5 Financial Management PART I Objectives Functions PART

5. Financial Management PART I: Objectives & Functions PART II: Capital Management PART III: Budgets and accounts PART IV: Introduction and types of Taxes

PART I FINANCIAL MANAGEMENT OBJECTIVES & FUNCTIONS Prof. S. K. Rawat 2

What is Financial Management? o Financial Management is that specialized function of general management, which is related to the procurement of finance and its effective utilization for the achievement of common goal of the organization. o It includes each and every aspect of financial activity in the business. Prof. S. K. Rawat 3

DEFINITION o “Financial Management is the application of the planning and control functions to the finance function. ” function - Howard and Upton. o “Financial Management is the operational activity of a business that is responsible for obtaining and effectively utilizing the funds necessary for efficient operations. ” - Joseph and Massie. Prof. S. K. Rawat 4

RESPONSIBILITIES o o o Financial Planning Raising of Necessary Funds Controlling the Use of Funds Disposition of Profits Wealth Maximization Other Responsibilities: n n Legal Obligations Responsibility to owners Responsibilities of Employees Responsibilities to Customers Prof. S. K. Rawat ial P c n a Fin lan 5

Functions of Financial M… o Financial Forecasting o Establishing Asset-Management Policies o Allocation of Net Profit o Cash Flows and Requirements o Deciding upon Borrowing Policy o Negotiations for New outside Financing o Checking upon Financial Performance Prof. S. K. Rawat 6

Functions of Financial M… o Some of the important incidental finance functions are: o Supervision of cash receipts, disbursements and safeguarding of cash balance. o Proper custody and safeguarding of the important and valuable papers, securities and insurance policies. o Taking care of all mechanical details of financing. o Record-keeping and reporting. o Cash planning and credit management. Prof. S. K. Rawat 7

Objectives of Financial M… q q q Profit Maximization Return Maximization Wealth Maximization Raising of funds To know the assets & liabilities To find out the profit & loss in the business Effective utilization of resources To know the business transactions for a given period Maintaining the transparency Determination and payment of taxes Investment decisions Overall appraisal of the organization Prof. S. K. Rawat 8

PART II CAPITAL GENERATION & MANAGEMENT Prof. S. K. Rawat 9

Capital Management o To start any industry it is necessary to have enough Capital. o Capital is wealth which yield income or helps in production of further income. o No industry can be set up without capital. Prof. S. K. Rawat 10

Nature of Capital o It is a life-blood of a business enterprise. o It is physical resources for production, and money when applied to finance. o Capital covers all the element to start a business. o Capital is the measure of amount of resources of an enterprise. o Capital develops products, keeps workers and machines at work, encourages management to make progress & create value. Prof. S. K. Rawat 11

Types of Capital o Capital are classified in two types: n Fixed or Blocking Capital. n Working or Current or Circulating Capital. Prof. S. K. Rawat 12

Fixed Capital o Fixed capital is required for purchasing fixed assets such as land, buildings, machinery, furniture, equipments etc. o Fixed capital is associated with long term assets. o These assets are not fixed in value; in fact, their value may increase or decrease in course of time. o They are fixed in the sense that without them, the business cannot be carried on. Prof. S. K. Rawat 13

Fixed Capital o Fixed capital is used for meeting the permanent or long-term needs. o The total cost of land, building, machinery & plant gives the amount to be invested in fixed assets. o It has to be raised before the company goes into production. o The amount of fixed capital requirements of a concern depends on: (a) nature of the business, and (b) size of the business unit. Prof. S. K. Rawat 14

Working Capital o Working capital means current assets such as cash, accounts receivables and inventory etc. o For management, working capital is as important as fixed capital. o The fate of most of the business very largely depends upon the manner in which their working capital is managed. o The working capital is required for the purchase of raw materials, and for meeting the day-to-day expenditure on salaries, wages, rents, advertising etc. Prof. S. K. Rawat 15

Working Capital o It is also term circulating capital or revolving capital for working capital. o This is because the working capital is invested, recovered and re-invested repeatedly during the life-time of the company. o Working capital requirements can be met with short-term funds. o Main constituents of working capital are current assets & current liabilities. Prof. S. K. Rawat 16

Working Capital o As long as the business continues, the working capital would be needed repeatedly. o This means that at least a part of the working capital can be called 'regular' or 'fixed' working capital. o The remaining part is known as the fluctuating or variable working capital. o This is needed to meet the requirements of a raise in the volume of production during the peak periods of the year. It can, of course, be met with short-term capital. Prof. S. K. Rawat 17

Sources of Finance o Fixed capital & Working capital are required to start and run an industry. o For purchasing fixed asset and also to meet day-to-day operational expenditure of an enterprise, there must be adequate finance. o So to meet these expenditures, one must know the sources of finance. o The different sources of finance may be (a)Internal & (b)External. Prof. S. K. Rawat 18

Internal Sources of Finance o Retained equity earning. o Personal funds by promoter. o Deferred Taxation. o Depreciation provision. Prof. S. K. Rawat 19

External Sources (Long Term) o Issues of Shares. n Preference Shares. n Ordinary or Equity Shares. n Deferred Shares. o Issue of debentures. o Loans from financial institution: n IFCI, IDFC. n LIC, UTI, etc o Corporate Bonds. Prof. S. K. Rawat 20

External Sources (Medium Term) o Bank Loan. o Public Deposits. o Sale & Lease back. o Profit plough back. F i n a n c i a. Public l I n s Deposits titutes o Special Financial Institutions. Prof. S. K. Rawat 21

External Sources (Short Term) o Bank Credit. o Trade Credit. o Customer Advances. o Money Market. o Instruments. Prof. S. K. Rawat 22

PART III BUDGETS & ACCOUNTING Prof. S. K. Rawat 23

BUDGETS o A budget is a financial or quantitative statement, prepared and approved prior to a period to attain the objectives of organization. o It is a written plan of action for a specific period. o It is used as cost control instrument. o It represents the financial requirement of different department of organization. o It is based on past statistical data & predicts the future requirements. Prof. S. K. Rawat 24

Objectives of Budgets o It helps the management to determine policies. o To provide a method, to check the achievements of organization. o To provide check over expenditure in the various departments. o To help in planning the expansion, development and diversification of organization. o To provide a measure for determining the efficiency of the business. o It provides the basis for expenditure of funds. Prof. S. K. Rawat 25

Budgetary Control o Budgetary control is the tool used to control and plan all the aspects of budget of an organization. o It compares actual performance and the predicted performance of business. o It enables all levels of management to know whether their departments are moving towards the achievements or objectives of the company. o Budgetary control attempts to bring actual performance at par with the predicted performance; and by taking corrective actions if necessary. Prof. S. K. Rawat 26

Types of Budget o Fixed Budget. o Variable Budget. o Functional Budget and o Master Budget. Prof. S. K. Rawat 27

Fixed Budget o It assumes that prediction or forecasting will prove correct in the future. o So no provision is made for any changes that may occur during the budget period. o Budget for R&D department, hospitals and budget of schools & colleges are examples of fixed budget; where a certain fixed amount is set for expenditure. Prof. S. K. Rawat 28

Variable Budget o It deals with unreliability of income or sales prediction. o It makes the provision in advance if any change may occur during the budget period. o Budget for manufacturing of soft drink bottles. o Budget of sugar mill. Prof. S. K. Rawat 29

Contents of Budget Fixed Budget/ Variable Budget Year: 2011 ABC Ltd, Mumbai-71 Particulars 1. Sales Date: 3/01/11 Amount (Rs) Schedule Details 50, 000/- Product A upto 30/11/10 Product B upto 31/12/10 2. Expenses Direct expenses 20, 000/Indirect expenses 6, 500/Other expenses 1, 700/- 3. Profit (1 -2) Product A upto 30/11/10 Product B upto 31/12/10 Product A & B upto 31/12/10 28, 200/21, 800/- Prof. S. K. Rawat Product A & B by 31/12/10 30

Functional Budget o Sales Budget. o Capital Expenditure Budget. o Materials & Purchase Budget. o Cash Budget. o Production Budget. o Labour Budget. o Master Budget. Prof. S. K. Rawat 31

Accounting o Accounting is making record of assets, liabilities, capital invested, cash inflows/outflows & profit gained. It is also referred as Books of Account. o It is recorded in form of statement such as petty cash book, trial balance, profit & loss accounts & balance sheet. o It is based on a double entry system. For every debit, there is a credit. o The net effect of accounting is zero, which results in balancing of books. Prof. S. K. Rawat 32

Purpose of Accounts Prof. S. K. Rawat 33

Purpose of Accounts o Provide information for stakeholders – customers, shareholders, suppliers, etc. o Provides the opportunity for the business to monitor its own activities o Provides transparency to enable the firm to attract investment o Reduces the chance for fraud – not 100% successful!! Prof. S. K. Rawat 34

Profit and Loss Account Prof. S. K. Rawat 35

Profit and Loss Account o Shows the flow of sales and costs over a period o Shows the level of profit or loss made during the period o Shows what has been done with the profit or loss Prof. S. K. Rawat 36

Profit and Loss Account Consolidated Profit & Loss Account for the year ended 2003 2002 2001 Weeks 52 52 52 Currency Rs Rs Rs Turnover 7688. 0 8340. 0 9278. 0 Cost of sales -7263. 0 -8291. 0 -8757. 0 Gross Profit 425. 0 49. 0 521. 0 Operating Expenses -130. 0 -137. 0 -77. 0 Operating Profit 295. 0 -88. 0 444. 0 95. 0 166. 0 -68. 0 Profit before interest and taxation 390. 0 78. 0 376. 0 Net interest receivable (payable) -255. 0 -278. 0 -226. 0 Profit on ordinary activities before taxation 135. 0 -200. 0 150. 0 Tax on profit on ordinary activities -50. 0 -71. 0 -69. 0 Profit on ordinary activities after taxation 85. 0 -129. 0 81. 0 Equity minority interests -13. 0 -14. 0 Profit for the financial period 72. 0 -142. 0 67. 0 Other costs/income Dividends Retained profit 0. 0 72. 0 Prof. S. K. Rawat -193. 0 -142. 0 -126. 0 Profit and Loss Gross Operating Profit = Ltd. Subtract tax. ABC due to Account for Final section called turnover Expenses – cost theof Dividend the get profit–– on ‘appropriation Operating Net sales fixed costs share of theor profit ordinary account’ – shows Profit = Gross profit returned toafter Subtract costs activitiesother – operating where the costs shareholders and tax expenses profit/loss isthe going incurred to–get profit Turnover Subtract Retainedinterest Profit – before tax revenue earned over payments/receipts the amount kept the year to get profit on back for future Cost of Sales – the ordinary activities investment, etc. variable costs, how before much it tax cost the firm to produce what it has sold – not to be confused with sales revenue! 37

Balanced Sheet Prof. S. K. Rawat 38

Balanced Sheet o Balance Sheet is a statement, which shows assets, liabilities and capital invested in the business on a particular date. o Left hand side shows total liabilities. o Right hand side shows total assets of the business. o Balance sheet is not for a specific period, but it shows the health of business from day one to the date when balance sheet is prepared. Prof. S. K. Rawat 39

Format of Balanced Sheet Liabilities & Equity Rs. (Cr) Assets Rs. (Cr) Current liabilities: Creditors expenses Creditors for trade Bills Payable Bank Overdrafts 20. 00 5. 00 Current assets: Cash in hand Cash at bank Bills Receivable Debtors Inventory 25. 00 Long term liabilities: Long term loan Mortgage property 20. 00 10. 00 Investments: 15. 00 Owners Equity: Capital Retained Profits 60. 00 50. 00 10. 00 Fixed assets: Furniture Plant & Machinery Building Land Good will 60. 00 10. 00 15. 00 Total Liabilities 100. 00 Total Assets 100. 00 Prof. S. K. Rawat 40

PART IV Taxes & Taxes Registration Prof. S. K. Rawat 41

INTRODUCTION TO TAXES o Taxes are the compulsory payment which is given to the government by the public. o Taxes are the important sources of government funds. o It helps the government to distribute the national income equally among the needy people of the country through various schemes. o Tax is the important tool in the hands of government to bring rapid economic development of the country & to facilitate equal distribution of wealth. Prof. S. K. Rawat 42

TYPES OF TAXES DIRECT TAXES q Income tax q Wealth tax q Property tax…. etc. INDIRECT TAXES q Service tax q Sales tax q Vat q Excise duty q Custom duty etc.

MAIN TAXES & DUTIES o INCOME TAX (except tax on agricultural income, which the State Governments can levy), o VAT (value added taxes) o Central Excise and Sales Tax (CST) o Service Tax (tax levied on service provided )

SERVICE TAX What is Service tax? q Service tax is an indirect tax levied under the Finance Act, 1994, as amended from time to time, on specified services. q At present, there approximately 96 categories (including 15 new services introduced by Budget 2006) of net services taxable under the service tax.

EXCISE DUTY o WHAT IS EXCISE DUTY Excise duty is an indirect tax levied and collected on goods manufactures in India.

CUSTOM DUTY ü Custom Duty Is A Tax Which A State Collects On Goods Imported Or Exported Out Of The Boundaries Of The Country ü In India, Custom Duties Are Levied On The Goods And At The Rates Specified In The Schedules To The Custom Tariff Act, 1975

OBJECTIVES OF CUSTOM DUTIES o Restricting Imports For Conserving Foreign Exchange o Protecting Indian Industry From Undue Competition o Regulating Exports o Prohibiting Imports And Exports Of Goods For Achieving The Policy Objectives Of The Government o Coordinating Legal Provisions With Other Laws Dealing With Foreign Exchange

Types of custom duties o Basic duty o Addition duty o Anti-dumping duty o Export duty o Protective duty

SALES TAX o Sales tax is a tax on the supply of goods and certain services , it is charged at the time of sale and then deposited in the Government treasury.

WHAT TYPES OF BUSINESS ARE NOT LIABLE FOR SALES TAX? o Agricultural Products o Most Of Pharmaceutical Products o Educational & Scientific Materials o Equipment For Fighting AIDS & CANCER

VAT o Vat Means Value Added Tax o Vat Paid By Dealers On Their Purchases Is Usually Available For Set-off Against The Vat Collected On Sales.

IS VAT YET ANOTHER TAX It Replaces The Following Existing Taxes: o The Bombay Sales Tax Act, 1959 o The Maharashtra Sales Tax On The Transfer Of Right To Use Any Goods o Bombay Sales Of Motor Spirit Taxation Act, 1958

BENEFIT OF VAT o It Is Simple, Transparent And Progressive o Business Friendly System Of Taxation o Reduction In The Number Of Tax Rates To Only Two Main Rates – 4% And 12. 5% o Reduction In The Effective Tax Rate For Many Goods o Elimination Of “Tax On Tax” Existing In The Sales Tax System o Simplification Of Tax Forms And Procedures

TYPES OF BUSINESS ARE LIABLE FOR VAT? VAT APPLIES TO ALL TYPES OF BUSINESS INCLUDING: o o o Importers Manufacturers Distributors Wholesalers Retailers Works Contractors

RATE OF VAT? Under The Vat, The Tax Rates Have Been Simplified: o 4% For Items Consisting Mainly Of Raw Materials Used In The Manufacturing Process o 12. 5% For All Goods Unless They Are Listed Under The Other Rates. o Food grains Including Pulses, Milk, Vegetables Books are Not Subject To Vat.

EXAMPLE on VAT Raw Material Producer Sale Price Rs. 1, 000 Vat Rs. 100 Manufacturer Sales Price Rs. 1, 500 Total Vat Rs. 150 Vat Payable 150 -100=50 Consumer Wholesaler Sales Price Rs. 1, 800 Total Vat Rs. 180 Vat Payable 180 -150=30 Retailer Sales Price Rs. 2, 000 Total Vat Rs. 200 Vat Payable 200 -180=20

INCOME TAX o “An income tax is tax levied on financial income of person cooperation or other legal entity. ”

BASIS OF INCOME TAX o o o o Personal Earnings May Be Strictly Defined Capital Gains May Be Taxed When Realized Business Income Rates For Different Types Of Income May Vary Tax Rates May Be Progressive, Regressive, or Flat A Progressive Taxes Differentially Based On How Much Has Been Earned o Personal Income Tax Is Often Collected On A Pay-asyou-earn Basis

INCOME TAX INCOME When Computed? Assessment Year TAX What Is Income? Whose Income? Income Of Every Person Income Of What Period? Income Of “Previous Year” Income How Computed? Income Computed According To Provisions Of Income Tax Act At What Rate? Rate Laid Down In Annual Finance Act I. E Budget Payable By Whom? Payable By Assessee

INCOME TAX RATES ACROSS THE WORLD Country Personal Income Tax Rate Australia 0% - 48. 5% Canada 16% - 29% Estonia 24% - 24% Denmark 44% - 63% Hong Kong 0% - 33% India 0% - 33% Israel 10% - 49% Malaysia 0% - 29% Mexico 3% - 32% Russia 13% - 13% Singapore 0% - 22% Uk 0% - 40% US 10% -35%

INDIVIDUAL INCOME TAX q Income Tax On Salary q Income Tax On House Property q Income Tax On Pension q Income Tax On Capital Gains q Income Tax Upon Income From Business Or Professions

INDIVIDUAL INCOME TAX RATES