We Also Provide SYNOPSIS AND PROJECT.Contact www.kimsharma.co.in for best and lowest cost solution or Email: [email protected] Call: 9971223030 1. Explain why debt is usually considered the cheapest source of financing available? Answer: Debt financing is the act of raising operating capital or other capital by borrowing for a business. Most often, this refers to the issuance of a bond, debenture, or other debt security. When a company takes loan from third party then it is considered as debt financing. It is one of the most commonly used ways of financing. Debt can be of short term, midterm and long term. Why debt is the cheapest source of financing: Company can manage its required funds through debt or equity or combination of both. Choosing an optimal capital structure different company use different ratio of debt and equity. But question is how an optimal capital structure can be formed. Basically the capital structure is formed by considering the financial strength of the company and cost of funds of different sources. Many people say that retained earnings is the cheapest source of financing but debt can be cheapest source of financing from different perspectives. From the share holder’s perspective tax deductibility feature of debt finance is lucrative. And from the lenders perspective debt is secured because creditors get the preference of getting their principal and interest before making any benefit to the share holders. Tax deductibility feature of debt is the main point, on which we can say debt is the cheapest source of financing. There are some other points that may include with deductibility feature. These are Time value of money and preference of funds. Dividends not payable to lenders Interest rate. Let us consider an example to show how debt financing helps to reduce the tax burden that is the tax deductibility features of interest. Example: Suppose XYZ company take loan of $1000000from ABC bank at the rate of 15%. Tax payable to the government is 30% of the income. Income is = $500000 Only Equity is used If there is no debt financing then XYZ company has to pay tax of total = $500000 X 30% = $150000 After tax income = $ 500000 – $150000 = $350000 Taking on higher levels of debt or financial liability therefore increases a business's level of financial risk. therefore. So we can say that debt can be cheapest source of financing for the company. That’s why company prefers debt financing. The level of financial risk.3 = 105000 After tax income is = $500000 – 105000 = $395000 From the example it is clear that because of debt financing XYZ Company is paying less amount of tax which increases the net income after tax. Interest on load amount = $1000000 X 15% = $150000 Taxable income is = $500000 – $150000 = $350000 Tax payable = $350000 X . business risk is independent of the amount of debt a business owes. Normally company making profit of $350000 but because of using Debt Company is making profit of 395000. The more debt a business owes. Cost of capital is reduced because of tax deductibility feature of debt financing. Here cost of debt capital is 14% but because of using debt capital company’s cost of capital for debut is 14 X (1 – 30%) = 9. rent and wages. Let us consider other example: XYZ company take loan at the rate of 14% and corporate tax rate is 30%. relates less to the business's operations themselves and more to the amount of debt a business incurs to finance those operations.If Debt and equity is used On the other hand if company use debt financing then. Business risk is the possibility that an organization's operations or competitive environment will cause it to generate financial results that are . Differenciate between financial and business risks? Answer Financial Risk Financial risk refers to the chance a business's cash flows are not enough to pay creditors and fulfill other financial responsibilities. There are two types of business risk: systematic risk and unsystematic risk. Business Risk Business risk refers to the chance a business's cash flows are not enough to cover its operating expenses like cost of goods sold. Unlike financial risk. the more likely it is to default on its financial obligations.80%. 2. • Financial risk is the risk that a business will not be able to generate enough cash flow and income to pay their debts and meet their other financial obligations. 3 . costs of raw materials. and company’s debt to equity ratio. • Business risk is the risk that a business faces in not being able to generate adequate income to cover operating expenses. It is important for business owners and entrepreneurs to identify and understand the various risks involved in running a business so that they can adapt their business strategies to deal with such risks in a better manner. • Financial risk can arise from volatile interest rates. etc. market competition. debtors and inventories. invested in current assets keep revolving and are constantly converted into cash and this cash flow is again used in exchange for other current assets. as opposed to financial risk that is very much influenced by the level of debt. Financial risk is the possibility that the use of debt to financial operations will have a negative impact on earnings.worse than expected. • Business risk is independent of the portion of the debt that a business holds. which is required for financing short-term or current assets such a cash marketable securities. It is a company’s surplus of current assets over current liabilities. Business Risk vs Financial Risk • The running of businesses involves a considerable amount of risk. Funds thus. • Business risk can arise from a number of factors such as fluctuations in demand. exchange rate risk. which measures the extent to which it can finance any increase in turnover from other fund sources.Discuss the different approaches of financing of working capital requirements? Answer Working capital is a measure of the company’s efficiency and short term financial health. etc. . That is why working capital is also known as revolving or circulating capital or short-term capital. It refers to that part of the company’s capital. It means the sources of funds should match with the nature of assets to be financed. It’s a . When I hit the road to speak. There are two types of working capital permanent and temporary working capital. the slide includes a quote from Nick Parsons. working capital being a function of current assets less current liabilities. most readers have likely experienced increased scrutiny from their lenders in this post-crisis world. To illustrate that point. There is low cost. Let us discuss them one by one: 1) Hedging approach or matching approach: this approach means matching the maturities of debt with the maturity of financial needs. head of research with the National Australia Bank: "So capitalism has changed…the owner or the custodian of capital [i. There is high cost. There is low cost. 3) Aggressive approach: as the name suggests it is an aggressive approach which suggests that the entire requirement of current assets should be financed through short term sources. lending institutions] is much more careful about where they use that capital. Now more than ever. low risk and low profit in this approach. high risk and high profit in this approach. Case Detail : Working capital—Do you have enough? Lending institutions are scrutinizing an operation’s working capital status as part of the lending decision. The hedging approach suggests that the permanent working capital requirement should be financed through long term funds. 2) Conservative approach: as the name suggests it is a conservative approach which suggests that the entire requirement of current assets should be financed through long term sources and short term sources should be used only in case of emergency. while temporary working capital should be financed through the short term funds. high risk and high profit in this approach.e. And one of the key criteria that lenders use to make decisions revolves around availability of working capital within any operation. one of the most important slides I regularly use highlights how lending criteria has changed since the financial crisis.Formula for Working Capital: "Current Assets – Current Liabilities" There are mainly 3 approaches to determine financing of working capital.” To that end. it’s time to do a little scrutinizing yourself. Working capital has declined nearly 50% . albeit simplified. as last week’s illustration depicts. Alas.measure of an operation’s buffer to meet its short-term obligations. it is an important component of risk management to ensure business continuity within the operation without the need to borrow additional funds. 1. declining revenue has taken a big hit out of working capital reserves for agriculture. Provide the brief summary of the case in your own words? Answer: The present case study talks about the latest trend regarding working capital. will clearly have implications in the coming years. companies need to take strategic decision to maintain working capital to meet the expectations of lenders. That’s a concerning trend – and if it continues. working capital as declined 50%. Clearly. 2. Perhaps equally important. What new expectations do your lenders have during the past several years and going into future? Answer: Working capital becomes important criteria for lenders. This week’s graph highlights USDA’s updated aggregate working capital estimates in agriculture. Their decision revolves around the ability to maintain working capital in operations as it is important measure to meet short-term obligations and can save business in short-term risk or unfortunate events. does the operation have sufficient working capital to meet the remainder of the obligation? This type of assessment has become more important to lenders since the financial crisis. working capital is importance criteria for lenders. As an example. it’s a key indicator of cash reserve availability to meet unexpected emergencies. What if it catches on fire and suddenly needs to be replaced. Present case study also define working capital as cash reserve availability to meet unexpected emergencies and component of risk management. What are you doing to maintain strong cash and working capital reserves amidst declining revenue? What new expectations do you your lenders have during the past several years and going into 2017? How will you adjust going forward? Leave your thoughts in the comments section below. else the cows don’t get fed? After insurance provides some portion towards replacement. a pickup is typically a critical operational asset for most cow-calf operations. Case study emphasize that in today’s modern time.Therefore. hence the importance to lenders. .the loss exceeds $82 billion in just three years. Thus. Dividend has no relationship with the value of the firm as per Walter Model. B Procurement . capital expenditures. Yes Sometimes No Can't say 3. 3. to improve yield through timely operations. to reduce expenditures that don’t increase production. However. When the business generates cash from the sale of products. What should be done to maintain strong cash and working capital reserves amidst declining revenue? Answer: Managing working capital involves maintaining an adequate portion of the asset base that can be easily converted to cash. it can be held in that form. So one of the easiest ways to manage working capital is to protect cash. Wealth management and profit maximisation are the ………………… concepts. and/or controlling the short-term drains on that cash resulting from debt service. The discussion above suggests that maintaining a strong cash position is an important way to manage working capital. Traditionally the role of finance manager was restricted to …………. Of funds. Purchasing assets or withdrawing cash from the business may be necessary in specific instances. B No 2. Other techniques to preserve cash are to lease capital assets or hire custom services. and to sell at higher prices. it is extremely important in today’s environment to carefully monitor these uses of cash because their use can significantly reduce the liquid financial reserves of the business. committed to the purchase of inputs for the upcoming production season. 1. or cash withdrawals. or it can be used to purchase capital items or withdrawn from the business. Current assets /Current liabilities describes ………. controlling costs and producing a satisfactory return on capital invested in the division. Assets. Ratio. Cash in hand and cash at bank are examples of …………. Implicit cost is the cost of using the funds. The process of calculating present value of projected cash flows. Discounting Brokerage Benefit Budgeting 7. A part of the organisation where the manager has responsibility for generating revenues. Business practices designed by companies to make production and delivery systems more competitive in world markets by eliminating or minimizing waste. The sales of a business or other form of revenue from operations of the business is called as ………… . 4. D Turnover 5. A Current 10. A Cash 11. A Reengineering 9. and costs. errors. B Quick . C Division 8. Baumol model and the Miller-Orr model belong to ……………. Management. A TRUE 6. by reducing the level of inventory held by a company. Inventory and receivables are both current assets.The factors to be considered in formulating a trade receivables policy relate to credit analysis.Holding costs can be ………………. Which technique brings inventory and cash requirment drastically down? LIFO Baumal ABC JIT 18.Which model belongs to cash management? B Miller Orr 19. is undertaken by analysing and evaluating information relating to a customer’s ……………… history? C Financial 14. . D time 20.JIT stands for just in …………. and thus remain in business. B TRUE 15. 12.The objective of liquidity ensures that companies are able to meet their liabilities as they fall due. A minimised 17. credit control and receivables collection. or the assessment of creditworthiness. Funds held in the form of cash do not earn a return. D TRUE 13. A TRUE 16. A TRUE . Credit analysis. 21. and on the nature of the business operations of a company..The cash operating cycle is the average …………. for example cash.Optimum cash balance must reflect the expected need for cash in the next budget period. A TRUE . depends on working capital policy in relation to the level of investment in working capital. C different 22. C Cash 24.Companies with the same business operations may have …………… levels of investment in working capital as a result of adopting different working capital policies. requirement Operating Cycle disbursal Management 28. is because they run out of ……………… . though. earn no return and so will not increase profitability..Liquid funds.The length of the cash …………………. C Always 25.The main reason that companies fail. B Always 26.Receivables management is all about? C Credit Management 23.Is it right to say that good cash management is an essential part of good working capital management.. C length 27. of time between paying trade payables and receiving cash from trade receivables. B Variable 37.Aggressive working capital finance means using more …………. not the Cash Flow Statement.………………….Short-term finance is more flexible than long-term finance. term finance B Short 33.? B A/Cs Receivables 36.Short-term finance tends to be more …………. D Ratios 30. A TRUE 34.Sales made but not collected is known as…………….Working capital investment policy is concerned with the level of investment in ………… assets. C Current 31. C Flexible 35. are your business’ “scores” that come from your Income Statement and Balance Sheet. FALSE .Short-term finance is more risky than long-term finance. with one company being compared with another. can also be used to cover some of the risks associated with giving credit to foreign customers. than long-term finance... Locking Awards C Insurance Rewards 32.………….. Interest rate depends upon an index and increases or decreases. 29.………………. Money paid (cost of credit) for the use of money.Never C Sometimes TRUE 38. principle suggests that long-term finance should be used for long-term investment. rate. Contact www.in for best and lowest cost solution or Email: [email protected] Call: 9971223030 ..kimsharma. A Interest We Also Provide SYNOPSIS AND PROJECT. Current Previous Accounting Industry 39.co. the rates may vary when compared to the ………….The ………….Rate risk refers to the fact that when short-term finance is renewed. Matching Traditional Dual Aspect Monetary 40.