Financial Management

Sandeep Gokhale

References
Financial Management
Authors :
Khan & Jain
Prasanna Chandra
Myers
Van Horne
2

Syllabus
Ratio Analysis
Fund & Cash flow
analysis
Cost of Capital
Working Capital Mgmt.
Means of Financing
Capital Budgeting
Dividend Structuring
Bonus Shares
Share Holder Value
Measurement
3

Corporate Financial Objective

Objective :

Create share holder value

Methodology :

Capturing of value at all Levels.

Business Process restructuring

Enterprise resource management.
Vertically integrated operations.
Customer relationship Management
Sustained up scaling of operations
4

Financial Management an Overview

Business Environment
Planning Policies & Decisions
(Management Accounting)

Financial
Markets

Restructuring

Investor
Preferences

Resource Mobilization
Treasury
Control & Information
( Audit & Taxation)
Valuation Technique

Government Policy: Industrial policy

Government programmes and expenditures
Tax regime Direct & Indirect
Allocation of natural resources
Tax regime & jurisdiction GAAR MAT
Lending norms of Institutions and banks
Infrastructure Development & CPSUs
Rating of Govt paper
GAAP : Consolidation of Accounts
Consequential ownership thresholds in
holding Co structures.
10

Technology:

Emergence of new technologies.

Access to technical Up gradation
Level of obsolescence.

Socio Demographic: Population trends

Age shifts in population
Educational profile.
Attitudes toward consumption and investment

11

Competition:

Number of players in the industry and their

market share.
Duty barrier and status of international cost
and volume positioning.
Degree of homogeneity and differentiation
among products.
Entry barriers for new capacities.
Comparison with substitute products.
Unorganised sector operations.
Marketing polices and practices.
12

ORGANISATIONAL INTERFACE OF FINANCE

Areas

Interface

Corp planning: Long term financial goals in terms of

assets, sales,profits,dividends etc.
Expansion, new projects diversifications
takeovers , mergers,disinvestments.
Internal generation, tax planning.
Operations:

Integrating functional plans.

Working capital management

13

Areas

Interface

Control:

Budgetary control of all divisions

Variance analysis

Marketing:

Credit norms

Cost analysis of decisions like discounts ,

premium pricing,product promotion etc.
Manufacturing:

Budgeting for manufacturing operations.

Product mix decisions.

Personnel:
Budgeting for personnel & administrative
function.
14

FINANCIAL FUNCTION

Money Mgmt

Accounting

Resource
Mobilisation

Financial
Accounting

Working Capital
Cost
Mgmt
Accounting
Investment
Mgmt

Mgmt
Accounting

Control

Advisory Role
Project
Financing

Budgets

Variance
Analysis

Pricing

Profit Center

Div. Policy

Cost Center

15

Valuation of
Assets

Financial Decision Areas

Investment analysis
Working capital management
Sources and cost of funds
Determination of capital structure
Dividend policy
Analysis of risks & returns
Treasury - interest / exchange rate swaps
Restructuring of operations / term debt profile
Equity buyback / Bonus / Capitalisation

To result in shareholder wealth maximisation

16

PROFIT AND LOSS ACCOUNT

For the Period 1st April to March 31st

Income:

Gross sales from Goods & Services

Less: Excise Duty
Net Sales
Other Income
Non operating Income
Total Income

17

Expenses

Raw materials consumed

Manufacturing expenses
Administrative expenses
Selling expenses
WIP +FG adjustment
PBIDT (Gross Profit)
Less: Interest
Less Depreciation
PBT (Operating Profit)
Less: Tax
PAT (net profit)
Gross cash accruals : PAT + Depn
Net cash accruals

: GCA - Dividend
18

THE BALANCE SHEET

As on March 31st
...
Liabilities:

Equity share capital

Reserves & Surplus
Term loan
Debentures
Fixed deposits
Other unsecured loans
Commercial bank borrowings
Creditors
Other current liabilities
19

Assets:

Gross fixed assets

Less: Acc. Depn
Net Block
Investments
Currents Assets: RM Stock
WIP
F.G.Stock
Debtors
Cash in bank
Loans & Advances
Deferred expenditure
Other Current assets
20

RATIO ANALYSIS

Principal tool for analysis

Inter firm comparison
Intra firm comparison
Industry analysis
Responsibility accounting

21

TYPES OF FINANCIAL RATIOS

Liquidity
Leverage
Turnover
Profitability / Valuation

22

LIQUIDITY RATIOS
Current Ratio:

Current assets
Current liabilities

Acid test ratio:

C.A- Inventories
Current liabilities

Cash position ratio:

Cash in bank + hand

Current liabilities
Inventory to G.W.C:
Inventory
Current assets
23

LEVERAGE RATIOS
Debt / Equity ratio:

Long term debt

Net worth
Borrowing / Assets:

1-

Net worth

Total Assets

Fixed asset / Networth: Fixed Assets

Net worth
Total Debt / EBIDTA : 5 times
24

Capital gearing ratio:

Capital entitled to fixed return

Capital not entitled to fixed return

Debt. Service coverage ratio:

PBDIT - Tax

Interest + Annual installment

Interest coverage ratio:

PBDIT - Tax

Interest
F. Asset coverage ratio:

Gross fixed asset - Acc. Depn

LT Secured liabilities
25

ACTIVITY RATIOS
Total asset turnover:

Net sales

Total assets
Fixed asset turnover:

Net sales

Fixed assets
Inventory turnover:

Net sales

Inventory

26

Debtors turnover:

Credit sales

Avg. debtor
Collection period:

Avg. debtor * 365

CR. Sales
Creditors Turnover:

Credit purchase

Avg.. Creditors
Payment period:

Avg. Creditor * 365

Net Purchases
27

PROFITABILITY / VALUATION RATIOS

Gross profit ratio:

PBDIT / Sales
EBITDA / Sales

RONW :

PAT / Networth

ROSE:

PAT - Pref. Div

Net worth

Return on CAP. Employed:

PBIT

Total Lia - Creditors Provisions

Return on Investment

PBIT / Investments
28

Book value per share:

Net Worth

NO of Equity Shares
EV / EBITDA:
Earning per share:

Enterprise value / Gross profit

PAT - Pref Div

No. of Equity shares

Price Earning ratio:

Market price

Earnings per share

Pay out ratio:

Dividend paid
Profit after Tax

29

USERS OF FINANCIAL RATIOS

Lenders of funds for appraising credit worthiness for long term / short
term lending decisions.
Valuations in investment / disinvestment decisions.
Financial analyst / Mutual Funds / Investment Bankers.
Management for operational short / long term planning.
Credit Rating Agencies
Tax authorities
30

LIMITATIONS OF RATIO ANALYSIS

A ratio in absolute terms has no meaning. It has to be compared.
Inter firm comparison.
Companies resort to window dressing of Balance sheets.
Operating and accounting practices differ from company to
company.
Consolidation of group / subsidiary companies figures.
E.G.

Changes in Depreciation methods

Inventory Valuation
Treatment of contingent liabilities.
Valuation of investments.
Conversion or transaction of foreign exchange items.
31

FUND FLOW ANALYSIS

It is a statement indicating the methods by which a company has been
financed and the uses to which it has applied its funds over a period of
time.
It provide an insight into the movement of funds and helps in
understanding the changes in the structure of asset & liabilities.
Provides information as to how funds are raised and utilised.
Determines need for funds and helps in deciding finance mix
Determines financial consequences of business decisions.
Free cash flow generation ability and Utilisation of the same.
32

FUND MANAGEMENT

Requirement

Mobilisation

Quantum

Normal
Capital
expenditure

Source

Incremental
Working
capital

Cost

New
Investments

33

Equity Buy
back

FUND FLOW OCCASIONS

Sources

Uses

Funds from operations

Loss from operations

Sale of fixed assets

Increase in fixed assets

Increase in liabilities

Redemption of liabilities

Sale of securities

Purchase of securities

Decrease in W.C

Increase In W.C
Cash Dividends, Equity buy back
34

FUND FLOW
Assets
Liabilities
Assets
Liabilities

Uses of funds
Uses of funds
Source of funds
Source of funds

Comparison of balance sheets of consecutive years.

35

TYPES OF FUND FLOW STATEMENTS

OVERALL FUND FLOW
OPERATIONAL FUND FLOW
WORKING CAPITAL BASED FUND FLOW
(ONLY STS/STU STATEMENT)

36

COST OF CAPITAL
Aggregate of the liabilities raised by a company is the total capital
employed in business.
Different sources have different cost and tax implications.
Cost of capital
It is a single rate (weighted average ) for a finance mix.
It is computed on a post - tax basis since cost of different sources
have different tax implications
E.g.. Interest on debt capital enjoys tax shield while dividend paid
on equity has no tax shield.
COC is used as a discounting rate in DCF analysis.
37

RELEVANCE OF COC
Used as a hurdle rate in DCF analysis.
Wt. Average cost of capital
Marginal cost of capital
K0 = Ki + Ke
K0 = WT. Average cost of capital
Ki = Cost of debt capital
Ke = Cost of equity capital
38

COST OF CAPITAL
Consists of three components:
Risk less cost of a particular type of finance (rj)
Business risk premium(b)
Finance risk premium(f)
K0 = rj + b + f

39

RELATIONSHIP BETWEEN WEIGHTED AVERAGE

COST AND MARGINAL COST OF CAPITAL
Degree of leverage
Cost of instruments
Tax Rate / Treatment
WACOC :

K0 1 = Ki1 + Ke1

MCOC :

K0 2 = Ki2 + Ke1
40

METHODS OF COMPUTATION OF COST OF

EQUITY
ROI approach
Ke =

PAT - pref. div + non tax shield portion of depn

Equity block (E + R +S + acc depn)

Market capitalisation approach
Ke = D/P + G
D = Dividend per share G = Growth rate
P = Market price per share

41

Capital Asset Pricing model

Ke = Rf +beta ( Rf Rm)
Rf = risk free rate of return
Beta = stock relationship with a index
Rm = Market expectations of return ( Bloomberg base )

42

 If ROI approach is used to determine Ke then book value to be

considered as weights.If market capitalization approach is used
then market value to be considered as weights.
All cost to be considered on a post tax basis.
The market capitalization approach is superior to the ROI
approach since the parameters are market determined and
futuristic as compared to the ROI approach.
The CAPM approach is a further refinement which also includes
premium for risk
In loss making companies minimum cash flow approach is used.
Cost of equity could be benchmarked with return on
guilts,market risk and portfolio risk ( Asset Beta )43

WORKING CAPITAL MANAGEMENT

Objective:

Optimise current asset deployment.

Advantages:

Lower interest cost.

Inventory holding cost reduced.

Disadvantages:

Interruption in production.

Stock out to customers.

44

ASSET STRUCTURE FOR VARIOUS

INDUSTRIAL SEGMENTS
FA
Power Generation

CA
80%

20%

Chemical process plants 50%

50%

Engineering

40%

60%

Service

20%

80%

Trading

10%

90%

45

WORKING CAPITAL
Current assets comprise of stocks of raw materials, work in progress,
finished goods, and receivables.
Gross working capital = total current assets.
Net working capital

= CA - CL

Objective is to optimse asset requirement and funding the same at

minimal cost.
Working capital
requirement

Permanent
component
Variable
component)46

CONSTITUENTS OF CURRENT ASSETS

Raw material stock

Work in progress
Finished goods stock
Cash in hand / bank
Debtors / Receivables

47

OPERATING CYCLE TIME

Time required for rolling or rotation of current assets.
Date of receipt
of RM

RM issued to

Throughput time

production Dept

Collection of Despatched to consumers

Converted to FG

Receivables
48

FACTORS INFLUENCING WORKING CAPITAL

REQUIREMENTS
Nature of business
Manufacturing process
Competitive forces in raw material & finished goods segment.
Infrastructural support.
Through put time
Seasonality in demand
Shelf life of RM / Finished product
Customer relationship management
49

CREDIT MANAGEMENT
Terms of payment

Cash against delivery

Consignee basis
Proforma invoice
Letter of credit
Advances
Suppliers / Buyers LOC
Credit policy variables

Credit standards

Credit period
Cash Discounts
50

 Credit evaluation

Character

Capacity
Capital
Collateral
Macro conditions
Control of accounts
receivables

Days sales outstanding

Ageing schedule (in days)

Collection matrix
Average collection period
51

RECEIVABLES MANAGEMENT
Credit standards

Collection cost

Average collection period

Bad debts
Level of incremental sale
Credit terms
Collection policies

Factoring
52

WORKING CAPITAL FINANCING

Cash accruals
Trade credit
Commercial bank borrowings
Cash credit limit
WCTL
Bill discounting
Letter of credit
Bank guarantee
Public deposits
53

 Short term / medium term loans from FIs Banks

Debentures for working capital
Commercial Paper.
Euro Commercial Borrowings
Inter Corporate deposits
Trade credit notes ( commodity exchanges )
Factoring

54

Long Term Financing

Basis of evaluation
Availability
Flexibility
Cost

Availability : should be available at the point / time when required

Flexibility : certain instruments are user/ application specific
Cost

: to be evaluated on a post tax basis

55

SOURCES OF TERM FINANCE

Term loans from Financial institutions & Banks
State level financial institutions
Debentures:

NCD

PCD
OFCD
Fixed Deposits
Equity share capital
Equity shares with Differential voting rights.
Non voting shares
Preference share capital
56

 Retained earnings
Exchangeables
Venture Capital
Deferred payment gurantees
Leasing
External commercial borrowings
Depository receipts
Floating interest rate Debt.
Securitisation of future receivables
Derivative linked bonds
57

FINANCIAL / INVESTMENT INSTITUTIONS

They are major source of long term debt funds for financing:
Fixed Assets
Margin money for working capital
Indian FIs
IDBI / ICICI / IFCI / IIBI
Foreign Institutions
Sectoral Institutions
HDFC / IL&FS / HUDCO / IDFC
Universal Banks
ICICI Bank
58

Investment institutions
GIC & Subsidiaries
UTI
LIC
Investment Banks
23 State level financial institutions (IDCs)
23 State level financial institutions (MSFC)
Scheduled Commercial Banks

59

Features: Interest rate is based upon the base rate + risk.

Basic interest rate linked to inflation rate
Linked to G-Sec rate or SBI FD rate
Security

Hypothecation & mortgage

Collateral
Covenants

Moratorium period
Amortisation schedule
Door to Door tenure

60

GUIDE LINES FOR KEY RATIOS

DCSR > 1.8 TIMES
D/E

1:5:1

Promoters contribution : 20 - 25%

CR: > 1.33
ADDITIONAL FEATURES :
- Interest rate re-set clause
- Tapering of interest rate post project risk

61

Debentures:
Approval from SEBI mandatory if public issue is proposed
Debentures used to finance margin money not to exceed more than
20% of N.W.C

Convertibility clause terms to be specified at issuance time.

Credit rating mandatory

62

 Types of Debentures:
NCD
FCD
PCD
OCD
Coupon rate depends on terms of issue.
Other features
No TDS for interest paid upto Rs 2500 per annum
Redemption premium
Listing on stock exchanges
Fully secured
Call and put options
63

Advantages from Issuers point of view:

Lower cost due to low risk and tax deductibility of interest
payment.
No / limited dilution of control
Offer stable return to investors having fixed maturity
and subsequently redemption/ conversion to equity
No increase in equity base during non conversion period

Fixed deposits
Limit on quantum : 25% of networth
Cost : 8-10 % depending on maturity period & risk
unsecured
64

EQUITY SHARE CAPITAL

Authorised , issued, subscribed and paid up
Par value, issue price, book value, market value
Residual claims on Income /Assets
No upper limit
Costliest sources of finance
Entails permanent servicing by way of dividends without tax
shield
Voting rights/ Control in management/ Limited liability
Under preview of SEBI and SEB guidelines
Buy Back allowed
65

Equity investments in foreign cos allowed to resident indian

shareholder in the event foreign co has 10% stake in Indian co.
For Listing on exchanges atleast 25% to be offered to the public by
way of a prospectus
Issuance of Non-Voting & differential rights shares allowed
Debentures on conversion becomes equity share capital.
Listed / Unlisted shares
Sweat Equity / Employee Stock Options

66

EVALUATION OF ESC
Companys point of view
Advantages
Represents almost permanent capital
Does not involve any fixed obligation for servicing
Enhances credit worthiness of the company to secure additional
debt.
Disadvantages
High cost of capital
Dividends paid on profit after tax further subjected to dividend
distribution tax of 15%
High flotation cost
Dilution of control (Treasury issue)

67

Investors point of view

Advantages
Enjoy voting right in the company with limited liability.
Short term capital gains tax reduced to 10%
Long term Capital gains tax abolished. ( Exchange traded
securities )
Indexation benefit available under 54E.
Disadvantages
Controlling power could be notional
Turn over tax on sale of the security on an exchange
Have residual claim to income / assets
Vide fluctuations in stock price
Dividends subjected to distribution tax of 15%
68

Retained earnings
Made up of Accumulated depreciation and retained profits.
Represent the internal sources of finance available to the
company.
Availability : Level of profitability / payout ratio
Cost

: Identical to ESC.

Flexibility

: High
69

Advantages
Reinvestment of profit may be convenient to many shareholders.
No dilution of control since Co. Relies on retained earnings
No flotation cost/ Losses on account of underpricing.
Proceeds could be used in a subsequent buyback.
Disadvantages
High opportunity cost
. Limitation on amount
Bonus issue may capitalise
reserves

70

Preference share capital

Fixed minimum dividend rate
No voting rights
Prior claim on income / assets
Redeemable at issuers & investors discretion
Features:
No dilution of control
Provision to skip dividend in absence of profits
71

CAPTAL BUDGETING

72

 Capital investment decision

Capital investments involve increase in the fixed assets of a
company.
(Expansion / diversification / Green field / takeover / merger)
Characteristics of investments
Capital outlay needs to be made up front returns come later
Certain amount of risk is involved
Capital investment tend to be indivisible. (difficult to phase out).
Financial techniques
The purpose of financial techniques is to enable the making of
investment acceptance / rejection decisions.
73

Non financial factors in project appraisal

Market
Technical
Infrastructure
Ecological
Economic
Influence of non - financial factors
Financial projections
Gestation period
Profitability
Life of project / Terminal value
Sensitivity analysis
74

NON FINANCIAL FACTORS DETERMINING

FINANCIAL VIABILITY OF PROJECTS
Market factors
Present and future size of the market
Present and future demand and supply situation
Achievable market share
Selling & distribution channels
Technical factors
Level of Technological obsolence

Plant location
Scales of operation
Raw material & utilities consumption norms75

Ecological factors
Pollutant levels
Treatment of effluent
Environmental impact of the project
Economic factors
Social cost benefit analysis
Economic rate of protection
Domestic resource cost
Protection enjoyed by industry.
76

FINANCIAL TECHNIQUES IN CAPITAL

BUDGETING
Return on investment
AVG ROI

= PBIT

(over 10 yrs)

Total Inv.

Advantages
Simple to calculate and easy to understand
Maximisation of shareholders wealth and maximising the market
value of investments.
.Disadvantages
Time value of money not considered
It is a concept based on profit and not cash
No objective criterion for acceptance / Rejection decision.
77

Payback period
It is the time required to get back the original investment
companies going through liquidity crisis /for small investments will
use the pay back period method.
Disadvantages
Cash inflows / Outflows after payback Period are ignored.
Time value for money is ignored

78

Discounted cash flow (DCF)

Cash inflow and outflow for the entire life of the project is
considered.
It considers time value for money as a result earnings in earlier
years have higher value than earned in later years.
IRR Method
IRR is that rate of discount at which the net present value of cash
flows equals net present value of cash outflows.
If IRR > COC Investment is support worthy.
NPV method
Using COC discount the netflows
If NPV is + VE investment is support worthy..
79

Comparison of elements
Elements

Payback

NPV

IRR

Net investment.

Comparable

comparable

Comparable

Subsequent
investment

Possible to use
rough approx.

Exact timing

Exact timing

Recovery of
terminal value

Not Possible

Accounting
profit

Rough
approximation

Not relevant

Not Relevant

Operating cash
flow

Approximation
of pattern

Not relevant

Not relevant

Specific
Specific
economic impact economic impact

80

Comparison of elements
Year by year
operating cash
flow pattern

Cannot
accomodate

Exact economic
impact

Exact Economic
impact

Economic Life

Not considered

Integral to
analysis

Integral to
analysis

Result

Years to cover
the initial
investment

Net Balance of
equivalent cash
inflows and
outflows

Yield rate of
discount equating
inflows and
outflows.

81

CONCEPTS IN CAPITAL BUDGETING

Life of project
Physical
Market
Techno efficient
Incremental principle
Sunk / Allocated costs to be ignored
Only incremental cash flows to be considered
Evaluation of post tax basis since COC is on a post tax basis
Principle of separation of Finance from Investment decision.
Financing cost (interest) to be ignored.
Effect of tax shield on the company as a whole to be considered
82

PROJECT COST COMPONENTS

Land
Civil Construction
Plant & Machinery
Misc Fixed Assets
Erection and commissioning
Technical Know how fees
Preliminary & preoperative expenses
Contingencies
Total Capital Cost
Margin money for working capital
Total project cost
83

PROJECT CASH FLOWS

Cash outflows

Capital expenditure

Margin money
Normal capital expenditure

Cash inflow

Net cash accruals

Salvage value
Recovery of WC

84

NPV vs IRR conflict

NPV is technically superior to IRR and is also able to
handle selection of mutually exclusive projects.
The decision rule for the NPV assumes that cash flows
resulting during the life cycle of the project have an
opportunity cost equal to the discount rate used.
The decision rule for the IRR assumes that such resulting
cash flows have an opportunity cost equal to IRR which
generated them.
NPV approach provides an absolute measure that fully
represents the value from the project to a company.
IRR by contrast provides a % figure from which the
benefits in terms of wealth creation cannot be85grasped.

Capital Budgeting Sensitivity Analysis

Monte Carlo Simulation
Break even analysis
Decision tree analysis
Expected value Criterion
Alternate business plans
86

Share holder value creation

Cash Dividends
Stock Dividends
Bonus Shares
Bonus Debentures-issued from free reserves
Equity Buy back / Secondary Listing
Stock Split
Synergic Investments
Synergic Acquisitions
Disinvest out of unrelated businesses
Shares of holding co. with fungibility
87

DIVIDEND STRUCTURING
Appropriation of PAT towards Dividend pay out and Reserves
Payout ratio

Retention ratio =

Dividend paid / PAT

PAT - Dividend paid / PAT

Dividend rate (%) could be high but payout could be low.

Dividend rate will be depended upon the PAT, Payout ratio and
Equity base.
88

Dividend Structuring
100% retention scenario
For some shareholders dividend acts as a regular income source
EX: investors for whom it is a regular source of income, mutual
funds, investment companies.
Declaration of dividend is perceived as an indication that the
companies operations are profitable.
100% payout scenario
Repeated raising of capital increases floatation cost
Companies requirement for expansion / margin money / new
investment.
Tax inefficient due to 15% distribution tax. Though not csacaded in
a holding Co structure.
89

Factors influencing dividend policy

If the appetite for funds is high due to increase in level of existing
operation or due to major capital investment plan then a high
retention policy will be adopted.
A closely held company having major capital investment plans
will follow a low pay out policy so that internal accruals could
act as a major source of finance in the future thereby reducing
dependence on infusion of fresh equity.
Tax implications
Company has to pay 15% distribution tax. Receipt of dividend tax
exempted in the shareholders hands. Grossing up of DDT allowed
90
to prevent cascading effect.

 Restriction in loan agreement / government regulations / FIs on

on payment of dividend during the currency of the loan.
Legal requirement under Companies act.
Liquidity position : Higher PAT does not necessarily mean
healthy liquidity. A strained liquidity position would force a
policy of low payout.
Stability in the rate of dividend : companies usually follow a
policy of gradually rising or stable dividend policy and not
directly link it with PAT.
Generally the Indian corporate sector follows a payout policy of
30% . The retention ratio keeps increasing so as to counter
inflation, floatation cost, help in Equity buyback etc.
91

BONUS SHARES
Bonus share are issued to existing share holders as a result of
capitalization of reserves.
In the wake of a bonus issue
The shareholders proportional ownership remains unchanged
The book value, market price, E.P.S decreases.
Fallout of a bonus issue
Normally the Ex-bonus price comes down by the proportion of
bonus given with a mark up of approximately 30 - 35%
More active trading in stock exchanges.
The nominal rate of dividend tends to decline this may dispel the
impression of profiteering.
Shareholders regard a bonus issue as a firm indication that the
prospects for the company are good.
Capital gains tax exemptions with indexation available for bonus
issue
92

GUIDELINES FOR ISSUE OF BONUS SHARES

Issuer : Security exchange board of India
Bonus issue should be made from capitalisation of free reserves
built out of genuine profits and share premium.Reserves created by
revaluation of assets, statutory reserves etc. are not allowed for
capitalisation
Bonus issue greater than 1:1 allowed
Residual reserve test: residual reserves after the proposed
capitalisation should be at least 40% of the increased capital For
computation all contingent liabilities, statutory reserves and
revaluation reserves to be excluded.
Yield test: 30% of the average P.B.T for the last 3 years should give
a return of at least 10% on the enhanced capital.
Bonus in lieu of dividend is not permitted
93

If R

= Reserves before bonus issue

= Share capital before bonus issue

= Bonus Quantum

PRT

= Average PBT for last 3 years

RPT

= .4 (S + B) > (R - B)

YIELD TEST

= .3 (PBT) > (.1) (S+B)

Bonus issue also to be given to debenture holders if there is an

impending conversion.

94