CA IPCC FINANCIAL MANAGEMENT (FM) – STUDY TIPS
CA IPCC FINANCIAL MANAGEMENT. This paper introduces you to the basic concepts, theories and techniques relating to Financial Management and aims to develop your ability in understanding the different concepts and their application in the real life situations. It also provides you with an opportunity to draw upon previous experiences and education to apply various business concepts and analytical tools to complex problems and issues in organisational settings.
The paper aims to achieve the following basic objectives:
(a) To develop ability to analyse and interpret various tools of financial analysis and planning;
(b) To gain knowledge of management and financing of working capital;
(c) To understand concepts relating to financing and investment decisions; and
(d) To be able to solve simple cases.
To begin with, you need to understand the scope, objectives and importance of financial management and its relationship with other disciplines followed by the concept of time value of money. These two topics lay the foundation for financial management and find an application in almost every area of study of the subject. After having an in-depth understanding of these two topics, you should start preparing for the other subject areas like tools and techniques of financial analysis and planning, financing and investment decisions, types of financing and working capital management.
All these topics are inter-related. Concepts of one topic are frequently used in another and so a student is advised to give equal weightage to each topic while preparing for the examination. For example, various tools and techniques of financial management namely ratio analysis, cash flow analysis and funds flow analysis are used to analyse the financial health of a company while the different sources of finance available to business enterprises to cater to their diverse requirements helps them in taking financial decisions, namely, financing, investment and working capital management.
PLANNING YOUR STUDY
Emphasis on Theoretical Portion
There are certain chapters/units which are wholly theoretical in nature like Scope and Objectives of Financial Management, Types of Financing and Financing of Working Capital. These chapters need equal focus as they form the basis of many concepts which you will learn in the later chapters.
Chapter One: Scope and Objectives of Financial Management
This being the first chapter, it introduces you to the area of Financial Management. It discusses the evolution, importance, scope and objectives of Financial Management and how this area is inter-related with other subject areas. This chapter is of utmost importance as it deals with the fundamentals of Financial Management. Without a clear understanding of the fundamentals the remaining chapters will not be easy to grasp. Therefore, knowledge of the background, the environment to which this paper relates, is important as it helps to put everything learnt later into appropriate perspective.
Chapter Five: Types of Financing
In this chapter you have to study the different sources of finance and their usage in making sound financial judgments. This chapter deals with long-term, short-term and international sources of finance. It helps you to understand the basics of different forms of finance and their importance therein. Most of the issues discussed in this chapter have practical implications in real life like where to get funds from for starting up, development or expansion of a business and these decisions are crucial for the success of the business. It is also important, therefore, that you understand the various sources of finance open to a business and are able to assess how appropriate these sources are in relation to the needs of the business. The concepts learnt here find application almost in all the other chapters as well.
Example: A decision regarding a particular source of finance is taken in Chapter Six on Investment Decisions when a company wants to invest in new machinery, which has a high cost and capital is required to source the fund.
Generally, you tend to pay less attention to theory chapters and the theoretical concepts of underlying different topics. But it is very pertinent that you have thoroughly studied the theoretical aspects of the subject so that they help you in understanding the concepts and logic behind the mathematical workings and formulae while solving problems related to that particular concept.
Solving Practical Problems You should be able to adopt the correct approach of solving the numericals using shorter approaches that require a little ‘think before attempt’ approach instead of lengthy procedures. You need to have conceptual clarity before attempting the questions. You should be able to understand how various concepts/figures are related to each other. This requires a lot of practice of solving such questions to develop this understanding without which, it would almost be impossible to achieve positive results in the examination. It appears that you either utilise too much of your time solving questions, without actually understanding the theories underlying the problems, or resort to selective studying.
Some outlines of the chapters which require extensive practice as they are practical-oriented are discussed for your better understanding. It also discusses how the different chapters are inter-related to each other and how the concepts studied in one chapter are relevant and applicable in other chapters as well.
Chapter Two: Time Value of Money
This chapter basically tries to impart you the concept and importance of monies worth today as compared to in the future. It talks about present value and future value of your money or investment. It discusses the concept of opportunity cost and the importance to know how to compute the time value of money so that you can distinguish between the worth of investments that offer you returns at different times. This chapter is of utmost importance as other chapters will expand on the concepts learnt in this chapter. For instance, time value concept forms the basis of all the modern tools and techniques of capital budgeting decisions like net present value (NPV) method, internal rate of return method (IRR) to name a few dealt in Chapter Six under Investment Decisions.
Chapter Three: Financial Analysis and Planning
This chapter requires loads of reading to understand the concepts and thorough practice of the problems. The first unit deals with ratio analysis. Here you need to understand the different types of ratios and their significance alongwith their application in decision-making scenarios. The second unit deals with cash flow and funds flow statement analysis. This chapter draws a lot from the paper of Accounting present in the same group. You should be conceptually clear with respect to the topics covered here as they create a stepping stone for you for understanding and implementation in further chapters.
Example: The acid test ratios are used in the Chapter Seven on Management of Capital Management. These ratios demonstrate a firm’s ability to manage its resources in an efficient manner. Capital structure ratios like equity, debt, debt-equity are revised in the Unit II: Capital Structure Decisions under Chapter Four on Financing Decisions. Similarly, funds flow analysis is an impor tant aspect of Chapter Seven on Working Capital Management while estimating working capital required by a firm in the future.
Chapter Four: Financing Decisions
This chapter covers the concept and significance of cost of capital, capital structure decisions and leverages. Cost of capital has relevance in almost every type of financial decision making.
Examples: While deciding the acceptance or rejection of an investment proposal, cost of capital is the major yardstick. It is also vital in designing a firm’s capital structure as one of the important criteria is to minimise the cost of capital. Again, it helps in deciding the method of financing to be used.
Leverages help in understanding what change in a firm’s policy in terms of say increase or reduction in the number of units it is producing or whether the firm should rely more or less heavily on borrowed money, etc affect the risk and return scenario of the firm.
The concept of financing mix has utility while deciding upon the hurdle rate for capital budgeting decisions under Chapter Six on Investment Decisions. Needless to say, this chapter too has applications in real life situations and requires thorough understanding of the concepts underlying each topic. Being a practically-oriented chapter, you need to practice a lot.
Chapter Six: Investment Decisions
The capital budgeting decisions are essential, fundamental and critical business decisions of a firm. Since these decisions need huge amount of capital outlay, are surrounded by great number of uncertainties and have long- term implications, therefore, there is an underlying need for thoughtful and correct decision-making. Capital budgeting decision-making is a difficult and complicated exercise for the management. These decisions require an overall assessment of future events which are quite uncertain. The basic concept underlining these decisions is investing in assets and projects which provide a greater return as compared to the minimum acceptable rate. This minimum acceptable rate also known as “hurdle rate” should be higher for riskier projects and should also reflect the financing mix used. Returns on projects should be measured based on cash flows generated and the timing of these cash flows. Both the positive and negative side effects of the projects should also be taken into consideration before a decision is taken. In this chapter you will not only study the importance of investment decisions but will also learn about the different tools and techniques which help in arriving at a sound financial decision. For instance, Net Present Value (NPV) represents the total value added or subtracted from the organisation if we invest in a particular project. Another method is Internal Rate of Return (IRR) which helps to determine the rate of return earned by a project.
One very pertinent concept of capital budgeting is what is relevant. For example, say what is relevant to a project cash flow? One of the main answers is Depreciation-Capital assets are subject to depreciation and you need to account for depreciation twice in your calculations of cash flows. Depreciation is deducted once to calculate the taxes paid on project revenues and then it is added back to arrive at cash flows because it is a non-cash item.
Chapter Seven: Management of Working Capital
This chapter introduces you to the concept of working capital management. Working capital is the capital needed by a firm for its day-to-day activity. From a company’s point of view, excess working capital means operating inefficiencies. Say for example, company’s money that is tied up in inventory or the amount of money that customers still owe to the company cannot be used to pay off any of the company’s obligations, therefore, if the company is not operating in the most efficient manner, it will show up as an increase in the working capital. Here you also study the management of cash, marketable securities, accounts receivables management, account payable, accruals and different means of short-term financing.
Two most important points to remember while studying working capital management are:
(a) The optimal level of investment in current assets, and
(b) The appropriate mix of short-term and long-term financing used to support this investment in current assets.
The chapter also delves upon the different approaches to management of working capital with the objective of maintaining optimum balance of each of the working capital components.
Examples: Here the concepts of ratio analysis, which you have studied in Chapter Three, can be used to monitor overall trends in working capital and to identify areas requiring closer management.
For computing the optimal level of Current Assets, you need to apply the ratio analysis concepts. As studied earlier, an ideal current ratio is 2. This means that the current ratio of 2 is considered as a safe margin of solvency due to the fact that if the current assets are reduced to half i.e. 1 instead of 2 then also the creditors will be able to get their payments in full. A very high current ratio is not desirable as it means less efficient use of funds by a company.
Similarly, the different forms of financing which you have gone through in Chapter Five on Types of Financing also have an implication in this chapter. Here the sources of short term financing are re-visited.
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