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CORPORATE FINANCE
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Corporate finance
Every decision that a business makes
has financial implications, and any decisionwhich affects the finances of a business is
a corporate finance decision.
Defined broadly, everything that a
business does fits under the head of
corporate finance.
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CORPORATE FINANCE Corporate Finance deals with the financial
aspects of a corporate enterprise, right from thestage of promotion of the organization.
includes administration during initial stages,
stages of growth and expansion. deals with financial restructuring during financial
crisis.
includes financial environment, strategies offinancial planning, financial markets, capital
formation &financial institutions.
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Corporate Finance & Other Functions
Finance is omnipresent and is intimatelyassociated with other functions in an
organization.
Finance is related to marketing ,purchasefunction, Production function, personnel
function,
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Organization of the Finance
Function
Shareholders
Board of Directors
Managing Director
Production Chief Marketing Chief Finance Chief Human Resources Chief
Financial Controller Treasurer
- Annual Reports - Cash Management
- Budgeting - Credit/Receivables Mgt - Tax Management - Banking Relations
- Internal Audit - Funds & Securities
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Objectives of Financial Management
Financial Decisions
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The Core Principles of Finance
Time value of money.
Compensation for risk
Dont put your eggs in one basket.
Markets are smart
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WORKING CAPITAL MANAGEMENT
Capital required for a business can beclassified under two main heads:
i. Fixed Capital
ii. Working Capital
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An inefficient management of working
capital leads to not only loss of profits but
also to the closure of the business firm
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There are two concepts ofWorking capital
namely,
1. Gross Working Capital (GWC) 2. Net Working Capital (NWC)
NWC can be +ve or ve.
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Components ofWorking Capital
Constituents ofCurrent Assets in the order ofdecreasing liquidity
1. Cash and bank balance
2. Investments (marketable securities)3. Government securities (other than for long term
purpose )
4. Fixed deposits with banks (maturing within one year)
5. Receivables arising out of sales6. Inventories:
a. Raw materials b. Work-in-process c. Stores andspares d. Finished goods
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7. Advance payment for tax8. Pre-paid expenses
9. Advances for purchase of raw materials,
components and consumables10.Deposits kept with public bodies for
normal business operation maturing
within the normal operating cycle11.Money receivable from contracted sale
of fixed asset during the next 12 months
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Constituents ofCurrent Liabilities
1. Short term borrowings
3. Public deposits maturing within one year
4. Sundry creditors (trade) for raw materials andconsumable stores and spares
5. Interest and other charges due for payment
6. Advance/Progress payments from customers 7. Deposits from dealers, selling agents etc.
8. Instalments on term loans, deferredpayments,debentures and long term deposits payable
within one year
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9. Statutory liabilities:
a. Provident fund dues b. Provision fortaxation c. Sales tax, excise
d. Statutory obligations towards workers
10.Miscellaneous current liabilities:
a. Dividends b. Liabilities for expenses c.
Gratuity payable within one year d. Any other payment due within 12
months
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Significance of Working
Capital
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The Cash Conversion Cycle
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Level ofCurrent Assets
The level of investment in current assets
determines the working capital policy. Abusiness firm can adapt any of the
following working capital policies:
1. Conservative working capital policy 2. Aggressive working capital policy
3. Moderate working capital policy
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Conservative approach
Under this the firm carries high investment incurrent assets such as cash, marketable
securities and carries large amount of
inventories and grants generous terms of credit
to customers resulting in a high level of debtors.
consequences of conservative working capital
policy are quick deliveries to customers and
more sales due to generous credit terms.
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Aggressive working capital policy
.
Under Aggressive working capital policy, investment in current
assets is very low. The firm keeps less amount of cash and
marketable securities, manages with less inventories and tight
credit terms resulting in low level of debtors. The consequences
of aggressive working capital policy are frequent production
stoppages, delayed deliveries to customers and loss of sales.
A trade off between two costs namely carrying cost and
shortage cost determines the optimal level of current assets.
Costs that rise with current assets i.e. that cost of financing a
higher level of current assets form carrying costs. Shortage costs are in the form of disruption in production schedule, loss of
sales and loss of goodwill.
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The optimum level of current assets is
denoted by the total costs (= carrying
costs + shortage costs) minimized at that
leve
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Working capital financing strategies
After determining the level of current
assets, the firm must determine how these should be financed.
Investment in current assets can be
broken into two parts 1. Permanent current assets
2. Temporary current assets
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A firm requires a certain amount of current
assets to meet even the minimum level of
sales where as temporary current assets
reflects a variable component that moves
in line with seasonal fluctuations.
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Several strategies are available for
financing capital requirements.
Graph
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Capital requirements and their financing
The fixed proportion of working capital
should be generally financed from the
fixed capital sources while the temporary
or variable working capital requirements of
a firm may be met from the short term
sources of capital. Based on this idea, we have 3 strategies possible.
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Strategy A
Long term financing is used to meet fixedasset requirement as
well as peak working capital requirement.When the working
capital requirement is less than its peak
level, the surplus is invested in liquid assets(cash &
marketable securities)
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Strategy B
Long term financing is used to meet fixed assetrequirements,
permanent working capital requirement, and aportion of
fluctuating working capital requirement.
During seasonal upswings, short term financingis used.
During seasonal downswings, surplus isinvested in liquid
assets.
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Strategy C
Long term financing is used to meet fixed
asset requirement and permanent working capital
requirement. Short term
financing is used to meet fluctuatingworking capital requirement.
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Integrated Working Capital Policy
Working capital requirement of a firm isdetermined by
considering two questions in mind. 1.What should be the level of current assets in
relation to
sales?
2.What should be the ratio of long term andshort term
financing?
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Current Asset Policy
Question 1 tell us what should be the level of current assets to
be maintained by the firm and hence it gives rise to three types
of current asset policy namely
a. Conservative approach : is carrying more amount of current
assets in relation to sales which results in more carrying costs,
relaxed credit terms and period and hence less turnover.
b. Moderate approach : is always maintaining required amount
of current assets depending upon sales.
c. Aggressive Approach :is managing with less current assets in
relation to sales and hence may result in more turnover, stringent credit terms and may lead to loss of customer
goodwill and low liquidity.
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Graph
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Current Assets Graph
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Current financing policy
Question 2 is about how the currents should be
financed,either long term or short term financing.
Current assets being financed using long term
funds namely Equity shares, Debentures results
in more costs of capital and relatively less profits
whereas short term financing namely short term
loans from banks and financial institutions,
overdrafts, trade credit, commercial paper etc.
results in more profits and relatively less costs
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A judicious mix of Current Asset policy and
Current Asset Financing Policy gives rise
to an integrate Working Capital policy.
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Current Asset Policy
Aggressive C
Moderate
Working Capital
Policy
Conservative
Working Capital
Policy
Aggressive
Working
Capital
Policy
Moderate
Working Capital
Policy
Current Asset Financing
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AggressiveWorking capital is a mix of Aggressive Current
Asset policy and Aggressive Current Asset Financing Policy.
Firms with short operating cycle can adopt this policy generally.
ConservativeWorking capital is a mix of Conservative Current
Asset policy and Conservative Current Asset Financing Policy.
Firms having long operating cycle namely manufacturing
companies can adopt this policy to decouple production and
distribution.
ModerateWorking capital is a mix of Aggressive Current Asset
policy and ConservativeCurrent Asset Financing Policy or a mix of
Conservative Current Asset policy and Aggressive Current AssetFinancing Policy.
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Sources for Financing Working Capital
Sources ofWorking Capital
(i) Permanent or Fixed (ii) Temporary or variable
1.Shares 1.Commercial banks
2.Debentures 2.Indigeneous bankers 3.Public deposits 3.Trade Creditors
4.Ploughing back of 4.Instalment Credit
profits
5.Loans from Financial 5.Advances
Institutions
6.Accounts Receivable-Credit/Factoring
7.Accrued Expenses
8.Commercial Paper
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