Principles and Form of Lending

Basically, there are five principles which must be duly observed while advancingmoney to the borrowers:

1. Safety
2. Liquidity
3. Dispersal
4. Remuneration
5. Suitability

Safety

Banker’s Fund comprise mainly of money borrowed from numerous customers on various accounts, such as Current Account, Savings Bank Account, Call Deposit Account, Special Notice Account and Fixed Deposit Account etc. it indicates that whatever money the banker hold is that of his customers who have entrusted the banker with it only because they have full confidence in the expert handling of money by their banker. Therefore , the banker must be very careful and ensure that his depositers’ money is advanced to safe hands where the risk of loss doesn’t exist.

The elements of character, capacity and capital can help a banker in arriving at a conclusion regarding the safety of advances allowed by him.

Liquidity

Liquidity means the possibilities of recovering the advances in emergency, because all the money borrowed by the customer is repayable in lumpsum on demand. Generally the borrowers repay their steadily, and the funds thus released can be used to allow fresh loans to other borrowers. Nevertheless the banker must ensure that the money he is lending is not blocked for an undue long time, and that the borrowers are in such a financial position as to pay back all the outstanding against them on a short notice. In such a situation, it is very important for a banker to study his borrower’s assets to liquidity, because he would prefer to lend only for a short period in order to meet the shortfalls in the working capital.

Corporate Finance

Managerial or corporate finance is the task of providing the funds for a corporation's activities. For small business, this is referred to as SME finance. It generally involves balancing risk and profitability, while attempting to maximize an entity's wealth and the value of its stock.

Long term funds are provided by ownership equity and long-term credit, often in the form of bonds. The balance between these forms the company's capital structure. Short-term funding or working capital is mostly provided by banks extending a line of credit.

Accounting Ratios for Financial Statement Analysis

Liquidity Analysis Ratios


                                  Current Assets
Current Ratio = ------------------------
                             Current Liabilities

                            Quick Asset
Quick Ratio = ----------------------
                           Current Liabilities


Quick Assets = Current Assets - Inventories

                                                  Net Working Capital
Net Working Capital Ratio = --------------------------
                                                     Total Assets

Net Working Capital = Current Assets - Current Liabilities

Profitability Analysis Ratios


                                                        Net Income
Return on Assets (ROA) = ----------------------------------
                                                    Average Total Assets

Average Total Assets = (Beginning Total Assets + Ending Total Assets) / 2

                                                               Net Income
Return on Equity (ROE) = --------------------------------------------
                                                 Average Stockholders' Equity

Average Stockholders' Equity = (Beginning Stockholders' Equity + Ending Stockholders' Equity) / 2

Financial Statement

There are five key financial statements

1. Income statement

2. Balance sheet

3. Statement of retained earning

4. Statement of cash flow

5. Notes to financial statement

Income Statement

The income statement provides a financial summary of the firm’s operating results during a specified period. Most common are income statements covering a 1-year period ending a specified date, ordinally 31 December or 30 June of the calender year.

Balance Sheet                                                Assets = Liabilities + Equity

The balance sheet presents a summary of the firm’s financial position at a given point in time. The statement balances the firm’s assets(what it owns) against its financing, which can be either debt (what it owns) or equity (what was provided by owners).

Insurance

Insurance, in law and economics, is a form of risk management primarily used to hedge against the risk of a contingent loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for a premium, and can be thought of as a guaranteed and known small loss to prevent a large, possibly devastating loss. An insurer is a company selling the insurance; an insured or policyholder is the person or entity buying the insurance. The insurance rate is a factor used to determine the amount to be charged for a certain amount of insurance coverage, called the premium.


Types of insurance

1. Auto Insurance

2. Home Insurance

3. Health

4. Accident, sickness and unemployment insurance

5. Casualty

6. Life

7. Property

8. Liability

9. Credit

Derivatives

A security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage.

Futures contracts, forward contracts, options and swaps are the most common types of derivatives. Derivatives are contracts and can be used as an underlying asset. There are even derivatives based on weather data, such as the amount of rain or the number of sunny days in a particular region.

Derivatives are generally used as an instrument to hedge risk, but can also be used for speculative purposes. For example, a European investor purchasing shares of an American company off of an American exchange (using U.S. dollars to do so) would be exposed to exchange-rate risk while holding that stock. To hedge this risk, the investor could purchase currency futures to lock in a specified exchange rate for the future stock sale and currency conversion back into Euros.

Financial Management

According to Wachowicz,


Financial Management concerns with the acquisition, financing, and management of assets with some overall goal in mind.

Three decisions are very important in Financial Management,

1. Investment Decision

2. Financing Decision

3. Asset Management Decision

Investment Decision:

Investment Decision is one of the most important of the three decision. It deals in deciding the optimal size of the firm. It answer the basic question of how much investment should be done. When size of firm is decided, the next thing is what specific asset should be aquired and what asset (should any)be reduced or eliminated.

Financing Decision:

When the investment decision has made, the next decision is what is the best type of financing; either it to finance with debt or equity. The financing mix should be decided in order to make a optimum balance between risk and return which is very important decision. Also the dividend policy should be considered carefully i.e either whole profit is to retained or any to be distributed among th shareholders, who are the owner of the firm.

Asset Management Decision:

Asset Management deals with how best is to manage the existing assets of the firm. Financial manager responsibility is more towards the current asset of the firm. The fixed assets is generally concern with the production/engineering manager’s responsibility.

Risk

Risk


Risk is a concept that denotes the precise probability of specific eventualities. Technically, the notion of risk is independent from the notion of value and, as such, eventualities may have both beneficial and adverse consequences. However, in general usage the convention is to focus only on potential negative impact to some characteristic of value that may arise from a future event.

Risk can be defined as “the threat or probability that an action or event will adversely or beneficially affect an organisation's ability to achieve its objectives”[1]. In simple terms risk is ‘Uncertainty of Outcome’, either from pursuing a future positive opportunity, or an existing negative threat in trying to achieve a current objective.

Formulas used in calculating Time Value of Money

Present value of a future sum


The present value formula is the core formula for the time value of money; each of the other formulae is derived from this formula. For example, the annuity formula is the sum of a series of present value calculations.
The present value (PV) formula has four variables, each of which can be solved for:

              
1. PV is the value at time=0

2. FV is the value at time=n

3. i is the rate at which the amount will be compounded each period

4. n is the number of periods (not necessarily an integer)

Present value of an annuity for n payment periods


In this case the cash flow values remain the same throughout the n periods. The present value of an annuity (PVA) formula has four variables, each of which can be solved for:

1. PV(A) is the value of the annuity at time=0

2. A is the value of the individual payments in each compounding period

3. i equals the interest rate that would be compounded for each period of time

4. n is the number of payment periods.

To get the PV of an annuity due, multiply the above equation by (1 + i).

Types of Interest

There are two types of interest

• Simple Interest
• Compound Interest

Simple Interest

Interest paid(earned) on only the original amount, or principal(borrowed) lent.

Compound Interest

Interest paid (earned) on any previous interest earned, as well as on the principal borrowed (lent).

Example of Simple Interest

Assume that you deposit $1,000 in an account earning 7% simple interest for 2 years. What is the accumulated interest at the end of the 2nd year?
SI = P0(i)(n) = $1,000(.07)(2) = $140

Time Value of Money

Which would you prefer --- $10,000 today or $10,000 in 5 years?
Obviously $10,000 today.....
You already recognize there is

" TIME VALUE OF MONEY!! "

The Time Value of money is the value of money figuring in a given amount of interest for a given amount of time. For example 100 dollar for todays money held for a 5 year at 5 percent interest is worth 105 dollars, therefore 100 dollar paid now or 105 dollar paid exactly one year from now is same amount of payment of money with that given interest at given amount of time.
Time is important factors because time allows you opportunity to postpone consumption and earn interest.

Finance

FINANCE:
Finance is defined as in either terms.

• The Science of Management of money and other assets.
• The Management of Money, Banking, Investment and credit.
• The Supplying of funds or capital

Finance is defined as art and science of managing money. Virtually all individuals and organization earn or raise money, and spend or invest money. Finance is concerned with the process, institution, market, and instrument involved in the transfer of money among individuals, businesses and governments. Most adults will benifit from understanding of finance, which will enable them to make better personal financial decision. Those who works in financial jobs will benifit by being able to interface effectively with the firm's financial personnel, process, and procedures.

Basically, finance is the field which deals with the concept of time, money, and risk. The management of finance is important task in every body's life, either he is individual person, household, small business, or a huge corporate entity