Solved Paper 2015-2016 | Financial Management | Ihm notes | sem 5

Previous year Solved Paper 2015-2016 | Financial Management | Ihm notes | sem 5 | NCHM JEE

Q.1. From the following Balance Sheet of M/s. XYZ Co. Ltd. for the period 31st March 2013 and 31st March 2014, you are required to prepare:

(i)  Statement of changes in the working capital

(ii)  Funds flow statement

Statement of changes in the working capital

Fund flow statement-

Working Notes:
1.Computation of the Cash Received and Cash Spent

Q.2. What are the different sources of raising finance for a large organisation?

Sources of finance mean the ways for mobilizing various terms of finance to the industrial concern. Sources of finance state that, how the companies are mobilizing finance for their requirements. The companies belong to the existing or the new which need sum amount of finance to meet the long-term and short-term requirements such as purchasing of fixed assets, construction of office building, purchase of raw materials and day-to-day expenses. Sources of finance may be classified under various categories according to the following important heads:

1. Based on the Period

Sources of Finance may be classified under various categories based on the period.
Long-term sources: Finance may be mobilized by long-term or short-term. When the finance mobilized with large amount and the repayable over the period will be more than five years, it may be considered as long-term sources. Share capital,
issue of a debenture, long-term loans from financial institutions and commercial banks come under this kind of source of finance. Long-term source of finance needs to meet the capital expenditure of the firms such as purchase of fixed assets, land and buildings, etc.
Long-term sources of finance include:
● Equity Shares
● Preference Shares
● Debenture
● Long-term Loans
● Fixed Deposits
Short-term sources: Apart from the long-term source of finance, firms can generate finance with the help of short-term sources like loans and advances from commercial banks, moneylenders, etc. Short-term source of finance needs to meet the operational expenditure of the business concern.
Short-term source of finance include:
● Bank Credit
● Customer Advances
● Trade Credit
● Factoring
● Public Deposits
● Money Market Instruments

2. Based on Ownership

Sources of Finance may be classified under various categories based on the period:
An ownership source of finance include
● Shares capital, earnings
● Retained earnings
● Surplus and Profits
Borrowed capital include
● Debenture
● Bonds
● Public deposits
● Loans from Bank and Financial Institutions.

3. Based on Sources of Generation

Sources of Finance may be classified into various categories based on the period.
Internal source of finance includes
● Retained earnings
● Depreciation funds
● Surplus
External sources of finance may be include
● Share capital
● Debenture
● Public deposits
● Loans from Banks and Financial institutions

4. Based in Mode of Finance

Security finance may be include
● Shares capital
● Debenture
Retained earnings may include
● Retained earnings
● Depreciation funds
Loan finance may include
● Long-term loans from Financial Institutions
● Short-term loans from Commercial banks.
The above classifications are based on the nature and how the finance is mobilized
from various sources. But the above sources of finance can be divided into three major
classifications:
● Security Finance
● Internal Finance

OR

What are the different financial statements which are usually prepared by the business organisation?

Financial Statements represent a formal record of the financial activities of an entity. These are written reports that quantify the financial strength, performance and liquidity of a company. Financial Statements reflect the financial effects of business transactions and events on the entity.

Four Types of Financial Statements

The four main types of financial statements are:

Statement of Financial Position 

Statement of Financial Position, also known as the Balance Sheet, presents the financial position of an entity at a given date. It is comprised of the following three elements:

Assets:Something a business owns or controls (e.g. cash, inventory, plant and machinery, etc)

Liabilities: Something a business owes to someone (e.g. creditors, bank loans, etc)

Equity: What the business owes to its owners. This represents the amount of capital that remains in the business after its assets are used to pay off its outstanding liabilities. Equity, therefore, represents the difference between the assets and liabilities.

Income Statement 

Income Statement, also known as the Profit and Loss Statement, reports the company’s financial performance in terms of net profit or loss over a specified period. Income Statement is composed of the following two elements:

Income:What the business has earned over a period (e.g. sales revenue, dividend income, etc)

Expense: The cost incurred by the business over a period (e.g. salaries and wages, depreciation, rental charges, etc)

Net profit or loss is arrived by deducting expenses from income.

Cash Flow Statement 

Cash Flow Statement presents the movement in cash and bank balances over a period. The movement in cash flows is classified into the following segments:

Operating Activities: Represents the cash flow from primary activities of a business.

Investing Activities: Represents cash flow from the purchase and sale of assets other than inventories (e.g. purchase of a factory plant)

Financing Activities: Represents cash flow generated or spent on raising and repaying share capital and debt together with the payments of interest and dividends.

Statement of Changes in Equity

Statement of Changes in Equity, also known as the Statement of Retained Earnings, details the movement in owners’ equity over a period. The movement in owners’ equity is derived from the following components:

Net Profit or loss during the period as reported in the income statement

Share capital issued or repaid during the period

Dividend payments

Gains or losses recognized directly in equity (e.g. revaluation surpluses)

Effects of a change in accounting policy or correction of accounting error

Q.3.  What do you understand by capital budgeting? What is its practical utility for a large hotel?

Capital budgeting is the process of making investment decisions in Capital expenditures. A Capital budgeting may be defined as an expenditure the benefits of which are expected to be received over a period of time exceeding one year. The main characteristics of a capital expenditure is that the expenditure is incurred at one point of time in future. In simple language, we may say that a capital expenditure is an expenditure incurred for acquiring or improving the fixed assets, the benefits of which are expected to be received over a number of years in future.

The examples of capital expenditure:
1. Purchase of fixed assets such as land and building, plant and machinery, goodwill, etc.
2. The expenditure relating to addition, expansion, improvement and alteration to
the fixed assets.
3. The replacement of fixed assets.
4. Research and development project.

It is clearly explained in the above definitions that a firm’s scarce financial resources are utilizing the available opportunities. The overall objectives of the company from are to maximize the profits and minimize the expenditure of cost.

Need and Importance of Capital Budgeting

1. Huge investments: Capital budgeting requires huge investments of funds, but the available funds are limited, therefore the firm before investing projects, plan are controlled its capital expenditure.

2. Long-term: Capital expenditure is long-term in nature or permanent in nature. Therefore financial risks involved in the investment decision are more. If higher risks are involved, it needs careful planning of capital budgeting.

3. Irreversible: The capital investment decisions are irreversible, are not changed back. Once the decision is taken for purchasing a permanent asset, it is very difficult to dispose of those assets without involving huge losses.

4. Long-term effect: Capital budgeting not only reduces the cost but also increases the revenue in long-term and will bring significant changes in the profit of the company by avoiding over or more investment or underinvestment. Over investments leads to be unable to utilize assets or overutilization of fixed assets. Therefore before making the investment, it is required careful planning and analysis of the project thoroughly.

OR

“Return on investments is considered to be the master ratio which reflects the overall performance of a company‟. Explain.

A profitability measure that evaluates the performance of a business by dividing net profit by net worth.

Return on investment, or ROI, is the most common profitability ratio. There are several ways to determine ROI, but the most frequently used method is to divide net profit by total assets. So if your net profit is $100,000 and your total assets are $300,000, your ROI would be .33 or 33 percent.

Return on investment isn’t necessarily the same as profit. ROI deals with the money you invest in the company and the return you realize on that money based on the net profit of the business. Profit, on the other hand, measures the performance of the business. Don’t confuse ROI with the return on the owner’s equity. This is an entirely different item as well. Only in sole proprietorships does equity equal the total investment or assets of the business.

We can use ROI in several different ways to gauge the profitability of your business. For instance, you can measure the performance of your pricing policies, inventory investment, capital equipment investment, and so forth. Some other ways to use ROI within your company are by:

• Dividing net income, interest, and taxes by total liabilities to measure the rate of earnings of total capital employed.
• Dividing net income and income taxes by proprietary equity and fixed liabilities to produce a rate of earnings on invested capital.
• Dividing net income by total capital plus reserves to calculate the rate of earnings on proprietary equity and stock equity.

Q.4. Define financial management. What are the main objectives of financial management? Explain.

Financial management is the responsibility of planning, directing, organizing and controlling a company & capital resources. Small business owners typically complete this function because they are responsible for all company resources. Larger business organizations may have a financial or accounting manager to handle this business function. Financial management has several objectives in a business. Most of the objectives serve in a support capacity to provide business owners with relevant information on the company & business operations.

Objectives of financial management

Support Accounting

Financial management has an objective to support the company & accounting department. Financial managers do not usually complete everyday accounting functions. They typically review the information from the accounting department and review this information for accuracy and validity. Corrective measures or suggestions can be made to improve the company & and it’s accounting information. Accounting information plays an important role in small business. Business owners often use accounting information to secure external financing from banks, lenders and investors.

Provide Decision Information

Business owners often require financial or accounting information when making business decisions. One objective of financial management is to provide business owners and other individuals with information for making business decisions. Information must be useful, relevant and accurate. Financial managers are usually an intermediary between the business owner and other operational managers. This saves the business owner time and effort from wading through extensive information with no relation to the decision at hand.

Risk Management

Risk management is often a primary objective for financial management functions in larger business organizations. Risk management ensures companies do not face undue pressure or risk from various financial situations. Financial rooms can result from business opportunities providing inadequate financial returns, debt financing with unfavourable loan terms, lack of available business credit and unstable financial investments. Financial managers often spend copious amounts of time reviewing their company & it’s financial activities to ensure the least amount of risk is absorbed by the company.

Improve Operational Controls

Financial management has a responsibility to improve operational controls and workflow. Financial managers often review information from several divisions or departments within their company. The focus of this review process ensures company employees are operating within standard company guidelines. Financial managers can make suggestions to business owners for improving the company & controls and business operations. These suggestions outline specific objectives for reducing waste, limiting unnecessary expenditures and improving employee productivity. Each objective can help business owners improve their company & overall financial operations.

Q.5. “Ratio analysis is a tool to examine the health of a business with a view to make financial results more intelligible”. Explain.

Take below answer as a reference and write your own views if required.

Ratio, in general, shows a proportional relationship between two different numbers or quantities. It may be a relationship between two amounts that is represented by a pair of numbers showing how much greater one amount is than the other, that is, the ratio of something to something. When undertaken by a business management in the process of Financial Analysis in order to identify the financial strengths and weaknesses of a business entity.

Effective planning and Financial Management are the keys to running a financially successful business. Ratio analysis is a useful management tool that assists in effective planning and running a financially successful business. Ratios, on the one hand, help greatly in summarizing a large amount of financial data by making the interpretation of financial statements easier; they enable to make a qualitative judgment about a business firm’s financial performance on the other. It’s through the ratio analysis that the liquidity, solvency, profitability and the activity of a business entity may be identified in an accurate manner.

Ratio Analysis is a powerful tool for Financial Analysis. Having simplified the understanding of Financial Statements, ratios reveal the interrelationship between various financial figures which in turn enables an analyst to gain insights in making forward-looking and projections accordingly. Though the ratio analysis is made on the basis of the accounting data which is historical in nature, the study of trends can also facilitate in effective planning and controlling and forecasting.

Besides, establishing a relationship between two figures and adding significance, ratios facilitate to make comparisons between a firm’s past and present performance, while they also aid greatly in comparing one business firm with another.

OR Write short notes on any two:

1. Over-capitalisation

Overcapitalization refers to the company which possesses an excess of capital in relation to its activity level and requirements. In simple means, overcapitalization is more capital than actually required and the funds are not properly used.

According to Bonneville, Dewey and Kelly, overcapitalization means, “when a business is unable to earn fair rate on its outstanding securities”.

Example
A company is earning a sum of Rs. 50,000 and the rate of return expected is 10%. This company will be said to be properly capitalized. Suppose the capital investment of the company is Rs. 60,000, it will be over capitalization to the extent of Rs. 1,00,000.

The new rate of earning would be:
50,000/60,000×100=8.33%
When the company has overcapitalization, the rate of earnings will be reduced from
10% to 8.33%.

2. Net present value method

Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyse the profitability of a projected investment or project.

The following is the formula for calculating NPV: 

where

Ct = net cash inflow during the period t

Co = total initial investment costs

r = discount rate, and

t = number of time period

3. Balance sheet

A balance sheet is a financial statement that summarizes a company’s assets, liabilities and shareholders’ equity at a specific point in time. These three balance sheet segments give investors an idea as to what the company owns and owes, as well as the amount invested by shareholders.

The balance sheet adheres to the following formula:

Assets = Liabilities + Shareholders’ Equity

The balance sheets get its name from the fact that the two sides of the equation above – assets on the one side and liabilities plus shareholders’ equity on the other – must balance out. This is intuitive: a company has to pay for all the things it owns (assets) by either borrowing money (taking on liabilities) or taking it from investors (issuing shareholders’ equity).

4. Distinguish between funds flow and cash flow

Q.6. From the following data, calculate the “Net Present Value” of two projects viz. X&Y and suggest which of the two projects should be accepted assuming a discount rate of 10%:

The profits before depreciation and after taxes (cash flows) are as follows:

Present value at 10% of Re.1/- is as under

Q.7. From the Balance Sheets of M/s. XYZ Hotel, you are required to prepare cash flow statement:

OR
Write short notes (any two):

A. Explain any two financial statements.

Income Statement

Income Statement, also known as the Profit and Loss Statement, reports the company’s financial performance in terms of net profit or loss over a specified

period. Income Statement is composed of the following two elements:

• Income: What the business has earned over a period (e.g. sales revenue, dividend income, etc.)
• Expense: The cost incurred by the business over a period (e.g. salaries and wages, depreciation, rental charges, etc.)

Net profit or loss is arrived by deducting expenses from income.

Cash Flow Statement

Cash Flow Statement presents the movement in cash and bank balances over a period. The movement in cash flows is classified into the following segments:

• Operating Activities: Represents the cash flow from primary activities of a business.
• Investing Activities: Represents cash flow from the purchase and sale of assets other than inventories (e.g. purchase of a factory plant)
• Financing Activities: Represents cash flow generated or spent on raising and repaying share capital and debt together with the payments of interest and dividends.

B. Explain objective of profit maximisation

C. Deferred Revenue Expenditure (with examples)

Revenue expenditure refers to the money that a business receives from cash flows and then spends on operations.

While revenue expenditure is a simple concept, deferred revenue expenditure is slightly more complicated. In this case, the value received from the expenditure is not immediate. Buying a training program may add skills to office labour forces over just a few days, but not all effects occur so quickly. Sometimes the benefit is delayed over months or even years. In this case, the business creates a deferred revenue expenditure account to match up the expense with the value received, similar to depreciation accounts but for a different set of activities.

Examples: A common example for deferred revenue expenditures is in marketing. Advertising, according to many theories, has a delayed effect. This means that the business can spend money on an advertising campaign, but not realize increased sales until several months down the line when customers absorb the full impact of the ads.

Imp: Deferred revenue should not be confused with deferred revenue expenditure. Deferred revenue occurs when a business is paid for a service before actually performing that service. The revenue is collected ahead of time and held by the business until the service is complete and it can be counted as cash received. It has nothing to do with expenses.

Q.8. BALANCE SHEET OF M/S. XYZ CO. LTD. AS ON 31.03.2015

Calculate:
(a) Current ratio

(b) Acid test ratio

(c) Debt equity ratio

(d) fixed assets to net worth ratio

OR

Define working capital. What factors would you take into account in estimating the working capital needs of a large organisation?

Working capital is a measure of both a company’s efficiency and its short-term financial health. Working capital is calculated as:

Working Capital = Current Assets – Current Liabilities

The working capital ratio (Current Assets/Current Liabilities) indicates whether a company has enough short-term assets to cover its short-term debt. Anything below 1 indicates negative W/C (working capital). While anything over 2 means that the company is not investing excess assets. Most believe that a ratio between 1.2 and 2.0 is sufficient.  Also known as “net working capital”.

Main factors affecting the working capital are as follows:

(1) Nature of Business:

The requirement of working capital depends on the nature of the business. The nature of the business is usually of two types: Manufacturing Business and Trading Business.

In the case of the manufacturing business, it takes a lot of time in converting raw material into finished goods. Therefore, capital remains invested for a long time in a raw material, semi-finished goods and the stocking of the finished goods.

(2) The scale of Operations:

There is a direct link between the working capital and the scale of operations. In other words, more working capital is required in case of big organisations while less working capital is needed in case of small organisations.

(3) Business Cycle:

The need for the working capital is affected by various stages of the business cycle. During the boom period, the demand for product increases and sales also increase. Therefore, more working capital is needed. On the contrary, during the period of depression, the demand declines and it affects both the production and sales of goods. Therefore, in such a situation less working capital is required.

(4) Seasonal Factors:

Some goods are demanded throughout the year while others have seasonal demand. Goods which have uniform demand the whole year their production and sale are continuous. Consequently, such enterprises need little working capital.

On the other hand, some goods have seasonal demand but the same are produced almost the whole year so that their supply is available readily when demanded.

Such enterprises have to maintain large stocks of raw material and finished products and so they need a large amount of working capital for this purpose. Woolen mills are a good example of it.

(5) Production Cycle:

Production cycle means the time involved in converting raw material into finished product. The longer this period, the more will be the time for which the capital remains blocked in raw material and semi-manufactured products.

Thus, more working capital will be needed. On the contrary, where the period of production cycle is little, less working capital will be needed.

(6) Credit Allowed:

Those enterprises which sell goods on cash payment basis need little working capital but those who provide credit facilities to the customers need more working capital.

(7) Credit Availed:

If the raw material and other inputs are easily available on credit, less working capital is needed. On the contrary, if these things are not available on credit then to make a cash payment quickly large amount of working capital will be needed.

(8) Operating Efficiency:

Operating efficiency means efficiently completing the various business operations. Operating efficiency of every organisation happens to be different.

Some such examples are: (i) converting raw material into finished goods at the earliest, (ii) selling the finished goods quickly, and (iii) quickly getting payments from the debtors. A company which has a better operating efficiency has to invest less in stock and the debtors.

Therefore, it requires less working capital, while the case is different in respect of companies with less operating efficiency.

(9) Availability of Raw Material:

Availability of raw material also influences the amount of working capital. If the enterprise makes use of such raw material which is available easily throughout the year, then less working capital will be required, because there will be no need to stock it in large quantity.

On the contrary, if the enterprise makes use of such raw material which is available only in some particular months of the year whereas for continuous production it is needed all the year round, then a large quantity of it will be stocked. Under the circumstances, more working capital will be required.

(10) Growth Prospects:

Growth means the development of the scale of business operations (production, sales, etc.). The organisations which have sufficient possibilities for growth require more working capital, while the case is different in respect of companies with fewer growth prospects.

(11) Level of Competition:

High level of competition increases the need for more working capital. In order to face competition, more stock is required for quick delivery and credit facility for a long period has to be made available.

(12) Inflation:

Inflation means a rise in prices. In such a situation more capital is required than before in order to maintain the previous scale of production and sales. Therefore, with the increasing rate of inflation, there is a corresponding increase in the working capital.

Q.9. The Income statement of a concern are given below for the year ending 31.03.2013 and 31.03.2014. You are required to prepare comparative income statement:

Q.10. State True or False:

(a)  Ratio analysis helps in the decision-making process.TRUE

(b)  Debt equity ratio is to measure outsiders funds to shareholders funds. TRUE

(c)  Working capital = current assets minus current liabilities. TRUE

(d)  Non-fund items are added back to profits & loss account in order to know funds from operation. TRUE

(e)  Net present value method recognizes the time value of money. TRUE

(f)  Payback method is not a simple method to calculate. FALSE

(g)  Depreciation is calculated on fixed assets as well as on current assets. FALSE

(h)  Equity shareholders and preference shareholders share profit equally. FALSE

(i)  Gross profit ratio = ( Gross profit x100) /Net profit     FALSE

(j) Current ratio is =  (Current liabilities x 100) /Current assets   FALSE