty. The estimates about cost, revenues and profits may not come true.
– 5. Difficult to make: Capital budgeting decision making is a difficult and complicated
exercise for the management. These decisions require an over all assessment of
future events which are uncertain. It is really a marathon job to estimate the future
benefits and cost correctly in quantitative terms subject to the uncertainties caused
by economic-political social and technological factors.
•
R'tist@Tourism, Pondicherry University 24
25. Kinds of capital budgeting decisions
•
Generally the business firms are confronted with three types of capital
budgeting decisions. (i) The accept-reject decisions; (ii) mutually exclusive
decisions; and (iii) capital rationing decisions
– 1. Accept-reject decisions: Business firm is confronted with alternative
investment proposals. If the proposal is accepted, the firm incur the investment
and not otherwise. Broadly, all those investment proposals which yield a rate of
return greater than cost of capital are accepted and the others are rejected.
Under this criterion, all the independent proposals are accepted.
– 2. Mutually exclusive decisions: It includes all those projects which compete
with each other in a way that acceptance of one precludes the acceptance of
other or others. Thus, some technique has to be used for selecting the best
among all and eliminates other alternatives.
– 3. Capital rationing decisions: Capital budgeting decision is a simple process in
those firms where fund is not the constraint, but in majority of the cases, firms
have fixed capital budget. So large amount of projects compete for these limited
budgets. So the firm rations them in a manner so as to maximize the long run
returns. Thus, capital rationing refers to the situations where the firm has more
acceptable investment requiring greater amount of finance than is available
with the firm. It is concerned with the selection of a group of investment out of
many investment proposals ranked in the descending order of the rate or
return.
R'tist@Tourism, Pondicherry University 25
26. • Non-discounted
techniques
– Pay back period
– Accounting rate of return
method
• Discounted techniques
– Net present value method
– Internal rate of return
method
R'tist@Tourism, Pondicherry University 26
27. Difference between capital and financial structures
• In simple terms, financial structure
consists of all assets, all liabilities and the
capital. The manner in which an
organization’s assets are financed is
referred to as its financial structure. There
is another term called capital structure
that confuses many. There are some
similarities between capital structure and
financial structure. However, there are
many differences also that will be
highlighted in this article.
• If you take a look at the balance sheet of a
company, the entire left hand side which
includes liabilities plus equity is called the
financial structure of the company. It
contains all the long term and short term
sources of capital. On the other hand,
capital structure is the sum total of all long
term sources of capital and thus is a part
of the financial structure. It includes
debentures, long term debt, preference
share capital, equity share capital and
retained earnings. In the simplest of
terms, capital structure of a company is
that part of financial structure that
reflects long term sources of capital.
• However, capital structure needs to be
distinguished from asset structure that
is the sum total of assets represented
by fixed assets and current assets. This
is the total capital of the business that is
contained in the right hand side of the
balance sheet. The composition of a
firm’s liabilities is therefore referred to
as its capital structure. If a firm has a
capital that is 30% equity financed and
70% debt financed, , the leverage of the
firm is only 70%.
• Capital Structure vs Financial Structure
– Capital structure of a company is long term
financing which includes long term debt,
common stock and preferred stock and
retained earnings.
– Financial structure on the other hands also
includes short term debt and accounts
payable.
– Capital structure is thus a subset of
financial structure of a company.
R'tist@Tourism, Pondicherry University 27
28. • In their seminal 1958 paper, FRANCO
MODIGLIANI and MERTON
MILLER initiated the modern
discussion of the amount of debt
corporations should use (both
received the Nobel Prize for this
work and other contributions to
economic research). The paper is so
well known that, for more than
thirty years, financial economists
have referred to their theory as
“the M&M theory.”
• Financial economists have singled
out three additional factors that
limit the amount of debt financing:
– personal taxes,
– BANKRUPTCY costs, and
– agency costs.
• Corporations trade off the benefits
of government-subsidized debt
against the costs of these three
factors. This model of corporate
financial structure is therefore
called the trade-off theory.
• Determinants of financial Structure
– Legal restrictions
– Liquidity
– Access to the capital market
– Restriction in loan agreements
– Control
– Investment opportunities
– Inflation
– Share holders expectations
– Financial needs of the company
R'tist@Tourism, Pondicherry University 28
29. Financial leverage
• Financial leverage is also called
trading on equity
• We need to understand debts and
interest on debts
• A company finances its projects
through various sources, thee
sources are debts.
• Preference share capital, common
share capital, reserves and surplus
are part of these sources
• A company is legally bound to pay
interest on debts
• The rate of dividend to be paid on
preference share capital is also fixed
• Dividend or preference share is paid
only when the company earns profit
• The earnings after deducting taxes,
interest and preference dividend
belong to equity share holders
• Effective of financial leverage on
share holders
– To increase share holders earnings
– Earnings per share increase
• Earnings per share is also called net
income
• It is obtained by dividing the earnings
after interest and taxes
• EPS = (X-R) (1-t)/N
R'tist@Tourism, Pondicherry University 29
30. Dividend Policy
• Dividend Policy refers to
the explicit or implicit
decision of the Board of
Directors regarding the
amount of residual
earnings (past or present)
that should be distributed
to the shareholders of the
corporation.
– This decision is considered a
financing decision because
the profits of the corporation
are an important source of
financing available to the
firm.
• Types of Dividends
• Dividends are a permanent
distribution of residual
earnings/property of the
corporation to its owners.
• Dividends can be in the form of:
– Cash
– Additional Shares of Stock (stock
dividend)
– Property
• If a firm is dissolved, at the end of
the process, a final dividend of any
residual amount is made to the
shareholders – this is known as a
liquidating dividend.
R'tist@Tourism, Pondicherry University 30
31. • Dividend Policy
• Once a company makes a
profit, management must decide
on what to do with those profits.
They could continue to retain
the profits within the company,
or they could pay out the profits
to the owners of the firm in the
form of dividends.
• Once the company decides on
whether to pay dividends they
may establish a somewhat
permanent dividend policy,
which may in turn impact on
investors and perceptions of the
company in the financial
markets. What they decide
depends on the situation of the
company now and in the future.
It also depends on the
preferences of investors and
potential investors.
• Dividend policy is concerned
with taking a decision regarding
paying cash dividend in the
present or paying an increased
dividend at a later stage. The
firm could also pay in the form
of stock dividends which unlike
cash dividends do not provide
liquidity to the investors,
however, it ensures capital gains
to the stockholders. The
expectations of dividends
by shareholders helps them
determine the share value,
therefore, dividend policy is a
significant decision taken by the
financial managers of any
company.
R'tist@Tourism, Pondicherry University 31
32. • Coming up with a dividend policy is challenging for the directors
and financial managers of a company, because
different investors have different views on present cash dividends
and future capital gains.
• Another confusion that pops up is regarding the extent of effect
of dividends on the share price.
• Due to this controversial nature of a dividend policy it is often
called the Dividend puzzle.
• Various models have been developed to help firms analyse and
evaluate the perfect dividend policy.
• There is no agreement between these schools of thought over
the relationship between dividends and the value of the share or
the wealth of the shareholders in other words.
• One school comprises of people like James E. Walter and Myron J.
Gordon (see Gordon model), who believe that current cash
dividends are less risky than future capital gains. Thus, they say
that investors prefer those firms which pay regular dividends and
such dividends affect the market price of the share. Another
school linked to Modigliani and Miller holds that investors don't
really choose between future gains and cash dividends.
R'tist@Tourism, Pondicherry University 32
33. • Types of Dividend Policy:
– a. Stable Dividend Policy
– b. Fluctuating Dividend Policy
– c. Small Constant Dividend per Share plus Extra Dividend.
• Forms of Dividend
– Cash Dividend
• Cash dividends(most common) are those paid out in the form of a cheque. Such
dividends are a form of investment income and are usually taxable to the
recipient in the year they are paid.
• This is the most common method of sharing corporate profits with the
shareholders of the company. For each share owned, a declared amount of
money is distributed. Thus, if a person owns 100 shares and the cash dividend is
$0.50 per share, the person will be issued a cheque for 50 dollars.
– Stock Dividend
– Stock or scrip dividends are those paid out in form of additional stock
shares of the issuing corporation, or other corporation (such as its
subsidiary corporation).
– They are usually issued in proportion to shares
owned (for example, for every 100 shares of stock owned, 5% stock
dividend will yield 5 extra shares). If this payment involves the issue of
new shares, this is very similar to a stock split in that it increases the total
number of shares while lowering the price of each share and does not
change the market capitalization or the total value of the shares held.
R'tist@Tourism, Pondicherry University 33
34. Tourism Finance corporation of India
• The Government of India had,
pursuant to the recommendations
of the National Committee on
Tourism viz Yunus Committee set
up under the aegis of Planning
Commission, decided in 1988, to
promote a separate All-India
Financial Institution for providing
financial assistance to tourism-
related activities/projects. In
accordance with the above
decision, the IFCI Ltd. along with
other All-India
Financial/Investment Institutions
and Nationalised Banks promoted
a Public Limited Company under
the name of "Tourism Finance
Corporation of India Ltd. (TFCI)" to
function as a specialised All-India
Development Financial Institution
to cater to the financial needs of
tourism industry.
• The Government of India had, pursuant to the
recommendations of the National Committee on
Tourism viz Yunus Committee set up under the aegis
of Planning Commission, decided in 1988, to
promote a separate All-India Financial Institution for
providing financial assistance to tourism-related
activities/projects. In accordance with the above
decision, the IFCI Ltd. along with other All-India
Financial/Investment Institutions and Nationalised
Banks promoted a Public Limited Company under
the name of "Tourism Finance Corporation of India
Ltd. (TFCI)" to function as a specialised All-India
Development Financial Institution to cater to the
financial needs of tourism industry. TFCI was
incorporated as a Public Limited Company under the
Companies Act, 1956 on 27th January 1989 and
became operational with effect from 1st February
1989 on receipt of Certificate of the
Commencement of Business from the Registrar of
Companies. TFCI has been notified as a Public
Financial Institution under section 4A of the
Companies Act, 1956, vide Notification No S.O 7(E)
dated the 3rd January 1990 issued by the Ministry
of Industry, Department of Company Affairs. TFCI's
Registered office is situated at 13th Floor, IFCI
Tower, 61, Nehru Place, New Delhi - 110 019.
R'tist@Tourism, Pondicherry University 34
35. • Objective
TFCI provides financial assistance to enterprises for setting up and/or development of tourism-
related projects, facilities and services, such as:
• Hotels, Restaurants, Holiday Resorts, Amusement Parks, Multiplexes and Entertainment Centers,
Education and Sports, Safari Parks, Rope-ways, Cultural Centers, Convention Halls, Transport, Travel
and Tour Operating Agencies, Air Service, Tourism Emporia, Sports Facilities etc.
• Forms of Financial Assistance
Rupee Loan , Underwriting of public issues of shares/debentures and direct subscription to such
securities, Guarantee of deferred payments and credit raised abroad., Equipment Finance,
Equipment Leasing, Assistance under Suppliers' Credit. Working-Capital Financing, Takeover
Financing, Advances Against Credit-Card Receivables
• Eligibility for AssistanceTFCI provides financial assistance to projects with capital cost of Rs. 3 crore
and above. In respect of projects costing between Rs. 1 crore and Rs. 3 crore, TFCI will consider
financial assistance to the extent of unavoidable gap, if any, remaining after taking into account
assistance from State Level Institutions/Banks. Unique projects, which are important from the
tourism point of view and for which assistance from State Level institutions/ Banks is not available,
may be considered on exceptional basis even though their capital cost is below Rs. 1 crore.
Financial assistance is considered on similar lines for heritage and restaurant projects. Projects
with high capital cost may be financed along with other All-India Financial/Investment Institutions.
TFCI considers assistance even if the total cost is less than Rs. 3 crore for existing concerns with
satisfactory performance for renovation/upgradation etc.
track record of atleast 3 years and assisted concerns of TFCI with satisfactory credit record. The
working capital limit would be calculated based on the turnover method as may be considered
appropriate.
R'tist@Tourism, Pondicherry University 35
36. • Promoters' Contribution
• The minimum promoters' contribution for the projects is 30%. Relaxation may, however, be allowed in
respect of large projects involving capital cost exceeding Rs. 50 crore.
Debt Equity Ratio
• TFCI extends term-loan assistance based on debt-equity ratio not exceeding 1.5:1. However, in case of
hotels in seasonal locations/ multiplexes/ entertainment centers, amusement parks and other tourism-
related projects, the debt-equity ratio would be stipulated in the range of 1:1 to 1.25:1.
Rate of Interest
• Interest on loan is flexible and linked to the PLR of TFCI which is presently 12.5% p.a. (since 1st August
2008). TFCI, while considering loans to the borrowers, evaluates each concern individually on various
parameters such as Industry/ Business Risk, Environmental Risk, Project Risk, Management Risk, Security
available, Income value to TFCI, etc. and accords rating ranging from AAA to B category. Loan is priced
according to the prevalent PLR and the rating so achieved by the individual client within a spread ranging
from PLR to PLR+1.5% per annum. High Risk Projects are charged interest at PLR+3% per annum. Interest
is levied on monthly rests. In case of consortium/ multiple funding, if higher rate is charged by any other
institution than the same rate is applicable to TFCI loan also. Besides, TFCI also charges appraisal-cum-
up front fee @ 1% of the loan amount sanctioned as one time charge.
Security
• First charge on movable and immovable fixed assets. Personal Guarantees of the Promoters and
Corporate guarantee of the group concern, if necessary. Pledge of promoters' share-holding.
Repayment Schedule
• This would depend on the period required for completion of the project and stabilisation of operations
as also the projected cash-flows available for debt-servicing. The general norm of repayment is 8 years
allowing moratorium of 2 years after full commercial operations. In case of multiplexes/ entertainment
centers the cash-flows in the initial years are satisfactory; as such, the repayment of the loans to this
sector could be made in 6-7 years allowing moratorium of 1-1½ years after full commercial operations.
Norms for Takeover Financing
• TFCI may consider financing well-established, assisted concerns having over 3 years' satisfactory track
record for takeover of tourism-related project/company.
Norms for Working-Capital Financing
• The Working Capital assistance would be provided to concerns in the tourism sector with proven
R'tist@Tourism, Pondicherry University 36
38. • Balance sheet indicates structure
of the assets belonging to the
company and financial means
used to finance these assets at a
particular point of time.
• For example: this statement as
of December 31, 2006 indicated
structure of the assets and how
they are finances on December
31, 2006.
• This statement is made on the
basis of accounting equation, i.e.
assets are equal to the sum of
liabilities and owners’ equity.
• The assets side includes current
and long-term assets.
• Liabilities and owners’ equity
side includes current and long-
term liabilities, owners’ equity
consisting of share capital,
retained earnings, i.e. net profit
earned and retained in the
business.
• Income statement indicates income earned
and expenses incurred by the company for a
particular period of time.
• For example: this statement for the year 2006
indicated, what income was earned and what
expenses were incurred by the company during
the year 2006. Difference between all income
and all expenses is called net profit for the year.
• Starting point of preparing financial statements
is adjusted trial balance, which includes list of
all general ledger accounts with the balances in
those accounts.
• Worth to notice several important points:
– 1. Accumulated depreciation account has a credit
balance.
• As it was explained earlier this account is
contrary to the fixed assets account, in Alfa’s
case Equipment account.
• In the financial statements on the assets’ side
difference between cost of fixed assets and
accumulated depreciation, called net book
value, is indicated
– 2. Balances of income and expenses are included
into the income statement 3. Net profit retained in
the business (5883$) from income statement is
transferred to the balance sheet under owners’
equity part
R'tist@Tourism, Pondicherry University 38
40. Balance Sheet
• A financial
statement that summarizes
a company's assets,
liabilities and shareholders'
equity at a specific point
in time. These three balance
sheet segments give
investors an idea as to what
the company owns
and owes, as well as the
amount invested by the
shareholders.
The balance sheet must
follow the following
formula:
Assets = Liabilities +
Shareholders' Equity
R'tist@Tourism, Pondicherry University 40
41. Cash flow statement
• The statement of cash flows is one of the main
financial statements. (The other financial
statements are the balance sheet, income
statement, and statement of stockholders'
equity.)
• The cash flow statement reports
the cash generated and used during the time
interval specified in its heading.
• The period of time that the statement covers is
chosen by the company. For example, the
heading may state "For the Three Months
Ended December 31, 2010" or "The Fiscal Year
Ended September 30, 2010".
• The cash flow statement organizes and reports
the cash generated and used in the following
categories:
– 1.Operating activities–converts the items
reported on the income statement from the
accrual basis of accounting to cash.
– 2.Investing activities–reports the purchase and
sale of long-term investments and property, plant
and equipment.
– 3.Financing activities–reports the issuance and
repurchase of the company's own bonds and
stock and the payment of dividends.
– 4.Supplemental information–reports the
exchange of significant items that did not involve
cash and reports the amount of income taxes
paid and interest paid.
R'tist@Tourism, Pondicherry University 41
42. Fund flow statement
• Financial statements do not give the
complete financial information. These
statements give the information of
funds on a particular date. The purpose
of preparation of fund flow statements
is to know about from where funds are
coming and where being invested. The
funds flow statements is generally
prepared from the data identifiable and
profit and loss account and balance
sheets. Fund flow statement is also
called as sources and application of
funds. It shows the detail of funds
business received from sources and the
amount of funds the business used for
different purposes in the year.
• Acc. To FOURLKE,” A statement of
sources and application of funds, is a
technical advice designed to highlight
the changes in financial position of
business enterprise between two
dates.”
• There are few other reasons to prepare
fund flow statement:
– It explains the financial consequences of
business operations: Fund flow statement
gives answer to following conflicting
situations.
• How the business could have good liquid
position in spite of business making loses
or acquisition of fixed assets?
• Where have the profits gone?
• How a business can earn more and more
profits.
– It answers intricate queries:
• How much fund is generated from normal
business operations?
• What are the sources of repayment of
loans?
• How to utilize the funds up to optimum
level?
– It acts as an instrument for allocation of
resources.
– It is a test of effectiveness in use of
working capital.
R'tist@Tourism, Pondicherry University 42
43. Hotel accounting
• Hotels follow the general principles of accounting, but due to the unique nature of guest accounting, hotel
accounting departments use terms that may not be familiar to accountants in other industries. Accounting
terms related to the management of guest payments, charges and disputes can be confusing to outsiders, but
they represent everyday concepts in the hotel industry.
Folio
• The record of all credits and debits associated with a guest or group is called an account and an account can be
organized by sections, or folios. Common folio divisions include one each for room charges, food and beverage
charges and miscellaneous charges. Multiple folios are often used with convention guest accounts, as the hotel
room rate may be paid by the group while the individuals are responsible for their additional, or incidental
charges.
• Separation of folios allows printing options, which is useful for blind rates--when the group room rate must
remain unknown to the guest. At checkout, a convention guest can present payment for incidental charges and
receive a printed receipt for only the folios that contain the charges for which she paid. The balance from the
room charges folio remains blind to the guest and is transferred to the group account for later billing.
Room Charge
• Guests that have a credit card on file for an account are eligible to sign for charges to guest rooms. At the point
of sale, guests sign a receipt authorizing the charge be paid by the method of payment on the account. The
charge is then posted to the appropriate folio for the charge type.
• The alternative to a room charge is using another method of payment for services, such as cash or credit.
Guests without credit cards on file are considered cash-only guests and do not have room charging privileges.
Posting
• Any charges posted to a guest account are posted, either manually or through the hotel's computer system.
Computer-posted charges are known as interface postings and these are common from hotel outlets that use a
cash register and point of sale system, such as a restaurant or gift shop.
• When room charge is designated as the payment type, the cashier enters the guest room number and the point
of sale system interfaces with the property management system to post the charge. Manual charges are posted
by a hotel employee, usually front desk or accounting. These charges might come from outlets without a point
of sale system but are most commonly interface postings that did not go through due to system outage or
incorrect room information.
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44. Late Charge
• A late charge occurs when a guest signs for a room charge after checking out of
the hotel. Common late charges include breakfast or minibar charges and
manual postings due to system outage. Since the guest had a credit card on
file, the front desk is able to use same card is used to pay for the charge. If the
credit card declines, an invoice is mailed to the guest's address of record.
Advance Deposit
• Advance deposits are prepayments for guest rooms or other hotel services.
These deposits are commonly used to secure reservations for weddings or
conventions held at the hotel. In most catering or group events, the advance
deposit is required 72 hours before the event occurs. The deposit is posted to
the group account and charges are posted against the account as they occur.
Allowance
• An allowance is a reversal of a posting. Allowances can occur due to duplicate
posting, disputes or bad debt. Although a voided payment through the point of
sale system can create a negative interface posting, this is a correction instead
of an allowance because revenue is not reduced. Allowances are always
manual posts, and department managers generally review and research large
allowances that would seriously impact revenue prior to authorizing posting.
R'tist@Tourism, Pondicherry University 44