Lecture notes on International Financial management

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FINANCIAL MANAGEMENT & INTERNATIONAL FINANCE FINAL GROUP - III PAPER - 12 STUDY NOTES THE INSTITUTE OF COST AND WORKS ACCOUNTANTS OF INDIA 12, SUDDER STREET, KOLKATA - 700 016First Edition : May 2008 Revised Edition : March 2009 First Reprint of Revised Edition : June 2010 Published by : Directorate of Studies The Institute of Cost and Works Accountants of India 12, Sudder Street, Kolkata - 700 016 Printed at : India Ltd., Navi Mumbai, India. Copyright of these Study Notes is reserved by the Institute of Cost and Works Accountants of India and prior permission from the Institute is necessary for reproduction of the whole or any part thereof.PAPER - 12 FINANCIAL MANAGEMENT AND INTERNATIONAL FINANCE Contents Study Note - 1 Overview of Financial Management Section Particulars Page No. Section 1 Finance and Related Discipline 1 – 5 Section 2 Objective & Scope of Financial Management 6 – 9 Section 3 Planning Environment 10 – 15 Section 4 Key Decisions of Financial Management 16 – 20 Section 5 Emerging Role of Finance Managers 21 Section 6 Earnings Distribution Policy 22 – 23 Section 7 Compliance of Regulatory Requirements in Formulation of Financial Strategies 24 – 36 Section 8 Sources of Finance - Long Term, Short Term and International 37 – 46 Section 9 Exchange rate - Risk Agencies Involved And Procedure Followed in International Financial Operations 47 – 56 Study Note - 2 Financial Management Decisions Section 1 Capital Structure Theory 57 – 65 Section 2 Cost of Capital 66 – 107 Section 3 Capital Budgeting 108 – 177 Section 4 Replacement and Lease Decisions 178 – 202 Section 5 Working Capital 203 – 264 Section 6 Financial Services 265 – 284 Section 7 Dividend Policy 285 – 319 Section 8 Financial Management in Public Sector 320 – 332 Section 9 Role of Treasury Function 333 – 336 Section 10 Contemporary Developments 337 – 340Study Note - 3 Financial Analysis and Planning Section 1 Funds Flow Analysis 341 – 382 Section 2 Ratio Analysis 383 – 399 Section 3 Identification of Information Required To Access 400 – 431 Financial Performance Study Note - 4 Leverage Section 1 Analysis of Operating and Financial Leverages 432 – 448 Study Note - 5 Financial Strategy Section 1 Understanding Financial Strategy 449 – 453 Section 2 Financial and Non-Financial Objectives of Different Organizations 454 – 465 Section 3 Impact on Investment, Finance and Dividend Decisions 466 – 473 Section 4 Alternative Financing Strategy in the Context of Regulatory Requirements 474 – 478 Section 5 Modeling and Forecasting Cash Flows and Financial Statements 479 – 481 Section 6 Sensitivity Analysis for Changes in Expected Values in the Models and Forecasts 482 – 497 Study Note - 6 Investment Decisions Section 1 Cost Benefits Risks Analysis for Projects 498 – 506 Section 2 Designing Capital Structure 507 – 511 Section 3 Capital Investment Real Options 512 – 514 Section 4 Venture Capital 515 – 518 Section 5 Hybrid Finance 519 – 542 Study Note - 7 Project Management Section 1 Project Identification and Formulation 543 – 548 Section 2 Identification of Project Opportunities 549 – 558 Section 3 Project Selection Considerations and Feasibility Studies 559 – 567 Section 4 Project Appraisal and Cost Benefit Analysis 568 – 579 Section 5 Sources of Project Finance and Foreign Collaboration 580 – 601Study Note - 8 International Finance Section 1 Risk – Management of Risk 602 – 614 Section 2 Risk – Diversification 615 – 619 Section 3 Derivatives 620 – 649 Section 4 Caps, Floors and Collars 650 – 652 Section 5 Money Market Hedge 653 – 677 Study Note - 9 Sources of International Finance Section 1 Raising Funds in Foreign Markets and Investment in Foreign Markets 678 – 690 Section 2 Forward (Interest) Rate Agreements – FRAS 691 – 693 Section 3 Exposures in International Finance 694 – 696 Section 4 Parity Theorems 697 – 703 Section 5 Foreign Direct Investment (FDI) 704 – 706 Study Note - 10 International Monetary Fund and Financial System Section 1 Understanding International Monetary System 707 – 717 Section 2 Export – Import Procedures and Documentation 718 – 724 Section 3 International Financial Management : Important 725 – 728 Issues and Features, International Capital Market Section 4 International Financial Services and Insurance : Important Issues and Features 729 – 734.SYLLABUS Paper 12: Financial Management & International Finance (One Paper: 3 hours: 100 marks) OBJECTIVES Understand the scope, goals and objectives of Financial Management. To provide expert knowledge on concepts, methods and procedures involved in using Financial Management for managerial decision-making. Learning Aims  Understand and apply theories of financial management  Identify the options available in financial decisions and using appropriate tools for strategic financial management  Identify and evaluate key success factors in the financial management for organisation as a whole  Evaluate strategic financial management options in the light of changing environments and the needs of the enterprise  Determining the optimal financial strategy for various stages of the life-cycle of the enterprise  Critically assess the proposed strategies Skill set required Level C: Requiring all six skill levels - knowledge, comprehension, application, analysis, synthesis, and evaluation CONTENTS 1. Overview of Financial Management 10% 2. Financial Management Decisions 15% 3. Financial Analysis & Planning 10% 4. Operating and Financial Leverages 5% 5. Financial Strategy 15% 6. Investment Decisions 15% 7. Project Management 10% 8. International Finance 10% 9. Sources of International Finance 5% 10. International Monetary and Financial System 5%1. Overview of Financial Management  Finance and Related Disciplines  Scope of Financial Management  Planning environment  Key decisions of Financial Management  Emerging role of finance managers in India  Earnings distributions policy  Compliance of regulatory requirements in formulation of financial strategies  Sources of finance – long term, short term and international  Exchange rate – risk agencies involved and procedures followed in international financial operations 2. Financial Management Decisions  Capital structure theories and planning  Cost of capital  Designing Capital Structure  Capital budgeting  Lease financing  Working capital management  Financial services  Dividend and retention policies  Criteria for selecting sources of finance, including finance for international investments  Effect of financing decisions on Balance Sheet and Ratios  Financial management in public sector  Role of Treasury function in terms of setting corporate objectives, funds management – national and international  Contemporary developments – WTO, GATT, Corporate Governance, TRIPS, TRIMS, SEBI regulations as amended from time to time 3. Financial analysis & planning  Funds flow and cash flow analysis  Financial ratio analysis -Ratios in the areas of performance, profitability, financial adaptability, liquidity, activity, shareholder investment and financing, and their interpretation.  Limitations of ratio analysis Identification of information required to assess financial performance  Effect of short-term debt on the measurement of gearing. 4. Operating and financial leverages  Analysis of operating and financial leverages  Concept and nature of leverages operating risk and financial risk and combined leverage  Operating leverage and Cost volume Profit analysis – Earning Before Interest and Tax (EBIT) and Earning Per Share (EPS), indifference point. 5. Financial Strategy  Financial and Non-Financial objective of different organizations  Impact on Investment, finance and dividend decisions  Sources and benefits of international financing  Alternative Financing strategy in the context of regulatory requirements  Modeling and forecasting cash flows and financial statements based on expected values for variables – economic and business  Sensitivity analysis for changes in expected values in the models and forecasts  Emerging trends in financial reporting 6. Investment Decisions  Costs, Benefits and Risks analysis for projects  Linking investment with customer’s requirements  Designing Capital Structure  The impact of taxation, potential changes in economic factors and potential restrictions on remittance on these calculations  Capital investment real options  Venture Capital financing  Hybrid financing / Instruments 7. Project Management  Project Identification and Formulation  Identification of Project opportunities  Project Selection Consideration and Feasibility Studies  Project appraisal & Cost Benefit analysis  Source of Project Finance & Foreign Collaboration8. International Finance  Minimization of risk  Diversification of risk  Forward and futures  Forward rate agreements  Interest rate swaps  Caps, floors and collars  Parity theorems  FDI  Money market hedge  Options. 9. Sources of International Finance  Rising funds in foreign markets and investments in foreign projects  Forward rate agreements and interest rate guarantees  Transaction, translation and economic risk, Interest rate parity, purchasing power parity and the Fisher effects  Foreign Direct Investment 10. International Monetary and Financial System  Understanding the International Monetary System  Export and Import Practices  International Financial Management: Important issues and features, International Capital Market  International Financial Services and Insurance: Important issues and featuresStudy Note - 1 OVERVIEW OF FINANCIAL MANAGEMENT 1.1 Finance and Related Discipline This Section includes : • Meaning and Definition of Finance • Meaning and Definition of Financial Management • Finance and Related Disciplines • Economics • Accounting • Production • Marketing • Quantitative Methods • Costing • Law • Taxation • Treasury Management • Banking • Insurance • International Finance • Information Technology INTRODUCTION : Finance is called “The science of money”. It studies the principles and the methods of obtaining control of money from those who have saved it, and of administering it by those into whose control it passes. Finance was a branch of Economics till 1890. Economics is defined as study of the efficient use of scarce resources. The decisions made by business firm in production, marketing, finance and personnel matters form the subject matters of economics. Finance is the process of conversion of accumulated funds to productive use. It is so intermingled with other economic forces that there is difficulty in appreciating the role it plays. MEANING AND DEFINITION OF FINANCE : Howard and Uptron in his book Introduction to Business Finance defined, “as that administrative area or set of administrative function in an organization which relate with the arrangement of cash and credit so that the organization may have the means to carry out its objectives as satisfactorily as possible”. Financial Management & International Finance 1Overview of Financial Management COST-VOLUME-PROFIT ANALYSIS In simple terms finance is defined as the activity concerned with the planning, raising, con- trolling and administering of the funds used in the business. Thus, finance is the activity concerned with the raising and administering of funds used in business. MEANING AND DEFINITION OF FINANCIAL MANAGEMENT : Financial management is managerial activity which is concerned with the planning and controlling of the firm’s financial resources. Definitions Howard and Uptron define financial management “as an application of general managerial principles to the area of financial decision-making”. Weston and Brighem define financial management “as an area of financial decision making, harmonizing individual motives and enterprise goal”. “Financial management is concerned with the efficient use of an important economic resource, namely capital funds” - Solomon Ezra & J. John Pringle. “Financial management is the operational activity of a business that is responsible for obtaining and effectively utilizing the funds necessary for efficient business operations”- J.L. Massie. “Financial Management is concerned with managerial decisions that result in the acquisition and financing of long-term and short-term credits of the firm. As such it deals with the situations that require selection of specific assets (or combination of assets), the selection of specific liability (or combination of liabilities) as well as the problem of size and growth of an enterprise. The analysis of these decisions is based on the expected inflows and outflows of funds and their effects upon managerial objectives”. - Phillippatus. Nature of Financial Management The nature of financial management refers to its relationship with related disciplines like economics and accounting and other subject matters. The area of financial management has undergone tremendous changes over time as regards its scope and functions. The finance function assumes a lot of significance in the modern days in view of the increased size of business operations and the growing complexities associated thereto. FINANCE AND OTHER RELATED DISCIPLINES : Financial management, is an integral part of the over all management, on other disciplines and fields of study like economics, accounting, production, marketing, personnel and quantitative methods. The relationship of financial management with other fields of study is explained as under : 2 Financial Management & International FinanceFinance and Other Disciplines Economics Corporate Finance Responsibility Cost Accounting Financial Accounting Business Finance FINANCE Transactional Accounting Accounting Management Accounting Human Resource Accounting Finance and Economics Finance is a branch of economics. Economics deals with supply and demand, costs and prof- its, production and consumption and so on. The relevance of economics to financial manage- ment can be described in two broad areas of economics i.e., micro economics and macro eco- nomics. Micro economics deals with the economic decisions of individuals and firms. It concerns itself with the determination of optimal operating strategies of a business firm. These strategies includes profit maximization strategies, product pricing strategies, strategies for valuation of firm and assets etc. The basic principle of micro economics that applies in financial manage- ment is marginal analysis. Most of the financial decisions should be made taken into account the marginal revenue and marginal cost. So, every financial manager must be familiar with the basic concepts of micro economics. Macro economics deals with the aggregates of the economy in which the firm operates. Macro economics is concerned with the institutional structure of the banking system, money and capital markets, monetary, credit and fiscal policies etc. So, the financial manager must be aware of the broad economic environment and their impact on the decision making areas of the business firm. Finance and Accounting Accounting and finance are closely related. Accounting is an important input in financial decision making process. Accounting is concerned with recording of business transactions. It generates information relating to business transactions and reporting them to the concerned parties. The end product of accounting is financial statements namely profit and loss account, balance sheet and the statements of changes in financial position. The information contained in these statements assists the financial managers in evaluating the past performance and fu- ture direction of the firm (decisions) in meeting certain obligations like payment of taxes and so on. Thus, accounting and finance are closely related. Financial Management & International Finance 3Overview of Financial Management COST-VOLUME-PROFIT ANALYSIS Finance and Production Finance and production are also functionally related. Any changes in production process may necessitate additional funds which the financial managers must evaluate and finance. Thus, the production processes, capacity of the firm are closely related to finance. Finance and Marketing Marketing and finance are functionally related. New product development, sales promotion plans, new channels of distribution, advertising campaign etc. in the area of marketing will require additional funds and have an impact on the expected cash flows of the business firm. Thus, the financial manager must be familiar with the basic concept of ideas of marketing. Finance and Quantitative Methods Financial management and Quantitative methods are closely related such as linear programming, probability, discounting techniques, present value techniques etc. are useful in analyzing complex financial management problems. Thus, the financial manager should be familiar with the tools of quantitative methods. In other way, the quantitative methods are indirectly related to the day-to-day decision making by financial managers. Finance and Costing Cost efficiency is a major strategic advantage to a firm, and will greatly contribute towards its competitiveness, sustainability and profitability. A finance manager has to understand, plan and manage cost, through appropriate tools and techniques including Budgeting and Activity Based Costing. Finance and Law A sound knowledge of legal environment, corporate laws, business laws, Import Export guidelines, international laws, trade and patent laws, commercial contracts, etc. are again important for a finance executive in a globalized business scenario. For example the guidelines of Securities and Exchange Board of India SEBI for raising money from the capital markets. Similarly, now many Indian corporate are sourcing from international capital markets and get their shares listed in the international exchanges. This calls for sound knowledge of Securities Exchange Commission guidelines, dealing in the listing requirements of various international stock exchanges operating in different countries. Finance and Taxation A sound knowledge in taxation, both direct and indirect, is expected of a finance manager, as all financial decisions are likely to have tax implications. Tax planning is an important func- tion of a finance manager. Some of the major business decisions are based on the economics of taxation. A finance manager should be able to assess the tax benefits before committing funds. Present value of the tax shield is the yardstick always applied by a finance manager in invest- ment decisions. Finance and Treasury Management Treasury has become an important function and discipline, not only in banks, but in every organization. Every finance manager should be well grounded in treasury operations, which is considered as a profit center. It deals with optimal management of cash flows, judiciously investing surplus cash in the most appropriate investment avenues, anticipating and meeting 4 Financial Management & International Financeemerging cash requirements and maximizing the overall returns, it helps in judicial asset liability management. It also includes, wherever necessary, managing the price and exchange rate risk through derivative instruments. In banks, it includes design of new financial products from existing products. Finance and Banking Banking has completely undergone a change in today’s context. The type of financial assistance provided to corporate has become very customized and innovative. During the early and late 80’s, commercial banks mainly used to provide working capital loans based on certain norms and development financial institutions like ICICI, IDBI, and IFCI used to provide long term loans for project finance. But, in today’s context, these distinctions no longer exist. Moreover, the concept of development financial institutions also does not exist any longer. The same bank provides both long term and short term finance, besides a number of innovative corporate and retail banking products, which enable corporate to choose between them and reduce their cost of borrowings. It is imperative for every finance manager to be up-to date on the changes in services & products offered by banking sector including several foreign players in the field. Thanks to Government’s liberalized investment norms in this sector. Finance and Insurance Evaluating and determining the commercial insurance requirements, choice of products and insurers, analyzing their applicability to the needs and cost effectiveness, techniques, ensur- ing appropriate and optimum coverage, claims handling, etc. fall within the ambit of a fi- nance manager’s scope of work & responsibilities. International Finance Capital markets have become globally integrated. Indian companies raise equity and debt funds from international markets, in the form of Global Depository Receipts (GDRs), American Depository Receipts (ADRs) or External Commercial Borrowings (ECBs) and a number of hybrid instruments like the convertible bonds, participatory notes etc., Access to international markets, both debt and equity, has enabled Indian companies to lower the cost of capital. For example, Tata Motors raised debt as less than 1% from the international capital markets recently by issuing convertible bonds. Finance managers are expected to have a thorough knowledge on international sources of finance, merger implications with foreign companies, Leveraged Buy Outs (LBOs), acquisitions abroad and international transfer pricing. The implications of exchange rate movements on new project viability have to be factored in the project cost and projected profitability and cash flow estimates. This is an essential aspect of finance manager’s expertise. Similarly, protecting the value of foreign exchange earned, through instruments like derivatives, is vital for a finance manager as the volatility in exchange rate movements can erode in no time, all the profits earned over a period of time. Finance and Information Technology Information technology is the order of the day and is now driving all businesses. It is all pervading. A finance manager needs to know how to integrate finance and costing with operations through software packages including ERP. The finance manager takes an active part in assessment of various available options, identifying the right one and in the implementation of such packages to suit the requirement. Financial Management & International Finance 5Overview of Financial Management COST-VOLUME-PROFIT ANALYSIS 1.2 Objective & Scope of Financial Management This Section includes : • Objective of Financial Management • Scope of Financial Management • Role of Financial Management • Liquidity • Profitability • Management • Functions • Investment Decisions • Financing Decisions • Dividend Decisions INTRODUCTION : Financial management is that managerial activity which is concerned with the planning and controlling of the firm’s financial resources. The funds raised from the capital market needs to be procured at minimum cost and effectively utilised to maximise returns on investments. There is a necessity to make the proper balancing of the risk-return trade off. OBJECTIVE OF FINANCIAL MANAGEMENT : Financial Management as the name suggests is management of finance. It deals with planning and mobilization of funds required by the firm. There is only one thing which matters for everyone right from the owners to the promoters and that is money. Managing of finance is nothing but managing of money. Every activity of an organization is reflected in its financial statements. Financial Management deals with activities which have financial implications. The very objective of Financial Management is to maximize the wealth of the shareholders by maximizing the value of the firm. This prime objective of Financial Management is reflected in the EPS (Earning per Share) and the market price of its shares. The earlier objective of profit maximization is now replaced by wealth maximization. Since profit maximization is a limited one it cannot be the sole objective of a firm. The term profit is a vague phenomenon and if given undue importance problems may arise whereas wealth maximization on the other hand overcomes the drawbacks of profit maximization. Thus the objective of Financial Management is to trade off between risk and return. The objective of Financial Management is to make efficient use of economic resources mainly capital. The functions of Financial Management involves acquiring funds for meeting short term and long term requirements of the firm, deployment of funds, control over the use of funds and to trade-off between risk and return. SCOPE OF FINANCIAL MANAGEMENT : Financial Management today covers the entire gamut of activities and functions given below. The head of finance is considered to be importantly of the CEO in most organizations and performs a strategic role. His responsibilities include : 6 Financial Management & International Financea. Estimating the total requirements of funds for a given period. b. Raising funds through various sources, both national and international, keeping in mind the cost effectiveness; c. Investing the funds in both long term as well as short term capital needs; d. Funding day-to-day working capital requirements of business; e. Collecting on time from debtors and paying to creditors on time; f. Managing funds and treasury operations; g. Ensuring a satisfactory return to all the stake holders; h. Paying interest on borrowings; i. Repaying lenders on due dates; j. Maximizing the wealth of the shareholders over the long term; k. Interfacing with the capital markets; l. Awareness to all the latest developments in the financial markets; m. Increasing the firm’s competitive financial strength in the market; and n. Adhering to the requirements of corporate governance. ROLE OF FINANCIAL MANAGEMENT : • To participate in the process of putting funds to work within the business and to control their productivity; and • To identify the need for funds and select sources from which they may be obtained. The functions of financial management may be classified on the basis of liquidity, profitability and management. 1. Liquidity Liquidity is ascertained on the basis of three important considerations: a. Forecasting cash flows, that is, matching the inflows against cash outflows; b. Raising funds, that is, financial management will have to ascertain the sources from which funds may be raised and the time when these funds are needed; c. Managing the flow of internal funds, that is, keeping its accounts, with a number of banks to ensure a high degree of liquidity with minimum external borrowing. 2. Profitability While ascertaining profitability, the following factors are taken into account: a. Cost control : Expenditure in the different operational areas of an enterprise can be analysed with the help of an appropriate cost accounting system to enable the financial manager to bring costs under control. b. Pricing : Pricing is of great significance in the company’s marketing effort, image and sales level. The formulation of pricing policies should lead to profitability, keeping, of course, the image of the organization intact. c. Forecasting Future Profits : Expected profits are determined and evaluated. Profit levels have to be forecast from time to time in order to strengthen the organization. Financial Management & International Finance 7Overview of Financial Management COST-VOLUME-PROFIT ANALYSIS d. Measuring Cost of Capital: Each source of funds has a different cost of capital which must be measured because cost of capital is linked with profitability of an enterprise. 3. Management The financial manager will have to keep assets intact, for assets are resources which enable a firm to conduct its business. Asset management has assumed an important role in financial management. It is also necessary for the financial manager to ensure that sufficient funds are available for smooth conduct of the business. In this connection, it may be pointed out that management of funds has both liquidity and profitability aspects. Financial management is concerned with the many responsibilities which are thrust on it by a business failures, financial failures do positively lead to business failures. The responsibility of financial management is enhanced because of this peculiar situation. Financial management may be divided into two broad areas of responsibilities, which are not by any means independent of each other. Each, however, may be regarded as a different kind of responsibility; and each necessitates very different considerations. These two areas are: • The management of long-term funds, which is associated with plans for development and expansion and which involves land, buildings, machinery, equipment, transport facilities, research project, and so on; • The management of short-term funds, which is associated with the overall cycle of activities of an enterprise. These are the needs which may be described, as working capital needs. FUNCTIONS OF FINANCIAL MANAGEMENT : The modern approach to the financial management is concerned with the solution of major problems like investment financing and dividend decisions of the financial operations of a business enterprise. Thus, the functions of financial management can be broadly classified into three major decisions, namely: (a) Investment decisions, (b) Financing decisions, (c) Dividend decisions. The functions of financial management are briefly discussed as under: 1. Investment Decision The investment decision is concerned with the selection of assets in which funds will be invested by a firm. The assets of a business firm includes long term assets (fixed assets) and short term assets (current assets). Long term assets will yield a return over a period of time in future whereas short term assets are those assets which are easily convertible into cash within an accounting period i.e. a year. The long term investment decision is known as capital budgeting and the short term investment decision is identified as working capital management. Capital Budgeting may be defined as long – term planning for making and financing proposed capital outlay. In other words Capital Budgeting means the long-range planning of allocation of funds among the various investment proposals. Another important element of capital budgeting decision is the analysis of risk and uncertainity. Since, the return on the investment proposals can be derived for a longer time in future, the capital budgeting decision should be evaluated in relation to the risk associated with it. 8 Financial Management & International FinanceOn the other hand, the financial manager is also responsible for the efficient management of current assets i.e. working capital management. Working capital constitutes an integral part of financial management. The financial manager has to determine the degree of liquidity that a firm should possess. There is a conflict between profitability and liquidity of a firm. Working capital management refers to a trade – off between liquidity (Risk) and profitability. Insufficiency of funds in current assets results liquidity and possessing of excessive funds in current assets reduces profits. Hence, the finance manager must achieve a proper trade – off between liquidity and profitability. In order to achieve this objective, the financial manager must equip himself with sound techniques of managing the current assets like cash, receivables and inventories etc. 2. Financing Decision The second important function is financing decision. The financing decision is concerned with capital – mix, financing – mix or capital structure of a firm. The term capital structure refers to the proportion of debt capital and equity share capital. Financing decision of a firm relates to the financing – mix. This must be decided taking into account the cost of capital, risk and return to the shareholders. Employment of debt capital implies a higher return to the share holders and also the financial risk. There is a conflict between return and risk in the financing decisions of a firm. So, the financial manager has to bring a trade – off between risk and return by maintaining a proper balance between debt capital and equity share capital. On the other hand, it is also the responsibility of the financial manager to determine an appropriate capital structure. 3. Dividend Decision The third major function is the dividend policy decision. Dividend policy decisions are concerned with the distribution of profits of a firm to the shareholders. How much of the profits should be paid as dividend? i.e. dividend pay-out ratio. The decision will depend upon the preferences of the shareholder, investment opportunities available within the firm and the opportunities for future expansion of the firm. The dividend pay out ratio is to be determined in the light of the objectives of maximizing the market value of the share. The dividend decisions must be analysed in relation to the financing decisions of the firm to determine the portion of retained earnings as a means of direct financing for the future expansions of the firm. A. Capital Budgeting 1. INVESTMENT DECISIONS B. Working Capital Management A. Cost of Capital 2. FINANCING FINANCIAL B. Capital Structure Decisions MANAGEMENT DECISIONS C. Leverages A. Dividend Policy 3. DIVIDEND DECISIONS B. Retained - Earnings Financial Management & International Finance 9Overview of Financial Management COST-VOLUME-PROFIT ANALYSIS 1.3 Planning Environment This Section includes : • Steps in Financial Planning • Establishing Objectives • Policy formulation • Forecasting • Formulation of procedures • Characteristics of Financial Planning • Computerized Financial Forecasting and Planning Models • Limitations of Financial Planning INTRODUCTION : Financial planning involves analyzing the financial flows of a company, forecasting the consequences of various investment, financing and dividend decisions and weighing the effects of various alternatives. The idea is to determine where the firm has been, where it is now and where it is heading – not only the most likely course of events, but deviation from the most likely outcome. The advantage of financial planning is that it forces management to take account of possible deviation from the company’s anticipated path. The aim in financial planning should be to match the needs of the company with those of the investors with a sensible gearing of short-term and long-term fixed interest securities. Financial planning aims at the eliminations of waste resulting from complexity of operation. For e.g. – technological advantage, higher taxes, fluctuations of interest rates etc. Financial planning helps to avoid waste by providing policies and procedures, which make possible a closer co- ordination between various functions of the business enterprise. A firm, which performs no financial planning, depends upon past experience for the establishment of its objectives, policies and procedures. It may be summarized that financial planning should:- • Determine the financial resources required in meeting the company’s operating program. • Forecast the extent to which these requirements will be met by internal generation of funds and to what extent they will be met from external sources. • Develop the best plans to obtain the required external funds. • Establish and maintain a system of financial control governing the allocation and use of funds. • Formulate programs to provide the most effective cost - volume - profit relationship. • Analyze the financial results of operation. • Report the facts to the top management and make recommendations on future operations of the firm. 10 Financial Management & International Finance

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