CHAPTER=1 AGENCY PROBLEM Definition of 'Agency Problem' A conflict of interest inherent in any relationship where one party is expected

to act in another's best interests. The problem is that the agent who is supposed to make the decisions that would best serve the principal is naturally motivated by self-interest, and the agent's own best interests may differ from the principal's best interests. The agency problem is also known as the "principalagent problem." Explanation of 'Agency Problem' In corporate finance, the agency problem usually refers to a conflict of interest between a company's management and the company's stockholders. The manager, acting as the agent for the shareholders, or principals, is supposed to make decisions that will maximize shareholder wealth. However, it is in the manager's own best interest to maximize his own wealth. While it is not possible to eliminate the agency problem completely, the manager can be motivated to act in the shareholders' best interests through incentives such as performance-based compensation, direct influence by shareholders, the threat of firing and the threat of takeovers Stockholders Vs Managers Motivating Managers to Act in Shareholders' Best Interests There are four primary mechanisms for motivating managers to act in stockholders' best interests:

Managerial compensation Direct intervention by stockholders Threat of firing Threat of takeovers

1. Managerial Compensation Managerial compensation should be constructed not only to retain competent managers, but to align managers' interests with those of stockholders as much as possible.
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This is typically done with an annual salary plus performance bonuses and company shares. Company shares are typically distributed to managers either as: Performance shares, where managers will receive a certain number shares based on the company's performance Executive stock options, which allow the manager to purchase shares at a future date and price. With the use of stock options, managers are aligned closer to the interest of the stockholders as they themselves will be stockholders. 2. Direct Intervention by Stockholders Today, the majority of a company's stock is owned by large institutional investors, such as mutual funds and pensions. As such, these large institutional stockholders can exert influence on mangers and, as a result, the firm's operations. 3. Threat of Firing If stockholders are unhappy with current management, they can encourage the existing board of directors to change the existing management, or stockholders may re-elect a new board of directors that will accomplish the task. 4. Threat of Takeovers If a stock price deteriorates because of management's inability to run the company effectively, competitors or stockholders may take a controlling interest in the company and bring in their own managers. Stockholders versus Creditors

Creditors decide to loan money to a corporation based on the riskiness of the company, its capital structure and its potential capital structure. All of these factors will affect the company's potential cash flow, which is a creditors' main concern. Stockholders, however, have control of such decisions through the managers.

Since stockholders will make decisions based on their best interests, a potential agency problem exists between the stockholders and creditors. For example, managers could borrow money to repurchase shares to lower the corporation's share base and increase shareholder return. Stockholders will benefit; however, creditors will be concerned given the increase in debt that would affect future cash flows.

Treasurer Paditing Credit management: Credit management is concerned with making sure that organisations, who buy goods or services on credit, or individuals who borrow money, can afford to do so and that they pay their debts on time Cost Control: The practice of managing and/or reducing business expenses. Cost controls starts by the businesses identifying what their costs are and evaluate whether those costs are reasonable and affordable. Inventory Management: The overseeing and controlling of the ordering, storage and use of components that a company will use in the production of the items it will sell as well as the overseeing and controlling of quantities of finished products for sale Capital budgeting: The process in which a business determines whether projects such as building a new plant or investing in a long-term venture are worth pursuing. Retirement benefits: a contract for a fixed sum to be paid regularly to a person, typically following retirement from service Risk management: A treasurer manages the risks such as the risk of bad debts. Capital Structure Planning: The capital structure is how a firm finances its overall operations and growth by using different sources of funds such as long term and short term debts, shares and initial investments, A treasurer manages them and plans the structure of the capital. Managing cash & Marketable securities Controller of Accounts

Cost Accounting: A type of accounting process that aims to capture a company's costs of production by assessing the input costs of each step of production as well as fixed costs such as depreciation of capital equipment Financial Accounting: The process of recording, summarizing and reporting the myriad of transactions from a business, so as to provide an accurate picture of its financial position and performance. The primary objective of financial accounting is the preparation of financial statements - including the balance sheet, income statement and cash flow statement Tax Department: Accounting methods that focus on taxes rather than the appearance of public financial statements Budgeting: Creating an estimation of the revenue and expenses over a specified future period of time. Profit Analysis: A method of cost accounting used in managerial economics. Cost-volume profit analysis is based upon determining the breakeven point of cost and volume of goods. Payroll & Accounts: The sum total of all compensation that a business must pay to its employees for a set period of time or on a given date. CHAPTER=2 SOURCES OF FINANCE In the theory of capital structure, internal financing is the name for a firm using its profits as a source of capital for new investment, rather than a) distributing them to firm's owners or other investors and b) obtaining capital elsewhere. It is to be contrasted with external financing which consists of new money from outside of the firm brought in for investment.

The Internal Sources Promoters initial capital: here the first form of Internal finance is the starting capital invested by the owner in a sole proprietorship, partners in a partnership or joint stock company. Sources of initial capital might include personal funds, bank loans, grants, or credit from suppliers.

 Retained Earnings: firm's profits kept as capital after dividend payments the share of a company's profits remaining after the distribution of dividends that is kept as capital. Also called retained profits. These are generally stored in Reserves or funds in the companys accounts which increases the amount of the working capital. Provision for Depreciation: The depreciation charge on the income statement can be a large number that spreads the initial cost of the investment in property, plant and equipment out over several years. It can also play a significant role on a tax filing by lowering the amount of income that is taxable, therefore lowering the effective tax rate of a company Outstanding Expenses: Making liability provision for the expenses relating to current year but actual payment to be incurred in the next financial year is outstanding expenses. Example of this case may be salary arrears. Provident fund of Employee: Here it is a mandatory saving to be done by the employee to the company from which the saved money will be given back as pension. This fund is however invested in the capital. Sale of Fixed assets: Certain fixed assets whose usefulness is finished due to obsolesce or any other factor can be sold off and turned into cash. Overuse of Fixed assets: The financial returns from a fixed asset can be calculated and spread over its life time as it will be fully utilized until it becomes scrap Provision for Doubtful debts: Recoverability of some receivables may be doubtful although not definitely irrecoverable. Such receivables are known as doubtful debts. Prudence requires that an allowance be created to recognize the potential loss arising from the possibility of incurring bad debts. External Sources of Finance Commercial bank: A financial institution that provides services, such as accepting deposits, giving business loans and auto loans, mortgage lending, and basic investment products like savings accounts and certificates of deposit. Investment bank/Merchant banks: A bank that deals mostly in (but is not limited to) international finance, long-term loans for companies and underwriting. Merchant banks do not provide regular banking services to the general public. Insurance Companies: are organizations that provide a security compensation for any type of loss suffered such as loss of fixed asset or goods in transit. Development Banks: A loan with no interest or a below-market rate of interest, or loans made by multinational development banks (such as the Asian Development fund), affiliates of the World Bank and government agencies to developing countries that would be unable to borrow at the market rate Leasing Companies: A Lease is a long term hiring contract for a fixed asset. Leasing companies tends to provide those assets which can be leased by a firm otherwise will have to be bought. Example. premises. Capital Market: A market in which individuals and institutions trade financial securities. Organizations/institutions in the public and private sectors also often sell securities on the capital markets in order to raise funds. Specialized financial institutions: There are specialized institutions which finance entrepreneurs and organizations such as SME loan, HBFC loans, IDLC Finance Limited. Financial aid acquired from these organizations can be classified as external source.

 Non institutional Credit: these sources include Trade Credit: An agreement where a customer can purchase goods on account (without paying cash), paying the supplier at a later date Outstanding expenses Mortgage: Mortgages are used by individuals and businesses to make large purchases of real estate without paying the entire value of the purchase up front. Bond and debenture savings bonds are one of the safest types of investments because they are endorsed by the government and, therefore, are virtually risk free and Debentures are backed only by the general creditworthiness and reputation of the issuer. Both corporations and governments frequently issue this type of bond in order to secure capital. Friends and Relatives: can become a loan guarantor, give loans without interest and may even become an investor in the firm. Money Lenders: Local money lenders in an area is also a form of non-institutional finance who can provide loans easier than that of the banks and mortgage. CHAPTER=3 SHORT AND LONG TERM FINANCE Characteristics of Short term Finance 1) Purpose: Short-term loans are helpful to businesses that are seasonal in nature such as retail businesses who have to build up inventory for the winter season. Such a business might need a short term loan to buy inventory well in advance of the winter and not be able to repay the loan until after the winter. That is the perfect use for the short-term business loan. Other uses for short-term business loans are to raise working capital to cover temporary deficiencies in funds so they can meet payrolls and other expenses 2) Cost and Risk: Short-term loans tend to have higher interest rates than long-term debts but short-term loans are less risky than long-term financing simply due to the fact of their maturity.

3)Security and recycling: Short-term business loans are dependent on credit history and the repay capability of the businessthese variables will affect the conditions (interest rate, repayment date and associated fees) attached to shortterm loan, they do not need collateral security 4)Renewal 5)Size and nature of Firm: If the size of the firm is small and the business is short timed or seasonal short term loan is an ideal design of finance for the firms. 6)Amount of fund: Sources of different types of short term financing
Spontaneous Financing: Financing which

flows with the volume of sales activity during normal business operation that requires no additional assistance from lenders or creditors. The most common resources for this kind of financing include accounts payables and accruals, trade credit and trade acceptance. Money Market Credit: A segment of the financial market in which financial instruments with high liquidity and very short maturities are traded. The money market is used by participants as a means for borrowing and lending in the short term, from several days to just under a year. Money market securities consist of negotiable certificates of deposit (CDs), bankers acceptances, U.S. Treasury bills, commercial paper, municipal notes, federal funds and repurchase agreements (repos).
Short term unsecured loan: Short term loans from commercial banks do not usually require a collateral security or

better known as unsecured loans. Credit Lines are a monetary spending loan balance offered by a financial

institution that cannot be suspended without notifying the borrower. A committed credit line is a legal agreement between the financial institution and the borrower outlining the conditions of the credit line. Revolving credit is a line of credit where the customer pays a commitment fee and is then allowed to use the funds when they are needed.
Secured short term bank credit: small timed and sized loans given by the lender without a collateral security or

assets backing debt or a debt instrument are considered security, which means they can be claimed by the lender if default occurs.
Characteristics of Long term financing Size of fund: Long-term debt typically has a higher principal balance than other debt obligations. This is

because people don't usually get long-term loans for smaller purchases. Mortgages are usually the most expensive purchase people make.

Use of Fund: The major use of these funds are at large purchases and whose payback will be possible only in the long run Ex. Buying of capital equipment and machinery. Companies with long term liabilities have a higher gearing ratio. Duration: The loan period for a long-term debt exceeds 12 months. The length of the term corresponds to

the perceived value of the itemA mortgage, on the other hand, would because the inherent value of the property can justify such a loan term..
Repayment: The repayment of long term financing is usually made at fixed installments which are calculated by adding the total interest with the principal and divided into the overall period in terms of months. Security: There is a necessity of collateral security in exchange of the loan , if the payback is failed that particular property will be seized to compensate the loss of the financer. Claim on income: N/A Cost of capital: is the interest rate that has to be paid for the capital which was acquired from the financer. Unlike short term finance, long term finance tends to have a lower cost of capital. Flexibility: the main advantage of a long-term loan is that the company that is taking out the loan will have

the choice of approaching a large number of lenders when seeking the loan. Each of these lenders may be willing to accept different terms for the loan. This can lead to a lower interest rate or a flexible payment structure Participation in management:

Importance of Long term financing. (I did not find these anywhere)

Initial cost: Construction cost /Incidental cost: Implement Long term Plan: Face Competition: Meet challenging circumstances: Replace fixed asset: Implement modernization & Expansion: Improve Quality:

Sources of Long Term Financing (Just copy the points as indicated, they are the same)

Promoters initial capital: (See Internal sources of finance point 1) Retained Earnings: (See Internal sources of finance point 2) Provisions: (See Internal sources of finance point 3&8) Share: (See External sources of finance point 6) Bond: A debt investment in which an investor loans money to an entity (corporate or governmental) that

borrows the funds for a defined period of time at a fixed interest rate. Bonds are used by companies, municipalities, states and governments to finance a variety of projects and activities Commercial banks: (See External sources of finance point 1) Investment/Merchant banks: (See External sources of finance point 2)

 Insurance companies: (See External sources of finance point 3) Underwriters: The word "underwriter" is said to have come from the practice of having each risk-taker write his or her name under the total amount of risk that he or she was willing to accept at a specified premium. In a way, this is still true today, as new issues are usually brought to market by an underwriting syndicate in which each firm takes the responsibility (and risk) of selling its specific allotment. Development Financing companies: (See External sources of finance point 4) Leasing companies: (See External sources of finance point 5) Specialized Financial Institutions: (See External sources of finance point 6)
CHAPTER=4 TYPES OF STATEMENTS

Income Statement: A financial statement that measures a company's financial performance over a specific

accounting period. Financial performance is assessed by giving a summary of how the business incurs its revenues and expenses through both operating and non-operating activities. It also shows the net profit or loss incurred over a specific accounting period, typically over a fiscal quarter or year. Balance Sheet: A financial statement that summarizes a company's assets, liabilities and shareholders' equity at a specific point in time. These three balance sheet segments give investors an idea as to what the company owns and owes, as well as the amount invested by the shareholders. Cash flow statement: The document provides aggregate data regarding all cash inflows a company receives from both its ongoing operations and external investment sources, as well as all cash outflows that pay for business activities and investments during a given quarter. Retained Earning statement: A financial statement outlining the changes in retained earnings for a specified period. The statement of retained earnings reconciles the beginning and ending retained earnings for the period, using information such as net income from the other financial statements. Capital Statement: Capital statement is the document which presents the opening balance of the capital at the first line, and then any kind of addition in shape of investment or profit earned during the accounting period is added in the next line arriving at the total balance of capital With Regards Heemel H Kabir