FINANCIAL MANAGEMENT INTERNATIONAL FINANCE

Overview of Financial Management Finance and Related Disciplines Scope of Financial Management, Planning environment Key decisions of Financial Management Emerging role of finance ma

FINANCIAL MANAGEMENT

&

INTERNATIONAL FINANCE

THE INSTITUTE OF COST AND WORKS ACCOUNTANTS OF INDIA

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FINAL GROUP - III PAPER - 12 STUDY NOTES

First Edition : May 2008

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Paper 12: Financial Management & International Finance

(One Paper: 3 hours:100 marks)OBJECTIVES

Understand the scope, goals and objectives of Financial Management To provide expert edge on concepts, methods and procedures involved in using Financial Management for mana-gerial decision-making

knowl-Learning Aims

 Understand and apply theories of financial management

 Identify the options available in financial decisions and using appropriate tools for tegic financial management

stra- Identify and evaluate key success factors in the financial management for organisation

 Critically assess the proposed strategies

Skill set required

Level C: Requiring all six skill levels - knowledge, comprehension, application, analysis,synthesis, and evaluation

CONTENTS

10 International Monetary and Financial System 5%

1 Overview of Financial Management

 Finance and Related Disciplines

 Scope of Financial Management,

 Planning environment

 Key decisions of Financial Management

 Emerging role of finance managers in India

 Earnings distributions policy

 Compliance of regulatory requirements in formulation of financial strategies

 Sources of finance – long term, short term and international

 Exchange rate – risk agencies involved and procedures followed in international financialoperations

2 Financial Management Decisions

 Capital structure theories and planning

 Dividend and retention policies

 Criteria for selecting sources of finance, including finance for international investments

 Effect of financing decisions on Balance Sheet and Ratios

 Financial management in public sector

 Role of Treasury function in terms of setting corporate objectives, funds management –national and international

 Contemporary developments – WTO, GATT, Corporate Governance, TRIPS, TRIMS, SEBIregulations as amended from time to time

3 Financial analysis & planning

 Funds flow and cash flow analysis

 Financial ratio analysis -Ratios in the areas of performance, profitability, financial ability, liquidity, activity, shareholder investment and financing, and their interpretation

adapt- Limitations of ratio analysis

 Effect of short-term debt on the measurement of gearing.

4 Operating and financial leverages

 Analysis of operating and financial leverages

 Concept and nature of leverages operating risk and financial risk and combined leverage

 Operating leverage and Cost volume Profit analysis – Earning Before Interest and Tax(EBIT) and Earning Per Share (EPS), indifference point

5 Financial Strategy

 Financial and Non-Financial objective of different organizations

 Impact on Investment, finance and dividend decisions

 Sources and benefits of international financing

 Alternative Financing strategy in the context of regulatory requirements

 Modeling and forecasting cash flows and financial statements based on expected valuesfor variables – economic and business

 Sensitivity analysis for changes in expected values in the models and forecasts

 Emerging trends in financial reporting

6 Investment Decisions

 Costs, Benefits and Risks analysis for projects

 Linking investment with customer’s requirements

 Designing Capital Structure

 The impact of taxation, potential changes in economic factors and potential

restrictions on remittance on these calculations

 Capital investment real options

 Venture Capital financing

 Hybrid financing / Instruments

7 Project Management

 Project Identification and Formulation

 Identification of Project opportunities

 Project Selection Consideration and Feasibility Studies

 Project appraisal & Cost Benefit analysis

 Source of Project Finance & Foreign Collaboration

8 International Finance

 Minimization of risk,

 Diversification of risk

 Forward and futures,

 Forward rate agreements

 Interest rate swaps

 Caps, floors and collars

 Parity theorems

 FDI

 Money market hedge

 Options

9 Sources of International Finance

 Rising funds in foreign markets and investments in foreign projects

 Forward rate agreements and interest rate guarantees

 Transaction, translation and economic risk, Interest rate parity, purchasing power parityand the Fisher effects

 Foreign Direct Investment

10 International Monetary and Financial System

 Understanding the International Monetary System

 Export and Import Practices

 International Financial Management: Important issues and features, International CapitalMarket

 International Financial Services and Insurance: Important issues and features

FINANCIAL MANAGEMENT AND INTERNATIONAL FINANCE

Contents Study Note - 1 Overview of Financial Management

Section 7 Compliance of Regulatory Requirements in Formulation

Section 8 Sources of Finance- Long Term, Short Term and 28-29

International Section 9 Exchange rate - Risk Agencies Involved and Procedure

followed in International Financial Operations 30Study Note - 2 Financial Management Decisions

Section 9 Effect of Financing Decisions on Balance Sheet and Ratios 84-85

Study Note - 3 Financial Analysis and Planning

Study Note - 4 Capital Budgeting

Study Note - 5 Financial Strategy

Section 2 Financial & Non-Financial Objectives of

Section 5&6 Sensitivity Analysis for changes in expected values in the

Study Note - 6 Investment DecisionsSection 1 Cost, Benefits and Risks Analysis for Projects 169-171 Section 2 Real Options in Capital Investement Decisions 172-176

Study Note - 7 Project Management

Section 4 Project Selection Considerations and Feasibility 207-210 Section 5 Project Appraisal and Cost Benefit Analysis 211-216 Section 6 Source of Project Finance & Foreign Collaboration 217-220

Study Note - 8 International Finance

Section 1 Rising Funds in Foreign Markets And Investment

Section 2 Forward Rate Agreement And Interest Rate Guarantees 260-262

Study Note - 10 International Monetary Fund and Financial SystemSection 1 Understanding International Monetary System 269-280 Section 2 Import and Export Procedures and Practices 281-286 Section 3 International Financial Management:Important

Issues and Features,International Capital Market 287-289 Section 4 International Financial Services and Insurance :

STUDY NOTE - 1

OVERVIEW OF FINANCIAL MANAGEMENT

SECTION- 1

FINANCE AND RELATED DISCIPLINES

• Basic Concepts of Finace and Relatid Desciplines

This Section include

1.1 FINANCE AND RELATED DISCIPLINES

1.1.1 Finance refers to funds required for a business or an activity ‘Finance’ requirements

of an enterprise is not ‘one time’ but recurring The discipline of financial ment as a separate and distinct subject of study has evolved over a period of time.The subject has its origins in Economics However, it has today grown into a special-ized discipline, integrating knowledge from many diverse fields as explained further

manage-in this chapter The head of fmanage-inance, also called Chief Fmanage-inancial Officer (CFO) mustposses adequate skills and exposure in the following areas

1.2 ECONOMICS

1.2.1 The mother discipline relating to human’s economic endeavors is Economics It deals

with various factors of production, the returns available on each of them, costs andrevenues and so on A fundamental knowledge of Economics is essential for the fi-nance manager to understand the macroeconomic environment in which an organiza-tion operates and the micro economic or firm level impact of macro economic environ-ment

1.3 ACCOUNTING

1.3.1 Accounting is the recording of financial transactions of an organization and is based

on several principles, conventions and legal requirement It provides the basic datafor financial analysis It helps the Finance Manager analyse, understand and inter-pret the implications of finance decision on the profitability and viability of the enter-prise on a time frame

1.4 MATHEMATICS AND STATISTICS

1.4.1 Today’s world of finance has become a lot more sophisticated and complex, relying

heavily on mathematical models and therefore, in certain areas of finance such asanalytics or risk modelling, knowledge of mathematics and statistics have become es-sential Financial modeling has become a separate subject by itself

1.5 COSTING

1.5.1 Cost efficiency is a major strategic advantage to a firm, and will greatly contribute

towards its competitiveness, sustainability and profitability A finance manager has

to understand, plan and manage cost, through appropriate tools and techniques cluding budgeting and Activity Based Costing

in-1.6 LAW

1.6.1 A sound knowledge of legal environment, corporate laws, business laws, Import

Ex-port guidelines, international laws, trade and patent laws, commercial contracts, etc.are again important for a finance executive in a globalized business scenario The guide-lines of Securities and Exchange Board of India [SEBI] for raising money from the capi-tal markets are an example Similarly, now many Indian corporates are sourcing frominternational capital markets and get their shares listed in the international exchanges.This calls for sound knowledge of Securities Exchange Commission guidelines, variouslisting requirements of international stock exchanges operating in different countriesetc.,

1.7 TAXATION

1.7.1 A sound knowledge in taxation, both direct and indirect, is expected of a finance

man-ager, as all financial decisions are likely to have tax implications Tax planning is animportant function of a finance manager Some of the major business decisions are based

on the economics of taxation A finance manager should be able to assess the tax efits before committing funds Present value of the tax shield is the yardstick alwaysapplied by a finance manager in investment decisions

ben-1.8 TREASURY MANAGEMENT

1.8.1 Treasury has become an important function and discipline, not only in banks, but in

every organization Every finance manager should be well grounded in treasury erations, which is considered as a profit center It deals with optimal management ofcash flows, judiciously investing surplus cash in the most appropriate investment av-enues, anticipating and meeting emerging cash requirements and maximizing theoverall returns It helps in judicial asset liability management It also includes, wher-ever necessary, managing the price and exchange rate risk through derivative instru-ments In banks, it includes design of new financial products from existing products

op-1.9 BANKING

1.9.1 Banking has completely undergone a change in today’s context The type of financialassistance provided to corpoates has become very customized and innovative Duringthe early and late 80’s, commercial banks mainly used to provide working capital loansbased on certain norms and development financial institutions like ICICI, IDBI, andIFCI used to provide long term loans for project finance But, in today’s context, thesedistinctions no longer exist Moreover, the concept of development financial institu-tions also does not exist any longer The same bank provides both long term and shortterm finance, besides a number of innovative corporate and retail banking products,which enable corporates to choose between them and reduce their cost of borrowings It

is imperative for every finance manager to be up-to date on the changes in services &products offered by banking sector including several foreign players in the field thanks

to Government’s liberalized investment norms in this sector

1.10 INSURANCE

1.10.1 Evaluating and determining the commercial insurance requirements, choice of ucts and insurers, analyzing their applicability to the needs and cost effectiveness, tech-niques, ensuring appropriate and optimum coverage, claims handling, etc fall withinthe ambit of a finance manager’s scope of work & responsibilities

prod-1.11 INTERNATIONAL FINANCE

1.11.1 Capital markets have become globally integrated Indian companies raise equity anddebt funds from international markets, in the form of Global Depository Receipts (GDRs),American Depository Receipts (ADRs) or External Commercial Borrowings (ECBs) and

a number of hybrid instruments like the convertible bonds, participatory notes etc., Access

to international markets, both debt and equity, has enabled Indian companies to lowerthe cost of capital For example, Tata Motors raised debt at less than 1% from the inter-national capital markets recently by issuing convertible bonds Finance managers areexpected to have a thorough knowledge on international sources of finance, mergerimplications with foreign companies, Leveraged Buy Outs(LBOs), acquisitions abroad

and international transfer pricing The implications of exchange rate movements onnew project viability have to be factored in the project cost and projected profitabilityand cash flow estimates This is an essential aspect of finance manager’s knowledge.Similarly, protecting the value of foreign exchange earned, through instruments likederivatives, is essential for a finance manager as the volatility in exchange rate move-ments can erode in no time all the profits earned over a period of time.

1.12 RISK MANAGEMENT

1.12.1 Modern business is fraught with various types of risks and is an integral part of thefinance function Proper identification of risks, installation of appropriate risk controlmeasures, risk transfer mechanisms through hedging, insurance, etc are key responsi-bilities of a finance executive A finance manager has to deal with three types of riskviz., price risk, interest rate risk and exchange rate risk Price risk is all about fluctua-tions in commodity prices going up or coming down, interest rate risk is all aboutinterest rates moving up or down and exchange rate risk means volatility in exchangerates For managing each of these types of risks, appropriate hedging tools have to beused Knowledge of such tools is a pre-requisite for a finance manager Besides theknowledge, the cost of using such tools should not be more than the benefits Also, thetiming of judgement is a crucial aspect in this respect

1.13 INFORMATION TECHNOLOGY

1.13.1 Information technology is the order of the day and is now driving all businesses It is allpervading A finance manager needs to know how to integrate finance and costing withoperations through software packages including ERP The finance manager takes anactive part in assessment of various available options, identifying the right one and inthe implementation of such packages to suit the requirement

1.14 MANAGEMENT

1.14.1 Of course, a finance professional when matures and moves up in the hierarchy of anorganization,, he or she becomes an important executive,, taking a broader view andcaters to a wider range of stakeholders A sound knowledge in general managementprinciples and strategy confers significant advantage and enhances the financeprofessional’s overall performance

1.14.2 Above all, he or she is expected to possess significant skills in people management.Modern management is all about managing talent, motivating people and ability towork as a team and influencing people, both within and outside the organization.1.14.3 Refer to the articles given at the end of the chapter The article titled, “The EssentialSkills”, gives a comprehensive overview of the skills of a Chief Financial Officer (CFO).The role of a CFO, in India and elsewhere, has metamorphed into a more all roundrole

1.15 SOFT SKILLS

1.15.1 Any senior executive in today’s competitive business world is expected to have siderable proficiency in various soft skills The most important of these is communica-tion – both verbal and non-verbal

con-1.15.2 The article titled “You’re On” shows the importance of possessing good presentationskills a CFO is expected have and the type of audience he / she has to handle today

1.16 CASE STUDY

The Essential Skills

To ascend to (and remain in) the CFO’s office, you need much more than financial acumen.Alix Stuart, CFO Magazine, November 1, 2007

No one becomes a CFO without possessing the commensurate finance skills No one thrives

as a CFO, however, without having much more As Scott Simmons, vice president of CristAssociates, a Chicago-based recruiter, puts it: “No company wants just a really good financeperson anymore; they want someone who can go beyond that.”

But exactly what are those other essential skills? What capabilities, talents, and expertiseshould be in a CFO’s toolbox no matter what industry or company he works for or chal-lenges she may face?

To hear CFOs tell it, “toolbox” may be the wrong metaphor: magician’s bag of tricks is morelike it There’s nothing easy about mastering the soft skills they say are essential, and whichseem to boil down to clairvoyance, X-ray vision, and the ability to bend time Ultimately,however, there is a common theme “Once you get past the technical skills, it’s all aboutpeople — communicating with them, developing them, empowering them, and listening tothem,” says Charles H Noski, retired CFO of AT&T and Northrup Grumman “If you dothose things well, it will contribute to your success as an executive, whether you’re a CFO ornot.” Patience, experience, and a solid dose of intuition can help you round out your finan-cial acumen with the following tricks of the trade

Young also takes a merciless approach to his E-mail inbox He glances at it several times aday but doesn’t respond to any messages until the end of the day unless they are clearlyurgent That establishes a very high bar — Young says he leaves about 60 percent of hismessages unopened.

Frank Gatti, CFO of ETS, also relies on a strict E-mail hierarchy “Not all E-mails are of equalimportance,” he says Aside from those sent by his CEO, “investors and bondholders comefirst Respond quickly even if you don’t have all the facts, just to let them know you’ll getback to them when you do.”

Managing Up

Every CFO has to deal with a CEO, and figuring out how to make the boss happy is a skill noaspiring finance chief can be without “The CEO connection is the single most importantthing a CFO must understand and maintain,” says David Johnson, CFO of The HartfordFinancial Services Group While a sound strategy will depend on myriad interpersonal fac-tors, Johnson says he thinks a critical element is candor, which is key to becoming a trustedadviser to the CEO

“You need to know what your CEO’s hot buttons are: what’s important to him, what is hebeing judged against, what’s his value system?” says Tony Panos, a consultant who devel-oped and teaches a class on managing up for one of Cornell University’s extension schools

“Anything you suggest should fit into that You should demonstrate how you are helpinghim meet his goals.”

But what about managing up to a dictatorial CEO? The advice is the same, Panos says, but

he recommends looking a bit deeper for motive “People who are dictatorial tend to havesome level of fear driving them Start by looking at what those fears are and how you canmitigate them.”

The Art of Saying No

CFOs are often labeled as the original “Dr No,” and in fact they may be more likely thanother senior executives to put the kibosh on ill-advised plans or projects But many CFOsagree that a thumbs down, or any form of unwelcome news, can be delivered professionallyand with a little less sting

One way is to “help people feel like they’re coming to a decision together,” says Bright zons Family Solutions CFO Elizabeth Boland, by giving them the facts and the potential risksrather than a final answer Richard Fearon, CFO of Eaton Corp., says that listening canmake all the difference “You just need to hear the idea through so that no one feels short-changed,” he says In a well-managed company, he adds, the CFO won’t have to play theheavy very often, because bad ideas will usually be weeded out before they get to his door.Sometimes, of course, the CFO will have to say no The toughest situations, in Boland’s view,are those in which the lack of revenue potential “makes it really evident that a proposal isnot even worth talking about.” She counsels patience “We try to talk through all possiblerevenue opportunities,” she says, “before saying it won’t work.” When all else fails, says

Hori-Fearon, you simply turn the tables “I just ask what the person would do if he or she owned

100 percent of Eaton.”

Vetting Vendors

Third-party consultants, contractors, and service providers have become essential in this era

of increased regulation and outsourcing And thanks to Sarbanes-Oxley, not only has ance on third-party vendors reached a new extreme,” says Jeff Burchill, CFO of FM Global,but so has the complexity of deciding which firms to hire In the past, the decision was basedlargely on who was the low bidder But now that public-company CFOs face a potentialpersonal liability regarding the quality of financial reporting, “price may not even come up,”Burchill says Consequently, CFOs often have to be “personally involved in the selectionprocess,” he says

“reli-That means digging deep on references Ideally, have a technical person on your staff findout exactly how a consultant handled, say, a software conversion at the reference’s com-pany and what complications ensued, says Bright Horizons’s Boland Then ease into therelationship slowly, signing up for only a short project to start Build in time for unexpectedproblems

Setting out detailed, measurable expectations can help guide the relationship “You don’twant to micromanage what you’ve outsourced, so you need to have the right reference points

to measure them against,” says ETS’s Gatti He recommends asking the vendor for an to-read dashboard showing early warning signs for problems, along with more-detailedweekly or monthly reports

easy-Finally, realize that managing vendors now carries the additional burden of being sible, at least to a degree, for the quality of their internal controls “It’s bad enough trying tomonitor your own internal controls,” Stephen Bainbridge, a law professor at the University

respon-of California, said at a recent symposium But overseeing another company is “more difficultand more expensive.”

Develop X-ray Vision

The CFO is in a unique position to have a window into every aspect of a company, but that’s

no substitute for real vision

“We participate in or lead some of the most complex decisions an enterprise can make, soone of our jobs is to see the consequences of all those paths that others can’t see,” says TheHartford’s Johnson And that, says Robert Mittelstaedt, dean of Arizona State University’sbusiness school and board member at two public companies, requires being “analytic enough

to constantly think about ‘what-if’ scenarios.” After all, CFOs “are better versed than one about the financial implications of any of those risks,” he says

any-Many CFOs are analytic by nature, of course, but Johnson says that what really helps hone

a CFO’s powers of perception is trouble, and the more the better “Until things go very

wrong in ways that were completely unanticipated, you don’t develop those skills,” he says.And he should know Having helped clean up fraud at Cendant and worked with compa-nies in bankruptcy as an investment banker, Johnson has seen his fair share of crises Heactually reads forensic audit reports of disasters at other companies to help keep him on histoes.

Legal Ease

The last thing any company needs is a lawsuit But in Corporate America, they come withthe territory Patent infringement, employee discrimination, workers’ compensation, and,perhaps scariest of all, securities class-action cases are all a fact of life

The real issue is risk avoidance, and there are some simple safeguards, says Cynthia Jamison,national director of CFO Services for Tatum LLC For example, “Have routine legal forms thatare used for ‘usual’ business [that is, customer contracts, NDAs, option agreements, and soon] Then, whenever something is out of the ordinary, or someone requests a substantial change

to normal policy, call a lawyer.”

Bill Stephan, the former CFO of Harborside Healthcare, added another layer of protection

“We had a policy that no field personnel could enter into contracts.” Instead, the company, an80-location nursing-home operator, mandated that only the CFO and the in-house counselwere allowed to sign But Stephan avoided bottlenecks by pledging to turn around any docu-ments very quickly — often in the same day

Having a good working relationship with your counsel — whether inside or outside — can be

a safeguard in itself In fact, says John Iino, a partner at Reed Smith LLP and co-chair of thefirm’s Corporate & Securities practice group, lawyers are most efficient “when they are keptclose to the internal decision makers.” Only then, he adds, can they help companies “draw theline between legal compliance and financial compliance” in such areas as executive-compen-sation disclosure Stephan worked close enough with his inside counsel, in fact, that he be-came adept at spotting legal red flags

Of course, there are times when outside counsel must be called in This is especially true, saysJamison, “if you are in a defensive posture — say, a customer threatens to sue or you getsubpoenaed for a court appearance.” That’s when the CFO’s skills come in handier than ever

“It’s just like managing anything else,” says Stephan “You want someone who is working inyour best interest And you want to avoid anyone with a tendency to overlawyer or who’s justout to win points.” If you don’t, you’ll regret it when the bills come in, he adds

Street Talk

Increasingly, a wide range of stakeholders want direct access to the CFO Knowing what munication techniques work with which audiences can help finance shine, both within andoutside the company

com-But honing your skills as a public face of the organization requires a bit of homework Beforehis company went public in March, Steffan Tomlinson, CFO of Aruba Networks, listened in on

some 20 conference calls and kept a log of questions asked by analysts so that he wouldknow just what to expect when Aruba held its first call From that, he learned that “tone andtenor mean a lot, especially over the phone,” and “how you answer questions about com-petitors is telling.” He says that when executives on one of the calls he listened in on stumbledover certain questions, their company was soon described by an analyst as faltering.

Frequent calls, road shows, and meetings can be a grind, but Boland of Bright Horizons saysit’s critical to stay focused “You get very routine about how you do your presentations andwhat you think people want to know,” she says “Try to hear what they’re really asking.”

If the audience is internal, be prepared to forgo finance jargon in favor of plain English “I’veworked with many CFOs who aren’t CPAs but became CFOs because they were able tosynthesize financial information into something useful,” says Bruce R Evans, a managingpartner at private-equity firm Summit Partners Offer a few select bar charts and graphswhen possible, instead of tables of numbers And don’t talk too much “Even when the workbehind something is extremely complex,” says Gatti, “your audience really just needs toknow the headlines.”

Massachu-There are times, however, when the pressure is such that a CFO must step into the fray.Esposito has found that a particularly effective approach is to jump in as a short-term projectleader As a CPA, he says, there have been many times when he’s been able to lead a techni-cal project, such as dealing with stock-options accounting, and that when he has done so ithas come as a big relief to his staff “To them, something like that is just a big pain in theneck,” he says, “since many have never seen it before and may never see it again.”

At the same time, sometimes it’s the little things that count For ETS’s Gatti, for example,leading by example means getting his expense reports in on time so that he can encourageothers to do the same

Alix Nyberg Stuart is a senior writer at CFO.

You’re On!

Sharpening your presentation skills.

Kate O’Sullivan, CFO Magazine

July 01, 2004

The stammering, the sweating, the laptop that freezes and leaves the speaker stranded at thepodium: presentations like this are the stuff of nightmares Today, finance executives are pre-senting to everyone from employees to equity analysts, and they’re taking steps to avoid suchdisastrous trips to the microphone.

According to corporate-presentation coaches, the CFO is a major client these days — not tomention a major challenge “It started with the whole stock-market run-up, when all theinvestor activity put the CFO in the spotlight,” says Deirdre Peterson, a New York-basedcommunications trainer who says she’s been coaching more finance executives than everlately “Now they’re in the spotlight because they’re being scrutinized.”

For both outsider and insider audiences, today’s CFO is often the one expected to deliver thehard financial news about a company, whether good or bad Finance executives convey thosemessages in traditional forums such as board meetings, departmental gatherings, and indus-try conferences, as well as, frequently, over the telephone in news interviews and earningscalls with analysts “There’s a sense of credibility about the financial picture when you’re hear-ing the numbers from the CFO,” says Timothy Cage, also a New York-based communicationscoach

Some of the presentation challenges finance executives face are universal “The most glaringproblem I see is a lack of connection with the audience,” says Cage “What to a busy executivemay seem like a professional, brisk, coherent approach comes across as cold, aloof, uninter-ested, and uninteresting.” Dan MacLean, a senior faculty member at Communispond, a NewYork communications training company, agrees “Most people don’t come across the way theythink they do,” he says The ubiquitous technique of videotaping speakers and allowing them

to watch themselves is a powerful — if often painful — tool for trainers to illustrate this point.But there are dangers, like information overload, that are more specific to the CFO “CFOshave a ton of information to present, and their tendency is to want to display it all and, frankly,bore the audience to tears,” says MacLean “Investors need the information, but not all of it.”Finance executives may “think a lot about what they’re going to say, but it’s how they deliverthe words that gives them their impact.”

Then there’s the seemingly dry material “Compared to a marketing presentation, where thematerial could be about ideas, image, or a new program,” says Peterson, a CFO may find that

“just walking through the numbers can get really boring really quickly.” And unlike sales andmarketing executives, who may receive more presentation training, CFOs often don’t learnintonation and gesturing techniques for capturing audiences

“It’s Not Intuitive”

Kevin Gregory sought out communications training in 2002, after he ascended to the financechief’s job at ProQuest Co., a $470 million electronic-content publisher based in Ann Arbor,Michigan “For a lot of people, myself included, presenting is not intuitive,” says Gregory

“And I had not had a lot of experience with it in the controller role.”

With a schedule that lately has included a number of shareholder and analyst phone callsand “mini road shows” with investors, Gregory says he now represents the company to the

outside world once a week on average He has learned to maintain an awareness of thelistener’s perspective when preparing a presentation “It’s easy to jump into a discussion andassume that there’s a certain level of understanding that’s just not there” when addressingunfamiliar groups, he says “If you just start drilling down immediately, you’re going to loseeverybody You need to start with the overall premise and then work through the specifics.”

It is vital to set a tone that’s tailored to your particular audience, says Peterson Investors,especially, “don’t want overt spin.” While the CFO’s approach must be “more than just recit-ing the numbers,” she says, “it can’t become too promotional, either.”

David S Johnson, CFO of Carter & Burgess Inc., an engineering and architectural firm based inFort Worth, learned the importance of effective presentations during his 15-year tenure at Gen-eral Electric Co., where he listened to such speaking legends as former CEO Jack Welch andformer finance chief Dennis Dammerman In the time between leaving GE and landing hiscurrent post in 1998, Johnson took a course from Communispond to hone his skills

“As you move from one job to the next, the amount of presenting you have to do goes updramatically,” says Johnson Especially after moving into “a leadership role like CFO or high-level controller, the ability to speak to large groups is critical.” At Carter & Burgess, which has

a workforce of around 2,300, Johnson says that training employees through presentations savessignificant time and effort Giving a targeted talk about the bottom-line benefits of facilitiesleasing, for example, helps him avoid answering dozens of questions on the subject later.Between training sessions and investor meetings, Johnson says, he sometimes finds himselftalking to groups as often as three times a week “There’s such an incredible jump in the impactyou have when you’re an effective speaker,” says the CFO “And it doesn’t take a lot of effort

to do it right.”

Say What?

Some speaking tips from the experts

to hear?” suggests Communispond’s Dan MacLean

Focus on delivery. “Voice quality matters,” says trainer Deirdre Peterson Especially on thephone, keep listeners alert with “verbal flags like ‘our top priority’ or ‘the key thing.’ ”

Don’t just read figures off a page or a computer screen. “It looks like the CFO lacks dence in the numbers,” notes communications coach Timothy Cage

says MacLean Emphasize important points and skip the extras “Sometimes we give PowerPoint

a little too much power.”

SCOPE OF FINANCIAL MANAGEMENT

This Section include

2.1 SCOPE OF FINANCIAL MANAGEMENT

2.1.1 Financial Management is all about acquisition of funds from financial markets, deploy

them in the organization’s business activities, efficiently allocating resources, ensuringrisk-return trade-off, invest surplus funds in securities, generate revenue through op-erations and handle the returns by reinvesting and for meeting out the repayment obli-gations

2.2 EXPANDING SCOPE OF FINANCIAL MANAGEMENT

2.2.1 Financial Management today covers the entire gamut of activities and functions given

below The head of finance is considered to be important ally of the CEO in most nizations and performs a strategic role His responsibilities include:

orga-a estimating the total requirements of funds for a given period

b raising funds through various sources, both national and international, keeping inmind the cost effectiveness;

c investing the funds in both long term as well as short term capital needs;

d funding day-to-day working capital requirements of business;

e collecting on time from debtors and paying to creditors on time;

f managing funds and treasury operations

g Ensuring a satisfactory return to all the stake holders;

h paying interest on borrowings;

i repaying lenders on due dates;

j maximizing the wealth of the shareholders over the long term

k Interfacing with the capital markets ;

OVERVIEW OF FINANCIAL MANAGEMENT

l Awareness to all the latest developments in the financial markets;

m Increasing the firm’s competitive financial strength in the market &

n Adhering to the requirements of corporate governance

The above aspects of Financial Management are covered in greater details under different ters

3.1.1 The Financial planning environment is becoming more and more dynamic and has

been undergoing a sea change in the last few years, mainly on account of tion, and better investor awareness The initiatives of regulators such as the SecuritiesExchange Board of India (SEBI) have only contributed to bring about better disclo-sure, transparency and governance

globaliza-3.1.2 The planning environment is governed by

f External influences such as foreign exchange movements

g Regulators such as the Reserve Bank of India and SEBI , etc;

3.1.3 All these call for a more demanding and adaptive planning system, that is responsive

to a competitive business environment

SECTION - 4

KEY DECISIONS OF FINANCIAL MANAGEMENT

This Section include

4.1 KEY DECISIONS OF FINANCIAL MANAGEMENT

4.1.1 The key or major areas of financial decisions are discussed briefly in this chapter andare covered in greater detail in subsequent chapters and modules

4.2 CAPITAL BUDGETING

4.2.1 This is the most paramount decision any business has to take After making the choice

of business one wants to be in, an entrepreneur has to develop an investment plan toallocate the funds on various assets, such as land & buildings, plant and machinery,distribution outlets, infrastructure, brand building, research and development, technol-ogy know-how and so on As capital is budgeted and allocated for these various assets,this decision is referred to as capital budgeting

4.2.2 As capital budgeting decisions have a long term impact and can confer a long termbenefit or have the potential to become a major problem and financial burden, it is im-portant to accord sufficient time and effort in making these decisions The choice ofdecision with regard to technology for manufacture of a product, location, configura-tion of machinery, and so on have business implications and have a major bearing onthe profitability and viability of an organization Most of the times, the decisions areirreversible The size of the investment, the likely returns and risks associated with theproject or investment and the timing of investments need to be carefully evaluated.4.2.3 A careful analysis of the requirement of working capital needs and the margin moneyrequired to be earmarked also forms part of capital budgeting as margin money is longterm fund

4.3 CAPITAL STRUCTURE

4.3.1 The next step after identifying an attractive investment opportunity and estimated

the size of the investment required is working out the sources of funds also called asmeans of financing

4.3.2 There are two major forms of capital: (1) Equity (own funds), and (2) Debt (borrowed

funds) A major decision is the mix of these two types of funds, widely known as thedebt-equity ratio Decisions on various related factors such as the optimum ratio, choice

of specific instruments, the capital markets the organization should access to raise thefunds, the timing (see box), pricing of securities, etc will need to be addressed

Meltdown worries Wockhardt; IPO review likely

Business Line, 23rd Jan.2008

Mumbai, Jan 22 With nine days to go for the opening of Wockhardt Hospital’s initial publicoffering (IPO), the management is concerned over the dramatic developments in the stockmarket “We will review developments and take a call,” Mr Habil Khorakiwala, Chairman ofWockhardt Hospitals Ltd told media persons, in response to queries whether the IPO would

be deferred

Steering clear of stating whether the management was looking at deferring the IPO, he ated that the company would take an appropriate decision when there is more clarity Cur-rently, the situation is fluid, he said, on a day when the market witnessed shares plummetingnearly 13 per cent during the day and trading being stopped for an hour

reiter-4.4 WORKING CAPITAL MANAGEMENT

4.4.1 After raising funds and creating facilities that can be put to use over the long term, the

next major decision is with regard to managing the day-to-day or short term operatingcycle, popularly called the working capital cycle

4.4.2 Working capital involves managing the current assets (inventories, debtors,

market-able securities and cash) and current liabilities (short-term debt, trade creditors, andprovisions)

4.4.3 The important decisions in relation to working capital revolve around the various

com-ponents of working capital given above, such as the optimum level of inventory ing, credit granting decisions, cash management (both deficits and surplus), arrangingfor short-term requirements of funds, and so on

hold-4.5 DIVIDEND

4.5.1 Dividend decisions are again critical for an organization The dividend payout should

meet a number of criteria and expectations of different shareholders Managing cash,providing for expansion and growth, satisfying expectations on dividend yields, creat-ing sufficient reserves, adhering to rules governing transfer of profits to reserves etc.,need to be factored in while deciding on dividends Dividend policy needs to be evolvedand followed, which will balance the requirements of the different types of investorsand the requirements of the business Some firms follow stable dividend policy-i.e pay-ing the same rate of dividend irrespective of the profits There are other firms whichfollow a variable dividend policy where the rates of dividend are varied depending onthe availability of profits Some firms do not distribute any dividend in cash but givebonus shares which has implications on the capital structure of the company There-fore, the decision has to be taken carefully as it has long term financial implications onthe company

SECTION - 5

EMERGING ROLE OF FINANCE MANAGERS IN INDIA

This Section include

5.1.1 As mentioned in the beginning of this module, a finance professional is expected to

have adequate and up-to-date knowledge in a vast array of subjects

5.1.2 While large organizations have a multitude of executives manning different

func-tions within Financial Management, headed by a CFO, in smaller organizafunc-tions, theCFO is expected to don different roles, including that of a company secretary.5.1.3 The key challenges for a modern finance manager in India has changed from a mere

finance function of securing and managing funds to encompass the following, to name

a few important areas:

7 Corporate governance etc;

5.1.4 Indian finance professionals are respected across the globe and today occupy top

posi-tions in several organizaposi-tions, including MNCs

5.2 TURNAROUND OF MCI INC, USA

5.2.1 The article titled “Extreme Makeover”, given at the end of the chapter, provides a

comprehensive view of the competence required and the extreme pressures a CFOfaces in a dynamic and exceedingly demanding business environment The articlehighlights how Robert Blakely and an army of accountants turned fraud-riddenWorldCom into a clean MCI

Extreme Makeover

How Robert Blakely and an army of accountants turned fraud-ridden WorldCom into

Robert Blakely had yet to accept the job as CFO of WorldCom Inc when CEO Michael Capellascalled on the evening of April 10, 2003 Creditors of the bankrupt telecommunications giantwere meeting with Capellas and his team in New York the following day, and he wantedBlakely by his side On the table: how to settle some $35 billion in outstanding debt Blakely,who would already be in town for a meeting of the trustees of Cornell University, agreed tocome — after, that is, he and Capellas hammered out an employment contract in the morning.But the next day, bad weather delayed Capellas’s flight from Washington, D.C “There was noway we could talk,” says Blakely “By the time [Capellas] arrived, all the senior creditors werethere.” The fact that he wasn’t formally on the payroll didn’t keep the CFO-in-waiting waitingfrom rolling up his sleeves and starting negotiations, which quickly grew acrimonious “Basi-cally, it was hand-to-hand combat all day,” recalls Blakely

At 11:30 a.m., he and Capellas slipped out of the negotiations to work through the remainingpoints of Blakely’s employment contract At noon, “We shook hands and I said, ‘Yep, I’m onboard,’ ” says Blakely

They returned to the fray Finally, by 8:30 in the evening, the WorldCom team had convinced

90 percent of the creditor groups to exchange most of their bonds for shares of stock in thereorganized company

For the new CFO, that first 12-hour day was a harbinger of things to come Raising WorldComfrom the ashes of the biggest fraud — and bankruptcy — in U.S corporate history, to emerge inApril 2004 as the rechristened MCI Inc., boasting a clean set of books and a mere $5 billion ofdebt, would require many more 12-hour-plus days Restating the company’s financials, a chorethat began before Blakely’s arrival, would take more than a year and a half to complete Inter-nal controls had to be overhauled, new directors named, and a new set of corporate-gover-nance policies adopted Even though the fraud directly involved fewer than 50 employees,every one of the company’s 50,000 workers worldwide had to undergo ethics training Andsomehow, while all this was being done, the business had to keep moving forward

The 62-year-old Blakely brought badly needed turnaround experience to WorldCom In thelate 1990s, the CFO led Houston-based Tenneco Inc., a $13 billion energy conglomerate, through

a massive restructuring Later, he made major improvements to internal controls and risk agement at Lyondell Chemical Co., another Houston company But nothing could have pre-pared him adequately for WorldCom, which declared bankruptcy in July 2002, not long afterthe disclosure of the fraud that drove CFO Scott Sullivan and CEO Bernard Ebbers from thecompany (see “Fall and Rise,” at the end of this article) (Full disclosure: both Blakely and

man-Sullivan were recipients of CFO Excellence awards.) “No one has that kind of turnaround

experience,” says Blakely, “because it has never been done before.”

That challenge was enough to lure Blakely out of retirement, where racing high-performancemotorcycles apparently didn’t provide enough of an adrenaline rush “What intrigued me

about [WorldCom] was that it was an opportunity to pull everything together that I hadlearned in my career,” he says “I don’t like stable situations Some might say that I’m a crisisjunkie.”

The Mother of All Audits

It was easy for Blakely to indulge his habit at WorldCom Even with the majority of creditors

on board, the most difficult tasks required to exit bankruptcy still lay ahead Hardest of all wasrestating results for three years — 2000, 2001, and 2002 — and filing audited financial state-ments Not only was $11 billion of fraud cooked into the books, but years of shoddy record-keeping and incompetent accounting clouded nearly every entry

Blakely and his finance team hoped they could complete the audit by July 2003, three monthsafter he was hired, but it took nearly that long just to size up the task “It was more complexthan anyone imagined,” he says Eventually, the team realized they had to reconstruct thefinancial statements from scratch “I went back to Michael [Capellas] and told him that it lookedmore like July 2004 than July 2003,” says Blakely But it would have to be done faster: bank-ruptcy court judge Arthur Gonzalez had already set February 28, 2004, as the deadline foremerging from bankruptcy

Reinforcements were needed WorldCom already had 500 to 600 employees working full-time

on the restatement, as well as 200 to 300 staffers from KPMG, the company’s auditor WorldComturned to Deloitte & Touche for more help, and the accounting firm responded with some 600professionals, culled from offices across the country At the peak of the audit work, in late

2003, WorldCom had about 1,500 people working on the restatement, under the combinedmanagement of Blakely and five controllers

The finance team started with the billing systems and reran all the revenue, deciding on theproper accounting Then it redid all the cash applications and rebuilt the income statementsfrom there It also reassessed every acquisition Ebbers had made since 1992 in the course oftransforming an obscure long-distance start-up into a global communications powerhouse —

12 major deals and several smaller ones, worth $70 billion “In some instances, we had to goback and reconstruct records to decide whether or not pooling of interest was the proper ac-counting at the time,” says Blakely In all, they found, WorldCom had overvalued severalacquisitions by a total of $5.8 billion

The difficulty of the audit work was compounded by the sorry state of WorldCom’s records Insome instances, Post-it notes were attached to journal entries in lieu of proper documentation.The FBI had taken documents that had to be tracked down and retrieved In the end, Blakely’steam made more than 3 million new or revised entries

But even with Deloitte’s help, WorldCom couldn’t finish the audit before Judge Gonzalez’sFebruary 2004 deadline It was forced to request a 60-day extension “To bring [the audit] toclosure was devilishly hard, because it’s so complex It just kept going on and on,” says Blakely.Finally, on March 10, Blakely’s team finished a version of the 10-K restatement that wouldserve as a foundation for future financial statements MCI executives planned a signing cer-emony for March 11, at a previously scheduled meeting of the board But later on the 10th,

company personnel and KPMG discovered two significant errors in the deferred tax ances, which rippled through about 100 pages of the 192-page document Dave Schneeman,vice president of general accounting, and Jim Renna, vice president of controls andremediation, led a small team that worked through the night to make the necessary fixes “Icalled at midnight, and they said they were making progress,” says Blakely “I called again

bal-at 6:00 a.m the next day, and they said they had just finished, and I cried,” he admits

To WorldCom’s investors, the story told by the restated results was a real tearjerker Sullivanand Ebbers had claimed a pretax profit for 2000 of $7.6 billion; the reality, according to therestatement, was a loss of $48.9 billion (including a $47 billion write-down of impaired as-sets) For 2001, WorldCom had reported a pretax profit of $2.4 billion; the restatement showed

a pretax loss of $15.6 billion For the year 2002, the company was $9.2 billion in the red,pretax

Blakely claims WorldCom’s restated 2002 10-K is the most complex document ever filed withthe Securities and Exchange Commission He calls it “my Mount Everest” and keeps a copy,signed by the major participants, in a glass-door cabinet next to his desk The audit, he says,

“is the hardest thing I have done in my career.” Total cost to complete it: a mind-blowing

$365 million

Hush Money

The audit provided new insights into the nature and the magnitude of the fraud at WorldCom

In fact, the same complexity that made the audit so difficult was one reason the fraud wasable to go undetected for so long As a result of Ebbers’s acquisition spree, WorldCom hadalso acquired a slew of accounting systems that were integrated loosely, if at all By Blakely’sreckoning, there were 60 billing platforms and more than 20 accounts-receivable systems.The numbers rolled up from the various operating units to the company’s former headquar-ters in Clinton, Mississippi There, it was easy for accounting staffers to simply change thenumbers

“It was a very low-tech fraud in a sense,” says Richard Breeden, a former SEC chairman andMCI’s court-appointed corporate monitor “If [a WorldCom employee] didn’t like the figure

he got, he just changed it.” He says it was not unknown for accountants at headquarters tocome to the office and find Post-it notes on their computer monitors telling them to changenumbers Breeden says that in some quarters, imaginary revenue was added to the books

using consolidated entries in big, round numbers that “didn’t even look real.”

Breeden also describes a command-and-control structure with a lot of power concentrated

at the top In his report of recommended reforms, he noted that Ebbers ruled with “nearlyimperial reign.” “The attitude at the company was that orders were to be followed, and itwas clear that anybody that didn’t would be fired,” says Breeden Along with the big stickcame a few carrots A generous stock-option plan was supplemented by a $238 million “em-ployee-retention program” that was dipped into and doled out at the discretion of Ebbersand Sullivan “It was basically a slush fund to give out quiet money,” says Breeden Sullivanwrote personal checks for $10,000 to some employees, he says, and gave $10,000 more to

their wives.

Breeden and Blakely say that the fraud involved fewer than 50 people, mostly those whorolled up the financial statements in Clinton When managers at operating units saw theconsolidated financials, they were surprised how well the rest of the company seemed to bedoing when the numbers they reported were so poor

Dennis Beresford, a former chairman of the Financial Accounting Standards Board whonow chairs MCI’s audit committee, led one of two internal investigations into the fraud He’sconvinced that everyone involved has been removed from the company Beresford saysWorldCom asked about 50 executives in the finance department to leave after the investiga-tion showed they either took part in the accounting fraud or should have known about it

“We had too many people who looked the other way,” he says

In March, Sullivan agreed to plead guilty to securities fraud, conspiracy, and giving falsestatements to regulators Those crimes could carry a sentence of up to 25 years in prisonunder federal sentencing guidelines, but Sullivan hopes to get less in exchange for his testi-mony in the trial against Ebbers that is scheduled to begin in November Former controllerDavid Myers and accounting executives Betty Vinson and Troy Normand have also pleadedguilty and are cooperating with authorities

Do the Right Thing

Impressive as it was, cleaning up the fraud wasn’t enough to restore the confidence ofWorldCom’s customers; Blakely had to make sure that nothing remotely like Sullivan’s ma-nipulations could ever happen again In July 2003, WorldCom’s largest customer, the federalgovernment, had barred it from bidding on federal contracts while it reviewed whether thecompany should be placed on an “excluded parties” list “Getting that [ban] lifted was thehighest priority,” says Blakely “If the government doesn’t want to do business with you, whyshould anyone else?”

The two main concerns identified by the General Services Administration, which administersthe list, were controls and ethics Indeed, KPMG, which succeeded Arthur Andersen asWorldCom’s auditor, had identified 96 control issues, and a separate assessment by Deloittezeroed in on several other “high risk” areas With help from both accounting firms, Blakely’sfinance team put together a “heat map” that listed high-priority risk areas, and then wentabout fixing them The solutions included adding basic checks and balances such as segrega-tion of duties among finance staffers, limited access, and documented policies The companythen implemented a much more stringent, and inclusive, policy for closing the books “It isimpossible to completely eliminate the possibility of fraud,” says Blakely But, he says, thehundreds of added controls will greatly diminish the chances of it reoccurring

MCI was also forced to implement what is likely the most stringent set of nance practices ever adopted As part of WorldCom’s $750 million cash and stock settlementwith the SEC, it agreed to accept all the recommendations of the court-appointed monitor.Breeden’s 150-page report on corporate governance, “Restoring Trust,” lists 78 recommenda-tions, including the separation of the CEO and chairman roles, and the required removal of

corporate-gover-one board member each year to make room for a new director “Some [of the requirements]

go beyond what is reasonable,” contends Beresford “But we have no choice but to acceptthem.”

As for ethics training, MCI put the entire company of 50,000 employees through a coursedesigned for it by professors at New York University’s Stern School of Business In addition,

90 executives attended a two-day ethics program at the University of Virginia’s DardenSchool Not surprisingly, MCI is trying to keep ethics in the foreground Large banners pro-claiming the company’s “guiding principles” festoon the halls of its Ashburn, Virginia, head-quarters They include such mottos as “Everyone should feel comfortable to speak his or hermind” and “Do the right thing.” The principles are also printed on the back of employeesecurity badges

All these measures were enough to convince the government that MCI had reformed LastJanuary, it lifted the debarment just in time for the renewal of a contract worth as much as $400million

There would be more to celebrate On April 20, the company emerged from bankruptcy, cially taking the name MCI Inc., with its debt slashed from $41 billion to $5.8 billion, and with

offi-$6 billion in cash reserves Its stock was scheduled to begin trading again on Nasdaq thismonth “A lot of people didn’t think we could get it done,” says Beresford “It took a Herculeaneffort to get to that point.” (Not to mention the $800 million in fees MCI spent during its so-journ in Chapter 11, for lawyers, accountants, appraisers, tax experts, and other consultants.)But the work on the controls isn’t finished Like most companies, MCI is busy documenting itscontrols in compliance with Section 404c of the Sarbanes-Oxley Act More than 60 people areworking on the project, and PricewaterhouseCoopers is providing outside assistance “We’vestill got a long summer ahead to get to where we need to be,” says Blakely

Was It Worth It?

Right now, MCI is trailing the field “They are third in a race of three,” says Muayyad Chalabi, managing director of San Francisco-based telecom research firm RHK Inc Comparedwith archrivals AT&T and Sprint, MCI has lower margins, pays more (as a percentage of totalrevenues) to other carriers in access fees, and has the fastest-declining revenues (17 percent inthe past year alone, year over year) “I don’t know if MCI was worth saving,” says Al-Chalabi.The company will also have to fend off competition from Baby Bells like Verizon and SBCCommunications, which are looking to provide enterprise telecom services to small and mid-size businesses — a key customer base for MCI And another setback came in June, when afederal court ruled that Baby Bells no longer had to lease access to their local networks to thelikes of MCI at deep discounts, increasing MCI’s cost to provide consumer long distance

Al-In May, MCI announced a $388 million loss for the first quarter of 2004, compared with a $52million profit for Q1 2003 The company said it would cut 7,500 jobs, or 15 percent of itsworkforce But Al-Chalabi says reducing head count alone won’t solve MCI’s problems He

points out that the company has a patchwork of networks left over from the acquisitions —the same problem that plagued the finance department — which impedes its efforts to ob-tain operating efficiencies “They have a thousand or more systems that all need to be sup-ported,” says Al-Chalabi “That increases the number of suppliers they have to deal with,and there is a lot of duplication in the systems.”

All of these factors have fed speculation that MCI will put itself up for sale, likely to one ofthe Baby Bells Yet Al-Chalabi notes that these potential buyers can already buy long-haulcapacity very cheaply, without buying the MCI cow Also, he says, “the Baby Bells still havehuge amounts of debt I’m not sure they are in a position to do a big purchase right now.”That could be bad news for MCI “I don’t think they can stand alone with the current trend,”says Al-Chalabi “They’ll either be part of another company, or they’ll have to dramaticallychange their ways.”

MCI isn’t ruling out a sale But Blakely, who admits that the industry is in rough shape,thinks that the company can stand on its own He is quick to point out that it generates $300million in positive cash flow each quarter A large portion of Internet traffic flows over MCI’snetwork, and the company still has more than 20 million customers Blakely says MCI will beprofitable in the second half of this year

Focusing on the future is a luxury MCI hasn’t had for a long time At a recent board meeting,Dennis Beresford noticed something he calls “astonishing”: “The conversation was almostentirely about the operations of the business.” That hadn’t happened since he was elected tothe board in July 2002, he says “Just to be able to sit around and talk about strategy is wonder-ful.”

Fall and Rise

(LDDS)

changes its name to WorldCom

1998: WorldCom’s $40 billion acquisition of MCI is the largest merger in corporate history atthe time

merge The deal is later blocked by antitrust regulators and abandoned

Commission on accounting procedures and loans to officers

Sidgmore takes over

July 2002: WorldCom files for Chapter 11 bankruptcy, the largest ever filed in terms of

out-standing debt Former Salomon Smith Barney analyst Jack Grubman admits to attendingWorldCom board meetings.

secu-rities fraud

fraud WorldCom files its restated 2002 10-K, which includes a write-down of $80 billion ingoodwill, assets, and property

SECTION - 6

EARNINGS DISTRIBUTION POLICY

This Section include

6.1 EARNINGS DISTRIBUTION POLICY

6.1.1 As already mentioned, distribution of earnings in the form of dividends is an

impor-tant financial management decision It is a function of a number of factors such as thefollowing:

a past trend

a potential future earnings

b requirements for funds in the immediate future

c past dividend payout record of the company

d shareholders expectations or preference

e liquidity position of the company as dividends entail cash outgo

f The proclivity of the management to retain management control by financing growthplans through internal funding which will mean increased retained earnings

g Industry benchmark

h Analysts expectations etc

6.1.2 The topic is covered in greater detail in a subsequent chapter

SECTION- 7

COMPLIANCE OF REGULATORY REQUIREMENTS IN FORMULATION OF FINANCIAL STRATEGIES

This Section include

7.1 COMPLIANCE OF REGULATORY REQUIREMENTS IN FOR

MULATION OF FINANCIAL STRATEGIES

7.1.1 The two major regulatory authorities are the Reserve Bank of India (RBI) and the

Securities Exchange Board of India (SEBI) The regulations in the Companies Act,Income tax Act etc are more for governance and compliance than for strategy RBImainly regulates the commercial banks which in turn may influence the policies of acompany Some of the situations a finance manager has to face, which requires regu-latory compliance are:

7.1.2 Raising finance through IPO or SPO: IPO refers to Initial Public Offering; the first

time a company comes to public to raise money SPO refers to seasonal public ing, the second and subsequent time a company raises money from the public di-rectly There are regulatory guidelines prescribed by SEBI regarding the entire process

offer-of going public which includes disclosure to public regarding the potential use offer-of thecash, financial projections and percentage of shares offered to various stakeholdersetc Similarly, every time a company wants to access the capital market, either forraising finance through debt or equity, these regulatory compliances have to be metwhere finance manager will play a key role in providing the necessary informationboth at the time of raising resources and also at regular intervals subsequently there-after

7.1.3 Capital structure changes: Today, companies are permitted to buy their own shares

The finance manager, some times, for strategic reasons, decide to reduce the equitycapital This is technically known as capital reduction, which again requires regulatorycompliances prescribed by SEBI and Companies Act

7.1.4 Credit rating: Whenever a company wants to raise money through debt, or through

a new instrument, the instrument has to be rated by a credit rating agency like CRISIL,ICRA etcas per the SEBI guidelines Similarly, company also has to be rated The wholeexercise of initiating the rating process, providing the relevant information and an-swering the queries of the rating agencies, will be the responsibility of the CFO.7.1.5 Foreign exchange transactions: A company needs foreign exchange for a variety of

reasons like importing equipment, setting up of foreign offices, travel of sales and

other company employees etc Similarly, a company may receive remittances of eign exchange for exports made In either of these situations, the rules and regulationsrelating to foreign exchange transactions needs to be complied with by the Financemanager, on behalf of the organization It involves some filing of returns in the pre-scribed format

for-7.1.6 Derivative transactions: Whenever a company uses derivatives for hedging, there are

accounting and disclosure requirements to be complied with as per Companies Act &GAAP Accounting, accounting standards of ICAI and the international accounting stan-dards For example, hedge accounting has to be maintained and profits/losses due tohedging should be reported

7.1.7 Project financing: If a company goes for major project financing option, involving

multiple agencies like suppliers, contractors etc, there are a number of requirementsfor the various stakeholders and financiers like consortium of banks, private equityplayers, etc Finance manager plays an important role in complying with the require-ments of various agencies involved in the exercise

SECTION - 8

SOURCES OF FINANCE - LONG TERM, SHORT

TERM AND INTERNATIONAL

8.1.1 To enable investments and creation of assets and infrastructure, an organization

re-quires funds As already mentioned, the two major forms of capital are:

(1) Equity (owners’ or shareholders’ funds), and

(2) Debt (loans or borrowings)

Both can be raised from both public and private sources

8.2 SOURCES OF EQUITY

8.2.1 Equity shareholders are the owners of an enterprise and enjoy the rewards of good

performance of the company and affected by risks faced by the company However,.their liability is limited to their shareholding in the company

8.2.2 Equity is in the form of:

a Equity capital

b Preference Capital and

c Internal accruals or retained earnings also known as ‘Reserves & Surplus’, i.e.,plowing back of profits rather than distributing them to shareholders

8.2.3 Preference Share Capital: It is a hybrid of equity capital and debt, and combines the

features of the two in terms of returns and risks More details of equity are covered insubsequent chapters

8.3 DEBT

8.3.1 Debt can be in form of either long term or short term Long term are generally in the

form of a Term loans and b Debentures

8.3.2 Short-term debt is in the form of:

a Working capital Loans from commercial banks for financing working capital quirements: Cash credit, overdrafts, loans, purchase or discounting of bills Etc; Theseare called fund-based There are also non fund-based limits such as letter of credit,guarantee etc;

re-b Trade credits: Credits given by suppliers of materials and services

8.4.1 Finance can be raised from international sources in the form of Global depository

receipts, American depository receipts, private placements, loans from internationalagencies such as International Finance Corporation, and so on

8.5.0 The article titled “An Overview of Project Finance” in the Reader gives a

comprehen-sive picture of the various sources of finance

SECTION - 9

EXCHANGE RATE - RISK AGENCIES INVOLVED

AND PROCEDURE FOLLOWED

IN INTERNATIONAL FINANCIAL OPERATIONS

• Exchange rate - risk agencies involved and procedure followed in international

financial operations:

This Section include

9.1 EXCHANGE RATE - RISK AGENCIES INVOLVED AND

PRO-CEDURE FOLLOWED IN INTERNATIONAL FINANCIAL ERATIONS

OP-9.1.1 Foreign exchange transactions require some special records to be maintained as per the

regulations At every stage in the international trade process, the finance manager has

to comply with some regulatory and reporting requirement For example, opening of aletter of credit in the context of exports or imports Here, the finance manager has todeal with the bank, submitting the requisite documents for ensuring the opening ofletter of credit Proper trade documents have to be submitted Foreign exchange remit-tances have to be complied with They have to be accounted in line with the require-ments of law and accounting standards Tax treatment is different in some cases andthey have to be adhered to such as withholding tax, tax exemption criteria etc;

1.1 THEORY OF CAPITAL STRUCTURE

1.1.1 One of the key elements of financial analysis of a company is to look at the capitalstructure of the company

1.1.2 Companies potentially have a choice between various sources of funding, right fromshort-term bank overdrafts to perpetual equity How can an organization choosebetween the alternatives, and add value by strategic financing decisions is calledcapital structuring

1.1.3 The capital structure of a company can be expressed in the form of a number of ratiosfor comparison between companies or over a period of time The main ratios are:

a Gearing

b Net gearing

c Leverage (gross)

d Leverage (tangible)

e Leverage (tangible including contingents)

f Debt / Equity or Debt / (Debt + Equity)

1.1.4 The traditional view was that the cost of equity and the cost of loan capital aredetermined independently It is expected that as it represents a more risky investment,the cost of equity would be greater than the cost of loan capital Accordingly, themore highly geared the company becomes, i.e., the more loan capital vis-à-vis equity

it obtains, the lower its cost of capital There must be a cut-off point to this processotherwise all organizations would be looking for total debt financing Therefore, atsome stage the proportion of loan capital increases the level of risk to the potentiallender as well as the equity holders This increased level of risk would cause theoverall cost of capital to rise Thus, it can be assumed that a rational organization will

This Section includes