Strategic Financial Management

VISHNURAJ CR
ANJANA KS
ANJALY GOKUL

UNIT-1
Strategic financial management
Definition: According to G P Jakhoti,” SFM refers to both, the financial implications or aspects of various
business strategies and the strategic management of finance.” SFM related to the concept of applying financial
management practices to strategic decisions related to financial status.
Features:
• It relates to long term management of funds.it incorporates management with a strategic perspective on
finance as to how they are to accumulated, allocated, invested and reaped back in multiples. SFM is an
approach that takes a long-term view of financial performance of the business enterprises.
• It focuses on profitability and wealth maximization of profit.
• It takes into account on integrated and holistic view of the organization at present and decides its roadmap
for future.
• It promotes growth, profitability and sustainability of the organization in the long term.
• It applies contemporary and traditional financial evaluation techniques to enhance strategic decision
making.
• It is an innovative, creative, multidimensional and lateral thinking-oriented approach.
Scope:
i. Strategic investment management decisions: it involves decisions related to the long-term benefits.
Capital budgeting techniques are available to analyze risk and return level, using a number of methods.
ii. Strategic financing management decisions: it takes into account the amount of funds required in the
longrun.in this how much debts and fixed sources of funds are to be considered.
iii. Strategic liquidity management decisions: this decision are important as a firm has to maintain cash
reserves for future and contingencies. If the liquidity is not there, then firm may face financial agony.
iv. Strategic value creation of firm: it enhances the market status of the firm consistently well performing
companies win the trust of existing as well as potential stakeholders or investors. This increases the worth
of companies share in capital market.
v. Strategic profitability management: A company cannot sustain in future unless and until consisted
adequate profits are planned and generated. The source of revenue is pre-decided.
Importance:
• Proactive planning and forecasting funding needs
• Optimal utilization of resources

• Strategic investment plans
• Liquidity maintenance
• Increases the value of a firm
• Encourage consisted in profitability.
• Risk hedging
Constraints to SFM:
• Closely linked to personal attributes of strategies
• Lack of Technical know-how.
• Approach towards problem
• Resource constraints.
• Conflict between owners and strategic vision.
Strategic planning
Strategic planning relates to planning in advance for a long period of time. Planning involve foreseeing the
possibilities that can emerge in the future.it relates to making provision before they happened. It is a continuous
process that involves forecasting, intention, aspiration and predicting the possible opportunities, challenges,
threats and changes etc.
Components of strategic planning process:
Vision: A Vision Statement is a statement (typically 2-3 sentences) that gives the reader (and more
importantly, the organization) a mental picture of what the organization hopes to become or what the
organization hopes to achieve. It is important to understand where an organization is going before it can
develop a strategic plan for how to get there. The value of a vision statement is that is gives leadership
and employees a shared goal.
To facilitate a visioning session:
o Get the visionaries in a room.
o Ask them to close their eyes and describe the mental picture they see when the organization has reached
its optimal state.
o Document thoughts that describe the picture on a flip chart.
o Come to agreement on all that is described.
o Take some time to wordsmith or play with the wording until it describes the thoughts accurately.

Mission: A Mission Statement is an explanation of why an organization exists and the path it will take to achieve
its vision. Mission statements are typically shorter than a vision statement but not always and are organization
specific. This is a statement that describes what the organization is passionate about and why it exists.
To facilitate the mission statement process:
o Have the group look at vision statement and begin the process to brainstorm a mission statement.
o Go around the room and have everyone give a brief description (5-7 words) describing their thoughts and
document their answers on a flip chart.
o Once everyone has put their ideas down, look for similarities and usually a natural statement will flesh
itself out.
o Reword and refine the statement until everyone agrees that it reflects the mission of the organization.
Goals: Goals should be monitored at least on a quarterly basis. This can be as simple as asking the responsible
person to give a status update on their goals for the quarter. It is very important that this is done because all
organizations are so busy today that the day-to-day responsibilities can sometimes get in the way of completing
long-term goals. Once a year the strategic plan and goals should be reviewed and updated to reflect current market
conditions and changes to ensure that goals are focused on the current state of the organization.
Objectives: objectives are concrete goals that the organization seek to reach. For eg; an earnings growth target.
The objectives should be challenging but not achievable. They also should be measurable so that the company
can monitor its progress and make corrections as needed.
Balancing financial and goals and sustainable growth
The concept of sustainable growth can be helpful for planning healthy corporate growth. This concept forces
managers to consider the financial consequences of sales increases and to set sales growth goals that are consistent
with the operating and financial policies of the firm. Often, a conflict can arise if growth objectives are not
consistent with the value of the organization’s sustainable growth. Question concerning right distribution of
resources may take a difficult shape if we take into consideration the rightness not for the current stakeholders
but for the future stakeholders also. To take an illustration, let us refer to fuel industry where resources are limited
in quantity and a judicial use of resources is needed to cater to the need of the future customers along with the
need of the present customers. One may have noticed the save fuel campaign, a demarketing campaign that
deviates from the usual approach of sales growth strategy and preaches for conservation of fuel for their use across
generation. This is an example of stable growth strategy adopted by the oil industry as a whole under resource
constraints and the long run objective of survival over years. Incremental growth strategy, profit strategy and
pause strategy are other variants of stable growth strategy. Sustainable growth is important to enterprise long-
term development.

Corporate Valuation Methods.
While there are many different possible techniques to arrive at the value of a company—a lot of which are
company, industry, or situation-specific—there is a relatively small subset of generally accepted valuation
techniques that come into play quite frequently, in many different scenarios. We will describe these methods in
greater detail later in this training course:
• Comparable Company Analysis (Public Comps): Evaluating other, similar companies’ current valuation
metrics, determined by market prices, and applying them to the company being valued.
• Discounted Cash Flow Analysis (DCF): Valuing a company by projecting its future cash flows and then
using the Net Present Value (NPV) method to value the firm.
• Precedent Transaction Analysis (M&A Comps): Looking at historical prices for completed M&A
transactions involving similar companies to get a range of valuation multiples. This analysis attempts to arrive
at a “control premium” paid by an acquirer to have control of the business.
• Leverage Buyout/ “Ability to Pay” Analysis (LBO): Valuing a company by assuming the acquisition of the
company via a leveraged buyout, which uses a significant amount of borrowed funds to fund the purchase,
and assuming a required rate of return for the purchasing entity.
These valuation techniques are easily the most commonly used, other than in valuations for specific, niche
industries such as oil & gas or metal mining (and even in those industries, the aforementioned valuation techniques
frequently come into play). Different parts of the investment bank will use these core techniques for different
needs in different circumstances. Frequently, however, more than one technique will be used in a given situation
to provide different valuation estimates, with the concept being to triangulate a company’s value by looking at it
from multiple angels.
Unit-2
Types of Corporate Risk
• Strategic Risk:
A possible source of loss that might arise from the pursuit of an unsuccessful business plan. For
example, strategic risk might arise from making poor business decisions, from the substandard execution
of decisions, from inadequate resource allocation, or from a failure to respond well to changes in the
business environment.
• Financial Risk
Financial risk is the possibility that shareholders or other financial stakeholders will lose money when
they invest in a company that has debt if the company's cash flow proves inadequate to meet its financial

obligations. When a company uses debt financing, its creditors are repaid before shareholders if the
company becomes insolvent.
• Compliance Risk
Compliance risk is exposure to legal penalties, financial forfeiture and material loss an organization faces
when it fails to act in accordance with industry laws and regulations, internal policies or prescribed best
practices. It is also sometimes known as integrity risk. Many compliance regulations are enacted to ensure
that organizations operate fairly and ethically.
• Operational Risks
Operational risks result from internal failures. That is, your business’s internal processes, people or
systems fail unexpectedly. Therefore, unlike a strategic risk or a financial risk, there is no return on
operational risks. Operational risks can also result from unforeseen external events such as transportation
systems breaking down, or a supplier failing to deliver goods.
• Reputational Risk
Loss of a company’s reputation or community standing might result from product failures, lawsuits or
negative publicity. Reputations take time to build but can be lost in a day. In this era of social networking,
a negative Twitter posting by a customer can reduce earnings overnight. A negative blog post or a bad
product review can occasionally spread like wildfire online, quickly thrusting a company into damage-
control mode.
Sources of Uncertainty
Uncertainty in measurement can be influenced by many different factors. Below is a list of the 6 most common
sources of uncertainty in measurement. When you begin to identify sources of measurement uncertainty, you
should start by think about influences that are in these categories.
6 common sources of uncertainty in measurement:
• Equipment
• Unit Under Test
• Operator
• Method
• Calibration
• Environment

Investment Decisions Under Risk and Uncertainty
Meaning of Investment Decisions:
In the terminology of financial management, the investment decision means capital budgeting. Investment
decision and capital budgeting are not considered different acts in business world. In investment decision, the
word ‘Capital’ is exclusively understood to refer to real assets which may assume any shape viz. building, plant
and machinery, raw material and so on and so forth, whereas investment refers to any such real assets.
In other words, investment decisions are concerned with the question whether adding to capital assets today will
increase the revenues of tomorrow to cover costs. Thus investment decisions are commitment of money resources
at different time in expectation of economic returns in future dates.
Techniques of Investment Decision
Risk Adjusted Discount Rate Certainty Equivalent Method Statistical methods
Risk-Adjusted Discount Rate Method:
An estimation of the present value of cash for high risk investments is known as Risk-Adjusted Discount Rate.
A very common example of risky investment is the real estate. Risk adjusted discount rate is representing required
periodical returns by investors for pulling funds to the specific property. It is generally calculated as a sum of risk
free rate and risk premium. The variation of risk premium is depending on the risk aversion of investor and the
perception of investor about the size of property’s investment risk.
Risk-adjusted discount rate = Risk free rate + Risk premium
Certainty-Equivalent Method:
Under this method, adjusting cash inflows rather than adjusting the discount rate compensates risk element. The
expected uncertain cash flow of each year are modified by multiplying them with what is known as “certainty
Standard
Deviation
method
Coefficient
of variation
method
Decision tree
approach
Probability
&expected
value method
Simulation
method
Sensitivity
analysis

equivalent coefficient’ (CEO) to remove the element of uncertainty. This coefficient is determined by
management’s preferences with respect to risk.
Statistical methods
1.Standard Deviation method
Standard deviation is a statistical technique used in capital budgeting decisions to determine the variation or
deviation from the mean of cash flows of the project. The capital investment decision will be taken keeping in
view the variation in the expected value where two projects have the same expected value.
2. Coefficient of variation method
A coefficient of variation (CV) is a statistical measure of the dispersion of data points in a data series around the
mean. It is calculated as follows: (standard deviation) / (expected value). The coefficient of variation represents
the ratio of the standard deviation to the mean, and it is a useful statistic for comparing the degree of variation
from one data series to another, even if the means are drastically different from one another. It is calculated as
follows:
3. Sensitivity analysis
In sensitivity analysis, we analyze the degree of responsiveness of the dependent variable (here cash flow) for a
given change in any of the dependent variables (here sales and market share). In other words, sensitivity analysis
is a method in which the results of a decision are forecasted, if the actual performance deviates from the expected
or assumed performance.it has 3 assumptions:
a. Worst or Pessimistic Conditions: Refers to the most unfavorable economic situation for the project
b. Most likely: Refers to the most probable economic environment for the project
c. Optimistic Conditions: Indicates the most favorable economic environment for the project
Sensitivity analysis basically consists of three steps, which are as follows:
• Identifying all variables that affect the NPV or IRR of the project
• Establishing a mathematical relationship between the independent and dependent variables
• Studying and analyzing the impact of the change in the variables

4. Simulation method
Simulation attempts to imitate a real-world decision setting by using a mathematical model capture the important
functioning characteristics of the project as it evolves through time encountering random events, conditional on
management's preset operating strategy. This is also known as Statistical Trials or Monte Carlo simulation. In
traditional capital budgeting use repeated random sampling from probability distributions of crucial primary variables
underlying cash flows to arrive at output distributions or risk profiles of probable cash flows in the project NPV for
a given management strategy
5. Probability &expected value method
Probability is the likelihood of happening of an event. It is the percentage change of occurrence of each possible
event. Probability of chances of occurrence of any event lies between 0 and 1. In this method there are two steps
to determine the variability of return.
• Probability assignment
• Estimation of expected return or value
6. Decision tree approach
Decision tree analysis is one of the most effective methods of assessing risks associated in a project. In this
method, a decision tree is drawn for analyzing the risks associated in a project. A decision tree is the representation
of different probable decisions and their probable outcomes in a tree-like diagram. This method takes into account
all probable outcomes and makes the decision-making process easier.
UNIT – 3
Evolution of Financial Analysis:
Financial statement analysis (or financial analysis) is the process of reviewing and analyzing a
company's financial statements to make better economic decisions. These statements include the income
statement, balance sheet, statement of cash flows, and a statement of changes in equity. Financial statement
analysis is a method or process involving specific techniques for evaluating risks, performance, financial health,
and future prospects of an organization.
History:
Benjamin Graham and David Dodd first published their influential book "Security Analysis" in 1934. A central
premise of their book is that the market's pricing mechanism for financial securities such as stocks and bonds is
based upon faulty and irrational analytical processes performed by many market participants. This result in the

market price of a security only occasionally coinciding with the intrinsic value around which the price tends to
fluctuate. Investor Warren Buffett is a well-known supporter of Graham and Dodd's philosophy.
The Graham and Dodd approach is referred to as Fundamental analysis and includes: 1) Economic analysis; 2)
Industry analysis; and 3) Company analysis. The latter is the primary realm of financial statement analysis. On
the basis of these three analyses the intrinsic value of the security is determined.
Objectives of Financial Analysis:
(i) To assess the earning capacity or profitability of the firm.
(ii) To assess the operational efficiency and managerial effectiveness.
(iii) To assess the short term as well as long term solvency position of the firm.
(iv) To identify the reasons for change in profitability and financial position of the firm.
(v) To make inter-firm comparison.
(vi) To make forecasts about future prospects of the firm.
(vii) To assess the progress of the firm over a period of time.
(viii) To help in decision making and control.
(ix) To guide or determine the dividend action.
(x) To provide important information for granting credit.
Sources of Information:
In the financial analysis, there are used the information about the past, but we are working with current data and
assumptions on future developments as well. The financial analysis compares, processes, assesses and interprets
data. The financial analysis works with a large number of input and output data. Input data is obtained from
various sources and are of different nature. For providing an assessment of the financial analysis, the essential is
the quality of the underlying data. Formalized quantitative view of economic processes and phenomena is called
the economic indicator. Input data of the analysis have the character of various indicators. Financial analysis’s
results are also the different indicators. The sources of the input data for financial analysis are mainly: financial
statements – an essential source of data
• Annual report

• The internal account statements
• Prospectuses of the securities (in case of an issuer of securities)
• Interim financial statements
• Other sources of information, such as newspapers, magazines, the press conference
Steps in Financial Statement Analysis:
For any financial professional, it is important to know how to effectively analyze the financial statements of a
firm. This requires an understanding of three key areas:
1. The structure of the financial statements
2. The economic characteristics of the industry in which the firm operates and
3. The strategies the firm pursues to differentiate itself from its competitors.
There are generally six steps to developing an effective analysis of financial statements.
1. Identify the industry economic characteristics.
First, determine a value chain analysis for the industry—the chain of activities involved in the creation,
manufacture and distribution of the firm’s products and/or services. Techniques such as Porter’s Five Forces or
analysis of economic attributes are typically used in this step.
2. Identify company strategies.
Next, look at the nature of the product/service being offered by the firm, including the uniqueness of product,
level of profit margins, creation of brand loyalty and control of costs. Additionally, factors such as supply chain
integration, geographic diversification and industry diversification should be considered.
3. Assess the quality of the firm’s financial statements.
Review the key financial statements within the context of the relevant accounting standards. In examining balance
sheet accounts, issues such as recognition, valuation and classification are keys to proper evaluation. The main
question should be whether this balance sheet is a complete representation of the firm’s economic position. When
evaluating the income statement, the main point is to properly assess the quality of earnings as a complete
representation of the firm’s economic performance. Evaluation of the statement of cash flows helps in
understanding the impact of the firm’s liquidity position from its operations, investments and financial activities
over the period—in essence, where funds came from, where they went, and how the overall liquidity of the firm
was affected.

4. Analyze current profitability and risk.
This is the step where financial professionals can really add value in the evaluation of the firm and its financial
statements. The most common analysis tools are key financial statement ratios relating to liquidity, asset
management, profitability, debt management/coverage and risk/market valuation. With respect to profitability,
there are two broad questions to be asked: how profitable the operations of are the firm relative to its assets—
independent of how the firm finances those assets—and how profitable is the firm from the perspective of the
equity shareholders. It is also important to learn how to disaggregate return measures into primary impact factors.
Lastly, it is critical to analyze any financial statement ratios in a comparative manner, looking at the current ratios
in relation to those from earlier periods or relative to other firms or industry averages.
5. Prepare forecasted financial statements.
Although often challenging, financial professionals must make reasonable assumptions about the future of the
firm (and its industry) and determine how these assumptions will impact both the cash flows and the funding.
This often takes the form of pro-forma financial statements, based on techniques such as the percent of sales
approach.
6. Value the firm.
While there are many valuation approaches, the most common is a type of discounted cash flow methodology.
These cash flows could be in the form of projected dividends, or more detailed techniques such as free cash flows
to either the equity holders or on enterprise basis. Other approaches may include using relative valuation or
accounting-based measures such as economic value added.
Traditional and Modern Approaches:
1) Traditional Approach to Financial Statement Analysis:
Meaning: Traditional approach to financial statement analysis includes the Profit and Loss Account (i.e. Income
Statement) and the Balance Sheet.
Method of Preparation: Preparations of these statements are very simple.
Supplying Information: These statements are not so informative.
Reliability: Traditional approaches to financial statement analysis are neither so reliable nor so dependable for
the purpose of analysis of financial statements.
Information: The detailed information relating to financial information is not available from these statements as
they do not exhibit the required material information.
Presentation: Presentation of these statements is very old.

Specificity: An individual’s specific information, say, the liquidity position of a firm, is not available from these
statements accurately.
Use: Usually these statements are prepared by the small firms.
Area of Application: Under Traditional approach to financial statement analysis, Profit and Loss Account or
Income Statement helps us to know the result of the operation at the end of the year. The other statement, viz. the
Balance Sheet, helps us to understand the financial position as a whole at the end of the financial year.
Preparation and Presentation: Preparation and presentation of these statements are quite simple and mandatory
for all firms.
2) Modern Approach to Financial Statement Analysis:
Meaning: Modern approach to financial statement analysis includes Cash Flow Statement, Funds Flow
Statement, Ratio Analysis, Budgetary Control etc.
Method of Preparation: Preparations of these statements are not so simple.
Reliability: These statements are quite informative.
Reliability: These statements are proved to be quite reliable and dependable for the purpose of analysis of
financial statements.
Information: These statements, no doubt, exhibit the required material information for the purpose of analysis
of financial statements.
Presentation: Presentation of these statements is quite new and more informative than the Traditional Approach.
Specificity: Modern approach to financial statement analysis is quite possible to understand any specific
information from these statements, say, the liquidity position.
Use: These statements are usually prepared by the big business houses.
Area of Application: Under Modern approach to financial statement analysis, in addition to the benefits that are
available under traditional approach, the other material information viz. liquidity position, solvency position,
profitability and management efficiency position can easily be understood accurately.
Preparation and Presentation: Preparation and presentation of these statements are not so simple and the
preparations of these statements are not mandatory for all firms.

Tools of Financial Analysis:
Various methods are used to study the relationship between different statements. An effort is made to use those
devices which clearly analyze the financial position of the enterprise. The following methods of analysis are
generally used.
1. Comparative financial statements
2. Trend analysis
3. Common size statements
4. Ratio analysis
5. Funds Flow Analysis.
6. Cash Flow Analysis.
Comparative Financial Statements:
The comparative financial statements will provide a comparison between two stipulated periods for an
organization. It will also provide a comparison for two or more enterprises for one or more accounting periods.
These statements are designed to disclose (i) Absolute figures, (ii) Changes in absolute figures, (iii) Absolute data
in terms of percentages and (iv) Changes in terms of percentages. Comparative figures will indicate the trend and
direction of financial position and operating results. The two comparative statements are Balance Sheet and
Income statement of an organization.
Comparative Balance Sheet:
It represents not merely the balance of accounts drawn on two different dates but also the extent of their increase
or decrease between these two dates. It focuses on the changes that have taken place in one accounting period.
The changes are the direct outcome of operational activities.
Comparative Income Statement:
The comparative income statement gives an idea of the progress made of a business over a period of time. The
changes in absolute money values and percentages can be determined to analyze the profitability of the business.
Trend Analysis:
The financial statements may be analyzed by computing trends of series of information. This method determines
the direction of change over the period. It involves the computation of the percentage relationship that each item
in the statement bears to the same item in the base year. The information for a number of years is taken up and

the first year is taken as the base year. The figures of base year are taken as 100 and trend ratios for the subsequent
years are calculated on the basis of base year. The analyst is able to ascertain the trend of figures upward or
downward. Trend analysis includes the selection of a representative period as a base and expressing all items in
the financial statements of the periods studied in terms of an index.
Common Size Statements:
When the balance sheet and income statement items are shown in analytical percentages i.e., the percentages that
each item bears to the total of the appropriate item such as total assets, total liabilities, capital and net sales, the
common base for comparison is provided. The statements compiled in this form are termed as common size
statements. Common-size income statement shows each item as a percentage of sales and a common size balance
sheet shows each item as a percentage of total assets. The significant advantage of common size statements is that
they facilitate comparisons of balance sheets and income statements overtime and across companies.
Ratio Analysis:
Ratio analysis is a powerful tool of financial analysis. Its application to financial statements however appears to
be of recent origin. The construction of ratios is a major analytical tool in the hands of financial executives. The
ratios facilitate the analysts in pointing out the relative importance of the various items appearing in the financial
statements. Each major item in the balance sheet and profit and loss account has a relationship with one or more
items in either or both statements which can be expressed in ratios. But using ratios comparison with financial
statements of other firms are facilitated and comparison of a firm's financial performance can too be made over a
period of time.
RATIO:
Ratios simply one number expressed in terms of another. It is an expression of relationship spelt out by dividing
one figure into the other. The relationship between two figures expressed mathematically is called a ratio.
As per the Dictionary meaning Ratio represents the relation of one thing on another of which the quotient is the
measure. According to J. Batty, the term accounting ratio is used to describe the significant relationship between
figures in a balance sheet, profit and loss account in a budgetary control, system or any other part of accounting
organization
Financial ratios portray relationships that exist between various items appearing in balance sheets and income
accounts and occasionally other items. They may be expressed in simple mathematical terms. They are used to
measure and evaluate the financial condition and operating effectiveness of a business enterprise.

Ratios provide the analyst with a set of summary which measures of the firm's debt burden, operating efficiency
and profitability. Financial ratios are no substitute for a crystal ball. They are just a convenient way to summarizes
large quantities of financial data and to compare firm's performance.
Ratios calculated from the available data in the financial statements may be classified as follows:
• PROFITABILITY RATIOS:
Profitability ratios measure the efficiency of the company's activities and its ability to generate profits. Poor
performance indicates the failure of the business which may lead to liquidation of the company in the long run.
• SOLVENCY RATIOS:
These ratios examine the adequacy of funds and the company's ability to pay its obligations when it becomes due.
These ratios measure the short-term solvency of the company.
• EFFICIENCY AND PERFORMANCE RATIOS:
These ratios indicate the effective utilization of various assets and funds invested by the creditors and
shareholders. The better the management of funds and assets the larger the amount of sales, and hence the profits
of the company.
Fund Flow Analysis:
Funds flow statement is a statement which discloses the analytical information about the different sources of a
fund and the application of the same in an accounting cycle. It deals with the transactions which change either the
amount of current assets and current liabilities (in the form of decrease or increase in working capital) or fixed
assets, long-term loans including ownership fund.
It gives a clear picture about the movement of funds between the opening and closing dates of the Balance Sheet.
It is also called the Statement of Sources and Applications of Funds, Movement of Funds Statement; Where Got—
Where Gone Statement: Inflow and Outflow of Fund Statement, etc. No doubt, Funds Flow Statement is an
important indicator of financial analysis and control. It is valuable and also helps to determine how the funds are
financed. The financial analyst can evaluate the future flows of a firm on the basis of past data.
This statement supplies an efficient method for the financial manager in order to assess the:
(a) Growth of the firm,

(b) Its resulting financial needs, and
(c) To determine the best way to finance those needs.
Cash Flow Analysis:
The cash flow statement shows how much cash comes in and goes out of the company over the quarter or the
year. At first glance, that sounds a lot like the income statement in that it records financial performance over a
specified period. But there is a big difference between the two.
What distinguishes the two is accrual accounting, which is found on the income statement. Accrual accounting
requires companies to record revenues and expenses when transactions occur, not when cash is exchanged. At the
same time, the income statement, on the other hand, often includes non-cash revenues or expenses, which the
statement of cash flows does not include.
Just because the income statement shows net income of $10 does not mean that cash on the balance sheet will
increase by $10. Whereas when the bottom of the cash flow statement reads $10 net cash inflow, that's exactly
what it means. The company has $10 more in cash than at the end of the last financial period. You may want to
think of net cash from operations as the company's "true" cash profit.
Because it shows how much actual cash a company has generated, the statement of cash flows is critical to
understanding a company's fundamentals. It shows how the company is able to pay for its operations and future
growth.
Indeed, one of the most important features you should look for in a potential investment is the company's ability
to produce cash. Just because a company shows a profit on the income statement doesn't mean it cannot get into
trouble later because of insufficient cash flows. A close examination of the cash flow statement can give investors
a better sense of how the company will fare.
Three Sections of the Cash Flow Statement
Companies produce and consume cash in different ways, so the cash flow statement is divided into three sections:
cash flows from operations, financing and investing. Basically, the sections on operations and financing show
how the company gets its cash, while the investing section shows how the company spends its cash.
i. Cash Flows from Operating Activities:

This section shows how much cash comes from sales of the company's goods and services, less the amount of
cash needed to make and sell those goods and services. Investors tend to prefer companies that produce a net
positive cash flow from operating activities. High growth companies, such as technology firms, tend to show
negative cash flow from operations in their formative years. At the same time, changes in cash flow from
operations typically offer a preview of changes in net future income. Normally it's a good sign when it goes up.
Watch out for a widening gap between a company's reported earnings and its cash flow from operating activities.
If net income is much higher than cash flow, the company may be speeding or slowing its booking of income or
costs.
ii. Cash Flows from Investing Activities:
This section largely reflects the amount of cash the company has spent on capital expenditures, such as new
equipment or anything else that needed to keep the business going. It also includes acquisitions of other businesses
and monetary investments such as money market funds.
You want to see a company re-invest capital in its business by at least the rate of depreciation expenses each year.
If it doesn't re-invest, it might show artificially high cash inflows in the current year which may not be sustainable.
iii. Cash Flow from Financing Activities:
This section describes the goings-on of cash associated with outside financing activities. Typical sources of cash
inflow would be cash raised by selling stock and bonds or by bank borrowings. Likewise, paying back a bank
loan would show up as a use of cash flow, as would dividend payments and common stock repurchases.
UNIT – 4
Corporate Restructuring
Definition: The Corporate Restructuring is the process of making changes in the composition of a firm’s one or
more business portfolios in order to have a more profitable enterprise. Simply, reorganizing the structure of the
organization to fetch more profits from its operations or is best suited to the present situation.
Corporate Restructuring means any change in the business capacity or portfolio that is carried out by inorganic
route or any change in the capital structure of a company that is not in the ordinary course of its business or any
change in the ownership of a company or control over its management or a combination of any two or all of the
above.
The Corporate Restructuring takes place in two forms:

1. Financial Restructuring: The Financial Restructuring may take place due to a drastic fall in the sales
because of the adverse economic conditions. Here, the firm may change the equity pattern, cross-holding pattern,
debt-servicing schedule and the equity holdings. All this is done to sustain the profitability of the firm and sustain
in the market. Generally, the financial or legal advisors are hired to assist the firms in the negotiations.
2. Organizational Restructuring: The Organizational Restructuring means changing the structure of an
organization, such as reducing the hierarchical levels, downsizing the employees, redesigning the job positions
and changing the reporting relationships. This is done to cut the cost and pay off the outstanding debt to continue
with the business operations in some manner.
Purpose for Corporate Restructuring
Purpose behind corporate restructuring are:
1. Induce higher earnings
2. Leverage core competencies
3. Divestiture and make business alliances
4. Ensure clarity in vision, strategy and structure
5. Provide proactive leadership
6. Empowerment of employees, and
7. Reengineering Process
1. Induce Higher Earnings: The prime goal of financial management is to maximize profit there by firm’s
value. Firm may not be able to generate constant profits throughout its life. When there is change in business
environment, and there is no change in firm’s strategies. The two basic goals of corporate restructuring may
include higher earnings and the creation of corporate value. Creation of corporate value largely depends on
the firm’s ability to generate enough cash. Thus, corporate restructuring helps to firms to increase their profits.
2. Leverage Core Competence: Core competence was seen as a capability or skill running through a firm’s
business that once identified, nurtured, and developed throughout the firm became the basis for lasting
competitive advantage. For example, Dell Computer built its first 10-year of unprecedented growth by
creating an organization capable of the speedy and in expensive manufacture and delivery of custom-built
PCs.
3. Divestiture and Business Alliances: Sometimes companies may not be able to run all the companies, which
are there in-group, and companies which are not contributing may need to be divested and concentrate on core

competitive business. Companies, while keeping in view their core competencies, should exit from
peripherals. This can be realized through entering into joint ventures, strategic alliances and agreements.
4. Ensure Clarity in Vision, Strategy and Structure: Corporate restructuring should focus on vision, strategy
and structure. Companies should be very clear about their goals and the heights that they plan to scale. A
major emphasis should also be made on issues concerning the time frame and the means that influence their
success.
5. Provide Proactive Leadership: Management style greatly influences the restructuring process. All
successful companies have clearly displayed leadership styles in which managers relate on a one-to-one basis
with their employees.
6. Empowerment of Employees: Empowerment is a major constituent of any restructuring process. Delegation
and decentralized decision making provides companies with effective management information system.
7. Reengineering Process: Success in a restructuring process is only possible through improving various
processes and aligning resources of the company. Redesigning a business process should be the highest
priority in a corporate restructuring exercise.
The above discussed are the purpose for corporate restructuring.
Types of corporate restructurings
1. expansion strategies
It is the most common and convenient form of restructuring, which involves only increasing the existing level of
capacity. Expansion of business needs more funds to be raised either in the form of equity or debt or both and the
funds are used to finance the fixed assets required for manufacturing the expanded level of production. This
increase firm’s profitability, thereby value of the firm
a) Merger / Amalgamation: A merger is a combination of two or more businesses into one business. Laws in
India use the term ‘amalgamation’ for merger. Amalgamation is the merger of one or more companies with
another or the merger of two or more companies to form a new company, in such a way that all assets and
liabilities of the amalgamating companies become assets and liabilities of the amalgamated company.
i. Merger through Absorption: - An absorption is a combination of two or more companies into an
‘existing company’. All companies except one lose their identity in such a merger. For example,
absorption of Tata Fertilizers Ltd (TFL) by Tata Chemicals Ltd. (TCL).
ii. Merger through Consolidation: - A consolidation is a combination of two or more companies into a
‘new company’. In this form of merger, all companies are legally dissolved and a new entity is created.
Here, the acquired company transfers its assets, liabilities and shares to the acquiring company for cash
or exchange of shares. For example, merger of Hindustan Computers Ltd, Hindustan Instruments Ltd,
Indian Software Company Ltd and Indian Reprographics Ltd into an entirely new company called HCL
Ltd.

2. Acquisitions and Takeovers:
A ‘takeover’ is acquisition and both the terms are used interchangeably. Takeover differs from merger in approach
to business combinations i.e. the process of takeover, transaction involved in takeover, determination of the share
exchange or cash price and fulfillment of goals of combination all are different in takeovers than in mergers. For
example, process of takeover is unilateral and the offeror company decides about the maximum price. Time taken
in completion of transaction is less in takeover than in mergers, top management of the offered company being
more co-operative. When an acquisition is ‘forced’ or ‘unwilling’, it is called a takeover.
3. Business alliances
A business alliance is a formal business relationship between two or more organizations to achieve collective
business objectives. Joint ventures, franchising, cross-licensing, cross-marketing and co-manufacturing are just
some of the formal structures used to govern business alliances. Each type of alliance offers both advantages and
disadvantages, but generally enables a company to realize its growth potential more quickly than if pursuing an
objective alone.
a) Joint Ventures
Occasionally two or more capable firms lack a necessary component for success in a particular competitive
environment. For example, no single petroleum firm controlled sufficient resources to construct the Alaskan
pipeline. Nor was any single firm capable of processing and marketing all of the oil that would flow through the
pipeline. The solution was joint ventures. A joint venture is set up an independent legal entity in, which two or
more separate firms participate. The joint venture agreement clearly indicates how the cooperating members will
share ownership, operational responsibilities, and financial risks and rewards example, of JV Fuji-Xerox, JV to
produce photocopiers, for the Japanese market.
b) Franchising
A special form of licensing is franchising, which allows the franchisee to sell a highly publicized product or
service, using the parent’s brand name or trademark, carefully developed procedures, and marketing strategies.
In exchange, a franchisee pays a fee to parent firm, typically based on the volume of sales of the franchisor in its
defined market area. Most attractive franchisees are Coca-Cola, Kentucky Fried Chicken, and Pepsi.
c) Strategic Alliances
A strategic alliance is cooperative relationship like joint venture but is does not create a separate legal entity. In
other words, companies involved do not take an equity position in one another. In many instances, strategic
alliances are partnerships that exist for a defined period during which partners contribute their skills (transfer
technology, or provide R&D service, or grant marketing rights etc.) and expertise to a cooperative project. For
example, service and franchise-based firms like Coca-Cola, McDonald’s and Pepsi have long engaged in licensing
arrangements with foreign distributors as a way to enter new markets.
4. leveraged buyout

A leveraged buyout (LBO) is a restructuring of the capitalization and ownership of a company. The
term leveraged refers to the use of debt as the primary method of financing the restructuring. The buyout portion
refers to the fact that the method is often used to transform a publicly held company into one that is privately held.
LBO can be defined as the acquisition, financed largely by borrowings of all the stocks or assets of a higher to
public company by a small group of investors. The LBO differs from the ordinary acquisition into ways: Firstly,
a large fraction of the purchase price is debt financed through junk bonds and secondly, the shares of LBOs are
not trades in the open market. There are a number of reasons why this type of transaction might take place. These
include cost savings, managerial incentives, decreasing the total number of owners, tax benefits, flexibility, and
control. Oftentimes, the group pursuing the buyout includes the publicly held firm's upper management. This type
of action is known as a management buyout (MBO).
5. Constraints to Restructuring
Restructuring is the corporate management term for the act of partially dismantling and reorganizing a company
for the purpose of making it more efficient and therefore more profitable. It generally involves selling off
portions of the company and making severe staff reductions. Restructuring is often done as part of a bankruptcy
or of a takeover by another firm, particularly a leveraged buyout by a private equity firm. It may also be done
by a new CEO hired specifically to make the difficult and controversial decisions required to save or reposition
the company. It indicates to a broad array of activities that expand or contract a firm’s operations or
substantially modify its financial structure or bring about a significant change in its organizational structure and
internal functioning. It includes activities such as mergers, buyouts, and takeovers, business alliances, slump
sales, demergers, equity carve outs, going private, leverage buyouts (LBOs), organizational restructuring, and
performance improvement initiatives.
6. buyback of shares
Buy-back of securities is similar to a company purchasing its own debentures for cancellation or redemption of
preference shares. In the case of buy-back, the company which has issued shares to the public, buys-back or
repurchases its own shares. Just as shares may be issued at par, at a premium or at a discount, re-purchase may
also be affected at par, at a premium or at a discount. Buy-back of shares has the effect of reducing the
company’s equity share capital to the extent of the par value of shares re-purchased.
Companies with surplus of cash, may resort to this method of paying the surplus back to its investors instead of
paying the same as dividend. Redundant capital may be reduced and the risk of over-capitalization may be
avoided. This method may also be resorted to in order to increase the share value, by enhancing the earning per
share.

Advantages of Buy-Back of Securities
(i) A company with capital, which cannot be profitably employed, may get rid of it by resorting to buy-back,
and re-structure its capital.
(ii) Free reserves which are utilized for buy-back instead of dividend enhance the value of the company’s shares
and improve earnings per share.
(iii) Surplus cash may be utilized by the company for buy-back and avoid the payment of dividend tax.
(iv) Buy-back may be used as a weapon to frustrate any hostile take-over of the company by undesirable persons.
7. Divestment strategies
Divestment is a form of retrenchment strategy used by businesses when they downsize the scope of their business
activities. Divestment usually involves eliminating a portion of a business. Firms may elect to sell, close, or spin-
off a strategic business unit, major operating division, or product line. This move often is the final decision to
eliminate unrelated, unprofitable, or unmanageable operations.
Reason for Divestment
• Market share too small
• Availability of better alternatives
• Need for increased investment.
• Lack of strategic fit.
• Legal pressures to divest.
8. Liquidation
Under liquidation, a company is broken apart and the assets or the divisions are sold piece by piece. Generally,
liquidations are linked to bankruptcies. Liquidation in finance and economics, is the process of bringing a business
to an end and distributing its assets to claimants. It is an event that usually occurs when a company is insolvent,
meaning it cannot pay its obligations when they come due. As company operations end, the remaining assets are
used to pay creditors and shareholders, based on the priority of their claims.

UNIT – 5
Mergers & Acquisitions
Mergers and acquisitions (M&A) are defined as consolidation of companies. Differentiating the two
terms, Mergers is the combination of two companies to form one, while Acquisitions is one company taken over
by the other. M&A is one of the major aspects of corporate finance world. The reasoning behind M&A generally
given is that two separate companies together create more value compared to being on an individual stand. With
the objective of wealth maximization, companies keep evaluating different opportunities through the route of
merger or acquisition.
Mergers & Acquisitions can take place:
• by purchasing assets
• by purchasing common shares
• by exchange of shares for assets
• by exchanging shares for shares
Reasons for Mergers and Acquisitions:
• Financial synergy for lower cost of capital
• Improving company’s performance and accelerate growth
• Economies of scale
• Diversification for higher growth products or markets
• To increase market share and positioning giving broader market access
• Strategic realignment and technological change
• Tax considerations
• Undervalued target
• Diversification of risk
• Create an image of aggressiveness and strategic opportunity, empire building and to amass vast economic
powers of the economy.
Problem with Merger
• Clash of corporate Cultures
• Increased Business Complexity
• Employees may be resistant to change

Types of Mergers & Acquisitions
1. Conglomerate
A merger between firms that are involved in totally unrelated business activities. There are two types of
conglomerate mergers: pure and mixed. Pure conglomerate mergers involve firms with nothing in common, while
mixed conglomerate mergers involve firms that are looking for product extensions or market extensions.
Example
A leading manufacturer of athletic shoes, merges with a soft drink firm. The resulting company is faced with the
same competition in each of its two markets after the merger as the individual firms were before the merger. One
example of a conglomerate merger was the merger between the Walt Disney Company and the American
Broadcasting Company.
2. Horizontal Merger
A merger occurring between companies in the same industry. Horizontal merger is a business consolidation that
occurs between firms who operate in the same space, often as competitors offering the same good or service.
Horizontal mergers are common in industries with fewer firms, as competition tends to be higher and the synergies
and potential gains in market share are much greater for merging firms in such an industry.
Example
A merger between Coca-Cola and the Pepsi beverage division, for example, would be horizontal in nature. The
goal of a horizontal merger is to create a new, larger organization with more market share. Because the merging
companies' business operations may be very similar, there may be opportunities to join certain operations, such
as manufacturing, and reduce costs.
3. Vertical Merger
A merger between two companies producing different goods or services for one specific finished product. A
vertical merger occurs when two or more firms, operating at different levels within an industry's supply chain,
merge operations. Most often the logic behind the merger is to increase synergies created by merging firms that
would be more efficient operating as one.
Example
A vertical merger joins two companies that may not compete with each other, but exist in the same supply chain.
An automobile company joining with a parts supplier would be an example of a vertical merger. Such a deal
would allow the automobile division to obtain better pricing on parts and have better control over the
manufacturing process. The parts division, in turn, would be guaranteed a steady stream of business.

4. Market Extension Mergers
A market extension merger takes place between two companies that deal in the same products but in separate
markets. The main purpose of the market extension merger is to make sure that the merging companies can get
access to a bigger market and that ensures a bigger client base.
5. Product Extension Mergers
A product extension merger takes place between two business organizations that deal in products that are related
to each other and operate in the same market. The product extension merger allows the merging companies to
group together their products and get access to a bigger set of consumers. This ensures that they earn higher
profits.
Steps involved in a merger transaction in India (for M&A process no need to 6 to 13)
1. Determine Growth Markets/Services:
Leaders start the acquisition evaluation process by identifying growth opportunities in business or service lines,
markets served, or any combination thereof. To determine growth markets and services, leaders must collect and
analyze extensive data, including the following: client origin; demographics (population, age,
employment/unemployment rates, income); employers; other competitors; business, program, and service mix
(performance and profitability by service line); field staff; employees; utilization/case mix (demand projections);
competitive cost/charge position; and consumer preferences/ opinions
2. Identify Merger and Acquisition Candidates:
The second step of the acquisition process involves the proactive identification of the universe of potential merger
or acquisition candidates that could meet strategic financial growth objectives in identified markets or service
lines. This involves methodically identifying “likely suspects” as well as “outside the box” possibilities based on
management experience, research, the use of consultants, and other methods.
3. Assess Strategic Financial Position and Fit:
At this stage following questions shall be answered,
• What are the likely benefits of a transaction with this acquisition target?
• What are the risks?
• How does this target compare to other targeted opportunities?
Financial Position:

A comprehensive evaluation of the financial and credit position of the target and the combined entities is based
on solid utilization and financial forecasts. The assessment focuses on volume, revenue, cost, and balance sheet
considerations.
4. Make a Go/No-Go Decision:
Corporate leadership must determine the likely benefits and drawbacks of the proposed acquisition or merger
according to the questions discussed earlier and make a high-quality decision.During the decision-making
process, leaders identify whether the strategic value-added case for a combined entity is compelling enough to
proceed (or not).
5. Conduct Valuation
The fifth step in the acquisition process involves assessing the value of the target, identifying alternatives for
structuring the merger or acquisition transactions, evaluating these, and selecting the structure that would best
enable the organization to achieve its objectives, and developing an offer.There are three key valuation methods:
discounted cash flow analysis, comparable transaction analysis, and comparable publicly traded company
analysis. To identify a realistic valuation range, corporate leadership should select best suitable method.
6. Approval of Board of Directors for the Scheme
7. Approval from other Boards
8. Examination of Object Clause
9. Application to Court for Directions
10. Approval of Registrar of High Court to notice for calling the meeting of Members / Creditors
11. Dispatch of Notices to Members / Shareholders
12. Holding the Shareholders’ General meeting and passing the resolutions
13. Allotment of Shares to Shareholders of Transferor Company
14. Implement Transaction and Monitor Ongoing Performance:
The analysis seeks answers to such questions as,
• Will management make the tough operational changes required to achieve the financial benefits?
• What are the HR implications? Is there constituent support (management, board, service providers,
community, and employees)?
• What are the legal and regulatory challenges (Court approvals, SEBI Regulations, Tax implications, etc)?
• What are the financial, organizational, and community-related risks of failure?
A successful merger or acquisition involves combining two organizations in an expedient manner to maximize
strategic value while minimizing distraction or disruption to existing operations.

REVERSE MERGER?
A reverse merger is a merger in which a private company becomes a public company by acquiring it. It saves a
private company from the complicated process and expensive compliance of becoming a public company. Instead,
it acquires a public company as an investment and converts itself into a public company.
However, there is another angle to the concept of a reverse merger. When a weaker or smaller company acquires
a bigger company, it is a reverse merger. In addition, when a parent company merges into its subsidiary or a loss-
making company acquires a profit-making company, it is also termed as a reverse merger.
financial distress
Tight cash situation in which a business, household, or individual cannot pay the owed amounts on the due date.
If prolonged, this situation can force the owing entity into bankruptcy or forced liquidation. It is compounded by
the fact that banks and other financial institutions refuse to lend to those in serious distress. When a firm is under
financial distress, the situation frequently sharply reduces its market value, suppliers of goods and
services usually insist on COD terms, and large customer may cancel their orders in anticipation of not
getting deliveries on time.

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