business finance

DPB5043 BUSINESS FINANCE SESI DIS 2019

BUSINESS FINANCE EXPOSES THE STUDENTS ON THE

CONCEPTS OF FINANCE AND TECHNIQUES USED TO MANAGE THE
FINANCIAL PLANNING OF AN ORGANIZATION.

THE THEORIES AND CONCEPTS OF BASIC FINANCIAL ARE DISCUSSED AS
A BENCHMARK AND INPUT FOR CONSIDERATION, IN ORDER TO MAKE

SHORT AND LONG TERM FINANCIAL DECISIONS FROM THE
ASPECT OF FINANCING AND INVESTMENT.

APART FROM THAT, ORGANIZATION’S FINANCIAL ANALYSIS IS USED
TO ANALYZE THE ORGANIZATION’S FINANCIAL POSITION.

COURSE LEARNING
OUTCOMES
(CLO)

UPON COMPLETION OF THIS COURSE, STUDENTS SHOULD
BE ABLE TO:
1. INTEGRATE THE THEORIES AND

CONCEPTS OF BASIC FINANCIAL.
(C5, PLO1)
2. ANALYZE ORGANIZATION’S FINANCIAL
POSITION USING APPROPRIATE METHODS
AND TECHNIQUES. (C4, PLO1)
3. DEMONSTRATE AND PRACTICE
INDEPENDENT ACQUISITION OF NEW
KNOWLEDGE FOR LIFE-LONG LEARNING IN
ACCOMPLISHING PROBLEM SCENARIO.
(C3, PLO1) (A2, PLO6)

CHAPTER 1
FINANCIAL
MANAGEMENT

(CLO1)

Describe the
financial
manager

responsibilities
in

organization

Basic of Financial
Management?

Imagine that you were to start your own business. No
matter the type of business, you would have to answer
the following three questions in some form or another.

1. What long term investment you take on? That is,
what lines of business will you be in and what sorts of
buildings, machinery and equipment will you need?

2. Where will you get the long-term financing to pay
for your investment? Will you bring in other owners or
will you borrow the money?

3. How will you manage your everyday financial
activities such as collecting from customers and paying
suppliers?

Financial management is concern with the
management of all matters associated with the cash

flow of an organization both short‐term and long
term. How the company uses its funds typically by

buying non‐current assets and funding its working
capital and where the funds came from typically
from the shareholders (equity) or by borrowing money

from third parties (loans/debt).

PRIMARY ACTIVITIES OF THE FINANCIAL
MANAGER

In addition to ongoing involvement in financial
analysis and planning, the financial manager’s
primary activities are (a) making investment
decisions and (b) making financing decision.

a) Investment decisions – Determine both the
mix and the type of assets held by the firm.

b) Financing decisions - Determine both the mix
and the type of financing used by the firm.

Goals/ Objectives of the Firm

The owners of the firm are normally distinct from its
managers. Actions of the financial manager should be
taken to achieve the objectives of the firm’s owners,
its stockholders. The financial managers need to
know the objectives of the firm’s owners.
1. Maximize profits
2. Maximize shareholders wealth

TO MAXIMIZE THE ORGANIZATION
PROFITS/BENEFITS:

 Some people believe that the firms objective is
always to maximize profit

 To achieve this goal, the financial manager would
take only those actions that were expected to
make major contribution to the firm’s overall
profits.

 For each alternative being considered, the financial
manager would select the one that is expected to
result in the highest monetary return.

 Earnings per share (EPS) commonly used to
measure profits, which represent the amount
earned during the period on behalf of each
outstanding share of common stock.

 Profit maximization is not a reasonable goal
because it ignores

(i) the timing of returns,

(ii) cash flows available to stockholder and

(iii) risk.

TO MAXIMIZE SHAREHOLDER
WEALTH:

 The wealth of the owners is measured by the share
price of the stock, which in turn is based on the
timing of returns (cash flows and their risk.

 When considering each financial decision alternative
or possible action in terms of its effect on the share
price of the firm’s stock, financial managers should
accept only those actions that are expected to
increase share price.

 Because share price represents the owner’s wealth
in the firm, maximizing share price will maximize
owner wealth.

RREESSPPOONNSSIIBBIILLIITTIIEESS OOFF FFIINNAANNCCIIAALL
MMAANNAAGGEERRSS

Making decisions on financial management is usually

done by a financial manager. The main task of the

financial manager is to determine how financial

resources are obtained and used effectively and

efficiently to achieve the objectives of the company that

is to maximize profits of the company or increase

shareholders’ wealth.

Among the most common activities undertaken by
financial managers are:

i) Forecasting and planning:

Financial managers must be able to forecast the
company’s future performance. Forecasting is made
based on the company’s past and present performance
as well as other factors such as economic performance,
customer’s preference and the future demand for their
products.

Based on the forecasts and interaction with other
executives, the financial manager will lay plans, which
will shape the company’s future position.

RESPONSIBILITIES OF FINANCIAL
MANAGERS

ii) Investment and financing decisions

Based on the forecasts and the plans, financial managers
will be able to do the following tasks :

 Determine sales growth rates ;
 Determine what specific assets to purchase ;
 Determine the best method of financing those

assets, whether to use debt (long term / short term)
or to use equity (common stock /preferred stock).

iii) Coordination and control

Financial manager have to interact with other
departments within the organization. This is necessary
because the decisions of other departments might affect
investment decisions. For example, the company has
decided to increase sales promotion activities (marketing
decision). This will usually result in an increase in sales.
The increase in sales would subsequently require an
increase in the production capacity that will then
influence the investment requirements.

RREESSPPOONNSSIIBBIILLIITTIIEESS OOFF FFIINNAANNCCIIAALL
MMAANNAAGGEERRSS

iv) Dealing with financial markets

As financial managers, they will have to deal with
money markets and capital markets. The financial
manager has to obtain financing either through the
money market or capital market. He may have to
decide on investing excess or idle fund in the financial
markets. He will also have to foster relationships with
creditors (for example – bank loan officers),
stockholders, investors and governmental regulatory
bodies.

10 PRINCIPLES THAT FORM THE
FOUNDATION OF FINANCIAL
MANAGEMENT

1 • We won’t take additional
The risk-return risk unless we expect to
be compensated with
trade off additional return

2 • a dollar received today
The time value is worth more than a
dollar received in the
of money future.

3 • in measuring value, we
Cash not profit is will use cash flows
rather than accounting
the king profits because it is only
cash flows that the firm
receives and is able to
reinvest.

10 PRINCIPLES THAT FORM THE
FOUNDATION OF FINANCIAL
MANAGEMENT

4 • it’s only what changes
Incremental cash that count. In making
business decisions, we
flows will concern ourselves
with what happens as a
5 result of that decision.
The curse of
competitive • it’s hard to find
exceptionally profitable
markets projects and economic
changes makes the
market more competitive

6 • The markets are quick
Efficient Capital and the prices are right.

Markets

7 • Government policy for the
Tax bias benefits of the country may
business results in tax bias in certain
decision business

10 PRINCIPLES THAT FORM THE
FOUNDATION OF FINANCIAL
MANAGEMENT

8 • The agency problem is the
The Agency result of the separation
between the decision
Problems makers and the owners of
the firm. As a result
9 managers may make
All risk are not decisions that are not in line
with the goal of
equal maximization of
shareholders wealth.
10
Ethical behavior • since some risk can be
diversified away and some
cannot. The process of
diversification can be reduce
risk, and as a result,
measuring projects or an
assets risk is very difficult

• means doing the right thing.
Ethical dilemmas are
everywhere in finance. Ethical
behavior is important in
financial management.
Unfortunately, precisely how
we define what is and what is
not ethical behavior is
sometimes difficult.

CHAPTER 2
RISK AND RETURN

(CLO1)

CONCEPT OF RETURN

All investors want a return or profit from each of their investments
without having to experience high risk. However, the returns and risks
are directly related to each other where a higher risk is associated with
a higher return that will be obtained and vice versa.

Consideration should be taken into account in determining the risks and
returns of an investment. This topic will emphasize the risks and returns
for investors that invest in common stock markets.

Types of investors:

Generally, investors can be divided into three types:

1. Risk free:

This type of investor, try to avoid investing in high-risk investments such
as investments in stocks. They are more interested in investing in the
investment that has a very low risk, such as Amanah Saham Bumiputera
(ASB), Premium Savings Certificates, or any investment guaranteed by
the government.

2. Risk adverse:

These types of investors will try to avoid investing in a risky market, but
tend to prefer low-risk investments even lower returns. They are always
careful to environmental conditions that affect the stock market.

3. Risk Taker:

These types of investors like to invest in high-risk market, they think the
higher the risk of an investment, the higher the potential returns
available. Investors do not have the constraints of funds to invest.

Reducing risk by diversifying

Diversification mean to spread an investment over a range of investment
instruments in order to minimize the risk of losing all the investment
should one investment go bad. Diversification would tend to reduce or
eliminate risk

CONCEPT OF RETURN

What is Return ?

Return, in finance, simply means the reward for investing. Return consists
of periodic cash payments or current income and capital gains (losses)
or increase (decrease) in market value. The periodic cash payments
maybe in the form of interest or dividends. In other words, return can be
referred to as total income obtained on an investment plus any changes
in market prices (usually shown in %).

Classification of Return:

Return in finance simply means the reward for investing. Return consists of
periodic cash payments of current income and capital gain (losses) or
increases (decreases) in market value

classification realized actual return that has been earned @ obtained.
Of return
required realized return is historical in nature
return return risk free rate of return- reward for deferring
expected consumption. required rate of return for riskless
return investments such as investment in government

securities
risk premium- additional return that we anticipate for

assuming risk. as level of risk increase, we would
demand an additional expected return

the return is anticipated or expected . expected
benefit or earnings that the investment would
generate. target return that the firm may desire

MEASUREMENT OF RETURN

Return can be expressed either as percentage or in RM value. But it is
best to present return as percentage because it would give a better
understanding of how much income is obtained from each RM that is
invested.
- Typically, the indicator most often used to measure the level of
return is by using the expected return R

Computing Expected Return ( )
Generally, expected return can be defined as the average results based on
all probability and possible yield or rate of return expected from an asset.

Expected rate of return (R ) = ΣRP
R = the possible return

P = probability to occur

Example 1:

Economic Probability Rate of Rate of Rate of
conditions (%) Return Return on Return on
on Stock A
Stock B Stock C
(%) (%) (%)

Growing 20 14 25 36

Stable 30 12 20 30

Down 50 10 15 28

Based on the example above, you are required to calculate the expected
rate of return for investments in Stock A, B and C.

RA =

RB =

RC =

MEASUREMENT OF RETURN

Example 2: Probability Rate of Rate of Rate of
Economic (%) Return Return on Return on
conditions on Stock RA
30 (RM) Stock B Stock C
Growing 40 (RM) (RM)
Stable 30 2800
Declines 1870 3000
2500
1700 2500
1800
1450 2000

Based on the example above, you are required to calculate the expected
rate of return for investments in Stock A, B and C.

RA=

R B=

RC=

CONCEPT OF RISK

What is Risk ?

Risk can be referred to as uncertainty or stability in the expected return
to be received from an investment. In the financial dictionary, risk is
defined as a chance of a monetary loss. If a project has a greater
probability of loss, then it is viewed as more risky than projects that
have a lesser probability of loss.

TYPES OF RISK

a) Systematic Risk:
- Referring to the risks affecting mostly the stock market. It is also known
as "market risk". An example of this risk is inflation, changes in foreign
exchange rates and changes in tax rates.
- The risk is also known as the risk that cannot be avoided. Risk cannot
be reduced by “diversification”.

b) Non Systematic Risk:
- Referring to the risk that does not affect the market but only affects
the firm.
- Example: shortage of raw materials, new competitors producing the
same products, change of management and labour strike.
- This risk can be minimized or eliminated through “diversification”.

MEASUREMENT OF RISK

The indicators often use to measure the risks of an investment are
known as Standard Deviation (б) and coefficient variation (CV).

Standard Deviation (б):
The standard deviation is used to measure the distribution of
results that may occur around the expected value.
The higher the standard deviation, the higher the returns will be
obtained and the higher the risk to be faced.

Standard Deviation (б) = √ Σ (R - R)² x P
R = rate of return may occur
R = expected rate of return
P = probability

Example 3: Probability Rate of Rate of Rate of
(%) Return Return on Return on
Economic on Stock A Stock B (%) Stock C (%)
conditions
(%)

Growing 20 14 25 36

Stable 30 12 20 30

Down 50 10 15 28

Calculate the risk for stock above?

Example 4 :
Based on the question in example 2, calculate the risk of each stock?

RISK FOR EVERY RETURN – COEFFICIENT OF
VARIATION (CV)

Coefficient of variation is a standardized measure of a risk per unit
of expected return. It is the ratio of the standard
deviation to the expected return. Thus, it is said to be measure of
relative risk. Coefficient of variation (CV) provides
a meaningful basis for a comparison when the expected return and
the standard deviation of alternative
investments are not the same.
Variation coefficient (CV) = Standard Deviation (б )

Expected rate of return ( R )

From example 3 and example 4, calculate the CV for the shares.

** RELATIONSHIP BETWEEN RISK AND RETURN
All investments have risk, but some investments are riskier than others
– there’s a greater chance you could lose some or all of your money.
In general, higher-risk investments offer higher potential returns, and
lower-risk investments offer lower returns.

CHAPTER 3
FINANCIAL ANALYSIS

(CLO2)

FINANCIAL ANALYSIS

Introduction

A firm operates from year to year and at the end of its financial year,
the management shareholders, creditors, potential investor, government
and other parties would be interested in its performance. They are
concerned about whether the company is making any profits or whether
the company is able to increase its profits compared to previous year.

What is financial analysis?

Financial analysis is the assessments of a firm’s past, present, expected
future financial performance. The analysis is made based on the firm’s
financial statement. It involves looking at historical performance.
Financial analysis helps an individual to check whether a business is
doing better this year than it was last year, or whether it is doing better
or worse than other companies in the same industry.

Objective of financial analysis

The main objective of financial analysis is to identify the firm’s strengths
and weaknesses. It is necessary for a firm to identify its strengths so that
it can capitalize on these strength and corrective actions to improve its
weaknesses.

Types of financial statement

A) Statement of Comprehensive Income

B) Statement of Financial Positions

C) Cash Flow Statement

D) Notes to account

FINANCIAL ANALYSIS

Financial ratio

The principal tools of financial analysis are financial ratio. Ratios are
mathematical aids for evaluation and comparison of financial
performance. Financial ratios are computed based on the firm’s financial
statement. They are used to summarize the information in a company’s
financial statement in assessing its financial health.

Objective of ratio analysis
1. To standardize financial information for comparison purposes
2. To evaluate current operations of the company
3. To compare present performance with past performance
4. To compare with other firms or industry standards
5. To assess the efficiency of operation
6. To assess the risk of operations

Types of comparison
1. Internal comparison
2. External comparison

Internal comparison
Internal comparison is an analysis based on comparisons of similar ratios
for the same firm. It compares present ratios past and expected future
ratios. The objective of internal comparison to analyze the financial
condition and performance of the firm over time.

FINANCIAL ANALYSIS

External comparison

External comparison involves comparison of ratios of a firm with ratios of
a firm with ratios of other firms in a similar industry. This is also called
inter-firm comparison @ cross sectional analysis. For example a firm may
want to analyze its performance relative to its competitor to know its
standing in the industry. External comparison is important as it will enable
the company to identify its strength and weaknesses as compared to its
competitors. The company will be able to improve its performance

Users of financial statement

1. Shareholder/owner

These users are interested in the profits earned, financial health
performance and potential growth of the company. They want to ensure
that they get good returns from their investment. They want to know
whether there is an increase in the value of their shares. They need to get
these statements to identify the firm’s strength and weaknesses for
remedial action and future planning.

2. Managers

Managers are hired by owners to manage the business on their behalf.
They have to ensure that they manage the business effectively and
efficiently so that owner’s wealth is maximized.

3. Creditors/lenders

Creditors consist of those who supply goods and services on a credit basis
as well as bank providing loans to companies. Supplier wants to ensure
that they are able to get timely payment. Banks are interested not only in
the firm’s profitability but also its ability to repay loans.

FINANCIAL ANALYSIS

Users of financial statement

4. Current and future employees
Employees are part of the company and feel that their contribute to the
firm’s profitability. They need the financial statement to determine the
monetary benefits that they can obtain from the firm.

5. Prospective investor
They need to analyze the firm’s financial statement to assess profitability,
stability, growth potential and financial health. They also want to assess the
efficiency of management before deciding whether to invest in the firm.

6. Customers
Customer would want to ensure that the company can deliver not only the
goods ordered. They want to ensure the company provide after sale
customer service

7. Government
Various government ministries and department require financial statement
to a firm’s declaration and payment of taxes and utilities and make
expansion plans for the economy.

FINANCIAL RATIO

Types Of Financial Ratio
 Liquidity ratios
 Efficiency ratios
 Leverage ratios
 Profitability ratios
 Market ratios

1. LIQUIDITY RATIO - Shows a firm’s ability to

meet its short term financial obligation.

Types of ratio Definition Formula Indicator

Company has the

a. Current ratio resources to pay its the higher

creditor when liquidity the

payments are due easier it is

↑ for the

Unit = 1 company to

pay its

creditor on

time

b. Quick ratio Indicates whether a −
firm has enough −
current asset to
cover its current its

liabilities without Unit = 1
selling inventory

2. EFFICIENCY RATIO
- MEASURE HOW EFFECTIVELY THE FIRM IS MANAGING ITS ASSET IN GENERATING SALES.

SHOW US THE FIRM’S EFFICIENCY IN COLLECTING DEBT

Types of ratio Definition Formula Indicator

a. Inventory Ratio indicates how many ↑ The higher
turnover times the stock is sold and the ratio
ratio replaced in a year faster stock
is being sold
Unit = 1

b. Average Ratio indicates the number
collection
period of days taken by a firm to ↓ The shorter
collect its account × 360 the ACP, the
c. Fixed
assets receivable Unit = 10 faster
turnover debtor are

paying their

account

Ratios measure the firm’s ↑

efficiency in utilizing its

property, plant, and Unit = 1
equipment in generating

sales

d. Total Ratio indicates is ↑
assets generating a higher
turnover
volume sales with the given Unit = 1
amount of assets

3. LEVERAGE RATIOS
- REFER TO THE USE OF BORROWED CAPITAL OR LOANS.

Types of ratio Definition Formula Indicator

A) Debt ratio Measure the + ( ) The lower
level of debt of ↓ the better,
borrowings in a
firm. Unit = % minimum
debt of
borrowing

Measure the The lower
B) Debt to percentage of the better,
equity ratio borrowings ↓ minimum
debt of
used compare Unit = 1 borrowing

with total

equity.

C) Times Measures the The higher
interest ↑ the ratio
earned firm’s ability to
the higher
cover its is the firm’s
ability to
interest fulfill
interest
charges out of obligation

operating

profits

4. PROFITABILITY RATIOS
- MEASURE HOW EFFECTIVELY THE FIRM USES ITS ASSETS TO MAKE PROFITS

Types of ratio Definition Formula Indicator

A) Gross profit It shows the efficiency of The higher
margin the company in the better.
controlling its cost of ↑ Ratio tells us
goods sold about
company’s
pricing policy

B) Operating Operating profit is ℎ ↑
profit margin derived after deducting
all costs and expenses
excluding interest and tax The higher

the better,

the higher

the

profitability

C) Net profit This ratio is not useful for ↑ of the

margin companies making losses company

The higher

D) Return on Indicates the the ROA due

assets management’s ability to ℎ to efficiency

make profits from the ↑ in asset

firm’s investment in asset utilization

E) Return on Measures the profit The higher
the ROE
equity earned by common ℎ ↑ better the
return for
stockholder shareholder

5. MARKET RATIOS
- ALSO CALLED INVESTORS RATIO. RELATE A FIRM’S STOCK PRICE TO ITS EARNINGS AND BOOK VALUE PER

SHARE

Types of ratio Definition Formula Indicator

A) Earnings per Profit earned per ↑ Market
share unit of issued share ℎ value will be
high the
B) Dividend per It indicate the . ℎ firms stock
share price will
amount of dividend increase
. ℎ
received by

ordinary

shareholder

C) Dividend Indicates the ℎ
payout ratio ℎ
proportion of ↑ The higher
P/E ratio
earnings that is high growth
potential
distribution and low risk

dividend to

shareholder

It compares the

D) Price current market
earnings ratio
price with earnings ℎ
ℎ
to establish

whether a stock is

overvalued @

undervalued

E) Dividend Indicates dividend
yield per share received
by the shareholder
with the current ℎ
market share price

EXAMPLE 1 :

You are required to make an analysis of Melati Sdn Bhd financial
position and present your analysis in a report. Financial statements of
the company are presented below:

Required:

1. Compute the ratios for Melati Sdn Bhd for the year ended 2019

2. Comment on the company’s profitability and debt management for
2019 as compared to the industry average

Melati Sdn Bhd
Income statement for the year ended 31 December 2019

Sales( All Credit) RM RM
350,000
Less: Cost Of Goods Sold
(250,000)
Gross Profit 100,000
Less: Expenses
25,000 (45,000)
Operating Expenses 5,000 55,000
Interest
Depreciation 15,000 (16,500)
38,500
Taxes
Net Profit

Melati Sdn Bhd
Balance sheet as at 31 December 2019

Assets RM
Cash
Marketable Securities 8,500
Account Receivable 3,600
Inventory 19,000
Prepaid Rent 46,500
Net Property, Plant And Equipment
550
Liabilities And Stockholder Equity 145,000
Accounts Payable 223,150
Notes Payable
Accruals 27,500
Long Term Debts 6,500
Common Stockholder Equity 2,500

Industry Average 75,000
Current Ratio 111,650
Quick Ratio 223,150
Debt Ratio
Times Interest Earned 2009
Average Collection Period 1.8x
Inventory Turnover 0.9x
Total Asset Turnover 50%
Return On Assets 10x
Net Profit Margins 20 days
Gross Profit Margin 7x
1.4x
8.40%
10.50%
27%

LIMITATION OF FINANCIAL RATIO

1. Comparison with industry averages is difficult for conglomerates.
If a firm in various kinds of businesses or has many divisions in
different industries, its industry category is often difficult to
identify.

2. Average performance as shown in the industry average may not
be desirable. It could be better for a firm to make comparison
with market leader.

3. Seasonal factors can also distort ratios. Year-end values may not
be representative. Certain account balances may increase or
decrease. Sales are usually higher during festive due to seasonal
factor. Such changes may distort the value of the ratio before and
after such seasons significantly different.

4. Inflation distorts the firm’s financial statement. It will cause the
recorded value to be different from true value.

5. It is sometime difficult to conclude whether a ratio is good or bad.
For example a high liquidity ratio may indicate that a company is
financially sound therefore efficient in the firm’s working capital
management. High liquidity ratios may indicate overstocking and
difficulty in collecting account receivable on time

6. It is also difficult to conclude whether a firms overall performance
is good or bad. This is because most ratios by themselves are not
highly meaningful. For example some ratios may be good while
others are bad.

CHAPTER 4
WORKING CAPITAL

MANAGEMENT
(CLO3)

WORKING CAPITAL
POLICY &

MANAGEMENT

DESCRIBE THE
CONCEPT OF
WORKING CAPITAL

IDENTIFY THE
WORKING CAPITAL
MANAGEMENT OF
CURRENT ASSET AND
CURRENT LIABILITY

INTRODUCTION WORKING CAPITAL MANAGEMENT

Managing the firm’s working capital, that is it current assets
and current liabilities, is one of the financial manager’s
function as working capital represents a significant
proportion of total assets. Current assets comprise mainly
inventory, accounts receivable, marketable securities and
cash while current liabilities comprise mainly accounts
payable, accruals, creditors for expenses and bank
overdraft.

WORKING CAPITAL POLICY refers to the firm’s investment
in current assets such as cash, debtors and stocks. Working
capital is obtained by subtracting the total current assets by
current liabilities. For a firm to be liquid, or solvent it is
imperative that net current assets are positive. In
management, the company must ensure that there are
appropriate levels of working capital in order to obtain high
profits or returns from investments over the potential risks
encountered.

The higher the level of working capital, the lower the returns
earned and at the same time facing low risk. WHY? This is
because companies do not make full use of liquid assets held
to generate revenue for the company.

For example, high levels of working capital may be due to
the high level of cash and stock in a company. Returns
obtained would be doubled if the cash is invested in a
profitable investment instruments such as the purchase of
shares, purchase of new assets to enhance the ability of the
firm or others. While a high stock holding will only harm the
company because it is better if the stock is sold to customers.

INTRODUCTION WORKING CAPITAL MANAGEMENT

IMPORTANCE OF WORKING CAPITAL MANAGEMENT

i. Normally, a substantial proportion of total assets of the firm is
made of current assets. Therefore it must be managed properly.

ii. Company must maintain a proper level of working capital so that
it is not compelled to bankruptcy when a company's total current
assets were lower than current liabilities.

iii. Each current asset is to be managed efficiently and effectively to
achieve the suitable level of liquidity and not to maintain any
current assets at a level that is too high.

iv. Working capital levels are the most important items and
generally accepted in the evaluation of firm performance. It is
used as an indication of the company's ability to meet liabilities
claims.

v. Cash is the most important component in the level of current assets
of the company. Inaccuracies in the forecast cash inflows and
outflows will cause problems in the management firm handling the
firm daily.

Factor affecting working capital level

Type of Business - Manufacturing and retail firms have higher
working capital requirements, especially in the form of inventory, as
compared with service organization

Volume of sales - A higher level of sales will require a higher level
of working capital

Seasonality - Peak seasons, for example festive seasons, require a
higher level of working capital

Length of operating and cash cycle - A longer operating and cash
cycle increases the level of working capital whereas a shorter cycle
will lower it.

INTRODUCTION WORKING CAPITAL MANAGEMENT

THE RISK-RETURN TRADE-OFF IN WORKING CAPITAL
MANAGEMENT

The risk-return trade-off in managing a firm’s working capital
is related to a trade-off between the firm’s liquidity and
profitability.

A firm can increase its investment in working capital by
increasing its investment in current assets (This in turn increase
firms liquidity). Example : Increase inventory and cash, firm
more liquid (able to pay bills on time).

However, this may not result in an increase in the firm’s
returns, if profits remain unchanged.

Therefore the financial manager has to determine a balance
between liquidity and profitability which is contribute
positively to the firm’s value.

Therefore the financial manager in considering the risk return
trade off in general should only take on additional risk when
an additional return is expected. We can now see that the risk
return trade off involves an increased risk of insolvency versus
increased profitability.

CASH
MANAGEMENT
AND MARKETABLE

SECURITIES

DESCRIBE VARIOUS
CASH MANAGEMENT
OBJECTIVES AND
DECISION

DIFFERENTIATE THE
TYPES OF MARKETABLE
SECURITIES AND THE
INVESTMENT IN
MARKETABLE
SECURITIES

EXPLAIN THE WAY TO
IMPROVE THE
EFFICIENCY IN CASH
MANAGEMENT

CASH MANAGEMENT

Cash or money itself are in the form of currency and current

accounts. Current account is known more formally as a demand in the
bank. The bank pays money out of the current account to another
person when the owner of the account issues cheque.

Cash is considered the most liquid asset of a company, which is non-

earning asset. It means that by holding cash we cannot earn any
interest or return on it.

But the company still need cash to pay bills, purchase goods, make
payment on interest, pay salaries/wages and so on. Even though
cash it self does not earn any return, a firm must have cash in hand
to run the business efficiently.

Cash management is mainly concerned with maintaining liquidity of
a firm so as to minimize the risk of insolvency.

A company becomes insolvent when it is unable to meet its maturing
liabilities on time because it lacks the necessary liquidity to make
prompt payment on its current debt obligations.

Objectives of Cash Management

1. Carrying minimum amount of cash: a company attempts to carry
the minimum amount so that it does not have a lot of cash in hand
since it does not earn any return. So a firm must minimize idle cash
balances.

2. Have enough cash to make payment.: to make sure a company
can make the payment during the operation of the business without
running out of cash.

CASH MANAGEMENT

Motives for holding cash by British economist John Maynard
Keynes are:

1. The transaction motive : cash balances held are for the
purpose of meeting cash need in term of the ordinary course
of doing business. Ex. buying inventories, pay bills etc.

2. The precautionary motive : Cash balances act as a buffer
for unexpected needs that may arise.

3. The speculative motive : Cash balances are held for
potential profit-making situations such as bargain purchase
opportunities that might arise and attractive interest rates.

Cash planning - Cash budget to forecast cash inflow and

outflow. Also referred to as cash budget.

Management of cash receipts and payments

- Float Refers to funds that have been paid for, but are as
yet not useable. 3 components – mail, processing and
clearing float

Mail – length of time between the mailing of payments
and its receipt

Processing – time between receiving of a payment and its
deposits into the firm’s account

Clearing float – time between the deposit of payment
into the firm’s account and when the fund can be used (time
for cheque to clear)

CASH MANAGEMENT

Methods to speed up collection and slow down
payments:

1. Reducing collection time – this will reduce customer float time which
will shortened the average collection period and cash conversion
cycle.
2. Increasing payment time – delay payment to supplier, must be use
carefully as longer payments period may cause a strain in
relationship with supplier.
3. Concentration of cash – transfer mechanism selected/choose by the
firm to concentrate deposits into one bank.
4. Zero-balance account – allows a firm to keep all of its operating
cash in an interest earning account. It allows the firm to maximize the
use of float on each cheque without altering the float time of
payment to its suppliers.

The Efficient Management of Cash

Since the objective of a company is to run the business effectively
without running out of cash, a company must keep the minimum cash
balance. By keeping the minimum cash balance, it will allow the
company to invest in various alternatives and to repay debts when
they are due.
Therefore the efficient cash management requires the following
steps:
1. Determine minimum operating Cash (MOC)
Most companies need to have minimum cash balance in operate their
business. This amount of cash is called Minimum Operating Cash
(MOC). MOC balances and safety stock of cash are influenced by the
firm’s production and sales techniques and also by its procedures for
collecting sales receipts and payment on purchase. In other hand, cash
balance are influence by the firm’s operating cycle and cash cycle. If
a company can manage these cycles efficiently, then the financial
manager of that company can maintain a minimum level of cash
investment and contribute toward maximization of share value.

CASH MANAGEMENT

2. Defining Operating Cycle (OC)

Operating cycle is an average time period to acquire inventory,
process it and sell the finished product until to the point when cash is
collected from the sale of it.

3. Defining Cash Cycle (CC)

Most of the time a company is able to purchase raw materials on
credit. The time its takes to pay for these inputs is called the average
payment period. The ability to purchase raw materials on credits
allows the firm to offset the length of time resources that are tied up
in the operating cycle. So cash cycle refers to an average time
between ‘cash out’ for inventory and ‘cash in’ from collection on sales.
In other words, cash cycle is an average time the company is without
cash.

MARKETABLE SECURITIES

Are assets that be converted into cash quickly. Ex. Treasury bills,
commercial papers, negotiable certificates of deposit and money
market mutual fund.

Rationale for holding marketable securities

As a substitute to cash. When cash outflow exceeds cash inflows at
any point in time, a firm will sell the marketable securities.

As a temporary investment: held as temporary investment for the
purpose of meeting the known financial requirements. Ex: to pay tax.

Selection criteria for marketable securities

1. Financial risk/ default risk – this is the risk of the borrower not
being able to pay interest/ principle on the security traded.

2. Interest rate risk – Financial instruments with longer terms to
maturity are more sensitive to changes in interest rate and therefore
have higher interest rate risk

3. Inflation risk – inflation will reduce purchasing power and those
financial instruments whose returns rise with inflation will experience
lower inflation risk, whereas those financial instruments whose returns
fall with inflation , will experienced higher inflation risk.

4. Marketable/ liquidity – financial instrument which can be sold
immediately at a price close to their market price are more
marketable and liquid as compared to those that cannot be sold
immediately.

5. Rates of return/yield – the return on marketable securities are
dependent on the four factors described above. The higher the risk,
the higher the return. However it must be said that safety/ liquidity
should not be sacrificed for higher returns.

MARKETABLE SECURITIES

Types of marketable securities

1. Malaysian Treasury Bills (MTB) –

MTB are short-term securities issued by the Government of Malaysia
to raise short-term funds for Government's working capital. Bills are
sold at discount through competitive auction, facilitated by Bank
Negara Malaysia, with original maturities of 3-month, 6- month, and
1-year. The redemption will be made at par. MTB are issued on
weekly basis and the auction will be held one day before the issue
date. The successful bidders will be determined according to the most
competitive yield offered. Normal auction day is Thursday and the
result of successful bidders will be announced one day after. MTB are
tradable on yield basis (discounted rate) based on bands of
remaining tenure (e.g., Band 4= 68 to 91 days to maturity). The
standard trading amount is RM5 million, and it is actively traded in
the secondary market.

2. Malaysian Islamic Treasury Bills (MITB) –

are issued to allow Islamic banks to hold liquid papers that meet their
statutory liquidity requirements.

3. Promissory Note –

A promissory note is a financial instrument that contains a written
promise by one party (the note's issuer or maker) to pay another
party (the note's payee) a definite sum of money, either on demand
or at a specified future date. It is an unconditional promise to pay a
specific amount to bearer or to the order of a named of person, on
demand or on a specific date. It is a written promise by a maker to
pay money to the payee.

MARKETABLE SECURITIES

Types of marketable securities

4. Bill of Exchange –

A bill of exchange is a written order once used primarily in
international trade that binds one party to pay a fixed sum of money
to another party on demand or at a predetermined date. Bills of
exchange are similar to checks and promissory notes—they can be
drawn by individuals or banks and are generally transferable by
endorsements. A bill of exchange transaction can involve up to three
parties. The drawee is the party that pays the sum specified by the
bill of exchange. The payee is the one who receives that sum. The
drawer is the party that obliges the drawee to pay the payee. The
drawer and the payee are the same entity unless the drawer
transfers the bill of exchange to a third-party payee.

5. Negotiable Instrument of Deposit (NID) :

also known as Negotiable Certificate of Deposit (NCD) are deposit
certificates used in the wholesale money market that are regularly
purchased and traded by institutional investors and high-net-worth
individuals in the stock market. A negotiable CD is one that can be
bought and sold on a secondary market. The bank that issues the
original certificate sets the face amount and interest to be paid. In
general, the longer the term, the higher the interest rate. Negotiable
CDs mature over relatively short periods, from two weeks up to a
year. At maturity, the holder of the CD receives the face amount from
the issuer and the CD expires. If the bank restricts the DPB50113
BUSINESS FINANCE | fiedahusain CD so that it can't be transferred
by the holder, and sets a penalty for the return of principal before
maturity, then the CD is non-negotiable.

MARKETABLE SECURITIES

Types of marketable securities

6. Banker’s Acceptance :

A bankers acceptance ( BA , aka bill of exchange) is a commercial
bank draft requiring the bank to pay the holder of the instrument a
specified amount on a specified date, which is typically 90 days from
the date of issue, but can range from 1 to 180 days. A banker's
acceptance is an instrument representing a promised future payment
by a bank. The payment is accepted and guaranteed by the bank as
a time draft to be drawn on a deposit. The draft specifies the amount
of funds, the date of the payment (or maturity), and the entity to
which the payment is owed.

7. Commercial Paper:

Commercial paper, in the global financial market, is an unsecured
promissory note with a fixed maturity of rarely more than 270 days.
Commercial paper is a money-market security issued (sold) by large
corporations to obtain funds to meet short-term debt obligations (for
example, payroll) and is backed only by an issuing bank or company
promise to pay the face amount on the maturity date specified on the
note. Since it is not backed by collateral, only firms with excellent
credit ratings from a recognized credit rating agency will be able to
sell their commercial paper at a reasonable price. Commercial paper
is usually sold at a discount from face value and generally carries
lower interest repayment rates than bonds due to the shorter
maturities of commercial paper. Typically, the longer the maturity on a
note, the higher the interest rate the issuing institution pays. Interest
rates fluctuate with market conditions but are typically lower than
banks' rates.

MARKETABLE SECURITIES

Types of marketable securities

8. Repurchase Agreement (Repo):

A repurchase agreement (repo) is a form of short-term borrowing for
dealers in government securities. In the case of a repo, a dealer sells
government securities to investors, usually on an overnight basis, and
buys them back the following day at a slightly higher price.