Operating leverage

A relatively small percent increase or decrease in sales volume that causes a much larger percent increase or decrease in profit because fixed expenses do not change with small changes in sales volume. Sales volume changes have a lever effect on profit. This effect should be called sales volume leverage, but in practice it is called operating leverage.

Operating leverage the proportionate relationship between

a companys variable and fixed costs

degree of operating leverage

a factor that indicates how a percentage change in sales, from the existing or current level, will affect company profits; it is calculated as contribution margin divided by net income; it is equal to (1 - margin of safety percentage)

degree of operating leverage (DOL)

Percentage change in profits given a 1 percent change in sales.

breakeven point
The annual sales volume level at which total contribution margin equals total annual fixed expenses. The breakeven point is only a point of reference, not the goal of a business, of course. It is computed by dividing total fixed expenses by unit margin. The breakeven point is quite useful in analyzing profit behavior and operating leverage. Also, it gives manager a good point of reference for setting sales goals and understanding the consequences of incurring fixed costs for a period.

margin of safety
the excess of the budgeted or actual sales of a company over its breakeven point; it can be calculated in units or dollars or as a percentage; it is equal to (1 - degree of operating leverage)

Leverage
The relationship between interest bearing debt and equity in a company(financial leverage) or the effect of fixed expense on after tax earnings(operating leverage).

Financial leverage
Debt financing amplifies the effects of changes in operating income on the returns to stockholders.

Financial leverage
The equity (ownership) capital of a business can serve as the basis for securing debt capital (borrowing money). In this way, a business increases the total capital available to invest in its assets and can make more sales and more profit. The strategy is to earn operating profit, or earnings before interest and income tax (EBIT), on the capital supplied from debt that is more than the interest paid on the debt capital. A financial leverage gain equals the EBIT earned on debt capital minus the interest on the debt. A financial leverage gain augments earnings on equity capital. A business must earn a rate of return on its assets (ROA) that is greater than the interest rate on its debt to make a financial leverage gain. If the spread between its ROA and interest rate is unfavorable, a business suffers a financial leverage loss.

Financial leverage
Use of debt to increase the expected return on equity. financial leverage is measured by the ratio of debt to debt plus equity.

Major functions of financial manager

a) Analise the existing system of accounts. Profit & Loss. b) Plan & achieve your own targets to get good results c) Monitor on daily basis your company expenses & daily income d)Prepare a true balance sheet & not a fabricated one.

What Are The Functions Of A Financial Manager?

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The main function of a Finance Manager (FM) is to provide materially accurate information to the general public, shareholders, stakeholders and the management of an enterprise, be this a joint stock (limited liability) Company, social enterprise/charity or community association, such as a sports club or a parent/teacher organisation. This information will be of two types The first will be management accounts that provides information from which decisions can be made, showing the success - or otherwise - of the organisation in achieving it's goals and targets. The second is financial accounts that is more formal and fulfils legal and moral obligations of organisations. This will include profit and loss accounts at the end of a trading period, together with a balance sheet showing the assets and liabilities of the organisation. The FM, working with auditors and accountants, will complete and file tax returns 2

and other information that is required by the Authorities that oversee the operation of the organisation. This type of information is usually produced annually, but for very large organisations, such as Corporations with operations all over the world, and whose shares are quoted on Stock Exchanges, data is often produced at the end of each quarter-year to ensure information is shared, and from which investors can make reasoned judgements. The format of the various reports can be quite simple - useful in small organisations, such as social clubs, but get more complex the larger the organisation. A second key function of an FM is to maintain control over the organisation. This is achieved in a number of ways. Target setting is the usual process, with objectives, defined as a budget set for each part of the organisation, showing how much revenue is required to support the cost structure, so that a trading profit is made at the end of the period. The FM has to work with all the other Managers in the organisation to make sure the objectives are reasonable, are understood and the whole team agrees with them. This process is very complicated and difficult, but once achieved helps the whole organisation. Once a budget is agreed, the FM can monitor progress by measuring what is actually happening against the plan, showing other Managers if they are on track, or some action needs to be taken to increase sales to generate more revenue, or stop spending to cut costs. The FM maintains control by determining processes and ways of doing things. For example, to spend money on something, it is unusual to have a process that establishes whether good value is being achieved by requiring the purchaser to look at different ways of buying what they want, getting different quotes from different suppliers. Processes like these help maintain control by having an audit trail that supports the purchase decision. Other functions will include those needed to be a manager, responsible for the people in the finance team, so good interpersonal skills are required, together with the ability to prioritise and organise. Finance Managers do lots of thinks and look all the financial parts of the company. They are responsible for allocating financial resources of the company. They also activity take part is budgeting, risk management and financial reporting. Other important finance manager tasks are have an eye on profits and loss, make financial reports, making certain plans to lesson the financial risk and so on. Anonymous Some of the main functions of a Finance Manager includes setting up financial goals, planning strategies to reach these goals, keeping a high check on profits and loss, preparing financial reports, investing funds, monitoring cash flows, advising the rest of on mergers and acquisitions, accounting and auditing, developing certain kind of procedures in order to minimize financial risk and establishing lending criteria. In short, financial managers handle all the financial dealings and accounts of the company. The whole lingo is to add value to the company by setting the right financial goals. They handle all the financial accounts with rigorous auditing. They decide on how much of the company's profits should be returned into investment and also how much should be reinvested into the organisation. Financial managers are pillars to your new organisation or a step to the growth of your organisation. Anonymous The main task of a financial manager is to supply investment advice along with financial planning services. Basically the financial manager helps the consumer to maximize their net worth via appropriate 3

asset allocation. Financial managers usually use stocks, bonds, mutual funds and insurance products to fulfil the requirements of a client. Quiet a few financial managers accept a commission imbursement for the different types of financial products which they negotiate for, even though "fee-based" development is gaining popularity in the market. One of the vital services which financial managers supply is the retirement planning. The financial managers have high scale knowledge in the field of budgeting, forecasting, taxation, asset allocation, etc. Financial managers may even help their client in investing for both long term as well as short term basis. Anonymous The five basic corporate finance functions are described as those functions related to; 1) raising capital to support company operations and investments (aka, financing functions); 2) selecting those projects based on risk and expected return that are the best use of a company's resources (aka, capital budgeting functions); 3) management of company cash flow and balancing the ratio of debt and equity financing to maximize company value (aka, financial management function); 4) developing a company governance structure to encourage ethical behavior and actions that serve the best interests of its stockholders (aka, corporate governance function); and 5) management of risk exposure to maintain optimum risk-return trade-off that maximizes shareholder value (aka, risk management function). Role of financial manager in the various functional areas are in planning - the role is to estimate the budget. In organising- the role is allocate the money . In staffing -the role is to determine the salaries and wages. Controlling and directing -the financial manager role is to allocate verify and direct the funds in the right ways for the effective out put The financial manager is responsible for planning, organizing, directing, controlling and evaluating the operations of financial and accounting departments. The role of financial managers are as follows: - Development and Implementation of financial policies and systems - Establishment of performance standards - Preparation of various financial reports for senior managers The functions of Financial manager are.... 1. Planning and Forecasting 2. Financing Decision 3. Investment Decision 4. Dividend Decision 5. Financial negotiation 6. Cash Management

7. Evaluating financial performance 8. Dealing with relevant parties in the Financial Markets Anonymous 1.To make investment decisions. 2.To make financing decisions. 3.To ensure a positive cash flow; so that cash inflows exceed cash outflws. 4.To ensure profitability; so that income exceed expenses. 5.To manage solvency profit maximization is the maximizing of money or terms of money,but not considering long term objective & goodwill of company, while Wealth maximization is concerned about the earning of goodwill & return on investment for a long time e.g: A makes a DJ Group, they make lot of advertisement to sell the tickets, but people finds it with low quality of sound system & not good music A just wanted to earn money at the time & what do u think people will go to his show in the same city again ? its only profit maximization While Sony Music makes a real deal of making music with high quality thus they have long run income in the business of music.. if they conduct a concert, live show, DJ Party, music CD All will be accepted because they have raised their wealth maximization
The financial management come a long way by shifting its focus from traditional approach to modern approach. The modern approach focuses on wealth maximization rather than profit maximization. This gives a longer term horizon for assessment, making way for sustainable performance by businesses.

1. A myopic person or business is mostly concerned about short term benefits. A short term horizon
can fulfill objective of earning profit but may not help in creating wealth. It is because wealth creation needs a longer term horizon Therefore, Finance Management or Financial Management emphasizes on wealth maximization rather than profit maximization. For a business, it is not necessary that profit should be the only objective; it may concentrate on various other aspects like increasing sales, capturing more market share etc, which will take care of profitability. So, we can say that profit maximization is a subset of wealth and being a subset, it will facilitate wealth creation.

2. Giving priority to value creation, managers have now shifted from traditional approach to modern
approach of financial management that focuses on wealth maximization. This leads to better and true evaluation of business. For e.g., under wealth maximization, more importance is given to

cash flows rather than profitability. As it is said that profit is a relative term, it can be a figure in some currency, it can be in percentage etc. For e.g. a profit of say $10,000 cannot be judged as good or bad for a business, till it is compared with investment, sales etc. Similarly, duration of earning the profit is also important i.e. whether it is earned in short term or long term.

3. In wealth maximization, major emphasizes is on cash flows rather than profit. So, to evaluate
various alternatives for decision making, cash flows are taken under consideration. For e.g. to measure the worth of a project, criteria like: present value of its cash inflow present value

of cash outflows (net present value) is taken. This approach considers cash flows rather than profits into consideration and also use discounting technique to find out worth of a project. Thus, maximization of wealth approach believes that money has time value.

4. An obvious question that arises now is that how can we measure wealth. Well, a basic principle is
that ultimately wealth maximization should be discovered in increased net worth or value of business. So, to measure the same, value of business is said to be a function of two factors earnings per share and capitalization rate. And it can be measured by adopting following relation:

5. Value of business = EPS / Capitalization rate 6. At times, wealth maximization may create conflict, known as agency problem. This describes
conflict between the owners and managers of firm. As, managers are the agents appointed by owners, a strategic investor or the owner of the firm would be majorly concerned about the longer term performance of the business that can lead to maximization of shareholders wealth. Whereas, a manager might focus on taking such decisions that can bring quick result, so that he/she can get credit for good performance. However, in course of fulfilling the same, a manager might opt for risky decisions which can put on stake the owners objectives.

7. Hence, a manager should align his/her objective to broad objective of organization and achieve a
tradeoff between risk and return while making decision; keeping in mind the ultimate goal of financial management i.e. to maximize the wealth of its current shareholders

What Does Risk-Free Rate Of Return Mean? The theoretical rate of return of an investment with zero risk. The risk-free rate represents the interest an investor would expect from an absolutely risk-free investment over a specified period of time. Investopedia explains Risk-Free Rate Of Return In theory, the risk-free rate is the minimum return an investor expects for any investment because he or she will not accept additional risk unless the potential rate of return is greater than the risk-free rate. In practice, however, the risk-free rate does not exist because even the safest investments carry a very small amount of risk. Thus, the interest rate on a three-month U.S. Treasury bill is often used as the risk-free rate.

Nominal Rate of Return

What Does Nominal Rate Of Return Mean? The amount of money generated by an investment before expenses such as taxes, investment fees and inflation are factored in. For example, detailed data on a mutual might show a fund's nominal rate of return as 10%, but also show its return after taxes on distributions and sale of fund shares is only 7%. Investors should look beyond an investment's nominal rate of return to get a true idea of what their investment will earn.

Nominal Rate Of Return Municipal bonds, for example, generally have a lower nominal rate of return than corporate bonds, but the nominal return and the after-tax return of Munis is usually identical since Munis are usually tax exempt, whereas income earned from corporate bonds will be subject to taxation. Corporate bonds are also subject to tax on capital gains when they are sold, giving them an actual rate of return that may be significantly lower than their nominal rate of return.

Most people do not enter financial markets directly but use intermediaries or middlemen. Commercial banks are the financial intermediary we meet most often in macroeconomics, but mutual funds, pension funds, credit unions, savings and loan associations, and to some extent insurance companies are also important financial intermediaries.1 When people deposit money in a bank, the bank uses the funds to make loans to home buyers for mortgages, to students so they can pay for their education, to business to finance inventories, and to anyone else who needs to borrow. A person who has extra money could, of course, seek out borrowers himself and bypass the intermediary. By eliminating the middleman, the saver could get a higher return. Why, then, do so many people use financial intermediaries? Financial intermediaries provide two important advantages to savers. First, lending through an intermediary is usually less risky than lending directly. The major reason for reduced risk is that a financial intermediary can diversify. It makes a great many loans, and even though some of those loans will be mistakes, the losses will be largely offset by loans that are sound. In contrast, an average saver could directly make only a few loans, and any bad loans would substantially affect his wealth. Because an intermediary can put its "eggs" in many "baskets," it insures its depositors from substantial losses. Another reason financial intermediaries reduce risk is that by making many loans, they learn how to better predict which of the people who want to borrow money will be able to repay. Someone who does not specialize in this lending may be a poor judge of which loans are worth making and which are not, though even a specialist will make some mistakes. A second advantage financial intermediaries give savers is liquidity. Liquidity is the ability to convert assets into a spendable form--money--quickly. A house is an illiquid asset; selling one can take a great deal of time. If an individual saver has lent money directly to another person, the loan can also be an illiquid asset. If the lender suddenly needs cash, he must either persuade the borrower to repay quickly, which may not be possible, or he must find someone else who will buy the loan from him, which may be very difficult. Although the intermediary may use its funds to make illiquid loans, its size allows it to hold some funds idle as cash to provide liquidity to
7

individual depositors. Only when a great many depositors want to withdraw deposits at the same time, which happens when there is a "run" on the institution, will the financial intermediary be unable to provide liquidity. Unless it can obtain help from the government or other institutions, it will be forced to suspend payments to depositors. In addition to lending money to individuals and groups, there are other ways in which banks are part of financial markets. Banks borrow and lend funds among themselves in the federal-funds market. They buy and sell foreign exchange. They buy and sell government and commercial debt. And finally, one form of bank debt serves as money in modern economies, and banks create this debt as a result of their financial transactions. Economists are concerned that financial intermediaries can be a source of shocks to the economy, bumps that can disrupt the normal flow of economic life. This concern arises for at least two reasons. First, bank debt serves as money, so disruptions to banks can affect the amount of money in circulation. We explore this idea in later chapters. Second, financial intermediaries are tied together through chains of debts and assets. Because of these linkages, the failure of one financial intermediary can weaken others, increasing their chances of failure. As a result, there is the possibility that if a key financial intermediary fails, that failure can create a domino effect that could cause other financial institutions to fail, ultimately causing the financial sector to "seize up" and stop functioning. Serious disruption of the financial markets will disrupt the rest of the economy. We will develop this idea a bit further in later sections of this chapter.