notes by aamir

8/4/2019 Notes by Aamir

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Operating leverage

A relatively small percent increase or decrease in

sales volume that causes a much larger percent increase or decrease inprofit because fixed expenses do not change with small changes in salesvolume. Sales volume changes have a lever effect on profit. This effectshould be called sales volume leverage, but in practice it is called operatingleverage.

Operating leverage the proportionate relationship betweena companys variable and fixed costs

degree of operating leverage

a factor that indicates how a percentage change in sales, from the existing or current

level, will affect company profits; it is calculated as contribution

margin divided by net income; it is equal to (1 - margin of safety percentage)

degree of operating leverage (DOL)

Percentage change in profits given a 1 percent change in sales.

breakeven point

The annual sales volume level at which total contribution

margin equals total annual fixed expenses. The breakeven point is only a

point of reference, not the goal of a business, of course. It is computed bydividing total fixed expenses by unit margin. The breakeven point is

quite useful in analyzing profit behavior and operating leverage. Also, it

gives manager a good point of reference for setting sales goals andunderstanding the consequences of incurring fixed costs for a period.

margin of safety

the excess of the budgeted or actual sales

of a company over its breakeven point; it can be calculated

in units or dollars or as a percentage; it is equal to

(1 - degree ofoperating leverage)

Leverage

The relationship between interest bearing debt and equity in a company(financial leverage) or

the effect of fixed expense on after tax earnings(operating leverage).
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Financial leverage

Debt financing amplifies the effects of changes in operating income on the returns to

stockholders.

Financial leverageThe equity (ownership) capital of a business can serve

as the basis for securing debt capital (borrowing money). In this way, a

business increases the total capital available to invest in its assets andcan make more sales and more profit. The strategy is to earn operating

profit, or earnings before interest and income tax (EBIT), on the capital

supplied from debt that is more than the interest paid on the debt capital.

A financial leverage gain equals the EBIT earned on debt capital

minus the interest on the debt. A financial leverage gain augments earnings

on equity capital. A business must earn a rate of return on its assets

(ROA) that is greater than the interest rate on its debt to make a financial

leverage gain. If the spread between its ROA and interest rate is unfavorable,

a business suffers a financial leverage loss.

Financial leverage

Use of debt to increase the expected return on equity. financial leverage is measured by

the ratio of debt to debt plus equity.

Major functions of financial manager

a) Analise the existing system of accounts. Profit & Loss.

b) Plan & achieve your own targets to get good results

c) Monitor on daily basis your company expenses & daily income

d)Prepare a true balance sheet & not a fabricated one.

What Are The Functions Of A Financial Manager?

Kaplan Financial - ACCA

Kaplan Financial ACCA Site. Enrol On An Award Winning Course.Financial.Kaplan.co.uk/Official

The main function of a Finance Manager (FM) is to provide materially accurate information to the

general public, shareholders, stakeholders and the management of an enterprise, be this a joint stock(limited liability) Company, social enterprise/charity or community association, such as a sports club or a

parent/teacher organisation. This information will be of two types The first will be management

accounts that provides information from which decisions can be made, showing the success - or

otherwise - of the organisation in achieving it's goals and targets. The second is financial accounts that

is more formal and fulfils legal and moral obligations of organisations. This will include profit and loss

accounts at the end of a trading period, together with a balance sheet showing the assets and liabilities

of the organisation. The FM, working with auditors and accountants, will complete and file tax returns
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and other information that is required by the Authorities that oversee the operation of the

organisation. This type of information is usually produced annually, but for very large organisations,

such as Corporations with operations all over the world, and whose shares are quoted on Stock

Exchanges, data is often produced at the end of each quarter-year to ensure information is shared, and

from which investors can make reasoned judgements. The format of the various reports can be quite

simple - useful in small organisations, such as social clubs, but get more complex the larger the

organisation. A second key function of an FM is to maintain control over the organisation. This is

achieved in a number of ways. Target setting is the usual process, with objectives, defined as a budget

set for each part of the organisation, showing how much revenue is required to support the cost

structure, so that a trading profit is made at the end of the period. The FM has to work with all the other

Managers in the organisation to make sure the objectives are reasonable, are understood and the whole

team agrees with them. This process is very complicated and difficult, but once achieved helps the

whole organisation. Once a budget is agreed, the FM can monitor progress by measuring what is

actually happening against the plan, showing other Managers if they are on track, or some action needs

to be taken to increase sales to generate more revenue, or stop spending to cut costs. The FM

maintains control by determining processes and ways of doing things. For example, to spend money on

something, it is unusual to have a process that establishes whether good value is being achieved by

requiring the purchaser to look at different ways of buying what they want, getting different quotes

from different suppliers. Processes like these help maintain control by having an audit trail that

supports the purchase decision. Other functions will include those needed to be a manager, responsible

for the people in the finance team, so good interpersonal skills are required, together with the ability to

prioritise and organise.

Finance Managers do lots of thinks and look all the financial parts of the company. They are responsible

for allocating financial resources of the company. They also activity take part is budgeting, risk

management and financial reporting. Other important finance manager tasks are have an eye on profits

and loss, make financial reports, making certain plans to lesson the financial risk and so on.

Anonymous

Some of the main functions of a Finance Manager includes setting up financial goals, planning strategies

to reach these goals, keeping a high check on profits and loss, preparing financial reports, investing

funds, monitoring cash flows, advising the rest of on mergers and acquisitions, accounting and auditing,

developing certain kind of procedures in order to minimize financial risk and establishing lending

criteria. In short, financial managers handle all the financial dealings and accounts of the company.

The whole lingo is to add value to the company by setting the right financial goals. They handle all the

financial accounts with rigorousauditing. They decide on how much of the company's profits should be

returned into investment and also how much should be reinvested into the organisation. Financial

managers are pillars to your neworganisationor a step to the growth of your organisation.

Anonymous

The maintaskof a financial manager is to supply investment advice along with financial planning

services. Basically the financial manager helps the consumer to maximize their net worth via appropriate
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asset allocation.

Financial managers usually use stocks, bonds, mutual funds and insurance products to fulfil the

requirements of a client. Quiet a few financial managers accept a commission imbursement for the

different types of financial products which they negotiate for, even though "fee-based" development is

gaining popularity in the market.

One of the vital services which financial managers supply is the retirement planning. The financial

managers have high scale knowledge in the field of budgeting,forecasting, taxation, asset allocation,

etc. Financial managers may even help their client in investing for both long term as well as short term

basis. Anonymous

The five basiccorporate financefunctions are described as those functions related to;

1) raising capital to support company operations and investments (aka, financing functions);

2) selecting those projects based on risk and expected return that are the best use of a company's

resources (aka, capital budgeting functions);3) management of company cash flow and balancing the ratio of debt and equity financing to maximize

company value (aka, financial management function);

4) developing a company governance structure to encourage ethical behavior and actions that serve the

best interests of its stockholders (aka, corporate governance function); and

5) management of risk exposure to maintain optimum risk-return trade-off that maximizes shareholder

value (aka, risk management function).

Role of financial manager in the various functional areas are

in planning - the role is to estimate the budget.

In organising- the role is allocate the money .In staffing -the role is to determine the salaries and wages.

Controlling and directing -the financial manager role is to allocate verify and direct the funds in the right

ways for the effective out put

The financial manager is responsible for planning, organizing, directing, controlling and evaluating the

operations of financial and accounting departments. The role of financial managers are as follows:

- Development and Implementation of financial policies and systems

- Establishment of performance standards

- Preparation of various financial reports for senior managers

The functions of Financial manager are....

1. Planning and Forecasting

2. Financing Decision

3. Investment Decision

4. Dividend Decision

5. Financial negotiation

6. Cash Management
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7. Evaluating financial performance

8. Dealing with relevant parties in the Financial Markets Anonymous

1.To make investment decisions.

2.To make financing decisions.

3.To ensure a positive cash flow; so that cash inflowsexceed cash outflws.

4.To ensure profitability; so that income exceed

expenses.

5.To manage solvency

profit maximization is the maximizing of money or terms of money,but not

considering long term objective & goodwill of company, while Wealth

maximization is concerned about the earning of goodwill & return on

investment for a long timee.g: A makes a DJ Group, they make lot of advertisement to sell the tickets,

but people finds it with low quality of sound system & not good music A just

wanted to earn money at the time & what do u think people will go to his

show in the same city again ? its only profit maximization While Sony

Music makes a real deal of making music with high quality thus they have

long run income in the business of music.. if they conduct a concert, live

show, DJ Party, music CD All will be accepted because they have raised

their wealth maximization

The financial management come a long way by shifting its focus from traditional approach to modern

approach. The modern approach focuses on wealth maximization rather thanprofit maximization. This

gives a longer term horizon for assessment, making way for sustainable performance by businesses.

1. A myopic person or business is mostly concerned about short term benefits. A short term horizon

can fulfill objective of earning profit but may not help in creating wealth. It is because wealth

creation needs a longer term horizon Therefore, Finance Management or Financial

Management emphasizes on wealth maximization rather thanprofit maximization. For a business,

it is not necessary that profit should be the only objective; it may concentrate on various other

aspects like increasing sales, capturing more market share etc, which will take care of

profitability. So, we can say thatprofit maximizationis a subset of wealth and being a subset, it will

facilitate wealth creation.

2. Giving priority to value creation, managers have now shifted from traditional approach to modern

approach of financial management that focuses on wealth maximization. This leads to better and

true evaluation of business. For e.g., under wealth maximization, more importance is given to
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cash flows rather than profitability. As it is said that profit is a relative term, it can be a figure in

some currency, it can be in percentage etc. For e.g. a profit of say $10,000 cannot be judged as

good or bad for a business, till it is compared with investment, sales etc. Similarly, duration of

earning the profit is also important i.e. whether it is earned in short term or long term.

3. In wealth maximization, major emphasizes is on cash flows rather than profit. So, to evaluatevarious alternatives for decision making, cash flows are taken under consideration. For e.g. to

measure the worth of a project, criteria like: present valueof its cash inflow present value

of cash outflows (net present value) is taken. This approach considers cash flows rather than

profits into consideration and also use discounting technique to find out worth of a project. Thus,

maximization of wealth approach believes that money has time value.

4. An obvious question that arises now is that how can we measure wealth. Well, a basic principle is

that ultimately wealth maximization should be discovered in increased net worth or value of

business. So, to measure the same, value of business is said to be a function of two factors -earnings per share and capitalization rate. And it can be measured by adopting following relation:

5. Value of business = EPS / Capitalization rate

6. At times, wealth maximization may create conflict, known as agency problem. This describes

conflict between the owners and managers of firm. As, managers are the agents appointed by

owners, a strategic investor or the owner of the firm would be majorly concerned about the longer

term performance of the business that can lead to maximization of shareholders wealth.

Whereas, a manager might focus on taking such decisions that can bring quick result, so that

he/she can get credit for good performance. However, in course of fulfilling the same, a manager

might opt for risky decisions which can put on stake the owners objectives.

7. Hence, a manager should align his/her objective to broad objective of organization and achieve a

tradeoff between risk and return while making decision; keeping in mind the ultimate goal of

financial management i.e. to maximize the wealth of its current shareholders

What Does Risk-Free Rate Of ReturnMean?The theoretical rate of return of an investment with zero risk. The risk-free rate represents the interest an investorwould expect from an absolutely risk-free investment over a specified period of time.

Investopedia explainsRisk-Free Rate Of Return

In theory, the risk-free rate is the minimum return an investor expects for any investment because he or she willnot accept additional risk unless the potential rate of return is greater than the risk-free rate.

In practice, however, the risk-free rate does not exist because even the safest investments carry a very small amountof risk. Thus, the interest rate on a three-month U.S. Treasury bill is often used as the risk-free rate.
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Nominal Rate of Return

What Does Nominal Rate Of ReturnMean?

The amount of money generated by an investment before expenses such as taxes, investment fees and inflation are

factored in. For example, detailed data on a mutual might show a fund's nominal rate of return as 10%, but also show

its return after taxes on distributions and sale of fund shares is only 7%. Investors should look beyond aninvestment's nominal rate of return to get a true idea of what their investment will earn.

Nominal Rate Of Return

Municipal bonds, for example, generally have a lower nominal rate of return than corporate bonds, but the nominal

return and the after-tax return of Munis is usually identical since Munis are usually tax exempt, whereas income

earned from corporate bonds will be subject to taxation. Corporate bonds are also subject to tax on capital gains

when they are sold, giving them an actual rate of return that may be significantly lower than their nominal rate of

return.

Most people do not enter financial markets directly but use intermediaries or middlemen.

Commercial banks are the financial intermediary we meet most often in macroeconomics, but

mutual funds, pension funds, credit unions, savings and loan associations, and to some extent

insurance companies are also important financial intermediaries.1

When people deposit money in

a bank, the bank uses the funds to make loans to home buyers for mortgages, to students so they

can pay for their education, to business to finance inventories, and to anyone else who needs to

borrow. A person who has extra money could, of course, seek out borrowers himself and bypass

the intermediary. By eliminating the middleman, the saver could get a higher return. Why, then,

do so many people use financial intermediaries?

Financial intermediaries provide two important advantages to savers. First, lending through an

intermediary is usually less risky than lending directly. The major reason for reduced risk is that

a financial intermediary can diversify. It makes a great many loans, and even though some of

those loans will be mistakes, the losses will be largely offset by loans that are sound. In contrast,

an average saver could directly make only a few loans, and any bad loans would substantially

affect his wealth. Because an intermediary can put its "eggs" in many "baskets," it insures its

depositors from substantial losses.

Another reason financial intermediaries reduce risk is that by making many loans, they learn how

to better predict which of the people who want to borrow money will be able to repay. Someone

who does not specialize in this lending may be a poor judge of which loans are worth making

and which are not, though even a specialist will make some mistakes.

A second advantage financial intermediaries give savers is liquidity. Liquidity is the ability to

convert assets into a spendable form--money--quickly. A house is an illiquid asset; selling one

can take a great deal of time. If an individual saver has lent money directly to another person, the

loan can also be an illiquid asset. If the lender suddenly needs cash, he must either persuade the

borrower to repay quickly, which may not be possible, or he must find someone else who will

buy the loan from him, which may be very difficult. Although the intermediary may use its funds

to make illiquid loans, its size allows it to hold some funds idle as cash to provide liquidity to


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individual depositors. Only when a great many depositors want to withdraw deposits at the same

time, which happens when there is a "run" on the institution, will the financial intermediary be

unable to provide liquidity. Unless it can obtain help from the government or other institutions, it

will be forced to suspend payments to depositors.

In addition to lending money to individuals and groups, there are other ways in which banks arepart of financial markets. Banks borrow and lend funds among themselves in the federal-funds

market. They buy and sell foreign exchange. They buy and sell government and commercial

debt. And finally, one form of bank debt serves as money in modern economies, and banks

create this debt as a result of their financial transactions.

Economists are concerned that financial intermediaries can be a source of shocks to the

economy, bumps that can disrupt the normal flow of economic life. This concern arises for at

least two reasons. First, bank debt serves as money, so disruptions to banks can affect the amount

of money in circulation. We explore this idea in later chapters. Second, financial intermediaries

are tied together through chains of debts and assets. Because of these linkages, the failure of one

financial intermediary can weaken others, increasing their chances of failure. As a result, there isthe possibility that if a key financial intermediary fails, that failure can create a domino effect

that could cause other financial institutions to fail, ultimately causing the financial sector to

"seize up" and stop functioning. Serious disruption of the financial markets will disrupt the rest

of the economy. We will develop this idea a bit further in later sections of this chapter.

notes by aamir

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