Financial Management (BBA 4th sem)

Question No 1: (10Marks): What do you mean by dividend & dividend policy? Explain dividend payment procedures

Answer: Dividend is a reward that is paid by company to its shareholders for providing capital and taking risk in business. In other words, dividend is the portion of net income that is paid to the shareholders in form of cash or share of stock. The portion of net income that is paid to the shareholders in form of cash is called “dividend pay-out ratio”

Dividend policy is one of the important financial decisions of the company. Dividend policy play an important role in determining how much portion of the earning of the firm to be distributed as dividend and how much portion of the earning is to be retained in the firm to be used for expansion of business

Process/Procedures of dividend distribution

Distributing the portion of earning as dividend is a key decision that affects the value of the common share of the firm in the open market. At the same time, the portion of undistributed part of earning (retained earning) is the most easily available internal source of financing for the future growth

There is a standard process of distribution or payment of dividend to shareholders. There are generally 3 steps for distribution of dividend as given below

(a) Declaration Date

The board of directors meets and decides to distribute dividend at a certain percent on par value of share or sometimes also a fixed amount per share. This is the first step of dividend distribution process. The date on which dividend is announced is called “ Date of declaration”

(b) Date of Record

On the date of declaration, the board of directors also fixes a date on which company shall prepare a list of shareholders on the close of the day. Such date is called “date of record”. The shareholders who are included in the list shall be generally eligible to get dividend.

Ex-dividend date is 2 days prior to the date of record. For example, suppose date of record is 10 June, 2022, then Ex-dividend date is 8 June 2022. Ex-dividend is considered in case of sale of share from old shareholders to the new shareholders. If a shareholder sells share to new shareholders then the transaction must be completed before the Ex-dividend date, i.e. 8 June, 2022 to be eligible for getting dividend by the new shareholder. Otherwise the new shareholder shall not be entitled to get dividend.

(d) Payment Date

When board of directors meets to announce dividend, they also announce the date of payment of dividend. On the date of payment, company pay dividend to all the eligible shareholders whose name is mentioned in the record on the date of record

Question No 2: (10 Marks): What is concept of working capital management? Discuss the working capital cash-flow cycle with example

Answer: Working capital is the fund that is managed by firm for running day to day business activities. The fund used by a firm to purchase Land & Building, Plant & Machinery is not working capital, rather that is fixed capital invested for fixed assets. There are two concepts of working capital, which are as follows

(i) Gross Working capital: It is a total sum of money invested in all the current assets of company like Inventory, Account Receivable, Cash etc

(ii) Net Working capital: It is the difference between current assets and current liabilities

Working capital cash flow cycle

Working capital cash flow cycle refers to the duration of time taken in a firm from purchase of raw material to collection of cash from customers/debtors. Let us take an example. Suppose a firm buy raw material and paid cash to suppliers for Rs 200,000. Now it shall take time to get the cash back. First of all the raw material is converted into work-in-progress, the work-in-progress shall be converted into finished goods, the finished goods shall be sold on credit (generally) and converted into Account receivables, the account receivables are collected and shall become cash. This way there is a cycle that cash travels and passes through a route and finally becomes cash again. This is called working capital cash flow cycle

Question No 3: (5 Marks): What is Receivable management? What are the purposes of Receivable management?

Answer: Business organizations mostly sell their goods and services on credit. Such credit sales are recorded in the books of account as Account Receivables. Account receivables help business to increase Sales, but in the other hand it also involves some cost and risk of bad debts. Therefore, it becomes necessary to manage the Receivables in order to reduce the cost and risk of bad debts. For the purpose, company announces credit policy, like cash discount, credit days, credit limit and so on

Purpose of Receivable Management

Following are some major purpose of receivable management.

a. To increase the efficiency of credit and collection department

b. To reduce the cost of receivable

c. To reduce bad debts

d. To increase the sales volume

e. To maintain a cost & benefits trade-off (equilibrium)

Question No 4 (5 Marks): What is cash management? Why it should be managed?

Answer: Cash management is a process of efficient collection and disbursement of cash for the purpose of maintaining optimal level of cash. Therefore cash management includes investment of surplus cash into marketable security and also managing the cash at the time of deficit

There are different motives of cash management, which are described briefly as below

(a) Transaction motive: To meet the need of daily transactional requirement

(b) Precautionary motive: To meet the need at the time of any unforeseen emergency

(d) Compensating balance motive: To fulfill the need of compensating balance demanded by commercial banks

Question No 5 (5 Marks): Describe factors influencing dividend policy

Answer: There are various factors which affect the dividend policy of a company. Following are some of the major factors among them

(a) Liquidity position of firm

A firm generally needs “retained earning” for distribution of dividend. But at the same time, the firm also needs cash for distribution of cash dividend. If there is not sufficient cash with them, then the firm prefers to distribute stock dividend

(b) Repayment of debt

A company may have some loan maturing in near future, for which it needs cash balance. If there is no such major loan maturing in near future, then company distribute cash dividend, but if company has such maturing loan, then company prefers to distribute stock dividend

If the company has opportunity of investment with higher rate of return, then company generally does not distribute cash dividend

(d) Stockholders tax situation

If stockholders are relatively in higher tax slabs, such stockholders prefer not to take dividend, rather they want to retain the earning into company for the purpose of capital gain

Question No 6 (5 Marks): Describe the sources of short term finance

Answer: There are basically two sources of short term finance. They are as follows

(a) Trade Credits

Generally, a firm purchase materials from suppliers on credit. Such credit purchases have payment term like, 2/10, net 30. If the firm does not take discount, then the firm could use the fund for 30 days. This way, trade credit (account payable) is a source of short term finance

(b) Short term bank loan

There are different kinds of short term bank loan available in commercial banks. Following are some of the major ones

(i) Simple Interest Loan:

It has a simple interest rate against the principal amount of loan. Both interest and principal amount is payable at the end of the loan period

(ii) Discounted Loan:

Under this category, the interest amount is deducted from the principal amount of loan and balance amount is given to the borrower

(iii) Loan with compensating balance:

Under this category, bank has a term that the borrower should maintain a certain percentage of principal amount of loan in the account throughout the loan period

(iv) Add-On Loan:

Under this category, interest amount for the period is added to the principal amount of loan and the whole amount is divided by the no of installment to find out the Installment amount. The borrower shall find out a equal amount of installment to be repaid with the help of present value table

(v) Revolving credit:

Under this type, a certain amount of fund is approved by bank and made available in the account of the borrower. Bank shall take interest on the amount used and also bank take a nominal amount on the unused amount of fund as commitment fee

Question No 7 (5 Marks): How can firm speed up its cash collections and slow down its cash disbursement? Or what are the motives of holding cash? Explain briefly

Answer: Speeding up collection and slowing down disbursement (payment) both are beneficial to company. It is also known as collection and disbursement policy. A firm could implement different collection policy as follows

(i) Correspondence: If there is any overdue with customers, then the firm should write letter/mails again and again to the customers

(ii) Telephone calls: If customer does not respond the mails/letters then the firm should make telephone calls

(iii) Personal visits: If calls are also not responded or the customer delays payments, then the firm should visit the customer’s place personally

(iv) Legal action: If customer does not make payment after all efforts, then the firm should take legal action against the customer

There are different motives of cash management, which are described briefly as below.

(a) Transaction motive: To meet the need of daily transactional requirement

(b) Precautionary motive: To meet the need at the time of any unforeseen emergency

(c) Speculative motive: To take advantages of profitable opportunity, bargaining purchases at attractive discount

(d) Compensating balance motive: To fulfill the need of compensating balance demanded by commercial banks

Question No 8: Explain the various elements of credit policy. How would you analyze the changing in credit policy variables?

Answer: There are three basic elements of credit policy of a firm. They are (i) Credit standards (ii) Credit terms (iii) Collection policy

(i) Credit standards:

A credit manager generally applies 5 Cs for setting credit standards. They are as follows

• Character of customer

• Capacity of customer

• Capital with customer

• Collateral a customer can give

• Condition of the market

(ii) Credit Terms:

Under credit term, the firms basically decide about the Cash discount rate, cash discount period and credit period

(iii) Collection Policy:

The firm also determine collection policy like (a) writing letter (b) making telephone calls (c) personal visit (d) legal action

Question No 8 (1 Mark): Very short question answers

(a) CCC: Cash Conversion Cycle. It is the period that takes from Purchase of materials till collection from customers

(b) Disbursement float: Slowing down the payments as far as possible without affecting the goodwill of firm and also taking care that fund does not remain idle

(d) Declaration date: It is date when board of directors announce dividend

(e) Operating cycle: It is the period taken for inventory conversion period and receivable conversion period, i.e. Operating cycle = ICP + RCP

(f) IRR: Internal rate of return: It is a tool of capital budgeting. Under which the internal rate of return of project or projects are determined

(g) Revolving credit agreement: A sum of loan is approved by bank, which can be used by a firm as per the requirement. Interest is payable on the used amount and commitment charge is paid in unused amount

(h) Annual Effective Rate: It is the cost of fund determined considering compounding effect of the period

(i) PI: Profitability Index: It is one of the discounted method of capital budgeting and is determined dividing PV of future cash flow by ICO

(j) What do you mean by working capital? : It is investment in current assets of the company. It is also determined as CA – CL

(k) Define the operating lease: An operating lease is a contract that permits the use of an asset without transferring the ownership rights to the leasee

(l) Define discount basis of short term loan: Under this the interest amount is deducted at the beginning of the period of the loan and balance amount is given to the borrower

(m) What do you mean by financial management?: It is a broad concept about how to manage all short term and long term financial decision to the best of the interest of the firm

Question No 9: “Working Capital Management plays a significant role in daily operating activities of an organization: Justify the statement and briefly discuss the concepts of working capital

Answer: Working Capital management in today’s business is one of the very important aspects. Working capital is directly connected to the business activities. Insufficient working capital disrupts the smooth operation of business and at the same time excess investment in working capital increase the cost of business operation in a big way. Hence an organization should be very much careful and should maintain a optimal working capital

For maintaining optimum level of working capital, management always keep an eye in different components of working capital like Cash management, Inventory management, Receivable management, Payable management and so on

There are basically two concepts of working capital, they are (a) Gross Working Capital and (b) Net Working Capital. Gross working capital is the total amount invested in the current assets and Net working capital is the difference between current assets and current liabilities. In other words, Gross working capital emphasizes the level of investment in current assets. Net working capital emphasizes in the liquidity position of the business

Question No 10: Briefly discuss the dividend payment schemes followed by the organizations

Dividends are paid out of the earnings. Generally dividends are increased along with increase in the earnings. There are basically two policies or schemes that are followed by organizations for payment of dividends. They are as follows

(a) Residual Policy:

Under the residual policy organizations first look into prospectus of investment opportunity with a higher rate of return. If there is a good investment opportunity available, organization gives priority to it. After making investment, if there is any surplus money in left, then only dividend is distributed. The idea behind the policy is that organizations do not want to unnecessarily issue Equity Share or take long term bank loan, rather it would like to retain the earning that is required for investment opportunity and balance amount is distributed as dividend

(b) Stable Dividend Policy:

Under this policy, organizations want consistency in payment of dividend to its shareholders. In dividend payment fluctuates every year, it affects the goodwill of the firm in market. If a dividend of Rs 40 per share were distributed last year, then organizations want to pay at least Rs 40 per share this year also

About Internal Rate of Return (IRR) in Capital Budgeting Techniques in brief

We have two kinds of Cash Flows, i.e. Even Cash Flow and Uneven Cash Flow. We use normally two different formula each for Even Cash Flow and Uneven Cash Flow as follows.

(a) For Even Cash Flow

Initial Cash Outlay

Step 1: Calculate Payback Period = ------------------------

Annual Cash Flow

Step 2: Look at the PVIFA table for the n th period (frequency) and locate the discount factor where lies. If the discount factor match exactly with the Payback period, then that is the IRR of the project. But the PBP lies in between two discount ffactor, then we find IRR by Interpolation as follow.

PVIFA at LR - PBP

IRR = LR + ------------------------------------- x (HR - LR)

PVIFA at LR - PVIFA at HR

(b) For uneven Cash Flow

Total Cash Flow

Step 1: Find out the average Annual Cash Flow (fake annuity) = --------------------------

No of Periods (N)

I C O

Step 2: Find out the fake Payback period = -------------------

Fake annuity

Step 3: Look at the PVIFA table for the n th period (frequency or no of years) and find out the factor (discount rate) for TRIAL and ERROR. The discount factor which is closest to the fake PBP is located and its corresponding interest rate is considered.

Step 4: Now start trial & error using the Interest rate discount factor and find out Net Present Value (NPV). Calculate the NPV with different discount rate until there come one positive and another negative NPV. Once you find out one positive and next negative NPV, then find out IRR by interpolation by using any one of the following formula.

PV at LR - NCO

IRR = LR + --------------------------- x (HR - LR)

PV at LR - PV at HR

Or,

NPV at LR

IRR = LR + ----------------------------- x (HR - LR)

NPV at LR - NPV at HR

Note: In the meantime, it should be noted that in the Capital Budgeting- Cash Flow Principles (i.e. NCO, Annual CFAT, Terminal Cash flow) there is never a case of even cash flow. There is always uneven cash flow because of the terminal cash flow at the final year which is generally different than regular annual cash flows. Therefore, uneven case is used for IRR.