Financial Management for Analysts

    • The long-term decisions of a firm involves setting up of the firm, expansion, diversification, modernization and other similar capital expenditure decisions.
    • All these decisions involve huge investment, the benefits of which will be seen only in the long-term. In addition to this they are also irreversible in nature.
    • One of the most important consideration for an investment and financing decision will be proper asset-liability management.Companies will have to face a severe asset-liability mismatch if the long-term requirements are funded by the short-term sources of funds.
    • Firms can issue three types of capital equity, preference and debenture capital. These three types of capital distinguish amongst themselves in the risk, return and ownership pattern.
    • Equity shareholders are the owners of the business. They enjoy the residual profits of the company after having paid the preference shareholders and other creditors of the company and their liability is restricted to the amount of share capital they contributes to the company.
    • The cost of equity capital is higher than other capital. Firstly, since the equity dividends are not tax-deductible expenses and secondly, the high costs of issue.
    • Preference shares have some attributes similar to equity shares and some to debentures. Like in the case of equity shareholders, there is no obligatory payment to the preference shareholders and the preference dividend is  not tax-deductible. (unlike in the case of the debentureholders, wherein interest payment is obligatory).
    • Preference shares can be of two types: (i) Cumulative or Non-cumulative preference shares: (ii) Redeemable or Perpetual preference shares.
    • For cumulative preference shares the dividends will be paid on a cumulative basis, in case they remain unpaid in any financial year due to insufficient profits.
    • Non-cumulative shares do not enjoy such right to dividend payment on cumulative basis.
    • Redeemable preference shares will be redeemed after a given maturity period while the perpetual preference share capital will remain with the company forever.
    • If the company issues debentures with a maturity period of more than 18 months, then it has to create a Debenture Redemption Reserve (DRR), which should be at least half of the issue amount before the redemption commences.
    • Debentures can be classified based on the conversion and security:

    - Non-Convertible Debentures (NCDs): These debentures cannot be convrted into equity shares and will be redeemed at the end of the maturity period.

    - Fully Convertible Debentures(FCDs): These debentures will be converted into equity shares after a specified period of time at one stroke or in instalments. These debentures may or may not carry interest till the date of conversion.

    - Partly Convertible Debentures(PCDs): These are debentures, a portion of which will be converted into equity share capital after  a specified period, Whereas the Non-Convertible Debenture (NCD) portion of the PCD will be redeemed as per the terms of the issue after the maturity period.

    - Secured Premium Notes (SPNs): This is a kind of NCD with an attached warrant that has recently started appearing in the Indian Capital Market.

    •  The warrant attached to the SPN  gives the holder the right to apply for and get allotment of one equity share for cash by payment of Rs.100 per share. This right has to be exercised between one and one-and-half year after allotment, by which time the SPN will be fully paid-up.
    • A firm can raise capital from the primary market( both domestic and foreign) by the issue of securities in the following ways: Public Issue Private Placement BODs Euro-Issues.
    • Companies issue securities to the public in the primary market and get them listed on the stock exchanges. These securities are then traded in the secondary market. The major activities involved in marking a  public issue of securities are appointment of the lead manager, preparation of prospectus and appointment of intermediaries.
    • Under Section 81 of the Companies Act, 1956, when a firm issues additional equity capital, it has to first offer such securities shareholders on a pro rata basis.
    • The private placement method of financing involves direct selling of securities to a limited number of institutional or high networth investors.
    • Buy-out is a procss whereby an investor or a group of investors buy-out a significat portion of the equity of an unlisted company with a view to take it public within an agreed time frame.
    • The instrument like Global Depository Receipts (GDRs), Euro-Convertible Bonds(ECBs), Foreign Currency Convertible Bonds (FCCBs)are issued abroad and listed and traded on a foreign stock exchange.
    • Term Loans consitute one of the major sources of debt finance for a long-term project. Term loans are generally repayable in more than one year but less than 10 years.
    • The interest rate on the term loans will be fixed after the financial institution appraises the project and assesses the credit risk.
    • The major advantages of this source of finance is its post-tax cost, which is lower than the equity/ preference capital and there will be no dilution of control. However, the interest and principal payments are obligatory and theraten the solvency of the firm.
    • Financing through internal  accurals can be done through the depreciation charges and the retained earnings.
    • The major advantages the company gets from using this as a source of long-term finance are its easy availability, elimination of issue expenses and the problem of dilution of control.
    • Very similar to leasing is hire purchase, Except that in hire purchase the ownership will be transferred to buyer after all the hire purchase instalments are paid-up. With the mushrooming of non-banking finance companies offering the leasing and hire purchase of equipments, many companies are opting for this route to finance their assets. The cost of such financing generally lies between 20-25%.