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Latest tools and techniques of Financial Management

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					LATEST TOOLS AND
TECHNIQUES OF
FINANCIAL MANAGEMENT

Dr. Navita Nathani
Head, Management,
Chief Coordinator EDC
Prestige Institute of Management, Gwalior
Overview of the subtopics
   Brief introduction
   Goal
   Need
   Why Valuation
   Tools of Wealth maximization and SVC
   Empirical evidences
   Tools of Working Capital Management
   Empirical evidences
   Tools of Capital Budgeting
   Conclusion
Introduction
   With the liberalization of Indian economy, the
    Indian corporate world has found itself in an
    environment where it has to contest with the market
    forces, large corporations with significant brand
    equity and also follow different resource strategies
    and practices.
   India faces the task of not only integrating itself
    with the rest of the world, but more importantly, of
    understanding future global trends to work towards
    finding a place among the leading economies.
GOAL
   It is widely accepted that the primary aim of the firm is to
    maximize the wealth or it is generally agreed that the goal of
    the firm should be Shareholders Wealth Maximization
   From the economist's viewpoint, value is created when
    management generates revenues over and above the economic
    costs.
   Costs come from four sources: employee wages and benefits;
    material, supplies, and economic depreciation of physical
    assets; taxes; and the opportunity cost of using the capital.
   It is therefore more important to know the variables which
    influence value addition.
NEED
    Today, financial managers play a dynamic role in solving complex
    problems like
         Shaping the fortunes of the enterprise,
         Decisions regarding allocation of capital,
         Raising of funds most economically and using them in the most
          efficient and effective manner.
   Because of this change , the descriptive treatment of the subject of
    financial management is being replaced by growing analytical contents.
    The subject now accords a far greater importance to management
    decision-making and policy.
   Hence new tools in financial management emerged. It comprises of
     Tools and techniques in
    Financial       Analysis,      Profit      Planning      and     Control
    Long-term        Investment     or     capital     budgeting    Decisions
    Working                         Capital                       Management
Why Value Addition
   Creating value for shareholders is now a widely accepted corporate
    objective. The interest in value creation has been stimulated by several
    developments.
   Performance measurement (qualitative or quantitative) is the key to value
    addition
   Capital markets are becoming increasingly global. Investors can readily
    shift investments to higher yielding, often foreign, opportunities.
   Institutional investors, which traditionally were passive investors, have
    begun exerting influence on corporate managements to create value for
    shareholders.
   Corporate governance is shifting, with owners now demanding
    accountability from corporate executives. Manifestations of the increased
    assertiveness of shareholders include the necessity for executives to justify
    their compensation levels, and well-publicized lists of under performing
    companies and overpaid executives.
   Greater attention is being paid to link top management compensation to
    shareholder returns.
Valuation tools
   Creating shareholder value is the key to success in
    today's marketplace.
   There is increasing pressure on corporate executives
    to measure, manage and report the creation of
    shareholder value on a regular basis.
   In the emerging field of shareholder value analysis,
    various measures have been developed that claim
    to quantify the creation of shareholder value and
    wealth.
Financial Performance Measurement

   Traditional Vs New Economic Measures
   ROE, ROI, EPS, NOPAT, and OP.
   New measures are given by different consultant
    from time to time
   It include lot many approaches
Marakon Approach

   Marakan Associates, an international management-
    consulting firm founded in1978, has done
    pioneering work in the area of value-based
    management.
    This measure considers the difference between the
    ROE and required return on equity (cost of equity)
    as the source of value creation.
ALCAR APPROACH

   The Alcar group Inc. a management and software company, has
    developed an approach to value-based management which is based
    on discounted cash flow analysis. In this framework, the emphasis
    is not on annual performance but on valuing expected performance.
    The implied value measure is akin to valuing the firm based on its
    future cash flows and is the method most closely related to the
    DCF/NPV framework.
   With this approach, one estimates future cash flows of the firm over
    a reasonable horizon, assigns a continuing (terminal) value at the
    end of the horizon, estimates the cost of capital, and then estimates
    the value of the firm by calculating the present value of these
    estimated cash flows. This method of valuing the firm is identical to
    that followed in calculating NPV in a capital-budgeting context.
    McKINSEY APPROACH
    McKinsey & Company a leading international consultancy firm has developed an
    approach to value-based management which has been very well articulated by Tom
    Copeland, Tim Koller, and Jack Murrian of McKinsey & Company. According to
    them:
   Properly executed, value based management is an approach to management
    whereby the company's overall aspirations, analytical techniques, and management
    processes are all aligned to help the company maximize its value by focusing
    decision making on the key drivers of value.

    The key steps in the McKinsey approach to value-based maximization are as
    follows:

    * Ensure the supremacy of value maximization
    * Find the value drivers
    * Establish appropriate managerial processes
    * Implement value-based management philosophy
THE DISCOUNT CASH FLOW
APPROACH
                                        

    The true economic value of a firm or a business or a project or any strategy
    depends on the cash flows and the appropriate discount rate
    (commensurate with the risk of cash flow). There are several methods for
    calculating the present value of a firm or a business/division or a project.
   The first method uses the weighted average cost of debt and equity
    (WACC) to discount the net operating cash flows. When the value of a
    project with an estimated economic life or of a firm or business over a
    planning horizon is calculated, then an estimate of the terminal cash flows
    or value will also be made. Thus, the economic value of a project or
    business                                                                     is:
    Economic Value=Present Value of net operating cash flows+ Present
                               value      of      terminal      value
ECONOMIC VALUE ADDED



 Consulting firm Stern Steward has developed the concept of
  Economic Value Added. Companies across a broad spectrum
  of industries and a wide range of companies have joined the
  EVA badwagon. EVA is a useful tool to measure the wealth
  generated by a company for its equity shareholders. In other
  words, it is a measure of residual income after meeting the
  necessary requirements for funds.
Computation of EVA
 EVA is essentially the surplus left after making an appropriate
  charge for capital employed in the business. It may be
  calculated by using following equation.
 EVA= Net operating profit after tax- Cost charges for capital
  employed
Market Value Added
   Market value is referred to as the “Enterprise
    value”. It is the total of the firm’s market value of
    debt and equity
   SVC is also referred to as MVA
   Market value added = Market value- Invested
    Capital
   MV increases only in case firm earns returns in
    excess of the cost of capital
Balance Score Card
   No manager can ignore the bottom line the key indicator of
    what has happened that is a “lagging indicators”. How well
    you are doing i.e. “current indicator” and “leading indicators”
    that means what can expect to do in the future ?
    For this we need a more comprehensive view with an equal
    emphasize on three important indicators. Indicators that
    clearly measures performance against objectives and can help
    you to set specific ,realistic, measurable and time bound
    targets so you get where you want to go.
Cont…
   Balance Scorecard is a way of
   Measuring organizational business unit or dept.
    success .
   Balancing long term & short term actions
   Balancing different measures of success
    Financial
    Customer
    Internal business
    Innovation & learning
EVA as tool for measuring the
Shareholder’s wealth
   The study was empirical and descriptive in nature.
    The total population was Indian banks which are
    listed in NSE-50.The sample frame were individual
    banks during the year 2005-06.
   The sample sizes were five Indian banks selected on
    the basis of the convenience sampling technique.
    The data was collected through secondary resources
    i.e. websites of NSE.
Objectives of the Study

   To calculate shareholders return using EVA.
   To calculate shareholder’s return using traditional
    measures (by OP, EPS, ROE, ROI)
   To determine the most accurate method of calculating
    shareholder’s wealth.
   To compare shareholder’s return calculated through EVA
    and traditional measures.
   To see correlation between EVA and traditional
    measures.
   To open new vistas for further research.
Empirical findings are different from
the views of consultant

   Ho = EVA is the best measure to evaluate the stock
    returnsEVA-deene.doc
Correlation

                                 OPERATIN

 ROI        ROE         EPS      G PROFIT        EVA

  0.1        0.16       29.2      67794947     -276433162

 0.112       0.16      27.92      13396615     -312728000

  0.12       0.11      32.49      39078072     -108772675

 0.115       0.17      17.45      7462826      -320172274

 0.057       0.11       27.1      12722456     -65259714

-0.57273   -0.98481   0.506888   0.002638312
Results of Correlation between EVA and other Variable of
Indian banks


   It is evident from this table that the only variable with which EVA
    strongly correlates is EPS and with returns on investment and return
    on equity it is showing negative correlation.
   Because of the negative EVA the correlation between EVA and ROI
    is -.57 and between EVA and ROE is -.98.
   Then it shows that there is no relation between EVA and return on
    equity and return on investment. So if any bank has higher earning
    per share then we can assume that bank is focusing on value
    creation and rewarding banks which increase shareholder value.
   The results are in alignment with Fernández (2001) who had
    calculated using EVA, MVA, NOPAT and WACC data for 582
    American companies provided by Stern Stewart. For each of the
    582 companies there are 210 companies for which the correlation
    with the EVA has been negative.
 Beta values
      Items    ROI     ROE      EPS      O.P     EVA

Beta

ROI            -       -7.815   -1.361   .990    7.581

dependent

ROE            -.128   -        -.174    0.127   -.970

dependent

EPS            -.735   -5.742   -        0.728   -5.570

dependent

OP dependent   1.010   7.890    1.374    -       -7.655

EVA            .132    1.031    0.180    -.131   -

dependent
Accurate method of measuring the shareholder’s
wealth


   For measuring the accurate method of performance
    the regression was applied among various variables
    (ROI, ROE, OP, EPS, and EVA).
    The value of beta is higher in the case of operating
    profit and hence it can conclude that the operating
    profit, which is a traditional measure, still is the best
    method of measuring the shareholder’s wealth.
    After that ROE is the second best method then EPS
    and ROI respectively.
Working capital management
   Many companies still underestimate the importance of
    working capital management as a lever for freeing up
    cash from inventory, accounts receivable, and Payables
   By effectively managing these components, companies
    can sharply reduce their dependence on outside
    funding and can use the released cash for further
    investments or acquisitions.
   This will not only lead to more financial flexibility, but
    also create value and have a strong impact on a
    company’s enterprise value by reducing capital
    employed and thus increasing asset productivity.
Value creation vs. working capital management: A study of manufacturing companies




   The present study was empirical in nature and was
    conducted on manufacturing companies by considering
    sample of about 35 manufacturing companies listed in NSE
    50 from duration 2005-2008.
   For evaluating the degree of relationship between net
    working capital and profitability and between net working
    capital and investment, correlation was applied. Moreover,
    Descriptive statistics was applied to know the distribution
    pattern of net working capital, investment and ROI. And
    also Non – parametric Mann Whitney U test was applied to
    know the significant difference between the above
    variables. and all such calculations and testing was done by
    using SPSS Statistical software.
Hypothesis
   There is significant difference between Net working
    capital and ROI of manufacturing companies.
   There is insignificant difference between ROI and
    investment of manufacturing companies.
   If these two hypotheses are true, then companies will
    always try to reduce their NWCValue and wc.doc
    balances and increase their investments with a view to
    enhance companies’ profitability and ultimately create
    value for them.
Results
   The findings indicate that Net working capital and ROI, Net
    working capital and Investment are negatively correlated to
    each other.
   The results show that firms are specifically for two years
    following this strategy but do not follow the above guidelines
    for another 2 years that’s in year 2006 and 2008. This is due to
    the downturn in economy.
   This shows that firms are reducing their holdings on working
    capital and thus results in enlarging investment and ROI.
    Thus, it can be concluded that Management of working capital
    in a strategic mode is now contributing to the value based
    management systems and with the help of that manufacturing
    companies under study are creating value for them. This is
    facilitating the manufacturing companies to manage their
    working capital in a new route instead of following the
    traditional views.
Other techniques
   Cash management – Cash Concentration and
    controlled disbursements through zero balance
    accounts
   Inventory management- MRP, JIT and Kanban
   Cash Collection –Factoring , lock boxes
   Credit- Credit scoring - five c’s
Capital Budgeting Techniques
Discounted cash flow techniques
 Net Present Value

 Internal Rate of return

 Profitability Index

Non-discounted cash flow techniques
 Pay Back

 Average Rate of Return

 Discounted pay back period
Conclusion
   Today the old adage “if you can’t measure it , you
    can’t manage it” has been taken to a new extreme
    in many organization the result is confusion.
   When there was a single overriding indicator, such
    as profit /ROI it was relatively easy for manager to
    know what they were supposed to achieve.
   In these days of multiple measures, all of which are
    assumed to be equally important its no longer clear
    to many people where the organization’s priorities
    lies.
Cont….
   However in lot many cases the empirical evidences
    are quite different from the views of consultants.
   There are n no of tools but the need of the hour is to
    identify the important indicators of the organization
    & implement that part which is necessary for the
    organization point of view.
   Lastly research and development activities may help
    the organization in adopting and not adopting a
    particular tool , which is possible through industry
    institute linkages.
Cont..
 Alfred Toffler has rightly said that
“In 21st century the illiterate person is not that person
    who is not able to read and write but the person
                who is not able to learn”.
Thank You

				
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posted:9/6/2011
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