Source of Finance for business organization

Sources of funding in the short term and long term

The activity requires two types of financing, namely:

1. Short-term financing

2. Long-term financing

Funding decisions in the short term with regard to the long-term assets and affected Liabilities and is also known as working capital financing.

In the short term financial decisions are generally the cash flow next year or in the duty cycle of the company. Normally, the short-term financing for a maximum period of 3 years.

The main sources of short-term financing are:

1. Cash Advance
2. Short-term bank loan
3. Bill discounting
4. Credit
5. Inter-corporate deposits
6. Commercial Papers
7. Factoring
8. advance of working capital from commercial banks

1. Cash Advance:
cash credit facility is generally taken to fund working capital needs of the organization. Interest is charged at the moment for the Cash Advance Bank A / C, regardless of credit through the use of the advance.

2. Short-term bank loans: bank overdraft
 

3. Update of the bill:
The bill discount is a source of short-term financing, ownership change was settled by the borrowers of the bank at a reduced rate.

4. Credit
Credit is an indirect form of financing working capital and banks than take the risk, the credit by the supplier itself provided.

A letter of credit by a bank on behalf of their clients issued to the seller. According to this document, the bank drafts drawn on them for deliveries to the customer's credit. I f the vendor complies with the conditions of the letter of credit established.

5. Inter Corporate Deposits
A deposit of one company to another, usually for a period of six months, that is, as described ICD. The short-term deposits with other firms as a relatively attractive form of money in the short term regarding the return.
These deposits are generally three types:
a. Call deposits: withdraw terminate a money market account is the lender on a given date can.
b. three-month deposits: These deposits must be taken by the borrower
commitments over a lack of short-term cash
c. Six-month deposits: Normally, businesses do not make loans to deposits that time. These deposits are usually made with high quality borrowers.

6. Commercial Papers
A business can commercial paper to raise funds. This is a promissory note. The implementation of the company to the amount and / or reimburse a specific date.

7. Factoring
One factor is a financial institution that services related to the management and financing of receivables offers credit sales. Factoring provides the resources to finance receivables, and facilitates the recovery of debts.
There are 2 banks, sponsored organizations that provide services such.

a. SBI Factors and Commercial Services Ltd.
b. CANBANK factors LTD, operated since early 1997.

8. advance of working capital from commercial banks
Since not allow the above sources, the use of funds over a longer period, the business climate to seek other sources when the need for a longer period, ie up 3 years and older.

If a company wants to invest in long-term assets, it must find to fund the needs. The Company may, to some extent rely on internally generated funds. But it is sufficient in most cases, internal resources, not to support investment projects. When this happens, the company plans to reduce their investments or seek external funding. Most companies choose to take outside funding. They supplement internal financing to external financing has risen from a variety of sources.
The main sources of long-term financing can be divided roughly into:

Internal sources include:

a. Share (equity shares and preference) in capital
b. Reserves and surplus
c. Personal loans are called by the owner as a "quasi-Capital"

External sources include:

a. loan from banks, financial institutions and international organizations like the International Monetary Fund, World Bank, Asian Development Bank.
b. Notes
c. The demands of family and friends
d. Deposits Inter-enterprise
e. Asian Depository Receipts / Global Depository Receipts
f.  Commercial documents.

Funding in the short term or long term is a function of financial management. The sound and efficient management that is to raise funds and, if necessary, at very attractive prices. Fundraising either internally or externally requires professional behavior, including compliance with both legal requirements, technical and legal Companies Act, the Securities Exchange Board of India, stock exchange authorities and other tax laws imposed as Income Act, the Foreign Exchange Management Regulations, the banking law, etc.

MBA Finance Topics-FINANCIAL RATIOS

Financial ratios are useful indicators of a firm's performance and financial situation. Most ratios can be calculated from information provided by the financial statements. Financial ratios can be used to analyze trends and to compare the firm's financials to those of other firms. In some cases, ratio analysis can predict future bankruptcy.

Financial ratios can be classified according to the information they provide. The following types of ratios frequently are used:

* Liquidity ratios
* Asset turnover ratios
* Financial leverage ratios
* Profitability ratios
* Dividend policy ratios

Liquidity Ratios

Liquidity ratios provide information about a firm's ability to meet its short-term financial obligations. They are of particular interest to those extending short-term credit to the firm. Two frequently-used liquidity ratios are the current ratio (or working capital ratio) and the quick ratio.

The current ratio is the ratio of current assets to current liabilities:

=	Current Assets Current Liabilities

Short-term creditors prefer a high current ratio since it reduces their risk. Shareholders may prefer a lower current ratio so that more of the firm's assets are working to grow the business. Typical values for the current ratio vary by firm and industry. For example, firms in cyclical industries may maintain a higher current ratio in order to remain solvent during downturns.
One drawback of the current ratio is that inventory may include many items that are difficult to liquidate quickly and that have uncertain liquidation values. The quick ratio is an alternative measure of liquidity that does not include inventory in the current assets. The quick ratio is defined as follows:

Quick Ratio

=

Current Assets - Inventory Current Liabilities

The current assets used in the quick ratio are cash, accounts receivable, and notes receivable. These assets essentially are current assets less inventory. The quick ratio often is referred to as the acid test.
Finally, the cash ratio is the most conservative liquidity ratio. It excludes all current assets except the most liquid: cash and cash equivalents. The cash ratio is defined as follows:

Cash Ratio

=

Cash + Marketable Securities Current Liabilities

The cash ratio is an indication of the firm's ability to pay off its current liabilities if for some reason immediate payment were demanded.

Asset Turnover Ratios

Asset turnover ratios indicate of how efficiently the firm utilizes its assets. They sometimes are referred to as efficiency ratios, asset utilization ratios, or asset management ratios. Two commonly used asset turnover ratios are receivables turnover and inventory turnover.
Receivables turnover is an indication of how quickly the firm collects its accounts receivables and is defined as follows:

Receivables Turnover

=

Annual Credit Sales Accounts Receivable

The receivables turnover often is reported in terms of the number of days that credit sales remain in accounts receivable before they are collected. This number is known as the collection period. It is the accounts receivable balance divided by the average daily credit sales, calculated as follows:

Average Collection Period

=

Accounts Receivable Annual Credit Sales / 365

The collection period also can be written as:

Average Collection Period

=

365 Receivables Turnover

Another major asset turnover ratio is inventory turnover. It is the cost of goods sold in a time period divided by the average inventory level during that period:

Inventory Turnover

=

Cost of Goods Sold Average Inventory

The inventory turnover often is reported as the inventory period, which is the number of days worth of inventory on hand, calculated by dividing the inventory by the average daily cost of goods sold:

Inventory Period

=

Average Inventory Annual Cost of Goods Sold / 365

The inventory period also can be written as:

Inventory Period

=

365 Inventory Turnover

Other asset turnover ratios include fixed asset turnover and total asset turnover.

Financial Leverage Ratios

Financial leverage ratios provide an indication of the long-term solvency of the firm. Unlike liquidity ratios that are concerned with short-term assets and liabilities, financial leverage ratios measure the extent to which the firm is using long term debt.
The debt ratio is defined as total debt divided by total assets:

Debt Ratio

=

Total Debt Total Assets

The debt-to-equity ratio is total debt divided by total equity:

Debt-to-Equity Ratio

=

Total Debt Total Equity

Debt ratios depend on the classification of long-term leases and on the classification of some items as long-term debt or equity.
The times interest earned ratio indicates how well the firm's earnings can cover the interest payments on its debt. This ratio also is known as the interest coverage and is calculated as follows:

Interest Coverage

=

EBIT Interest Charges

where EBIT = Earnings Before Interest and Taxes

Profitability Ratios

Profitability ratios offer several different measures of the success of the firm at generating profits.
The gross profit margin is a measure of the gross profit earned on sales. The gross profit margin considers the firm's cost of goods sold, but does not include other costs. It is defined as follows:

Gross Profit Margin

=

Sales - Cost of Goods Sold Sales

Return on assets is a measure of how effectively the firm's assets are being used to generate profits. It is defined as:

Return on Assets

=

Net Income Total Assets

Return on equity is the bottom line measure for the shareholders, measuring the profits earned for each dollar invested in the firm's stock. Return on equity is defined as follows:

Return on Equity

=

Net Income Shareholder Equity

Dividend Policy Ratios

Dividend policy ratios provide insight into the dividend policy of the firm and the prospects for future growth. Two commonly used ratios are the dividend yield and payout ratio.
The dividend yield is defined as follows:

Dividend Yield

=

Dividends Per Share Share Price

A high dividend yield does not necessarily translate into a high future rate of return. It is important to consider the prospects for continuing and increasing the dividend in the future. The dividend payout ratio is helpful in this regard, and is defined as follows:

Payout Ratio

=

Dividends Per Share Earnings Per Share

Use and Limitations of Financial Ratios

Attention should be given to the following issues when using financial ratios:

• A reference point is needed. To to be meaningful, most ratios must be compared to historical values of the same firm, the firm's forecasts, or ratios of similar firms.
• Most ratios by themselves are not highly meaningful. They should be viewed as indicators, with several of them combined to paint a picture of the firm's situation.
• Year-end values may not be representative. Certain account balances that are used to calculate ratios may increase or decrease at the end of the accounting period because of seasonal factors. Such changes may distort the value of the ratio. Average values should be used when they are available.
• Ratios are subject to the limitations of accounting methods. Different accounting choices may result in significantly different ratio values.
  
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MBA Finance Topics-Common Size Financial Statements

Common size ratios are used to compare financial statements of different-size companies, or of the same company over different periods. By expressing the items in proportion to some size-related measure, standardized financial statements can be created, revealing trends and providing insight into how the different companies compare.

The common size ratio for each line on the financial statement is calculated as follows:

Common Size Ratio

=

Item of Interest Reference Item

For example, if the item of interest is inventory and it is referenced to total assets (as it normally would be), the common size ratio would be:

Common Size Ratio for Inventory

=

Inventory Total Assets

The ratios often are expressed as percentages of the reference amount. Common size statements usually are prepared for the income statement and balance sheet, expressing information as follows:

• Income statement items - expressed as a percentage of total revenue
• Balance sheet items - expressed as a percentage of total assets

The following example income statement shows both the dollar amounts and the common size ratios:

Common Size Income Statement

	Income Statement	Common-Size Income Statement
Revenue	70,134	100%
Cost of Goods Sold	44,221	63.1%
Gross Profit	25,913	36.9%
SG&A Expense	13,531	19.3%
Operating Income	12,382	17.7%
Interest Expense	2,862	4.1%
Provision for Taxes	3,766	5.4%
Net Income	5,754	8.2%

For the balance sheet, the common size percentages are referenced to the total assets. The following sample balance sheet shows both the dollar amounts and the common size ratios:

Common Size Balance Sheet

	Balance Sheet	Common-Size Balance Sheet
ASSETS
Cash & Marketable Securities	6,029	15.1%
Accounts Receivable	14,378	36.0%
Inventory	17,136	42.9%
Total Current Assets	37,543	93.9%
Property, Plant, & Equipment	2,442	6.1%
Total Assets	39,985	100%
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities	14,251	35.6%
Long-Term Debt	12,624	31.6%
Total Liabilities	26,875	67.2%
Shareholders' Equity	13,110	32.8%
Total Liabilities & Equity	39,985	100%

The above common size statements are prepared in a vertical analysis, referencing each line on the financial statement to a total value on the statement in a given period.
The ratios in common size statements tend to have less variation than the absolute values themselves, and trends in the ratios can reveal important changes in the business. Historical comparisons can be made in a time-series analysis to identify such trends.
Common size statements also can be used to compare the firm to other firms.

Comparisons Between Companies (Cross-Sectional Analysis)

Common size financial statements can be used to compare multiple companies at the same point in time. A common-size analysis is especially useful when comparing companies of different sizes. It often is insightful to compare a firm to the best performing firm in its industry (benchmarking). A firm also can be compared to its industry as a whole. To compare to the industry, the ratios are calculated for each firm in the industry and an average for the industry is calculated. Comparative statements then may be constructed with the company of interest in one column and the industry averages in another. The result is a quick overview of where the firm stands in the industry with respect to key items on the financial statements.

Limitations

As with financial statements in general, the interpretation of common size statements is subject to many of the limitations in the accounting data used to construct them. For example:

• Different accounting policies may be used by different firms or within the same firm at different points in time. Adjustments should be made for such differences.
• Different firms may use different accounting calendars, so the accounting periods may not be directly comparable.

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MBA Finance Topics-CAPITAL BUDGETING

A capital expenditure is an outlay of cash for a project that is expected to produce a cash inflow over a period of time exceeding one year. Examples of projects include investments in property, plant, and equipment, research and development projects, large advertising campaigns, or any other project that requires a capital expenditure and generates a future cash flow.

Because capital expenditures can be very large and have a significant impact on the financial performance of the firm, great importance is placed on project selection. This process is called capital budgeting.

Criteria for Capital Budgeting Decisions

Potentially, there is a wide array of criteria for selecting projects. Some shareholders may want the firm to select projects that will show immediate surges in cash inflow, others may want to emphasize long-term growth with little importance on short-term performance. Viewed in this way, it would be quite difficult to satisfy the differing interests of all the shareholders. Fortunately, there is a solution.

The goal of the firm is to maximize present shareholder value. This goal implies that projects should be undertaken that result in a positive net present value, that is, the present value of the expected cash inflow less the present value of the required capital expenditures. Using net present value (NPV) as a measure, capital budgeting involves selecting those projects that increase the value of the firm because they have a positive NPV. The timing and growth rate of the incoming cash flow is important only to the extent of its impact on NPV.

Using NPV as the criterion by which to select projects assumes efficient capital markets so that the firm has access to whatever capital is needed to pursue the positive NPV projects. In situations where this is not the case, there may be capital rationing and the capital budgeting process becomes more complex.

Note that it is not the responsibility of the firm to decide whether to please particular groups of shareholders who prefer longer or shorter term results. Once the firm has selected the projects to maximize its net present value, it is up to the individual shareholders to use the capital markets to borrow or lend in order to move the exact timing of their own cash inflows forward or backward. This idea is crucial in the principal-agent relationship that exists between shareholders and corporate managers. Even though each may have their own individual preferences, the common goal is that of maximizing the present value of the corporation.
Alternative Rules for Capital Budgeting

While net present value is the rule that always maximizes shareholder value, some firms use other criteria for their capital budgeting decisions, such as:

* Internal Rate of Return (IRR)
* Profitability Index
* Payback Period
* Return on Book Value

In some cases, the investment decisions resulting from the IRR and profitability index methods agree with those of NPV. Decisions made using the payback period and return on book value methods usually are suboptimal from the standpoint of maximizing shareholder value.

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MBA Finance Topics-PERPETUITIES

A perpetuity is a series of equal payments over an infinite time period into the future. Consider the case of a cash payment C made at the end of each year at interest rate i, as shown in the following time line:

Perpetuity Time Line

0		1		2		3
PV		C		C		C

Because this cash flow continues forever, the present value is given by an infinite series:

PV = C / ( 1 + i ) + C / ( 1 + i )² + C / ( 1 + i )³ + . . .

From this infinite series, a usable present value formula can be derived by first dividing each side by ( 1 + i ).

PV / ( 1 + i ) = C / ( 1 + i )² + C / ( 1 + i )³ + C / ( 1 + i )⁴ + . . .

In order to eliminate most of the terms in the series, subtract the second equation from the first equation:

PV - PV / ( 1 + i ) = C / ( 1 + i )

Solving for PV, the present value of a perpetuity is given by:

PV =

C i

Growing Perpetuities

Sometimes the payments in a perpetuity are not constant but rather, increase at a certain growth rate g as depicted in the following time line:

Growing Perpetuity Time Line

0		1		2		3
PV		C		C(1+g)		C(1+g)2

The present value of a growing perpetuity can be written as the following infinite series:

PV =

C ( 1 + i )

+

C ( 1 + g ) ( 1 + i )2

+

C ( 1 + g )2 ( 1 + i )3

+ . . .

To simplify this expression, first multiply each side by (1 + g) / (1 + i):

PV ( 1 + g) ( 1 + i )

=

C ( 1 + g ) ( 1 + i )2

+

C ( 1 + g )2 ( 1 + i )3

+ . . .

Then subtract the second equation from the first:

PV -

PV ( 1 + g) ( 1 + i )

=

C ( 1 + i )

Finally, solving for PV yields the expression for the present value of a growing perpetuity:

PV =

C i - g

For this expression to be valid, the growth rate must be less than the interest rate, that is, g < i .

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