MBA FINANCE DEGREE - International MBA Institute

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DedicationTo all of the International MBA Institute students, thank you for inspiring us, keeping usfocused, and making sure we do our best to help you grow in your career with your skillsand knowhow. Without you, your engagement and your loyal support, International MBAInstitute could not come where it is today.

TABLE OF CONTENTSCLICKABLEWELCOME .5ABOUT INTERNATIONAL MBA INSTITUTE .6Nature and Importance of the Finance Function .7Functions of the Finance Manager .10Interface Between Finance and Other Business Functions .14Environment of Corporate Finance.18Time Value for Money .22The Measure of Return .27Sources of Financial Risks .30Financial Portfolios and Risks .33Financial Risk Management .40Risk Management Process .43Thank you .49

WELCOMEHi! I’m Yeliz.I love that you are taking your time to read your MBAbook. I want to briefly share with you why we wantedto write this book for you and how you can get thebest use out of it.Within the context of our MBA degrees we made athorough research in MBA education space.The conclusion was: We failed to find one singletextbook, we could sincerely recommend to ourstudents!We talked to our successful students and found outthat, almost none of the MBA books in the marketcould really help them make a smooth entry to MBAknowhow and practical business execution space.Significant number of MBA books in the marketplaceclaim that they cover all details of MBA, but whatthey are not telling is that, they don't haveunderstandable, clear and logical content to helptheir readers comprehend and most importantly loveMBA!Therefore, we wrote for you MBA books and broughtthem for your service!We are absolutely confident that your MBA books willmake you proficient in MBA subjects, so that you willhave an outstanding opportunity to love MBA andkeep on taking the tangible benefits of being an MBAprofessional.Take some coffee to enjoy and some paper totake your notes, and spend some quiet time toread your MBA books!Afterwards you will have a great understandingabout MBA domains and be prepared to pass yourMBA degree exam. You will be ready to deliver greatproducts and services to your clients and employersand to build your bright career and future!Yeliz ObergfellVice President - Student ExperienceInternational MBA Institute 5

ABOUT INTERNATIONAL MBA INSTITUTE International MBA Institute is an independentinstitute which helps organisations and professionalsget accredited with worldwide renowned and validMBA degrees and prove their competence in MBAdomains. We empower professionals worldwide tobuild their careers, and companies to create and selltheir outstanding products and services.Your MBA Leadership , MBA Management , MBASales , MBA Human Resources , MBA Finance ,MBA Marketing , MBA Business Strategy and MBARecruitment degrees have proven their worldwideacceptance and reputation by being the choice ofmore than 987’000 MBA professionals in 143countries.MBA is a set of open business execution, product,service delivery and leadership frameworks, and yetbefore International MBA Institute was established,there used to be no reasonable way for MBApractitioners like yourself to obtain your accreditedMBA degrees and to prove your competence in MBAdomains. MBA practitioners had to pay expensivefees for the one way profit-driven MBA degrees ofother MBA education providers.International MBA Institute aims to remove thesebarriers set in front of the MBA professionals indeveloped and emerging markets by saving themfrom paying unreasonable fees for MBA classroomtrainings and MBA degree examinations before theyaccredited their knowhow in MBA Domains.Moreover, feel free to check out "What makes YourMBA Degrees Best of the Industry?" section on web portal to read why weperform and serve you far more better than ourcompetition.International MBA Institute provides 8 major onlineMBA degrees which are designed by our consortiumof renowned business and people Leaders, coaches,mentors, experts and authorities from all majorindustries. You can check your MBA degrees fromthis List of MBA Degrees.6

Nature and Importance of theFinance FunctionIn this chapter, you will: Understand the nature and importance of thefinance function Understand the various objectives of financialmanagementOne participant in a course titled, ‘Finance for NonFinance Executives’, made a very interestingobservation during the discussion. He said, “Thereare no executive development programs titled‘Production Management for Non-ProductionExecutives’ or ‘Marketing Management for NonMarketing Executives’ and so on. Then how comebooks and Executive Development Programs titled‘Finance for Non-Finance Executives’ are so popularamong managers of all functions like marketing,production, personnel, R&D, etc.?”The answer is very simple. The common threadrunning through all the decisions taken by thevarious managers is money and there is hardly anymanager working in any organization to whommoney does not matter. To illustrate this point, let usconsider the following instances.The R&D manager has to justify the money spent onresearch by coming up with new products andprocesses which would help to reduce costs andincrease revenue. If the R&D department is like abottomless pit only swallowing more and moremoney but not giving any positive results in return,then the management would have no choice but toclose it. No commercial entity runs a R&Ddepartment to conduct infructuous basic research.Likewise the materials manager should be awarethat inventory of different items in stores is nothingbut money in the shape of inventory. He shouldmake efforts to reduce inventory so that the fundsreleased could be put to more productive use. At thesame time, he should also ensure that inventory ofmaterials does not reach such a low level as tointerrupt the production process. He has to achievethe right balance between too much and too littleinventory. This is called the liquidity- profitabilitytrade-off about which you will read more in thelessons on Working Capital Management. The sameis true with regard to every activity in anorganization. The results of all activities in anorganization are reflected in the financial statementsin dollars. The Finance Manager (you), as your verydesignation implies, should be involved in allfinancial matters of the organization since almost all7

activities in the organization have financialimplications. It would therefore not be inaccurate tosay that the Finance Manager is involved in mostdecisions of the organization. Let us try tounderstand what financial management is byexamining what the Finance Manager does and withwhat objectives.Objective of Financial ManagementLet us examine the purpose or objective sought to beachieved by a Finance Manager. Suppose youmanage to make available the required funds at anacceptable cost and that the funds are suitablyinvested and that everything goes according to planbecause of the effective control measures employedby you. If the firm is a commercial or profit-seekingfirm, then the results of good performance arereflected in the profits the firm earns. How are theprofits utilized? They are partly distributed amongthe owners as dividends and partly recycled into theoperations of the firm. As this process continues overa period of time the value of the firm increases forthe simple reason that the firm is able to generateattractive surpluses from operations. If the shares ofa firm are traded on the stock exchange, the goodperformance of the firm is reflected in the price atwhich its shares are traded. When the firm’s sharesattract a good price, the owners or shareholders arebetter off because they would realize much morethan what they had invested. Their wealth increases.So we can see that as a result of good financialmanagement the value of the company to theowners (shareholders) increases, thereby increasingtheir wealth. Therefore, we can say that yourobjective as a Finance Manager is to increase ormaximize the wealth of the owners by increasing thevalue of the firm which is reflected in its Earnings perShare (EPS) and the market price of its shares.In the case of public sector companies, till recentlythe only objective was to increase the wealth to thesociety and nation at large. This objective wasachieved by ensuring availability of essential goodsand services to all citizens in all corners of thecountry, uniform development of all regions in thecountry, providing employment opportunities,investing in projects with long gestation periodswhere private investment may not be forthcomingand investing in import-substitution industries, etc.But now the public sector has also come to realizethat they have to perform in order to exist and thatits products/services will not be subsidized anylonger by the government. Public SectorUndertakings (PSUs) are now going in for8

disinvestment and privatization for increasedefficiency.Summary:1 The Finance Manager should be involved in allfinancial matters of the organization sincealmost all activities in the organization havefinancial implications.2 If the firm is a commercial or profit-seekingfirm, then the results of good performance arereflected in the profits the firm earns.3 As this process continues over a period of timethe value of the firm increases for the simplereason that the firm is able to generateattractive surpluses from operations.4 Public Sector Undertakings (PSUs) are nowgoing in for disinvestment and privatization forincreased efficiency.9

Functions of the Finance ManagerIn this chapter, you will: Understand the process of deployment offunds Understand finance manager’s control over theuse of organization’s funds Also understand the risk vs return trade-offAs finance manager, you have to plan for andmobilize the required funds from various sourceswhen they are required and at an acceptable cost.This decision is called the Financing Decision. For thispurpose you would be liaising with banks andfinancial institutions. You also deal with merchantbanking agencies for procuring funds from the publicthrough issue of shares, debentures and inviting thepublic to subscribe to its fixed deposits. In decidinghow much to procure from various sources, youwould weigh many considerations like the cost of thefunds in the form of interest / dividend and the costof public issue in the case of shares and debentures,the length of time for which funds would beavailable, etc. Banks and other financial institutionswhich give short-term and long-term loans generallylay down some conditions. These conditions areaimed at ensuring the safety of the loans given bythem and contain provisions restricting the freedomof the borrower to raise loans from other sources.Therefore, as Finance Manager, you would try tobalance the advantages of having funds availablewith the costs and the loss of flexibility arising fromthe restrictive provisions of the loan contract.Let us take a look at a real life example:Account MMPublic issue of equity shares includingpremiumTerm Loan – Wells FargoLeasing – Wells Fargo- OthersDeferred payment guaranteeInternal accruals180.41312.57.59.9134.5357.8XYZ Limited, a well-known company in computertraining, software development. Informationsystems, consultancy, etc. is undertaking amodernization cum expansion scheme whichenvisages addition of new services, product lines andupgradation of existing systems. The cost of thisexpansion cum modernization program is estimated10

at 357.8 million, which is going to be mobilized asfollows as per the prospectus of the dimensions to determine its worthiness inrelation to the investment involved. This decisioncalled the ‘Investment Decision’ constitutes one ofthe core activities of your role as a Finance Manager.The funds mobilized through various sources by XYZare proposed to be deployed as follows, as indicatedin the prospectus of the company.Functions of the Finance ManagerDeployment of FundsThere are always many competing needs for theallocation of funds. In consultation with themanagers of various departments such asproduction, marketing, personnel, R&D and the topmanagement you (the Finance Manager) decide onthe manner of deployment of funds in various assetssuch as land, buildings, machinery, materials, etc.Sometimes the managers of the variousdepartments named above constitute an ‘InvestmentCommittee’ and appraise an investment proposalalong the marketing, technical and financialdimensions. You appraise the proposal along theAccount MMBuildingComputers & AccessoriesPlant & MachineryInfrastructureNormal Capital ExpenditureRepayment of LoansIncrease in Working Capital98.594.111.621.324.128.379.9357.8Control Over the Use of FundsAfter deciding on projects and proposals in which thefunds are to be invested and after procuring them,you have to continuously monitor their use in orderto ensure that procurement and deployment of11

funds proceeds according to plan. This task of theFinance Manager is called Financial Control. You sendfrequent reports to the Managing Director. Thesereports contain information in the form of facts andfigures regarding the extent to which procurementand deployment of funds is proceeding according toplan. For example, the reports would inform themanagement regarding the extent to which creditsanctioned by banks for the day-to-day use of thefirm (working capital) has been utilized and howmuch more can be borrowed. It would also containinformation on how much money is due to the firmfrom various customers and how much the firmowes its suppliers. The report would also containinformation on the funds required at different pointsof time in the future and the availability of fundsfrom various sources including those available out ofany surpluses generated internally. You would alsobe reporting to the top management about theperformance of individual departments within theorganization. All such reports are called ‘ControlReports’ and the whole process constitutes ‘control’because it helps management to take timelycorrective action to ensure that planned results areachieved.Risk-return Trade-offWhile making the decisions regarding investmentand financing, as Finance Manager, you seek toachieve the right balance between risk and return. Ifthe firm borrows heavily to finance its operations,then the surpluses generated out of operationswould be utilized to ‘Service the Debt’ in the form ofinterest and principal payments. The surplus orprofit available to the owners would be reducedbecause of the heavy ‘Debt-servicing’. If things do notwork out as planned and the firm is unable to meetits obligations, the company is even exposed to therisk insolvency. Similarly, the various investmentopportunities have a certain amount of riskassociated with the return and also the time whenthe return would materialize. You have to decidewhether the opportunity is worth more than its costand whether the additional burden of debt can besafely borne. In fact, decision making in all areas ofmanagement including financial managementinvolves the balancing of the trade-off between riskand return.Summary:1 The Finance Manager has to plan for andmobilize the required funds from varioussources when they are required and at an12

2345acceptable cost. This decision is called theFinancing Decision.The Finance Manager would try to balance theadvantages of having funds available with thecosts and the loss of flexibility arising from therestrictive provisions of the loan contract.The Finance Manager appraises the proposalalong the financial dimensions to determine itsworthiness in relation to the investmentinvolved. This decision called the ‘InvestmentDecision’ constitutes one of the core activitiesof the Finance Manager.After deciding on projects and proposals inwhich the funds are to be invested and afterprocuring them, the Finance Manager has tocontinuously monitor their use in order toensure that procurement and deployment offunds proceeds according to plan. This task ofthe Finance Manager is called FinancialControl.While making the decisions regardinginvestment and financing, the FinanceManager seeks to achieve the right balancebetween risk and return.13

Interface Between Finance andOther Business FunctionsIn this chapter, you will: Understand the interface between finance and: The Marketing Function The Production Function The Top Management Understand other challenges in FinancialManagement including: Treasury Operations Foreign Exchange Financial Structuring Maintaining Share prices Ensuring Management ControlLet us discuss in greater detail the reasons whyknowledge of the financial implications of the financemanager’s decisions is important to the non-financemanagers. One common factor among all managersis that they use resources and since resources areobtained in exchange for money, they are in effectmaking the investment decision and in the processof ensuring that the investment is effectively utilizedthey are also performing the control function.Interfaces of Finance with other BusinessFunctionsMarketing – Finance InterfaceThe Marketing Manager takes many decisions whichhave a significant impact on the profitability of thefirm. For example, he should have a clearunderstanding of the impact of the credit extendedto the customers on the profits of the company.Otherwise in his eagerness to meet the sales targetshe is likely to extend liberal terms of credit whichmay put the profit plans out of gear. Similarly, heshould weigh the benefits of keeping a large14

inventory of finished goods in anticipation of salesagainst the costs of maintaining that inventory.Other key decisions of the Marketing Manager whichhave financial implications are pricing, product,promotion and advertisement, choice of product mixand distribution policy.Production – Finance InterfaceIn any manufacturing firm, the Production Managercontrols a major part of the investment in the formof equipment, materials and men. He should soorganize his department that the equipments, underhis control are used most productively, the inventoryof work-in-process or unfinished goods and storesand spares is optimized and the idle time and workstoppages are minimized. If the production managercan achieve this, he would be holding the cost of theoutput under control and thereby help in maximizingprofits. He has to appreciate the fact that whereasthe price at which the output can be sold is largelydetermined by factors external to the firm likecompetition, government regulations, etc. the cost ofproduction is more amenable to his control.Similarly, he would have to make decisions regardingmake or buy, buy or lease, etc. for which he has toevaluate the financial implications before arriving ata decision.Top Management – Finance InterfaceThe top management, which is interested in ensuringthat the firm’s long-term goals are met, finds itconvenient to use the financial statements as ameans for keeping itself informed of the overalleffectiveness of the organization. We have so farbriefly reviewed the interface of finance with thenon-finance functional disciplines like production,marketing, etc. Besides these, the finance functionalso has a strong linkage with the functions of thetop management. Strategic planning andmanagement control are two important functions ofthe top management. Finance function provides thebasic inputs needed to undertake these activities.With the recent liberalization of many economies,abolition of the office of the Controller of CapitalIssues who used to fix issue prices beforehand andefforts of these economies towards globalization,finance managers are presently facing some newchallenges as indicated below:Other Challenges in Financial ManagementTreasury Operations:Short-term fund management must be moresophisticated. As finance manager, you could make15

speculative gains by anticipating interest ratemovements.Foreign Exchange:You will have to weigh the costs and benefits oftransacting in foreign exchange particularly now thatmost of the economies are going global and thefuture value of the currencies is becoming difficult topredict.Financial Structuring:An optimum mix between debt and equity will beessential. Firms will have to tailor financialinstruments to suit their and investors’ needs. Pricingof new issues is an important task for the FinanceManager’s portfolio now.Maintaining Share Prices:In the premium equity era, firms must ensure thatshare prices stay healthy. You will have to deviseappropriate dividend and bonus policies.Ensuring Management Control:Equity issues at premium mean management maylose control if it is unable to take up its shareentitlements. Strategies to prevent this are vital.Summary:1 Marketing-finance interface: A finance manager should weigh thebenefits of keeping a large inventory offinished goods in anticipation of salesagainst the costs of maintaining thatinventory. Other key decisions are pricing, product,promotion and advertisement, choice ofproduct mix and distribution policy.2 Production-finance interface: The production manager should soorganize his department that theequipment’s, under his control are usedmost productively, the inventory of workin-process or unfinished goods andstores and spares is optimized and theidle time and work stoppages areminimized.3 Top management-finance interface: Strategic planning and managementcontrol are two important functions ofthe top management. Finance functionprovides the basic inputs needed toundertake these activities.4 Other Challenges in Financial Management: Treasury Operations16

Foreign ExchangeMaintaining Share PricesEnsuring Management Control17

Environment of Corporate FinanceIn this chapter, you will: Understand the environment of corporatefinance Understand the important forms of businessorganization Sole Proprietorship Partnership CompaniesOne of the important aspects of your job as aFinance Manager is to understand the externalenvironment in which you operate. In a countrywhere investment and financing activities are subjectto numerous governmental controls and legislations,you must have a thorough understanding of the legalframework circumscribing his decisions. Let usconsider the following examples to clarify the point: Colgate is the market leader in dental products(toothpaste and tooth powder) and it canincrease its market share by increasingproduction. But the finance manager ofColgate cannot recommend a proposal forexpanding the manufacturing capacity oftoothpaste even though the project is certainto increase the shareholders’ wealth. Why? Because in most countries toothpastemanufacture is an activity reserved for thesmall scale sector and the government doesnot permit units other than small-scale unitsengaged in this activity to expand theircapacity.The confectionery products of Nutrine enjoy astrong brand image. Its finance manager wouldpossibly like to exploit this strength for raisingfunds from public through issue of shares. Buthe cannot resort to this option even if he sodesires because Nutrine is a private limitedcompany and the Companies Act in manycountries prohibits private limited companiesfrom raising capital from the public.From these examples, it is clear that the legislativeframework has an important bearing on theinvestment and financing decisions of a firm. Thenext question is: Are there external factors otherthan legal provisions and governmental regulationsthat that intervene in the decision making process ofthe finance manager? The answer is ‘Yes’. The formof organization that business entity adopts oftenlimits the investment and financing options. Forinstance, a partnership firm engaged in trading yarncannot follow Castrol and set up a 4000 MM18

petrochemical complex because the partnershipform of organization limits both the size and theability to mobilize such massive funds.The structure of the financial markets from whereyou have to raise funds and the regulationsgoverning the financial intermediaries (like banksand financial institutions) also influence yourdecisions as finance manager. Last but not the leastin terms of importance is the tax factor. Whileevaluating the feasibility of the investments you alsotake into account the fiscal (tax) factors associatedwith these investments.So, we find that you pursue your objective of owners’wealth maximization under a set of externalconstraints apart from the internal constraints thatarise from the inherent strengths and weaknesses ofeach entity. This makes your job complex andinteresting because he has to make optimaldecisions within the framework of these constraints.We have identified four aspects of the externalenvironment which are directly relevant to your jobas Finance Manager. They are: Forms of Business Organization. Regulatory Framework. Financial System (which will include financialmarkets and intermediaries).Tax Aspects.The Important Forms of Business OrganizationImportant Forms of Business OrganizationsSolo ProprietorshipThis type of concern is owned by a single person. Theproprietor enjoys all the powers of taking andassuming risks for his/her concern. The rewards,profits, losses and incurring of all the liabilities of thebusiness is to him/her.19

The advantages of a sole proprietorship are: Easy and inexpensive to set up. Few governmental regulations. No firm tax.The disadvantages are: Life of the firm is limited to the life of theowner. Unlimited personal liabilities. Outside fund raising is not possible and canresult in lack of growth. Tax on the income will be very high.PartnershipIn this type of firm the business is owned by two ormore persons. They are partners in business andthey bear the risks and reap the rewards of thebusiness.The partnership comes into being through apartnership agreement or a partnership deed.The advantages of the partnership firm are: Like a sole ownership firm it can be set upeasily and inexpensively. It is relatively free from governmentalregulations. The expertise and experience of the partners isuseful to the firm’s operations.The disadvantages are: The life of the firm depends upon theagreement between the partners. If any ofthem withdraws or is met with death, it mayresult in dissolution of the firm. Possible conflict between the partners is athreat to the company’s existence. Personal liabilities of the partners is unlimited. Its ability to raise funds is limited.CompaniesA group of persons working together towards acommon objective is a company. It representsdifferent kinds of associations, be it business or nonbusiness. Details about company structures arespecified by the Chamber of Commerces ofrespective countries.Summary:1 A finance manager must have a thoroughunderstanding of the legal frameworkcircumscribing his decisions.2 The structure of the financial markets fromwhere the finance manager has to raise fundsand the regulations governing the financial20

3intermediaries (like banks and financialinstitutions) also influence the decisions of afinance manager.Important Forms of Business Organizationinclude: Sole Proprietorship: This type of concernis owned by a single person. Partnership: In this type of firm thebusiness is owned by two or morepersons. Companies: A group of persons workingtogether towards a common objective isa company.21

Time Value for MoneyIn this chapter, you will: Understand the process of compounding Understand the process of discounting Understand the future value of single flow(lump sum) Understand what is doubling period Understand what is growth rateTo keep pace with the increasing competition,companies have to go in for new ideas implementedthrough new projects be it for expansion,diversification or modernization. A project is anactivity that involves investing a sum of money nowin anticipation of benefits spread over a period oftime in the future. How do you determine whetherthe project is financially viable or not? Yourimmediate response to this question will be to sumup the benefits accruing over the future period andcompare the total value of the benefits with theinitial investment. If the aggregate value of thebenefits exceeds the initial investment, the project isconsidered to be financially viable.While this approach prima facie appears to besatisfactory, you must be aware of an importantassumption that underlies. You have assumed thatirrespective of the time when money is invested orreceived, the value of money remains the same. Putdifferently, you have assumed that: value of onedollar now value of one dollar at the end of year 1 value of one dollar at the end of year 2 and so on.You know intuitively that this assumption is inco

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