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5th Sem Financial Management Notes

Profitability Index

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Last updated: 17 July 2023

 ‘Profitability Index’

The profitability index is an index that attempts to identify the relationship between the costs and benefits of a proposed project through the use of a ratio calculated as:

 

Profitability index        Profitability

A profitability index of 1.0 is logically the lowest acceptable measure on the index, as any value lower than 1.0 would indicate that the project’s present value (PV) is less than the initial investment. As the value of the profitability index increases, so does the financial attractiveness of the proposed project.

Profitability index is an appraisal technique applied to potential capital outlays. The technique divides the projected capital inflow by the projected capital outflow to determine the profitability of a project. As indicated by the formula above, the profitability index uses the present value of future cash flows and the initial investment to represent the aforementioned variables.

When using the profitability index to compare the desirability of projects, it’s important to consider that the technique disregards project size. Therefore, projects with larger cash inflows may result in lower profitability index calculations because their profit margins are not as high.

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Syllabus BHM307

01 Financial Management

  1. MEANING & SCOPE
    1. Meaning of business finance
    2. Meaning of financial management
    3. Objectives of financial management

02 Financial Statement

  1. ANALYSIS AND INTERPRETATION
    1. Meaning and types of financial statements
    2. Techniques of financial analysis
    3. Limitations of financial analysis
    4. Practical problems

03 Ratio Analysis

  1. Meaning of ratio
  2. Classification of ratios
  3. Profitability ratios
  4. Turnover ratios
  5. Financial ratios
  6. Du Pont Control Chart
  7. Practical Problems

04 Funds Flow Analysis

  1. Meaning of funds flow statement
  2. Uses of funds flow statement
  3. Preparation of funds flow statement
  4. Treatment of provision for taxation and proposed dividends (as non-current liabilities)
  5. Practical problems

05 Cash Flow Analysis

  1. Meaning of cash flow statement
  2. Preparation of cash flow statement
  3. Difference between cash flow and funds flow analysis
  4. Practical problems

06 Financial Planning

  1. MEANING & SCOPE
    1. Meaning of Financial Planning
    2. Meaning of Financial Plan
    3. Capitalisation
    4. Practical problems

07 Capital Expenditure

  1. Meaning of Capital Structure
  2. Factors determining capital structure
  3. Point of indifference
  4. Practical problems

08 Working Capital Management

  1. Concept of working capital
  2. Factors determining working capital needs
  3. Over trading and under trading

09 Basics of Capital Budgeting

  1. Importance of Capital Budgeting
  2. Capital Budgeting appraising methods
  3. Payback period
  4. Average rate of return
  5. Net Present Value
  6. Profitability index
  7. Internal rate of return
  8. Practical problems