UNIT- A

1. Meaning & Importance of Finance

Meaning of Finance:
Finance refers to the management of money and other financial instruments. It involves activities
such as investing, borrowing, lending, budgeting, saving, and forecasting.
Types of Finance:
 Personal Finance – Managing individual finances, including budgeting, savings, insurance,
and investments.
 Corporate Finance – Managing a company’s finances, including capital structure, funding,
and investment decisions.
 Public Finance – Managing a country’s revenue, expenditures, and debt through government
policies.
Importance of Finance:
 Capital Allocation: Ensures optimal use of financial resources.
 Decision Making: Helps in planning and decision-making for future growth.
 Business Operations: Maintains cash flow for day-to-day operations.
 Economic Growth: Drives investment and innovation in the economy.
 Risk Management: Helps mitigate financial and operational risks.

2. Goals of Financial Management

Profit Maximization:
 Definition: Aim to increase the earnings (net income or profit) of the business.
 Focus: Short-term gains.
 Advantages: Easy to measure and compare.
 Limitations:
o Ignores time value of money.
o Ignores risk and uncertainty.
o May overlook long-term sustainability.
o Doesn’t consider social responsibilities or shareholders’ wealth.
Wealth Maximization (Shareholder Value Maximization):
 Definition: Maximize the market value of shareholders’ equity.
 Focus: Long-term growth and sustainability.
 Advantages:
o Considers time value of money.
o Focuses on risk and return.
o Encourages efficient resource allocation.
o Aligns with investors' expectations.
 Preferred Goal: Most modern financial managers consider wealth maximization as the
superior objective.

3. Forms of Business Organization

a. Sole Proprietorship
 Definition: A business owned and run by one individual.
 Features:
o Easy to start and manage.
 o Owner has full control and receives all profits.
o Unlimited liability.
o Limited access to capital.
o Business ceases upon owner’s death.
b. Partnership
 Definition: A business owned by two or more individuals sharing profits and liabilities.
 Types: General Partnership, Limited Partnership, LLP (Limited Liability Partnership).
 Features:
o More capital than sole proprietorship.
o Shared responsibilities.
o Partnership deed governs rights and duties.
o Unlimited liability for general partners.
o Limited life span (dissolves on death/retirement of a partner).
c. Corporation (Company)
 Definition: A legal entity separate from its owners (shareholders).
 Features:
o Limited liability for shareholders.
o Perpetual succession.
o Can raise large capital via equity/debt.
o Regulated by government (e.g., Companies Act).
o Management separated from ownership.

4. Overview of Financial Statements

a. Balance Sheet (Statement of Financial Position)
 Purpose: Shows the financial position of the company at a specific point in time.
 Assets = Liabilities + Shareholders’ Equity
 Components:
o Assets: Resources owned (e.g., cash, inventory, property).
 Current Assets – used within one year (e.g., cash, accounts receivable).
 Non-Current Assets – long-term use (e.g., machinery, land).
o Liabilities: Obligations owed (e.g., loans, accounts payable).
 Current Liabilities – due within one year.
 Non-Current Liabilities – due after one year.
o Equity: Owner’s interest (e.g., share capital, retained earnings).
b. Profit & Loss Account (Income Statement)
 Purpose: Shows performance over a period (e.g., quarterly, annually).
Revenues – Expenses = Net Income (Profit/Loss)
 Components:
o Revenue (Sales): Income from primary business operations.
o Expenses: Costs incurred (e.g., cost of goods sold, salaries, rent).
o Net Income: Profit after deducting all expenses including taxes and interest.
 Positive → Net Profit
 Negative → Net Loss
UNIT- B
Financial Ratios
a. Liquidity Ratios
Measure the firm's ability to meet short-term obligations.
i. Current Ratio
Current Ratio=Current Assets / Current Liabilities
Benchmark: Ideally > 1 (usually around 2:1)
 Indicates: Ability to pay short-term debts.
ii. Quick Ratio (Acid-Test Ratio)
Quick Ratio=(Current Assets−Inventory) / Current Liabilities
 Excludes inventory due to its lower liquidity.
 More stringent test of short-term liquidity.

b. Profitability Ratios
Measure the firm’s ability to generate profit relative to sales, assets, or equity.
i. Net Profit Margin
Net Profit Margin=Net Profit/ Sales×100
 Indicates overall profitability and efficiency.
ii. Return on Assets (ROA)
ROA=Net Income/Total Assets×100
- Shows how effectively assets are used to generate profit.

c. Solvency Ratios
Evaluate long-term financial stability and debt-paying capacity.
i. Debt-Equity Ratio
Debt-Equity Ratio=Total Debt/ Shareholders’ Equity
- Indicates proportion of external financing vs. internal financing.
 Lower ratio is safer, but ideal depends on industry.

2. Break-Even Analysis
Key Concepts:
 Fixed Costs (FC): Do not change with production (e.g., rent, salaries).
 Variable Costs (VC): Change with production (e.g., raw materials).
 Contribution Margin (CM):
CM per unit=Selling Price per unit−Variable Cost per unit
Break-Even Point (BEP):
BEP (units)=Fixed Costs/ (Selling Price per unit−Variable Cost per unit.
 Interpretation: Number of units to be sold to cover all costs.
 No profit or loss at break-even.

3. Sources of Long-Term Finance

a. Equity Shares (Common Stock)
 Ownership in the company.
 Voting rights and dividends (not fixed).
  High risk, high return.
 Permanent capital.
b. Preference Shares
 Preference in dividend payments and repayment during liquidation.
 Fixed dividend rate.
 No voting rights (generally).
 Hybrid of equity and debt features.
c. Debentures & Bonds
 Debt instruments issued to the public.
 Fixed interest payments (coupon).
 No ownership; creditors to the company.
 Redeemable after a fixed period.
d. Term Loans from Financial Institutions
 Loans provided by banks or financial institutions.
 Fixed repayment schedule (e.g., 5–10 years).
 May require collateral (secured).

4. Raising Long-Term Finance

a. Initial Public Offering (IPO)
 First-time sale of shares to the public.
 Raises equity capital.
 Requires compliance with SEBI and stock exchange norms.
b. Private Placement
 Sale of securities to a select group of investors.
 Faster and less costly than an IPO.
 Used for raising funds from institutional or wealthy investors.
c. Loans and Credit Facilities
 Term loans from banks.
 Syndicated loans (from multiple lenders).
 Revolving credit and overdrafts for flexible financing.

UNIT-3
1. Capital Budgeting Techniques
Used to evaluate investment opportunities/projects based on expected cash flows.

a. Payback Period:
Time it takes to recover the initial investment.
Payback Period=Time taken to recover investment from cash inflows.
 Pros: Simple, easy to understand.
 Cons: Ignores time value of money and cash flows after payback.

b. Net Present Value (NPV):

Difference between the present value of cash inflows and the initial investment.
NPV=∑(Present value of Cash Flow – Cash outflow/ Initial investment.
Accept if: NPV > 0 (project adds value).
  Considers time value of money and profitability.

c. Internal Rate of Return (IRR):

The discount rate at which NPV = 0.
 Decision Rule: Accept project if IRR > Cost of Capital.
 Shows expected return of the project.
 May have multiple values if cash flows are non-conventional.

2. Capital Structure
a. Debt vs. Equity
Aspect Debt Equity
Ownership No Yes (shareholders)
Repayment Fixed interest, repayable No repayment, residual claim
Risk Lower for investors Higher risk, higher return
Tax Treatment Interest is tax-deductible Dividends not tax-deductible

b. Optimal Capital Structure

 Mix of debt and equity that minimizes cost of capital and maximizes firm value.
 Strikes a balance between risk and return.
 Depends on factors like industry, cash flows, interest rates, tax policy, etc.

3. Cost of Capital
a. Cost of Debt (Kd):
Kd=Interest rate×(1−Tax rate) / net proceeds

b. Cost of Equity (Ke):

Estimated using models like the Capital Asset Pricing Model (CAPM):
Ke= Dividend / net proceeds

c. Weighted Average Cost of Capital (WACC):

Overall cost of capital considering the proportion of debt and equity.

4. Working Capital
1. Definition:
Working Capital refers to the capital required for the day-to-day operations of a business. It is the
difference between a firm’s current assets and current liabilities.
Net Working Capital (NWC)=Current Assets−Current Liabilities

Importance of Working Capital:

 Ensures smooth business operations.
 Maintains liquidity and solvency.
 Helps in timely payment to suppliers and creditors.
 Affects profitability and risk of the business.
 Supports sales and production levels.
Types of Working Capital:
Type Meaning
Gross Working Capital Total Current Assets
Net Working Capital Current Assets – Current Liabilities

2. Components of Working Capital

a. Current Assets:
Assets expected to be converted into cash within a year.
 Inventory – Raw materials, work-in-progress, finished goods.
 Receivables – Amounts due from customers (debtors).
 Cash & Bank – Cash in hand or deposited in the bank.
 Short-term investments – Marketable securities.
b. Current Liabilities:
Obligations due within a year.
 Accounts Payable – Payments due to suppliers.
 Short-term Loans – Bank overdrafts, cash credits.
 Accrued Expenses – Salaries, wages, taxes payable.

3. Operating Cycle
Definition:
The time duration between the purchase of inventory and collection of cash from sales.
 Inventory Conversion Period: Time taken to convert inventory into finished goods and sell
them.
 Receivables Collection Period: Time taken to collect payments from customers.
 Payables Deferral Period: Time allowed by suppliers to pay for purchases.
Shorter Operating Cycle → More efficient working capital management.

4. Estimation of Working Capital

Steps to Estimate:
1. Project sales for the year.
2. Estimate required current assets based on operating cycle and sales.
3. Estimate current liabilities expected from suppliers, creditors, etc.
4. Calculate working capital requirement:
Working Capital Requirement=Estimated Current Assets−Estimated Current Liabilities.

Factors Affecting Estimation:

 Business nature and size.
 Seasonal variations.
 Credit policy and inventory turnover.
 Production cycle duration.

5. Operating Income & EBIT

a. Operating Income:
Operating Income=Revenue−Operating Expense
  Reflects profit from core operations.
 Excludes non-operating items (e.g., interest income, gains/losses).
b. EBIT (Earnings Before Interest and Taxes):
EBIT=Operating Income
- Sometimes adjusted for non-operating income/expenses if present.
 Used to analyze operating performance before the effect of financing and taxes.