Financial Plan

Prepared for: Sam and Sara Knight

Prepared by: Jack Silver, CFP Financial advisor

Date prepared: December 19th, 2017

Introduction ................................................................................................................................ 3

Goals for Sam and Sara Knight ............................................................................................... 12

Financial Assumptions ............................................................................................................. 17

Financial Management ............................................................................................................. 21

Asset Management ................................................................................................................... 26

Tax Planning ............................................................................................................................ 31

Retirement Planning................................................................................................................. 33

Risk Management .................................................................................................................... 38

Estate Planning......................................................................................................................... 39

Recommendations and Action Steps ....................................................................................... 41

References ................................................................................................................................ 44

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Disclaimer:

All the figures stated in the attached report are derived according to assumptions and

information provided by Sam and Sara Knight. These assumptions and information will be

changed year by year. Some of the data presented is based on current tax rules and legislation

which may be subject to change. Therefore, it is compulsory for me to review your financial

plan regular to firmly ensure that data will be updated constantly and address current needs

properly. More importantly, it is also necessary to look at some different scenarios to get an

idea of the impact of various assumptions on planning objectives. All information provided in

the attached report is general in nature and should NOT be construed as providing legal,

accounting and tax advice. If you have any specific enquiries and issues, please consult your

legal, tax and accounting advisor.

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Introduction

Cash Inflows Monthly Annually

Employment Income

Salary - Sam $ 10,625.00 $ 1,27,500.00

Payroll Deductions - Income Tax $ -2,452.00 $ -29,423.00

Payroll Deductions - CPP/EI Premiums $ -261.00 $ -3,132.00

Salary - Sara $ 8,333.00 $ 1,00,000.00

Payroll Deductions - Income Tax $ -1,886.00 $ -22,628.00

Payroll Deductions - CPP/EI Premiums $ -261.00 $ -3,132.00

Total Available Cash Inflows $ 14,098.00 $ 1,69,185.00

Cash Outflows Monthly Annually

Lifestyle Expenses

Non-Discretionary Expenses

Household expenses, insurance and utilities 1,200 14,400

Heating Oil (monthly level payment program) 200 2,400

Property taxes 400 4,800

House Maintenance 300 3,600

Groceries 700 8,400

Special Education - Philip 700 8,400

Car Lease 1,500 18,000

Car maintenance and insurance 300 3,600

Clothing 350 4,200

Total Non-Discretionary Expenses 5,650 67,800

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Discretionary Expenses Monthly Annually

Vacations 500 6,000

Club Membership 90 1,080

Restaurants 750 9,000

Summer Camp 500 6,000

Extra-Curricular Activities 250 3,000

Theatre Subscription 80 960

Entertainment 500 6,000

Total Non-Discretionary Expenses 2,670 32,040

Debt Payments Monthly Annually

Mortgage 2,270 27,240

RSP catch-up Loan 300 3,600

Student Loan 480 5,760

Furniture Loan 571 6,852

Total Debt Payments 3,621 43,452

Revolving Debt - Interest Payments Monthly Annually

Visa 185 2,220

MasterCard 1,305 15,660

Line of Credit 85 1,020

Total Revolving Debt - Interest Payments 1,575 18,900

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 Savings Monthly Annually

Sam's DC pension Plan contributions 700 8,400

Sam's RRSP contributions 350 4,200

Sara's RRSP contributions 350 4,200

Total Savings 1,400 16,800

We normally read about how corporates are doing financially with reference to their profits,

asset values, debt, equity, and other measures. These measures are indicative of how effective

the corporate is doing financially. The next time you read about these measures, do think

about the people who enable these performance indicators and these are the finance and

treasury functions of the corporates.

Before we proceed further, we would like to remind you that the Treasury or the Finance

function does not actualize the broader financial performance which is determined by the

various strategic, operational, and financial management. Rather, the role of the finance

function is to record, and keeps track of the various matters related to financial management

in corporates.

The finance and the treasury functions are also responsible for tax calculations, social

security payments, payroll, managing the receivables and the payable, and in recent years, the

emergence of the treasury function has meant that they also deal with foreign exchange

management and hedging that has been necessitated due to globalization which means that

many corporates are now actively dealing in multiple currencies and hedging.

The External Functions of the Finance Department

The functions of the finance department can be broadly broken down into external and

internal financial management. The external function encompasses the entire range of

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activities to do with paying the suppliers, vendors, and the other stakeholders who do

business with the corporates.

In addition, the finance function also keeps track of the receivables meaning that they follow

up with the clients and the customers who owe the corporate money for the services rendered.

Apart from this, the finance function also handles the social security payments of the

employees wherein each month or quarter (depending on the prevailing laws of the country),

Further, the finance function is also responsible for remitting the TDS or the Tax Deducted at

Source from the employees into the relevant accounts of the governmental agencies. Above

all, the finance department also liaises with the banks in which the corporate holds account.

The Internal Functions of the Finance Department

The internal functions of the finance department are similarly important wherein it stars the

payroll processing and ensures that employees are paid on time. Indeed, payroll is perhaps the

most visible interface that the finance department has with the employees.

The next time when your salary is credited, do think of the people sitting in the secluded

(usually the finance department in many multinationals is seated separately in glassed

enclosures for diligence and compliance reasons) areas working to get your salary paid on

time.

Further, the internal functions of the finance department also encompass the processing of

reimbursements on account of travel, dining and hospitality, same city transportation, perks,

and any other benefits that are due to the employees. Indeed, perhaps the biggest reason why

many employees either praise or curse the finance department is when their vouchers and

bills have to be cashed.

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In many corporates, this takes some time as not only are the finance personnel overworked

but also they have to perform due diligence before processing the payments. Therefore, the

next time you have a bill to be cashed, you can think of the various steps and the approvals

needed before you shoot off a mail or message on the Bulletin Boards of the organization.

The Treasury Function

We have considered the external and internal functions of the finance department. In recent

years, many multinationals as well as domestic companies that operate globally have added

another key and vital function to the tasks of the finance department and this is the Treasury

Function.

Simply put, Treasury is all about managing the foreign exchange payments and ensuring that

the corporate does not lose money due to fluctuations in the exchange rates. Indeed, as those

who have received payments in Dollars or Euros would cash them when the exchange rate is

favourable.

Similarly, the Treasury’s job is to ensure that the corporate does not lose out and towards this

end, it ensures that hedging and escrow accounts are managed. For instance, there are active

treasury desks in the headquarters of most corporates worldwide due to their global

payments.

Most of the time, the employees are unaware of this function since the Treasury staff do not

sit in the operational offices but instead, are based in the financial capitals such as New York,

London, and Mumbai. Further, details of hedging and treasury management are usually

revealed in the annual reports that many employees do not usually read and hence, little is

known to them about this vital function.

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Anybody who has followed the severe and protracted financial crises of the last Eight years

would be aware of the damaging role played by Exotic Financial Products such as Derivate,

Swaps, Credit Default Swaps, and Options.

These instruments that are supposedly in place to hedge against risk instead have become so

toxic to the health of the global financial system and the global economy that it was no

wonder the legendary American investor, Warren Buffett called them “Financial Weapons

of Mass Destruction”.

This is because the financial innovative instruments which were hailed as bringing a measure

of stability and hedge against risk when they were first invented instead turned into liabilities

because as it turned out, they were not that good at pricing risk and hedging against defaults

after all.

What is Financial Innovation and Why it was Welcomed?

Before proceeding further, it would be in the fitness of things to understand what is meant by

Financial Innovation. As management students learn during their MBAs and other courses,

financial instruments are usually invented to price, factor in risk, hedge against risks such as

counterparty default. In addition, innovations in finance are also due to the very real

possibility that financial and physical assets might lose value suddenly due to economic

cycles and at the same time, they can also inflate beyond measure leading to wild gyrations in

the financial markets.

Thus, derivatives which are so named because they “derive” their value from underlying

assets are created in a manner that protects both the buyers and sellers of the assets against

excessive volatility and wild price movements.

When is Financial Innovation Bad?

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So, one might very well ask, what is the problem if risk is priced in and credit events such as

defaults are hedged against?

The partial answer to this is that innovation is good as long as it is directed and controlled in

a stable manner. Once innovation takes on a life of its own, the net result or the end result is

that it often leads to a situation where neither its creators nor its users understand what

exactly they are all about.

Of course, this does not mean that innovation is per se bad and more so, financial innovation

is something that is inherently wrong. Indeed, it is only because of the financial innovations

of the last few decades that consumers and especially the retail ones like you and we have

been able to have greater control over our savings, portfolios, and assets.

How can we use Financial Innovation for Good?

Thus, while we are not suggesting that financial innovation should cease, we are certainly

advocating financial innovation that benefits society and which does not become overly

complicated and complex that very few of the financial experts understand what it is all

about. Indeed, there are numerous examples of how financial innovation is undertaken with a

view to genuinely improving the condition of the poor rather than solely as a way of making

profits alone.

These include the Microcredit Initiative that was pioneered by the Nobel Prize Winning

Bangladeshi Banker and Social Entrepreneur, Mohammed Yunus, who with his Grameen

Bank succeeded in bringing banking to poor women who were hitherto denied access to

structured credit and were at the mercy of unscrupulous money lenders.

Or, banks such as Bandhan in the Eastern Indian State of Bengal which similarly, is

spearheading a revolution in banking for the masses. Of course, even in the West, there are

numerous instances such as the Commodity Bourses which as a result of Bankers merging the

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financial profit imperative with that of social responsibility has helped the farmers in hedging

against bad harvests, weather changes, and even pure speculation that can result in the

volatility of the prices.

Profits are not the Only Criteria

Thus, it can be said that like everything else in the world of business and finance, as long as

financial innovation has the underlying them of genuinely merging the profitability with that

of social change, then it must be welcomed and even supported and encouraged at all costs.

However, when financial innovation becomes yet another instance of speculation wherein the

sole objective is to make as much money as possible, then it is certainly something that we

must be worried about.

The Emerging Threats of High Speed Trading with Uber Complex Financial

Instruments

Moreover, with the advent of high speed trading and electronic trading, it is certainly the case

that the marriage of advanced technology with that of overly complex financial products is

leading us to a dangerous situation where the speed of technological change and the increase

in complexity results in a high stakes game of cards where the decisions are not made by

humans but machines which though supposedly objective can also veer out of control.

Indeed, the fact that at the moment, computers have taken over the roles that traders used to

perform in the markets means that there is every chance that one day, there would not be too

many of the experts who understand what is going on.

Financial Planning is the process of meeting your life goals through the proper management

of your finances. Life goals can include buying a house, saving for your child's higher

education or planning for retirement. The Financial Planning Process consists of six steps that

help you take a 'big picture' look at where you are currently. Using these six steps, you can

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work out where you are now, what you may need in the future and what you must do to reach

your goals. The process involves gathering relevant financial information, setting life goals,

examining your current financial status and coming up with a strategy or plan for how you

can meet your goals given your current situation and future plans.

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Goals for Sam and Sara Knight

This case presents the financial situation of Sara and Sam Knight, a couple in their mid-40s

who are heavily in debt. Together, they have a 5-year-old son named Aaron. Sam also has a

15-year-old son from a previous marriage named Philip. Philip has been diagnosed with a

medical disorder. Not only do Sam and Sara wish to reduce their debt and plan for retirement,

they also want to ensure that they plan for the future needs of their children and provide for

the financial protection of their family in the event that Sam or Sara dies prematurely or

becomes ill or disabled.

Name Sam Sara

Age 46 44

Expected age of retirement 63 61

Life expectancy 90 90

Estimated years of retirement 27 29

Job Engineer Lawyer

Philip Aaron

Age 15 5

Status (diagnosed with a Normal

medical disorder)

Jack Silver, their CFP professional, will review Sam and Sara’s financial situation and

prepare a financial plan to address the couple’s debt load and spending, retirement goals, and

desire to provide for their children and the protection of their family.

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Financial Planning is the process of estimating the capital required and determining its

competition. It is the process of framing financial policies in relation to procurement,

investment and administration of funds of an enterprise.

Financial Planning has many objectives to look forward to:

a. Determining capital requirements- This will depend upon factors like cost of

current and fixed assets, promotional expenses and long- range planning. Capital

requirements have to be looked with both aspects: short- term and long- term

requirements.

b. Determining capital structure- The capital structure is the composition of capital,

i.e., the relative kind and proportion of capital required in the business. This includes

decisions of debt- equity ratio- both short-term and long- term.

c. Framing financial policies with regards to cash control, lending, borrowings, etc.

d. A finance manager ensures that the scarce financial resources are maximally

utilized in the best possible manner at least cost in order to get maximum returns on

investment.

Financial Planning is process of framing objectives, policies, procedures, programmes and

budgets regarding the financial activities of a concern. This ensures effective and sufficient

financial and investment policies. The importance can be outlined:

1. Adequate funds have to be ensured.

2. Financial Planning helps in ensuring a reasonable balance between outflow and

inflow of funds so that stability is maintained.

3. Financial Planning ensures that the suppliers of funds are easily investing in

companies which exercise financial planning.

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 4. Financial Planning helps in making growth and expansion programmes which helps in

long-run survival of the company.

5. Financial Planning reduces uncertainties with regards to changing market trends

which can be faced easily via adequate funds.

6. Financial Planning assists in reducing the uncertainties which may be a hindrance to

growth of the firm which may help in ensuring stability and profitability in concern.

One of the most crucial finance functions is to intelligently allocate capital to long term

assets. This activity is also known as capital budgeting. It is important to allocate capital in

those long term assets so as to get maximum yield in future. Following are the two aspects of

investment decision.

Since the future is uncertain therefore there are difficulties in calculation of expected return.

Along with uncertainty comes the risk factor which has to be taken into consideration. This

risk factor plays a very significant role in computing the expected return of the prospective

investment. Hence, while considering investment proposal it is important to take into

consideration both expected return and the risk involved.

Investment decision not only involves allocating capital to long term assets but also involves

decisions of using funds which are obtained by selling those assets which become less

profitable and less productive. It wise decisions to decompose depreciated assets which are

not adding value and utilize those funds in securing other beneficial assets. An opportunity

cost of capital needs to be calculating while dissolving such assets. The correct cut off rate is

calculated by using this opportunity cost of the required rate of return (RRR).

Financial decision is yet another important function which a financial manger must perform.

It is important to make wise decisions about when, where and how should a business acquire

funds. Funds can be acquired through many ways and channels. Broadly speaking a correct

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ratio of an equity and debt has to be maintained. This mix of equity capital and debt is known

as a firm’s capital structure.

A firm tends to benefit most when the market value of a company’s share maximizes this not

only is a sign of growth for the firm but also maximizes shareholder’s wealth. On the other

hand, the use of debt affects the risk and return of a shareholder. It is riskier though it may

increase the return on equity funds.

A sound financial structure is said to be one which aims at maximizing shareholders return

with minimum risk. In such a scenario the market value of the firm will maximize and hence

an optimum capital structure would be achieved. Other than equity and debt there are several

other tools which are used in deciding a firm capital structure.

Earning profit or a positive return is a common aim of all the businesses. But the key function

a financial manger performs in case of profitability is to decide whether to distribute all the

profits to the shareholder or retain all the profits or distribute part of the profits to the

shareholder and retain the other half in the business.

It’s the financial manager’s responsibility to decide an optimum dividend policy which

maximizes the market value of the firm. Hence an optimum dividend playout ratio is

calculated. It is a common practice to pay regular dividends in case of profitability Another

way is to issue bonus shares to existing shareholders.

It is very important to maintain a liquidity position of a firm to avoid insolvency. Firm’s

profitability, liquidity and risk all are associated with the investment in current assets. In

order to maintain a trade-off between profitability and liquidity it is important to invest

sufficient funds in current assets. But since current assets do not earn anything for business

therefore a proper calculation must be done before investing in current assets.

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Current assets should properly be valued and disposed of from time to time once they become

non profitable. Currents assets must be used in times of liquidity problems and times of

insolvency.

Contemporary organizations need to practice cost control if they are to survive the

recessionary times. Given the fact that many top tier companies are currently mired in low

growth and less activity situations, it is imperative that they control their costs as much as

possible. This can happen only when the finance function in these companies is diligent and

has a hawk eye towards the costs being incurred. Apart from this, companies also have to

introduce efficiencies in the way their processes operate and this is another role for the

finance function in modern day organizations.

There must be synergies between the various processes and this is where the finance function

can play a critical role. Lest one thinks that the finance function, which is essentially a

support function, has to do this all by themselves, it is useful to note that, many contemporary

organizations have dedicated project office teams for each division, which perform this

function.

In other words, whereas the finance function oversees the organizational processes at a macro

level, the project office teams indulge in the same at the micro level. This is the reason why

finance and project budgeting and cost control have assumed significance because after all,

companies exist to make profits and finance is the lifeblood that determines whether

organizations are profitable or failures.

The next role of the finance function is in payroll, claims processing, and acting as the

repository of pension schemes and gratuity. If the US follow the 401(k) rule and the finance

function manages the defined benefit and defined contribution schemes, in India it is the EPF

or the Employee Provident Funds that are managed by the finance function. Of course, only

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large organizations have dedicated EPF trusts to take care of these aspects and the norm in

most other organizations is to act as facilitators for the EPF scheme with the local or regional

PF (Provident Fund) commissioner.

The third aspect of the role of the finance function is to manage the taxes and their collection

at source from the employees. Whereas in the US, TDS or Tax Deduction at Source works

differently from other countries, in India and much of the Western world, it is mandatory for

organizations to deduct tax at source from the employees commensurate with their pay and

benefits.

The finance function also has to coordinate with the tax authorities and hand out the annual

tax statements that form the basis of the employee’s tax returns. Often, this is a sensitive and

critical process since the tax rules mandate very strict principles for generating the tax

statements.

Financial Assumptions

Capital Structure is referred to as the ratio of different kinds of securities raised by a firm as

long-term finance. The capital structure involves two decisions-

a. Type of securities to be issued are equity shares, preference shares and long term

borrowings (Debentures).

b. Relative ratio of securities can be determined by process of capital gearing. On this

basis, the companies are divided into two-

i. Highly geared companies - Those companies whose proportion of equity

capitalization is small.

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 ii. Low geared companies - Those companies whose equity capital dominates

total capitalization.

For instance - There are two companies A and B. Total capitalization amounts to be USD

200,000 in each case. The ratio of equity capital to total capitalization in company A is USD

50,000, while in company B, ratio of equity capital is USD 150,000 to total capitalization,

i.e., in Company A, proportion is 25% and in company B, proportion is 75%. In such cases,

company A is considered to be a highly geared company and company B is low geared

company.

Trading on Equity- The word “equity” denotes the ownership of the company. Trading on

equity means taking advantage of equity share capital to borrowed funds on reasonable basis.

It refers to additional profits that equity shareholders earn because of issuance of debentures

and preference shares. It is based on the thought that if the rate of dividend on preference

capital and the rate of interest on borrowed capital is lower than the general rate of

company’s earnings, equity shareholders are at advantage which means a company should go

for a judicious blend of preference shares, equity shares as well as debentures. Trading on

equity becomes more important when expectations of shareholders are high.

Degree of control- In a company, it is the directors who are so called elected

representatives of equity shareholders. These members have got maximum voting rights in a

concern as compared to the preference shareholders and debenture holders. Preference

shareholders have reasonably less voting rights while debenture holders have no voting

rights. If the company’s management policies are such that they want to retain their voting

rights in their hands, the capital structure consists of debenture holders and loans rather than

equity shares.

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 Flexibility of financial plan- In an enterprise, the capital structure should be such that

there is both contractions as well as relaxation in plans. Debentures and loans can be refunded

back as the time requires. While equity capital cannot be refunded at any point which

provides rigidity to plans. Therefore, in order to make the capital structure possible, the

company should go for issue of debentures and other loans.

Choice of investors- The company’s policy generally is to have different categories of

investors for securities. Therefore, a capital structure should give enough choice to all kind of

investors to invest. Bold and adventurous investors generally go for equity shares and loans

and debentures are generally raised keeping into mind conscious investors.

Capital market condition- In the lifetime of the company, the market price of the shares

has got an important influence. During the depression period, the company’s capital structure

generally consists of debentures and loans. While in period of boons and inflation, the

company’s capital should consist of share capital generally equity shares.

Period of financing- When company wants to raise finance for short period, it goes for

loans from banks and other institutions; while for long period it goes for issue of shares and

debentures.

Cost of financing- In a capital structure, the company has to look to the factor of cost

when securities are raised. It is seen that debentures at the time of profit earning of company

prove to be a cheaper source of finance as compared to equity shares where equity

shareholders demand an extra share in profits.

Stability of sales- An established business which has a growing market and high sales

turnover, the company is in position to meet fixed commitments. Interest on debentures has to

be paid regardless of profit. Therefore, when sales are high, thereby the profits are high and

company is in better position to meet such fixed commitments like interest on debentures and

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dividends on preference shares. If company is having unstable sales, then the company is not

in position to meet fixed obligations. So, equity capital proves to be safe in such cases.

Sizes of a company- Small size business firm’s capital structure generally consists of

loans from banks and retained profits. While on the other hand, big companies having

goodwill, stability and an established profit can easily go for issuance of shares and

debentures as well as loans and borrowings from financial institutions. The bigger the size,

the wider is total capitalization.

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Financial Management

We have discussed the pension fund management and the tax deduction. The other role of the

finance function is to process payroll and associated benefits in time and in tune with the

regulatory requirements.

Claims made by the employees with respect to medical, and transport allowances have to be

processed by the finance function. Often, many organizations automate this routine activity

wherein the use of ERP (Enterprise Resource Planning) software and financial workflow

automation software make the job and the task of claims processing easier. Having said that,

it must be remembered that the finance function has to do its due diligence on the claims

being submitted to ensure that bogus claims and suspicious activities are found out and

stopped. This is the reason why many organizations have experienced chartered accountants

and financial professionals in charge of the finance function so that these aspects can be

managed professionally and in a trustworthy manner.

The key aspect here is that the finance function must be headed by persons of high integrity

and trust that the management reposes in them must not be misused. In conclusion, the

finance function though a non-core process in many organizations has come to occupy a

place of prominence because of these aspects.

Financial activities of a firm are one of the most important and complex activities of a firm.

Therefore, in order to take care of these activities a financial manager performs all the

requisite financial activities.

A financial manager is a person who takes care of all the important financial functions of an

organization. The person in charge should maintain a far sightedness in order to ensure that

the funds are utilized in the most efficient manner. His actions directly affect the Profitability,

growth and goodwill of the firm.

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Every firm has a predefined goal or an objective. Therefore, the most important goal of a

financial manager is to increase the owner’s economic welfare. Here economics welfare may

refer to maximization of profit or maximization of shareholder’s wealth. Therefore,

Shareholders wealth maximization (SWM) plays a very crucial role as far as financial goals

of a firm are concerned.

Profit is the remuneration paid to the entrepreneur after deduction of all expenses.

Maximization of profit can be defined as maximizing the income of the firm and

minimizing the expenditure. The main responsibility of a firm is to carry out business by

manufacturing goods and services and selling them in the open market. The mechanism of

demand and supply in an open market determine the price of a commodity or a service. A

firm can only make profit if it produces a good or delivers a service at a lower cost than what

is prevailing in the market. The margin between these two prices would only increase if the

firm strives to produce these goods more efficiently and at a lower price without

compromising on the quality.

The demand and supply mechanism plays a very important role in determining the price of a

commodity. A commodity which has a greater demand commands a higher price and hence

may result in greater profits. Competition among other suppliers also effect profits.

Manufacturers tends to move towards production of those goods which guarantee higher

profits. Hence there comes a time when equilibrium is reached and profits are saturated.

According to Adam Smith - business man in order to fulfil their profit motive in turn

benefits the society as well. It is seen that when a firm tends to increase profit it eventually

makes use of its resources in a more effective manner. Profit is regarded as a parameter to

measure firm’s productivity and efficiency. Firms which tend to earn continuous profit

eventually improvise their products according to the demand of the consumers. Bulk

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production due to massive demand leads to economies of scale which eventually reduces the

cost of production. Lower cost of production directly impacts the profit margins. There are

two ways to increase the profit margin due to lower cost. Firstly, a firm can produce at lower

sot but continue to sell at the original price, thereby increasing the revenue. Secondly a firm

can reduce the final price offered to the consumer and increase its market thereby superseding

its competitors.

Both ways the firm will benefit. The second way would increase its sale and market share

while the first way only tends to increase its revenue. Profit is an important component of any

business. Without profit earning capability it is very difficult to survive in the market. If a

firm continues to earn large amount of profits, then only it can manage to serve the society in

the long run. Therefore, profit earning capacity by a firm and public motive in some way goes

hand in hand. This eventually also leads to the growth of an economy and increase in

National Income due to increasing purchasing power of the consumer.

Following are the main functions of a Financial Manager:

1. Raising of Funds

In order to meet the obligation of the business it is important to have enough cash and

liquidity. A firm can raise funds by the way of equity and debt. It is the responsibility of a

financial manager to decide the ratio between debt and equity. It is important to maintain a

good balance between equity and debt.

2. Allocation of Funds

Once the funds are raised through different channels the next important function is to allocate

the funds. The funds should be allocated in such a manner that they are optimally used. In

order to allocate funds in the best possible manner the following point must be considered

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  The size of the firm and its growth capability

 Status of assets whether they are long-term or short-term

 Mode by which the funds are raised

These financial decisions directly and indirectly influence other managerial activities. Hence

formation of a good asset mix and proper allocation of funds is one of the most important

activity.

3. Profit Planning

Profit earning is one of the prime functions of any business organization. Profit earning is

important for survival and sustenance of any organization. Profit planning refers to proper

usage of the profit generated by the firm.

Profit arises due to many factors such as pricing, industry competition, state of the economy,

mechanism of demand and supply, cost and output. A healthy mix of variable and fixed

factors of production can lead to an increase in the profitability of the firm.

Fixed costs are incurred by the use of fixed factors of production such as land and machinery.

In order to maintain a tandem, it is important to continuously value the depreciation cost of

fixed cost of production. An opportunity cost must be calculated in order to replace those

factors of production which has gone thrown wear and tear. If this is not noted, then these

fixed cost can cause huge fluctuations in profit.

4. Understanding Capital Markets

Shares of a company are traded on stock exchange and there is a continuous sale and

purchase of securities. Hence a clear understanding of capital market is a crucial function of a

financial manager. When securities are traded on stock market there involves a huge amount

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of risk involved. Therefore, a financial manger understands and calculates the risk involved

in this trading of shares and debentures.

It’s on the discretion of a financial manager as to how to distribute the profits. Many

investors do not like the firm to distribute the profits amongst shareholders as dividend

instead invest in the business itself to enhance growth. The practices of a financial manager

directly impact the operation in capital market.

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Asset Management

Overcapitalization is a situation in which actual profits of a company are not sufficient

enough to pay interest on debentures, on loans and pay dividends on shares over a period of

time. This situation arises when the company raises more capital than required. A part of

capital always remains idle. With a result, the rate of return shows a declining trend. The

causes can be-

1. High promotion cost- When a company goes for high promotional expenditure, i.e.,

making contracts, canvassing, underwriting commission, drafting of documents, etc.

and the actual returns are not adequate in proportion to high expenses, the company is

over-capitalized in such cases.

2. Purchase of assets at higher prices- When a company purchases assets at an inflated

rate, the result is that the book value of assets is more than the actual returns. This

situation gives rise to over-capitalization of company.

3. A company’s floatation boom period- At times company has to secure its solvency

and thereby float in boom periods. That is the time when rate of returns is less as

compared to capital employed. This results in actual earnings lowering down and

earnings per share declining.

4. Inadequate provision for depreciation- If the finance manager is unable to provide

an adequate rate of depreciation, the result is that inadequate funds are available when

the assets have to be replaced or when they become obsolete. New assets have to be

purchased at high prices which prove to be expensive.

5. Liberal dividend policy- When the directors of a company liberally divide the

dividends into the shareholders, the result is inadequate retained profits which are

26
 very essential for high earnings of the company. The result is deficiency in company.

To fill up the deficiency, fresh capital is raised which proves to be a costlier affair and

leaves the company to be over- capitalized.

6. Over-estimation of earnings- When the promoters of the company overestimate the

earnings due to inadequate financial planning, the result is that company goes for

borrowings which cannot be easily met and capital is not profitably invested. This

results in consequent decrease in earnings per share.

Effects of Overcapitalization

1. On Shareholders- The over capitalized companies have following disadvantages to

shareholders:

a. Since the profitability decreases, the rate of earning of shareholders also

decreases.

b. The market price of shares goes down because of low profitability.

c. The profitability going down has an effect on the shareholders. Their earnings

become uncertain.

d. With the decline in goodwill of the company, share prices decline. As a result,

shares cannot be marketed in capital market.

2. On Company-

a. Because of low profitability, reputation of company is lowered.

b. The company’s shares cannot be easily marketed.

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 c. With the decline of earnings of company, goodwill of the company declines

and the result is fresh borrowings are difficult to be made because of loss of

credibility.

d. In order to retain the company’s image, the company indulges in malpractices

like manipulation of accounts to show high earnings.

e. The company cuts down it’s expenditure on maintenance, replacement of

assets, adequate depreciation, etc.

3. On Public- An overcapitalized company has got many adverse effects on the public:

a. In order to cover up their earning capacity, the management indulges in tactics

like increase in prices or decrease in quality.

b. Return on capital employed is low. This gives an impression to the public that

their financial resources are not utilized properly.

c. Low earnings of the company affect the credibility of the company as the

company is not able to pay its creditors on time.

d. It also has an effect on working conditions and payment of wages and salaries

also lessen.

An undercapitalized company is one which incurs exceptionally high profits as compared to

industry. An undercapitalized company situation arises when the estimated earnings are very

low as compared to actual profits. This gives rise to additional funds, additional profits, high

goodwill, high earnings and thus the return on capital shows an increasing trend. The causes

can be-

1. Low promotion costs

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 2. Purchase of assets at deflated rates

3. Conservative dividend policy

4. Floatation of company in depression stage

5. High efficiency of directors

6. Adequate provision of depreciation

7. Large secret reserves are maintained.

Effects of Under Capitalization

1. On Shareholders

a. Company’s profitability increases. As a result, rate of earnings goes up.

b. Market value of share rises.

c. Financial reputation also increases.

d. Shareholders can expect a high dividend.

2. On company

a. With greater earnings, reputation becomes strong.

b. Higher rate of earnings attract competition in market.

c. Demand of workers may rise because of high profits.

d. The high profitability situation affects consumer interest as they think that the

company is overcharging on products.

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3. On Society

a. With high earnings, high profitability, high market price of shares, there can

be unhealthy speculation in stock market.

b. ‘Restlessness in general public is developed as they link high profits with high

prices of product.

c. Secret reserves are maintained by the company which can result in paying

lower taxes to government.

d. The general public inculcates high expectations of these companies as these

companies can import innovations, high technology and thereby best quality

of product.

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Tax Planning

Many economists have argued that profit maximization has brought about many

disparities among consumers and manufacturers. In case of perfect competition, it may

appear as a legitimate and a reward for efforts but in case of imperfect competition a firm’s

prime objective should not be profit maximization. In olden times when there was not too

much of competition selling and manufacturing goods were primarily for mutual benefit.

Manufacturers didn’t produce to earn profits rather produced for mutual benefit and social

welfare. The aim of the single producer was to retain his position in the market and sustain

growth, thereby earning some profit which would help him in maintaining his position. On

the other hand, in today’s time the production system is dominant by two tier system of

ownership and management. Ownership aims at maximizing profit and management aims at

managing the system of production thereby indirectly increasing the income of the business.

These services are used by customers who in turn are forced to pay a higher price due to

formation of cartels and monopoly. Not only have the customers suffered but also the

employees. Employees are forced to work more than their capacity. they are made to pay in

extra hours so that production can increase.

Many times manufacturers tend to produce goods which are of no use to the society and

create an artificial demand for the product by rigorous marketing and advertising. They tend

to make the product so tempting by packaging and labelling that it’s difficult for the

consumer to resist. These happen mainly with products which aim to target kids and

teenagers. Ad commercials and print ads tend to provide with wrong information to

artificially hike the expectation of the product.

In case of oligopoly where the nature of the product is more or less same exploit the customer

to the max. Since they form cartels and manipulate prices by giving very less flexibility to the

31
consumer to negotiate or choose from the products available. In such a scenario it is the

consumer who becomes prey of these activities. Profit maximization motive is continuously

aiming at increasing the firm’s revenue and is concentrating less on the social welfare.

Government plays a very important role in curbing this practice of charging extraordinary

high prices at the cost of service or product. In fact, a market which experiences a high

degree of competition is likely to exploit the customer in the name of profit maximization,

and on the other hand where the production of a particular product or service is limited there

is a possibility to charge higher prices is greater. There are few things which need a greater

clarification as far as maximization of profit is concerned

Profit maximization objective is a little vague in terms of returns achieved by a firm in

different time period. The time value of money is often ignored when measuring profit.

It leads to uncertainty of returns. Two firms which use same technology and same factors of

production may eventually earn different returns. It is due to the profit margin. It may not be

legitimate if seen from a different stand point.

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Retirement Planning

Below are 7 strategies you can use to reduce tax in retirement.

1 – Commence an account-based pension

This is a common strategy to reduce tax in retirement. When you commence a pension from

your super fund, the 15% tax applied to fund earnings is removed. In other words, fund

earnings become tax-free once you commence a pension from your fund. Additionally, if you

are aged 60 or more, the pension income is also tax-free, regardless of the amount of income

you draw.

For those aged 55-59, fund earnings will also be tax-free but there may be a small amount of

tax to pay on pension income prior to turning 60. If considering this strategy however, you

need to be aware of the minimum annual pension payment factors. These specify a minimum

percentage (of your fund balance) that you need to draw as income for the year. The

minimum percentage increases with age. With this in mind, if you have income from other

sources, you may end up with more income than you actually need and if you are over age

65, you may not be eligible to re-contribute the surplus back into superannuation.

2 – Consider using a self-managed super fund (SMSF)

A SMSF provides far greater scope and flexibility for tax planning compared to other super

funds. Because of this, if you have a SMSF, you will have more avenues available to

managing tax during (and leading up to) retirement. A common scenario for those without an

SMSF is commencing an account-based pension to eliminate the 15% earnings tax where

there is no need for pension income which must be drawn with respect to the minimum

payment factors (as discussed above). This situation effectively forces a withdrawal of funds

33
from superannuation before the 15% earnings tax is removed. Because of the increased tax-

planning flexibility afforded by SMSF’s, this situation can often be avoided.

Having complete control over fund investments and being able to ‘time’ buying and selling

decisions is key with most tax-planning strategies within an SMSF, and this situation is no

different. The franking credits received from Australian share dividends can often be used to

offset the 15% earnings tax when the fund lodges its tax return at the end of the year.

Franking credits (also known as imputation credits) represent the company tax already paid

on a dividend before it’s paid to shareholders.

The company tax rate is currently 30%, meaning the franking credit is also equal to 30%. It’s

worth noting that where franking credits (in dollar terms) exceed the amount of earnings tax

payable for the year, the unused amount is not wasted. The ATO will, in fact, include a

refund for this amount in the fund’s tax return. Simply put, not only have you eliminated all

tax on your SMSF for the year, the ATO has actually given your super fund a refund!

3 – Take advantage of tax offsets and rebates

Once retired and aged 60, income from a superannuation pension is not your only avenue to

receiving tax-free income in retirement. If you are Age Pension age (currently 65 for men and

64 for women), you may be able to apply the Senior Australians Tax Offset (SATO) and

enjoy a higher tax-free threshold. For the 2011/12 financial year, singles can earn up to

$30,685 and couples $26,680 each without paying any income tax. If you are under age 65

and retired, you can take advantage of the $6,000 tax-free threshold and the low income tax

offset (LITO) and earn up to $16,000 (2011/12 financial year) without paying income tax.

Therefore, you may be able to retain some assets (e.g. a rental property) outside

superannuation and still receive income from them tax-free during retirement.

34
4 – Consider selling assets and transferring the proceeds to super

Liquidating assets and contributing the proceeds to superannuation may reduce tax and

simplify your estate planning arrangements. This strategy is often even more appealing if you

have a self-managed super fund (SMSF) (as discussed above). Once you commence a

pension from your super fund, pension income will be tax-free if you are age 60 or over. If

you hold significant assets outside superannuation, the income generated from them may still

be taxable once you retire. Additionally, assets outside superannuation will form part of your

estate and will be distributed to beneficiaries in accordance with your Will. Superannuation

generally does not form part of your estate, it is payable to beneficiaries directly (in

accordance with separate beneficiary nominations) as a lump sum, pension or combination of

each. And because superannuation is a type of trust, asset protection is provided. This simply

means that superannuation monies are generally protected after your death (e.g. from

creditors or from a challenge to your estate). Furthermore, superannuation benefits are

usually distributed to beneficiaries quickly, whereas estate assets cannot be distributed until

probate has occurred.

5 – Time the sale of assets to reduce CGT

If you hold assets outside super (e.g. shares) and there are significant capital gains, you could

consider timing the sale of such assets to reduce the amount of capital gains tax (CGT). The

proceeds may then be contributed to your super fund as concessional or non-concessional

contributions (if you are eligible to make such contributions). For this strategy to be effective,

you need to calculate the amount of taxable income you will receive each year and

understand how this relates to your tax-free threshold (or marginal rate of income tax). As

capital gains are added to your taxable income at the end of the year, you can then establish

the optimal amount of capital gains for the year and liquidate (in the case of shares) the

35
appropriate number of units to achieve your desired result. This process can be repeated for

as long as you are eligible to make contributions to superannuation. If you were intending on

selling the asset(s) in the future anyway, you could reduce your future CGT bill by using this

strategy now. If you were intending on passing the asset(s) to beneficiaries, you may save

them tax in the future because super funds don’t pay CGT once you have commenced a

pension. Remember to account for the 50% CGT discount if you have owned the asset for

more than 12 months.

6 – Make deductible contributions to super

If you are retired and under age 65, you may be eligible to make personal contributions to

superannuation and claim a tax deduction for them. If you are paying income tax in

retirement, this strategy will reduce your taxable income and therefore the amount of income

tax you pay. It will also boost your super account balance and therefore the amount of tax-

free income available if you start a pension at age 60 or over. However, you need to be

mindful that deductible contributions will incur 15% contributions tax within your super fund

and that such contributions will count towards your annual concessional contribution cap. If

you exceed this cap in a given year, the ATO may ask you to pay penalty tax on the excess.

Furthermore, you also need to consider the tax implications of concessional super

contributions with regard to your estate planning objectives. For example, if your

beneficiaries are non-dependent adult children, they may have to pay tax upon receipt of your

superannuation benefits after you pass away.

7 – Consider a re-contribution strategy to reduce tax

A re-contribution strategy can reduce tax for your beneficiaries after your death. If you are

retired and have reached preservation age (55-59), you can consider withdrawing a lump sum

from your super fund and then re-contributing it as a non-concessional contribution. By doing

36
this, you are increasing the amount of non-concessional component in your super fund and

reducing the amount of concessional component. Non-concessional amounts are tax-free in

the hands of beneficiaries after you die, concessional amounts may be subject to tax.

If you are under age 60 and considering a re-contribution strategy, you need to ensure your

withdrawal does not exceed the low rate cap applying to lump sum benefits. Tax will apply to

any excess amounts. Additionally, when re-contributing the amount to your fund, you should

consider the annual non-concessional contribution cap (currently $150,000) and triggering

the bring-forward rules if your contribution exceeds this amount. The bring-forward rules

allow you to bring-forward contributions for the next 2 years, meaning you are able to

contribute up to $450,000 in a single year.

37
Risk Management

Whether you’re a business or an individual, you have to find a way to manage your finances

now and in the future. The cost of everything continues to increase and there’s no sign that

this trend of price increases will stop anytime soon. As a result, all entities have to develop a

financial management system to ensure their stability for many years to come.

This system has to provide the businesses in question with enough flexibility for them to

continue to grow and pay for their necessary expenses. It also has to be stringent enough to

allow for money to be put away in the event of future catastrophes.

In the case of a business, all expenses have to be prioritized in the interest of spending money

on the right things.

When it comes time for cost cutting measures to be implemented, they have to be come with

consequences in mind. Everything that’s done to cut costs has an end result once it becomes a

common procedure.

You have to ponder whether you’re cutting enough or you’re cutting too much. Work has to

be done to ensure that cutting individuals from the workforce is the last possible resort. Odds

are there are expenses that can be sliced without having to touch the workforce.

Individuals in the private sector have to manage their finances in the interest of being able to

acquire credit.

A person’s credit score can affect every possible aspect of their life. The biggest issue

currently impacting the financial future of most people is the regular use of high interest

credit cards.

38
Most retail establishments try to push their credit card on their customers on a regular basis.

These cards should only be used for small purchases that can be paid shortly after they have

been completed.

Financial management is a challenge in a world where spending is seen as the key to getting

ahead.

Estate Planning

The vast majority of planning and zoning law occurs at the local council level, with state laws

governing the processes and requiring final state approval of locally developed controls. The

state governments intervene in matters of state significance – for example, state-based zoning

controls may apply to specific types of land use, either to encourage and facilitate such use

(e.g., affordable rental housing or housing for seniors) or to provide uniform controls for

high-impact land uses (e.g., mining, or offensive or hazardous industry). Even where state-

mandated controls apply, the consent authority for development is usually still the local

council or regional body (depending upon the cost of the development).

Although this varies somewhat between jurisdictions and it is difficult to generalise, the states

tend to limit their involvement to a strategic level in land use planning and rarely act as an

approval body for private development. Some exceptions apply – for example, state-

significant sites in New South Wales and subdivisions in Western Australia.

Different procedural and documentary requirements apply in each jurisdiction. A landowner,

or any person with consent from the landowner, is eligible to seek planning permission from

a consent authority.

39
A risk-based approach applies: developments of greater environmental impact are subjected

to more rigorous assessment and notification requirements, and require more onerous

environmental justification and documentation.

Applicants typically provide:

a completed application form;

building and site plans;

the owner’s consent;

a report setting out a general overview of the development and an assessment of its

compliance with the relevant zoning and development controls;

a cost of works estimates;

any other expert reports relevant to the development (e.g., heritage impact, acoustic, waste

management and traffic); and

payment of fees.

Upon receipt of an application, the consent authority will assess it against applicable local,

state or federal planning controls, notify the development for public comment, request further

information if necessary and then approve or refuse the application.

40
Recommendations and Action Steps

A financial intermediary is a firm or an institution that acts an intermediary between a

provider of service and the consumer. It is the institution or individual that is in between

two or more parties in a financial context. In theoretical terms, a financial intermediary

channels savings into investments. Financial intermediaries exist for profit in the financial

system and sometimes there is a need to regulate the activities of the same. Also, recent

trends suggest that financial intermediaries’ role in savings and investment functions can be

used for an efficient market system or like the sub-prime crisis shows, they can be a cause for

concern as well.

Financial Intermediation

Financial intermediaries work in the savings/investment cycle of an economy by serving

as conduits to finance between the borrowers and the lenders. In the financial system,

intermediaries like banks and insurance companies have a huge role to play given that it has

been estimated that a major proportion of every dollar financed externally has been done by

the banks. Financial intermediaries are an important source of external funding for

corporates. Unlike the capital markets where investors contract directly with the corporates

creating marketable securities, financial intermediaries borrow from lenders or consumers

and lend to the companies that need investment.

Role of the Financial Intermediaries

The reason for the all-pervasive nature of the financial intermediaries like banks and

insurance companies lies in their uniqueness. As outlined above, Banks often serve as the

“intermediaries” between those who have the resources and those who want resources.

Financial intermediaries like banks are asset based or fee based on the kind of service they

provide along with the nature of the clientele they handle. Asset based financial

41
intermediaries are institutions like banks and insurance companies whereas fee based

financial intermediaries provide portfolio management and syndication services.

Need for regulation

The very nature of the complex financial system that we have at this point in time makes the

need for regulation that much more necessary and urgent. As the sub-prime crisis has shown,

any financial institution cannot be made to hold the financial system hostage to its

questionable business practices. As the manifestations of the crisis are being felt and it is now

apparent that the asset backed derivatives and other “exotic” instruments are amounting to

trillions, the role of the central bank or the monetary authorities in reining in the rogue

financial institutions is necessary to prevent systemic collapse.

As capital becomes mobile and unfettered, it is the monetary authorities that have to step in

and ensure that there are proper checks and balances in the system so as to prevent losses to

investors and the economy in general.

Recent trends

Recent trends in the evolution of financial intermediaries, particularly in the developing

world have shown that these institutions have a pivotal role to play in the elimination of

poverty and other debt reduction programs. Some of the initiatives like micro-credit reaching

out to the masses have increased the economic well-being of hitherto neglected sectors of the

population.

Further, the financial intermediaries like banks are now evolving into umbrella institutions

that cater to the complete needs of investors and borrowers alike and are maturing into

“financial hyper marts”.

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As we have seen, financial intermediaries have a key role to play in the world economy

today. They are the “lubricants” that keep the economy going. Due to the increased

complexity of financial transactions, it becomes imperative for the financial intermediaries to

keep re-inventing themselves and cater to the diverse portfolios and needs of the investors.

The financial intermediaries have a significant responsibility towards the borrowers as well as

the lenders. The very term intermediary would suggest that these institutions are pivotal to

the working of the economy and they along with the monetary authorities have to ensure that

credit reaches to the needy without jeopardizing the interests of the investors. This is one of

the main challenges before them.

Financial intermediaries have a central role to play in a market economy where efficient

allocation of resources is the responsibility of the market mechanism. In these days of

increased complexity of the financial system, banks and other financial intermediaries have to

come up with new and innovative products and services to cater to the diverse needs of the

borrowers and lenders. It is the right mix of financial products along with the need for

reducing systemic risk that determines the efficacy of a financial intermediary.

43
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