Financial Management Mindmap PDF

Financial management mindmap Financial management aspects affected by financial management decisions The size and the compositions of the fixed assets of the business The quantum of current assets and its break up into cash, inventory and receivables The amount of long-term and short-term fund...

Financial management mindmap Financial management aspects affected by financial management decisions The size and the compositions of the fixed assets of the business The quantum of current assets and its break up into cash, inventory and receivables The amount of long-term and short-term funds to be use Break-up of long-term financing into debt, equity etc All items in the Profit and Loss Account, e.g., Interest, Expense, Depreciation, etc. Meaning Financial management is concerned with optimal procurement of finance. Objectives The primary aim of financial management is to maximize shareholder's wealth, which is referred to as the wealth-maximization concept. Financial Decisions Investment decision A long-term investment decision is also called a capital budgeting decision. A short-term investment decision is also called a working capital decision. Factors affecting Capital Budgeting Decision: (CRI) Cash flows of the project When a company takes an investment decision it expects to generate some cash flows over a period. These cash flows are in the form of cash receipts and payments. These should be carefully analyzed before considering a capital budgeting decision. The rate of return It is the most important criterion. The calculations are based on expected returns from each proposal and the assessment of the risks involved. The investment criteria involved The different techniques to evaluate investment proposals which are known as capital budgeting techniques. Financing Decision The shareholder's funds refer to the equity capital and the retained earnings Borrowed funds refer to the finance raised through debentures or other forms of debt. Factors affecting Financing Decisions:(3C2FRS) Cost A prudent financial manager would opt for a source that is the cheapest. Risk Flotation costs Higher the flotation cost, less attractive the source Cash Flow Position of the company A stronger cash flow position may make debt financing more viable Fixed Operating Costs Fixed operating costs (building rent, Insurance premium, salaries,etc.) If a business has high fixed operating costs, It must reduce fixed financing costs. If fixed operating cost is less, more of debt financing is preferred. Control Considerations Issues of more equity may lead to dilution of management's control over the business. Companies afraid of takeover bid would prefer debt to equity. State of Capital Market Health of the capital market also affects choice of fund. During the period stock marker is rising, more people invest in equity. however, depressed capital market may make issue of shares difficult. Dividend Decision Dividend is the portion of profit which is distributed to the shareholders. the decision involved here is how much of the profit earned here is to be distributed to the shareholders and how much of it should be retained in the business Factors affecting Dividend Decision: Amount of Earnings Dividends are paid out of current and past earnings. thus, earnings is a major determinant of the decision about dividend. Stability Earnings A company having stable earning is in a better position to declare higher dividends. As against this, a company having unstable earnings is likely to pay smaller dividend. Stability of Dividends The increase in dividends is generally made when there is confidence that their earning potential has gone up and not just the earnings of the current year.  Growth Opportunities Companies having good growth opportunities retain more money out of their earnings so as to finance the required investment. Cash Flow Position The payment of dividend involves the outflow of cash. Availability of enough cash in the company is necessary for declaration of dividend. Shareholders' Preference While declaring dividends, management must keep in mind the preferences of the shareholders in this regard. If the shareholders in general desire that a certain amount is paid as dividend, the companies are likely to declare the same. Taxation policy If tax on dividend is higher, it is better to pay less by way of dividends, As compared to this, Higher dividends may be declared if tax rates are relatively lower. Under the current tax policy, shareholders are likely to prefer higher dividends. Stock market requirements Investors in general, view an increase in dividend as a good news and stock prices react positively to it. Similarly, a decrease in prices may have a negative impact on the share prices in the stock market. (it is one of the most important factors considered by the management while taking a decision about it). Access to Capital Market Large and reputed companies generally have easy access to the capital market. These companies tend to pay higher dividends than the smaller companies which have relatively low access to the market. note: large companies may depend less on retained earnings to finance their growth. Thus, they pay higher dividends. Legal constraints Certain provisions of the companies act place restrictions on payouts as dividend Contractual Constraints While granting loans to a company, sometimes the lender may impose certain restrictions on the payment of dividends in the future. The company is required to ensure that the dividend does not violate the terms of the loan agreement. Financial Planning  Meaning of financial management Financial planning is essentially the preparation of a financial blueprint of an organization's future operations. The objective of financial planning is to ensure that enough funds are available at the right time. If adequate funds are not available the firm will not be able to honor its commitments. This process of estimating the fund requirement of a business and specifying the sources of funds if called financial planning Difference between financial management and financial planning Financial Management Financial management aims at choosing the best investment and financing alternatives by focusing on their costs and benefits. Its objective is to increase the shareholders wealth. Financial Planning Financial Planning aims at smooth operations by focusing on fund requirements and their availability in the light of financial decisions Its objective is to ensure that enough funds are available at the right time Twin objectives of financial planning To ensure availability of funds whenever required This include a proper estimation of the funds required for different purposes such as for the purchase of long term assets or to meet day-to-day expenses. There is also a need to estimate the time at which these funds are made available. To see that the firms does not raise resources unnecessarily Good financial planning would put resources to the best possible use so that financial resources are not left idle and don't unnecessarily add to the cost. How it works Financial planning usually begins with the preparation of a sales forecast Based on these, the financial statements are prepared keeping in mind the requirement of funds for investment in the fixed capital and working capital. Then the expected profits during the period are estimated so that an idea can be made of how much of the fund requirements can be met internally This result in an estimation of the requirements for external funds. The sources from which the external funds requirement can be met are identified and cash budgets are made To note about financial planning Short-term planning covers short-term financial plan called budget  Plans made for periods of one year or less are termed as budgets Typically, financial planning is done for 3 to 5 years. For longer periods it becomes more difficult and less useful. Importance of financial planning 1. It helps in forecasting what may happen in the future under different business situations. By doing so, it helps the firms to face the eventual situation in a better way. 2. It helps in avoiding business shocks and surprises and helps the company in preparing for the future. 3. It helps in coordinating various business situations by providing clear policies and procedures. 4. Detailed plans of action prepared under financial planning reduce waste, duplication of efforts, gaps in planning. 5. It tries to link the present with the future. 6. It provides a link between investment and financing decisions on a continuous basis. 7. By spelling out detailed objectives for various business segments, it makes the evaluation of actual performance easier. Capital structure The proportion of the use of different sources in raising funds. Capital structure refers to the mix between owners and borrowed funds. It can be calculated as debt-equity ratio. On the basis of ownership, the sources of business finance can be: Owners funds it consists of equity share capital, preference share capital, and reserves and surpluses Borrowed funds It can be in the form of loans, debentures, public deposits etc Difference between debt and equity 1. The cost of debt is lower than the cost of equity for a firm because the lender's risk is lower than the equity shareholder's risk, since the lender earns an assured return and repayment of capital and, therefore, they should require a lower rate of return. 2. Increased use of debt is likely to lower the over-all cost of capital of the firm provided that the cost of equity remains unaffected. 3. Debt is cheaper but is more risky for a business because the payment of interest and the return of principal is obligatory for the business. Financial risk is the chance that a firm would fail to meet its payment obligations Capital structure of a company thus, affects both the profitability and the financial risk A capital structure will be said to be optimal when the proportion of debt and equity is such that it resulting an increase in the value of equity share The proportion of debt in the overall capital is also called financial leverage. (debt/equity) Trading on equity refers to the increase in profit earned by the equity shareholders due to the presence of fixed financial charges like interest. Factors affecting the choice of Capital structure: 1. Cash flow position Cash flows must not only cover fixed cash payment obligations but there must be sufficient buffer also. It must be kept in mind that company has cash payment obligations for: i. normal business operations ii. for investment in fixed assets iii. for meeting the debt service commitments 2. Interest coverage ratio (ICR) It refers to the amount of times earnings before interest and taxes of a company cover the interest obligation ICR= EBIT/Interest The higher the ratio, the lower shall be the risk of the company failing to meet its interest payment obligations. However, this ratio is not an adequate measure. A firm may have a high EBIT but low cash balance. apart from interest, repayment obligations are also relevant. 3. Debt service coverage ratio (DSCR) Debt service coverage ratio takes care of the deficiencies referred to in the Interest Coverage ratio (ICR). Profit after tax+ depreciation + Interest + Non- cash exps/ Pref. Div + Interest + Repayment obligation A higher DSCR indicates better ability to meet cash commitments and consequently, the company's potential to increase debt commitments. 4. Return on Investment (RoI) If the RoI of the company is higher, it can choose to use trading on equity to increase EPS. its ability to use debt is greater. 5. Cost of debt A firm's ability to borrow at a lower rate increases its capacity to employ higher debt. 6. Tax Rate Since interest is a deductible expense, cost of debt is affected by the tax rate. 7. Cost of Equity When a company increases debt, the financial risk faced by the equity holders, increases. Consequently, their desired rate of return may increase. If debt is used beyond a point, cost of equity may decrease in spite of increased EPS. Consequently, for maximization of shareholders wealth, debt can be used only upto a level. 8. Flotation costs Sub title