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CA-IPCC-FM-SHORT NOTES Contact No. 9133430222, 9133530222, Page | 1

1. TIME VALUE OF MONEY

1. Future Value: PV x (1+r)n

(or)

PV x FVF (r, n)

2. Present Value: FV X1

(1+r)n

(or)

FV x PVF (r, n)

3. Future Value of Annuity = Periodic Payment x FVAF (r, n)

(or)

PP x (1+r)

n-1

r

4. Future Value of Annuity due (payment made at the beginning of each period)

PP x FVAF (r, n) + (i+r)

(or)

PP x [(1+r)

n-1

r] X (i+r)

5. PV of Annuity = PP x PVAF (r, n)

(or)

PP x [1-(1+r)

-n

r]

Where r = Interest Rate per period

n = no. of periods.

Period may be one month, quarter, half year or one year.

6. PV of perpetuity = Cash Inflows (c)

r

C = Cash inflows per period

r = Interest Rate per period

Discount Rate

(or) Investors expected rate of return

7. PV of growing per petuity = C

r−g

Where C = Cash inflows per period

r = Interest rate per period

(or)

g = Growth rate

8. Effective Rate of Interest = [1+r

m]m

-1

Where r= Interest Rate per annum

m = No of times compounding in a year.


2. CAPITAL BUDGETING

How to define cash flows

Step1: Calculation of initial cash out flows

Investment in fixed assets = xxx

Investment in working capital = xxx

xxx

Note1: Sunk Cost i.e. already incurred costs must be ignored in cash out flows

e.g.: Cost of own land research cost already incurred etc.

Step2: Calculation of Depreciation

Depreciation = SLM / WDV

Step3: Calculation of operating cash in flows

Particulars Amount (Rs.) year (i-n)

A) Sales XXX

B) Total Cost

Variable Cost XXX

Fixed Cost XXX

(Other than Depreciation) XXX

XXX

PBDT A –B XXX

(-) Depreciation XXX

PBT XXX

(-) tax XXX

PAT XXX

(+) Depreciation XXX

CFAT/ Operating Cash in flows

Note:

1. Total Cost = Variable Cost + Fixed cost

2. Total Cost = COGS + Admin expenses + Selling and dist. expenses

3. Total Cost can be given in any form

4. Total Cost = COGS + Fixed Cost + Admin Exp +Advertisement expenses

5. Allocation (or) Apportionment of factory admin, corporate overheads must be ignored in total cost

computation.

6. Opportunity Cost must be deducted while calculating CFAT

Opportunity Cost

Before tax opportunity Cost

After tax opportunity Cost

It must be deducted from sales

(or) gross revenue before

It must be deducted from CFAT

directly i.e. after-tax deduction


deducting tax i.e. before tax

deduction

7. If there is no tax then PBDT can be considered as CFAT.

8. Sometimes fixed cost will be loaded with depreciation we have to identify it and separate it carefully.

9. Identify all the revenue expenses in the problem like operating cost variable cost, fixed cost, COGS,

Advert expenditure, admin expenditure etc., and carefully deduct all such expenses while calculating

PDBT.

10. The profit terms can be given in any form

• Profit after tax = PAT

• Profit before tax = PBT

• Profit after tax and depreciation = PAT

• Profit after tax but before depreciation = CFAT

• Profit after depreciation = PBT

• Cash flows after tax = CFAT

• Cash flows before tax = PBDT

(or)

Before tax cash flows

Step4: Calculation of terminal cash flow

A) Gross Sale Proceeds XXX

(-) Book Value XXX

Capital gain/ capital loss XXX

B) Capital gain tax / Tax shield XXX

Net Sale proceeds XXX

(A) – (B), (A) +(B)

(+) Realisation of WC XXX

Capital Budgeting Techniques

Non-Discounting Techniques Discounting Techniques

➢ ARR NPV

➢ Payback period Profitability Index

IRR

Discounted Payback period

Modified NPV

Modified IRR

ARR: Average Rate of Return

Annual Rate of Return

Accounting Rate of Return


ARR = Average PAT

Average Investement

Average Investment = 1

2 [Initial Investment - Salvage Value] + Salvage Value + Additional Working Capital

Average Investment = 1

2 [Initial of Investment - Salvage Value] + Salvage Value + Additional Working

Capital

Initial Investment Basis:

ARR = Average PAT

Initial Investement

Average PAT = Total PAT

No.of years

Payback Period:

1. If the cash flows are equal

Payback Period = Initial Investement

Annual Cash in flows

2. If the Cash flows are unequal

Payback Period = on proportionate basis

Illustration:

Initial Investment = Rs.10,00,000

Life of the project = 5 years

Year 1 2 3 4 5

Cash flows 2,00,000 3,00,000 4,00,000 2,00,000 2,00,000

Solution:

Year EFAT Cumulative CFAT

1 2,00,000 2,00,000

2 3,00,000 5,00,000

3 4,00,000 9,00,000

4 2,00,000 11,00,000

5 2,00,000 13,00,000

Investment Covered by the end of year 3 = Rs. 9,00,000

Balance of Investment to be Covered = 10,00,000 – 9,00,000 =Rs. 1,00,000

1. Year - 2,00,000

2. Year - 1,00,000

Payback Period = 3 year + 1,00,000 x 1

2,00,000 = 3.5 years.

Net Present Value (NPV):

Step1: Calculation of PV of Cash out flows

Investment in fixed assets = xxx

Investment in working capital = xxx


Step2: Calculation of PV of Operating Cash in flows

Particulars Year (1-n)

A) CFAT pa XXX

B) PVF (r, n) XXX

PV of Operating Cash in flows XXX

(A x B)

Step3: Calculation of PV of Terminal Cash in flows

NSP of the fixed asset XXX

(+) Realisation of WC XXX

A) TCF XXX

B) PVF(r,n) XXX

PV of terminal cash inflow (A X B) XXX

NPV: PV of Operation Cash Inflows XXX

(+) PV of Terminal Cash in Flow XXX

(-) PV of Cash out flows XXX

NPV XXX

Profitability Index (or) Present value Index (or) Benefit Cost Ratio

Profitability Index = PV of Operating Cash inflows + PV of Terminal cash inflow

PV of cash out flows

PV of cash out flows

Relevant Discount Rate:

For NPV - Cost of Capital

For Profitability index = Cost of Capital

Internal Rate of Return (IRR)

IRR is the discount Rate at which

PV of Cash Inflows = PV of Cash out flows

PV of Cash Inflows - PV of Cash out flows = 0

NPV =0.

If the Cash flows are equal (No Terminal Cash flow)

Setp1: IRR is the discount Rate at which PV of Cash inflows = PV of Cash out flows

Cash Inflows x PVAF (r,n) =Cash Out Flow

Cash Inflow = xxx

Trace the PVAF (r,n) in PVAF table and Identify IRR. If it lies in between two discount rate then we can

use Interpolation.

Using Interpolation:

IRR = L1 + NPV at L1

NPV at L1−NPV at L1 (L2 − L1)

L1 = Lowest guess Rate L2= Highest of less rate


If the Cash flows are unequal:

Trail & Error Method:

Step1: Calculate NPV at 10%

Step2: If Step1: is positive then we will use 20%.

Step3: If Step2: is positive then we will use 30% if Step3: NPV is –ve then we will use Interpolation

between 20% & 30%.

IRR = 20% +NPV at 20%

NPV at 20% −NPVat30% x (30-20)

Discounted Payback Period:

Same as payback period but the only differentiation is investment will be recovered from PV of Cash inflows

Year PV of Cash Inflows Cumulative PV of Cash Inflows

1 xxx xxx

2 xxx xxx

3 xxx xxx

4 xxx xxx

5 xxx xxx

Discounted Payback Period will be calculated proportionately

Relevant Discount Rate: Cost of Capital

Modified NPV:

Step1: Covert all the cash inflows into project ending period by using re investment rate.

Step2: The aggregate of all the converted cash flows is terminal cash inflow.

Step3: Modified NPV

PV of Terminal Cash inflow = xxx

(Discounted at Cost of Capital)

(-) PV of Cash out flows = xxx

Modified NPV = xxx

Year Cash Inflows Calculation

1 xxx xxx (1 + 𝑟)2 = xxx

2 xxx xxx (1 + 𝑟)1 = xxx

3 xxx xxx (1 + 𝑟)𝑞 = xxx

Terminal Cash Inflow = xxx

Where r = Re Investment Rate

Annualised NPV

Annualised NPV = NPV

PVAF (r,n)

r = Cost of Capital

n = life of the project.

Equivalent Annualised Cost

(or)

Equated Annual Cost


Equated Annual Cost = PV of Cash out flows

PVAF (r, n)

Note1: No Operating Cash Inflows will be given in the problem.

Note2: Cost of the machine, Running and operating expenses will be given in the problem salvage value

will be given in the problem.

Calculation of PV of net Cash out flows:

year Cash flows PVF PV of Cash flows

0 Cash of the machine 1 Cash flow

1-n Running expenses xxx xxx

n Salvage Value xxx xxx

Calculation of PV of net cash out flows

year Particulars Cash flows PVF PV of Cash flows

0 Cash of the machine xxx xxx xxx

1-n Running expenses xxx xxx xxx

n Salvage Value xxx xxx xxx

PV of net Cash out flows = xxx

Relevant Discount Rate: Cost of Capital

Modified IRR:

Step1: Convert all the Cash Inflows into terminal year by using Cost of Capital

year Cash flows Re-investment

period

calculation

1 xxx 2 xxx (1 + 𝑟)2 = xxx

2 xxx 1 xxx (1 + 𝑟)1 = xxx

3 xxx 0 xxx (1 + 𝑟)0 = xxx

Terminal Value = xxx

Step2: Modified IRR is the discount rate at which PV of terminal value = PV of Cash out flows

TV X PVF (r, n) = PV of Cash out flows

PVF (r, n) = Cash out flows

Termila Value

= xxx

Trace this PVF (r, n) in PVF table and identify the modified IRR.


3. COST OF CAPITAL

1. Cost of Debentures

2. Cost of PSC

3. Cost of Equity

4. WACC(K)

Debentures

Irredeemable debentures Redeemable Debentures

Redemption in lump sum

Irredeemable Debentures:

In Case of fresh Issue

Cost of Debentures (Kd) = I (1-T)

NP

In Case of existing Debentures:

Cost of Debentures (Kd) = I (1-T)

MP

Where I = Interest, MP = Market Price of debentures

t= tax rate

NP

Face Value =xxx

(+) (-) Premium/ discount =xxx

Issue Price =xxx

(-) Issue expenses

Flotation Cost = xxx

Underwriters

Commission = xxx

Brokerage = xxx

Net Proceeds = xxx

Note:

1. If there is no information regarding market price of debentures we assume that MP = face value

2. Generally, the market price of the debenture will be near to the face value of debenture.

E.g.: If MP of debenture is Rs.90 (or) Rs.110 then the face value must be Rs. 1000 if MP of debenture

is Rs.12 or Rs.8 then the face value must be equal to Rs.10.

3. Interest must be calculated on face value of debentures.

4. Sometimes Issue expenses can be expensed as a % of face value or Issue price. Then Issue expenses

must be calculated as per the instruction given in the problem.

5. If the problem is not specific about issue expenses then the % of Issue expenses will be applied on

face value or Issue price whichever is higher.

6. If there is no information regarding market price (or) Net proceeds in the problem then the cost of

debentures can be calculated by using the following formula.


Cost of debentures (kd) = I (1-t)

Where I = Interest Rate (or) company Rate

T = Tax Rate.

The above formula is applicable only for irredeemable debentures .It only for Irredeemable Debentures.

It should not be applied to cost of redeemable debentures.

Redeemable Debentures:


Cost of Debentures (Kd) = I (1-t) + RV−NP

N

RV+NP

2

In Case of Existing Debentures:

Cost of Debentures (Kd)= I (1-t) + RV−MP

N

RV+MP

2

Where RV = Redemption value

N = Life of Debentures.

Note:

1. If there is no information regarding ‘RV’ then redemption value must be face value (i.e. Redemption at

par).

2. If there is no information regarding face value it can be considered as Rs.100. But if the market price

is given then the face value will be near to the market price must be considered.

Cost of PSC:

Irredeemable PSC

In case of fresh Issue

Cost of PSC (Kp) = PD

NP

In case of existing PSC

Cost of PSC (Kp) = PD

MP

Where PD = Preference Dividend

NP = Net Proceeds

MP Market Price Preference Shares.

Note 1: If there is no information regarding NP (or) MP then Kp Can be considered as follows.

Cost PSC Kp = Preference Dividend Rate.

Redeemable PSC:

• In Case of fresh issue

Cost of PSC (Kp) = PD+ RV−NP

N

RV+NP

2

• In Case of Existing PSC

Cost of PSC (Kp) = PD+ RV−MP

N

RV+MP

2


RV = Redemption Value of PSC

N = Life of PSC

Cost of Equity (Ke)

1. Dividend

Price Approach:


Cost of Equity (Ke) = DPS1

Np

DPS1 = Expected Dividend per Share

NP = Net Proceeds

MPO = Current Market Price of Equity Shares.

2. Earnings

Price Approach:


Cost of Equity (Ke) = EPS1

NP

In Case of Existing Instrument


MPO

EPS1 = Expected Earnings per share

3. Dividend

Price + Growth Approach.

In case of fresh Issue


NP+ g

In Cash of Existing Instrument


MPO+ g

Where DPS1 = Expected DPS at the end of year -1

= DPSO [1+g]

g = Growth Rate

MPo = Current Market Price of the Debentures

Dividend Just Paid

Dividend Just payable DPSo

Last year dividend paid

Expected DPS at the end of current year

Expected DPS at the end of next year DPS1

4. Earnings

Price + g Approach



NP +g

In case of Existing Instrument


MPO +g

5. Realised yield Approach

Cost of Equity (Ke) = IRR Technique will be used


6. Capital Asset Pricing Model (CAPM)

Cost of Equity (Ke) = Rf + β (Km − Rf)

Where Rf = Risk free Rate of return

Rm = Return on market portfolio

β = Systematic Risk

Rm = Average Market Return

Rm−Rf = Market Risk Premium (or) Average Market Risk Premium.

Note1: Rf = Interest Rate on Treasury bills (or) GOI bonds (or) RBI bonds.

Cost of Reserves: If opportunity Cost of Capital is not given

Cost of Reserves Kr = Cost of Existing Equity Ke

If opportunity Cost of Capital of Equity Share holder is given

Cost of Reserves Kr = (1 − tp) – Brokerage Rate.

Where tp Personal Tax Rate.

Weighted Average Cost of Capital (WACC)

Based on Book Value Weights

Based on Market Value Weights

Balance Sheet Figures will be

considered while calculating weights

Market Values will be Considered while

Calculating weights

Reserves and Surplus will be

considered as one of the source

Reserves & Surplus will be ignored

while calculating Market Value weights

Calculation of WACC:

Sources Amount (Rs.) Proportion C/C Prop x C/C

Equity (1) xxx (1)

(T) XX

xx xx

PSC (2) xxx (2)

(T) XX

xx xx

Debt (3) xxx

(T) xxx

(3)

(T) XX

xx xx

Market Value Weights:

MV of Equity = No. of Equity Shares X MPS

MV of PSC = No. of Preference Shares X Market Price per Preference Share.

MV of Debentures = No. of Debentures Market Price Per Debentures.


4. CAPITAL STRUCTURE

For all the Alternative Capital Structures EBIT is same.

P/E Ratio = MPS

EPS

MPS = EPS x P/E Ratio

Calculation of MPS at different alternative Capital Structures.

Particulars Alternative

I II III

EBIT xxx xxx xxx

(-) Interest xxx xxx xxx

EBT xxx xxx xxx

(-) Tax xxx xxx xxx

EAT xxx xxx xxx

(-) Preference dividend xxx xxx xxx

(A) EAESH xxx xxx xxx

(B) No. of Equity Shares xxx xxx xxx

(C) EPS A/B xxx xxx xxx

(D) P/E Ratio MPS / EPS xxx xxx xxx

EBIT Indifference Point/ EPS Equivalency Point

It is the level of EBIT at which EPS of alt –I = EPS of alt –II

(EBIT-Interest)(1-t)-PD

No. of Equity Shares =

(EBIT−Interest)(1−t)−PD

No.of Equity Shares

Note:

1. EBIT is a variable term in the above formula and we have to find out EBIT

2. Remaining all the terms will be given in the problem

3. EBIT =?

Financial BEP:

It is the level of EBIT at which EASH = 0

Financial BEP i.e., EBIT = Interest + Preference Dividend

(1-t)

Where t = Tax Rate

Capital Structure Theories:

1. Net Income Approach:

Step 1: EBIT = xxx

(-) Interest = xxx

EAESH = xxx

Step 2: Calculation of Value of Equity and Value of the firm

Particulars Amount Rs.

Value of Equity = EAESH

Ke

xxx

(+) Value of debt xxx


Value of the firm xxx

Step 3: Calculation of Overall Cost of Capital Ko

Overall Cost of Capital Ko = EBIT

Value of the firm

2. Net Operating Income Approach (NOT Approach):

Step1: Calculation of Value of the firm and value of Equity.

Value of the firm = EBIT

Ko = xxx

(-) Value of debt = xxx

Value of Equity = xxx

Step2: Calculation of Value of the firm and value of Equity.

EBIT = xxx

(-) Interest = xxx

EAESH = xxx

Step3: Calculation of Cost of Equity

Cost of Equity (Ke) EAESH

Value of Equity

3. Traditional Approach:

Valuation same as in NI Approach.

4. Modigliani & Miller Approach (Without Taxes):

Proposition I:

Value of levered firm = Value of unlevered firm = EBIT

Ko

Where Ko = Ke of 100% Equity (At Equilibrium Level)

Proposition II:

Cost of Equity (Ke) of levered firm = EAESH

Value of Equity

Value of Equity of levered firm = Value of levered firm – Value of debt

(or)

Ke of levered firm = Ko of unlevered. Firm + (Ko of unlevered firm - Kd)Debt

Equity

5. Modigliani & Miller Approach (With Taxes):

Proposition I:

Value of Unlevered firm = EBIT (1+T)

Ko = Ko of Unlevered firm.

Value of levered firm = Value of Unlevered firm + debt x tax rate

Proposition II:

Ke of levered firm = EAESH

Value of Equity

Value of equity of levered firm = Value of levered firm – Value of debt


Ke of levered firm = Ko of levered firm + (Ko of unlevered firm - Kd) Debt

Equity [1-t]

Ke of levered firm = Ko + (Ko − Kd =Debt

Equity (1-t)

Ko of levered firm = EBIT (1-t)

Value of levered firm

5. LEVERAGES

1. Degree of operating Leverage (DOL) = % Change in EBIT

% Change in Sales

(or)

Contuibution

EBIT

2. Degree of Financial Leverage (DFL) = % Change in EPS

% Change in EBIT

EBIT

EBT-PD1-t

It there is no PSC then DFL = EBIT

EBT

3. Degree of Combined Leverage (DCL) = % Change in EPS

% Change in Sales

(or)

Contuibution

EBT −PD

1 − t

If there is no PSC

DCL = Contribution

EBT

DOL of 2 means for every 1% change in sales EBIT change by 2%

DFL of 1.5 means for every 1% change in EBIT, EPS changes by 1.5%.

DCL of 3 means for every 1% change in sales, EPS changes by 3%

6. WORKING CAPITAL MANAGEMENT

Estimation of Working Capital Requirement particulars:

Particulars Amount (Rs.)

(A) Current Assets xxx

Investment in stock of RM xxx

= Raw Material Consumption units

X RMHP

365 / RM / 52W X RM Cost per


Invest in Stock of WIP:

* Raw Material = xxx

Production units x WIPHP

365/ 12M / 52W x RM Cost per unit

* Labour = xxx


365 / 12M / 52W x Labour Cost Per unit

* Overheads xxx


365 / 12M / 52W x OH Cost per unit / FOH Cost per unit

Invest in stock of FG

Sales units x FGHP

365 / 12M/ 52W x Total Cost per unit

(or)

Outstanding overheads xxx

Production units x Time leverage in OH

365 / 12M / 52W x OH Cost per unit

Provision for tax xxx

xxx

Net Working Capital (A) – (B)

Note:

1. It is advice table to value the debtors always at total cost of sale if there is no information in the

problem in this regard.

2. Depreciation must be excluded while preparing cost statement.

3. COGS/ Cost of production = Sales – Gross Profit.

4. If there is no information about opening and costing closing inventory.

Cost of production = Cost of goods sold

Gross Works Cost = Cost of production.

5. Cost Statement

Raw Material Consumption

Particulars Amount

Opening Stock of RM xxx

(+) Purchases xxx

(-) Closing Stock of RM Xxx

xxx

Direct labour xxx

Factory overhead xxx

Gross works Cost xxx

(+) Opening Work – in – progress xxx

xxx

(-) Closing WIP xxx


Cost of production xxx

(+) Opening Stock of finished goods xxx

(-) Closing Stock of finished goods xxx

Cost of goods Sold xxx

(+) Administration Expenses xxx

(+) Selling & Distribution Expenses xxx

Cost of Sales xxx

6. Stock of finished goods must be value at cost of production.

7. Debtors must be valued at total cost of sales.

8. While Calculating Debtors we should consider credit sales but not total sales.

9. RMHP = Raw Material Holding Period

10. WIPHP = Work – In – Progress Holding Period

FGHP = Finished goods holding period

DCP = Debtors Collection period

CPP = Creditors Payment Period

Calculation of net operating cycle period

Particulars Period (in days)

RMHP = Average stock of RM

Total RM Consumption for the year x 365

xxx

WIPH = Average stock of WIP

Total Cost of production x 365

xxx

FGHP = Average stock of FG

Total Cost of goods Sold x 365

xxx

Debtors Collection Period = Average Debtors

Total Credit Sales x 365

xxx

Gross operating cycle period Xxx

(-) Creditors payment period =Average Creditors

Total Credit Purchases x 365

Xxx

Net operating cycle period xxx

Notes:

1. No of operating cycles = 365 days

Net operating cycle period

2. Net working capital = Cost of Sales (or) Total Operating Cost

No. of operating cycle

3. If there is no. information regarding no of days in a year, then we a leverage assume that 1 year = 365

days

4. Operating cycle is also known as working capital cycle or cash to cash cycle.

Debtors Management

Evaluation of Alternative credit policies

Particulars Policy Option –I (existing) Policy Option –II

(A) Credit Sales xxx xxx


(B) Total Cost Other

than bad debts & Cash discount

Variable Cost xxx xxx

Fixed Cost xxx xxx

xxx xxx

Profit before adjustment of bad debts

& cash discount

(A) – (B) xxx xxx

(-) Bad debts xxx xxx

Cash discount xxx xxx

PBT xxx xxx

(-) tax xxx xxx

PAT xxx xxx

PAT xxx xxx

(-) Opportunity Cost of Invest in

Deters xxx xxx

Net Benefit xxx xxx

Incremental Net

Benefits II –I - xxx

Note:

INVETSTMENT IN DEBTORS

Sales Value basis

Total Cost Basis Variable Cost Basis

Credit Sales x DCP

365 Total Cost x

DCP

365 Variable Cost x

DCP

365

Sales Value Basis:

Opportunity Cost of Investment in Debtors = Credit Sales x DCP

365 x Required Rate of Return

Total Cost Basis:

Opportunity Cost of invest in debtors = Total cost of sales x DCP

365 x Required Rate of Return

Variable Cost Basis:

Opportunity Cost of Invest in Debtors = Variable cost x DCP

365 x Required Rate of Return.

1. It is always advisable to value the debtors at total cost (or) variable cost if there is no information in the

problem.

2. If the before tax required rate of return is given in the problem it should be converted to after tax required

rate of return.


Factoring:

Evaluation of factoring agreement:

a) Benefit:

Savings in bad debts XXX

Savings in admin expenses XXX

Savings in opportunity cost XXX

XXX

b) Costs:

Factors commission XXX

Interest in advance XXX

XXX

Net benefit a) – b) XXX

Effective cost of factoring = net cost of factoring

net advance amount receivable

Calculation of net cost of factoring:

a) Cost

Factors commission XXX

Interest in advance XXX

XXX

b) Benefits:

Savings in bad debts XXX

Savings in admin cost XXX

Savings in opportunity cost XXX

Net cost of factoring a) – b) XXX

Net advance amount:

Amount of debtors = credit sales × debtors collection period

365

Debtors XXX

Factor

Client Company

Customer


(-) factors reserve XXX

Debtors X reserve %

XXX

(-) factors commission (Debtors X commission %) XXX

A) Advance before deducting interest XXX

(-) interest on advance XXX

(A) Interest rate pa X DCP / 365 365

Net advance amount receivable XXX

Note 1: while calculating net cost of factoring all the costs and benefits must be converted to one year.

Cash management

Cash budget:

Particulars Jan Feb March

A) Opening balance XXX XXX XXX

B) Receipts

Cash sales XXX XXX XXX

Collection from debtors XXX XXX XXX

Sales of fixed assets / investment XXX XXX XXX

Interest received / dividend received XXX XXX XXX

XXX XXX XXX

C) Payments:

Particulars Jan Feb March

Payment of purchase XXX XXX XXX

Wages XXX XXX XXX

Over heads XXX XXX XXX

Instalments XXX XXX XXX

Interest payment XXX XXX XXX

Repayment of loan XXX XXX XXX

Payment of tax XXX XXX XXX

XXX XXX XXX

Closing balance (A) + (B) – (C) XXX XXX XXX

Optimum cash balance models

Baumol’s model Miller orr model

Or Or

Inventory model stochastic model


Baumol’s model:

Optimum lot size or cash balance = √2fT

r

Where f = annual cash disbursement or cash out flow

T = Cost per transaction

r = Opportunity cost of capital or interest rate per amount.

No. of transaction = annual cash disbursement

lot size

Total transaction cost = No. of transaction X cost per transaction.

Average cash balance = lot size

2

Opportunity cost = Average cash balance X Interest rate p.a.

Miller orr model:

H

2Z

R

Z L

Lower level = L

R = Return level

= L + Z

H = Upper level

= L + Z + 2Z

= L + 3Z

Average cash balance = L + R + H

3

Spread between lower level and higher level = 3Z

Spread between return level and lower level = Z

Spread between return level and higher level = 2Z.

Note:

1. If the cash balance touches lower level we should sell ‘Z’ worth of securities in order to touch higher

level

2. If the cash balance touches the higher level we should buy ‘2Z’ worth of securities of securities to touch

return level.

Ca

sh

bala

nce

Time


Z = √3TV

4i

3

Where, T = cost per transaction

V = Variance of duty cash flows

I = Interest rate per day.

Variance = (Standard deviation)2

Cost of non-avoiding cash discount = d

1-d ×

365

n-p × 100

Where d = discount

N = normal credit period

P = discount period

2

10 net 30 means 2% cash discount if payment is made with in 10 days normal credit period is 30 days.

RATIO ANALYSIS

A) Liquidity ratios:

1) Current ratio = current assets

current liabilities

2) Quick ratio = quick assets

current liabilities

Quick assets = CA – stock – prepaid expenses

3) Absolute cash ratio / super quick ratio / cash reservoir ratio.

Absolute cash ratio = cash + Bank + marketable securities

current liabilities

4) Defensive interval ratio / interval measure ratio:

Defensive interval ratio = liquid assets

project daily cash expenses

B) Capital structure ratios / solvency ratios:

➢ Capital employed / Long term fund = ESC + reserves & surplus + PSC + Long term Debt –

miscellaneous expenditure not W / off

Or

Fixed assets + current assets – current liabilities.

➢ Equity / proprietors fund / shareholders fund = ESC + Reserves & surplus + PSC – miscellaneous

expenditure not W / off.

Or

FA + CA – CL – LTD

➢ Equity shareholders fund = ESC + Reserves & surplus – miscellaneous expenditure not W / off.

Or


FA + CA – CL – LTD – PSC

➢ Debt ratio = debt

capital employed

➢ Equity ratio = equity

capital employed

➢ Debt equity ratio:

Are two types –

1) Debt -equity ratio = long term debt

equity

2) Debt -equity ratio = total debt

equity

Total debt = LTD + CL

Capital gearing ratio = LTD + PSC

ESC + reserves & surplus - miscellaneous expenditure

Debt to total assets ratio = total debt

total assets

Proprietary ratio / Shareholders equity ratio = shareholders fund / proprietors fund

total assets

Fixed assets to capital employed ratio = fixed assets

capital employed

Working capital to capital employed ratio = working capital

capital employed

Coverage ratios:

• Interest coverage ratio = EBIT

interest

• Preference dividend coverage ratio = EAT

preference dividend

• Equity dividend coverage ratio = EAESH

equity dividend

5. Debt Service Coverage Ratio = Earning avilabe for debt service

Interest+Instalment

Earnings available for debt service = PAT + Interest + Noncash Expenses + Non-operating losses

e.g.: Non-Cash Expenses

Depreciation, write off of preliminary expenses, good will etc.

Non- operating losses

Loss on sale of fixed assets and investments.

Fixed charges converge ratio = EBIT+Depreation

Interest+Repayment of loan / 1−t


Activity Rations:

Capital turnover Ratio = Net Sales

Capital Employed / Net assets

Net Assets = FA + CA –CL = Capital employed

In the absence of sales we can also use COGS for calculating capital turnover Ratio

Fixed assets turnover ratio = Net Sales

Fixed Assets

Total Assets turnover ratio = Net Sales

Total Assets

Total Assets = FA + CA

Current Assets turnover ratio = Sale

Current Assets

• Working Capital turnover ratio = Not Sales

Working Capital

• Stock turnover Ratio = COGS

Average stock

• Stock velocity = 365 days / 12 months / 52 weeks

Stock turnover Ratio

• Debtors turnover Ratio = Credit Sales

Average Debtors

• Debtors velocity = 365 days / 12 months / 52 weeks

Debtors turnover Ratio

• Creditors turnover ratio = Credit Purchases

Average creditors

• Creditors value city = 365 days / 12 months / 52 weeks

Creditors turnover Ratio

Profitability Ratios:

A. Based on Sales:

i) Gross profit Ratio = Gross Profit

Sales

ii) Net profit Ratio = Net Profit (or)PAT

Sales

(or)

Net Profit Ratio = EBIT (1-t)

Sales

iii) Operating profit ratio = Operating Profit

Sales

(or) EBIT

Sales


Operating Profit (From P & L A/c) = Sales –COGS – Admin & Selling & distribution expenses –

depreciation..

B. Expenses ratios:

i) COGS ratio = COGS

Sales

ii) Operating expenses ratio = administrative expenses + selling & distribution overheads

Sales

iii) Operating ratio = COGS + operating expenses

Sales

iv) Financial expenses ratio = financial expenses

Sales

C. Profitability ratios related to overall return on assets / investment:

• Return on capital employed [Pre-tax] = EBIT

average capital employed

×100

• Return on capital employed [Post tax] = EBIT [1-t]

average capital employed

• Capital employed = FA + CA – CL

• Return on assets (ROA) = PAT

Average total assets or

EBIT [1-t]

average total assets

Note 1: Most of the cases in problems the first formula will be used.

• Return on equity [From ESH point of view] = EAESH

Equity shareholders fund

EAESH = PAT – preference dividend.

• Return on equity (from shareholders point of view) = PAT

shareholders fund

Based on market / valuation / investors:

➢ Price earnings ratio = MPS

EPS

➢ EPS = EAESH

no. of equity shares

➢ DPS = total dividend paid to equity shareholders

no. of equity shares out-standing

➢ Dividend pay-out ratio = DPS

EPS

➢ Dividend yield = DPS

MPS

➢ Earning yield = EPS

MPS


➢ Market value to book value ratio = market value per share

book value per share

➢ Book value per share = ESC + reserves & surplus - miscellaneous expenditure not w/off

no. of equity shares

Q – ratio = market value of equity & liability

estimated replacement cost of the assets

➢ The formulae with star mark are much important to solve all the problems.

Date post:	30-Apr-2020
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