Dr.

Komal Taneja
(Ph.D (Management), MBA (Finance), M.com, M.A (Economics),UGC NET
(Management), MP-SLET (Commerce))

ASSOCIATE PROFESSOR
Sant Hirdaram Institute of Management
Bhopal
E-mail: [email protected]
What is
Dividend?

“A dividend is a distribution to shareholders out

of profit or reserve available for this purpose”.

- Institute of Chartered Accountants of India

Forms/Types of
Dividend
 On the basis of Types of Share
 Equity Dividend
 Preference Dividend
 On the basis of Mode of Payment
 Cash Dividend
 Stock Dividend
 Bond Dividend
 Property Dividend
 Composite Dividend
 On the basis of Time of Payment
 Interim Dividend
 Regular Dividend
 Special Dividend
 Dividend Policy
 “ Dividend policy determines the division of earnings between
payments to shareholders and retained earnings”.
- Weston and Bringham
Dividend Policies involve the decisions,
whether-
 To retain earnings for capital investment and other
purposes; or
 To distribute earnings in the form of dividend among
shareholders; or
 To retain some earning and to distribute
remaining earnings to shareholders.
Factors Affecting Dividend Policy
 Legal Restrictions
 Magnitude and trend of earnings
 Desire and type of Shareholders
 Nature of Industry
 Age of the company
 Future Financial Requirements
 Taxation Policy
 Stage of Business cycle
 Regularity
 Requirements of Institutional Investors
Dimensions of Dividend
Policy
 Pay-out Ratio
 Funds requirement
 Liquidity
 Access to external sources of financing
 Shareholder preference
 Difference in the cost of External Equity and
Retained Earnings
 Control
 Taxes
 Cont
d.
 Stability
 Stable dividend payout Ratio
 Stable Dividends or Steadily changing
Dividends
Types of Dividend Policy

 Regular Dividend Policy

 Stable Dividend Policy
 Constant dividend per share
 Constant pay out ratio
 Stable rupee dividend + extra
dividend
 Irregular Dividend Policy
 Dividend Theories

Irrelevance Theories
Relevance Theories
(i.e. which consider dividend
(i.e. which consider dividend
decision to be irrelevant as it
decision to be relevant as it
does not affects the value of the
affects the value of the
firm)
firm)

Walter’ Gordon’s
s Model
Model

Modigliani and Traditional

Miller’s Model Approach
 Walter’s Model
 Prof. James E Walter argued that in the long- run the
share prices reflect only the present value of expected
dividends. Retentions influence stock price only through
their effect on future dividends. Walter has formulated this
and used the dividend to optimize the wealth of the equity
shareholders.
Assumptions of Walter’s Model:
 Internal Financing
 constant Return in Cost of Capital
 100% payout or Retention
 Constant EPS and DPS
 Infinite time
Formula of Walter’s Model

D+ r (E-D)
P = k
k
Where,
P = Current Market Price of equity
share E = Earning per share
D = Dividend per share
(E-D)= Retained earning per share
r = Rate of Return on firm’s investment or Internal Rate
of Return
k = Cost of Equity Capital
Illustration
:
 Growth Firm (r > k):
r = 20% k = 15% E = Rs. 4
If D = Rs. 4
P = 4+(0) 0.20 /0 .15 = Rs. 26.67
0.15
If D = Rs. 2
P = 2+(2) 0.20 / 0.15 = Rs. 31.11
0.15
Illustration
:
 Normal Firm (r = k):
r = 15% k = 15% E = Rs. 4
If D = Rs. 4
P = 4+(0) 0.15 / 0.15 = Rs. 26.67
0.15
If D = Rs. 2
P = 2+(2) 0.15 / 0.15 = Rs. 26.67
0.15
Illustration
:
 Declining Firm (r < k):
r = 10% k = 15% E = Rs.
4
If D = Rs. 4
P = 4+(0) 0.10 / 0.15 = Rs. 26.67
0.15
If D = Rs. 2
P = 2+(2) 0.10 / 0.15 = Rs. 22.22
0.15
Effect of Dividend Policy on
Value of Share
Case If Dividend Payout If Dividend Payout
ratio Increases Ration decreases

1. In case of Growing Market Value of Share Market Value of a share

firm i.e. where r > k decreases increases

2. In case of Declining Market Value of Share Market Value of share

firm i.e. where r < k increases decreases

3. In case of normal firm No change in value of No change in value of

i.e. where r = k Share Share
Criticisms of Walter’s Model

 No External Financing
 Firm’s internal rate of return does not always
remain constant. In fact, r decreases as
more and more investment in made.
 Firm’s cost of capital does not always
remain constant. In fact, k changes directly
with the firm’s risk.
 Gordon’s
Model
 According to Prof. Gordon, Dividend Policy
almost always affects the value of the firm. He
Showed how dividend policy can be used to
maximize the wealth of the shareholders.
 The main proposition of the model is that the

value of a share reflects the value of the future

dividends accruing to that share. Hence, the
dividend payment and its growth are relevant in
valuation of shares.
 The model holds that the share’s market price is

equal to the sum of share’s discounted future

dividend payment.
 Assumptions:
 All equity firm
 No external Financing
 Constant Returns
 Constant Cost of Capital
 Perpetual Earnings
 No taxes
 Constant Retention
 Cost of Capital is greater then growth rate
(k>br=g)
Formula of Gordon’s Model

E (1 – b)
P =
K - br

 Where,
P = Price
E = Earning per
Share b = Retention
Ratio
k = Cost of Capital
br = g = Growth
Criticisms of Gordon’s model
 As the assumptions of Walter’s Model and Gordon’s
Model are same so the Gordon’s model suffers from
the same limitations as the Walter’s Model.
Modigliani & Miller’s Irrelevance
Model

Value of Firm (i.e. Wealth of Shareholders)

Depends on

Firm’s Earnings

Depends on

Firm’s Investment Policy and not on dividend policy

Modigliani and Miller’s Approach
 Assumption
 Capital Markets are Perfect and people are
Rational
 No taxes
 Floating Costs are nil
 Investment opportunities and future profits of
firms are known with certainty (This
assumption was dropped later)
 Investment and Dividend Decisions are
independent
 M-M’s Argument
 If a company retains earnings instead of giving it out as
dividends, the shareholder enjoy capital appreciation
equal to the amount of earnings retained.
 If it distributes earnings by the way of dividends instead
of retaining it, shareholder enjoys dividends equal in
value to the amount by which his capital would have
appreciated had the company chosen to retain its
earning.
 Hence,
the division of earnings between dividends and retained
earnings is IRRELEVANT from the point of view of
shareholders.
 Formula of M-M’s Approach

1
Po =
( D1+P1 ) (1 + p)

Where,
Po = Market price per share at time
0,
D1 = Dividend per share at time 1,
P1 = Market price of share at time 1
Criticism of M-M
Model
 No perfect Capital Market
 Existence of Transaction Cost
 Existence of Floatation Cost
 Lack of Relevant Information
 Differential rates of Taxes
 No fixed investment Policy
 Investor’s desire to current
obtain income
 Traditional Approach
 This theory regards dividend decision merely as a part of
financing decision because
 The earnings available may be retained in the business for re-
investment
 Or if the funds are not required in the business they may be
distributed as dividends.
 Thus the decision to pay the dividends or retain the earnings
may be taken as a residual decision
 This theory assumes that the investors do not differentiate
between dividends and retentions by the firm
 Thus, a firm should retain the earnings if it has profitable
investment opportunities otherwise it should pay than as
 Definition of Working Capital
 Working Capital refers to that part of the firm’s capital, which is required for
financing short-term or current assets such a cash marketable securities, debtors
and inventories. Funds thus, invested in current assets keep revolving fast
and are constantly converted into cash and this cash flow out again in exchange for
other current assets.
 Working Capital is also known as revolving or circulating capital or short-term
capital.
Important factors determining the
requirements of working capital are as follows

 Sales
 Length of Operating Cycle
 Nature of Business
 Terms of Credit
 Seasonal Variations
 Turnover of Inventories
 Nature of Production Technology
 Contingencies
 Cash Management

 In narrow sense: currency and generally

accepted equivalents of cash like cheques,
drafts etc.
 In broad sense: includes near-cash assets, such
as marketable securities and time deposits in
banks.
 They can be readily sold and converted into cash.
 Can serve as a reserve pool of liquidity.
 Also provide short term investment outlet for excess
 Four Steps of Cash Management
Cash planning
Managing the cash flows
Optimum cash level
Investing surplus cash

 Transaction motive
 Precautionary motive
 Speculative motive
 Compensating motive
 Holding of cash to meet routine cash requirements to finance the
transactions which a firm carries on in the ordinary course of
business.
 Cash is held to pay for goods or services.It is useful for
conducting our everyday transactions or purchases.

• The cash balances held in reserve for random and

unforeseen fluctuations in cash flows.
• A cushion to meet unexpected contingencies.
– Floods, strikes and failure of imp customers
– Unexpected slowdown in collection of accounts receivable
– Sharp increase in cost of raw materials
– Cancellation of some order of goods
• Defensive in nature
 Is a motive for holding cash/near-cash to quickly take
advantage of opportunities typically outside the
normal course of business.
 Positive and aggressive approach
 Helps to take advantage of:
 An opportunity to purchase raw
materials at reduced price
 Make purchase at favorable prices
 Delay purchase on anticipation of
decline in prices
 Buying securities when interest rate is
expected to decline
• Meeting payments schedule
– It prevents insolvency
– relationship with bank is not constrained
– Helps in fostering good relationships
– Cash discount can be availed
– Strong credit rating
– Take advantage of business opportunities
– Can meet unanticipated cash expenditure with a
minimum of strain.
• Minimizing funds committed to cash
balances
– High level of cash: large funds remain idle
– Low level of cash: failure to meet payment schedule
 Accelerating Cash Collections
Slow down cash payments
1.Decentralised
Collections
• Number of collection centres
• Collection centres will collect cheques from customers and
deposit in their local bank accounts
• They will deposit the funds to a central bank
2. Lock-box System
• Collection centers are established considering the customer
locations and volume of remittances
• At each centre the firm hires a post office box
• Remittances are directly picked from the bank whom the
firm gives the authority
Advantages of lock-box system are:
• Cheques are deposited immediately upon receipt of
remittances
• Eliminates the period between the time cheques are
 3. Prompt payment by customers.
 4. Quick conversion of payments into cash: This can be
done by reducing the floats like postal float, lethargy and
deposit float.
 5. Allowing online payments to customers.
Slow down cash payments

It means delay the payments as much as possible. Can

help the firm in conserving cash and reducing the
financial requirements.
This can be done by:
1. Paying on last date.
2. Payment through drafts.
3. Adjusting payroll funds.
4.Centralisation of payments
5.Inter-bank transfer
6. Making use of float.
 Cash Management Models
William J. Baumol’s model of cash
management-
 Trades off between opportunity cost or carrying
cost or holding cost & the transaction cost. As such
firm attempts to minimize the sum of the holding
cash & the cost of converting marketable
securities in to cash.
 Helps in determining a firm's optimum cash
balance under certainty
William J. Baumol’s
model
 Limitations of Baumol’s Model
The important limitations in Baumol’s model are
as follows:
(i) The model can be applied only when the payments
position can be reasonably assessed.
(ii) Degree of uncertainty is high in predicting the cash
flow transactions.
(iii) The model merely suggests only the optimal
balance under a set of assumptions. But in actual
situation it may not hold good.
Nevertheless it does offer a conceptual framework and
can be used with caution as a benchmark.
 Overview
 The Miller and Orr model of cash management
is one of the various cash management models in
operation. It is an important cash management
model as well. It helps the present day companies
to manage their cash while taking into
consideration the fluctuations in daily cash
flow.
Assumptions of Miller and Orr Model
 (a) The major assumption with this model is that there is no underlying
trend in cash balance over time.
 (b) The optimal values of ‘h’ and ‘z’ depend not only on opportunity
costs, but also on the degree of likely fluctuations in cash balances.
 The model can be used in times of uncertainty and random cash flows. It
is based on the principle that control limits can be set which when
reached trigger off a transaction. The control limits are based on the
day-to-day variability in cash flows and the fixed costs of buying and
selling government securities.
 The model specifies the following two control limits:
 h = Upper control limit, beyond the cash balance should not be carried.
 0 = Lower control limit, sets the lower limit of cash balance, i.e. the firm
should maintain cash resources atleast to the extent of lower limit.
 z = Return point for cash balance
The Miller-Orr model, will work as follows:
(i) When cash balance touched the upper control limit
(h), securities are bought to the extent of Rs. (h-z).
(ii) Then the new cash balance is z.
(iii) When cash balance touches lower control limit (o),
marketable securities to the extent of Rs. (z-o) will be
sold.
(iv) Then the new cash balance again return to point z.
 Limitations
  May prove difficult to calculate.
  Monitoring needs to be
calculated for the organizations
benefits becomes a tedious Work.
Meaning of Inventory

The term inventory is defined as the

itemised list of goods with their estimated
worth specifically annual account of stock
taken in any business.
 Allthe materials , parts,
expenses and in process or suppliers,
products recorded on the books finished
by an
organization and kept in its stocks,
warehouses or plant for some period of
time.
Definition of Inventory
Management
Inventory Management is the technique
of maintaining the size of the
inventory at some desired
level
keeping in view the best economic
interest of an organization.
OBJECTIVES OF INVENTORY CONTROL

 To reduce investment in inventories and made

effective use of capital investments.
 To supply drugs in time.
 Efforts are made to procure goods at minimum price
without bargaining the quality.
 To avoid stock out and shortages.
 Wastages are avoided.
 Inventory management is essential to maintain a large
size inventory for efficient and smooth production and
also for sales operation.
Benefits of Inventory Control
 Ensures an adequate supply of materials
 Minimizes inventory costs
 Facilitates purchasing economies
 Eliminates duplication in ordering
 Better utilization of available stocks
 Provides a check against the loss of materials
 Facilitates cost accounting activities
 Enables management in cost comparison
 Locates & disposes inactive & obsolete store items
 Consistent & reliable basis for financial statements
The common and widely used techniques are:
 ABC ANALYSIS (Always Better Control)
 VED ANALYSIS (Vital, Essential, Desirable)
 EOQ (Economic Order Quantity)
 Lead Time
 Buffer stock
 Perpetual inventory control system
 SDE classification
 HML Classification
 FSN Classification
 SOS classification
 XYZ Classification
 ABC ANALYSIS
 In this technique the materials are divided
into 3 groups. A,B,C according to the cost of
the materials and money value.
 A items - A few costly items come under this
category these items require proper
storage and handling, overstock is avoided.
 B items - These are neither costly nor
cheap.
 C items - Cheaper in cost.
 It is also known as Selective Inventory
Control Method (SIM).
ABC ANALYSIS
A ITEMS B ITEMS C ITEMS

 it covers 10% of  It covers 20% of the  It covers 70% of the

the total total inventories. total inventories.
inventories.
 It consumes about  It consumes about It consumes about 10%
70% of the total 20% of the total of the total expenditure
budget budget.
 It requires very strict  It requires moderate  It may require low
control control. control.

 It requires either no  It requires low safety  It requires high

safety stock or low stock. safety stock.
safety stock.
 It needs maximum  It requires periodic  It needs close follow
follow up follow up up
 It must be handled  It can be handled by  It can be handled by
by senior officers. middle management. any official of the
management
ABC Analysis

A
Percent of annual dollar usage
80 –
Items
70 –
60 –
50 –
40 –
30 –
20 – B Items
10 – C Items
0 – | | | | | | | | | |

10 20 30 40 50 60 70 80 90 100

Percent of inventory items

 VED ANALYSIS
 VITAL,ESSENTIAL, DESIRABLE
 It is based on the importance of the item and its effects.
ECONOMIC ORDER QUANTITY
 It is the most effective technique for
determination of the quantity.
 It is defined as the quantity of materials to be
ordered at one time which minimises the lost.
 The basic objective of EOQ is to have an ideal
order quantity for any item and to economise on
the cost of the purchase.
Computation of EOQ
 The widely used formula is

EOQ =√{2A×O/C}
Where ,
A=Annual or periodic requirement
O=Ordering cost
C=Carrying cost
FSN Analysis:
 The abbreviation for FSN in “Fast moving, Slow moving
and Non moving”.
 Here in this analysis, the date of receipt or the last date of issue,
which ever is later, to determine the no. of months which have
lapsed from last transaction.
 FSN is helpful in identifying active items which need to be
reviewed regularly and surplus items and non- moving items are
examined.
SDE Classification:
 The SDE is based upon the availability of items.
 Here ‘S’ refers to ‘Scarce’ items
 ‘D’ refers to ‘Difficult’ items
 ‘E’ refers to ‘Easy to acquire’
 This is based on problems faced in procurement,
were some strategies are made on purchasing.
 Inventory Costs

Carrying cost

• cost of holding an item in inventory

Ordering cost

• cost of replenishing inventory

Shortage cost

• temporary or permanent loss of sales when

demand cannot be met
JUST IN TIME (JIT) METHOD
 In Just in Time method of inventory control, the company
keeps only as much inventory as it needs during the
production process.
 With no excess inventory in hand, the company saves the
cost of storage and insurance. The company orders further
inventory when the old stock of inventory is close to
replenishment.
 This is a little risky method of inventory management
because a little delay in ordering new inventory can lead to
stock out situation. Thus this method requires proper
planning so that new orders can be timely placed
Receivables Management
It refers to the sum of all monies owed to the firm by customers arising from the
sale of goods or services in the ordinary course of business. It includes:-
• Debtors
• Accounts Receivable
• Book debts/ customer receivable
• Trade Receivable

Features
Process of decision making regarding investment of receivables.

High working capital implies high interest rates.

If receivables are low, sales becomes restricted.

Receivables to be managed to optimise profits.

Maximises the overall return on investment of the firm.

 Purpose
Increase in Sales

Increase in Profits

Meeting the Competition

 Cost of Maintaining Receivables
• Capital Cost
• Time gap between cost incurred and sales incurred.
• Funds to be raised for payment of wages and suppliers.
• Such funds to be raised from outside or from retained earnings.
• Liability to pay interest to creditors.
• Opportunity cost incurred – the money the firm could have earned if invested outside the firm.
• Administrative Costs
 Costs incurred for maintenance of customers’ accounts

 Costs incurred for investigating the creditworthiness of the customers in the market.

 Collection Costs

 Expenses for collection of payments from credit customers.

 Costs of recovery from defaulting customers

 Defaulting costs

 Bad debts
Aspects of Receivables Management
• Whether to grant credit or not?
How much is the credit limit?
These depend on the credit standards that are either tight and restrictive
OR liberal and non- restrictive

Credit Standards -
determinants
• Collection Costs

• Avg Collection Period

• Extent of bad debts

• Level of sales
 Internal Financing
 A new company can raise funds only through external sources such as share ,
debenture , loans etc. But an existing or a going concern which needs finance for its
future growth and expansion can also generate through its internal sources . Such
as retained earnings or ploughing back of profits , capitalisation of profits and
depreciation.

PLOUGHING BACK OF PROFITS

In this all the profits of the year are not distributed among the shareholders . Total
profit retained in the firm . The process of retaining profits year after year and their
utilisation in business known as self financing or inter financing .

NEED OF PLOUGHING BACK OF PROFITS

 For replacement of old asset which have been obsolete .
 For expansion and growth .
 For making company self dependent .
 For redemption of loan and debenture .
 For satisfy the working capital needs of company .