Financial Management - Case Study Example

Financial Management Introduction Finance is one of the integral elements of any business without which the entity cannot function. It is becausesources of fund is crucial for any kind of activities, be it a major or minor activity. The proper allocation and utilization of funds is the responsibility of the finance manager or his associates. Finance is the support of every business and is major contributor to the accomplishment of organizational, administrative, and managerial operations in every phase of its functioning. Financial management is a concept which deals with the professional and successful handling of economic resources, such as capital, funds, and the like in order to accomplish the most proficient result. Cash tell Plc is a manufacturing company that operates in UK and Europe. The company has now announced an important proposal or bid contract. The winner of bid contract will get around '12 million within 12 months time. a) Minimization of Uncertainty due to fluctuating exchange rates Every foreign exchange market is in a position to mitigate the risk of uncertainty occurred due to the variations in the exchange rates on cash flows of both payables and receivables. "Under the hypothesis of efficient foreign exchange markets, the validity of the Purchasing Power Parity theorem may take care of the company's uncertainty with respect to the mean value of its foreign currency portfolio. The remaining uncertainty, i.e. the variance of the value of the foreign currency portfolio around its mean, can be reduced by hedging" (Soenon 2006). Under this kind of marketing, generally, there should be equilibrium between the estimated cost of hedging and the actual cost. In addition, the chances of risks and uncertainty will be higher in case of exchange rates and its variations. It is necessary to consider the uncertainty caused by fluctuating exchange rates on cash flows both payable and receivable. This is due to the fact that one of the important tools with the finance manager to determine the changes in cash in hand and at bank is the cash flow statement. The statement of cash flows, both inflows and outflows can be analyzed to reveal significant relationships. Cash generating efficiency is the ability of an organization or a company to generate cash from its current or continuing operations. To evaluate this, fundamentally, certain ratios are used. They include- 1. Cash flow yield= Net cash flow from operating activities/ Net income. 2. Cash flow to sales= Net cash flow from operating activities/Net sales. 3. Cash flow to assets= Net cash flow from operating activities/ Average total assets. Similarly, free cash flow is significant in this regard. It is the amount of cash that remains after deducting funds a company must commit to continue operating as its planned level. Such commitments must cover current continuing operations, interest, income tax, dividend, and net capital expenditures. When the free cash flow is positive, it means that the company has met all its planned commitments and has cash available to reduce debt or expand. A negative free cash flow would mean that the company needs to sell investments, borrow money or issue stock, in a short term, to carry on its finance at the planned levels. Besides measuring the cash efficiency and free cash flow with the help of cash flow statement, the financial analyst also calculates various ratios on cash figures rather than the earnings of the company. Such major ratios are- 1. Price per share/free cash flow per share 2. Operating cash flow/Operating profit 3. Self financing investment ratio, which is the internal funding/ Investment activities (net). It helps to indicates how much of the funds generated by the business are reinvested in assets. It is evident that the concepts of investment and risk are related to each other. Every business entity aims to maximize its returns. The business that deals with the investment in different securities by the investors is beneficial to a great extend but at the same time is quiet risky. More importantly, in the globalized competitive scenario, depending on the available ways of raising finance is not enough, but it also requires undertaking the resource mobilization through various recent technological and innovative measures. In addition to this, the theory of financial management is giving appropriate stress for the importance of time value of money. It is because the time preference of money highly relies on certain facts like risk, various investment opportunities, and the preference for present consumption. In addition to this, for any kind of business category, it is crucial to stress certain elements while developing an appropriate capital structure. Such elementary factors are- Profitability. Flexibility. Preservation. Solvency. Control. All stock market aims to raise and utilize the funds so raised in an effective and efficient manner. There is a mutual relation between the risk and return. As far as a business firm is taken considered, return from investment is the expected cash inflows. It is necessary to maximize the shareholders wealth as reflected in the market price of the share, which is depending on the risk-return concept. The investment project that is expected to provide a high return may be very risky as it creates a significant increase in the estimated risk of the entity. Therefore, a step to step procedure is required in all kinds of business or financing aspects, such as estimating the requirement of funds, take adequate decision regarding capital structure, taking of relevant investment and dividend decision, analyzing the financial performance by keeping in touch with stock exchange quotations and share prices reflected in the market avenue. Other than this, it is also fundamental to make an analysis of technical feasibility and financial viability. Therefore, procurement and effective utilization of funds is essential to encourage the investing behaviour of relevant consumers. Likely, the concept of capital structure is a significant factor while formulating the overall scope of financing. This is for the reason that financing and investment in shares or stock market are interrelated. It is also necessary to undertake an appropriate analysis of financial statement foe taking the best alternative decision for the future carry out of the organization or stock markets. "The monetary authority may gain efficiency by reducing volatility of both the exchange rate and the interest rate at the same time. Furthermore, the model is consistent with some known stylized facts in the empirical literature on target zones that previous models were not able to generate jointly-namely, the positive relation between the exchange rate and the interest rate differential, the degree of nonlinearity of the function linking the exchange rate to fundamentals, and the shape of the exchange rate stochastic distribution" (Lopez & Mendizabal 2007). Therefore, it is necessary to take appropriate measures in order to minimize the risk and uncertainty factors related to the exchange rates fluctuations in both the form of cash inflows and out flows. b) Hedging There is a direct relationship between the concepts of finance and hedge. It is an investment form which helps minimize the risk factor related to another investment context. Hedging is an important and effective measure that is utilized by the business organization to reduce the risk factor to certain extends. The risk in relation to hedge may be either the risk of hedging credit or the risk of hedging cash. "Most importantly, hedging is contingent on the preferences of the firm's shareholders. There are companies whose shareholders refuse to take anything that appears to be financial price risk while there are other companies whose shareholders have a more worldly view of such things. It is easy to imagine two companies operating in the same sector with the same exposure to fluctuations in financial prices that conduct completely different policy, purely by virtue of the differences in their shareholders' attitude towards risk" (Hedging). In order to manage the risk related to the investment aspects of a business entity, the concept of hedging is used by which it is possible to avoid the level of risk to a certain extend. More importantly, the concept of hedging is wide in stock exchange markets, for the purpose of minimizing the risk related with the changes of price concepts. If any change takes place in the cash position, whether it is a profit or a loss concept which happens as a result of the level of price changes, ultimately a change takes place in the overall financial position in the future. The movement of price, and the bid contract or betting concept is related to the concept of hedging significantly. Whether there is an increase or decrease in the price levels, it will ultimately affect the value of future bond. Hedging is an important process of counterbalancing the risk of price movement and its fluctuations in the market place. In the process of hedging, it is essential to give stress for various accounting fundamentals and policies also. If a financial manager gives attention to cover the market risks only, it is possible to maintain a risk free rate of return only. CAPM is based on Security Market Line (SML), which is a straight line joining risk free asset, which has a beta coefficient of zero, and the market portfolio, which has a beta coefficient of one. "Hedging costs money. The main benefit of hedging activity is to reduce the risk of the portfolio. This benefit must be compared to the hedging cost. If the marginal benefit of reducing the risk with an individual transaction is less than its marginal cost, it is not worthwhile to hedge that risk" (Hedging Swaps). The cash flows play an important role in hedging and stock markets. It means there should be an appropriate relation between the cash flows and the market rates. Therefore, as far as the situation of Cash tell plc is considered, it is necessary to take a crucial decision regarding the best suitable method of hedging that will generate the potential future cash flow of '12 million, as result of its competitive bid on a contract, if the company wins such contract of bid. The term risk with reference to investment decision may be the variability in the actual return from a project in future over its working life in relation to the estimated returns as forecasted at the time of initial capital budgeting decisions. But the concept of risk is differentiated with uncertainty. Risk is a situation, where the possibility of happening or non happening an event can be quantified and measured, while uncertainty is defined as a situation where this possibility cannot be measured. However, return is the motivating force and the principal reward to the investment process. Mostly, the return may be of realized return and expected return. In the case of a firm, the return from an investment is the expected cash inflows. The return may be measured as the total gain or loss to the firm over a given period of item and may be measured as the total gain or loss to the firm over a given period of item. It may be defined as percentage return on the initial amount invested. The main objective of financial management is to maximize the wealth of shareholders as reflected in the market price of the share, which depends on the risk-return characteristics of the financial decisions taken by the firm. It is also necessary to emphasis the risk and return as the two important determinants of the value of a share. So, a finance manager as well as any investor, in general, has to consider the risk and return of each and every financial decision. Therefore, in this particular case, Cash tell plc is in a position to receive an inflow of '12 million as the winning price of the bid of contact. Projected Cash Flow Statement of Cash tell Plc for 12 months. Months 1 2 3 4 5 6 7 8 9 10 11 12 Sales '0 49 171,5 269,5 294 294 294 294 490 637 833 980 Cash Receipts '0 24,5 122,5 245 294 294 294 294 392 588 784 882 Disbursements '80 190 181,5 241 255 267 271 295 453,5 542,5 630 736,5 Opening Balance 0' 80 245 304 300 261 234 211 212 273,5 228 74 Closing Balance 80' 245 304 300 261 234 211 212 273,5 228 74 71,5 (Assume all figures are estimated.) Conclusion In this particular situation, it is necessary to consider the economic and market situations in the economy while planning the finance and other requirements in order to make appropriate dividend decision. As a finance manager, it is essential to give a thorough analysis of almost all areas of business, in order to conclude the applicability of which is beneficial or which is not. Finance manager stresses the judgment making of profitability, solvency, liquidity, and growth aspects of the firm. Bibliography Hedging. What is hedging' Why do companies hedge' [online]. The Financial pipe line. Last accessed 5 December 2007 at: http://www.finpipe.com/hedge.htm Hedging Swaps. Why will the dealer only partially hedge the swaps portfolio' [online]. The financial pipe line. Last accessed 5 December 2007 at: http://www.finpipe.com/hedgeswaps.htm LOPEZ, Jesus Rodriguez & MENDIZABEL, Hugo Rodriguez (2007). Review of international economics. The optimal degree of exchange rate flexibility: A target zone approach. Abstract. [online]. Black well synergy. Last accessed 5 December 2007 at: http://www.blackwellsynergy.com/doi/abs/10.1111/j.14679396.2007.00698.x'journalCode=roie SOENON, L.A (2006). Efficient market implications for foreign exchange exposure management. Summary. [online]. Spingerlink. Last accessed 5 December 2007 at: http://www.springerlink.com/content/rh477t2w46834931/ Read More