Module 1 as well as constant attention to the strategic

direction of the organization.

Introduction to Financial
Management 1.2 Functions of Finance
Manager
1.1 Definition of Financial The finance manager plays a very big role in
Management the finance function which requires him to
have possessed knowledge in the area of
Financial management is concerned with the accounting, finance, economics and
acquisition, financing, and management of management. His position is highly critical
assets with some overall goal in mind. Its and analytical to solve various problems
decision function includes areas such as related to finance. He performs the
investment, financing, and asset following major functions:
management decisions (Van Horne and
Wachowicz, 2008).  Forecasting Financial Requirements
 Acquiring Necessary Capital
1.2 Objectives of Financial  Investment Decision
Management  Cash Management
Objectives of Financial Management may be  Interrelation with Other Departments
broadly divided into two parts which
includes profit maximization and wealth 1.3 Importance of Financial
maximization: Management
Profit Maximization Proper financial management must be done
for business to operate smoothly. Effective
This is a process that companies undergo to financial management leads to the
determine the best output and price levels in achievement of the goals of the business.
order to maximize its return. The company That’s why there must have good
will usually adjust influential factors such as management when it comes to financial
production costs, sale prices, and output planning, acquisition of funds, usage of
levels as a way of reaching its profit goal. funds, financial decision, profitability
improvement, firm value maximization, and
Wealth Maximization savings promotion. The following are their
importance as described by Paramasivan and
Wealth maximization is the concept of T. Subramanian:
increasing the value of a business in order to
increase the value of the shares held by Financial Planning
stockholders. The concept requires a
company's management team to continually This is considered an important part of the
search for the highest possible returns on business because almost everything starts
funds invested in the business, while with planning. Financial management helps
mitigating any associated risk of loss. This you determine the financial requirement of a
calls for a detailed analysis of the cash flows certain business and help you make a good
associated with each prospective investment, financial plan.
 Savings Promotion
Acquisition of Funds
Savings are possible only when the business
Financial management involves the earns higher profit and thus maximizing
acquisition of required resources wealth. Effective financial management
for the business. Acquiring needed funds helps you promote and mobilize individual
play a major role in financial management and corporate savings. Nowadays, financial
and this involves finding possible source of management is also popularly known as
finance having a minimal cost. business finance or corporate finances.
Financial management is essential in the
Proper Use of Funds business especially in the corporate sectors.

Proper use and allocation of funds leads to

the improvement of the operational Glossary
efficiency of the business. When the funds
are utilized properly, this can reduce the cost Financial Management - concerned with
of capital and increase the value of the acquisition, financing, and management
the firm. of assets with some overall goal in mind
Profit – the difference between income and
expenses
Financial Decision Wealth – the true value or net worth of
business
Financial management helps you make
sound financial decision. Financial decision
will affect the entire business operation
because decisions have direct relationships Module 2
with various department functions.
Financial Statement
Improvement of Profitability
Analysis
Profitability of the business depends on the
effectiveness and proper utilization of funds. 2.1 Classification of Financial
With the help of strong financial control Statement Analysis
devices such as budgetary control, ratio Financial statements are records that outline
analysis and cost volume profit analysis, the financial activities of a business, an
financial management can improve the individual or any other entity. These are
profitability position of the business. meant to present the financial information of
the entity in question as clearly and
Increasing the Value of the Firm concisely as possible for both the entity and
for readers (Investopedia).
Financial management is very important in
the field of increasing the wealth of the The objective of financial statements is to
investors and the business. The ultimate aim provide information about the financial
of most businesses is to achieve the position and the financial performance and
maximum amount of profit leading to the cash flows of an entity that is useful to a
maximization of the wealth of the investors. wide range of users in making economic
decisions (Valix, 2015).
 This type of analysis is made by people
The elements of financial statement include inside the business entity. This analysis is
the financial position and financial usually used to understand operational
performance. Financial position is the status performance of the entity to help in making
of the assets, liabilities, and owners' equity their business decisions.
while the financial performance is a
subjective measure of how well a firm can Financial Statement Analysis based on
use assets from its primary mode of business Methods of Operation
and generate revenues.
This type of analysis may be classified into
A complete set of financial statements two types which includes horizontal analysis
comprises of the following: and vertical analysis:

 Statement of Financial Position Horizontal Analysis

 Income Statement
 Statement of Comprehensive Income From the word itself, we can say that the
 Statement of Changes in Equity figures subject to mathematical analysis is
 Statement of Cash Flows on a horizontal basis. For instance, we
 Notes compare figures from several years, so we
are comparing the amounts in each account
Financial analysis can be classified on the from the past up to the present.
basis of materials used and
on the basis of the methods of application. Vertical Analysis

Financial Statement Analysis based Under this type of analysis, the financial
on Material Used statements are measured based on the
relationship of each item in the financial
Based on the material used, financial statement with respect to the amount of a
statement analysis may be classified into certain account. This facilitates analysis
two types: external analysis and internal that is on a vertical basis
analysis.
2.2 Basic Financial Statement
External Analysis Analysis Techniques
This type of analysis is usually done by There are many methods or techniques that
other people or entities that are outside a are used to analyze the financial statements.
certain business entity. They are just relying In this part we will just discuss the basic
upon the data that are published by the entity methods that are the following:
that they are analyzing. External
analysis is usually done by investors, Index Analysis
creditors, government organizations and
other credit agencies. This is an analysis of percentage financial
statements where all balance sheet or
Internal Analysis income statement figures are expressed for a
base year equal 100 percent and subsequent
financial statement items are expressed as
percentages of the values in the base year.
Common Size Analysis

In this method, figures reported are

converted into percentage to some common
base. It is usually considered as the vertical
analysis. In the balance sheet, the total assets
figure is assumed to be 100% and all other
figures are expressed as percentages with
respect to the amount of the total assets.

2.3 Ratio Analysis

Ratio is a mathematical relationship between
one number to another number. This is used Profitability Ratios
as an index for evaluating the financial
performance of the business concern. We These are ratios that relate profits to sales
can classify ratio in various types. This and investment. From the word itself, this
includes liquidity ratio, activity ratio, ratio deals with profitability. The following
leverage ratio and profitability ratio. are some of the profitability ratios:

Liquidity Ratio

These ratios are financial metrics used to

determine a company's ability to pay off its
short-term debts obligations. The following
are some of the liquidity ratios:

Leverage Ratios

Activity Ratio This measures the long-term obligation of

the business. This ratio helps to understand
This is also known as efficiency or turnover how the long-term funds are used in the
ratio for this measures how effectively the business concern. Some of the solvency
firm is using its assets. This focuses ratios are given below:
primarily on how effectively the firm is
managing two specific asset groups, the
receivables and the inventories, and its total
assets in general. The following are the
activity ratios:
 3.2 General Sources of
Glossary Financing
Financial statements - records that outline A business can generate funds from many
the financial activities of an entity sources. Generally, it can get funds from
Liquidity - the ability of an entity to meet its security finance, internal finance and loan
short-term financial obligations. finance.
Profitability - the ability of a business to
have more income than expenses Security Financing
Solvency - the ability of an entity to meet its
long-term financial obligations. If the finance is mobilized through the
issuance of securities such as shares and
Module 3 debenture, it is called security finance. It is
also called as corporate securities. This
Financial Requirements includes ownership securities or capital
stock and creditorship securities or debt
and Sources capital. Ownership Securities is commonly
called shares which include ordinary shares,
preference shares, no par stock and deferred
3.1 Financial Requirements shares. On the other hand, creditorship
shares include debenture and bonds.
The financial needs of a business can be
categorized as follows: Internal Financing
Fixed Capital Requirement The business entity which has already
operated may get funds internally from
In order to start business, funds are required depreciation funds and retained earnings.
to purchase fixed assets such as land,
building, plant, machinery, furniture and Loan Financing
fixtures. This is termed as fixed capital
requirements of the enterprise. The funds This type financing borrows money with
required in fixed assets remain invested in interest from financial institutions such as
the business for a long period of time. banks and credit-unions.
Working Capital Requirement
3.3 Classification of the
No matter how small or large a business is, Sources of Financing
it needs funds for its day-to-day operations.
This fund is known as the working capital. The sources of financing mentioned above
This is used for holding current assets such can be further classified
as stock of material, bills receivables and for based on period, ownership and source of
meeting current expenses like salaries, generation.
wages, taxes, and rent.
Based on Period Glossary
On the basis of period, the different sources Fixed Capital - funds are required to
of funds can again be categorized into three purchase fixed assets
parts. These are long-term sources, medium- Working Capital - funds used for its day-to-
term sources and short-term sources. day operations

Short term sources of finances are those

which are required for a period not Module 4
exceeding one year. The Cost of Capital,
Medium-term sources of finances are those Capital Structure
which are required for a period of more than Theories, and Dividend
one year but less than five years.
Policy
Long-term sources of finances are those
which are required for a period of more than 4.1 The Cost of Capital
five years.
This is the required return on the various
Based on Ownership types of financing. The overall cost of
capital of a firm is a proportionate average
On the basis of ownership, the sources can of the costs of the various components of the
be classified into ‘owner’s funds’ and firm’s financing including the equity, debt,
‘borrowed funds’. preference share and cost of retained
earnings
Owner’s funds are those that are provided by
the proprietors, partners or shareholders of Ko= Kd Wd + Kp Wp + Ke We
an entity.
Where,
Borrowed funds refer to the funds raised Ko = Overall cost of capital
through loans or borrowings. Kd = Cost of debt
Kp = Cost of preference share
Based on the Source of Generation Ke = Cost of equity
Wd= Percentage of debt of total capital
Another basis of categorizing the sources of Wp = Percentage of preference share to total
funds can be whether the funds are capital
generated from within the organization or We = Percentage of equity to total capital
from external sources.
Cost of Debt
Internal sources of funds are those that are
generated from within the business. This is the required return on investment of
the lenders of a company. This is the after
External sources of funds include those tax cost of long-term funds through
sources that lie outside an organization. borrowing. It may be issued at par, at
premium or at discount.
Cost of Preference Share

This is the required return on investment of

the preferred shareholders of the company

4.2 Leverage
Where, Leverage is the use of various financial
Kp = Cost of preference share instruments or borrowed capital, such as
Dp = Fixed preference dividend margin, to increase the potential return of an
Np = Net proceeds of an equity share investment. We have to major types of
leverage namely the operating leverage and
Cost of Equity the financial leverage.
This is the required rate of return on Operating Leverage is a measurement of the
investment of the common shareholders of degree to which a firm or project incurs a
the company. This can be calculated using combination of fixed and variable costs.
the following approaches

• Dividend price (D/P) approach

• Dividend price plus growth (D/P + g)
approach
• Earning price (E/P) approach
Financial leverage is a metric that measures
the degree to which a company uses fixed-
income securities such as debt and preferred
equity.

4.3 Capital Structure Theories

Capital Structure is the mix or proportion of In this approach, the capital structure
a firm’s permanent longterm financing decision is relevant to the valuation of the
represented by debt, preferred stock, and firm. In other words, a change in the capital
common stock equity. This is the major part structure leads to a corresponding change in
of the firm’s financial decision which affects the overall cost of capital as well as
the value of the firm and it leads to change the total value of the firm. The value of
EBIT and market value of the shares. There income in this approach is the earnings
is a relationship among the capital structure, before interest and taxes.
cost of capital and value of the firm. The
aim of effective capital structure is to Net Operating Income Approach
maximize the value of the firm and to reduce
the cost of capital This is the opposite of the Net Income
approach for the capital Structure decision is
The objective of having a good capital irrelevant to the valuation of the firm. The
structure is to maximize the value of the market value of the firm is not at all affected
firm and minimize the overall cost of by the capital structure changes. The income
capital. With such objectives being amount in this approach is the net income
achieved, we can have an optimum capital after interest and taxes.
structure where the weighted average cost of
Modigliani and Miller Approach
capital is minimum and thereby the value of
the firm is maximum.
Modigliani and Miller approach states that
The capital Structure theories include the the financing decision of a firm does not
traditional approach and the modern affect the market value of a firm in a perfect
approach. The modern approach includes the capital market. In other words this approach
net income, net operating income and the maintains that the average cost of
Mogliani and Miller approach. capital does not change with the change in
the debt weighted equity mix or capital
Traditional Approach structures of the firm.

It is the mix of Net Income approach and 4.4 Dividend Policy

Net Operating Income approach. Hence, it is
also called as intermediate approach. Dividend refers to dributed net profits
According to the traditional approach, mix among the shareholders. A dividend policy
of debt and equity capital can increase the is the policy a company uses to decide how
value of the firm by reducing overall cost of much it will pay out to shareholders in
capital up to certain level of debt. dividends (investopedia).
Traditional approach states that the Ko
decreases only within the responsible limit Dividend may be distributed as cash
of financial leverage and when reaching dividend, stock dividend, bond dividend or
the minimum level, it starts increasing with property dividend.
financial leverage.
Dividend policy of the business is one of the
Net Income Approach crucial functions because it determines the
amount of profit to be distributed among
shareholders
and amount of profit to be treated as retained Cost of Equity - the required rate of return
earnings for financing the entity’s long-term on investment of the common shareholders
growth. of the company
Cost of Preferrence Share - the required
On the basis of the dividend declaration by return on investment of the
the firm, the dividend preferrence shareholders of the company
policy may be classified under the following Dividend – the dributed net profits among
types such as regular the shareholders.
dividend policy, stable dividend policy, Dividend Policy - the policy a company uses
irregular dividend policy and to decide how much it will pay out to
no dividend policy shareholders in dividends
Leverage - the use of various financial
Regular Dividend Policy instruments or borrowed capital, such as
margin, to increase the potential return of an
Dividend payable at the usual rate is called investment.
as regular dividend policy.

Stable Dividend Policy

Module 5
Capital Budgeting
Stable dividend policy means payment of
certain minimum amount of dividend
regularly. 5.1 Definition and Importance
of Capital Budgeting
Irregular Dividend Policy
The word capital refers to the financial
When the companies are facing constraints resources available for use. This may be
of earnings and unsuccessful business the total investment in form of money,
operation, they may follow irregular tangible and intangible assets. Budgeting
dividend policy. It is one of the temporary on the other hand is the planning on how
arrangements to meet the financial and how much of the resources will be
problems. These types are having adequate used for a certain thing or event.
profit. For others no dividend is distributed.
Capital budgeting is the process in which
No Dividend Policy a business determines and evaluates
potential expenses or investments that
Sometimes the company may follow no are large in nature. These expenditures
dividend policy because of its unfavorable and investments include projects such
working capital position of the amount as building a new plant or investing in a
required for future growth of the concerns long-term venture (Investopedia).

Glossary Examples of capital expenditure are the

purchase of fixed assets such as land and
Cost of Debt - the required return on building, plant and machinery, expenses
investment of the lenders of a company- the relating to improvement or renovation
required return on investment of the these fixed assets and costs incurred for
preferred shareholders of the company the research and development projects
 2. Screening or Matching the
Capital budgeting has the most crucial Proposals
part in financial decision making because
they have significant impact on the The planning committee will then analyze
profitability of the firm. Investments and screen the various proposals. The
decisions are large, long-term and selected proposals are considered with
irreversible. That’s why capital budgeting the available resources of the concern.
is very important in in evaluating and
choosing investments. 3. Evaluation

There are great financial risks involved in After screening, the proposals are evaluated
the investment decisions. A good with the help of various methods, such as
investment decision can result into great payback period proposal, net discovered
returns while a bad investment decision present value method, accounting rate of
can endanger the survival of the entity. If return and risk analysis.
higher risks are involved, then it needs
careful planning of capital budgeting. 4. Fixing Property
Usually, investment decisions require
large amount of funds from your limited In this part, the planning committee will
resources that’s why capital budgeting predict which proposal will give more profit
would help in making ways on how to or economic consideration. If the projects or
make these investments possible and proposals are not suitable for the concern’s
more profitable. Capital budgeting financial condition, the projects are rejected
does not only reduces the cost but also without considering other nature of the
increases the revenue in long-term and proposals.
will bring significant changes in the profit
of the company by avoiding over- 5. Final Approval
investment or under-investment.
The planning committee approves the final
proposals, with the help of profitability,
5.2 Capital Budgeting Process economic constituents, financial volatility
and market conditions.
The following are the processes that must
be done in capital budgeting 6. Implementing

1. Identification of Various The competent authority spends the money

Investment Proposals and implements the proposals. They assign
responsibilities to the proposal and ensures
Various investment proposals may be that this will be completed within the time
defined from the top management or may allotted.
even be from the lower rank. The heads of
various departments analyze the various 7. Performance Review
investment decisions and select proposals
submitted to the planning committee of The final stage of capital budgeting is actual
competent authority. results compared with the standard results.
The adverse or unfavorable results are
identified then they make solutions to Profitability Index
remove the various difficulties in the project.
Payback Period
5.3 Kinds of Capital
Budgeting Decisions Payback period is the time required to
recover the initial investment in a project.
The Accept- Reject Decision

This type of decision making applies

when the projects proposed are
independent from each other. The Post Payback Profitability
acceptance or rejection of one proposal
does not affect the decision on the other This one measures and considers the cash
proposals. inflows earned after pay-back period.

Mutually Exclusive Decision Post Payback Period = Cash inflow

(Estimated life – Pay-back period)
Mutually exclusive proposals are those
that compete with other. Therefore, the Accounting Rate of Return
acceptance of one proposal will exclude
the acceptance of the other proposals. This is the amount of profit, or return,
that an individual can expect based on an
Capital Rationing Decision investment made.

In this decision type of decision making,

there are more than one proposal to be
chosen however the firm has limited
funds so that’s why they must ration Internal Rate of Return
these project proposals. Usually, they
select a group of projects that yield the This is the discount rate that equates the
highest total return given such limited present value of the expected net cash
funds. flows with the initial cash outflow

5.4 Methods of Capital

Budgeting Evaluation
Traditional or Non-discount Methods

Payback Period
Post Payback
Accounting Rate of Return Net Present Value
Modern or Discount Methods
Net Present Value
Internal Rate of Return
Net Present Value is the difference Market Risk - refers to the variability of
between the present value of cash inflows returns due to fluctuations
and the present value of cash outflows. in the securities market which is more
particularly to equities
market

Inflation Risk - rise in inflation leads to

reduction in the purchasing power which
influences only few people to invest due
to Interest Rate Risk which is nothing but
the variability of return of the investment
due to oscillation of interest rates due to
Profitability Index
deflationary and inflationary pressures.
This is also known as the benefit-cost
Business Risk - risk which arises only
ratio of a project. This is the
due to the presence of the fixed cost of
ratio of the present value of future net
operations
cash flows to the initial cash
outflow.
Financial Risk - the probability of loss
inherent in financing methods which may
impair the ability to provide adequate
return

Capital budgeting requires the projection

of cash inflow and outflow of the future.
Of course these are just estimates and
thus, cannot be exact. Thus, we are
dealing with probability
5.5 Risk and Uncertainty in
We have the following measures for risk
Capital Budgeting and uncertainties
Risk refers to a situation in which Expected Value
possible future events can have Standard Deviation
reasonable probabilities assigned while Coefficient of Variation
uncertainty refers to situations in which Decision Tree
there is no viable method of assigning
probabilities to future random events. Expected Value
The following are the types of risks
This is the weighted average of possible
outcomes, with the weights being the
Interest Rate Risk– refers to the
probabilities of occurrence.
variability in a security's return resulting
from the changes in the level of interest
rates
 and utility. In the modern business world,
putting the investments are become more
complex and taking decisions in the risky
situations. So, the decision tree analysis
helpful for taking risky and complex
decisions, because it considers the
possible events and each possible event
Standard Deviation are assigned with the probability.

Standard deviation is a statistical measure Glossary

of the variability of a distribution around Accounting rate of return - the amount
its mean. It is the square root of the of profit, or return, that an individual can
variance. In comparing projects which expect based on an investment made.
have the same cash outflow and net Capital - refers to the financial resources
values, standard durations of the available for use.
expected cash inflows of the two Projects Capital Budgeting - the process in which a
may be calculated to measure the business determines and evaluates
comparative and risk of the projects. The potential expenses or investments that
project having a higher standard are large in nature.
deviation is said to be more risky as Coefficient of Variation - this is the ratio
compared to the other. of the standard deviation of a distribution
to the mean of that distribution.
Decision Tree Analysis - this is a decision
support tool that uses a tree-like graph or
model of decisions and their possible
consequences, including chance event
outcomes, resource costs, and utility
Expected Value - this is the weighted
average of possible outcomes, with the
weights being the probabilities of
Coefficient of Variation occurrence.
Internal rate of Return - this is the
This is the ratio of the standard deviation discount rate that equates the present
of a distribution to the mean of that value of the expected net cash flows with
distribution. This is simply a measure of the initial cash outflow
relative risk per unit of expected value. Net Present Value - the difference
between the present value of
Coefficient of Variation = (Standard cash inflows and the present value of cash
Deviation) / (Expected Value) outflows
Payback period - the time required to
Decision Tree Analysis recover the initial
investment in a project.
This is a decision support tool that uses a Post-payback - measures and considers
treelike graph or model of decisions and the cash inflows earned
their possible consequences, including after pay-back period.
chance event outcomes, resource costs,
Profitability Index - the ratio of the exceed the current assets it is said to be
present value of future net cash flows to Negative working capital.
the initial cash outflow Standard
deviation is a statistical measure of the Working capital may be classified into two
variability of a distribution around its major types, namely the permanent and
mean. temporary working capital. Permanent
Working Capital is the minimum amount of
capital that must be maintained at all times
Module 6 to ensure a minimum level of uninterrupted
Working Capital business operations. Since this is permanent,
it will not change irrespective of time or
Management volume of sales while temporary working
capital is the excess of working capital
6.1 The Concept and over the permanent working capital.
Importance of Working The formula above depicts that working
Capital Management capital management is essentially an
accounting strategy with a focus on the
There are two important concepts in maintenance of a sufficient balance between
working capital and these are the gross a company’s current assets and liabilities.
working capital and the net working capital. An effective working capital management
system allows businesses to not only cover
Gross Working Capital is the general their financial obligations, but it also helps
concept which determines the working companies boost their earnings. Managing
capital concept. Thus, the gross working working capital means managing
capital is the capital invested in total current inventories, cash, accounts payable and
assets of the business concern. This is accounts receivable. Working capital
simply management is needed in the proper cash
controlling in purchase of raw materials or
Gross Working Capital = Current Assets goods, payment of salaries and wages,
coping with daily expenses and providing
Usually, when we say working capital, we credit obligations. This also strengthens
are referring to the Net Working Capital. solvency, improves inventory management,
This considers both current assets and smoothens business operations and gives the
current liability of the concern. Net Working firm the ability to face crisis.
Capital is the excess of current assets over
the current liability of the concern during a An efficient working capital management
particular period and is therefore represented system often uses key performance ratios
by the formula discussed the past modules such as the
working capital ratio, the inventory turnover
Net Working Capital = Current Assets - Current ratio and the account receivable turnover to
Liabilities help identify areas that require focus in order
to maintain liquidity and profitability
If the current assets exceed the current
liabilities it is said to be positive working
capital. However, if the current liabilities
6.2 Inventory Management To avoid both over stock and under stock of
inventory
Inventories constitute the most significant
part of current assets of the business Commonly Used Inventory
concern. It is also essential for smooth Management Techniques
running of the business activities. ABC Analysis

Inventory management involves proper The ABC Analysis is based on the principle
purchasing of raw material, handling, storing that a small portion of the items may
and recording. It also considers things such typically represent the bulk of money value
as what to purchase, how to purchase, how of the total inventory used in the production
much to purchase, from where to purchase, process, while a relatively large number of
where to store and when to use for items may from a small part of the money
production value of stores. This is the inventory
management techniques that divide
Kinds of Inventories inventory into three categories based on the
value and volume of the inventories.
Inventories can be classified into three major
categories Economic Order Quantity (EOQ)

Raw Material- these are goods which have This refers to the level of inventory at which
not yet been committed to production in a the total cost of inventory comprising
manufacturing business concern ordering cost and carrying cost. Determining
an optimum level involves two types of cost
Work in Progress - these include materials such as ordering cost and carrying cost. The
which have been put into production process EOQ is that inventory level that minimizes
but have not yet been completed the total of ordering of carrying cost.

Finished Goods - these are the completed

products and is already final output of the
production process

Objectives of Inventory Management

The following are the major objectives of
the inventory management 6.3 Cash Management
To efficient and smooth production process
To maintain optimum inventory to maximize The business needs cash to make payments
the profitability for acquisition of resources and services for
To meet the seasonal demand of the the normal conduct of business. Cash is one
products of the most important parts of the current
To avoid price increase in future assets. This is the money which a business
To ensure the level and site of inventories concern can disburse immediately without
required any restriction. The term cash includes cash
To plan when to purchase and where to on hand such as bills and coins and the
purchase cash in bank.
Motives of Holding Cash A concentration bank is a financial
institution that is considered as the
Transactions motive: to meet payments, primary bank of an entity or the bank where
such as purchases, wages, taxes, and the entity does most of its transactions.
dividends, arising in the ordinary course of Several businesses use multiple banks, but
business. generally deal significantly with one bank in
particular. This is a collection procedure in
Speculative motive: to take advantage of which payments are made to regionally
temporary opportunities, such as a sudden dispersed collection centers, and deposited
decline in the price of a raw material. in local banks for quick clearing. It is a
system of decentralized billing and multiple
Precautionary motive: to maintain a safety collection points.
cushion or buffer to meet unexpected cash
needs. The more predictable the inflows and Lock Box System
outflows of cash for a firm, the less cash that
needs to be held for precautionary needs. It is a collection procedure in which payers
Ready borrowing power to meet emergency send their payment or cheques to a nearby
cash drains also reduces the need for this post box that is cleared by the firm’s bank.
type of cash balance. Several times that the bank deposits the
cheque in the firms account. Under the lock
Cash Management Techniques box system, the business entity hires a post
office lock box at important collection
Speed up Cash Collection centers where the customers remit payments.
The local banks are authorized to open the
Prompt Payment by Customers box and pick up the remittances received
from the customers. As a result, there is
The business must find ways on how some extra savings in mailing time
customers can pay promptly. This may compared to concentration bank.
include the offering discounts and special
offer. The firms may use some of the Slow Down Cash Disbursement
techniques for prompt payments like billing
devices, self-address cover with stamp and Playing the Float
online payments.
This is refers to the period that elapses from
Early Conversion of Payments into Cash the time you write a check until it clears
your account, which can work to your
The entity must be concerned regarding the advantage. If you are the one disbursing the
quick conversion of the payment into cash money through check, it would more
because cash on hand is needed for business beneficial that the money would not
operations and this avoids risks that the immediately be deducted against
instruments used are of no value or have no your account. However, as checks are
sufficient funds. increasingly cleared electronically at the
point of deposit, this float is disappearing.
Concentration Banking
Centralized Disbursement System
Hence centralized disbursement of cash
system takes time for collection from the Credit Policies
entity’s accounts as well as they can pay on
the date. This allows the corporate Credit policies provide the framework to
headquarters’ staff to oversee each determine whether or not to extend credit to
disbursement and possibly also initiate each a customer and how much credit to extend.
disbursement. It also ensures disbursement It has two broad dimensions namely the
account balance adequacy credit standards and the credit analysis.

6.4 Receivable Management Credit standards represent the basic criteria

for the extension of credit to customers. The
Accounts receivable is the amount of money quantitative basis of establishing credit
owed to a firm by customers who have standards are credit ratings, average
bought goods or services on credit. A payment period and financial ratios. In
current asset, the accounts receivable deciding the credit standards, it considers
account is also called receivables. factors such as collection costs, investments
Receivable management is defined as the in receivables or the average collection
process of making decision resulting to the period, bad debt expenses and sales volume
investment of funds in these assets which
will result in maximizing the overall return Credit analysis is the method by which one
on the investment of the firm. This also calculates the creditworthiness of a business
refers to the decision that a business makes or organization. It is also considered as the
regarding to the overall credit, collection evaluation of the ability of a company to pay
policies and the evaluation of individual its financial obligations. The following are
credit applicants. the two basic steps are involved in the credit
investigation process
Objectives of Receivable Management
1. Obtaining credit information
The main purpose of receivables
management is to promote sales and Internal sources
profit until that point is reached where the Filling up of various forms
return on investment in further funding Internal records
receivables is less than the cost of funds
raised to finance that additional credit. External sources
Specifically, the following are its purpose Financial statements
Bank references
 To evaluate the creditworthiness of References
customers before granting or extending the
credit. 2. Analysis of credit information
 To minimize the cost of investment in Quantitative
receivables. Qualitative
 To minimize the possible bad debt losses.
 To minimize the cost of running credit and It must be clear that the main purpose of
collection department. credit analysis is to assess the credit
 To maintain a tradeoff between costs and worthiness of the customers.
benefits associated to credit policy.
 are great enough to cover the risk of default
Credit Terms by the borrower. Special finance loans
typically carry a higher interest rate than is
These are the terms under which goods are available to borrowers with a clean credit
sold on credit are referred as credit terms. history (Investopedia).
This basically includes credit period, cash
discount and cash discount period Lease Financing

Credit Policies Lease may be defined as a contractual

arrangement in which a party owning an
This refers to the procedures followed to asset provides the asset for use to another,
collect account receivables when they the right to use the assets to the user over a
become due after the expiry of the credit certain period of time, for consideration in
period. Their purpose should be the speed up form of periodic payment, with or without a
the collection of dues. Various steps to further payment. Lease financing is one of
collect dues from customer by firm are the popular and common methods of assets-
letter, telephone calls etc. based finance, which is the alternative to the
loan finance. Lease is a contract. It is
Glossary contractual agreement between the owner of
the assets and user of the assets for a specific
Credit Terms - these are the terms under period by a periodical rent
which goods are sold on credit are referred
Credit Policies - provide the framework to Venture Capital
determine whether or not to extend credit to
a customer and how much credit to extend The term Venture Capital fund is usually
Gross Working Capital is the general used to denote mutual funds or institutional
concept which determines the working investors. This is the money provided by
capital concept investors to startup firms and small
Inventory - the raw materials, work-in- businesses with perceived long-term
process goods and completely finished growth potential. This is a very important
goods that are considered to be the portion source of funding especially for new
of a business's assets which are ready or will businesses that do not yet have access to
be ready for sale. capital markets. Venture Capital termed as
Net Working Capital is the excess of current long-term funds in equity or semi-equity
assets over the current liability of the form which involves high risk but has strong
concern during a particular period potential of high profitability

Factoring
Module 7
Special Financing This is financing method in which a business
owner sells accounts receivable at a discount
to a third-party funding source to raise
Special finance is an industry for borrowers capital. Here the risk of credit, risk of credit
with a limited or tainted credit history. worthiness of the debtor and as
Special financing is risk based, this means number of incidental and consequential risks
that the terms of the loan are set so that the are involved. These risks are taken by the
expected returns to the lender or investor
factor which purchase these credit capital markets. These are operated by
receivables without recourse and collects money managers, who invest the fund's
them when due. These balance-sheet items capital and attempt to produce capital gains
are replaced by cash received from the and income for the fund's investors. A
factoring agent. mutual fund's portfolio is structured and
maintained to match the investment
Foreign Direct Investment objectives stated in its prospectus.

This is an investment made by a company Glossary

from one country into a company from Factoring - selling of accounts receivable at
another country. In this type of financing, a discount to a third-party funding source to
overseas institutions invest in equities listed raise capital.
on the national stock exchange. This can Foreign Direct Investment - an investment
provide the receiving firm with the made by a company from one country into a
investment, new technologies, capital, company from another country.
processes, products, organizational and Lease Financing - defined as a contractual
management technologies which can help in arrangement in which a party owning an
economic development. asset provides the asset for use to another,
the right to use the assets to the user over a
Merchant Banking certain period of time, for consideration in
Merchant banking is one of the fee based form of periodic payment, with or without a
financial services which includes further payment.
underwriting, consultancy and other allied Merchant Banking - one of the fee based
services to the business concern. This is financial services which includes
basically a service banking which provides underwriting, consultancy and other allied
non-financial services such as issue services to the business concern.
management, portfolio management, asset Mutual Fund - is an investment vehicle for
management, underwriting of new issues, to investors who pool their savings for
act as registrar, share transfer agents, investing in diversified portfolio of
trustees, provide leasing and project securities with the aim of attractive yields
consultation. The merchant banks may and appreciation in their value.
function in the form of a bank, financial Venture Capital - the money provided by
institutions, company or firm. investors to startup firms and small
businesses with perceived long-term growth
Mutual Fund potential.

A mutual fund is an investment vehicle for

investors who pool their savings for
investing in diversified portfolio of
securities with the aim of attractive yields
and appreciation in their value. The pool of
funds collected from many investors is for
the purpose of investing in securities such as
stocks, bonds, money market instruments
and similar assets. Mutual fund is a trust that
attracts savings which are then invested in