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It’s a pleasure to submit this assignment on “Application of the Knowledge of Intermediate Financial Management at the Time of Managing an Industry’ as part of completion of the requirements for our FIN 503 Intermediate Financial Management course. The broad and overall objective of this assignment is to provide the reader with an overview about the application of the knowledge of this course at the time of managing an industry. preparing this assignment has been a rewarding experience. Thank you for your kind support and help throughout the course.
Sincerely yours, Particulars Page 1. 0 Introduction 2. 0 An Overview of Finance 1-4 3. 0 Working Capital Management 4-8 4. 0 Managing Short Term Liabilities 8-11 5. 0 Financial Planning and Control 11-13 6. 0 Capital Structure 13-14 7. 0 Managing Short Term Assets 1 4_ 19 8. 0 Conclusion 19-20 1. 01ntroduction Finance is the cornerstone of the enterprise system. Good financial management is vitally important to the economic health of business firms, hence to the nation and the world. Because of its importance, finance should be widely and thoroughly understood.
The field is relatively complex and undergoing constant change in response to shifts in economic conditions. All Of this makes finance stimulating and exciting but also challenging and sometimes perplexing. Intermediate Financial Management is designed with tools and techniques that managers use for efficient functioning of the finance department of an organization. In this course, Intermediate Financial Management, we have learned how to manage working capital, short term assets such as cash and marketable securities, credit management, receivables and inventory of an organization.
We also learnt about managing of short term financing, financial planning & control, and capital structure. Applications of these concepts play an important role for the proper conduction and growth of the organization. These tools and techniques are discussed in details in the following sections. 2. 0An Overview of Finance Finance consists Of providing and utilizing Of money, capital rights, credits & funds of any kind, which are employed in the operation of an enterprise. That means there are two functions of finance – providing or raising of fund and utilizing or investing that fund.
Making a business plan is the first and foremost activity of finance which is done by the financial managers. Based n the plan, funds are raised and utilized by the firm. The essential elements that a business plan must contain are: Objective, vision and mission of the enterprise; Marketing survey to determine the demand for the product and the supply of the product in the existing market to find out the potential market; Resources required by the firm such as plant and machineries, factory premises, infrastructure, human resource, etc; Capital requirements and how capital can be raised, that is, the capital structure of the firm e. . by issuing shares or by raising bank loan; Production plan and Marketing plan. Classification of Finance Finance can be classified into two types: Public Finance: This is concerned with government’s financial activities. Government prepares both long and short term financial plans. Governments short term plan usually consists Of the budget which identifies its sources of expenditure (e. g. allocation of fund for salaries of government employees, health sector, education, agriculture, subsidies, defense) and its sources of revenue (e. g. ax, VAT, stamp duty, custom & excise, foreign loans & grants) to finance the expenditure. This type of financing activities are non- profitable and for social welfare. Private Finance: Here the financial manager is concerned with the financial activities of the firm and engages in making financial plan, identifying the sources of finance, selecting sources of finance, raising the necessary fund, investing the fund and protecting the fund in order to achieve the ultimate goal of the business. In this case, the financial manager always thinks about the welfare of the firm.
Private finance can be classified into two types: 1 . Finance for non-profitable organization (e. g. hospitals, educational institutions, Trusts, clubs, NGOs) and 2. Finance for profitable organization which can be subdivided into three ain forms of business organization: a. Sole Tradership: It is an unincorporated business owned by one individual who participates in management of the organization and has to pay the tax. It has a relatively short life, small capital and unlimited liability. This type of organization is self regulated. b.
Partnership: It is also an unincorporated business but owned by two or more persons. Some of these partners participate in management of the organization. It has a relatively moderate life and capital, and unlimited liability. In this type of organization, partners pay the tax and the business IS elf regu lated. c. Corporation: It is a legal entity created by a state, separate and distinct from its owners and managers, having unlimited life. It can be a private limited company with 7 to 50 owners, but for banking company the maximum number of owners is 20.
It can also be a public limited company where the number of owner is unlimited depending on share capital. This type of organization is managed by professional managers, has relatively long life, more capital and liability limited by shares. It has to pay double taxation- corporate tax paid on corporate profit and tax on dividend paid by shareholders. This type of business is monitored by the government agencies such as Registrar of Joint Stock Companies (RJSC), Securities and Exchange Commission and Stock Exchange.
Corporation is considered to be the best form of profitable organization. Formation Process of a Public Limited Company Here we need to know that only a public limited company can issue common stock to the public to raise capital and in order to form a public limited company, the following steps must be followed: Make business plan, Memorandum of Association, Articles of Association and prospectus; Apply to RJSC for issuing Certificate of Incorporation; Apply to Bangladesh Securities & Exchange Commission for permission of IPO; Apply to Stock Exchange for enlistment and Offer IPO.
Responsibilities of Financial Managers Financial managers need to make decisions concerning the acquisition and use of funds for the greatest benefit of the firm. Their major responsibilities include: Forecasting and planning: They need to prepare business plan, following a marketing survey, for both new and existing corporation. This is a continuous process. Major investment and financial decision: They have to decide how to raise fund to establish the firm and how to raise working capital to finance the day o day activities of the firm.
Once the fund is raised, they need to determine how to invest the fund as per the business plan. Coordination and control: Financial managers work as coordinators and controllers within different departments of the organization such as, procurement department, production department, human resource department, marketing department, and research & development department. Dealing with financial market: In financial market financial instruments are traded, financial transactions take place and it is a mechanism Of interaction between surplus spending units and deficit spending units.
It can be divided into the money market where instruments such as Treasury bills, Commercial Paper and Negotiable Certificate of Deposit are traded, and the capital market where common stock, preferred stock, bond and debenture are traded. Financial instruments/ transactions have a maturity of up to one year in the money market and more than one year in the capital market. Financial managers are responsible to deal with the raising of long term fund from the capital market for acquiring plant, machineries, building, etc. nd short term fund from the money market to meet working capital requirement. If the bove responsibilities are performed optimally, financial managers will help maximize the values of their firm. Goals of Bussiness Organization Goals of a business organization can be classified into ?o types: Profit Maximization Sometimes financial managers seek to maximize profit of the firm. When the organization is engaged in providing service or product that is changing rapidly, financial managers should choose profit maximization as the main goal of the firm.
For example, the prices of IT products, such as computers, change frequently due to technological innovation and product modification. It is better for the firm to maximize current profit as the product changes rapidly and becomes obsolete after a certain period of time. However, there are certain disadvantages of profit maximization, such as: It does not consider the longevity of project; It does not consider time value of money; Try to maximize current profit and It does not consider social responsibilities towards customers, employees and society.
Wealth Maximization This goal allows financial managers to think about the business for the longer period and consider social responsibility. This goal aims to reduce production ost and sales price, and improve product quality which will ultimately increase sales. As a result, firm’s net income will increase and so will it’s earnings per share. Subsequently the firm’s share price will increase and it can spend more on expansion and reinvestment maximizing the wealth of the shareholders.
This is the appropriate goal of an organization because: It considers longevity of the project; It considers time value of money; It tries to maximize wealth of the corporation; It considers social responsibility towards customers (by providing quality product to them at reasonable price), employees (by providing them with ood remuneration package), and society (by carrying out activities for social welfare) and It tries to maximize share price. Stakeholders and the Agency Issue Stakeholders are all the related parties who have a direct economic link to the firm such as employees, customers, suppliers, creditors, owners and others.
The control of the corporation is frequently placed in the hands of the professional non-owner managers. Thus management can be viewed as agents of the owners who have hired them and given them the decision- making authority to manage the firm for the owners’ benefit. However, this an cause the agency problem, where the managers may place personal goals ahead of corporate goals. This issue gives rise to additional expenses for the organization such as, monitoring expenses, bonding expenses, structuring expenses and opportunity costs.
But the issue can be resolved by electing a Board of Directors, empowering them to hire or fire, expel underperforming management and by threat of hostile takeover. 3. 0Working Capital Management Working capital management involves management of the current assets & Current liabilities of a firm. The term working capital, sometimes called gross orking capital, generally refers to current asset. Net working capital is defined as current assets minus current liabilities. A firm’s value cannot be maximized in the long run unless it survives the short run.
Thus, sound working capital management is a requisite for firm survival. Firms may face three different working capital situations: Inadequate working capital: If firms have inadequate working capital, production will be interrupted and firms’ profitability will decrease. Surplus working capital: Firms with surplus working capital means that they have excess fund which increases cost of fund and reduces profitability. Optimum working capital: Neither inadequate nor surplus working capital is good for firms. They should identify and maintain optimum working capital.
Firms need to remember that the requirement of external working capital finance depends on seasonal variation and business cycle fluctuations. For instance, demand for soft drinks increases during summer. Thus raw material requirements of firms producing soft drinks increase during summer. On the other hand, demand for products increases during boom in the economy as people’s purchasing power increases resulting in an increase in working capital requirement. But when there is recession in the economy, working capital requirement decreases as demand for products decreases.
Cash Conversion Cycle (CCC) To analyze the effectiveness of a firm’s working capital management process, it is essential to analyze its cash conversion cycle. CCC is the length Of time from the payment for the purchase of raw materials to manufacture a product until the collection of accounts receivable associated with the sale of the product. CCC= ICP + RCP – PDP The firm’s goal should be to shorten its CCC as much as possible without harming operations. This would improve profits because the longer the CCC, he greater the need for external, or nonspontaneous, financing, and such financing has a cost.
With the help of CCC, firms can judge their own performance & also compare their performance with similar types of industries. To analyze the CCC, we need to analyze the firm’s inventory conversion period (ICP), receivables collection period (RCP) and payables deferral period (POP) Inventory Conversion Period (ICP) ICP is the average length of time required to convert materials into finished goods and then to sell those goods; it is the amount of time the product remains in inventory in various stages of completion.
ICP Inventory / Cost of goods sold per day = Inventory / (Cost of goods sold / 360) Shorter ICP is better as it shortens the CCC. Production department is directly responsible for ICP. Receivable Collection Period (RCP) The RCP is the average length of time required to convert the firm’s receivables into cash – that is, to collect cash following a sale. RCP Receivables / Daily credit sales = Receivables / (Credit sales / 360) Shorter RCP is better as it shortens CCC. Sales & marketing department is responsible for RCP.
Payable Deferral Period (PDP) The PDP is the average length of time between the purchase Of raw materials nd labor & the payment of cash for them. PDP = Accounts payable / Credit purchases per day Accounts payable / (Cost of goods sold/ 360) Larger PDP is as it shortens CCC. Purchase & procurement department is directly responsible for PDP. Classification of Current Assets Current assets can be classified into: Permanent current assets: Current assets’ balances that do not change due to seasonal or economic conditions such as, rent on factory premises, loan installment, lease payments, salaries, etc.
Temporary current assets: Current assets that fluctuate with seasonal or conomic variations in firm’s business such as, raw materials, utility bills, fuel and power, wages, etc. Alternative Current Asset Investment Policies Firm has to analyze three current asset investment policies to determine the appropriate level of current assets suitable for it considering the nature of the firm. Figure: Alternative Current Asset Investment Policies 1.
Relaxed current asset investment policy: It’s a policy in which large amounts of cash, marketable securities and inventories are carried, and under which sales are stimulated by a liberal credit policy and liberal financing to customers that results in high level of eceivables. As a result the firm has a long cash conversion cycle which results in an increase in working capital requirement and cost causing the firms profitability to fall. But, on the other hand, this policy reduces the uncertainty of inadequate working capital. 2.
Restricted current asset investment policy: It’s a policy under which holding of cash, marketable securities, inventories, and receivables are minimized by the firm because their reputation allows them to raise bank loans and avail trade credit from creditors as needed. Uncertainty is more under this policy although that is minimized by the wealth of the firm. The firm has tougher credit terms and policies which results in a lower level of receivables and a short cash conversion cycle. This leads to minimum cost, highest expected return and profitability for the firm although the firm has to face greater risk under this policy. . Moderate current assets investment policy: It’s a policy between relaxed and restrictive policies where the firm maintains moderate amount of cash and inventories. The cash conversion cycle is of moderate length resulting in moderate risk, return and profitability for the firm. Considering its nature, i. e. financial strength, reputation and credit orthiness, a firm should adopt its current asset investment policy. A new/ small/ unreputed/ financially weak should adopt relaxed or moderate policy. A large, established, reputed and financially strong firm should adopt restricted policy.
Alternative Current Asset Financing Policies Once a firm identifies the current asset investment policy suitable for it, it needs to decide how to finance its permanent and temporary current assets. 1. Maturity Matching (Moderate Investment Policy): This approach is usually practiced in new firms. This approach matches assets and liabilities Of the firm so that temporary current assets are financed with hort term nonspontaneous financing, and permanent current assets and fixed assets are financed with long term debt plus equity plus spontaneous current liabilities.
Although two factors that prevent exact maturity matching are, uncertainty about the lives of assets and the use of common stock equity which has no maturity. This approach is considered to be a moderate current asset financing policy. 2. Relatively Aggressive Approach (Restricted Investment Policy): Under this approach all fixed assets and part of permanent assets of the firm are financed with long term capital but the remaining level of permanent ssets and all the temporary assets are financed with short term nonspontaneous debt. se of short term debt makes this approach cheaper but at the same time risky for the firm. Aggressiveness is relative since the firm can finance all permanent asset and part of fixed asset with short term financing. This would be highly aggressive because of the risk of rising interest rate and loan renewal problems associated with short term financing. 3. Conservative Approach (Relaxed Investment Policy): Under this approach all of the permanent current assets and some of the temporary current assets of a firm are financed with long term debt.