Question

Briefly write 4-5 short sentences on each of the 6 topics below. Explain its relevance to that of a financial manager.

1) Financial Statement Analysis

2) Working Capital Management

3) Time Value of Money

4) Risk and Return Tradeoff

5) Securities Valuation

6) Capital Budgeting

Answer 1

1.financial statement analysis: is the analysis of the company's balance sheet, cash flow statement and income statement to understand the company's current financial position and financial health. this information is useful to the investors,creditors and other third party and the results of this analysis helps on better decision making.

it generally happens in 3 different forms:

a) horizontal analysis b) vertical analysis c) ratio analysis

horizontal analysis: compares the data between two or more financial years.

vertical analysis : it shows the percentage of individual accounts to the total accounts in a balance sheet.

ratio analysis: it determines the liquidity position and profitability of the company .

relevance to a financial manager : a financial manager can take several decsions on the bais of these financial staements . for example if the ratios are a not good indicator of the finacial health of the company then he can work towards better utilization of its assets and genrating sufficient cash flows to pay the creditors on time. by comparing the ratios across differnet time periods they may develop a trend to anlyse the functioning of the business.

2. working capital management: working capital management is done to determine weather, the company is operating efficiently to pay for its short term obligations of the creditors and operating costs. it includes inventory management and management of receivables and payables.

the working capital ratio is calculated as dividing the current assets/current liabilities

it determines how efficiently the company is using the current assets to pay the current liabilities on time. a ratio of 2 is the ideal ratio. greater than 2 indicates that the company is not using its assets efficiently to generate sufficient revenues.

if the ratios are poor, the finance manager can improve the use of its assets and if it is good then maintain the good performance of ths business.

3. time value of money is the concept where a person decides weather he should be receiving money today or wait for a few years before receiving money. if a person may find it beneficial to receive his money after few years because he is then compensates for the time value of money.

the interest we receive on a deposit we have made in a bank for a particular period is because we have invested for a period of time say 2-3 years and hence we are compensated for the time value of money.the greater the time period we have invested it in the greater we will be compensated for it.

the finance manager may take several decisions on investing/financing or dividends based on the time value of money. A particular project may generate cash flows in different time periods also the outflows and inflows are not in the same time period and hence not comparable due to the time value of money. hence, the cash flows can be made comparable by introducing the interest factor as FV = PV(1+R)^N

4) risk and return trade off: it is known to all that with greater risks comes higher benefits. but there should be a trade off between risk and return. the risk should be within the acceptable levels. when the risks level crosses the acceptable levels then its hazardous for the financial health of the business.

for example, introducing debt in the company ,can help in increasing the value of the company due to the debt tax shield, but raising the level of debt beyond acceptable levels may also lead to bankruptcy and is hazardous to the financial health of the company.

the finance manager can develop a trade off between the equity and debt levels for the safety of the business.

5) securities valuation : is valuing the present value of a security which can be an equity investment ,debt instruments or derivatives(options and futures).

it helps in determining weather a security is undervalued or overvalued by comparing the value of the security derived from the valuation models with the current market price. for example, the dividend discount model determines the value of a security on the basis of its expected dividend , required return on equity and the sustainable growth rate.

for valuation of debt instruments the interest rates, the coupon rates ,the yield to maturity ,the time period during which the bond is held is taken into account.

the finance manager can take decision to buy ,sell or hold certain securities on the basis of these valuations.

6) capital budgeting: capital budgeting is a process ,where a manager determines a given project is viable or not or a particular expansion should be undertaken or not. by determining the expected future cash flows and the investment outlay of a project, a project manager can determine its viability.

various methods of capital budgeting are 1.NPV 2.IRR 3.PAY BACK PERIOD 4.DISCOUNTED CASH FLOWS.

a project generating a positive NPV will generate value for the company and a project generating negative NPV will erode its wealth.NPV is calculates as the present value of the expected future cash flows, discounted at the required rate of return minus the investment outlay to determine its viability.

if the NPV is postive the financial manager will go ahead with the project otherwise discard it.