Unit 1: Financial strategy & sources of finance
Advanced Financial Management notes · PTU syllabus (BCOP 512-18)
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Unit summary
At the top of a company, finance is about strategy — how to fund growth and keep the balance sheet resilient. This unit covers the role of the senior financial adviser, formulating financial strategy, ratio analysis and gearing considerations, and the full range of sources of finance — equity, debt, hybrids, leasing, venture capital, business angels, private equity and asset securitisation.
After this unit you can
- Explain the role of a senior financial adviser and the formulation of financial strategy
- Use ratio analysis and gearing in strategic financial decisions
- Evaluate equity, debt and hybrid sources of finance
- Explain lease finance, venture capital, angel finance, private equity and securitisation
PTU syllabus topics
- Role of the senior financial adviser
- financial strategy formulation
- ratio analysis and gearing considerations
- sources of finance — equity
- debt
- hybrids
- lease finance
- venture capital
- business angel finance
- private equity
- asset securitisation
Equity
Highest
Dilutes ownership
Debt
Lower (tax-deductible interest)
No dilution; fixed obligations
Hybrids (convertibles)
Medium
May dilute later
Venture capital / private equity
High expected return
Investors take board influence
Topic 1
Role of the senior financial adviser
The senior financial adviser (CFO or finance director) advises the board on major financial decisions to maximise long-term shareholder value.
Investment
Major projects, acquisitions, divestments
Financing
Capital structure, raising funds, managing cost of capital
Dividend and returns
Payout, buy-backs
Risk management
Currency, interest rate, commodity, strategic risks
Governance and ethics
Compliance, stakeholder interests, integrated reporting
Communication
Investors, analysts, lenders, rating agencies
- Works within constraints: regulation (SEBI, RBI, Companies Act), lenders' covenants, market conditions, stakeholder expectations.
Topic 2
Formulating financial strategy
- 1
Corporate objectives
Value maximisation, growth, stakeholder goals
- 2
Assess current position
Ratios, gearing, cash flows, cost of capital
- 3
Forecast funding needs
Projects, working capital, debt maturities
- 4
Evaluate options
Equity, debt, hybrids, internal funds
- 5
Choose mix and timing
Cost, risk, control, flexibility
- 6
Implement and monitor
Covenants, ratings, market feedback
- Key interlinked decisions: investment, financing and dividend decisions must be consistent (e.g., high growth with high payout requires external finance).
- Stakeholder considerations: shareholders (return), lenders (security), employees, government, community — conflicts must be balanced.
Topic 3
Ratio analysis and gearing considerations
Financial gearing (book)
Debt ÷ Equity, or Debt ÷ (Debt + Equity)
Market gearing
Market value of debt ÷ Market value of equity
Interest cover
PBIT ÷ Interest
Debt service coverage
Cash available for debt service ÷ (Interest + Principal)
Operating gearing
Fixed costs ÷ Variable costs (or Contribution ÷ PBIT)
Net debt to EBITDA
(Borrowings − Cash) ÷ EBITDA
- Effects of high gearing: higher EPS volatility and financial risk, higher cost of equity, possible covenant breaches, lower credit rating; benefits — tax shield on interest, no dilution of control.
- Optimal gearing considerations: stability of cash flows, asset tangibility, industry norms, tax position, growth opportunities, management's risk appetite, credit-rating targets.
Example
Company with PBIT ₹50 crore and interest ₹20 crore has interest cover 2.5× — lenders typically prefer 3× or more; further debt would be risky.
Exam tip
In strategy answers, always link ratios to the funding decision: "Gearing is already 60%, so the new project should be financed by equity or a rights issue."
Topic 4
Sources of finance: equity, debt and hybrids
| Source | Features | Pros | Cons |
|---|---|---|---|
| Equity (IPO, FPO, rights, private placement, QIP) | Ownership, residual return | No fixed charge, permanent | Costly, dilutes control |
| Retained earnings | Internal funds | No issue costs, no dilution | Limited, opportunity cost |
| Term loans | Bank/FI loans | Flexible, interest tax-deductible | Covenants, security required |
| Debentures and bonds | Fixed interest, may be secured | Cheaper than equity | Fixed burden, refinancing risk |
| Commercial paper | Short-term unsecured notes | Low cost for rated firms | Only for strong credit |
| External commercial borrowings / masala bonds | Foreign debt (rupee-denominated for masala) | Access to global funds | Currency risk (for ECBs) |
| Preference shares | Fixed dividend | No dilution of voting | Dividend not tax-deductible |
- Hybrids: convertible debentures, compulsorily convertible preference shares (CCPS), warrants, mezzanine finance, perpetual bonds — combine features of debt and equity; give investors upside while lowering coupon.
Topic 5
Leasing, venture capital, angel finance, private equity and securitisation
- Lease finance: finance lease (substantially all risks and rewards transferred; long-term) vs operating lease (short-term, lessor bears risks). Lease vs buy decision: compare PV of lease rentals (after tax) with PV of cost of borrowing to buy.
- Venture capital: equity finance for high-risk, high-growth start-ups; stages — seed, start-up, early, expansion, mezzanine, buy-out; exit via IPO, trade sale, buy-back. Regulated as Alternative Investment Funds (AIF Category I) by SEBI.
- Business angel finance: wealthy individuals investing their own money at the idea/seed stage, offering mentoring; angel networks (Indian Angel Network, Mumbai Angels).
- Private equity: large equity investments in established unlisted (or listed — PIPE) companies for growth, buy-outs or restructuring; active involvement; exit in 4–7 years.
- Asset securitisation: pooling illiquid assets (home loans, car loans, receivables) and selling them to a Special Purpose Vehicle (SPV), which issues securities (pass-through certificates) to investors — converts loans into cash and transfers risk.
- 1
Originator (bank) pools loans
- 2
Sells pool to SPV
True sale
- 3
SPV issues pass-through certificates
- 4
Investors buy PTCs
- 5
Borrowers' EMIs collected by servicer
- 6
Cash passed to investors
Stage
Early-stage start-ups
Mature, established firms
Ticket size
Smaller
Larger
Risk
Very high
Moderate
Stake
Minority
Often majority or significant minority
Focus
Innovation, growth
Efficiency, restructuring, expansion
Key terms
- Financial strategy
- Plan for investment, financing and dividend decisions to maximise value
- Gearing
- Proportion of debt in the capital structure
- Mezzanine finance
- Hybrid finance between senior debt and equity
- Business angel
- Individual investor funding early-stage ventures
- Securitisation
- Converting pools of loans into tradable securities via an SPV
Quick revision
- Senior adviser: investment, financing, dividend, risk, governance.
- Strategy: objectives → position → needs → options → mix → monitor.
- Gearing ratios, interest cover, DSCR guide funding choices.
- Sources: equity, retained earnings, debt, hybrids, leasing, VC, angels, PE.
- Securitisation: originator → SPV → PTCs → investors.
Important exam questions
Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).
Short-answer questions
- Q1.What is the role of a senior financial adviser?
- Q2.Define financial gearing.
- Q3.What is mezzanine finance?
- Q4.Distinguish finance and operating lease.
- Q5.Who is a business angel?
- Q6.What is asset securitisation?
Long-answer questions
- Q1.Explain the role of the senior financial adviser and the formulation of financial strategy.
- Q2.Discuss the use of ratio analysis and gearing in financial decisions.
- Q3.Evaluate various sources of long-term finance including hybrids.
- Q4.Explain venture capital, private equity, lease finance and securitisation.
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