17535638 HND Business Management Managing Financial Resources

8/6/2019 17535638 HND Business Management Managing Financial Resources

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HND Business Management

Chapter -2Finance as a Resource

P.Suthaharan

BBA (Marketing Special )(Col)


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Cost of Finance Finance cost is the cost associated

with raising finance. The cost of

finance is depending on the sourcethe finance and the companys riskprofile.


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Cost of Finance Interest Cost

Simple Interest

Compound Interest

Fixed and Floating Interest

Dividend

Ordinary dividend

Special dividend

Stock dividend

Cash dividend

Opportunity Cost of Financing


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Simple interest Simple interest is calculated

only on the principal amount, or

on that portion of the principalamount which remains unpaid.


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Compound interest Compound interest is very similar to simple

interest; however, with time, the differencebecomes considerably larger. This

difference is because unpaid interest isadded to the balance due. Put another way,the borrower is charged interest onprevious interest. Assuming that no part ofthe principal or subsequent interest has

been paid, the debt is calculated by thefollowing formulas:


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Fixed and floating rates Commercial loans generally use simple

interest, but they may not always have asingle interest rate over the life of the loan.

Loans for which the interest rate does notchange are referred to as fixed rate loans.

Loans may also have a changeable rate overthe life of the loan based on some referencerate (such as LIBOR and EURIBOR in Sri

Lanka with the treasury bills rate), usuallyplus (or minus) a fixed margin. These areknown as floating rate, variable rate oradjustable rate loans.


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Ordinary (or regular) dividends

Regular dividends are paid in cash at

regular intervals. Most firms paythese out quarterly, but there arefirms that pay at other intervals(monthly or annually).


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Special (or extra)D

ividends

A one-time dividend that is not

expected to be reoccurring. In theevent of excess profits, most of thecompanies share these benefits toshareholders in the form of special

dividends


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StockD

ividends Stock dividends are really mini-stock

splits. The company gives new shares toexisting shareholders.

These are paid out in form of additionalstock shares of the issuing corporation, orother corporation (such as its subsidiarycorporation). They are usually issued inproportion to shares owned

ExampleFor every 100 shares of stock owned, 5%stock dividend will yield 5 extra shares.


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Cash dividends These are paid out in the form of cash. Such

dividends are a form of investment incomeand are usually taxable to the recipient in

the year they are paid. This is the most common method of sharingcorporate profits with the shareholders ofthe company. For each share owned, adeclared amount of money is distributed.

Example:If a person owns 100 shares and the cash dividend is LKR 0.50 pershare, the person will be gettingLKR 50.00


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Opportunity cost or economicopportunity loss is the value of the nextbest alternative forgone as the result ofmaking a decision.

Opportunity cost analysis is an importantpart of a company's decision-makingprocesses but is not treated as an actual costin any financial statement.

The next best thing that a person can engagein is referred to as the opportunity cost ofdoing the best thing and ignoring the nextbest thing to be done.

It has been described as expressing "thebasic relationship between scarcity andchoice.


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Example:

An organization that invests LKR1 million inacquiring a new asset instead of spending

that money on maintaining its existingasset portfolio incurs the increased risk offailure of its existing assets.

The opportunity cost of the decision to

acquire a new asset is the financial securitythat comes from the organization'sspending the money on maintaining itsexisting asset portfolio.


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How to calculate Opportunity

cost?

When considering a choice, ask yourself threequestions:

1.What alternative opportunities are there?2.Which is the best of these alternative

opportunities?3.What would be the result if the best

alternative been selected instead of thenext best alternative?


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Financial planning The process involves gathering

relevant financial information, setting

organizations finance related goals,examining the current financial statusand coming up with a strategy or planon how you can meet your

organizational goals given your currentand projected situation is calledfinancial planning.


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Importance of financial

planning Maximization of the cash

utilization.:

Every resource has an opportunitycost. Cash is also considered as aresource, if it is not utilized properlyit will have an opportunity cost.Therefore organizations have to planwell in advance about their utilizationof the cash resources.


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Importance of financial

planning Minimize the cost of capital and

working capital shortages.

When cash resources are managedproperly, business can be conducted withthe cash inflows from trading operations(i.e. from the sales), without raisingadditional finance to run the day to day

operations. This will minimize the cost ofraising external finance like overdraft, shortterm loans etc.


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Cash Budgets Cash budget is a tool used to forecast

the future cash receipts and plan out

the future cash expenditures. Preparing a cash budget involves the

following steps. Forecast the anticipated Cash receipts

Forecast the anticipated cash payments Compare the anticipated cash payments

and receipts

Calculate the cumulative cash flow:


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Forecast the anticipated Cash

receipts Future cash receipts have to be

identified and estimated to make a

forecast.e.g. Expected cash receipts:

Cash sales

Collections of accounts receivable Other income (interest income/ commission

income etc)


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Forecast the anticipated cash

payments:

Future cash expenses have to be identified and shouldbe planned out accordingly to match with the cashreceipts. This will be helpful to avoid the cash deficit

situations and reduce the cost for the organization andwill improve profitability.

e.g. Raw material (inventory)

Payroll

Advertising

Selling expenses

Administrative expense

Plant and equipment expenditures

Other payments


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Compare the anticipated cashpayments and receipts:

This will help to identify the net cash flowfor the organization.

Calculate the cumulative cash flow:

For each period by adding the opening cashbalance to the net cash flow for the periodcumulative cash flow can be calculated.

17535638 HND Business Management Managing Financial Resources

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