Krishna Mr. Rajesh Madhavan Dr. Alka Munjal Dr. Muneesh Kumar Mr. Mayya Dr. Mishra Dr. Banikant Misra Dr. Pitabas Mohanty Prof. Raj Singh Prof. Padmini Srinivasan Dr. Srinivasan Dr. Marti Subrahmanyam Dr. Ashok Thampy Dr. Thirpalraju Dr. Narasimha Rao Dr. Narasimhan Prof. Sridhar Natarajan Dr. Nayak Dr. Obaidullah Dr. Mohandas Pai Dr. Narayani Dr.
Jinesh Panchali Dr. Alok Pandey Dr. Parashar Dr. Parasuraman Dr. Richard Ponarul Dr. Neeti Sasan Dr. Premchander Dr. Raghunath Dr. Raghunathan Prof. Rajesha Prof. Ramachandran Dr. Raj Dr. Janaki Ramudu Prof. Rao Mr. Rao Prof. Sabarinathan Dr. Sankaran Dr. Sarma Dr. Sethu Dr. Arvind Subramaniam Prof. Anand Sharma Dr. William Sharpe Prof. Sharanabasappa Dr.
Uma Shashikant Dr. Varma Mr. George Verughese Dr. Madhu Vij Dr. Vasumathi Hariharan Dr. Vaidyanthan Dr. Sankarshan Basu Mr.
I am grateful to Pushpalatha for her help in preparing the manuscript. I am thankful to Mr. Nikhil Wadhera, Mr. Shivkant Singhal, Mr. Sachin Kumar, Mr. Atul Gupta, and the entire team of McGraw Hill Education for their timely completion of this project. I eagerly look forward to suggestions for improvements in this book.
If you look at a business newspaper any day, you will find several news items about corporate financial decisions. For example, the Business Standard of July 25, reported, among others, the following.
Financial management is concerned with maximising shareholder value primarily through sound investment and financing decisions, efficient working capital management, sensible corporate restructuring, judicious risk management, and a well-designed performance management system. This book discusses various concepts, theories, and techniques that are helpful in financial management.
In this note we provide a flavour of what happens in the real world of finance to whet your appetite for the material that lies ahead. Chandrasekaran listed his strategic priorities. Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.
In this report, her task was to develop a target price for eBay over the subsequent 12 months. According to some sources, the information provided to the banks was also at variance with reality. While this may be an extreme example, it highlights the pitfalls of forecasting. Indian companies prefer Luxembourg stock exchange for GDR issues as the deal at Luxembourg can be closed very fast. The investment banks who arranged the deal pocketed a cool million dollars.
The issue received enthusiastic response from investors and was over-subscribed 6. The bonds were issued at The bonds carried no interest.
HDFC was the first company to issue these bonds in Investors assume foreign-exchange risk in addition to currency risk. Investors can buy protection against currency risks by hedging their rupee exposure. Obviously, these bonds make sense for issuers who want to avoid foreign-exchange risk and investors who are inclined to assume foreign-exchange risk. While there are global standards for green bonds, in India a standard code has not been developed so far.
The company will buy back up to 5. The buyback is proposed to be made on a proportionate basis under the tender offer route using the stock exchange mechanism. It is subject to approval of shareholders by means of a special resolution through a postal ballot. The TCS stock rallied as much as 6. The money was used to repay the crore loan from the World Bank carrying This makes a mockery of disinvestment.
The primary purpose of PSU disinvestment is to transfer government ownership in the hands of non-government entities and expose PSUs to the discipline of the capital market. By forcing PSUs to buyback shares, these objectives are not achieved.
Further, they deprive PSUs of the resources required for further investments. From a corporate finance perspective, buybacks make sense when a firm has excess liquidity or when its stock is undervalued and not when the owners need money for their own purposes.
So, the government-directed buybacks to PSUs will hurt their competitiveness and harm the interest of minority shareholders. These deposits were time deposits which can be drawn by the Company at any point without prior notice or penalty on the principal.
The portfolio consists of wide ranging fixed income instruments, viz. The diversification across instruments and counterparties ensures that there is a minimal concentration risk. The investment portfolio is monitored and operated under a robust risk management framework with a very nimble and dynamic adjustment to portfolio mix as and when necessary to ensure capital protection and appropriate risk adjusted returns.
It turns its inventory over 26 times a year, making its inventory period very short. Finally, it takes about 46 days to pay the suppliers. All this implies that Amazon. So, the company found it challenging to move cash from these countries to places where cash is required for growth or debt servicing. To address this challenge, the company is implementing an efficient cash pooling scheme that enables a virtual fungibility, without moving the cash physically.
The bankers providing this facility would run a virtual consolidated book that would allow the company to withdraw funds in one country against cash balances held in another country. The PFMS platform minimised float in the system by releasing funds only when implementing agencies need them.
At the turn of the millennium, ITES was the sunrise industry. As per the deal, shareholders of Cairn India received, for each equity share held, one equity share of face value of 1 and four 7. Tata Motors will lead the consortium.
Tata Motors has strengths in design, development, and integration of mobility platforms. Bharat Forge has competence in fighting platforms and manufacturing. General Dynamics has expertise in systems integration. We three have joined hands for a complete FICV solution for the armed forces. According to the management of Arvind the rationale for demerger is to impart greater focus, enhance operational efficiency, attract different types of investors as well as management teams, and incentivise management through aligned ESOP schemes.
The World Bank, however, could borrow in the US market on attractive terms. With the help of IBM, which was quite acceptable in the Swiss market, the problem was solved. We are not looking to beat the market. We are just trying to increase certainty around our cost structure. We do not hedge for translational exposure. When we communicate with the market, we actually give guidance and provide our information data both on a currency-neutral basis and with the impact of currencies.
Then that exposure is systematically hedged over the horizon available in the market, with a rolling forex strategy. To avoid paying too much in fees to bank, we use an electronic platform. When it was introduced, it was not introduced by the accountants but by the businesses themselves.
We felt that the best way to implement the system was to get the businesses to buy into it. Therefore, with it came both focus and acceptability. There are other non-financial measures, but among the financial measures, this is now the single-most important financial performance measure that we use as the only yardstick today.
After this move, its performance improved significantly and its market capitalisation soared, tripling between and Whatever the compensation arrangement, though, I try to keep it both simple and fair. When we use incentives—and these can be large—they are always tied to the operating results for which a given CEO has authority.
The consistent growth of the company can be attributed to the culture of ownership and partnership that is nurtured amongst the employees. Such a move would short-change the minority shareholders of Maruti Suzuki. Thanks to the opposition of institutional investors in the following months, Maruti Suzuki dropped the proposal. Suppose you are planning to start your own business. That is, what will be the mix of equity and debt in your financing plan? While these are not the only concerns of financial management, they are certainly the central ones.
This book discusses the theories, analytical methods, and practical considerations that are helpful in addressing various issues in financial management, a discipline that has assumed great significance in recent times. It also describes the financial environment in which the business operates. This chapter provides such an overview. However, these issues tend to be more complex for companies than for other forms of organisation.
Since this book focuses primarily on financial management of companies—note that large firms are almost invariably organised as companies—you should know how a company differs from other forms of business organisation like sole proprietorship, partnership, and cooperative society.
Sole Proprietorship A sole proprietorship firm is a business owned by a single person. This is the simplest form of business, subject to minimal regulation. You can set up a sole proprietorship firm by obtaining a license, if the same is required for the business you want to engage in, and throwing open your doors.
Thanks to its simplicity, most businesses begin as sole proprietorship firms. No wonder there are more sole proprietorships than any other form of organisation. From a legal and tax point of view, a sole proprietorship firm has no separate status apart from its owner. The owner realises all the profits and bears all the losses. The owner indeed has unlimited personal liability for the debts of the business. By the same token, there is no distinction between business and personal income and all business income is taxed as personal income.
A variant of sole proprietorship is a One Person Company which allows a single individual to operate a corporate entity with limited liability protection. The equity capital of a sole proprietorship is limited to the personal wealth of the owner. Hence such firms often cannot grow beyond a point for want of capital. Partnership A partnership firm is a business owned by two or more persons. It may be viewed as an extension of sole proprietorship.
The partners bear the risks and reap the rewards of the business. Generally, a partnership comes into being with the execution of a partnership deed that specifies, inter alia, the capital contributions, shares, rights, duties, and obligations of the partners.
In India, partnerships are governed by the Partnership Act, A partnership firm is a distinct legal and tax entity. It can pay interest and remuneration to the partners and claim the same as tax-deductible expenses. Of course, these incomes are taxable in the hands of the partners. The tax rate applicable to the net profit of the partnership firm is presently 30 percent. While a partnership firm can benefit from the varied experience and expertise of the partners and draw on their combined capital resources, its advantages and disadvantages are more or less similar to that of a sole proprietorship firm.
Its distinctive feature is that it is a partnership firm wherein the liability of some or all the partners is limited. An LLP must have at a minimum two partners and at least one of them should be an Indian resident. The partners are accountable for regulatory and legal compliance. The rights and duties of the partners are governed by the agreement between the partners or between the LLP and the partners.
Since the LLP is treated as a firm, it does not have to pay the minimum alternative tax on book profits and the dividend distribution tax. The interest that an LLP can pay on the investments made by the partners is limited to 12 percent of the total income of the LLP.
The remuneration can be paid to the partners as per the slabs fixed under the law. The net profit of the LLP would be taxed at 30 percent. The partners, of course, have to pay taxes for their interest and remuneration received from the LLP.
The management of the cooperative society is vested in the hands of the management committee elected by the members. The advantages of a cooperative organisation are as follows: a It can be formed easily. Company A company is collectively owned by the shareholders who entrust the task of management to their elected representatives called the directors. It can own assets, incur liabilities, enter into contracts, sue and be sued in its name. In India, a company is formed under The Companies Act, , a central legislation.
Once this amount is fully paid up, they have no further obligation. Moreover, shareholders of the company are liable to pay taxes on the dividend received by them. A company may be a private limited company or a public limited company. While there is no limit on the number of shareholders of a public limited company, the number of shareholders of a private limited company cannot exceed It is exempted from a number of requirements or restrictions that are applicable to the latter.
On the whole, the public limited company is the most appropriate form of business organisation, except, of course, when the business is small. The reasons are: a The risk to investors is limited. Thanks to these advantages, large and medium-sized businesses are generally organised as public limited companies. To identify that a firm is a company, the following letters are used after its name: Inc.
Capital Budgeting The first and perhaps the most important decision that any firm has to make is to define the business or businesses that it wants to be in. This is referred to as strategic planning and it has a significant bearing on how capital is allocated in the firm. As strategic planning calls for evaluating costs and benefits spread out over time, it is essentially a financial decision making process.
Once the managers of a firm choose the business or businesses they want to be in, they have to develop a plan to invest in buildings, machineries, equipments, research and development, godowns, showrooms, distribution network, information infrastructure, brands, and other long-lived assets.
This is the capital budgeting process. Considerable managerial time, attention, and energy is devoted to identify, evaluate, and implement investment projects. When you look at an investment project from the financial point of view, you should focus on the magnitude, timing, and riskiness of cash flows associated with it.
In addition, consider the options embedded in the investment projects. Capital Structure Once a firm has decided on the investment projects it wants to undertake, it has to figure out ways and means of financing them. The key issues in capital structure decision are: What is the optimal debt-equity ratio for the firm?
Which specific instruments of equity and debt finance should the firm employ? Which capital markets should the firm access? When should the firm raise finances? At what price should the firm offer its securities? An allied issue is the distribution policy of the firm. What is the optimal dividend payout ratio for the firm? Should the firm buyback its own shares? Capital structure and dividend decisions should be guided by considerations of cost and flexibility, in the main.
The objective should be to minimise the cost of financing without impairing the ability of the firm to raise finances required for value creating investment projects. Working Capital Management Working capital management, also referred to as short-term financial management, refers to the day-to-day financial activities that deal with current assets inventories, debtors, short- term holdings of marketable securities, and cash and current liabilities short-term debt, trade creditors, accruals, and provisions.
The key issues in working capital management are: What is the optimal level of inventory for the operations of the firm? Should the firm grant credit to its customers and, if so, on what terms? How much cash should the firm carry on hand? Where should the firm invest its temporary cash surpluses? What sources of short-term finance are appropriate for the firm? But in companies, particularly large public limited companies, which have many shareholders, ownership is separated from management.
For example, it is practically impossible for tens of thousands shareholders of Larsen and Toubro to participate actively in management. They have to necessarily delegate authority to the board of directors, which in turn appoints the top management.
Since shareholders differ in their tastes, wealth, investment horizons, and personal opportunities, delegation can work only if they can agree on a common objective. Shareholders, regardless of their personal tastes or preferences, can do more if their shares are worth more.
They can give money for charity or travel to exotic locations; they can spend now or save for future. Much of the theory in corporate finance is based on the assumption that managers should strive to maximise the value of the firm.
The value of the firm is equal to the value of its equity and debt claims. Under normal circumstances the value of the debt claims remains fairly stable. So maximising the value of the firm is equivalent to maximising the value of equity. There are three compelling arguments in support of the goal of shareholder wealth maximisation, viz. From a legal point of view, managers, as agents of shareholders are expected to further the interests of shareholders, who are their principals, as established in Anglo-Saxon law.
If a manager is told to maximise market share, current profits, employment, future growth in profits, and something else, he cannot make a well- reasoned decision. In effect, he will be left with no objective. The absence of a well-defined function handicaps the firm in its competition for survival. Despite the forceful arguments in favour of the goal of shareholder wealth maximisation, its supremacy has been challenged, among others, by the capital market skeptics, the strategic visionaries, and the balancers.
The arguments of these critics and the rebuttal by the defendants of shareholder wealth maximisation principle are summarised below. For maximising the market share, or example, satisfied and loyal enhancing customer satisfaction, customers are essential for value or minimising costs in relation to creation.
However, beyond a competitors, or achieving a zero certain point customer satisfaction defect level. If the firm succeeds comes at the cost of shareholder in implementing its product market value. When that happens, the strategy, investors would be conflict should be resolved in amply rewarded. There is no viz. When managers community and others. Each manager would be left to his own judgment. In a large organisation this can lead to confusion and even chaos.
Let us examine them. It should be expressed either on a per share basis or in relation to investment. There is no guide for comparing profit now with profit in future or for comparing profit streams of different durations.
The goals of maximisation of earnings per share and maximisation of return on equity do not suffer from the first limitation mentioned above. However, they do suffer from the other limitations and hence are also not suitable. In view of the shortcomings of the alternatives discussed above, maximisation of the wealth of equity shareholders as reflected in the market value of equity appears to be the most appropriate goal for financial decision-making.
A Modification Given a certain number of outstanding shares, managers should act to maximise the current share price of their firm. If they seek to maximise the current market price they serve the interest of short-term shareholders; if they seek to maximise the intrinsic value of the share they serve the interest of long-term shareholders.
What Do Firms Do? Business firms often pursue several goals. They seek to achieve a high rate of growth, enjoy a substantial market share, attain product and technological leadership, promote employee welfare, further customer satisfaction, support education and research, improve community life, and solve other societal problems. Since managers spend most of their working day dealing with employees, customers, and suppliers, and building relationships with them, it is quite natural for them to consider their interests.
Some of these goals may, of course, be in consonance with the goal of shareholder wealth maximisation. For, a rapid growth rate, a dominant market position, and a higher customer satisfaction may lead to increasing returns for equity shareholders.
Even efforts towards solving societal problems may further the interest of shareholders in the long run by improving the image of the firm and strengthening its relationship with the environment.
When these other goals seem to conflict with the goal of maximising shareholder wealth, it is helpful to know the cost of pursuing these goals.
The tradeoff has to be understood. It should be appreciated that maximisation of the wealth of shareholders constitutes the principal guarantee for efficient allocation of resources in the economy and hence is to be regarded as the normative goal from the financial point of view. Shareholder Orientation in India Most companies in India till the early s paid lip service to the goal of shareholder wealth maximisation. They showed sporadic concern for the shareholders, mainly when they approached the capital market for raising capital.
Things, however, have been changing since the mids. A confluence of forces appears now to be prodding companies to accord greater importance to the goal of shareholder wealth maximisation. The important ones are as follows: Foreign Exposure The scions of most business families have gone abroad for higher education, particularly to the U. Hence they seem to appreciate the importance of shareholder value more. Greater Dependence on Capital Market In the wake of liberalisation, the investment opportunities for the private sector have expanded considerably and consequently its appetite for funds has increased substantially.
Thanks to significant freedom that companies now enjoy in pricing equity issues, there is a stronger incentive to access the capital market. The higher corporate needs for funds and the greater dependence on the capital market have induced firms to become more shareholder friendly.
Growing Importance of Institutional Investors Companies are relying more on mutual funds, private equity funds, financial institutions, and foreign portfolio investors for raising equity capital. Institutional investors tend to be more discerning and have the muscle and motivation to nudge companies to pursue shareholder friendly policies.
Abolition of Wealth Tax on Financial Assets Previously wealth tax, subject to some exemptions, was payable on equity shares.
This induced many controlling groups to ignore and even depress share prices. With the abolition of wealth tax on equity shares and other financial assets, there is now an incentive to enhance share prices. To sum up, in the new environment there is a greater incentive and compulsion to focus on creating value for shareholders. Those companies where the promoters continue to believe that they own the company and everything they do is in their own interest, are in trouble.
To answer this question, let us look at the fundamental principle of finance: A business proposal—regardless of whether it is a new investment or acquisition of another company or a restructuring initiative—raises the value of the firm only if the present value of the future stream of net cash benefits expected from the proposal is greater than the initial cash outlay required to implement the proposal. As shown in Exhibit 1. To convert the expected cash returns from the proposal into a present value figure an appropriate discount rate has to be applied.
The discount rate reflects the riskiness of the proposal. Dewing, published in , was the major textbook on corporate finance for generations. It focused primarily on certain episodic events like formation, issuance of capital, major expansion, mergers, reorganisation, and liquidation in the life cycle of a firm and discussed them mainly in descriptive and institutional terms. Prior to the s, corporate finance theory was riddled with inconsistencies and had a predominantly prescriptive orientation.
Likewise, the theory of financial markets prior to s was as undeveloped as the theory of corporate finance. In the s, fundamental changes began to occur in the field of finance. The analytical methods and techniques of economics began to be applied to problems in finance, resulting in a major transformation. This evolution was accompanied by a change from the normative to the positive. It must be recognised that a richer set of positive theories provides the basis for answering normative questions.
This important relation between positive and normative theories is often not realised. Purposeful decisions are founded on an explicit or implicit use of positive theories. To decide what action you should take to meet your objective, you should know how the alternative actions affect the desired outcome — and this is what a positive theory does. For example, to choose among alternative financial structures you should know how the alternatives affect expected cash flows, risk, and therefore the firm value.
If you use incorrect positive theories, your decisions would have unexpected and undesirable outcomes. The years since the early s have witnessed the development of the following major building blocks of modern financial economics.
Apart from the above building blocks, which form the core of the neoclassical finance, another major development that has a bearing on financial decisions is behavioural finance.
Unlike neoclassical finance which assumes that people are rational, behavioural finance considers social, cognitive, and emotional factors that influence decisions and examines their effects on market prices, returns, and allocation of resources.
Should the firm set up a plant which has a capacity of one million tons or two million tons? Should the debt-equity ratio of the firm be or ? Should the firm pursue a generous credit policy or niggardly credit policy? Should the firm carry a large inventory or a small inventory? The alternative courses of action typically have different risk-return implications.
A large plant may have a higher expected return and a higher risk exposure, whereas a small plant may have a lower expected return and a lower risk exposure. A higher debt-equity ratio, compared to a lower debt- equity ratio, may save taxes but expose the firm to greater risk. In general, when you make a financial decision, you have to answer the following questions: What is the expected return? What is the risk exposure? Given the risk-return characteristics of the decision, how would it influence value?
Exhibit 1. But in companies, particularly large public limited companies, owners typically are not active managers. Instead, they entrust this responsibility to professional managers who may have little or no equity stake in the firm. Hence it becomes necessary to pool capital from thousands or even hundreds of thousands of owners.
It is impractical for many owners to participate actively in management. Such diversification is achievable only when ownership and management are separated. While there are compelling reasons for separation of ownership and management, a separated structure leads to a possible conflict of interest between managers agents and shareholders principals.
Though managers are the agents of shareholders they are likely to act in ways that may not maximise the welfare of shareholders. In practice, managers enjoy substantial autonomy and hence have a natural inclination to pursue their own goals. To prevent from getting dislodged from their position, managers may try to achieve a certain acceptable level of performance as far as shareholder welfare is concerned.
However, beyond that their personal goals like presiding over a big empire, pursuing their pet projects, diminishing their personal risks, and enjoying generous compensation and lavish perquisites tend to acquire priority over shareholder welfare. To mitigate the agency problem, effective monitoring has to be done and appropriate incentives have to be offered. Monitoring may be done by bonding managers, by auditing financial statements, by limiting managerial discretion in certain areas, by reviewing the actions and performance of managers periodically, and so on.
Incentives may be offered in the form of cash bonuses and perquisites that are linked to certain performance targets, stock options that grant managers the right to purchase equity shares at a certain price thereby giving them a stake in ownership, performance shares given when certain goals are achieved, and so on. Yes, it is. Many companies which have created enormous value for their shareholders are highly admired for their ethical behaviour and concern for society.
Every company should consider its business ethics and its corporate social responsibility. Business ethics essentially focuses on the behaviour of employees and corporate social responsibility is concerned with the contributions that a company should make to worthwhile social causes. Business Ethics Business ethics refers to the standards of conduct or moral behaviour as applied to business practices.
Ethics and fraud are used commonly in business reporting, but they have different meanings. Fraud involves violating the law, whereas unethical behaviour involves breaching the code of ethics or moral behaviour.
While fraud can be defined objectively, unethical behaviour is defined rather subjectively. A business firm is deemed to practice high standards of ethics if it deals with its employees, suppliers, customers, creditors, shareholders, and community in a fair and honest manner.
In general, ethical behaviour and long-run profitability are positively correlated. Ethical behaviour helps a firm to avoid fines and legal expenses, build public trust, attract and retain talented people, and gain the loyalty of customers who appreciate its policies. Customers, employees, suppliers and investors trust organisations that live by a clear set of values.
Most important, good corporate behaviour tends to attract the best talent to work for an organisation. So being good is not only good for itself, but also very good for business growth and sustainability.
However, the most important thing is the example set by top management through its actions and behaviour and the system of reward and punishment. Of course, given the subjective nature of ethics, in many cases the choice between ethics and profits is not unambiguous. Corporate Social Responsibility Corporate social responsibility CSR , an allied issue, has received a great deal of attention particularly in recent years.
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