Cor Fin Class1

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CORPORATE FINANCE


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Corporate finance

Every decision that a business makes

has financial implications, and any decisionwhich affects the finances of a business is

a corporate finance decision.

Defined broadly, everything that a

business does fits under the head of

corporate finance.


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CORPORATE FINANCE Corporate Finance deals with the financial

aspects of a corporate enterprise, right from thestage of promotion of the organization.

includes administration during initial stages,

stages of growth and expansion. deals with financial restructuring during financial

crisis.

includes financial environment, strategies offinancial planning, financial markets, capital

formation &financial institutions.


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Corporate Finance & Other Functions

Finance is omnipresent and is intimatelyassociated with other functions in an

organization.

Finance is related to marketing ,purchasefunction, Production function, personnel

function,


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Organization of the Finance

Function

Shareholders

Board of Directors

Managing Director

Production Chief Marketing Chief Finance Chief Human Resources Chief

Financial Controller Treasurer

- Annual Reports - Cash Management

- Budgeting - Credit/Receivables Mgt - Tax Management - Banking Relations

- Internal Audit - Funds & Securities


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Objectives of Financial Management

Financial Decisions


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The Core Principles of Finance

Time value of money.

Compensation for risk

Dont put your eggs in one basket.

Markets are smart


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WORKING CAPITAL MANAGEMENT

Capital required for a business can beclassified under two main heads:

i. Fixed Capital

ii. Working Capital


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An inefficient management of working

capital leads to not only loss of profits but

also to the closure of the business firm


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There are two concepts ofWorking capital

namely,

1. Gross Working Capital (GWC) 2. Net Working Capital (NWC)

NWC can be +ve or ve.


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Components ofWorking Capital

Constituents ofCurrent Assets in the order ofdecreasing liquidity

1. Cash and bank balance

2. Investments (marketable securities)3. Government securities (other than for long term

purpose )

4. Fixed deposits with banks (maturing within one year)

5. Receivables arising out of sales6. Inventories:

a. Raw materials b. Work-in-process c. Stores andspares d. Finished goods


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7. Advance payment for tax8. Pre-paid expenses

9. Advances for purchase of raw materials,

components and consumables10.Deposits kept with public bodies for

normal business operation maturing

within the normal operating cycle11.Money receivable from contracted sale

of fixed asset during the next 12 months


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Constituents ofCurrent Liabilities

1. Short term borrowings

3. Public deposits maturing within one year

4. Sundry creditors (trade) for raw materials andconsumable stores and spares

5. Interest and other charges due for payment

6. Advance/Progress payments from customers 7. Deposits from dealers, selling agents etc.

8. Instalments on term loans, deferredpayments,debentures and long term deposits payable

within one year


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9. Statutory liabilities:

a. Provident fund dues b. Provision fortaxation c. Sales tax, excise

d. Statutory obligations towards workers

10.Miscellaneous current liabilities:

a. Dividends b. Liabilities for expenses c.

Gratuity payable within one year d. Any other payment due within 12

months


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Significance of Working

Capital


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The Cash Conversion Cycle


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Level ofCurrent Assets

The level of investment in current assets

determines the working capital policy. Abusiness firm can adapt any of the

following working capital policies:

1. Conservative working capital policy 2. Aggressive working capital policy

3. Moderate working capital policy


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Conservative approach

Under this the firm carries high investment incurrent assets such as cash, marketable

securities and carries large amount of

inventories and grants generous terms of credit

to customers resulting in a high level of debtors.

consequences of conservative working capital

policy are quick deliveries to customers and

more sales due to generous credit terms.


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Aggressive working capital policy

.

Under Aggressive working capital policy, investment in current

assets is very low. The firm keeps less amount of cash and

marketable securities, manages with less inventories and tight

credit terms resulting in low level of debtors. The consequences

of aggressive working capital policy are frequent production

stoppages, delayed deliveries to customers and loss of sales.

A trade off between two costs namely carrying cost and

shortage cost determines the optimal level of current assets.

Costs that rise with current assets i.e. that cost of financing a

higher level of current assets form carrying costs. Shortage costs are in the form of disruption in production schedule, loss of

sales and loss of goodwill.


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The optimum level of current assets is

denoted by the total costs (= carrying

costs + shortage costs) minimized at that

leve


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Working capital financing strategies

After determining the level of current

assets, the firm must determine how these should be financed.

Investment in current assets can be

broken into two parts 1. Permanent current assets

2. Temporary current assets


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A firm requires a certain amount of current

assets to meet even the minimum level of

sales where as temporary current assets

reflects a variable component that moves

in line with seasonal fluctuations.


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Several strategies are available for

financing capital requirements.

Graph


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Capital requirements and their financing

The fixed proportion of working capital

should be generally financed from the

fixed capital sources while the temporary

or variable working capital requirements of

a firm may be met from the short term

sources of capital. Based on this idea, we have 3 strategies possible.


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Strategy A

Long term financing is used to meet fixedasset 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 &

marketable securities)


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Strategy B

Long term financing is used to meet fixed assetrequirements,

permanent working capital requirement, and aportion of

fluctuating working capital requirement.

During seasonal upswings, short term financingis used.

During seasonal downswings, surplus isinvested in liquid

assets.


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Strategy C

Long term financing is used to meet fixed

asset requirement and permanent working capital

requirement. Short term

financing is used to meet fluctuatingworking capital requirement.


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Integrated Working Capital Policy

Working capital requirement of a firm isdetermined by

considering two questions in mind. 1.What should be the level of current assets in

relation to

sales?

2.What should be the ratio of long term andshort term

financing?


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Current Asset Policy

Question 1 tell us what should be the level of current assets to

be maintained by the firm and hence it gives rise to three types

of current asset policy namely

a. Conservative approach : is carrying more amount of current

assets in relation to sales which results in more carrying costs,

relaxed credit terms and period and hence less turnover.

b. Moderate approach : is always maintaining required amount

of current assets depending upon sales.

c. Aggressive Approach :is managing with less current assets in

relation to sales and hence may result in more turnover, stringent credit terms and may lead to loss of customer

goodwill and low liquidity.


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Graph


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Current Assets Graph


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Current financing policy

Question 2 is about how the currents should be

financed,either long term or short term financing.

Current assets being financed using long term

funds namely Equity shares, Debentures results

in more costs of capital and relatively less profits

whereas short term financing namely short term

loans from banks and financial institutions,

overdrafts, trade credit, commercial paper etc.

results in more profits and relatively less costs


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A judicious mix of Current Asset policy and

Current Asset Financing Policy gives rise

to an integrate Working Capital policy.


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Current Asset Policy

Aggressive C

Moderate

Working Capital

Policy

Conservative

Working Capital

Policy

Aggressive

Working

Capital

Policy

Moderate

Working Capital

Policy

Current Asset Financing


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AggressiveWorking capital is a mix of Aggressive Current

Asset policy and Aggressive Current Asset Financing Policy.

Firms with short operating cycle can adopt this policy generally.

ConservativeWorking capital is a mix of Conservative Current

Asset policy and Conservative Current Asset Financing Policy.

Firms having long operating cycle namely manufacturing

companies can adopt this policy to decouple production and

distribution.

ModerateWorking capital is a mix of Aggressive Current Asset

policy and ConservativeCurrent Asset Financing Policy or a mix of

Conservative Current Asset policy and Aggressive Current AssetFinancing Policy.


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Sources for Financing Working Capital

Sources ofWorking Capital

(i) Permanent or Fixed (ii) Temporary or variable

1.Shares 1.Commercial banks

2.Debentures 2.Indigeneous bankers 3.Public deposits 3.Trade Creditors

4.Ploughing back of 4.Instalment Credit

profits

5.Loans from Financial 5.Advances

Institutions

6.Accounts Receivable-Credit/Factoring

7.Accrued Expenses

8.Commercial Paper


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Cor Fin Class1