Basics on Finance
A webinar by PR Cell, IIM Rohtak for Preparation for WAT-PI process, Admissions - 2016
Discussion Topics
FINANCIAL ACCOUNTING: Accounting Principles and Accounting Concepts Accounting Policies Financial Statements Financial RatiosFINANCIAL MANAGEMENT: Procurement and Utilization of Funds Cost of Capital Role of CFO Profit Maximization vs Value Maximization Risk and Return
Financial Accounting “Accounting is the art of recording, classifying,
and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least of financial character, and interpreting the results thereof.” - American Institute of Certified Public Accountants (AICPA)
Accounting is also understood as the systematic and comprehensive recording of financial transactions pertaining to a business.
Accounting is one of the key functions for almost any business; it may be handled by a bookkeeper and accountant at small firms or by sizable finance departments with dozens of employees at larger companies.
Accounting Concepts
There are few basic rules for recording any accounting transactions
a) Dual Aspect Concept - It must have two sides
b) Money Measurement Concept - It has to be in terms of money
c) Periodicity Concept - It falls between a specified period
d) Entity Concept – It is specific to a particular entity
e) Conservatism Concept - Future losses to be recorded but not future gains
Accounting Concepts
f) Matching Concept - Expenses related to Incomes only can be recorded
g) Historical Cost Concept - Assets to be recorded at purchase price
h) Realisation Concept - Profits to be recorded only when sale has taken place
i) Materiality Concept - It needs to be material for decision making
j) Capitalisaiton Concept - Costs related to capital assets before put to use
Accounting Standards and AssumptionsAccounting Standards issued by ICAI
31 Active Accounting Standards
Also converging to IFRS (International Financial Reporting Standards) – IND AS
Important Accounting Assumptions:
a) Going Concern
b) Consistency
c) Accrual
Process of Records
Consists of a) Profit & Loss Statementb) Balance Sheetc) Cash flow Statement
Final Accounts
Helps in ensuring that the entries in a company’s book keeping system are accurate in figures
Trial Balance
A general ledger is a complete record of financial transactions over the life of a company
LedgerFirst recording of financial transactions as they occur in time, so that they can then be used for future reconciling
JournalAny monetary transaction for exchangeExample: Money exchanged for a pen
Transaction
Financial Statements – Profit and Loss Account It reports a company's revenues, expenses, and
most of the gains and losses which occurred during the period of time specified
Generally prepared for one year period
The bottom line of this financial statement appears as net income, which is the net amount of the revenues, expenses, gains, and losses being reported
Financial Statements – Balance Sheet It represents a company's financial position at the end
of a specified dateAssets: Businesses need to use assets in order to generate
wealth. Assets are the things that a business owns or sums that are owed to the business at any one moment in time
The business obtains the finance for these assets from two main source: Internally (inside the business) from capital raised
from the business owners (the shareholders in the case of a company)
Externally - for example, in the form of loans, and other forms of finance which needs to be repaid
Financial Statements – Balance SheetLiabilities: When you set up a business, the business becomes
a legal body in its own right Internal finance (shareholders' funds) is owed
to shareholders External finance is owed to people outside the
business - liabilities The Balance Sheet will therefore balance since in
simple terms this shows that the value of a businesses assets is financed by the two groups – Internal (owner's capital), External (liabilities).
A balance sheet typically appears in a vertical format
Financial Statements – Cash Flow Statement A financial statement that shows how changes in
balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing and financing activities
Management decisions for the next years can be based on the cash inflows or cash outflows from each individual activities
Also it portrays the usage or generation of cash from which of the following operating, investing or financing activities
Financial Statements – Ratios Liquidity Ratio
Profitability Ratio
Activity Ratio
Solvency Ratio
Leveraging Ratio
Financial Management
The theory of Financial Management is the theory of financial decision making by business firms
It can be described as the study of decisions that every firm has to make related to financial matters
It is the managerial activity which is concerned with the planning and controlling of the firm’s financial resources
It can be viewed as proper management of flows of funds in a firm
“Financial Management is concerned with the managerial decisions that result in the acquisition and financing of short term and long-term credits for the firm”
Financial Management – Procurement of Funds
Sources of
Funds
Equity
Debt
Hire Purchase
Angel Financing
Venture Capital
Commercial Banks
Financial Management – Types of Capital
Equity Share CapitalReserves and Surplus
Preference Share Capital
Long Term Loan Funds
Term LoansDebentures
Short Term Loan Funds
Bank OverdraftCredit Limit
Types of Capital
Financial Management – Cost of Capital Cost of Capital is the cost of using funds of the owners
or the creditors (can also be termed as expectation from the owners)
Cost of Equity (Ke):
Dividend Discount Method
Ke = (D1/P0 )+g
Capital Asset Pricing Method
Ke = Rf+ ß *(Equity Risk Premium)
Factor Model
Financial Management – Cost of Capital
Cost of Preference Shares
KPS = (Dividend+(M.V.-N.P.))/(0.5*(M.V.+N.P.))
(M.V.=Maturity Value, N.P.=Net Proceeds)
Cost of Debt
Kd = r(1-t)
Yield to maturity approach and Debt
Weighted Average Cost of Capital
= (We*Ke + Wd*Kd + WPS*KPS)
Financial Management – Utilization of Funds
Utilization of
Funds
Fixed Assets
InvestmentCurrent Assets
Role of a CFO
Finance
Accounting
Audit
Treasurer
Controller
Finance Manager
Decisions made by CFO
Investment Decisions Long-Term Decisions
Financing Decisions Capital Structure Decisions
Dividend Decisions Profit Distribution Decisions
Liquidity Decisions
Working Capital or Short-Term Decisions
Financial Management Objectives
Profit Maximization
Profit After Tax Maximization
Earning Per Share Maximization
Sales Maximization
Market Share Maximization
Firm’s Wealth MaximizationShareholder’s Wealth or Value Maximization
Basic Axioms of Financial Management
Money has time value/opportunity cost
Every Financial Decision involves a trade-off between Risk and Return
Financial Markets are Efficient
Accounting Profits are not relevant for financial decisions. Profits based on Cash Flows are more relevant
Options have a value
Return Risk
Remember that each Financial Decisions are evaluated in terms of
Looking into the brighter side
Looking into the darker side
Relationship between Risk and Return Can we say that a person who has taken high risk
will get higher return?
Should a person go for higher risk if he/she has to earn higher return?
Should a person be compensated by higher return for taking higher risk?
Is it High Risk, High Return?
Or, Is it High Return, High Risk?
Financial Management - Derivatives A derivative is a financial contract which derives its
value from the performance of another entity such as an asset, index, or interest rate, called the "underlying".
Futures Forwards Options
Put Option Call Option
Swaps Interest Rate Swaps Currency Swaps Commodity Swaps Credit Default Swaps
Q & A
THANK YOU
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