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8/13/2019 Gravity India

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C H A P T E R1

INTRODUCTIONFINACNEA concept

It would be worthwhile to recall what Henry Ford once remarked: Money is an arm or a

leg. You either use it or lose it. This statement though apparently simple, is quite

meaningful. It brings home the significance of money or finance. In the modern money oriented economy finance is one of the basic foundations of all kinds of economic activities.

It is the master key which provides access to all the sources for being employed in

manufacturing and merchandising activities. The Sanskrit saying Arthah Sachivah,which

means finance reigns supreme, speaks volumes for the significance of the finance

function of an organization.

It has rightly been said that Business needs Money to make more money.

However, it is also true that money begets more money, only when it is properly managed.

Hence, efficient management of every business enterprise is closely linked with efficient

management of its finances. In conclusion we can say that: Finance is regarded as The life

blood of a business enterprise. Finance is the backbone of every business.

MEANING OF FINANCE AND BUSINESS FINANCE:-Finance is one of the major elements, which activates the overall growth of the economy.

Finance is the lifeblood of the economic activity.

Finance is the application of skills for manipulation use and control of money. The term

Business finance kindly involves rising of funds and their effective utilization keeping in

view the overall objectives of the firm.

Business Finance explains the two terms. They are Business and Finance. In

common speaking the word Business is used to denote merchandising the operation of

some sort of a shop or store, large or small.

Business Finance is that business activity which is concerned with the acquisition andconservation of capital funds in meeting financial needs and overall objectives of a business

enterprise.

DEFINITIONS:-According to Bonneville and Dewey, Financing consists in rising, providing and

managing of all the money or funds of any kind used in connection with the business.

According to Prather and Wert, Business Finance deals primarily with raising

administrating and distributing funds by privately owned business units operating in non-

financial fields of industry.

According to H.G. Gathman and H.E. Dougall, Business Finance can be broadly

defined as the activity concerned with planning, raising, controlling and administrating offunds in the business.

FUNCTIONS OF BUSINESS FINANCE:-Finance functions can be classified into two types. They are

Recurring Finance Function and Non-Recurring Finance Function.

Recurring Function -Recurring finance function encompasses all such financial activities as are carried out

regularly for the efficient conduct of a firm. Planning of funds, placing of funds, allocation of

funds, income and controlling the uses of funds are the contents of recurring finance function.

a) Planning of fundsb) Rising of funds


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c) Allocation of fundsd) Allocation of incomee) Control of funds

NonRecurring FunctionIt refers to the use of financial activities that a functional activity has to prefer very

infrequently, preparation of financial plan at the time of promotion of the company. The

financial readjustment is done at the time of liquidity crisis and valuation of the firm at the

time of merger.

Successful handling of such problems requires financial skills & understanding of

principle & techniques of finance recurring to non-recurring situation.

Meaning of Financial Management:Financial Management is the specialized functions directly associated with the top

management. The significance of this function is not only seen in the Line but also in the

capacity of Staff in the overall administration of a company.

The management makes uses of various financial techniques, devices etc, foradministrating the financial assets of the firm in the most effective way. Financial

management includes Anticipating Financial Needs, Acquiring Financial Resources and

Allocating Funds in Business (i.e. Three As of financial management).

Definitions of Financial Management:-According to Joseph and Massie, Financial Management is the operational activity of

a business i.e. responsible for obtaining and effectively utilizing the funds necessary for

efficient operation.

According to Archer and Ambrosia, Financial Management is the application of the

planning and control functions to the finance function.

Objectives of Financial Management:-The objectives of financial management are Profit maximization and Wealth

maximization.

1) Profit Maximization:Financial management is concerned with efficient use of improved resources, mainly capital

funds. Profit maximization is a term which denotes the maximum profit to be earned by an

organization in a given time period. Earnings Profits (OR) Profit Maximization by a company

is a social obligation. Profit is the only means through which an efficiency of an organization

can be measured.

Points in Favour to Profit Maximization:-a) Profit is a barometer through which the performance of business unit can be

measured.

b) Profit enables the business to face risk.c) It ensures to maximize welfare of shareholders, employees and prompt management

to creditors as a company.

d) Profit maximization increases the confidence of management in expansion anddiversification of programmes of a company.

e) Profit attracts investors to invest their savings in securities.


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f) Profit indicates the efficient use of funds for different requirements.Points against Profit Maximization:-a) Profit maximization does not consider the elements of risk.

b) Profit is not a clear term, it may be accounting profit, economic profit, profit beforetax, profit after tax, net profit, gross profit or Earnings per share.

c) It encourages corrupt practices to increase the profits.d) It does not consider the impact of time value of money.e) The true and fair picture of the organization is not reflected through profit

maximization.

f) Profit maximization attracts cut-throat competition.g) Huge amount of profit attracts government intervention.h) It is a narrow concept, later it affects the long-term liquidity of a company.2) Wealth Maximization:

Wealth maximization is also called value maximization. It refers to the gradual growth of the

value of assets of the firm. It is the net present value of a financial decision. Any financialaction results in positive NPV, creates wealth to the organization. If NPV is negative, it

reduces the existing wealth to the shareholders.

Wealth maximization symbolically, it is expressed as W = NP

W = Wealth of the firm

N = Number of shares owned

And P = Price per share in the market.

The goal of financial management may be such that they should be beneficial to

owners, management, employees, customers, their goals is achieved only by maximizing the

value of the firm.

Points in Favour of Wealth Maximization:-a) It is a clear term. Here, the present value of cash flows is taken into consideration.

b) It considers the concept of time value of money. The present values of cash inflowsand outflows help management to achieve the overall objective of a company.

c) The concept of wealth maximization is universally accepted, because, it takes care ofinterest of financial institution, owners, employees and society.

d) It guides the management in framing consistent strong dividend policy to reachmaximum returns to the equity holders.

Points against Wealth Maximization:-

a)

The objective of wealth maximization is a prescriptive but not descriptive.b) The objective of wealth maximization faces some difficulties between owners andshareholders, there will be some conflicts.

Functions of Financial Management:-1. Profitability2. Diversification3. Growth4. Survival5. Market Share6. Minimum Cost7. Huge Competition.


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MEANING OF FINANCIAL ANALYSIS:-One of the important steps of accounting is the analysis and interpretation of the

financial statements which results in the presentation of data that helps various categories of

persons in forming opinion about the profitability and financial position of a business

concern.

The most important objective of the analysis and interpretation of financial statementsare to understand the significance and meaning of financial statement data to know the

strength and weakness of a business undertaking, so that a forecast may be made of the

prospects of the undertaking. It also establishes strategic relationship between the items of the

balance sheet, profit and loss account and other operative data.

Definition of Financial Analysis:According to Myres, Financial statement analysis is largely a study of relationship

among the various factors in a business as disclosed by a single set of statement and a study

of the trend of these factors as shown in a series of statements.

FINANCIAL STATEMENTS:-A financial statement is an organized collection of data according to logical and

consistent accounting procedures. Its purpose is to convey an understanding of some financial

aspects of a business firm. It is a way to show a position at a moment of time as in the case of

balance sheet, or sometimes it reveals a series of activities over a given period of time, as in

the case of income statement.

Therefore, the term financial statement generally refers to two basic statements, such

as Income statement and Balance Sheet. Apart from these two statements, a company may

also prepare a statement of retained earnings and statement of changes in financial position.

Definition:-Financial statement is a schedule or a report which is prepared at the end of financial

year by an accountant to reveal the financial positions of the enterprise which shows the

result of its recent activities and an analysis of what has been done with earning.

OBJECTIVES OR USES OF FINANCIAL ANALYSIS:-Financial analysis is helpful in assessing the financial position and profitability of a

concern. The following are the main objectives of analysis of financial statements:

1. To identify the reasons for change in the profitability position of the firm.2. To judge the present and future earning capacity or profitability of the concern.3. To find out the relative importance of different components of the financial position

of the firm.

4.

To judge the operational efficiency as a whole and of its various parts or departments.5. To assess the short as well as long-term liquidity position of the firm for the benefit ofthe debenture holder and trade creditors.

6. To have comparative study in regard to one department with another department.7. It helps in assessing developments in the future by making forecasts and preparing

budgets.

8. It helps in prediction of bankruptcy and failure.9. To provide decision makers information about a business enterprise for use in

decision making.

PROCESS OF FINANCIAL ANALYSIS:-

The analysis of financial statements is a process of evaluating the relationshipbetween component of financial statements to obtain a better understanding of the firms


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position & performance. The functional analysis is the process of selections, relation &

evaluation.

1) The first task of the financial analyst is to select the information relevant to the decision

under consideration from the total information contained in the financial statements.

2) The second step is to arrange the information in a highlight significant relationship.

3) The final step is interpretation & drawing of inferences & conclusions.

TYPES OF FINANCIAL ANALYSIS:-

On the basis of nature of the analysis:-a) External analysisIt is made by those persons who are not connected with the enterprise. They do not have

access to the detailed record of the company and have to depend mostly on published

statements. Such type of analysis made by investors, credit agencies, government agencies

and research scholar.

b) Internal analysisIt is made by those persons who have access to the books of accounts. They are the

members of the organization. Analysis of the financial statements or other financial data for

managerial purpose is the internal type of analysis. The internal analyst can give more

reliable result than the external analyst because every type of information is at his disposal.

On the basis of objectives of analysis:-a) Long-term analysisIt is made in order to study the long-term financial stability, solvency, liquidity,

profitability, (or) Earning capacity of a business concern. The purpose is to know whether in

the long run the concern will be able to earn minimum amount which will be sufficient to

maintain a reasonable rate of return on the investment so as to provide the funds required for

modernization, growth, and development of business and to meet its cost of capital. It also

helps in long-term financial planning.

b) Short-term analysisIt is made to determine short-term solvency, stability, liquidity and earning capacity of a

business. The purpose of this analysis is to know whether in the short run a business concern

will have adequate fund, readily available to meet its short-term obligation, so, it helps for

short-term financial planning.

On the basis of models operated by analysis:-a) Horizontal (or) Dynamic analysisIt is made to review and analyze financial statement of number of years. It is useful for

long-term trend analysis.

b) Vertical (or) Static analysisIt is made to review and analyze the financial statement of one particular year only, for

example ratio analysis.

TECHNIQUES OF FINANCIAL NANLYSIS:-The analysis and interpretation of financial statement is used to determine the

financial position and operation as well. A number of techniques are used to study therelationship between different statements. The following methods of analysis are used:


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Comparative Financial Statements:The comparative financial statements are statements of the financial position at different

periods of time. The elements of financial position are shown in a comparative form so as to

facilitate easy comparison. Both the Income statement and Balance sheet can be prepared in

the form of comparative financial statements.

Comparative Income Statements:The income statement discloses net profit or net loss or account of operations. A

comparative income statement will show the absolute figures for two or more periods, the

absolute change from one period to another and if desired the change in items of percentages.

Since the figures two or more periods are shown side by side, with the help of this we can

quickly ascertain sales have increased or decreased, whether cost of sales have increased or

decreased etc. Therefore, only a glance of data incorporated in this statement will be helpful

in making useful conclusions.

Comparative Balance Sheet:Balance sheet of two or more different dates can be used for comparing assets and

liabilities and finding out increase or decrease in those items. Therefore, in a single balance

sheet the emphasis is on present position, it is a change in the comparative balance sheet. This

type of balance sheet is very helpful in studying the trends in a business concern.

a) Common size Financial Statements:Common size financial statements are those in which figures reported are converted into

percentage to some common base. When this method is pursued, the income statement

exhibits each expense item or group of expense items as a percentage of net sales, and net

sales are taken at 100 percent. Similarly, each individual assets and liability classification is

shown as a percentage of total assets and liabilities respectively. Statements prepared in this

way are referred to as common size statements.

Common size statements prepared for one firm over the years would highlight the

relative changes in each group of expenses, assets and liabilities. These statements can be

equally useful for inter-firm comparisons, given the fact that absolute figures of two firms of

the same industry are not comparable.

b) Trend Percentages:Trend percentages are very much helpful in making a comparative study of the financial

statements for several years. The way of calculating trend percentages involves the

calculation of percentage relationship that each item bears to the same item in the base year.

Each item of base year is taken as 100 and on that basis the percentages for each of the items

of each of the years are calculated. These percentages can be taken as index number showing

the relative changes in the financial data resulting with the passage of time. This method isvery much useful, analytical device for the management, since by substitution of percentages

for large amounts, brevity and readability are achieved.

c) Fund Flow Statement:Fund flow statement is a financial statement, which indicates the various means by which

the funds have been obtained during the certain period and the ways to which these funds

have been used during the period.

In short, it is the statement, which shows the movement of funds between two balance

sheet dates.

The fund flow statement is called by different names, such as statement of sources and

application of funds, statement of changes in working capital.


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d) Cash Flow Statement:Cash flow statement shows the movement of cash and their causes during the period

under consideration. It may be prepared annually, half yearly, monthly, weekly or for any

other duration.

Cash flow statement is prepared to show the impact of financial policies and procedures

on the cash position of the firm and takes into consideration all transactions that have a directimpact upon cash.

A cash flow statement concentrates on transactions that have direct impact on cash. It

deals with the inflow and outflow of cash between two balance sheet dates. In other words, a

statement of changes in a financial position of a firm on cash basis is called a cash flow

statement.

e) Leverage Ratios:Leverage refers to an increased means of accomplishing some purpose. In financial

management, it refers to employment of funds to accelerate rate of return to owners, it may

be favorable. An unfavorable leverage exists if the rate of return remains to be lower. It can

be used as a tool of financial planning by the finance manager.

MEANING OF FINANCIAL PERFORMANCE ANALYSIS

One of the important step of accounting is the analysis (and interpretation) of the

financial statements which results in the presentation of data that helps various categories of

persons in forming opinion about the profitability and financial position of the business

concern.

The most important objective of the analysis and interpretation of financial statements

are to understand the significance and meaning of financial statement data to know the

strength and weakness of a business undertaking so that a forecast may be made of the

prospects of that undertaking.

OBJECTIVES OR USES OF FINANCIAL PERFORMANCE ANALYSISFinancial analysis is helpful in assessing the financial position and profitability of a

concern. The following are the main objectives of analysis of financial statements:

To help in assessing development in the future by making forecasts and preparingbudgets.

To judge the operational efficiency as a whole and of its various parts ordepartments.

To have comparative study in regard to one department with another department. To judge the short-term and long-term solvency of the concern for the benefits of the

debentures holders and trade creditors.

To know the profitability of the concern.PROCESS OF FINANCIAL ANALYSIS:

The analysis of financial statements is a process of evaluating the relationship betweencomponent of financial statements to obtain a better understanding of the firms position andperformance. The functional analysis is the process of selection, relation and evaluation.

1. The first task of the financial analyst is to select the information relevant to thedecision under consideration from the total information contained in the financial

statements.

2. The second step is to arrange the information in a highlight significant relationship.3. The final step is interpretation and drawing of inference and conclusion.

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