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Tourism Finance Management

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Tourism Finance Management

  1. 1. Tourism Finance Mgt©Ramakrishna Kongalla
  2. 2. Meaning of Financial Management• Financial Management means planning, organizing, directing andcontrolling the financial activities such as procurement and utilization offunds of the enterprise. It means applying general managementprinciples to financial resources of the enterprise.Scope/Elements• Investment decisions includes investment in fixed assets (called ascapital budgeting). Investment in current assets are also a part ofinvestment decisions called as working capital decisions.• Financial decisions - They relate to the raising of finance from variousresources which will depend upon decision on type of source, period offinancing, cost of financing and the returns thereby.• Dividend decision - The finance manager has to take decision withregards to the net profit distribution. Net profits are generally dividedinto two:– Dividend for shareholders- Dividend and the rate of it has to be decided.– Retained profits- Amount of retained profits has to be finalized which willdepend upon expansion and diversification plans of the enterprise.Rtist@Tourism, Pondicherry University 2
  3. 3. • There are three key elements to the process of financial management:(1) Financial Planning• Management need to ensure that enough funding is available at the right time to meetthe needs of the business. In the short term, funding may be needed to invest inequipment and stocks, pay employees and fund sales made on credit.• In the medium and long term, funding may be required for significant additions to theproductive capacity of the business or to make acquisitions.(2) Financial Control• Financial control is a critically important activity to help the business ensure that thebusiness is meeting its objectives. Financial control addresses questions such as:– Are assets being used efficiently?– Are the businesses assets secure?– Do management act in the best interest of shareholders and in accordance with business rules?(3) Financial Decision-making• The key aspects of financial decision-making relate to investment, financing anddividends:– Investments must be financed in some way – however there are always financing alternatives thatcan be considered. For example it is possible to raise finance from selling new shares, borrowingfrom banks or taking credit from suppliers– A key financing decision is whether profits earned by the business should be retained rather thandistributed to shareholders via dividends. If dividends are too high, the business may be starved offunding to reinvest in growing revenues and profits further.Rtist@Tourism, Pondicherry University 3
  4. 4. Functions of Financial ManagementEstimation of capital requirements: A finance manager has to make estimation with regards to capitalrequirements of the company. This will depend upon expected costs and profits and future programmesand policies of a concern. Estimations have to be made in an adequate manner which increases earningcapacity of enterprise.Determination of capital composition: Once the estimation have been made, the capital structure have to bedecided. This involves short- term and long- term debt equity analysis. This will depend upon theproportion of equity capital a company is possessing and additional funds which have to be raised fromoutside parties.Choice of sources of funds: For additional funds to be procured, a company has many choices like-– Issue of shares and debentures– Loans to be taken from banks and financial institutions– Public deposits to be drawn like in form of bonds.• Choice of factor will depend on relative merits and demerits of each source and period of financing.Investment of funds: The finance manager has to decide to allocate funds into profitable ventures so thatthere is safety on investment and regular returns is possible.Disposal of surplus: The net profits decision have to be made by the finance manager. This can be done in twoways:– Dividend declaration - It includes identifying the rate of dividends and other benefits like bonus.– Retained profits - The volume has to be decided which will depend upon expansional, innovational, diversificationplans of the company.Management of cash: Finance manager has to make decisions with regards to cash management. Cash isrequired for many purposes like payment of wages and salaries, payment of electricity and water bills,payment to creditors, meeting current liabilities, maintainance of enough stock, purchase of rawmaterials, etc.Financial controls: The finance manager has not only to plan, procure and utilize the funds but he also has toexercise control over finances. This can be done through many techniques like ratio analysis, financialforecasting, cost and profit control, etc.Rtist@Tourism, Pondicherry University 4
  5. 5. Importance• (i) success of Promotion Depends on FinancialAdministration. One of the most importantreasons of failures of business promotions is adefective financial plan. If the plan adopted failsto provide sufficient capital to meet therequirement of fixed and fluctuating capital anparticularly, the latter, or it fails to assume theobligations by the corporations withoutestablishing earning power, the business cannotbe carried on successfully. Hence soundfinancial plan is very necessary for the successof business enterprise.• (ii) Smooth Running of an Enterprise. SoundFinancial planning is necessary for the smoothrunning of an enterprise. Money is to anenterprise, what oil is to an engine. As, Financeis required at each stage f an enterprise, i.e.,promotion, incorporation, development,expansion and administration of day-to-dayworking etc., proper administration of finance isvery necessary. Proper financial administrationmeans the study, analysis and evaluation of allfinancial problems to be faced by themanagement and to take proper decision withreference to the present circumstances inregard to the procurement and utilisation offunds.• (iii) Financial Administration Co-ordinatesVarious Functional Activities. Financialadministration provides complete co-ordinationbetween various functional areas such asmarketing, production etc. to achieve theorganisational goals. If financial management isdefective, the efficiency of all otherdepartments can, in no way, be maintained. Forexample, it is very necessary for the finance-department to provide finance for the purchaseof raw materials and meting the other day-to-day expenses for the smooth running of theproduction unit. If financial department fails inits obligations, the Production and the sales willsuffer and consequently, the income of theconcern and the rate of profit on investmentwill also suffer. Thus Financial administrationoccupies a central place in the businessorganisation which controls and co-ordinates allother activities in the concern.• (iv) Focal Point of Decision Making. Almost,every decision in the business is take in the lightof its profitability. Financial administrationprovides scientific analysis of all facts andfigures through various financial tools, such asdifferent financial statements, budgets etc.,which help in evaluating the profitability of theplan in the given circumstances, so that aproper decision can be taken to minimise therisk involved in the plan.Rtist@Tourism, Pondicherry University 5
  6. 6. • (v) Determinant of Business Success. It hasbeen recognised, even in India that the financialmanger splay a very important role in thesuccess of business organisation by advising thetop management the solutions of the variousfinancial problems as experts. They presentimportant facts and figures regarding financialposition an the performance of variousfunctions of the company in a given periodbefore the top management in such a way so asto make it easier for the top management toevaluate the progress of the company to amendsuitably the principles and policies of thecompany. The financial manges assist the topmanagement in its decision making process bysuggesting the best possible alternative out ofthe various alternatives of the problemavailable. Hence, financial management helpsthe management at different level in takingfinancial decisions.(vi) Measure of Performance. The performanceof the firm can be measured by its financialresults, i.e, by its size of earnings Riskiness andprofitability are two major factors which jointlydetermine the value of the concern. Financialdecisions which increase risks will decrease thevalue of the firm and on the to the hand,financial decisions which increase theprofitability will increase value of the firm. Riskan profitability are two essential ingredients of abusiness concern.• importance of financial management canbe summarized as follows:• It brings economic growth anddevelopment through investments ,financing, dividend and risk managementdecision which help companies toundertake better projects.• When there is good growth anddevelopment of the economy it willultimately improve the standard of livingof all people.• Improved standard of living will lead togood health and financial stress willreduce considerably.• It enables the individual to take betterfinancial decision which will reducepoverty, reduce debts and increasesavings and investments.• Better financial ability will lead toprofitability which will create new jobsand in turn lead to more development ,expansion and will promote efficiency.Rtist@Tourism, Pondicherry University 6
  7. 7. Types of Finance• OverdraftA popular form of finance because it has theadvantages of availability, convenience andflexibility. However, because interest rates are high,it should only be used for short-term requirementssuch as funding working capital. Find out moreabout Overdraft.Bank term loansThese provide fixed-term finance for longerperiods. They are often secured by a charge againstcompany assets and require you to sign legallybinding covenants. Find out more about our Loansand Finance productsAsset-based financeThis describes financing an asset over its estimatedlife span using the asset as security for the loan. Itcan be structured so that the borrower has thesole right to use the asset and ownership transfersto the borrower at the end of the loan period. Findout more about our Asset Finance productsReceivables FinanceThis form of finance uses outstanding customerinvoices as security. Find out moreabout Receivables Finance.• Invoice discountingSimilar to Receivables Finance, this is usually onlyoffered to larger companies with strong creditmanagement systems.Angel fundingAn individual invests in a company in return forshares in the company.Venture capitalThere are organisations that specialise in investingin unquoted companies which they believe willoffer high returns to investors. There is strongcompetition for this type of finance and youshould only consider it after assessing all thealternatives.Personal resourcesThese include personal savings, money borrowedfrom family and friends, or profits generated bythe business.Rtist@Tourism, Pondicherry University 7
  8. 8. Financial goals of organisation• Financial Goals of Organization• The two important financial goals oforganization can be– profit maximization and– wealth maximization.• Out of this wealth maximization is mostimportant because it is based on cash flows ofthe organizations.• On the other profit maximization can be vagueas there can be multiple interpretations ofprofits.• Moreover profits do not take care of time valueof money and ignore risk attached to thereturns.• Also profit maximization focus on short termprofitability which may not lead to long termwealth creation.• Hence financial management is concerned withvalue maximization.• Managements efforts are for increasing thevalue of the company for the shareholders.• This requires investing in projects that are likelyto provide positive returns to the company.• Hence wealth maximization accounts for thetiming and risk of the expected benefits.• Earnings are valued by deducting the total costsfrom total income.• Hence Net Earnings = Total Income - Total costs.• Cash flows will only take cash inflows and cashoutflows.• Increase in cash flows can lead to improvement inwealth maximization.• Management decisions affect the stockholderwealth greatly. They can affect the wealth byfollowing decisions:– Present and future earnings per share– Investment decision: This is related to decidingabout the composition of fixed assets– Financing decision: This is deciding about the mixof sources of funds– Working capital managements– Profit allocation decisions• We must understand that the firms primaryobjective is maximizing the welfare of owners,but, in operational terms, they focus on thesatisfaction of its customers through theproduction of goods and services needed bythem.• Firms state their vision, mission and values inbroad terms. Wealth maximization is moreappropriately a decision criterion, rather than anobjective or a goal.Rtist@Tourism, Pondicherry University 8
  9. 9. Financial Forecasting• Financial Forecasting describes the process by which firms think about andprepare for the future. The forecasting process provides the means for a firmto express its goals and priorities and to ensure that they are internallyconsistent. It also assists the firm in identifying the asset requirements andneeds for external financing.• For example, the principal driver of the forecasting process is generally thesales forecast. Since most Balance Sheet and Income Statement accounts arerelated to sales, the forecasting process can help the firm assess the increasein Current and Fixed Assets which will be needed to support the forecastedsales level. Similarly, the external financing which will be needed to pay for theforecasted increase in assets can be determined.• Firms also have goals related to Capital Structure (the mix of debt and equityused to finance the firms assets), Dividend Policy, and Working CapitalManagement. Therefore, the forecasting process allows the firm to determineif its forecasted sales growth rate is consistent with its desired CapitalStructure and Dividend Policy.• The forecasting approach presented in this section is the Percentage of Salesmethod. It forecasts the Balance Sheet and Income Statement by assumingthat most accounts maintain a fixed proportion of Sales. This approach,although fairly simple, illustrates many of the issues related to forecasting andcan readily be extended to allow for a more flexible technique, such asforecasting items on an individual basis.Rtist@Tourism, Pondicherry University 9
  10. 10. Financial plan• a financial plan is a series of steps which are carried out, or goals that areaccomplished, which relate to an individuals or a businesss financial affairs.• This often includes a budget which organizes an individuals finances andsometimes includes a series of steps or specific goals for spendingand saving future income.• This plan allocates future income to various types of expenses, such as rent orutilities, and also reserves some income for short-term and long-term savings.• A financial plan sometimes refers to an investment plan, which allocates savings tovarious assets or projects expected to produce future income, such as a newbusiness or product line, shares in an existing business, or real estate.• In business, a financial plan can refer to the three primary financialstatements (balance sheet, income statement, and cash flow statement) createdwithin a business plan.• Financial forecast or financial plan can also refer to an annual projection ofincome and expenses for a company, division or department.• A financial plan can also be an estimation of cash needs and a decision on how toraise the cash, such as through borrowing or issuing additional shares in acompany.Rtist@Tourism, Pondicherry University 10
  11. 11. Break Even analysis• Break-even analysis is a techniquewidely used by productionmanagement and managementaccountants. It is based oncategorising production costsbetween those which are "variable"(costs that change when theproduction output changes) andthose that are "fixed" (costs notdirectly related to the volume ofproduction).• Total variable and fixed costs arecompared with sales revenue inorder to determine the level ofsales volume, sales value orproduction at which the businessmakes neither a profit nor a loss(the "break-even point").• The Break-Even Chart• In its simplest form, the break-evenchart is a graphical representation ofcosts at various levels of activityshown on the same chart as thevariation of income (or sales,revenue) with the same variation inactivity. The point at which neitherprofit nor loss is made is known asthe "break-even point“• the line OA represents the variationof income at varying levels ofproduction activity ("output"). OBrepresents the total fixed costs inthe business. As output increases,variable costs are incurred, meaningthat total costs (fixed + variable) alsoincrease. At low levels of output,Costs are greater than Income. Atthe point of intersection, P, costs areexactly equal to income, and henceneither profit nor loss is made.Rtist@Tourism, Pondicherry University 11
  12. 12. • Fixed Costs• Fixed costs are those businesscosts that are not directly relatedto the level of production oroutput. In other words, even ifthe business has a zero output orhigh output, the level of fixedcosts will remain broadly thesame. In the long term fixedcosts can alter - perhaps as aresult of investment inproduction capacity (e.g. addinga new factory unit) or throughthe growth in overheadsrequired to support a larger,more complex business.• Examples of fixed costs:- Rent and rates- Depreciation- Research and development- Marketing costs (non- revenuerelated)- Administration costsRtist@Tourism, Pondicherry University 12
  13. 13. • Variable Costs• Variable costs are those costs which vary directly with the level of output. Theyrepresent payment output-related inputs such as raw materials, direct labour, fuel andrevenue-related costs such as commission.• A distinction is often made between "Direct" variable costs and "Indirect" variablecosts.• Direct variable costs are those which can be directly attributable to the production of aparticular product or service and allocated to a particular cost centre. Raw materialsand the wages those working on the production line are good examples.• Indirect variable costs cannot be directly attributable to production but they do varywith output. These include depreciation (where it is calculated related to output - e.g.machine hours), maintenance and certain labour costs.• Semi-Variable Costs• Whilst the distinction between fixed and variable costs is a convenient way ofcategorising business costs, in reality there are some costs which are fixed in nature butwhich increase when output reaches certain levels. These are largely related to theoverall "scale" and/or complexity of the business. For example, when a business hasrelatively low levels of output or sales, it may not require costs associated withfunctions such as human resource management or a fully-resourced financedepartment. However, as the scale of the business grows (e.g. output, number peopleemployed, number and complexity of transactions) then more resources are required. Ifproduction rises suddenly then some short-term increase in warehousing and/ortransport may be required. In these circumstances, we say that part of the cost isvariable and part fixed.Rtist@Tourism, Pondicherry University 13
  14. 14. Break-Even Analysis• Study ofinterrelationshipsamong a firm’s sales,costs, and operatingprofit at various levelsof output• Break-even point isthe Q where TR = TC(Q1 to Q2 on graph)TRTCQ$’sProfitQ1 Q214Rtist@Tourism, Pondicherry University
  15. 15. Management of current Assets• Working capital (abbreviated WC) isa financial metric whichrepresents operatingliquidity available to a business,organization or other entity,including governmental entity.• Along with fixed assets such asplant and equipment, workingcapital is considered a part ofoperating capital.• Net working capital is calculatedas current assets minus currentliabilities.• It is a derivation of working capital,that is commonly used in valuationtechniques such as DCFs(Discounted cash flows).• If current assets are less thancurrent liabilities, an entity hasa working capital deficiency, alsocalled a working capital deficit.• Net Working Capital = CurrentAssets − Current Liabilities• Net Operating Working Capital =Current Assets − Non Interest-bearing Current Liabilities• Equity Working Capital = CurrentAssets − Current Liabilities − Long-term Debt• A company can be endowedwith assets and profitability butshort of liquidity if its assets cannotreadily be converted into cash.• Positive working capital is requiredto ensure that a firm is able tocontinue its operations and that ithas sufficient funds to satisfy bothmaturing short-term debt andupcoming operational expenses.• The management of working capitalinvolves managing inventories,accounts receivable and payable,and cash.Rtist@Tourism, Pondicherry University 15
  16. 16. Calculation• Current assets and current liabilities include three accounts which are ofspecial importance. These accounts represent the areas of the business wheremanagers have the most direct impact:– accounts receivable (current asset)– inventory (current assets), and– accounts payable (current liability)• The current portion of debt (payable within 12 months) is critical, because itrepresents a short-term claim to current assets and is often secured by longterm assets. Common types of short-term debt are bank loans and lines ofcredit.• An increase in working capital indicates that the business has eitherincreased current assets (that is has increased its receivables, or other currentassets) or has decreased current liabilities, for example has paid off someshort-term creditors.• Implications on M&A: The common commercial definition of working capitalfor the purpose of a working capital adjustment in an M&A transaction (i.e.for a working capital adjustment mechanism in a sale and purchaseagreement) is equal to:– Current Assets – Current Liabilities excluding deferred tax assets/liabilities, excesscash, surplus assets and/or deposit balances.– Cash balance items often attract a one-for-one purchase price adjustment.Rtist@Tourism, Pondicherry University 16
  17. 17. Management of working capital• Guided by the above criteria, management will use a combination of policiesand techniques for the management of working capital.• These policies aim at managing the current assets (generally cash and cashequivalents, inventories and debtors) and the short term financing, such thatcash flows and returns are acceptable.– Cash management. Identify the cash balance which allows for the business to meetday to day expenses, but reduces cash holding costs.– Inventory management. Identify the level of inventory which allows foruninterrupted production but reduces the investment in raw materials - andminimizes reordering costs - and hence increases cash flow. Besides this, the leadtimes in production should be lowered to reduce Work in Progress (WIP) andsimilarly, the Finished Goods should be kept on as low level as possible to avoidover production– Debtors management. Identify the appropriate credit policy, i.e. credit terms whichwill attract customers, such that any impact on cash flows and the cash conversioncycle will be offset by increased revenue and hence Return on Capital (or viceversa);– Short term financing. Identify the appropriate source of financing, given the cashconversion cycle: the inventory is ideally financed by credit granted by the supplier;however, it may be necessary to utilize a bank loan (or overdraft), or to "convertdebtors to cash" through "factoring".Rtist@Tourism, Pondicherry University 17
  18. 18. • Characteristics of Working Capital• Needs that are Short Term: Workingcapital is being utilized in acquiringcurrent assets which will be converted tocash for a short period only.• Circular Movement: Working capital isbeing converted to cash constantlywhich will just be turned as a workingcapital all over again.• Permanency: Although it is just a kind ofshort term capital, working capital isneeded by a business forever andalways.• Fluctuation: Working still fluctuatesevery now and then even it is somethingpermanent.• Liquidity: It is very liquid for it can beconverted as cash any time withoutlosing anything.• Less Risky: Investments in current assetssuch as working capital comes with lessrisk for it is just for short term.• No Need for Special Accounting System:Since working capital is a short termasset that will last for a year only, therewill be no need for adoption of a specialaccounting system.• Sources of Working Capital– Operational funds– Sales of assets that are non-current– Long term investments’ sales– Physical fixed assets’ sales– Intangible fixed assets’ sales– Financing for longer term– Borrowings that are long term– Issuance of preference and equity sharesOperating cycle and cash cycle:• The investment in working capital isinfluenced by four key events in theproduction and sales cycle of the firm:– 1. Purchase of raw materials2. Payment of raw materials3. Sale of finished goods4. Collection of cash for salesRtist@Tourism, Pondicherry University 18
  19. 19. • Several strategies are available to a firm forfinancing its capital requirements. Three strategiesare illustrated by lines A,B, and C below.– Strategy A: Long term financing is used to meet fixedasset requirement as well as peak working capitalrequirement. When the working capital requirement isless than its peak level, the surplus is invested in liquidassets (cash and marketable securities).– Strategy B: Long term financing is used to meet fixedassets requirement, permanent working capitalrequirement, and a portion of fluctuating working capitalrequirement. During seasonal swings, short-termfinancing is used during seasonal down swing surplus isinvested in liquid assets.– Strategy C: Long term financing is used to meet fixedasset requirement and permanent working capitalrequirement. Short term financing is used to meetfluctuating working capital requirement.Rtist@Tourism, Pondicherry University 19
  20. 20. Cash Management• cash management,or treasury management, isa marketing term for certainservices offered primarily tolarger business customers.• It may be used to describe allbank accounts (suchas checking accounts)provided to businesses of acertain size, but it is moreoften used to describespecific services such as cashconcentration, zero balanceaccounting, and automatedclearing house facilities.• Sometimes, privatebanking customers are givencash management services.• Cash management servicesgenerally offered– Account Reconcilement Services– Advanced Web Services– Armored Car Services (CashCollection Services)– Automated Clearing House– Balance Reporting Services– Cash Concentration Services– Lockbox – Retail– Lockbox – Wholesale– Positive Pay– Reverse Positive Pay– Sweep accounts– Zero Balance Accounting– Wire Transfer– Controlled DisbursementRtist@Tourism, Pondicherry University 20
  21. 21. Receivables ManagementManaging and collecting commercial receivables (unpaid receivables betweencompanies or organisations) is linked to the credit insurance business and theinformation business.• reducing claims expenses by setting up efficient receivables managementprocesses, developing excellent knowledge of local payment and collectionregulations and practices, accurately predicting the commercial and financialbehaviour of buyers throughout the world and closely monitoring changes intheir behaviour.• You can benefit from our experience and recognition in this field:• - Better manage your amount of outstandings,- Maintain your trading relationship with a valued customer either on domesticor international level- Be fully informed of progress,- Get liquidity and cash flow- Increase own company financial attractiveness- Save personal resourcesRtist@Tourism, Pondicherry University 21
  22. 22. Inventory Management and Inventory Control• must be designed to meet the dictates of the marketplace and support the companysstrategic plan. The many changes in market demand, new opportunities due toworldwide marketing, global sourcing of materials, and new manufacturing technology,means many companies need to change their Inventory Management approach andchange the process for Inventory Control.• Despite the many changes that companies go through, the basic principles of InventoryManagement and Inventory Control remain the same. Some of the new approaches andtechniques are wrapped in new terminology, but the underlying principles foraccomplishing good Inventory Management and Inventory activities have not changed.• The Inventory Management system and the Inventory Control Process providesinformation to efficiently manage the flow of materials, effectively utilize people andequipment, coordinate internal activities, and communicate with customers. InventoryManagement and the activities of Inventory Control do not make decisions or manageoperations; they provide the information to Managers who makemore accurate andtimely decisions to manage their operations.• The basic building blocks for the Inventory Management system and Inventory Controlactivities are:Sales Forecasting or Demand ManagementSales and Operations PlanningProduction PlanningMaterial Requirements PlanningInventory Reduction• The emphases on each area will vary depending on the company and how it operates,and what requirements are placed on it due to market demands. Each of the areasabove will need to be addressed in some form or another to have a successfulprogram of Inventory Management and Inventory Control.Rtist@Tourism, Pondicherry University 22
  23. 23. Fixed assets management• Fixed assets management is an accounting process that seeks totrack fixed assets for the purposes of financial accounting, preventivemaintenance, and theft deterrence.•Many organizations face a significant challenge to track the location,quantity, condition, maintenance and depreciation status of their fixedassets. A popular approach to tracking fixed assets utilizes serialnumbered Asset Tags, often with bar codes for easy and accuratereading. Periodically, the owner of the assets can take inventory with amobile barcode reader and then produce a report.• Off-the-shelf software packages for fixed asset management aremarketed to businesses small and large. Some Enterprise ResourcePlanning systems are available with fixed assets modules.• Some tracking methods automate the process, such as by using fixedscanners to read bar codes on railway freight cars or by attachinga radio-frequency identification(RFID) tag to an asset.Rtist@Tourism, Pondicherry University 23
  24. 24. Importance of capital budgeting• Capital budgeting decisions are of paramount importance in financial decision.So it needs special care on account of the following reasons:– 1. Long-term Implications: A capital budgeting decision has its effect over a longtime span and inevitably affects the company’s future cost structure and growth. Awrong decision can prove disastrous for the long-term survival of firm. On the otherhand, lack of investment in asset would influence the competitive position of thefirm. So the capital budgeting decisions determine the future destiny of thecompany.– 2. Involvement of large amount of funds: Capital budgeting decisions needsubstantial amount of capital outlay. This underlines the need for thoughtful, wiseand correct decisions as an incorrect decision would not only result in losses butalso prevent the firm from earning profit from other investments which could notbe undertaken.– 3. Irreversible decisions: Capital budgeting decisions in most of the cases areirreversible because it is difficult to find a market for such assets. The only way outwill be scrap the capital assets so acquired and incur heavy losses.– 4. Risk and uncertainty: Capital budgeting decision is surrounded by great numberof uncertainties. Investment is present and investment is future. The future isuncertain and full of risks. Longer the period of project, greater may be the risk anduncertainty. The estimates about cost, revenues and profits may not come true.– 5. Difficult to make: Capital budgeting decision making is a difficult and complicatedexercise for the management. These decisions require an over all assessment offuture events which are uncertain. It is really a marathon job to estimate the futurebenefits and cost correctly in quantitative terms subject to the uncertainties causedby economic-political social and technological factors.•Rtist@Tourism, Pondicherry University 24
  25. 25. Kinds of capital budgeting decisions•Generally the business firms are confronted with three types of capitalbudgeting decisions. (i) The accept-reject decisions; (ii) mutually exclusivedecisions; and (iii) capital rationing decisions– 1. Accept-reject decisions: Business firm is confronted with alternativeinvestment proposals. If the proposal is accepted, the firm incur the investmentand not otherwise. Broadly, all those investment proposals which yield a rate ofreturn greater than cost of capital are accepted and the others are rejected.Under this criterion, all the independent proposals are accepted.– 2. Mutually exclusive decisions: It includes all those projects which competewith each other in a way that acceptance of one precludes the acceptance ofother or others. Thus, some technique has to be used for selecting the bestamong all and eliminates other alternatives.– 3. Capital rationing decisions: Capital budgeting decision is a simple process inthose firms where fund is not the constraint, but in majority of the cases, firmshave fixed capital budget. So large amount of projects compete for these limitedbudgets. So the firm rations them in a manner so as to maximize the long runreturns. Thus, capital rationing refers to the situations where the firm has moreacceptable investment requiring greater amount of finance than is availablewith the firm. It is concerned with the selection of a group of investment out ofmany investment proposals ranked in the descending order of the rate orreturn.Rtist@Tourism, Pondicherry University 25
  26. 26. • Non-discountedtechniques– Pay back period– Accounting rate of returnmethod• Discounted techniques– Net present value method– Internal rate of returnmethodRtist@Tourism, Pondicherry University 26
  27. 27. Difference between capital and financial structures• In simple terms, financial structureconsists of all assets, all liabilities and thecapital. The manner in which anorganization’s assets are financed isreferred to as its financial structure. Thereis another term called capital structurethat confuses many. There are somesimilarities between capital structure andfinancial structure. However, there aremany differences also that will behighlighted in this article.• If you take a look at the balance sheet of acompany, the entire left hand side whichincludes liabilities plus equity is called thefinancial structure of the company. Itcontains all the long term and short termsources of capital. On the other hand,capital structure is the sum total of all longterm sources of capital and thus is a partof the financial structure. It includesdebentures, long term debt, preferenceshare capital, equity share capital andretained earnings. In the simplest ofterms, capital structure of a company isthat part of financial structure thatreflects long term sources of capital.• However, capital structure needs to bedistinguished from asset structure thatis the sum total of assets representedby fixed assets and current assets. Thisis the total capital of the business that iscontained in the right hand side of thebalance sheet. The composition of afirm’s liabilities is therefore referred toas its capital structure. If a firm has acapital that is 30% equity financed and70% debt financed, , the leverage of thefirm is only 70%.• Capital Structure vs Financial Structure– Capital structure of a company is long termfinancing which includes long term debt,common stock and preferred stock andretained earnings.– Financial structure on the other hands alsoincludes short term debt and accountspayable.– Capital structure is thus a subset offinancial structure of a company.Rtist@Tourism, Pondicherry University 27
  28. 28. • In their seminal 1958 paper, FRANCOMODIGLIANI and MERTONMILLER initiated the moderndiscussion of the amount of debtcorporations should use (bothreceived the Nobel Prize for thiswork and other contributions toeconomic research). The paper is sowell known that, for more thanthirty years, financial economistshave referred to their theory as“the M&M theory.”• Financial economists have singledout three additional factors thatlimit the amount of debt financing:– personal taxes,– BANKRUPTCY costs, and– agency costs.• Corporations trade off the benefitsof government-subsidized debtagainst the costs of these threefactors. This model of corporatefinancial structure is thereforecalled the trade-off theory.• Determinants of financial Structure– Legal restrictions– Liquidity– Access to the capital market– Restriction in loan agreements– Control– Investment opportunities– Inflation– Share holders expectations– Financial needs of the companyRtist@Tourism, Pondicherry University 28
  29. 29. Financial leverage• Financial leverage is also calledtrading on equity• We need to understand debts andinterest on debts• A company finances its projectsthrough various sources, theesources are debts.• Preference share capital, commonshare capital, reserves and surplusare part of these sources• A company is legally bound to payinterest on debts• The rate of dividend to be paid onpreference share capital is also fixed• Dividend or preference share is paidonly when the company earns profit• The earnings after deducting taxes,interest and preference dividendbelong to equity share holders• Effective of financial leverage onshare holders– To increase share holders earnings– Earnings per share increase• Earnings per share is also called netincome• It is obtained by dividing the earningsafter interest and taxes• EPS = (X-R) (1-t)/NRtist@Tourism, Pondicherry University 29
  30. 30. Dividend Policy• Dividend Policy refers tothe explicit or implicitdecision of the Board ofDirectors regarding theamount of residualearnings (past or present)that should be distributedto the shareholders of thecorporation.– This decision is considered afinancing decision becausethe profits of the corporationare an important source offinancing available to thefirm.• Types of Dividends• Dividends are a permanentdistribution of residualearnings/property of thecorporation to its owners.• Dividends can be in the form of:– Cash– Additional Shares of Stock (stockdividend)– Property• If a firm is dissolved, at the end ofthe process, a final dividend of anyresidual amount is made to theshareholders – this is known as aliquidating dividend.Rtist@Tourism, Pondicherry University 30
  31. 31. • Dividend Policy• Once a company makes aprofit, management must decideon what to do with those profits.They could continue to retainthe profits within the company,or they could pay out the profitsto the owners of the firm in theform of dividends.• Once the company decides onwhether to pay dividends theymay establish a somewhatpermanent dividend policy,which may in turn impact oninvestors and perceptions of thecompany in the financialmarkets. What they decidedepends on the situation of thecompany now and in the future.It also depends on thepreferences of investors andpotential investors.• Dividend policy is concernedwith taking a decision regardingpaying cash dividend in thepresent or paying an increaseddividend at a later stage. Thefirm could also pay in the formof stock dividends which unlikecash dividends do not provideliquidity to the investors,however, it ensures capital gainsto the stockholders. Theexpectations of dividendsby shareholders helps themdetermine the share value,therefore, dividend policy is asignificant decision taken by thefinancial managers of anycompany.Rtist@Tourism, Pondicherry University 31
  32. 32. • Coming up with a dividend policy is challenging for the directorsand financial managers of a company, becausedifferent investors have different views on present cash dividendsand future capital gains.• Another confusion that pops up is regarding the extent of effectof dividends on the share price.• Due to this controversial nature of a dividend policy it is oftencalled the Dividend puzzle.• Various models have been developed to help firms analyse andevaluate the perfect dividend policy.• There is no agreement between these schools of thought overthe relationship between dividends and the value of the share orthe wealth of the shareholders in other words.• One school comprises of people like James E. Walter and Myron J.Gordon (see Gordon model), who believe that current cashdividends are less risky than future capital gains. Thus, they saythat investors prefer those firms which pay regular dividends andsuch dividends affect the market price of the share. Anotherschool linked to Modigliani and Miller holds that investors dontreally choose between future gains and cash dividends.Rtist@Tourism, Pondicherry University 32
  33. 33. • Types of Dividend Policy:– a. Stable Dividend Policy– b. Fluctuating Dividend Policy– c. Small Constant Dividend per Share plus Extra Dividend.• Forms of Dividend– Cash Dividend• Cash dividends(most common) are those paid out in the form of a cheque. Suchdividends are a form of investment income and are usually taxable to therecipient in the year they are paid.• This is the most common method of sharing corporate profits with theshareholders of the company. For each share owned, a declared amount ofmoney is distributed. Thus, if a person owns 100 shares and the cash dividend is$0.50 per share, the person will be issued a cheque for 50 dollars.– Stock Dividend– Stock or scrip dividends are those paid out in form of additional stockshares of the issuing corporation, or other corporation (such as itssubsidiary corporation).– They are usually issued in proportion to sharesowned (for example, for every 100 shares of stock owned, 5% stockdividend will yield 5 extra shares). If this payment involves the issue ofnew shares, this is very similar to a stock split in that it increases the totalnumber of shares while lowering the price of each share and does notchange the market capitalization or the total value of the shares held.Rtist@Tourism, Pondicherry University 33
  34. 34. Tourism Finance corporation of India• The Government of India had,pursuant to the recommendationsof the National Committee onTourism viz Yunus Committee setup under the aegis of PlanningCommission, decided in 1988, topromote a separate All-IndiaFinancial Institution for providingfinancial assistance to tourism-related activities/projects. Inaccordance with the abovedecision, the IFCI Ltd. along withother All-IndiaFinancial/Investment Institutionsand Nationalised Banks promoteda Public Limited Company underthe name of "Tourism FinanceCorporation of India Ltd. (TFCI)" tofunction as a specialised All-IndiaDevelopment Financial Institutionto cater to the financial needs oftourism industry.• The Government of India had, pursuant to therecommendations of the National Committee onTourism viz Yunus Committee set up under the aegisof Planning Commission, decided in 1988, topromote a separate All-India Financial Institution forproviding financial assistance to tourism-relatedactivities/projects. In accordance with the abovedecision, the IFCI Ltd. along with other All-IndiaFinancial/Investment Institutions and NationalisedBanks promoted a Public Limited Company underthe name of "Tourism Finance Corporation of IndiaLtd. (TFCI)" to function as a specialised All-IndiaDevelopment Financial Institution to cater to thefinancial needs of tourism industry. TFCI wasincorporated as a Public Limited Company under theCompanies Act, 1956 on 27th January 1989 andbecame operational with effect from 1st February1989 on receipt of Certificate of theCommencement of Business from the Registrar ofCompanies. TFCI has been notified as a PublicFinancial Institution under section 4A of theCompanies Act, 1956, vide Notification No S.O 7(E)dated the 3rd January 1990 issued by the Ministryof Industry, Department of Company Affairs. TFCIsRegistered office is situated at 13th Floor, IFCITower, 61, Nehru Place, New Delhi - 110 019.Rtist@Tourism, Pondicherry University 34
  35. 35. • ObjectiveTFCI provides financial assistance to enterprises for setting up and/or development of tourism-related projects, facilities and services, such as:• Hotels, Restaurants, Holiday Resorts, Amusement Parks, Multiplexes and Entertainment Centers,Education and Sports, Safari Parks, Rope-ways, Cultural Centers, Convention Halls, Transport, Traveland Tour Operating Agencies, Air Service, Tourism Emporia, Sports Facilities etc.• Forms of Financial AssistanceRupee Loan , Underwriting of public issues of shares/debentures and direct subscription to suchsecurities, Guarantee of deferred payments and credit raised abroad., Equipment Finance,Equipment Leasing, Assistance under Suppliers Credit. Working-Capital Financing, TakeoverFinancing, Advances Against Credit-Card Receivables• Eligibility for AssistanceTFCI provides financial assistance to projects with capital cost of Rs. 3 croreand above. In respect of projects costing between Rs. 1 crore and Rs. 3 crore, TFCI will considerfinancial assistance to the extent of unavoidable gap, if any, remaining after taking into accountassistance from State Level Institutions/Banks. Unique projects, which are important from thetourism point of view and for which assistance from State Level institutions/ Banks is not available,may be considered on exceptional basis even though their capital cost is below Rs. 1 crore.Financial assistance is considered on similar lines for heritage and restaurant projects. Projectswith high capital cost may be financed along with other All-India Financial/Investment Institutions.TFCI considers assistance even if the total cost is less than Rs. 3 crore for existing concerns withsatisfactory performance for renovation/upgradation etc.track record of atleast 3 years and assisted concerns of TFCI with satisfactory credit record. Theworking capital limit would be calculated based on the turnover method as may be consideredappropriate.Rtist@Tourism, Pondicherry University 35
  36. 36. • Promoters Contribution• The minimum promoters contribution for the projects is 30%. Relaxation may, however, be allowed inrespect of large projects involving capital cost exceeding Rs. 50 crore.Debt Equity Ratio• TFCI extends term-loan assistance based on debt-equity ratio not exceeding 1.5:1. However, in case ofhotels in seasonal locations/ multiplexes/ entertainment centers, amusement parks and other tourism-related projects, the debt-equity ratio would be stipulated in the range of 1:1 to 1.25:1.Rate of Interest• Interest on loan is flexible and linked to the PLR of TFCI which is presently 12.5% p.a. (since 1st August2008). TFCI, while considering loans to the borrowers, evaluates each concern individually on variousparameters such as Industry/ Business Risk, Environmental Risk, Project Risk, Management Risk, Securityavailable, Income value to TFCI, etc. and accords rating ranging from AAA to B category. Loan is pricedaccording to the prevalent PLR and the rating so achieved by the individual client within a spread rangingfrom PLR to PLR+1.5% per annum. High Risk Projects are charged interest at PLR+3% per annum. Interestis levied on monthly rests. In case of consortium/ multiple funding, if higher rate is charged by any otherinstitution than the same rate is applicable to TFCI loan also. Besides, TFCI also charges appraisal-cum-up front fee @ 1% of the loan amount sanctioned as one time charge.Security• First charge on movable and immovable fixed assets. Personal Guarantees of the Promoters andCorporate guarantee of the group concern, if necessary. Pledge of promoters share-holding.Repayment Schedule• This would depend on the period required for completion of the project and stabilisation of operationsas also the projected cash-flows available for debt-servicing. The general norm of repayment is 8 yearsallowing moratorium of 2 years after full commercial operations. In case of multiplexes/ entertainmentcenters the cash-flows in the initial years are satisfactory; as such, the repayment of the loans to thissector could be made in 6-7 years allowing moratorium of 1-1½ years after full commercial operations.Norms for Takeover Financing• TFCI may consider financing well-established, assisted concerns having over 3 years satisfactory trackrecord for takeover of tourism-related project/company.Norms for Working-Capital Financing• The Working Capital assistance would be provided to concerns in the tourism sector with provenRtist@Tourism, Pondicherry University 36
  37. 37. AccountingRtist@Tourism, Pondicherry University 37
  38. 38. • Balance sheet indicates structureof the assets belonging to thecompany and financial meansused to finance these assets at aparticular point of time.• For example: this statement asof December 31, 2006 indicatedstructure of the assets and howthey are finances on December31, 2006.• This statement is made on thebasis of accounting equation, i.e.assets are equal to the sum ofliabilities and owners’ equity.• The assets side includes currentand long-term assets.• Liabilities and owners’ equityside includes current and long-term liabilities, owners’ equityconsisting of share capital,retained earnings, i.e. net profitearned and retained in thebusiness.• Income statement indicates income earnedand expenses incurred by the company for aparticular period of time.• For example: this statement for the year 2006indicated, what income was earned and whatexpenses were incurred by the company duringthe year 2006. Difference between all incomeand all expenses is called net profit for the year.• Starting point of preparing financial statementsis adjusted trial balance, which includes list ofall general ledger accounts with the balances inthose accounts.• Worth to notice several important points:– 1. Accumulated depreciation account has a creditbalance.• As it was explained earlier this account iscontrary to the fixed assets account, in Alfa’scase Equipment account.• In the financial statements on the assets’ sidedifference between cost of fixed assets andaccumulated depreciation, called net bookvalue, is indicated– 2. Balances of income and expenses are includedinto the income statement 3. Net profit retained inthe business (5883$) from income statement istransferred to the balance sheet under owners’equity partRtist@Tourism, Pondicherry University 38
  39. 39. Rtist@Tourism, Pondicherry University 39
  40. 40. Balance Sheet• A financialstatement that summarizesa companys assets,liabilities and shareholdersequity at a specific pointin time. These three balancesheet segments giveinvestors an idea as to whatthe company ownsand owes, as well as theamount invested by theshareholders.The balance sheet mustfollow the followingformula:Assets = Liabilities +Shareholders EquityRtist@Tourism, Pondicherry University 40
  41. 41. Cash flow statement• The statement of cash flows is one of the mainfinancial statements. (The other financialstatements are the balance sheet, incomestatement, and statement of stockholdersequity.)• The cash flow statement reportsthe cash generated and used during the timeinterval specified in its heading.• The period of time that the statement covers ischosen by the company. For example, theheading may state "For the Three MonthsEnded December 31, 2010" or "The Fiscal YearEnded September 30, 2010".• The cash flow statement organizes and reportsthe cash generated and used in the followingcategories:– 1.Operating activities–converts the itemsreported on the income statement from theaccrual basis of accounting to cash.– 2.Investing activities–reports the purchase andsale of long-term investments and property, plantand equipment.– 3.Financing activities–reports the issuance andrepurchase of the companys own bonds andstock and the payment of dividends.– 4.Supplemental information–reports theexchange of significant items that did not involvecash and reports the amount of income taxespaid and interest paid.Rtist@Tourism, Pondicherry University 41
  42. 42. Fund flow statement• Financial statements do not give thecomplete financial information. Thesestatements give the information offunds on a particular date. The purposeof preparation of fund flow statementsis to know about from where funds arecoming and where being invested. Thefunds flow statements is generallyprepared from the data identifiable andprofit and loss account and balancesheets. Fund flow statement is alsocalled as sources and application offunds. It shows the detail of fundsbusiness received from sources and theamount of funds the business used fordifferent purposes in the year.• Acc. To FOURLKE,” A statement ofsources and application of funds, is atechnical advice designed to highlightthe changes in financial position ofbusiness enterprise between twodates.”• There are few other reasons to preparefund flow statement:– It explains the financial consequences ofbusiness operations: Fund flow statementgives answer to following conflictingsituations.• How the business could have good liquidposition in spite of business making losesor acquisition of fixed assets?• Where have the profits gone?• How a business can earn more and moreprofits.– It answers intricate queries:• How much fund is generated from normalbusiness operations?• What are the sources of repayment ofloans?• How to utilize the funds up to optimumlevel?– It acts as an instrument for allocation ofresources.– It is a test of effectiveness in use ofworking capital.Rtist@Tourism, Pondicherry University 42
  43. 43. Hotel accounting• Hotels follow the general principles of accounting, but due to the unique nature of guest accounting, hotelaccounting departments use terms that may not be familiar to accountants in other industries. Accountingterms related to the management of guest payments, charges and disputes can be confusing to outsiders, butthey represent everyday concepts in the hotel industry.Folio• The record of all credits and debits associated with a guest or group is called an account and an account can beorganized by sections, or folios. Common folio divisions include one each for room charges, food and beveragecharges and miscellaneous charges. Multiple folios are often used with convention guest accounts, as the hotelroom rate may be paid by the group while the individuals are responsible for their additional, or incidentalcharges.• Separation of folios allows printing options, which is useful for blind rates--when the group room rate mustremain unknown to the guest. At checkout, a convention guest can present payment for incidental charges andreceive a printed receipt for only the folios that contain the charges for which she paid. The balance from theroom charges folio remains blind to the guest and is transferred to the group account for later billing.Room Charge• Guests that have a credit card on file for an account are eligible to sign for charges to guest rooms. At the pointof sale, guests sign a receipt authorizing the charge be paid by the method of payment on the account. Thecharge is then posted to the appropriate folio for the charge type.• The alternative to a room charge is using another method of payment for services, such as cash or credit.Guests without credit cards on file are considered cash-only guests and do not have room charging privileges.Posting• Any charges posted to a guest account are posted, either manually or through the hotels computer system.Computer-posted charges are known as interface postings and these are common from hotel outlets that use acash register and point of sale system, such as a restaurant or gift shop.• When room charge is designated as the payment type, the cashier enters the guest room number and the pointof sale system interfaces with the property management system to post the charge. Manual charges are postedby a hotel employee, usually front desk or accounting. These charges might come from outlets without a pointof sale system but are most commonly interface postings that did not go through due to system outage orincorrect room information.Rtist@Tourism, Pondicherry University 43
  44. 44. Late Charge• A late charge occurs when a guest signs for a room charge after checking out ofthe hotel. Common late charges include breakfast or minibar charges andmanual postings due to system outage. Since the guest had a credit card onfile, the front desk is able to use same card is used to pay for the charge. If thecredit card declines, an invoice is mailed to the guests address of record.Advance Deposit• Advance deposits are prepayments for guest rooms or other hotel services.These deposits are commonly used to secure reservations for weddings orconventions held at the hotel. In most catering or group events, the advancedeposit is required 72 hours before the event occurs. The deposit is posted tothe group account and charges are posted against the account as they occur.Allowance• An allowance is a reversal of a posting. Allowances can occur due to duplicateposting, disputes or bad debt. Although a voided payment through the point ofsale system can create a negative interface posting, this is a correction insteadof an allowance because revenue is not reduced. Allowances are alwaysmanual posts, and department managers generally review and research largeallowances that would seriously impact revenue prior to authorizing posting.Rtist@Tourism, Pondicherry University 44
  45. 45. Thank You…Rtist@Tourism, Pondicherry University 45