financial management 1

1.      What is the goal of an organization

 (i) Investment decision i.e., where to invest fund and in what amount,

(ii) Financing decision i.e., from where to raise funds and in what amount, and

(iii) Dividend i.e., how much to pay dividend and how much to retain for future expansion. In order to make these decisions the management must have a clear understanding of the objective sought to be achieved. It is generally agreed that the financial objective of the firm should be maximization of owner's economic welfare.

2.      Why maximization of shareholder’s wealth is preferred over profit maximization as the objective of a firm?

Profit maximization is short term as compare to share holder's wealth maximization, managers should focus on share holder's wealth maximization because it’s what they are hired for also there are several reasons such as:
1) The share holders wealth is be considered.
2) Profit maximization doesn’t say which type of profit it should maximize-short term or long term.
3) Profit maximization ignores the social values but only aims at earning maximum profit.
4) Wealth maximization also considers improving the goodwill of the organization.

3.      Explain five function of a financial manager

1) Raising capital to support company operations and investments (aka, financing functions);

2) Selecting those projects based on risk and expected return that are the best use of a company's resources (aka, capital budgeting functions);

3) Management of company cash flow and balancing the ratio of debt and equity financing to maximize company value (aka, financial management function);

4) Developing a company governance structure to encourage ethical behavior and actions that serve the best interests of its stockholders (aka, corporate governance function); and

5) Management of risk exposure to maintain optimum risk-return trade-off that maximizes shareholder value (aka, risk management function).

4.      define :

a. Net working capital : Net Working Capital, is defined as Current Assets minus Current Liabilities. Current assets include stocks, debtors, cash & equivalents and other current assets. Current liabilities include all the short-term borrowings. The formula is the following and the figures are expressed in millions:

= (stocks + debtors + cash & equivalents + current assets,other) - creditors,short

b. working capital management : Current assetsminuscurrent liabilities. Workingcapitalmeasureshow much inliquid assetsacompanyhasavailabletobuilditsbusiness. Thenumbercan bepositiveornegative, dependingonhow muchdebtthe company is carrying. Ingeneral, companies that have alotof working capital will be more successful since they canexpandandimprovetheiroperations. Companies withnegative working capitalmaylackthefundsnecessaryforgrowth.also callednet current assetsorcurrent capital.

c . Working capital policy : Working Capital is the money used to make goods and attract sales. The less Working Capital used to attract sales, the higher is likely to be the return on investment. Working Capital management is about the commercial and financial aspects of Inventory, credit, purchasing, marketing, and royalty and investment policy. The higher the profit margin, the lower is likely to be the level of Working Capital tied up in creating and selling titles. The faster that we create and sell the books the higher is likely to be the return on investment. Thus when we have been using the word investment in the chapter on pricing, we have been discussing Working Capital.

5.      Define these three categories

Temporary current assets: Temporary current assets would probably refer to items that are used up quickly and then replaced. 

Items such as office supplies, cleaning supplies, things to keep a business operational are considered assets, but because they are used up quickly and replenished regularly, they are considered "temporary". 

Supplies once used, become an expense. 

Permanent current assets : The current assets a firm needs in order to continue operations. Examples include inventory and perhaps rapidly depreciating assets such as computers. These assets are current because they do not remain assets for longer than a year, but they are permanent because they must be replaced with similar assets. Despite the seeming contradiction in the name, they are called permanent current assets because every company must permanently maintain a certain amount in current assets in order to exist.

Fixed assets : Along-term,tangible assetheldforbusinessuse and not expected to be converted tocash inthecurrentorupcomingfiscal year, such asmanufacturingequipment,real estate, and furniture.also calledplant.

6.      Explain the three sources of financing

1.      Financial planning: management need to ensure that enough funding is available at the right time to meet the needs of the business. In the short term, funding may be needed to invest in equipment and stocks, pay employees and fund sales made on credit

2.      Financial control: financial control is critically important activity to help the business ensure that the business is meting its objectives.

3.      Financial decision making:  the key aspects of financial deision-making relate to investment financing and dividends. Investment must be financed in some way-however there are always financing alternatives that can be considered.

7.      Differentiate between aggressive approach and conservative approach

Aggressive approach: The aggressive method is where a company predominantly finances all its fluctuating current assets and most of its permanent current assets using short-term source of finance and it is only a small proportion of its permanent current assets that is financed using long-term source of finance. A company that uses more short-term source of finance and less long-term source of finance will incur less cost but with a corresponding high risk. This has the effect of increasing its profitability but with a potential risk of facing liquidity problem should such short-term source of finance be withdrawn or renewed on unfavorable terms.

conservative approach : The other extreme method of financing working capital is where a company decides to use mainly long-term source of finance and very little short-term source of finance to finance its working capital. This option means that the company’s finance is going to be relatively high cost (that is sacrificing low cost finance) but low risk; this will make the company’s profit to be low but does not run the risk of being faced with liquidity problem as a result of withdrawal of its source of finance. The conservative method is where a company predominantly finances all its permanent current assets and most of its fluctuation current assets using long-term source of finance and it is only a small proportion of its fluctuating current assets that is financed using short-term source of finance.

8.      Summarize the effect on a firm liquidity, risk and profitability when the firm holds either high or low level of current assets

Liquidity ratios demonstrate a company's ability to pay its current obligations. In other words, they relate to the availability of cash and other assets to cover accounts payable, short-term debt, and other liabilities. All small businesses require a certain degree of liquidity in order to pay their bills on time, though start-up and very young companies are often not very liquid. In mature companies, low levels of liquidity can indicate poor management or a need for additional capital. Any company's liquidity may vary due to seasonality, the timing of sales, and the state of the economy. But liquidity ratios can provide small business owners with useful limits to help them regulate borrowing and spending. Some of the best-known measures of a company's liquidity include:

Current ratio:Current Assets / Current Liabilities—measures the ability of an entity to pay its near-term obligations. "Current" usually is defined as within one year. Though the ideal current ratio depends to some extent on the type of business, a general rule of thumb is that it should be at least 2:1. A lower current ratio means that the company may not be able to pay its bills on time, while a higher ratio means that the company has money in cash or safe investments that could be put to better use in the business.

Quick ratio (or "acid test"):Quick Assets (cash, marketable securities, and receivables) / Current Liabilities—provides a stricter definition of the company's ability to make payments on current obligations. Ideally, this ratio should be 1:1. If it is higher, the company may keep too much cash on hand or have a poor collection program for accounts receivable. If it is lower, it may indicate that the company relies too heavily on inventory to meet its obligations.

Cash to total assets:Cash / Total Assets—measures the portion of a company's assets held in cash or marketable securities. Although a high ratio may indicate some degree of safety from a creditor's viewpoint, excess amounts of cash may be viewed as inefficient.

Sales to receivables (or turnover ratio):Net Sales / Accounts Receivable—measures the annual turnover of accounts receivable. A high number reflects a short lapse of time between sales and the collection of cash, while a low number means collections take longer. It is best to use average accounts receivable to avoid seasonality effects.

Days' receivables ratio:365 / Sales to receivables ratio—measures the average number of days that accounts receivable are outstanding. This number should be the same or lower than the company's expressed credit terms. Other ratios can also be converted to days, such as the cost of sales to payables ratio.

Cost of sales to payables:Cost of Sales / Trade Payables—measures the annual turnover of accounts payable. Lower numbers tend to indicate good performance, though the ratio should be close to the industry standard.

Cash turnover:Net Sales / Net Working Capital (current assets less current liabilities)—reflects the company's ability to finance current operations, the efficiency of its working capital employment, and the margin of protection for its creditors. A high cash turnover ratio may leave the company vulnerable to creditors, while a low ratio may indicate an inefficient use of working capital. In general, sales five to six times greater than working capital are needed to maintain a positive cash flow and finance sales.

9.      Define

Cash : Ready money. For accounting purposes, cash includes money in the cash pan, petty cash, cash in the locker, bank account balance, customer checks, and marketable securities. It may also include the un-utilized portion of an overdraft facility or line of credit.

Cash management : Cash management is a marketing term for certain services offered primarily to larger business customers.

10.  Describe the three principle motives for business to hold cash

1. Transaction motive

It refers to the demand for money for the current transaction of the people. People hold cash in order to bridge the interval between receipt of income and the expenditure. This amount will depend upon the interval at which income is received. The businessmen and entrepreneurs also will keep a portion of their resource in ready cash to meet the current needs. Keynes calls this as business motive. The amount hold in liquid form will depend upon the business turnover. Transaction demand for money is independent of rate of interest and it will remain constant at a particular level of income.

2. Precautionary motive

It refers to the desire of the public to hold cash balances for meeting unforeseen or unpredictable contingencies such as unemployment, sickness, accidents etc. The amount of money hold under this motive will depend on the nature of individuals’ income.

3. Speculative motive

It refers to the desire to hold one’s resources in liquid form in order to take advantage in market movements regarding future changes in price and rate of interest. There is an inverse relation between rate of interest and people’s tendency to spend money.