C1 & C2 ABMF

• 3 main activities/decisions in Finance


  Financing decision decides level of funds required, which type of funds to raise and the raising in funds.

  Example: ABC decided to raise 10 millions by issuing new common stocks
• Investment decision decides amount to be invested into which types of assets

  Example: ABC decided to purchase land worth 5 million
• Dividend decision establish a dividend policy to retain earnings for reinvestment or pay dividends to shareholders

  Example: ABC decide to retain 75% of current year profit and distribute 25% as dividend to shareholders
• Profit maximization

  Short term in nature

  Major emphasises is on profit.

  Mostly concerned about short term benefits.

  Short term horizon can fulfill objective of earning profit but may not help in creating wealth.

  Ignores the timing of returns, magnitude of returns and risk.
• 
  

  Cash is money, in the form of notes and coins.

  Most liquid of assets and represents the lifeblood for growth and investment.

  
  

  Examples:

  Coin and notes

  Current accounts and short term deposits

  Foreign currency and deposits that can be easily converted to the domestic currency
• Cash flow is a term for receipts and payments of cash. In other words, it represents the cash movement for a particular organisation.
• Funds can be defined as any arrangement that enables goods or services to be bought ie money or credit.
• Cash inflows

  Cash received for sales immediately from cash customers; or from debtors for sales made on credit. These are revenue receipts.

  ii. Cash received as a result of sale of non current assets after their useful life, or the liquidation of the short term investment

  iii. Cash received from providers of finance: equity share capital invested in the business; or long term loans provided by banks and other financial institutions.
• Cash outflows:

  1. Payment to suppliers for goods purchased, and to employees for wages, these are revenue expenditure

  2. Payment to supplier of finance: dividend to shareholders and interest to debenture holders, bondholders and bank

  3. Payment to cover the purchase cost of non-current assets, such as buildings, equipment. These are capital payments in that they are purchased for long term use in the business.

  4. Payments to acquire investment: new business or takeover of companies and short term financial instruments.

  5. Purchase of foreign currency for trading overseas.
• Revenue receipts are cash receipts from cash sales and payments by trade debtors/receivables
• Revenue payments are payments to:

  Trade creditors

  Employees for salaries and wages

  Business expenses such as office rental, utility bills, and so on.
• Capital receipts proceeds of long term funds from company’s owner or cash from the sales of fixed assets or long term investments
• Capital payments are cash payments for capital expenditure, such as the purchase of new fixed asset (equipment, motor vehicles)
• 1. Transaction motives - the principal motive for holding cash is to enable the firm to conduct its ordinary business eg making purchases. A balance of cash is needed to cover the mismatch between receipts and payments. A firm cannot guarantee that it will collect sufficient cash each day to meet its obligations; therefore a balance is held to ensure expenses can be met as they fall due.
• i. Precautionary motives - the precautionary motive for holding safety stocks of cash relates primarily to the predictability of cash inflow and outflow and also to the maintenance of balances to be used to satisfy possible but indefinite needs.

  ii. Speculative motives - cash is held for speculative purposes in order to take advantage of potential profit making situations or to exploit opportunities that although unknown may arise at any future time.
• Problems

  Business that is loss making

  A business may still hold sufficient cash if the loss is only temporary. However, if a business continually makes losses, it will eventually have cash flow problems as it won’t have enough money on hand to cover all its expenses.
• ii. Inflation

  In a period of rising prices, a business needs increasing amount of cash just to replace used up and worn-out assets. The business can be making a profit in historical cost accounting terms, but might still be not receiving enough cash to buy replacement assets it needs
• iii. Growth

  A successful business in order to grow must be able to manage its resources carefully. As its sales increases, the growing company may need additional financing in order to employ more employees, buy additional equipments for production, purchase additional materials and to extend customers payment period.
• iv. Seasonal business

  When a business has seasonal or cyclical sales, it may have cash flow difficulties at certain times of the year. For example, during off season, the seller of mandarin orange or “Chinese dried meat” may not have enough cash inflow from sales to cover its outgoings.
• Ways to overcome cash shortages

  (i) Postponing capital expenditure

  (ii) Accelerating cash inflows

  (iii) Sell assets

  (iv) Negotiate with supplier for longer credit period
• Wealth maximisation


  maximising the value of the firm through maximising the price of the firm’s common stock.

  Long term in nature

  Concentrate on various other aspects like increasing sales, developing goodwill, customer service, corporate responsibility for the purpose of capturing more market share which will take care of profitability.

  priority to value creation

  Leads to better and true evaluation of business e.g., under wealth maximisation, more importance is given to cash flows rather than profitability.