FINANCIAL MANAGEMENTTheory and Practice

FINANCIAL MANAGEMENTTheory and Practice

SATISH B. MATHURPh.D. (Business Management), CAIIB.

Mentor, Mathur Management Consultants, (MMC), LucknowFormer Professor of Finance and AccountingIndian Institute of Management, Lucknow, (IIML),

Administrative Staff College of India, (ASCI), Hyderabad, and State Bank Staff College, (SBSC), Hyderabad, India

With a Foreword by

DR. C. RANGARAJANChairman, Economic Advisory Council to the Prime Minister

Government of India, New Delhi, (India)Former Governor, Reserve Bank of India, Mumbai, and

Governor, Andhra Pradesh, Hyderabad

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FINANCIAL MANAGEMENT: THEORY AND PRACTICE

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Bran

ches

To

my Students

for their inspiration

and

my Wife, Meera Mathur,

and my Daughters,

Archana Mathur

and

Kartika Mathur

for their sustained support

FOREWORD

Financial Management is critical to the succes of any organization. It is all the more so in the case of business organizations, since almost all decisions taken have financial implications. It becomes, therefore, imperative for all executives in a business organization to acquire a fairly good knowledge of the fundamental principles of financial management and control.

Several books by Indian and foreign authors on the subject are available in the market. However, not all of them are reader-friendly. Dr. Satish B. Mathur’s ‘Financial Management : Theory and Practice’ is an exception. It is written in a conversational style. The narrative is lucid. Difficult and complex topics like analysis and interpretation of financial statements, management and control of working capital, classification and control of costs and cost-volume-profit analysis are presented in a manner that readers may go through them with ease and sustained interest. In writing the book, the author has brought to bear on it his personal experience as a senior executive with the State Bank of India for almost three decades. As a senior faculty at the Indian Institute of Management, Lucknow, he knows what the requirements of students are.

I congratulate Dr. Mathur on his endeavour to produce a book covering the basic and essential aspects of financial management and control. I am sure that the book will be widely used by students and faculty in academic institutions as well as practising executives in industry and financial institutions.

(C. Rangarajan)

My friends, colleagues and well-wishers, in banks, industries and academia, and the top and senior executives of banks and industries, participating in my Management Development Programmes (MDPs), and the PGP students at the Indian Institute of Management, Lucknow, have been persuading me, to venture into writing a comprehensive book on ‘Financial Management’, in the Indian context and conditions, citing suitable illustrative live cases and examples, drawn from Indian experiences. They were, perhaps, thinking that, with my vast and varied experience as a professional banker with the State Bank of India for around three decades, in several senior positions, I may be able to do full justice to the subject.

In fact, their such a high opinion of, and expectation from me, had been more a deterrent, rather than a facilitating factor, in my daring to take up such a demanding endeavour on my part. Besides, my varied experience and widespread knowledge in the area had made me feel that the task was rather too stupendous, difficult and demanding, even to make a humble beginning in this direction. But then, it took me long precious time to realise that howsoever long and difficult a journey may be, it can be completed only after taking the first step; that is, when a small beginning is made. Thus, the hard and hefty, concerted and concentrated efforts, made in the right direction, and in right earnest, have made it possible for me to place the book, my humble work, before you.

A book, like one’s own baby, is invariably the most beloved and beautiful one to its author. But then, the real judges are, definitely and decidedly, the readers themselves. And, if they would think that the book has presented the difficult and dull subject like ‘Financial Management’ in a quite easy-to-understand, interesting and entertaining manner, I would think that my sincere endeavour was worth the effort. And, if the readers, the students (of B.Com. and M.Com., MBA and PGP, degrees and diplomas), the Chartered Accountants, the professional and practising bankers and industrialists, experience that, while reading the book, they tend to feel as if the author had personally been talking to them, instead, on a one-to-one basis, I would sincerely thank them all, and think that my sincere and strenuous efforts have been amply rewarded. I sincerely feel that even the practising professionals of commercial banks and industries may find the book quite relevant for reference and refreshing purposes.

A summary, containing the essence of each Chapter at its end, may be found very useful and handy for the students at the time of their examination. Even the Professors, teaching the subject, may find the synopsis immensely useful for preparing the required transparencies or slides on Power-Point Software, for use in their lecture sessions. I earnestly solicit valuable suggestions from my worthy readers, for bringing in further improvements in the next edition of the book.

Satish B. Mathur

PREFACE

At the very outset, I must thank my friends and colleagues in banks and academia, and the top and senior executives of industries and banks, who participated in my Management Development Programmes (MDPs), and the PGP students at the Indian Institute of Management, Lucknow, for their persistent persuasion and encouragement, which made it possible for me to write the book on the subject.

I am immensely grateful to Meera Mathur, my wife, for her self-less sacrifice and support, and valuable views, from time to time. My hearty gratitude is due to my lovely dear daughters – Archana Mathur and Kartika Mathur, for their free and frank opinion, and constructive suggestions, which have gone a long way in making the book so very reader-friendly, lucid and easy-to-understand, even by non-experts and non-finance executives, in the business and industry. I am greatful to the publisher for timely publication this book.

Satish B. Mathur

ACKNOWLEDGEMENTS

CONTENTS

Foreword by Dr. C. Rangarajan ............................................................................................................................vii

Preface .....................................................................................................................................................................ix

Acknowledgements .................................................................................................................................................xi

Part I: FINANCIAL ANALYSIS

1. Financial Management and Control: An Overview 3–12 Introduction .................................................................................................................................................4 Facets of Financial Management ...............................................................................................................4 Historical Perspective .................................................................................................................................5 Deep Depression of the 1930s.....................................................................................................................6 Financial Management as a Distinct Discipline .......................................................................................6 Vital Functions of Financial Management ................................................................................................7 Roles and Responsibilities of Internal Auditors ........................................................................................8 Summary ...................................................................................................................................................10 Review Questions .......................................................................................................................................11

2. Financial Statements 13–26 Introduction ...............................................................................................................................................14 Components of Financial Statements ......................................................................................................14 Basic Concepts and Conventions .............................................................................................................16 Basic Concepts Pertaining to ‘Balance Sheet’ .........................................................................................16 Basic Concepts Pertaining to ‘Profit and Loss Account’ or ‘Income Statement’ ...................................18 Format of Balance Sheet ..........................................................................................................................20 Interpretation of Balance Sheet ..............................................................................................................21 Summary ...................................................................................................................................................23 Review Questions .......................................................................................................................................25

3. Balance Sheet 27–58 Introduction ..............................................................................................................................................28 Liabilities (Sources of Funds) ..................................................................................................................28

xiv FINANCIAL MANAGEMENT: THEORY AND PRACTICE

Share Capital ............................................................................................................................................28 Equity Share (Ordinary Share) Capital...................................................................................................28 Some Terminologies ..................................................................................................................................28 Some Other Terminologies .......................................................................................................................31 Issuing of Shares .......................................................................................................................................33 Preference Share Capital ..........................................................................................................................34 Types of Preference Shares ......................................................................................................................35 Reserves and Surplus ...............................................................................................................................37 Secured Loans ...........................................................................................................................................39 Types of Secured Loans ............................................................................................................................40 Equitable Mortgage ..................................................................................................................................45 Unsecured Loans .......................................................................................................................................46 Current Liabilities and Provisions ...........................................................................................................47 Fixed Assets ..............................................................................................................................................48 Investments ...............................................................................................................................................48 Current Assets ..........................................................................................................................................49 Miscellaneous Expenses and Losses ........................................................................................................51 Summary ...................................................................................................................................................51 Review Questions .......................................................................................................................................56 Practise Problems ......................................................................................................................................57

4. Profit and Loss Account 59–74 Introduction ...............................................................................................................................................60 Items Reported in Profit and Loss Account .............................................................................................60 Profit and Loss Appropriation Account ...................................................................................................64 Cash Profit .................................................................................................................................................65 Summary ...................................................................................................................................................66 Review Questions .......................................................................................................................................67 Appendix 4.1: Economic Value Added (EVA)...........................................................................................68

5. Evaluation of Financial Performance through Ratio Analysis Techniques 75–82 Introduction ...............................................................................................................................................76 Reclassification of Assets and Liabilities.................................................................................................76 Computation of Ratios ..............................................................................................................................78 Analysis and Interpretation of the Ratios ...............................................................................................79 Review Questions .......................................................................................................................................82

6. Evaluation of Financial Performance through Ratio Analysis Techniques: Case Studies with Suggested Approaches 83–108 Introduction ...............................................................................................................................................84 Case Study—I: Light Motor Vehicles Limited .........................................................................................85 Case Study—II: Videsh Vyapar Nigam Limited .....................................................................................98

CONTENTS xv

7. Sources and Application (Uses) of Funds Statements 109–128 Introduction .............................................................................................................................................110 Components of Sources and Application of Funds ................................................................................110 Rationale behind Excluding Cash ..........................................................................................................111 Case Studies with Suggested Approaches .............................................................................................112 Case Study I: Rashtriya Chemicals Limited (RCL) ...............................................................................113 Case Study II: Reliable Automobiles Ltd. (RAL) ..................................................................................119 Case Study III: Puja Paints Ltd. (PPL) .................................................................................................122 Summary .................................................................................................................................................125 Review Questions .....................................................................................................................................125 Practise Problems ....................................................................................................................................125

Part II: FUND-BASED WORKING CAPITAL MANAGEMENT AND CONTROL

8. Working Capital Management and Control: An Overview 131–138 Introduction .............................................................................................................................................132 Working Capital Management ...............................................................................................................132 Operating Cycle Approach ......................................................................................................................132 Importance of Working Capital Management .......................................................................................132 Assessment of Working Capital Requirements and Formulation of Working Capital Policies .........133 Sources of Working Capital Financing (Short-Term and Long-Term Sources of Funds) ...................134 Working Capital Financing by Banks ....................................................................................................134 Management of Credit Risks ..................................................................................................................134 Effective Supervision and Follow-Up of Advances ................................................................................134 Non-Fund Based Working Capital Finance ..........................................................................................135 Conclusion ...............................................................................................................................................135 Summary .................................................................................................................................................135 Review Questions .....................................................................................................................................136

9. Working Capital Policy 139–154 Introduction .............................................................................................................................................140 Components of Working Capital Management .....................................................................................140 Working Capital Management vs Project Management .......................................................................141 Special Features of Current Assets........................................................................................................141 Synergy of Team Spirit ...........................................................................................................................142 Factors Affecting Working Capital Requirements ................................................................................143 Optimal Level of Current Assets ............................................................................................................145 Working Capital Financing Policy .........................................................................................................146 Operating Cycle and Cash Cycle ............................................................................................................149 Time-Series Analysis vs Cross-Section Analysis ...................................................................................150 Summary .................................................................................................................................................151 Review Questions .....................................................................................................................................152 Practise Problems ....................................................................................................................................154