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UNIT I Business Finance: Introduction Meaning Concepts -Scope Function of Finance Traditional and Modern Concepts Contents of Modern

dern Finance Functions. Introduction In our present day economy, finance is defined as the provision of money at the time when it is required. Every enterprise, whether big, medium or small, needs finance to carry on its operations and to achieve its targets. In fact, finance is so indispensable today that it is rightly said to be the lifeblood of an enterprise. The subject of finance has been traditionally classified into two classes: (i) Public Finance and (ii) Private Finance. Public finance deals with the requirements, receipts and disbursements of funds in the government institutions like states, local self governments and central government. Private finance is concerned with requirements, receipts and disbursements of funds in case of an individual, a profit seeking business organisation and a non profit organisation. Thus, private finance can be classified into: (i) Personal finance (ii) Business Finance and (iii) Finance of non profit organisations.

FINANCE

PUBLIC FINANCE

PRIVATE FINANCE

Government institutions State Governments Local Self-Governments Central Governments

Personal Finance Business Finance Finance of Non-Profit Organisations

Meaning of Finance The word finance was originally a French word. In the 18th century, it was adapted by English speaking communities to mean the management of money. It is the study of how people allocate their assets over time under conditions of certainty and uncertainty. Today, finance is not merely a word else has emerged into an academic discipline of greater significance. Finance is now organized as a branch of Economics. Every enterprise needs finance to carry on its operations. It is the lifeblood of any business. The objective of the business could not be achieved without finance.

Finance is nothing but an exchange of available resources. Finance is not restricted only to the exchange and/or management of money. A barter trading system is also a type of finance. Thus, we can say, Finance is an art of managing various available resources like money, assets, investments, securities, etc. Finance is the science of managing financial resources in an optimal pattern i.e. the best use of available financial sources. Finance consists of three interrelated areas 1) Money & Capital markets, which deals with securities markets & financial Institutions. 2) Investments, which focuses on the decisions of both individual and institutional Investors as they choose assets for their investment portfolios. 3) Financial Management, or business finance which involves the actual management of Firms. Definitions of Finance In General sense, "Finance is the management of money and other valuables, which can be easily converted into cash." According to Entrepreneurs, "Finance is concerned with cash. It is so, since, every business transaction involves cash directly or indirectly." According to Academicians, "Finance is the procurement (to get, obtain) of funds and effective (properly planned) utilization of funds. It also deals with profits that adequately compensate for the cost and risks borne by the business." Meaning of Business finance Business finance refers to using an outside resource to help cover the financial needs of a business. It is an activity or a process, which is concerned with acquisition of funds, use of funds and distribution of profits by a business firm. Thus it deals with financial planning, acquisition of funds, use and allocation funds and financial controls. The following characteristics of business finance will make its meaning clearer Business finance includes all types of funds used in business. Business finance is needed in all types of organisations large or small, manufacturing or trading. The amount of business finance differs from one business firm to another depending upon its nature and size. It also varies from time to time. Business finance involves estimation of funds. It is concerned with raising funds from different sources as well as investment of funds for different purposes. Need and Importance of Business finance Business finance is required for the establishment of every business organisation. With the growth in activities, financial needs also grow. Funds are required for the purchase of land and building, machinery and other fixed assets. Besides this, money is also needed to meet day-today expenses e.g. purchase of raw material, payment of wages and salaries, electricity bills, telephone bills etc. You are aware that production continues in anticipation of demand. Expenses

continue to be incurred until the goods are sold and money is recovered. Money is required to bridge the time gap between production and sales. Besides producers, may be necessary to change the office set up in order to install computers. Renovation of facilities can be taken up only when adequate funds are available. 1. To meet contingencies Funds are always required to meet the ups and downs of business and unforeseen problems. Suppose, some manufacturer anticipates shortage of raw materials after a period. Obviously he would like to stock raw materials. But he will be able to do so only when money would be available. 2. To promote sales In this era of competition, lot of money is required to be spent on activities for promoting sales like advertisement, personal selling, home delivery of goods etc. 3. To avail of business opportunities Funds are also required to avail of business opportunities. Suppose a company wants to submit a tender but some minimum amount is required to be deposited along with the application. In the case of non-availability of funds it would not be possible for the company to apply. Financial Management Financial management refers to that part of the management activity which is concerned with the planning and controlling of firms financial resources, it deal with finding out various sources for raising funds for the firm. The sources must be suitable and economical for the needs of business. The most appropriate use of such funds also forms a part of financial management. EVOLUTION OF FINANCIAL MANAGEMENT Financial management emerged as a distinct field of study at the turn of this century. Its evolution may bedivided into three broad phases (though the demarcating lines between these phases are somewhatarbitrary): the traditional phase, the transitional phase, and the modern phase.The traditional phase lasted for about four decades. The following were its important features:1. The focus of financial management was mainly on certain episodic events like formation, issuance ofcapital, major expansion, merger, reorganization, and liquidation in the life cycle of the firm.2. The approach was mainly descriptive and institutional. The instruments of financing, the institutionsand procedures used in capital markets, and the legal aspects of financial events formed the core offinancial management.3. The outsiders point of view was dominant. Financial management was viewed mainly from thepoint of the investment bankers, lenders, and other outside interests.The transitional phase begins around the early forties and continues through the early fifties. Though thenature pf financial mgmt during this phase was similar to that of the traditional phase, greater emphasiswas placed on the day to day problem faced by the finance managers in the area of funds analysis,planning, and control. These problems however were discussed within limited analytical framework.The modern phase begin in mid 50s and has witnessed an accelerated pace of development with theinfusion of ideas from economic theories and applications of quantitative methods of analysis. Thedistinctive features of modern phase are:* The scope of financial management has broadened. The central concern of

financial management isconsidered to be a rational matching of funds to their uses in the light of appropriate decision criteria* The approach of financial management has become more analytical and quantitative* The point of view of the managerial decision maker has become dominantSince the beginning of the modern phase many significant and seminal developments have occurred inthe fields of capital budgeting, capital structure theory, efficient market theory, optional pricing theory,agency theory, arbitrage pricing theory, valuation models, dividend policy, working capital management,financial modeling, and behavioral finance. Many more exciting developments are in the offing makingfinance a fascinating and challenging field. Goals of financial management Financial theory in general rests on the premises that the goal of the firm should be maximized the valueof he firm to its equity share holders. This means that the goal of the firm should be to maximize the sharevalue of the equity share which represents the value of the firm to its equity share holders. It appears toprovide a rational guide for business decision making and promote an efficient allocation of resources inthe economic system.Savings are allocated primarily on the basis of expected returns and risk and the market value of thefirms equity stock reflects the risk return trade off investors in the market place. If a firm makesdecision aimed at maximizing the market value of its equity, it will raise capital only when its investmentswarrant the use of capital from the overall point of the economy. This suggests that resources areallocated optimally.If a firm does not pursue the goal of shareholders wealth maximization, it implies that its action results ina sub optimal allocation of resources. This in turn leads to inadequate capital formation and lower rate ofeconomic growth.Equity shareholders provide the venture capital required to start a business firm and appoint hemanagement of the firm indirectly through the board of directors.. Therefore it is obligatory on the part ofcorporate management to take care of the welfare of equity shareholders Importance of financial management In a big organisation, the general manger or the managing director is the overall incharge of the organisation but he gets all the activities done by delegating all or some of his powers to men in the middle or lower management, who are supposed to be specialists in the field so that better results may be obtained. For example, management and control of production may be delegated to a man who is specialist in the techniques, procedures, and methods of production. We ma designate him Production Manager'. So is the case with other branches of management, i.e., personnel, finance, sales etc. The incharge of the finance department may be called financial manger, finance controller, or director of finance who is responsible for the procurement and proper utilisation of finance in the business and for maintaining co-ordination between all other branches of management. Importance of finance cannot be over-emphasised. It is, indeed, the key to successful business operations. Without proper administration of finance, no business enterprise can reach its full potentials for growth and success. Money is a universal lubricant which keeps the enterprise dynamic-develops product, keeps men and machines at work, encourages management to make progress and creates values. The importance of financial administration can be discussed under the following heads:-

(i) success of Promotion Depends on Financial Administration. One of the most important reasons of failures of business promotions is a defective financial plan. If the plan adopted fails to provide sufficient capital to meet the requirement of fixed and fluctuating capital an particularly, the latter, or it fails to assume the obligations by the corporations without establishing earning power, the business cannot be carried on successfully. Hence sound financial plan is very necessary for the success of business enterprise. (ii) Smooth Running of an Enterprise. Sound Financial planning is necessary for the smooth running of an enterprise. Money is to an enterprise, what oil is to an engine. As, Finance is required at each stage f an enterprise, i.e., promotion, incorporation, development, expansion and administration of day-to-day working etc., proper administration of finance is very necessary. Proper financial administration means the study, analysis and evaluation of all financial problems to be faced by the management and to take proper decision with reference to the present circumstances in regard to the procurement and utilisation of funds. (iii) Financial Administration Co-ordinates Various Functional Activities. Financial administration provides complete co-ordination between various functional areas such as marketing, production etc. to achieve the organisational goals. If financial management is defective, the efficiency of all other departments can, in no way, be maintained. For example, it is very necessary for the finance-department to provide finance for the purchase of raw materials and meting the other day-to-day expenses for the smooth running of the production unit. If financial department fails in its obligations, the Production and the sales will suffer and consequently, the income of the concern and the rate of profit on investment will also suffer. Thus Financial administration occupies a central place in the business organisation which controls and co-ordinates all other activities in the concern. (iv) Focal Point of Decision Making. Almost, every decision in the business is take in the light of its profitability. Financial administration provides scientific analysis of all facts and figures through various financial tools, such as different financial statements, budgets etc., which help in evaluating the profitability of the plan in the given circumstances, so that a proper decision can be taken to minimise the risk involved in the plan. (v) Determinant of Business Success. It has been recognised, even in India that the financial manger splay a very important role in the success of business organisation by advising the top management the solutions of the various financial problems as experts. They present important facts and figures regarding financial position an the performance of various functions of the company in a given period before the top management in such a way so as to make it easier for the top management to evaluate the progress of the company to amend suitably the principles and policies of the company. The financial manges assist the top management in its decision making process by suggesting the best possible alternative out of the various alternatives of the problem available. Hence, financial management helps the management at different level in taking financial decisions. (vi) Measure of Performance. The performance of the firm can be measured by its financial results, i.e, by its size of earnings Riskiness and profitability are two major factors which jointly determine the value of the concern. Financial decisions which increase risks will decrease the

value of the firm and on the to the hand, financial decisions which increase the profitability will increase value of the firm. Risk an profitability are two essential ingredients of a business concern. CLASSIFICATION OF FINANCE: FINANCE => PRIVATE FINANCE and PUBLIC FINANCE PRIVATE FINANCE => Personal finance and Business finance. The personal finance is concerned with the acquisition and the proper utilization of economic resource by the individuals and households for meeting their different needs. The business finance is also a part of private finance. The business finance is concerned with the acquisition, management and utilization of fund by the private business organizations. PUBLIC FINANCE => Is the study of the financial aspect of the government. Here we study about the government expenditure, public revenue, public borrowing and financial administration. The economic activities of the pubic enterprises also fall under public finance. The objective of private of business finance is to earn maximum return or profit. On the contrary the objective of public finance is to maximize social welfare. Approaches to finance function The finance function also plays a key role in articulating business performance and enabling management to address and react to trends quickly. Financial management has undergone significant changes, over the years in its scope and coverage. Approaches: Broadly, it has two, as mentioned below: Traditional Approach The traditional approach to the scope of financial management refers to its subject matter in the academic literature in the initial stages of its evolution as a separate branch of study. According to this approach, the scope of financial management is confined to the raising of funds. Hence, the scope of finance was treated by the traditional approach in the narrow sense of procurement of funds by corporate enterprise to meet their financial needs. Since the main emphasis of finance function at that period was on the procurement of funds, the subject was called corporation finance till the mid-1950's and covered discussion on the financial instruments, institutions and practices through which funds are obtained. Further, as the problem of raising funds is more intensely felt at certain episodic events such as merger, liquidation, consolidation, reorganisation and so on. These are the broad features of the subject matter of corporation finance, which has no concern with the decisions of allocating firm's funds. But the scope of finance function in the traditional approach has now been discarded as it suffers from serious criticisms. Again, the limitations of this approach fall into the following categories. The emphasis in the traditional approach is on the procurement of funds by the corporate enterprises, which was woven around the viewpoint of the suppliers of funds such as investors, financial institutions, investment bankers, etc, i.e. outsiders. It implies that the traditional

approach was the outsider-looking-in approach. Another limitation was that internal financial decision-making was completely ignored in this approach. The second criticism leveled against this traditional approach was that the scope of financial management was confined only to the episodic events such as mergers, acquisitions, reorganizations, consolation, etc. The scope of finance function in this approach was confined to a description of these infrequent happenings in the life of an enterprise. Thus, it places over emphasis on the topics of securities and its markets, without paying any attention on the day to day financial aspects. Another serious lacuna in the traditional approach was that the focus was on the long-term financial problems thus ignoring the importance of the working capital management. Thus, this approach has failed to consider the routine managerial problems relating to finance of the firm. During the initial stages of development, financial management was dominated by the traditional approach as is evident from the finance books of early days. The tradi-tional approach was found in the first manifestation by Green's book written in 1897, Meades on Corporation Finance, in 1910; Doing's on Corporate Promotion and Reorganisation, in 1914, etc. As stated earlier, in this traditional approach all these writings emphasized the finan-cial problems from the outsiders' point of view instead of looking into the problems from managements, point of view. It over emphasized long-term financing lacked in analytical content and placed heavy emphasis on descriptive material. Thus, the traditional approach omits the discussion on the important aspects like cost of the capital, optimum capital structure, valuation of firm, etc. In the absence of these crucial aspects in the finance function, the traditional approach implied a very narrow scope of financial management. The modern or new approach provides a solution to all these aspects of financial management. According to this approach the scopes of finance function was confined to only procurement of funds needed by a business on most suitable terms. The utilization of funds was considered beyond the purview of finance function. It was felt that decisions regarding application of funds are taken somewhere else in the organization. The scope of finance function was treated, in the narrow sense of procurement or arrangement of funds. It was felt that the finance manager had no role to play in decision making for its utilization As per this approach, the following aspects only were included in the scope of financial management: (i) Estimation of requirements of finance, (ii) Arrangement of funds from financial institutions, (iii) Arrangement of funds through financial instruments such as shares, debentures, bonds and loans, (iv) Looking after the accounting and legal work connected with the raising of funds. The limitations are i. It is outsider-looking approach that completely ignores internal decision-making as to the proper utilization of funds.

ii. iii. iv.

The focus of traditional approach was on procurement of long term funds. Thus, it ignored the important issue of working capital finance and management. The issue of allocation of funds, which is so important today, is completely ignored. It does not lay focus on day-to-day financial problems of an organization.

Modern Approach After the 1950's, a number of economic and environmental factors, such as the technological innovations, industrialization, intense competition, interference of government, growth of population, necessitated efficient and effective utilisation of financial resources. In this context, the optimum allocation of the firm's resources is the order of the day to the management. Then the emphasis shifted from episodic financing to the managerial financial problems, from raising of funds to efficient and effective use of funds. Thus, the broader view of the modern approach of the finance function is the wise use of funds. Since the financial decisions have a great impact on all other business activities, the financial manager should be concerned about deter-mining the size and nature of the technology, setting the direction and growth of the business, shaping the profitability, amount of risk taking, selecting the asset mix, determination of optimum capital structure, etc. The new approach is thus an analyti-cal way of viewing the financial problems of a firm. According to the new approach, the financial management is concerned with the solution of the major areas relating to the financial operations of a firm, viz., investment, and financing and dividend decisions. The modern financial manager has to take financial decisions in the most rational way. These decisions have to be made in such a way that the funds of the firm are used optimally. These decisions are referred to as managerial finance functions since they require special care with extraordinary administrative ability, management skills and decision - making techniques, etc. It views finance function in broader sense. It includes both rising of funds as well as their effective utilization under the preview of finance. The modern approach considers the three basic management decisions. i.e., Investment decisions, financing decisions and dividend decisions within the scope of finance function. Financial management is considered as vital and an integral part of overall management. The modern approach is analytical way of looking into the financial problems of the firm. Advice of finance manager is required at every moment, whenever any decision with involvement of funds is taken. Hardly, there is an activity that does not involve funds. SCOPE OF FINANCIAL MANAGEMENT: Estimating financial requirements: The amount required for purchasing fixed assets as well as needs of funds for working capital will have to be ascertained. Deciding capital structure: The proportion of how the funds should be raised has to be decided. A decision about various sources for funds should be linked to the cost of raising funds.

Selecting a source of finance: After preparation of capital structure, an appropriate source of finance is selected. It includes share capital, debentures. Financial institutions, commercial banks, public deposits etc Selecting pattern of Investment: Decision has to be taken on where the funds procured or raised should be invested. Techniques such as Capital budgeting, Opportunity Cost Analysis etc. may be applied for this purpose Proper Cash Management: Various cash needs at different times has to be assessed. The cash management should be in such a way that there is neither shortage of cash nor it is idle. Proper use of surplus: A judicious use of surpluses is essential for expansion and diversification of plans and also in protecting the interests of shareholders.

Implementing Financial controls: Efficient system of financial management necessitates the use of various control devices. The control devices and techniques help in evaluating the performance in various areas and take corrective measures. 1. 2. 3. 4. 5. 6. Budgetary control, Break-even analysis, Cost control, Ratio analysis Cost and internal audit. Return on investment

AREAS & CONCEPTS OF FINANCIAL MANAGEMENT As already discussed, the general meaning of finance refers to providing funds, as and when needed. However, as management function, the term Financial Management has a distinct meaning. Financial management deals with the study of procuring funds and its effective and judicious utilization, in terms of the overall objectives of the firm, and expectations of the providers of funds. The basic objective is to maximize the value of the firm. Financial Management is concerned with the efficient use of an important economic resource, namely, Capital Funds Solomon Financial Management is concerned with the managerial decisions that result in the acquisition and financing of short-term and long-term credits for the firm Phillioppatus Business finance is that business activity which is concerned with the conservation and acquisition of capital funds in meeting financial needs and overall objectives of a business enterprise - Wheeler

AREAS OF FINANCIAL MANAGEMENT Analysis of Financial Statements: Analysis of financial statement is one of the most common techniques of Financial analysis, in which the financial performance and financial health of the companies are analyzed based on its past performance. The following financial statements are used in the analysis process. Profit & Loss Statement or Income Statement Balance Sheet Statement of Shareholders equity Statement of Cash Flow

Investment Decisions & Capital Budgeting: Investment decisions are the most critical as they usually involve huge sum of money and these decisions are likely to bring prosperity or end to a business. A companys future income depends on how much investment is made, in what type of assets, and how these assets add to the overall value of the company. Capital budgeting is a term strictly related to investment in fixed assets. Here, the term capital refers to the fixed assets that are used in production, while budget is a plan which details projected cash inflows and outflows over some future period. The following concepts and techniques are employed while analyzing investment decisions. Interest rate formulas Time Value of Money Discounted Cash Flows Net Present Value Internal Rate of Return

Risk & Return: Investors, individual or institutional, invest their money with the expectations of earning a return on their investment. While investors wish and attempt to earn maximum return, they are constrained by risk. How the risks and returns are related and how do investors make a choice of their portfolios is important for investment decision-making. Following concepts and theories would be discussed while discussing the risk-return choices of the investor. Uncertainty Risk Portfolio Theory and Capital Asset Pricing Model

Corporate Financing & Capital Structure: When a firm plans to expand, it needs capital or funds. Acquisition of funds is considered to be a primary responsibility of a finance department in an organization. There are numerous ways to acquire funds, i.e., finances can be raised in the form of debt or equity. The proportion of debt and equity constitutes the capital structure of the firm. Financial experts attempt to find a combination of debt and equity that could increase the

overall value of the company, i.e., they try to find the optimal capital structure. The following concepts would be used to understand how an optimal capital structure could be attained. Cost of Capital Leverage Dividend Policy Debt Instruments Valuation.

Asset or company valuation is important not only for financial managers, but also for creditors and investors. It is important to know the value of the company or its assets to make important financing and investment choices. Different valuation techniques and factors that influence the value of a company or its financial instruments would be discussed Share Bond Option Corporate Working Capital & Inventory Management: Working capital and inventory management pertains to the effective management of current assets. As we will see, an optimal and effective utilization of working capital and inventory increases the operating efficiency of the firm. International Finance & foreign exchange: With the increasing importance of international trade and global markets, the role of international finance has increased manifold. In a global environment, the finance managers have more choices pertaining to investing and financing than ever before. However, it is important to understand the implications of working in a global environment, since fluctuations in the currency rates can convert a good financing or investment decision into a bad one. ROLE OF FINANCE MANGER Financial manger is the person responsible for carrying out the finance function. He occupies the key position in an organization. Raising of Fund See that firm has adequate cash to meet the daily needs. Make financial decisions Raise the needed funds form combination of various sources. Funds Allocation Using skills and techniques in implementing a system of optimum allocation of firms resources. There should be efficient allocation of resources. Financial manger must find a rationale for answering the following questions i. How large should an enterprise be and how fast should it grow? ii. In What form should it hold its assets?

iii.

How should the funds required be raised?

The answers will three broad decisions 1. Investment, 2. Financing and 3. Dividend. IMPORTANCE OF FINANCIAL MANAGEMENT Financial management is indispensable in any organization as it helps in i. Financial planning and successful promotion of an enterprise ii. Acquisition of funds as and when required a minimum possible cost. iii. Proper use and allocation of funds iv. Taking sound financial decisions v. Improving the profitability through financial controls vi. Increasing the wealth of the investors and the nation vii. Promoting and mobilizing individual and corporate savings FUNCTIONS OF FINANCE Finance function is the most important function of a business. Finance is, closely, connected with production, marketing and other activities. In the absence of finance, all these activities come to a halt. in fact, only with finance, a business activity can be commenced, continued and expanded. Finance exists everywhere, be it production, marketing, human resource development or undertaking research activity. Understanding the universality and importance of finance, finance manager is associated, in modern business, in all activities as no activity can exist without funds. AIMS OF FINANCE FUNCTION 1. Acquiring sufficient and suitable funds: The primary aim of finance function is to assess the needs of the enterprise, properly, and procure funds, in time. Time is also an important element in meeting the needs of the organisation. If the funds are not available as and when required, the firm may become sick or, at least, the profitability of the firm would be, definitely, affected. It is necessary that the funds should be, reasonably, adequate to the demands of the firm. The funds should be raised from different sources, commensurate to the nature of business and risk profile of the organisation. When the nature of business is such that the production does not commence, immediately, and requires long gestation period, it is necessary to have the long-term sources like share capital, debentures and long term loan etc. A concern with longer gestation period does not have profits for some years. So, the firm should rely more on the permanent capital like share capital to avoid interest burden on the borrowing component. 2. Proper Utilization of Funds: Raising funds is important, more than that is its proper utilization. If proper utilization of funds were not made, there would be no revenue generation. Benefits should always exceed cost of funds so that the organisation can be profitable. Beneficial projects only are to be undertaken. So, it is all the more necessary that careful planning and costbenefit analysis should be made before the actual

commencement of projects. 3. Increasing Profitability: Profitability is necessary for every organisation. The planning and control functions of finance aim at increasing profitability of the firm. To achieve profitability, the cost of funds should be low. Idle funds do not yield any return, but incur cost. So, the organisation should avoid idle funds. Finance function also requires matching of cost and returns of funds. If funds are used efficiently, profitability gets a boost. 4. Maximizing Firms Value: The ultimate aim of finance function is maximizing the value of the firm, which is reflected in wealth maximisation of shareholders. The market value of the equity shares is an indicator of the wealth maximisation.

OBJECTIVES OF FINANCIAL MANAGEMENT: The objectives of financial management are:1. Profit maximization : The main objective of financial management is profit maximization. The finance manager tries to earn maximum profits for the company in the short-term and the long-term. He cannot guarantee profits in the long term because of business uncertainties. However, a company can earn maximum profits even in the longterm, if:i. The Finance manager takes proper financial decisions. ii. He uses the finance of the company properly. 2. Wealth maximization : Wealth maximization (shareholders' value maximization) is also a main objective of financial management. Wealth maximization means to earn maximum wealth for the shareholders. So, the finance manager tries to give a maximum dividend to the shareholders. He also tries to increase the market value of the shares. The market value of the shares is directly related to the performance of the company. Better the performance, higher is the market value of shares and vice-versa. So, the finance manager must try to maximise shareholder's value. 3. Proper estimation of total financial requirements : Proper estimation of total financial requirements is a very important objective of financial management. The finance manager must estimate the total financial requirements of the company. He must find out how much finance is required to start and run the company. He must find out the fixed capital and working capital requirements of the company. His estimation must be correct. If not, there will be shortage or surplus of finance. Estimating the financial requirements is a very difficult job. The finance manager must consider many factors, such as the type of technology used by company, number of employees employed, scale of operations, legal requirements, etc. 4. Proper mobilisation : Mobilisation (collection) of finance is an important objective of financial management. After estimating the financial requirements, the finance manager must decide about the sources of finance. He can collect finance from many sources such as shares, debentures, bank loans, etc. There must be a proper balance between owned finance and borrowed finance. The company must borrow money at a low rate of interest.

5. Proper utilisation of finance : Proper utilisation of finance is an important objective of financial management. The finance manager must make optimum utilisation of finance. He must use the finance profitable. He must not waste the finance of the company. He must not invest the company's finance in unprofitable projects. He must not block the company's finance in inventories. He must have a short credit period. 6. Maintaining proper cash flow : Maintaining proper cash flow is a short-term objective of financial management. The company must have a proper cash flow to pay the day-today expenses such as purchase of raw materials, payment of wages and salaries, rent, electricity bills, etc. If the company has a good cash flow, it can take advantage of many opportunities such as getting cash discounts on purchases, large-scale purchasing, giving credit to customers, etc. A healthy cash flow improves the chances of survival and success of the company. 7. Survival of company : Survival is the most important objective of financial management. The company must survive in this competitive business world. The finance manager must be very careful while making financial decisions. One wrong decision can make the company sick, and it will close down. 8. Creating reserves : One of the objectives of financial management is to create reserves. The company must not distribute the full profit as a dividend to the shareholders. It must keep a part of it profit as reserves. Reserves can be used for future growth and expansion. It can also be used to face contingencies in the future. 9. Proper coordination : Financial management must try to have proper coordination between the finance department and other departments of the company. 10. Create goodwill : Financial management must try to create goodwill for the company. It must improve the image and reputation of the company. Goodwill helps the company to survive in the short-term and succeed in the long-term. It also helps the company during bad times. 11. Increase efficiency : Financial management also tries to increase the efficiency of all the departments of the company. Proper distribution of finance to all the departments will increase the efficiency of the entire company. 12. Financial discipline : Financial management also tries to create a financial discipline. Financial discipline means:i. To invest finance only in productive areas. This will bring high returns (profits) to the company. ii. To avoid wastage and misuse of finance. 13. Reduce cost of capital : Financial management tries to reduce the cost of capital. That is, it tries to borrow money at a low rate of interest. The finance manager must plan the capital structure in such a way that the cost of capital it minimised. 14. Reduce operating risks : Financial management also tries to reduce the operating risks. There are many risks and uncertainties in a business. The finance manager must take steps to reduce these risks. He must avoid high-risk projects. He must also take proper insurance. 15. Prepare capital structure : Financial management also prepares the capital structure. It decides the ratio between owned finance and borrowed finance. It brings a proper balance between the different sources of. capital. This balance is necessary for liquidity, economy, flexibility and stability.

The main objectives of financial management deals with PROFIT MAXIMIZATION Objective of financial management is same as the objective of a company that is to earn profit. But profit maximization cannot the sole objective of a company. It is a limited objective. If profits are given undue Importance then problems may arise as discussed below. The term profit is vague and it involves much more contradictions. Profit maximization has to be attempted with a realization of risks involved. A positive relationship exists between risk and profits. So both risk and profit objectives should be balanced. Profit Maximization does not take into account the time pattern of returns. Profit maximization fails to take into account the social considerations. It is the main objective of any business. It is a measure of efficiency of any business. The arguments in favor of Profit maximization are as follows Profit maximization is the obvious objective Justified on the grounds of its rationality Economic and business conditions do not remain same at all times. Therefore a business should be survived under unfavorable condition only if it has some past earnings to rely upon. Profits are needed for growth and development. Essential for fulfilling social goals. Profit maximization is rejected because of the following drawbacks The term profit is vague Ignores the time value of money It doesnt take the risk prospective into consideration The market price of the shares is not considered. WEALTH MAXIMIZATION It is the maximizing of value of stock as course of action to shareholders. When the firm maximizes the stock holders wealth, the individual stock holders can use this wealth to maximize his individual utility. Stockholders current wealth in a firm = (no. of shares owned) * (current stock price per share) It is commonly agreed that the objective of a firm is to maximize value or wealth. Value of a firm is represented by the market price of the company's common stock. The market price of a firm's stock represents the focal judgement of all market participants as to what the value of the particular firm is. It takes in to account present and prospective future earnings per share, the timing and risk of these earning, the dividend policy of the firm and many other factors that bear upon the market price of the stock. Market price acts as the performance index or report card of the firm's progress. Prices in the share markets are largely affected by many factors like general economic outlook, outlook of particular company, technical factors and even mass psychology. Normally this value is a function of two factors as given below, the anticipated rate of earnings per share of the company the capitalization rate.

The likely rate of earnings per shares (EPS) depends upon the assessment as to how profitably a company is growing to operate in the future. The capitalization rate reflects the liking of the investors for the company. Methods of Financial Management: In the field of financing there are various methods to procure funds. Funds may be obtained from long-term sources as well as from short-term sources. Long-term funds may be availed by owners that are shareholders, lenders by issuing debentures, from financial institutions, banks and public at large. Short-term funds may be availed from commercial banks, public deposits, etc. Financial leverage or trading on equity is an important method by which a finance manager may increase the return to common shareholders. At the time of evaluating capital expenditure projects methods like average rate of return, pay back, internal rate of returns, net present value and profitability index are used. A firm can increase its profitability without affecting its liquidity by an efficient utilization of the current resources at the disposal of the firm. A firm can increase its profitability without affecting its liquidity by an efficient management of working capital. Similarly for the evaluation of a firm's performance there are different methods. Ratio analysis is a popular technique to evaluate different aspects of a firm. An investor takes in to account various ratios to know wheather investment in a particular company will be profitable or not. These ratios enable him to judge the profitability, solvency, liquidity and growth aspect of the firm. Arguments favoring Wealth maximization Increases the share holders interest by increasing the value of holdings Ensures security to lenders Productivity and efficiency is increased The management may survive for a longer period The shareholders may not like to change a management if the value of holdings is increased. The economic interest of the society is served. Criticisms The idea is not descriptive as to what the firms actually do. It is not necessarily socially desirable There is controversy as to whether the objectives is to maximize the stock holders wealth of the wealth of the firm which includes other financial claim holders such as debenture holders, preference shareholders etc. There is difficulty when the management and ownership differs. When managers act as agents of real owners there is possibility for them to increase the managerial interests and not the interest of owners.

FINANCIAL DECISIONS
Some of the important functions which every finance manager has to take are as follows:

i. Investment decision ii. Financing decision iii. Dividend decision


A. Investment Decision (Capital Budgeting Decision)

This decision relates to careful selection of assets in which funds will be invested by the firms. A firm has many options to invest their funds but firm has to select the most appropriate investment which will bring maximum benefit for the firm and deciding or selecting most appropriate proposal is investment decision. The firm invests its funds in acquiring fixed assets as well as current assets. When decision regarding fixed assets is taken it is also called capital budgeting decision. Factors Affecting Investment/Capital Budgeting Decisions 1. Cash Flow of the Project: Whenever a company is investing huge funds in an investment proposal it expects some regular amount of cash flow to meet day to day requirement. The amount of cash flow an investment proposal will be able to generate must be assessed properly before investing in the proposal. 2. Return on Investment: The most important criteria to decide the investment proposal is rate of return it will be able to bring back for the company in the form of income for, e.g., if project A is bringing 10% return and project is bringing 15% return then we should prefer project B. 3. Risk Involved: With every investment proposal, there is some degree of risk is also involved. The company must try to calculate the risk involved in every proposal and should prefer the investment proposal with moderate degree of risk only. 4. Investment Criteria: Along with return, risk, cash flow there are various other criteria which help in selecting an investment proposal such as availability of labour, technologies, input, machinery, etc. The finance manager must compare all the available alternatives very carefully and then only decide where to invest the most scarce resources of the firm, i.e., finance. Investment decisions are considered very important decisions because of following reasons:

(i) They are long term decisions and therefore are irreversible; means once taken cannot be changed. (ii) Involve huge amount of funds. (iii) Affect the future earning capacity of the company.
B. Importance or Scope of Capital Budgeting Decision:

Capital budgeting decisions can turn the fortune of a company. The capital budgeting decisions are considered very important because of the following reasons: 1. Long Term Growth: The capital budgeting decisions affect the long term growth of the company. As funds invested in long term assets bring return in future and future prospects and growth of the company depends upon these decisions only. 2. Large Amount of Funds Involved: Investment in long term projects or buying of fixed assets involves huge amount of funds and if wrong proposal is selected it may result in wastage of huge amount of funds that is why capital budgeting decisions are taken after considering various factors and planning. 3. Risk Involved: The fixed capital decisions involve huge funds and also big risk because the return comes in long run and company has to bear the risk for a long period of time till the returns start coming. 4. Irreversible Decision: Capital budgeting decisions cannot be reversed or changed overnight. As these decisions involve huge funds and heavy cost and going back or reversing the decision may result in heavy loss and wastage of funds. So these decisions must be taken after careful planning and evaluation of all the effects of that decision because adverse consequences may be very heavy.
C. Financing Decision:

The second important decision which finance manager has to take is deciding source of finance. A company can raise finance from various sources such as by issue of shares, debentures or by taking loan and advances. Deciding how much to raise from which source is concern of financing decision. Mainly sources of finance can be divided into two categories: 1. Owners fund. 2. Borrowed fund.

Share capital and retained earnings constitute owners fund and debentures, loans, bonds, etc. constitute borrowed fund. The main concern of finance manager is to decide how much to raise from owners fund and how much to raise from borrowed fund. While taking this decision the finance manager compares the advantages and disadvantages of different sources of finance. The borrowed funds have to be paid back and involve some degree of risk whereas in owners fund there is no fix commitment of repayment and there is no risk involved. But finance manager prefers a mix of both types. Under financing decision finance manager fixes a ratio of owner fund and borrowed fund in the capital structure of the company. Factors Affecting Financing Decisions: While taking financing decisions the finance manager keeps in mind the following factors: 1. Cost: The cost of raising finance from various sources is different and finance managers always prefer the source with minimum cost. 2. Risk: More risk is associated with borrowed fund as compared to owners fund securities. Finance manager compares the risk with the cost involved and prefers securities with moderate risk factor. 3. Cash Flow Position: The cash flow position of the company also helps in selecting the securities. With smooth and steady cash flow companies can easily afford borrowed fund securities but when companies have shortage of cash flow, then they must go for owners fund securities only. 4. Control Considerations: If existing shareholders want to retain the complete control of business then they prefer borrowed fund securities to raise further fund. On the other hand if they do not mind to lose the control then they may go for owners fund securities. 5. Floatation Cost: It refers to cost involved in issue of securities such as brokers commission, underwriters fees, expenses on prospectus, etc. Firm prefers securities which involve least floatation cost.

6. Fixed Operating Cost: If a company is having high fixed operating cost then they must prefer owners fund because due to high fixed operational cost, the company may not be able to pay interest on debt securities which can cause serious troubles for company. 7. State of Capital Market: The conditions in capital market also help in deciding the type of securities to be raised. During boom period it is easy to sell equity shares as people are ready to take risk whereas during depression period there is more demand for debt securities in capital market.
D. Dividend Decision:

This decision is concerned with distribution of surplus funds. The profit of the firm is distributed among various parties such as creditors, employees, debenture holders, shareholders, etc. Payment of interest to creditors, debenture holders, etc. is a fixed liability of the company, so what company or finance manager has to decide is what to do with the residual or left over profit of the company. The surplus profit is either distributed to equity shareholders in the form of dividend or kept aside in the form of retained earnings. Under dividend decision the finance manager decides how much to be distributed in the form of dividend and how much to keep aside as retained earnings. To take this decision finance manager keeps in mind the growth plans and investment opportunities. If more investment opportunities are available and company has growth plans then more is kept aside as retained earnings and less is given in the form of dividend, but if company wants to satisfy its shareholders and has less growth plans, then more is given in the form of dividend and less is kept aside as retained earnings. This decision is also called residual decision because it is concerned with distribution of residual or left over income. Generally new and upcoming companies keep aside more of retain earning and distribute less dividend whereas established companies prefer to give more dividend and keep aside less profit. Factors Affecting Dividend Decision: The finance manager analyses following factors before dividing the net earnings between dividend and retained earnings:

1. Earning: Dividends are paid out of current and previous years earnings. If there are more earnings then company declares high rate of dividend whereas during low earning period the rate of dividend is also low. 2. Stability of Earnings: Companies having stable or smooth earnings prefer to give high rate of dividend whereas companies with unstable earnings prefer to give low rate of earnings. 3. Cash Flow Position: Paying dividend means outflow of cash. Companies declare high rate of dividend only when they have surplus cash. In situation of shortage of cash companies declare no or very low dividend. 4. Growth Opportunities: If a company has a number of investment plans then it should reinvest the earnings of the company. As to invest in investment projects, company has two options: one to raise additional capital or invest its retained earnings. The retained earnings are cheaper source as they do not involve floatation cost and any legal formalities. If companies have no investment or growth plans then it would be better to distribute more in the form of dividend. Generally mature companies declare more dividends whereas growing companies keep aside more retained earnings. 5. Stability of Dividend: Some companies follow a stable dividend policy as it has better impact on shareholder and improves the reputation of company in the share market. The stable dividend policy satisfies the investor. Even big companies and financial institutions prefer to invest in a company with regular and stable dividend policy. There are three types of stable dividend policies which a company may follow: (i) Constant dividend per share: In this case, the company decides a fixed rate of dividend and declares the same rate every year, e.g., 10% dividend on investment. (ii) Constant payout ratio: Under this system the company fixes up a fixed percentage of dividends on profit and not on investment, e.g., 10% on profit so dividend keeps on changing with change in profit rate.

(iii) Constant dividend per share and extra dividend: Under this scheme a fixed rate of dividend on investment is given and if profit or earnings increase then some extra dividend in the form of bonus or interim dividend is also given. 6. Preference of Shareholders: Another important factor affecting dividend policy is expectation and preference of shareholders as their expectations cannot be ignored by the company. Generally it is observed that retired shareholders expect regular and stable amount of dividend whereas young shareholders prefer capital gain by reinvesting the income of the company. They are ready to sacrifice present day income of dividend for future gain which they will get with growth and expansion of the company. Secondly poor and middle class investors also prefer regular and stable amount of dividend whereas wealthy and rich class prefers capital gains. So if a company is having large number of retired and middle class shareholders then it will declare more dividend and keep aside less in the form of retained earnings whereas if company is having large number of young and wealthy shareholders then it will prefer to keep aside more in the form of retained earnings and declare low rate of dividend. 7. Taxation Policy: The rate of dividend also depends upon the taxation policy of government. Under present taxation system dividend income is tax free income for shareholders whereas company has to pay tax on dividend given to shareholders. If tax rate is higher, then company prefers to pay less in the form of dividend whereas if tax rate is low then company may declare higher dividend. 8. Access to Capital Market Consideration: Whenever company requires more capital it can either arrange it by issue of shares or debentures in the stock market or by using its retained earnings. Rising of funds from the capital market depends upon the reputation of the company. If capital market can easily be accessed or approached and there is enough demand for securities of the company then company can give more dividend and raise capital by approaching capital market, but if it is difficult for company to approach and access capital market then companies declare low rate of dividend and use reserves or retained earnings for reinvestment. 9. Legal Restrictions: Companies Act has given certain provisions regarding the payment of dividends that can be paid only out of current year profit or past year profit after providing depreciation fund. In case company is not earning profit then it cannot declare dividend.

Apart from the Companies Act there are certain internal provisions of the company that is whether the company has enough flow of cash to pay dividend. The payment of dividend should not affect the liquidity of the company. 10. Contractual Constraints: When companies take long term loan then financier may put some restrictions or constraints on distribution of dividend and companies have to abide by these constraints. 11. Stock Market Reaction: The declaration of dividend has impact on stock market as increase in dividend is taken as a good news in the stock market and prices of security rise. Whereas a decrease in dividend may have negative impact on the share price in the stock market. So possible impact of dividend policy in the equity share price also affects dividend decision. Inter-relationship between Investment, Financing and Dividend Three major functions of finance department are : Financing Decision: This function is mainly concerned with determination of optimum capital structure of the company keeping in mind cost, control and risk. It is also known as Procurement of Fund. Investment Decision: It is also known as Effective Utilization of Fund. In this respect finance department has to identify the investment opportunities and to choice the best one , after a proper evaluation. Dividend Decision: The finance manager is also concerned with the decisions to pay or declare dividend. He assists the top management to decide the portion of profit to be declared as dividend. So far the objective is concerned , the above stated three functions are same i.e. maximizing shareholders wealth. As their objectives are same the decisions are interrelated. A company having profitable investment opportunities , generally prefer lower dividend pay out ratio. On the other hand having a good investment means profit of the company would be more and more dividend can be paid to shareholders. Similarly , finance function and investment functions are also highly correlated. Cost of capital plays a major role whether to accept or not an investment opportunities. Financing decisions also dependent on amount of to be retained in the profit. So , we can conclude that investment , financing and dividend decisions are interrelated and are to be taken jointly keeping in view their joint effect on the shareholders wealth.

Investment decisions/ Long-term asset-mix Involve Capital expenditure Referred as Capital budgeting

Allocation of funds to long term assets which yield returns in future Evaluation of new projects Measurement of cut off rate against new investments Evaluation on the basis of return and risk Involves replacement decisions Financing Decision / Capital Mix o From where and how to acquire funds o Determination of appropriate proposition of equity and debt o Debt equity mix is called Capital Structure o Change in shareholders returns by a change in Capital structure is called Financial Leverage o Best combination of debt-equity that would increase returns with the given risk should be found out o Legal aspects, loan facilities, controls etc should also be considered while deciding capital structure. Factors influencing financial decisions: External Factors: State of economy Structure of capital and money markets Requirements of investors Government policy Taxation policy Lending policy of financial institutions. Internal Factors: Nature and size of business Expected return Composition of assets Structure of ownership Trend of earnings Age of the firm Liquidity position Working capital requirements Conditions of debt agreements

RELATIONSHIP BETWEEN RISK AND RETURN Risk: Risk is defined as the chance of future loss that can be foreseen. Return: The return represents the benefits derived by a business from its operations. Measurement of Return: On the basis of Profit On the basis of Income On the basis of Earnings Before Interest and Tax (EBIT)

On the basis of Earnings Before Tax (EBT) On the basis of Earnings After Tax (EAT) On the basis of Cash flows generated in the business operations On the basis of different accounting Ratios

Functions of A Finance Manager


As a company grows, the responsibilities of the finance manager expand, with more outsourced functions coming in-house and more long-term strategic planning added to the finance manager's plate. Understanding the roles and responsibilities of a corporate finance manager will help you decide if this career is right for you and how to prepare to land these types of finance jobs.

Planning
Unlike a bookkeeper or accountant, a financial manager, often known as a chief financial officer, plans long-term financial strategy for a company, delegating bookkeeping work to lower-level staff. The financial planning aspect of the job includes setting goals for achieving specific revenues, profit margins and gross profits. It also requires setting targets for overhead and production expense levels and debt-service management. The financial manager needs to create a master budget thats tied to the companys balance sheet, accounts receivable and pa yable reports and cash flow and profit-and-loss statements. The financial manager conducts regular reviews of the master budget, called budget variance analyses, to determine if any changes should be made based on the actual performance of the company vs. its financial projections. Financial managers also determine the best investment options for a businesss excess cash and review ways to acquire capital for expansion or acquisitions.

Cost Containment
A key responsibility of a financial manager is to control the companys expenses. This requires more than simply setting spending levels and cutting costs. Cost containment includes creating requests for proposals, bidding processes and purchasing policies for contractors, vendors and suppliers to ensure the company gets the best combination of quality and price. The financial manager sets benchmarks that determine when its most cost-effective to perform activities using in-house staff and when its better to use contractors. Cost-containment efforts include managing debt to ensure interest payments dont wipe out company profits. Financial managers also create strategies that help reduce a companys tax liability, such as depreciating assets.

Cash Flow Management


One of the most important functions of a financial manager is to project and manage the companys cash flow. Cash flow refers to the actual receipt of money and payment of bills, as opposed to the companys budgeted income and expenses. Assuming that because a business has more income than expenses it can pay its bills can lead to disaster. For example, if the company does not negotiate customer credit terms and vendor and supplier payment terms correctly, the business might be waiting to collect sales invoices long after bills have come due. Cash flow

management includes monitoring receivables turnover and keeping enough credit and cash reserves available to keep the company financially stable.

Legal Compliance
The corporate financial manager ensures the business meets all of its legal obligations, such as sales and income tax payments; employee benefits contributions; state and federal labor wage requirements; and Securities and Exchange Commission reporting, if the company is a public corporation. At small and medium-sized businesses, the financial manager often works with tax experts and CPAs who guide the company regarding its legal obligations.

The Financial Manager: An Overview of the Role


The financial manager is responsible for budgeting, projecting cash flows, and determining how to invest and finance projects.
Key Points

The finance manager is responsible for knowing how much the product is expected to cost and how much revenue it is expected to earn so that s/he can invest the appropriate amount in the product. The finance manager uses a number of tools, such as setting the cost of capital (the cost of money over time, which will be explored in further depth later on) to determine the cost of financing. The financial manager must not just be an expert at financial projections; s/he also must have a grasp of the accounting systems in place and the strategy of the business over the coming years. The head of the financial department is the chief financial officer (CFO) who is responsible for all financial decisions and reporting done in the company.

The Role of the Financial Manager


The role of a financial manager is a complex one, requiring both an understanding of how the business functions as a whole and specialized financial knowledge. The head of the financial operations is called the chief financial officer (CFO). The structure of the company varies, but a financial manager is responsible for the same general things across the board. The manager is responsible for managing the budget. This involves allocating money to different projects and segments so that the business can continue operating, but the best projects get the necessary funding. The manager is responsible for figuring out the financial projections for the business. The development of a new product, for example, requires an investment of capital over time. The finance manager is responsible for knowing how much the product is expected to cost and how much revenue it is expected to earn so that s/he can invest the appropriate amount in the product. This is a lot tougher than it sounds because there is no accurate financial data for the future. The

finance manager will use data analyses and educated guesses to approximate the value, but it's extremely rare that s/he can be 100% sure of the future cash flows. Figuring out the value of an operation is one thing, but it is another thing to figure out if it's worth financing. There is a cost to investing money, either the opportunity cost of not investing it elsewhere, the cost of borrowing money, or the cost of selling equity. The finance manager uses a number of tools, such as setting the cost of capital (the cost of money over time, which will be explored in further depth later on) to determine the cost of financing. At the same time that this is going on, the financial manager must also ensure that the business has enough cash to pay upcoming financial obligations without hoarding assets that could otherwise be invested. This is a delicate dance between short-term and long-term responsibilities. The CFO is the head of the financial department and is responsible for all of the same things as his/her subordinates, but is also the person who has to sign off that all of the company's financial statements are accurate. S/he is also responsible for financial planning and record-keeping, as well as financial reporting to higher management. The financial manager is not just an expert at financial projections, s/he must also have a grasp of the accounting systems in place and the strategy of the business over the coming years . Notes: capital Money and wealth; the means to acquire goods and services, especially in a non-barter system. Collaboration The finance manager must collaborate across business functions in order to determine how to best allocate and manage assets. Controller: The controller or Chief Accounting Officer is responsible for the maintenance of adequate internal control and for the preparation of accounting records and financial statements such specialized activities as budgeting, tax planning and preparation of tax returns are usually placed under the controller's jurisdiction. Treasurer: (vice president of finance) The Treasurers has custody of the company funds and is generally responsible for planning and controlling the company cash position. The treasurer's department also has responsibility for relations with the company's financial institutions and major creditors CONTROLLERSHIP TREASURERSHIP
a. b. c. d. e. f. g. Planning & Control a. Provision of capital Reporting & interpreting b. Investor relations Evaluating & Consulting c. Banking & custody Government reporting d. Credit & collections Protection of assets e. Investments Economic appraisal f. Insurance Tax administration g. Short-term financing.

Section A 1. Corporation finance deals with the company form of organization. True / False. 2. In the present days, corporation finance is also referred to as business finance and financial management. True / False. 3. The principles of corporation finance can be applied to every type of organization. True/ False. 4. Traditional approach confines finance function only to raising of funds. True/ False. 5. Finance function is one of the most important functions of business management. True/ False. 6. Investment decisions are outside the purview of financial decisions. True/ False. 7. The appropriate objective of an enterprise is _______________. 8. The job of a finance manager is __________ 9. Business finance can be defined as the activity concerned with -------, -------- and __________ of funds used in business. 10. Finance functions or decisions can be classified into ------- and --------- decisions. Section B 1. Write the scope and features of business finance. 2. How should a finance function of an enterprise be organised explain in detail 3. Objectives of finance functions 4. How does traditional approach differ from modern concept of finance? 5. Explain Criticism of traditional approach in business finance 6. Can you state the nature of finance and its interaction with other management functions. 7. Can you state the contents of modern finance? 8. Brief the modern concept of finance functions. 9. Illustrate the organisation of finance function. 10. What are the difference between short and long term finance functions or decisions? Section C 1. Explain the important finance function of a business. 2. Discuss the modern finance function concept. 3. Functions of a finance manager in a large scale industrial establishment Enumerate 4. What is business finance? Discuss its objectives in detail. 5. State the functions of a financial controller. 6. Concepts of business finance. 7. What are the main considerations to be followed with the finance function in an organisation. 8. What are the main considerations to be followed with the finance function in an organisation. 9. Name four finance functions and briefly explain on each. 10. What are the objectives/scope of a business finance?

UNIT II FINANCIAL PLANNING Introduction Finance is the life blood of business. No business can run successfully without adequate finance. Finance is required to bring a business into existence, to keep it alive and also to see it growing and prospering. Finance is an important function of business. The application of planning to this function is called financial planning. Financial planning is mainly concerned with the economical procurement and profitable use of funds. According to Gutlman and Dougall, "Financial planning is concerned with raising, controlling and administering of funds used in business." In the words of Bouneville and Dewey, "Financial planning consists in the raising, providing and managing of all the money, capital of funds of any kind to be used in connection with the business." Financial planning is an important element of the overall planning of business enterprise. Financial planning includes the following:

Estimating the amount of capital required for financing the business enterprise; Determining capital structure; Laying down policies for the administration of capital; Formulating the programmes to provide the most effective use of capital.

Meaning Finance is the important function of business. Financial policy and procedure are the broad guides in the procurement, administration and disbursement of funds. A well prepared financial plan will not only ensure the procurement of sufficient funds but their proper utilization also. Financial planning results in the formation of the financial plan. It is the process of framing financial policies in relation to procurement, investment and administration of funds of an enterprise. It is primarily a statement estimating the amount of capital and determining its composition. The application of planning to the functions of finance is mainly concerned with the economical procurement and profitable uses of funds. It involves the determination of objectives policies and procedures relating to the financial function. The term "financial plan" often refers to a formal and defined series of steps or goals and provides direction and meaning to your financial decisions. The process of determining person's or firm's financial needs or goals for the future and the means to achieve them. Why should you plan? Everyone who has financial challenges to overcome or financial goals to achieve need a plan that contributes to their financial stability and wealth.

Steps to follow during financial planning Identify goals and objectives. Gather the information needed. Analyze present situation and think about options. Work out strategies to reach your goals. Execute those strategies. Periodically exam and revise them. DEFINITIONS: Broadly conceived, financial planning can be viewed as a presentation or an overall plan for the firm in financial terms. Narrowly conceived financial planning may refer only to the process of determining the financial requirements necessary to support a given set of plans in other areas - Erra Solemn Financial planning pertains only to the function of finance and includes the determination of the firms financial objective, financial policies and financial procedures - J.H.Bonneville According to Robinsons, financial planning is 1. To determine the financial resources required meeting the companies operating program me 2. Forecast the extent to which these requirements will be met by the internal generation of funds and the extent to which they will be met by the external source of funds. 3. It envelopes the best plan to obtain then required external; funds. 4. Establish and maintain a system of financial controls governing the allocation and use of funds. 5. Formulates programmes to provide the most effective profit volume cost relationship. 6. Analysis the financial results of operations and to meet other expenses. 7. Report facts to the top management and make recommendations on future operations of the firm. Objectives of Financial Planning 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. Adequate funds: A financial plan would ensure the availability of sufficient funds to achieve enterprise goals. Balancing of costs and risk: There should be a balancing of costs and risks so as to protect the investors.

Determining capital structure: The capital structure is the composition of capital, i.e., the relative kind and proportion of capital required in the business. Framing financial policies with regards to cash control, lending, borrowings, etc. 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. Flexibility: A financial plan should ensure flexibility so as to adjust as per the requirements. It should be adjustable as per the changing conditions. Simplicity: The financial structure should not be complicated by issuing a variety of securities should be less to that. Long term view: A financial plan should take a long term view. The needs for funds in the near future and over a longer period should be considered while selecting the pattern of financing Liquidity: The liquidity of funds should always be kept in mind while preparing a financial plan. During the period of depression it is the liquidity which can support t the concern going. Optimum use: A financial plan should ensure sufficient funds for the genuine needs, either the plans would suffer due to shortage of funds neither there should be wasteful use of them. The funds should be put to their optimum use. Financial planning deals with the following: Estimation of capital to be raised. Decision regarding form and proportion of various securities. Layout the policies regarding financial administration. Financial planning deals with formulation of financial plan. In simple words, it is nothing but the estimation of amount of capital and deciding its beneficial sources. Thus, financial plan covers The quantum of finance needed for commencing the business. The decision regarding form and proportion of various corporate securities to be issued to raise the required amount of capital. The decision regarding policies to be followed for floating of various corporate securities.

Principles of Financial Plan: Principle of Simplicity Principle of Long-term view Principle of Foresight Principle of Optimum Use Principle of Contingencies Principle of Flexibility

Principle of Liquidity Principle of Economy.

CHARATERISTICS OF A SOUND FINANCIAL PLAN

The main characteristics of a good financial planning are as follows: Simplicity The financial plan should be as simple as possible so that it can be easily understood even by a layman, property executed and administered. A complicated financial plan creates unnecessary complications and confusion. Based on Clear-cut Objectives The financial plan should be based on the clear-cut objectives of the company. It should aim to procure adequate funds at the lowest cost so that the profitability of the business is improved. Flexibility The financial plan should not be rigid, but rather flexible enough to accommodate the changes which may be introduced in it as and when necessary. The rigid composition of the financial plan may cause unnecessary irritation and may limit the future development of the business unit. Solvency an Liquidity The financial plan should ensure solvency and liquidity of the business enterprise. solvency requires that short-term and long-term payments should be made on due dates positively. This will ensure credit worthiness and good will to the business enterprise. Liquidity means maintenance of adequate cash balance in hand. Sometimes insufficiency of cash may make a business enterprise bankrupt. Planning Foresight Financial planning should have due foresight and vision to access the future needs, scope and scale of operation of the business enterprise. On the basis, financial planning should be done in such a manner that any adjustment needed in the future may be made without much difficulty. As the business proceeds, the financial adjustments become necessary which should be adjustable properly as and when desired. Contingencies Anticipated

The financial plan should be able to anticipate various contingencies which may arise in the near future. The financial plan should make adequate provision for meeting the challenge of unforeseen events. Minimum Dependence on Outside Sources A long-term financial planning should aim at minimum dependence on outside resources. This can be possible by retaining a part of the profits for ploughing back. Intensive Use of Capital Financial planning should ensure intensive use of capital. As far as possible, a proper balance between fixed and working capital should be maintained. Profitability A financial plan should be drafted in such a way that the profitability of the business enterprise is not adversely affected. Economical The financial plan should be quite economical i.e., the cost burden of raising various types of capital should be minimum. Government Financial Policy and Regulation The financial policy should be prepared in accordance with the government financial policy and regulation. It should not violate it under any circumstances.

STEPS IN FINANCIAL PLAN


Past performance-Analysis of the firms past performance to ascertain the relationships between financial variables, and the firms financial strength and weaknesses. Operating characteristics- Analysis of the product, market, competition, production and marketing policies, control systems, operating risk etc to decide about its growth objectives. Cash flow from operations-Forecasting the forms revenues and expenses and need for funds based on its investments and dividend policies. Financing alternatives: Analyzing financial alternatives within the financial policy and deciding the appropriate means of raising funds. Consistency- Evaluating the consistency of financial policies with each other and with the corporate strategy.

Uniformity: Figures and reports should be expressed in a manner which is consistent with the structure of the organization. Al the costs incurred on or for a given department may be included. Flexibility: The use of debt financing may be minimized so that a flexible capital structure may be maintained. It would be desirable, on the country, to resort to equity financing. Exceptions: Sometimes it is useful for financial executives to know the areas and the extent of deviations from actual performance. If deviations are thrown up, they may be able to readily accept one of the exceptions under abnormal circumstances. Conservative: A financial plan should be conservative in the sense that the debt capacity of the company should not be exceeded. Solvency: The plan should take proper care of solvency because most of the companies have failed by reason of insolvency. Adequate liquidity will give to an organization that degree of flexibility which is necessary for absorbing the stocks of its normal operations. Profitability: A financial plan should maintain the required proportion between fixed charges obligations and the liabilities in such a manner that the profitability of the organization is not adversely affected. The most crucial factor in financial planning is the forecast of sales, for sales almost crucial factor in financial planning is the forecast of sales, for sales almost invariably represent the primary source of income and cash receipts. Varying Risks: A financial plan should provide for ventures with varying degrees of risks so that it might enable a corporation to achieve substantial earnings from risky adventures. Planning Foresight: A plan should be such that it should derive a practical purpose. It should be realistic and capable of being put to intensive use. But a proper balance between fixed and working capital should be maintained. Availability: The sources of finance that a corporation may select should be available at a given point of time. If certain sources are not available, the corporation may even prefer to violate the principles of suitability Availability sometimes bears no relation to cost. Timing: A sound financial policy involves effective timing in the acquisition of funds. The key to effective timing is correct forecasting. A sound financial policy implies not only a wise selection of sources but also an effective timing thereof. But this would depend upon the understanding of the management of how business cycles behave during different phases of business operations. MAJOR AREAS OF FINANCIAL PLANNING

FIXED CAPITAL REQUIREMENTS Definition of Fixed Capital


In general, the definition of fixed capital can be stated as under. Fixed capital is a compulsory initial investment made by the entrepreneur to start up the activities of his business. Fixed capital is a mandatory one-time investment made at the introductory phase of a business establishment. Fixed capital is not alike working capital, which is required on a continuous basis to operate (run) the ordinary course of production and distribution of goods and services. According to Hoagland, Fixed capital is comparatively easily defined to include land, building, machinery and other assets having a relatively permanent existence. Fixed capital is a permanent investment made to meet the longer-term needs (requirements) of the business activities. Thus, fixed capital has a permanent existence in the business. It is usually present in the form of fixed assets like land, building, plant, machinery, etc.

Meaning of Fixed Capital


The meaning of fixed capital is depicted in the following chart. The meaning of fixed capital can be easily grasped from these points: 1. Fixed capital is a compulsory initial investment made in the business. 2. It helps to lay down the basic infrastructure on which business is supposed to stand and flourish in a long run. 3. It is a part of total capital invested in the business. 4. It has a permanent existence in the business to meet its long-term needs. 5. It is used for purchasing fixed assets like land, building, plant, machinery, etc. 6. It is also used for purchasing intangible assets like patents, copyrights, goodwill, etc. 7. It is required for promoting the business. 8. It is also required for expansion, modernization and diversification of business. 9. Fixed capital gets depreciated as an asset is used over time with few exceptions like in case of land. 10. Fixed capital requirement is estimated by the promoters of business. This estimation must be made as accurately as possible. To achieve this, the promoters seek professional help and take advice from experts such as engineers, architects, etc.

Examples of Fixed Capital


The examples of fixed capital are depicted in the following image.

Common examples of fixed capital investments are as follows:


Plant and machinery. Factory's land and its buildings. Company's headquarter (HQ), administrative areas, regional and local offices, and their premises. Computing and communication infrastructure that mostly includes workstations, servers, data-storage facilities, local-area networks, the internet, telephones, fax, so on. Patents, copyrights, goodwill, etc., also gets covered under fixed capital. FINANCIAL NEEDS OR ESTIMATION OF FINANCIAL

PLANNING THE REQUIREMENTS.

(1) Planning the total capitalization Capitalization refers to the total financial resources required by an organization to attain the specified objectives. Poor planning or lack of planning of capitalization drags the firm either towards over capitalization or under capitalization. Under earnings theory, the expected earnings are capitalized art the rate of return that prevails in similar competitive firms. (2) Estimation of short term and long term funds Long-term funds are invested in fixed assets and permanent working capital. While short term funds are needed to finance temporary working capital. if short term funds are used to finance fixed assets, it may hamper the liquidity of the company. Conversely, if the long-term funds are used to finance temporary working capital, it may prove costly to the organization. Hence the estimation of the total needs and its subdivision into long term and short term is highly essential. (3) Capital structure planning Capital structure refers to the finance mix of the different types of long term funds in total capitalization. The change in capital structure affects the cost of capital of the firm as well as the financial risk as represented by the debt-equity ratio. The EPs can be magnified with the help of debt-equity ratio. Thus proper planning is essential. (4) Profit planning Profit planning is done in terms of the different budgets regarding sales, manufacturing costs, operating costs, administrative costs, sales and distribution costs, interest liabilities,etc.Profit planning is done with the help of the projected profit and loss account. Profit planning estimates the projected profits of the company.. It is valuable for certain important decisions. (5) Dividend planning a. Need of internal financing b. Stability in dividend rate.

ASSESSMENT OF FIXED CAPITAL REQUIREMENTS


Fixed capital is required to finance the cost of acquisition of permanent assets such as land, building, plant and machinery, etc and to fund the cost of intangible assets like promotion

expenses, organisation expenses, operating losses, costs of financing, patents, copyrights and goodwill, etc. Hence, the assessment of the total amount of fixed capital required in a business involves: I. Estimation of Fixed Assets Requirements II. Estimation of Intangible Assets Requirements.

I. ESTIMATION OF FIXED ASSETS REQUIREMENTS


Fixed assets requirements are estimated usually at the time of promotion of a new enterprise. However, existing firms any also need it at the time of expansion, growth, replacement and improvement of the existing facilities. It is important not only to estimate the investments needed for these assets but also the time at which these amounts are required. The promoters and managers of the business can determine various fixed assets required by them from their own experience in the business or by making a study of similar units or by taking advice from technical experts in that line of business. The estimation of the cost of these assets could be made by them by making enquires with the manufactures or suppliers of these assets. Estimation of the cost of land usually poses no problem and the cost of building can be estimated by taking help from building engineers and contractors. Further, the cost of installation of plant and machinery and other equipments should also be made. A sufficient margin for non-firm costs should, however, is made to meet the exigencies. The requirement of fixed assets varies from business to business. There are a number of factors that determine the requirements of fixed assets in a business.

FACTORS AFFECTING THE ESTIMATION OF FIXED ASSETS REQUIREMENTS


Various factors which affect the estimation of fixed assets requirements in a business can be studied under two heads: Internal Factors External factors INTERNAL FACTORS Nature or character of business The fixed assets requirements of a business basically depend upon the nature of its business. Public utility undertakings such as electricity, water supply and railways require huge fuds to be invested in fixed assets. On the other hand, trading and financial firms have very less requirements for fixed assets but have to invest large amounts in current assets. Manufacturing concerns also require sizeable fixed capital as they have to set up production facilities and invest large funds in fixed assets such a land and buildings, plant and machinery, etc. Thus, the nature of business determines the requirements of fixed assets/capital to a large extent.

Size of business The fixed assets/capital requirements of concern are also influenced by the size of its business which may be determined in terms of scale of operations. Generally, larger the size of a business unit, greater is the requirement of fixed assets needed to set up the business operations. Activities Undertaken by the Enterprise or Scope of Business The requirement of fixed capital also depends upon the number of activities undertaken by the enterprise. For example, if a concern manufactures and markets its products itself, it needs more fixed capital as compared to a concern that undertakes only manufacturing activities or only marketing activities. Similarly, if a concern is engaged in production of all parts of a product, it will require more capital than a concern which is engaged in assembling parts manufactured by other units. Production Techniques Another factor that influences the requirements of fixed capital in a business is the production technique that is to be adopted in the enterprise. For example, use of automatic machinery calls for larger investment in the fixed assets. On the other hand, if production methods are simple, which do not require such equipments, lesser amount of fixed capital shall be needed. Mode of Acquisition of Fixed Assets (Extent of Lease or Hire) Fixed assets may be purchased out rightly or acquired on lease or hire basis. If an outright purchase of fixed assets is to be made, larger amount of fixed capital shall be required in comparison to the acquisition of fixed assets on leasehold basis or on hire. It is therefore, essential to decide in advance as to which assets are to be acquired on leasehold basis and which are to be purchased out rightly. In the same manner if some of the fixed asset are available on hire or rent, decision has to be taken in regard to the purchase of these assets on outright or hire basis. Acquisition of old Equipment and plant In certain industries, old plant and machinery or equipments may be available at prices much below the prices of the new plant and machinery. If old plant and machinery could be satisfactorily used in the business, especially in the areas where the technological change in production method is moderate or slow, it would substantially reduce the required investment in fixed assets. Decision as regards ancillary units In certain industries, there may be a possibility of carrying out certain processes through ancillary units or sub-contracts without compromising with the quality and cost of the product. If it is so, the requirements of fixed assets can be decreased. Availability of fixed assets at concessional rates In some areas, the Government provides land and other materials/ facilities at concessional rates to promote balanced industrial growth and regional development of industries. Further, plant and machinery may be made available on instalment basis. Such concessions induce the promoters to establish business in these areas reducing their investment in fixed assets.

EXTERNAL FACTORS International conditions and Economic Outlook While taking decision relating to investment in fixed assets, particularly in a large concern, the general economic and international conditions also play an important role. For example, if the level of business activity is expected to increase, the needs for fixed assets and funds to finance their acquisition will also grow. In the same manner, companies expecting war, may commit large investment in fixed assets before there is a shortage of such material. Population Trends and its Composition If a firm is planning for national market for its products, national population trends must be evaluated while forecasting for fixed assets requirements. In India, certain promoters are encouraged to expand business because the population is increasing at a fast rate. The age and sex composition of the population may also be important for certain businesses. Shift in Consumer Preferences Another factor that affects the future requirements of fixed assets is shift in consumer preferences. Fixed assets requirements should be planned in a manner so as to provide goods or services that consumers will accept. Competitive factors The decision making process on planning future requirements of fixed assets is also influenced by competitive factors. For example, if an existing company shifts to a particular line of business, then others may also follow the lead. Shift in Technology Future improvements and shifts in technology have also to be considered while deciding about the future requirements of fixed assets. The financial plan should allow a scope for adjustments as and when new situations emerge. Government Regulations There may be certain government regulations affecting the size and the direction of a business enterprise. Hence, these should also be considered while assessing requirements of fixed assets. Although, it may not be possible to forecast changes in the Government policy, a margin should be provided to absorb the impact of such changes.

II. ESTIMATION OF INTANGIBLE ASSET REQUIREMENTS


The expenses of promotion, incorporation of an organization or an establishment of business cost of financing and the amount to be invested in intangible assets. Such as goodwill, patents, copyrights etc., also forms part of fixed capital of a concern. 1. Promotional expenses The expenses incurred by the promoter to make preliminary investigation, study marketing possibilities, enquires about the technical aspects of production processes and assembling the

elements of business are called promotion expenses. These are to be paid to the promoter as compensation for the services rendered by him in promoting the business. Although, it is very difficult to determine the remuneration of the promoter for his personal efforts, time and skill in promoting the business, sufficient provision should be made for the same while estimating the requirement of intangible assets for the purpose of assessing the fixed capital requirements of a business. 2. Incorporation and organization expenses Expenses incurred in setting up the business such as legal counseling, stamp duty, registration fees, filing fees, incorporation taxes, printing, etc. form part of incorporation or organisational cost. It is very essential to make an estimate of such expenses while determining the requirements of fixed capital in a business. 3. Cost of finance The expenses incurred for arranging the funds required for a business are called costs of financing. These include the remuneration of underwriters, brokers, investment bankers as well as the expenses to be incurred in the preparation of a registration statement and prospectus for making capital issues. These costs would also be estimated while assessing the requirements of intangible assets forming part of the fixed capital. 4. Initial operating losses Every enterprise needs some time to stabilize the production and reach the self supporting stage. Until that time, it incurs certain cash losses and funds drain out of the business. Such losses are most prolonged in business requiring huge initial investment, complex production techniques and marketing or developing a novel product. While planning for capital, it is very essential to estimate and provide for such operating initial losses. 5. Cost of acquisition of patents, copyrights, goodwill.etc. If the company is considering to purchase patents, copyrights, goodwill, etc. then it is very essential to make an estimate of the cost of these intangible assets and include the same in the fixed capital requirements of a business. After preparing estimates of fixed assets and intangible assets requirements separately, we can determine the total fixed capital requirements of an enterprise by simply adding the funds needed for fixed assets and intangible assets.

WORKING CAPITAL
Working capital refers to that part of the firms capital which is required for financing short term or current assets such as cash, marketable securities, debtors and inventories. Funds thus invested in current assets keep revolving fast and are being constantly converted into cash and this cash flow out again in exchange for other current assets. Hence, it is also known as revolving or circulating capital or short term capital. The working capital requirements of a concern depend upon a large number of factors such as: Nature or character of business.

Size of business/ scale of operations Production policy Manufacturing process/ length of production cycle Seasonal variations Working capital cycle Rate of stock turnover Credit policy Business cycles Rate of growth of business Earning Capacity and dividend policy Price level changes Other factors To avoid the shortage of working capital at once, an estimate of working capital requirements should be made in advance so that arrangements can be made to procure adequate working capital. The working capital should be determined by estimating the investment in current assets minus moneys expected from current liabilities. The following factors should be taken into consideration while making an estimate of working capital requirements: 1. Total costs incurred on material, wages and overheads. 2. The length of time for which raw materials are to remain in stores before they are issued for production. 3. The time taken for conversion of raw material into finished goods. 4. The length of sales cycle during which finished goods are to be kept waiting for sales. 5. The average period of credit allowed to customers. 6. The amount of cash required to pay day-to-day expenses of the business. 7. The average amount of cash required to make advance payments, if any. 8. The average credit period expected to be allowed by suppliers. 9. Time lag in payment of wages and other expenses. From the total amount blocked in current assets estimated on the basis of the first seven items given above, the total of the current liabilities, i.e. the last two items is deducted to find out the requirements of working capital. METHODS USED FOR FINANCIAL PLANNING The two important tools of financial planning are Pro-forma financial statements Maintenance of solvency and liquidity are the two basic issues in financial management. When the net worth of the firm is nit sufficient to discharge the liabilities in full, the firm is said to be solvent, this is known as legal insolvency. Legal insolvency results in either the reorganization or the liquiditation of the firm. In some cases the firm financially sound, net worth of the firm is sufficient to discharge the liabilities on maturity. Such a situation is described as technical insolvency. Technical insolvency indicates the liquidity crisis. The pro-forma financial statement involves the preparation of the following two statements.

1. Pro forma profit and loss account (Income statement) 2. Pro forma balance sheet. 2. Cash Budgeting The budget is simply a time-phased schedule of activities of transactions presented usually in rupee form. It can also be presented in other quantitative data. A budget can be presented for any activity with reference to 1. Specific future periodicity and 2. Exact quantitative data relating to that specified period. A cash budget is important and key instrument of financial planning, especially cash management. A cash budget is time-phased schedule of expected cash inflows and cash outflows, disclosing the cash shortages with reference to timings and magnitude. Cash budget is a planning tool as well as a control technique. NEED FOR FINANCIAL PLANNING 1. Availability of sufficient cash h for meeting expenses, emergencies and contingencies. 2. To maintain the necessary liquidity throughput the year. 3. To indicate in points of time when funds will be required and how much. 4. To indicate the surplus resources available for expansion or external investments. 5. To provide ahead for any more funds, if required. 6. To increase the confidence in then minds of the surplus of funds by adopting suitable financial policies. 7. The environment under which the bu8siness firms operate are constantly changing. There is cut throat competition and consequent narrow margin of profit. Hence, planning becomes essential to overcome the risk an reduce the uncertainty as far as possible.

Limitations of Financial Planning


Some of the limitations of financial planning are discussed as follows: Difficulty in Forecasting Financial plans are prepared by taking into account the expected situations in the future. Since, the future is always uncertain and things may not happen as these are expected, so the utility of financial planning is limited. The reliability of financial planning is uncertain and very much doubted. Difficulty in Change Once a financial plan is prepared then it becomes difficult to change it. A changed situation may demand change in financial plan but managerial personnel may not like it. Even otherwise, assets might have been purchased and raw material and labour costs might have been incurred. It becomes very difficult to change financial plan under such situations. Problem of Co-ordination

Financial function is the most important of all the functions. Other functions influence a decision about financial plan. While estimating financial needs, production policy, personnel requirements, marketing possibilities are all taken into account. Unless there is a proper co-ordination among all the functions, the preparation of a financial plan becomes difficult. Often there is a lack of co-ordination among different functions. Even indecision among personnel disturbs the process of financial planning. Section A 1. Financial plan is primarily a statement estimating the_________ 2. The statement establishing amount of capital and determining its composition is termed as _____________ 3. Financial planning involves evaluating the__________ condition of a firm. 4. __________ and _________ are some of the steps involved in financial planning. 5. Firms develop financial plan within the overall framework of ____________ 6. Long term financial plan in large companies is for _________ years. 7. Financial plan indicates firms growth, _________ , ___________ and requirement of funds. 8. __________ is to analyze a firms investment option and estimating the fund requirement. 9. ___________ is an integral part of financial planning. 10. Finance planning involves___________ and financing decisions of a firm. 11. Financial plan may be prepared for a period of ________ to________ years. 12. Financial plan of a company has close links with -__________ 13. _______should be developed within the overall context of strategic plan. 14. Financial planning also involves the interface between__________ and financial planning. 15. Financial planning and profit planning helps a firms financial manager to regulate flow of funds. True / False Section B 1. What are the steps involved in financial plan? 2. Highlight the problems involved in financial plan. 3. State the objectives of financial plan. 4. What are the principles of a financial plan. 5. Define financial planning. 6. What is financial forecasting? How does it differ from financial plan? 7. Process of financial process model. 8. Describe the importance of financial planning. 9. What is long and short term financial plan. 10. State the role of sensitivity in financial plan. 11. What are the steps in preparing a financial plan? Merits of financial plan. 12. State the relationship between strategic planning and financial planning. 13. Illustrate the development of a simple financial model. What are the advantages and disadvantages of the same. 14. What are the methods of developing a long term financial plan. 15. Can you brief on how financial requirements are estimated? Section C

1. What is financial plan and what are the steps involved in preparing a financial plan. 2. Can you state the problems involved in financial planning. 3. How will you estimate the long term and short term needs in financial plans. 4. What is working capital and what are the factors determining working capital? 5. Give the significance of financial plan and the types. 6. Explain in detail about the principles governing a sound financial plan. 7. Can you discuss about what is financial planning. 8. What is the importance of financial forecasting? 9. Name few types of financial plan and explain in detail. 10. How does financial plan differ from financial forecasting? 11. Is there a relationship between strategic planning and financial planning? Explain. 12. Financial planning is considered to be the most important aspect of financial managers job. Illustrate. 13. Can you explain on some of the factors to be considered while estimating financial requirements? 14. How would you plan for short term and long term requirements? 15. What are the main elements of a successful plan.

Unit III CAPITALIZATION: Meaning: Capitalization is an important constituent of the financial plan and in common, the term capitalization means the total amount of capital employed in business. It can be meant as the process of building up a capital structure and tapping the sources to mobilize the capital in the form of shares or bonds or loans, reserves etc. Capitalization is the long-term funding that allows a business firm to operate. It is the investment that the business owner and any other investors make in the firm. It is a financial term which refers to the sum of the stockholder's equity of the firm and the firm's long-term debt, such as bonds or mortgages. Capitalization can be used as a tool to commit financial statement reporting fraud. Capitalization is the sum of par value of the stocks and bonds outstanding

DEFINITION Capitalization is the sum of par value of the stocks and bonds outstanding. And according to this definition, the term capitalization includes only the par value of share capital and debentures and it does not include reserves and surplus. However in actual practice, it is found that firms to meet their long-term capital requirements frequently resort to reserves and surplus. Hence this definition seems not to be logical. How can we view Capital in different terms? 1. In accounting use: The term capital is used in accounting literature to represent the net worth means assets and liabilities. 2. In Business use: Total assets required operating a business and the money needed to acquire such assets. 3. As used by economists: All the accumulated wealth used to produce additional wealth. 4. In legal usage: The amount received in return for securities,ie.,shares allotted to the investors. The total amount of share value paid as shown in the companys book of accounts is legall y known as its capital. ACTUAL CAPITALSIATION Vs. PROPER CAPITALSIATION Capitalization comprises ownership capital which includes capital stocks and surplus in whatever form it may appear and borrowed capital which consists bonds or similar evidence of long term debt. Actual capitalization of a company is arrived by adding the paid up value of companies shared and debentures, reserves and other surpluses while proper capitalization of company is arrived at according to any of the two theories (cost & earnings). In case a companys actual capitalization is more than its proper capitalization the company is said to be over capitalized. In case actual capitalization of the company is less than it proper capitalization, the company is said to be undercapitalized. CAPITAL & CAPITALISATION The English word 'capitalization' has several different meanings: The act of capitalizing on an opportunity; An estimation of the value of a business; Writing in capital letters;

The sale of capital stock the value of a company calculated by multiplying the price of its shares on the stock exchange by the number of shares issued. Also called market capitalization Capitalization is the long-term funding that allows a business firm to operate. It is the investment that the business owner and any other investors make in the firm Noted that the term capitalization is used only in respect of companies and not in relation to partnership firms or sole proprietorship. The term capital in accounting sense means the net worth of the business undertaking. Net worth, means assets minus liabilities of the Business. Similarly the term share capital refers only to the paid up value of shares issued by the company. The term capitalization is also used by accountant in varies senses. For example, when bonus shares are issued out of profits, it is said that the profits have been capitalized; similarly, it may be capitalized but the company and treated as deferred revenues expenditure in its books. However, scholars of financial management are not common regarding the concept of capitalization. Some have given very broad interpretation to the term while others have taken a narrow view. What is capitalization of fixed assets? Capitalization of fixed assets means the assets which are acquired with a useful life of atleast two years, and recording the cost of that fixed asset in balance... BROAD INTERPRETATION According to this, the term capitalization is identical with the term financial planning, where financial planning of a company includes. 1. The determination about the total amount of capital to be raised 2. Decision regarding the types of securities to be issued for the purpose of raising such capital and the relative proportion is the different securities and the administration of the capital Thus in broad sense, the term capitalization refers to the process of determining the quantum as well as patterns of financing. And it not only includes the determination of quantity of finance but also the quality of financing. In other words, it includes decision regarding amount of finance and the modes of finance. NARROW INTERPRETATION Here, the term capitalization refers to the process of quantum of long-term funds that an enterprise would require to run its business and the decisions regarding makeup of capitalization

are done in the term capital structure. The narrow interpretation of the term capitalization is more popular since it is very specific in its meaning. The constituents of capitalization as follows: 1. Par value of share capital 2. Reserves and surplus 3. Long-term loans BASES OF CAPITALIZATION After estimating financial requirements of business, the promoters of the company have to determining the value at which the company has to be capitalized; this will help them in determining the quantum of securities to be issued for raising the necessary funds. There are two recognized theories of capitalization for new companies 1. Cost Theory: The total amount of capitalization of a new company is arrived at by adding up the cost of fixed assets such as plant and machinery, buildings etc, the amount of working capital and the cost of establishing then business e.g. preliminary expenses, underwriting commission, expenses on issue of shares etc. For example if fixed assets for the company would cost Rs.1, 00,000 working capital required amounts to Rs.50,000 and the cost of establishing the business would amount t to Rs.20,000, the amount of capitalization for the company would be Rs.1,70,000. The company would sell securities i.e. shares and debentures of this amount. Cost theory is useful in so far as it enables the promoters to know the amount of capital to be raised. But it fails to provides basis for ascertain net worth of the business in real term because net worth depends not on the cost of assets but on its earnings capacity. 2. Earnings Theory: According to this theory, the true value (capitalization) of an enterprise depends upon its earnings capacity. In other words, the worth of a company is not measured by the capital raised but by the earnings made out of the productive harness of the capital. For this purpose a new company will have to estimate the average annual future earnings and the normal earnings rate also termed s as capitalization rate. The earnings theory of Capitalization recognizes the fact that the true value (capitalization) of an enterprise depends upon its earnings and earning capacity. According to it, therefore, the value or Capitalization of a company is equal to the capitalized value of its estimated earnings. For this purpose a new company has to prepare an estimated profit and loss account. For the first few year of its life, the sales are forecast ad the manager has to depend upon his experience for determining the probable cost. The earnings so estimated may be compared with the actual earnings of similar companies in the industry and the necessary adjustments should be made. Then the promoters will study the rate at which other companies in the same industry similarly situated are earnings. The rate is then applied to the estimated earnings of the company for finding out the capitalization. To take an example a company ma estimate its average profit in the first few years at Rs. 50,000. Other companies of the same type are, let us assume, earnings a return of 10 per cent on their capital. The Capitalization of the company will then be 50,000 x 100

---------------- = Rs. 5,00,000. 10 It will be noted that the earnings basis for Capitalization has the merit of valuing (capitalizing) a company at an amount which is directly related to its earning capacity. A company is worth what it is able to earn. But it cannot, at the same time be denied that new companies will find it difficult, and even risky, to depend merely on estimate of their earnings as the generally expected return is an industry. In case of new companies, therefore, the cost theory provides a better basis for capitalisation than the earning theory. In established concerns too, the Capitalization can be arrived at either (i) on the basis of the cost of business, or (ii) the average or regular earnings and the rate of return expected in an industry If cost is adopted as the basis, the Capitalization may fall to reveal the true worth of a company. The assets of a company stand at their original values while its earnings may have declined considerably. In such a situation, it will be risky to believe that the Capitalization of the company is high. Earnings, therefore, provide a better basis of Capitalization in established concerns The figure will be arrived at in the same manner as above. Actual and Proper Capitalization. The capitalisation of a company as arrived at by totaling up the value of the shares, debentures and non-divisible retained earnings of the company may be called the actual Capitalization of the company. Let us take the relevant items in a company balance sheet for illustration. The actual Capitalization as per balance sheet given below will be Rs. 16,00,000.

XYZ CO. LTD. BALANCE SHEET AS ON 31ST DECEMBER, 1981 Liabilities Paid-up capital Rs. 20,000 8 percent preference Shares of Rs.10 each 2,00,000 16,00,000 50,000 Shares of Rs. 8 each 10,000 Debentures of Rs. 100 each 4,00,000 10,00,000 --------------16,00,000 -------------Assets Rs. SundryAssets

-----------16,00,000 -----------

As against the actual Capitalization the proper, normal or standard Capitalization for a company can be found out by capitalizing the average annual profits at the normal rate of return earned by comparable companies in the same line of business. Thus if a company gets an annual return of Rs. 1,50,000 and the normal rate of return in the industry is 0 per cent, the proper Capitalization will be arrived at as under: 100 1,50,000 x ------ = Rs. 15,00,000 10 A comparison between the actual and the proper on normal Capitalization will show whether the company is properly capitalized, over-capitalized or under-capitalized.

OVER-CAPITALISATION
Meaning Over-capitalization 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. A business is said to be over-capitalized when 1) Capitalization exceeds the real economic value of its net assets (2) A fair return is not realized on capitalization and (3) Business has more net assets than it needs. Over-capitalization may be considered to be in the nature of redundant capital. It is generally found in companies which have useless assets such as oil and mining concerns. This condition is commonly known as watered stock. A company is said to be over-capitalized when the aggregate of the par value of its shares and debentures exceeds the true value of its fixed assets. In other words, over-capitalization takes place when the stock is watered or diluted. It is wrong to identify over-capitalization with excess of capital, for there is every possibility that an overcapitalization with excess of capital, for there is every possibility that an over-capitalized concern may be deal with problems of liquidity. The correct indicator of over-capitalization is the earnings of the company. If the earnings are lower than the expected returns, it is over-capitalized. Over-capitalization does not involve surplus of funds any more than under-capitalization indicates a shortage of funds. It is quite possible that a company may have more funds and yet have low earnings. Often, funds may be inadequate, and the earnings may be relatively low. In both situations, there is overcapitalization. The average distributable income of a company may be insufficient to pay the contract rate of return on fixed income securities and a dividend on equity shares, comparable with that of similar securities elsewhere. For example a company is earning a sum of Rs.1, 50,000 on a total capital investment of Rs.15, 00,000. This company will be said properly capitalized, if the general expectation is 10%.

However if the company earns only Rs.90,000 while the general expectation is 10% the company will be said to be over capitalized because it will be in a position to give a return of only 6% in the total capital employed. Over-capitalization takes place when Prospective income is over-estimated at the start; Unpredictable circumstances reduce down the income; The total funds required have over-estimated; Excess funds are not efficiently employed; The low yield makes it difficult for a firm to raise new capital, particularly equity capital; The market value of the securities falls below the issue price; The low yield may discourage competition and this limited competition becomes a social disadvantage. Over-capitalization may go unnoticed during the period a business be encouraged by prosperity. It may be productive of ill- consequences when the distributable income diminishes under the pressure of declining demand and falling prices. OVER CAPITALISATION AND EXCESS OF CAPITAL It may be noted that over capitalization is different from excess of capital. Over capitalization is there only when the existing capital is not effectively utilized on account of fall in the earning capacity of the company while excess of capital means that the company has raised funds more than requirement. The chief sigh of over capitalization is fall in the rate of dividend in the long run, which results in fall in the value of the shares of the company. Thus, a company will be said to be over capitalized when it has consistently been unable to earn the prevailing rater of return on its capital employed. Causes of over-capitalization 1. Difference between Book Value and Real worth of Assets: It is possible that a company may have purchased its assets at a value that is higher than their real worth. This gap between the book value and the real worth of assets may account for over-capitalization. 2. Promotional Expenses: There is a possibility that promoters may have charged excessive promotional expenses for their services in creating the corporation. This charge may be a cause of over-capitalization. 3. Inflation: Due to these conditions a corporation might have acquired assets at high prices. Inflationary conditions rash over-capitalization, which affects new as well as established corporations. 4. Shortage of capital: When faced with a shortage of funds, a company may borrow at unremunerative rates of interest, which is bound to result in excessive or unjustified fixed charges.

5. Depreciation Policy: Inadequate provision for depreciation, obsolescence or maintenance of assets may lead to over-capitalization, and this is bound to adversely affect the profit-earning capacity of a corporation. 6. Taxation Policy: High corporate tax may discourage corporations from implementing programs of replacement, renewals and renovations, as a result of which their profitability may suffer. 7. Dividend Policy: Some corporations adopt a lenient dividend policy in order to gain popularity with their stockholders. However, such cash-down payment in the form of dividends weakens their liquidity position. Their valuable resources are likely to be waste away and, as a result, they may find themselves in a state of over-capitalization. 8. Market Sentiment: Company may be tempted to raise security floatation in the market in order to create a favorable market sentiment on the stock exchange. While doing so, it may be saddled with the issue of unwarranted securities, which are of no practical value to it. As a result, it becomes over-capitalized and the burden of its liabilities is unnecessarily inflated. 9. Under-estimation of capital Rate: If the actual rate at which capital is available is higher than the rate at which a companys earnings are capitalized, the capitalization rate is under estimated, and this results into over-capitalization. Advantages 1. The management is assured of adequate capital for present operations. 2. If conserved, an excess of capital may preclude the necessity of financing sometime in the future when capital is needed and can be obtained only with difficulty. 3. Ample capital has a beneficial effect on an organizations morale. 4. Ample capitalization gives added flexibility and latitude to the corporations operation. 5. Allegedly. Losses can be more easily absorbed without endangering the future of the corporations. 6. The rate of profits tends to discourage possible competitors. 7. For public utility companies, when the price of service is based upon a fair return to capital, a high capitalization may be advantageous. Disadvantages I) When stock is issued in excess of the assets received, a companys stock is said to be watered. Watered stock may arise by the issue of stock in any of the following ways: For over-valued property or services As a bonus For cash at less than the par or stated value of the stock

As a stock dividend when the surplus of the corporation is not offset by actual assets of at least an equal amount.

If known to be watered, stock has a market value which is lower than it would enjoy if it were not watered-until the water has been squeezed out (until sufficient assets have been acquired from earning to offset the excess of stock). II) There is the possibility of stockholders liability to creator in case a court should conclude that the stock was heavily watered, that the corporation did not receive reasonable or proper value for the stock. This liability would attach only to such stock as was received as a result of an unreasonably excessive valuation of properties or services given in exchange for such stock. III) There may be a possible difficulty of raising new capital funds. This may be by the use of no-par stock. 1. In some States, the rate of the annual franchise tax depends on the amount of outstanding stock. Large capitalizations in such States may attract large franchise taxes. 2. There is a tendency to raise the prices of a companys products and/or lower their quality. This may be partly or wholly prevent, however, by competition and would apply more to public utility services than to others, for public utility rates are based, in part, upon a reasonable return on capital. 3. Over-capitalization may induce a failure, and the failure of a corporation may bring about an unhealthy economic situation. 4. The ethical atmosphere of a business is not improved by over-capitalization. 5. The necessary ropes of the market for the securities which first offered to the public usually results in market value losses to the investors after this support are removed. This is not to attack the legal support of the market in the above-board floatation of a security issue. 6. There may be an inability to pay interest on bonds (when bonds constitute a large portion of the capitalization of an over-capitalized company) 7. Injury to credit worthiness. 8. Decline in the value of securities. 9. Possible loss of orders because of inability to expand. 10. Temptation for the management to fit in with depreciation, obsolescence, maintenance, reserve accounts in order to appear to make a profit possible in order to pay a dividend. 11. Possible injury to goodwill in case a necessary reorganization. 12. The holders of securities may be dissatisfied. 13. The business may give way to its competitors through its inability to obtain funds for expansion.

EFFECTS
Over-capitalization has some effect on the corporation, its owners, consumers and the society at large. 1. On Corporation: The market value of the corporations stock falls and it may find it difficult to raise new capital. Artificial devices such as the reduction in depreciation, limitation in maintenance, etc are made use of cover over-capitalization.

The credit of the company is adversely affected. The company may appear to be in a healthy condition even though it may have lost its energy and life and may end at any time because of the weak financial condition from which it suffers. 2. On Owners: Owners who have a real risk in the corporation are the biggest losers. Because of a fall in market value of its shares, shareholders are not in a position to dispose of their holdings profitably. Moreover of fall in dividends, shareholders lose heavily and they develop the feeling that the corporation is funded on shifting sands. 3. On Consumers: A corporation cannot resist the temptation of increasing the prices of its products to inflate its profits. At the same time, there is every possibility that the quality of the product would go down. The consumer may thus suffer doubly. 4. On Society: Over-capitalized concerns often come to grief in the course of time. They lose the backing of owners, customers and society at large. They suffer multi-pronged attacks from various sections of society. They are not in a position to face competition. No wonder, therefore, that they gradually draw closer to a situation ordering liquidation. While the existence of such corporations cannot be justified, their extinction would cause irreparable damage to society.

REMEDIES
1. Reduction in Funded Debt: This is generally impossible unless the company goes through a thorough re-organisation. Funds have to be raised for the redemption of bonds; and the sale of large quantities of stock, presumably at low prices, would probably do more damage than good. Moreover, the creation of as much stock as the bonds retired would not reduce the total capitalization. A true reduction in capitalization can be effected only if the debts are retired from earnings. 2. Reduction in Interest Rate on Bonds: Here again, without a through re-organisation, it would probably not be practicable to effect a reduction in the interest rate on bonds. A refunding operation, however, might be performed; but the saving in interest payments on the lower-rate refunding bonds would hardly offset the premium the company would be forced to allow the bond-holders in order to induce them to accept the refunding bonds; and, moreover, this procedure would not really reduce capitalization. However, it would alleviate the situation. 3. Redemption of Preferred Stock, if it carries a High Dividend Rate: Funds for redemption would probably have to come from the sale of common stock at low prices. The saving from the retirement of the preferred stock might be sufficient to increase somewhat the earnings from the common stock, even if this common stock is increased substantially. If, however, the preferred stock is cumulative, and if dividends on such stock are in arrears, this avenue of escape would appear to be a dead-end street. 4. Reduction in Par Value of Stock: This is a good method but is something impossible because of the stockholders tenacious belief in the importance of par value. If the stockholders

are convinced of the desirability of the move, it might be somewhat effective, though not nearly as much as the reduction in high fixed charges. 5. Reduction in Number of Shares of Common Stock: This likewise is a good method but, again, is difficult of implementation because of the average stockholders unwillingness to turn in several shares in order to receive one, through it does happen occasionally. Since this procedure does not decrease the stockholder' proportionate interest in the equity, it is sometimes used. In some cases, several of these methods may be used, but unless a company goes through a thorough re-organisation) a rather complicated and legally involved affair), the consent of the security-holders should be obtained. UNDER-CAPITALISATION Under-capitalization is the reverse of over-capitalization. It should not be confused with a condition implying a lack of funds. It merely refers to the amount of outstanding stock the condition is not a serious as that of over-capitalization and its remedies are much easily applied. Under-capitalization comes about as a result of: Under-estimation of future earnings at the time of promotion; and/or An unforeseeable increase in earning resulting from later developments; Under-capitalization exists when a company earns sufficient income to meet its fixed interest and fixed dividend charges, and is able to pay a considerably better rate on its equity shares than the prevailing rate on similar shares in similar businesses. At this stage, the real worth of the assets exceeds their book value, and the rate of earnings is higher than a corporation is ordinarily able to afford. When a corporation is earning an extra ordinarily large return on its outstanding stock, it is said to be under capitalization.

CAUSES
1. Under-estimation of Earnings: It is possible that earnings may be under-estimated, as a result of which the actual earnings may be much higher than those expected. 2. Efficiency: A corporation may have optimally utilized its assets and enhanced its efficiency its efficiency by exploiting every possibility of modernization and by taking the maximum advantage of market opportunities. 3. Under-estimation of Funds: It may takes place when the total funds required have been under-estimated. 4. Retained Earnings: Because of its conservative dividend policy a corporation may retain the earnings, which might have accumulated into a mass of savings. This is bound to improve its financial health.

5. Windfall Gains: Companies that can afford to continue to operate during the period the period of depreciation may find their earnings are unusually high when they enter the boom period. This shift from an adverse business cycle to a prosperous one may under-capitalize the corporation. 6. Indulgence in rivalry: Under indulgence in rivalries flowing from unusually high earnings may tempt an organization to embark upon speculative activities in the hope that it can easily survive its ill effects; for if speculative activities turn out to be unfavorable, its earlier earnings are likely to be washed away. 7. Taxation: Because of excessive earnings, corporations are exposed to a heavy burden of taxation.

Disadvantages
1. The stock would enjoy a high marker value, but would limit its marketability and may cause wide (though not necessarily relatively wide) fluctuations in market prices. In many cases, this may not be considered a disadvantage. 2. Owing to its limited marketability, the stock may not enjoy as high a market Price as its earnings justify. 3. A high rate of earnings per share may encourage potential competitors to enter the market. 4. In view of the high rate of earnings, employees may become dissatisfied. Dissatisfaction would probably reduce their efficiency and have other undesirable effects. 5. In view of the high rate of earnings, customers may feel they have been over-charged. Except possibly in public utility undertakings, this is not an entirely justifiable point, for competitors might easily enter the field and force reduction in prices. 6. If a company is an extremely large one and virtually controls the industry, its Enormous earnings per share may encourage competitors or the government to bring suit against it under the anti-trust laws. 7. Depending on the nature of excess profit taxes, if any, the company may lose by undercapitalization. EFFECTS 1. Labour Unrest: Employees are often organized and become conscious of the fact that the corporation is making enormous profits. They feel that they have a legitimate right to share in those profits. In other words, they develop the feeling that they are not adequately paid and that the corporation is reluctant to pay what is their legitimate due. This generates a feeling of hostility on the part of the employees, and leads to labour unrest.

2. Consumer Dissatisfaction: Consumers feel that the unusual earnings of the corporation could have been utilized by effecting a price reduction or by improving the quality of the product. 3. Governmental Interference: The Government generally keeps a watchful eye on underestimated. 4. Retained Earnings: Because of its conservative dividend policy a corporation may retain the earnings, which might have accumulated into a mass of savings. This is bound to improve its financial health. 5. Windfall Gains: Companies, which can afford to continue to operate during the period of depreciation, may find their earnings are unusually high when they enter the boom period. This shift from an adverse business cycle to a prosperous one may under-capitalize the corporation. 6. Indulgence in Rivalries: Under indulgence in rivalries flowing from unusually high earnings may tempt an organisation to embark upon speculative activities in the hope that it can easily survive its ill effects; for if speculative activities turn out to be unfavorable, its earlier earnings are likely to be washed away. 7. Taxation: Because of excessive earnings, corporations are exposed to a heavy burden of taxation. 8. Financial need increases: A corporation may have to resort frequently to short-term credit and may even seek additional long-term funds without much notice. 9. Lack adaptability: Adaptability to changed circumstance may be impaired and expansion programmes may slow down. 10. Unnecessary Expansion: Enormous earnings on equity shares may result in an increase in market price, and the company will be tempted to raise new capital. 11. Attracts Competition: The prospect of enormous earnings may generate competition, which may adversely affect the profitability of a corporation. Remedies: Under-capitalization is easily remedied. One or more of the following methods may do it: 1. Stock Split-up: The Corporation may offer the stockholders several shares of new stock for every share of the old. If there is a par value, the par must be reduced to correspond with the increase in the number of shares, for by this method the capital stock account is not affected. With this increase in shares and reduction in par value per share the rate of earnings will not be changed, but the earnings per share will be very substantially decreased. The effect is much more apparent than real, for the capitalization is not increased though the earnings per share are reduced. 2. Increase in Par Value of Stock:

If the surplus is large or can be made large (by revaluing assets upward, or otherwise), the corporation might offer the stockholders new stock for the old, the new stock to carry a higher per value. This would not reduce the earnings per share, but it would reduce the rate of earnings per share. This method, however, is seldom used, partly because it would not improve the marketability factor. If it were desired to go still further, the corporation could offer the stockholders a stock split-up and an increase in par value. This would reduce both the earnings and the rate of earnings per earnings per share value enormously. This method, however, is very radical and is almost never used. 3. Stock Dividend: If the surplus is large or can be made larger, the corporation might declare a dividend payable in stock. This would not affect par value per share, but would increase the capitalization and the number of shares. But the earnings per share and the rate of earnings per share would be reduced. This is probably the most used method and the most easily effected. WATERED STOCK OR CAPITAL When assets of equivalent value do not represent the stock or capital of a company, it is termed as watered stock signifying presence of water in the capital of the company. In simple words, watered capital means that the releasable value of assets of a company is less than its book value. In the words of Hoagland, A stock is said to be watered when its true value is less than its book value. CAUSES OF WATERD STOCK The problem of watered stock generally arises at the time of incorporation of a company but in some cases, it may also arise latter during the life time of the company. The following are the main causes of watered stock situation. Valuing the services of the prompters at unduly high value and paying for their services in the form of stocks. Acquiring of intangible assets such as patents, copyrights, goodwill, etc at high values which later prove worthless Adopting defective depreciation policy WATERED STOCK VS OVER CAPITALSIAITON Watered stock and over capitalizations are not synonymous. There is difference between the two. The situation of watered stock arises usually art the time of incorporation of a company, but it gets over capitalized only when it fails to earn sufficient earnings to justify its funds. Signs of over trading 1. Increase in bank borrowings and loans 2. Increases in stocks 3. Purchase of fixed assets out of short term funds 4. Decline in the working capital ratio 5. Decline in the rate of gross and net profits

6. Low current ratio and very high turn-over ratio Consequences of over trading 1. Inability of the management in paying wages to the employees and taxes to the government 2. Decline in sales and costly purchases 3. Difficulty in raising funds because of poor credit worthiness 4. Problems with debtors and creditors 5. Inability of the management to carry out timely repairs and maintenance resulting in efficient working 6. Lack of funds will compel the company to go in for out dated and old machinery for replacement purpose. Remedies of over trading 1. The company should cut down it business and over spending or it should arrange for more funds 2. Preventing a situation of over trading by taking precautionary steps.

Section A 1. When a true value of the assets of a company is less than its book value, it is termed as ----2. Raising more capital than actual requirement denotes situation of ----3. Excess of current assets over current liabilities is ----------4. Situation where profits earned are exceptionally high, but the capital employed is relatively small ----------5. Company is said to be ------- when its earnings on capital is not upto the industrial average. 6. As per earnings theory of capitalisation, if a companys annual net profit is 200000 and its fair rate of return is 20%, the capitalisation of the company will be RS. ----------7. Capitalisation is an important constituent of --------------8. The 2 theories of capitalisation for new companies are ---------- and ------------ theory 9. Capitalisation means the total amount of ----------- in a business 10. Total amount of capitalisation of a new company is arrived by adding cost of fixed assets, amount of working capital and cost of establishing business is -----------

Section B 1. Write a note on cost theory of capitalisation. 2. State the merits and demerits of earnings theory. 3. Define capitalisation and explain its need. 4. List out the evils of over capitalisation. 5. Describe the term watered capital. 6. What is under capitalisation of a firm? 7. Explain the bases of determining the capitalisation of a firm. 8. Can you explain what earnings theory is? 9. What is over capitalisation? 10. Can you give the remedies for over capitalisation? Section C 1. Explain capitalisation and about the two interpretations. 2. What is over capitalisation and under capitalization. 3. What are the causes of over capitalisation? And how will you rectify. 4. What are the remedial measures do you suggest to overcome the effects of under capitalization. 5. What are the different bases of determining the capitalisation of a firm. 6. What are the advantages and disadvantages of over and under capitalisation. 7. How will you explain on over capitalisation and excess of capital? 8. Can you state some points on effects of under capitalisation? 9. Explain the differences of the cost and earnings theories. 10. Differentiate between over capitalisation and under capitalization.

UNIT IV CAPITAL STRUCTURE Capitalization refers to the total amount of securities issued by a company while capital structure refers to the kinds of securities and the proportionate amounts that make up capitalization. The capital structure is how a firm finances its overall operations and growth by using different sources of funds. The optimum capital structure may be defined as that capital structure or combination of debt and equity that leads to the maximum value of the firm. Capital structure is what describes the relationship of these financing sources as they appear on the corporations balance sheet. It refers to all the financial resources organized by the firm, short as well as long term, and all forms of debt as well as equity.

Depending on how complex the structure, there may in fact be dozens of financing sources included, drawing on funds from a variety of entities in order to generate the complete financing package. For raising long term finances, a company can issue three types of securities viz., Equity shares, Preference shares and debentures. A decision about the proportion among these types of securities refers to the capital structure of an enterprise. Forms/ Patterns of Capital Structure: The capital structure of a new company may consist of nay of the following forms a. Equity Shares only b. Equity and preference shares c. Equity shares and debentures d. Equity shares, preference shares and debentures.

THEORIES OF CAPITAL STRUCTURE: Net Income Approach: A firm can minimize the weighted average cost of capital and increase the value of the firm as well as the market price of equity shares by using debt finance to the maximum possible extent. The total market value of a firm on the basis of Net Income Approach Can be ascertained as below: V=S+D V = Total market value of a firm S = Market value of equity shares D = Market value of debt Net Operating Income Approach: It is opposite to the net income approach. According to this approach change in the capital structure of accompany does not affect the market value of the firm and the overall cost of capital remains constant irrespective of the method of financing This theory presumes that The market capitalizes the value of the firm as w whole The business risk remains constant at every level of debt equity mix. There are no corporate taxes Traditional approach: It is also known as intermediate approach. A proper debt-equity mix can reach optimum capital structure. Beyond a particular point, the cost of equity increases because increased debt increases the financial risk of the equity shareholders. The overall cost of capital decreases up to ca certain point, remains unchanged for moderate increase in debt thereafter and increases or rises beyond a certain point. Even the cost of debt may increase at this stage due to increases financial risk. Factors determining the capital structure:

a. Financial leverage or Trading on equity: The use of long term fixed interest bearing debt and preference share capital along with equity share capital is called financial leverage or trading on equity. b. Growth and stability of sales: The capital structure is influenced by the sales. If the sales is high, the firm can use the debt more for financing the firm. c. Cost of capital: Cost of capital refers to the minimum return expected by its suppliers. The capital structure should provide for the minimum cost of capital. The return expected by the suppliers of capital depends upon the risk they have to undertake. the main sources of finance for a firm are equity, preference share capital and debt capita.. While formulating a capital structure, effort must be made to minimize the overall cost of capital. d. Cash flow ability to service debt: If the firm has good cash flow I t can choose more debt in its capital structure. Whenever a firm wants to raise additional funds, it should estimate, project its future cash inflows to ensure the coverage of fixed charges. e. Nature and size of the firm: Nature and size of the firm also influences the capital structure. Public utility concerns may employ more of debt because of stability and regularity of their earnings. On the other hand, concern that cannot provide stable earnings due to the nature of its business will have to rely mainly on equity capital. Small companies have to depend mainly upon owned capital, as it is very difficult for them to raise l9ong term loans on reasonable terms and also cannot issue equity and preference shares to the public f. Control: The management should raise the funds without loosing the control. If the funds are raised through the issue of equity shares, the control is diluted. Preference shareholders and debenture holders do not have the voting right. And hence it may be recommended. But it would cause heavy burden to the company. g. Flexibility: Capital structure should be in such a way that it must be capable of being adjusted according to the needs of the changing conditions. h. Requirements of investors. Requirements of the investors should also be considered. Bold investors may prefer equity capital while the conservative investors prefer debt and preference capital. i. Capital market conditions:

The choice of the securities are influenced by the market conditions such as depression and , boom etc. the company shall not issue equity shares during depression and may issue them at boom. j. Assets structure The liquidity and the composition of assets should also be kept in mind while selecting he capital structure. k. Purpose of financing. If funds are required for productive purpose, debt financing shall be suitable and if the funds are required for general development of unproductive purpose, equity capital shall be preferred. l. Period of Finance: If funds are needed for permanent basis, equity capital shall be used and if it is for a limited period, best financing or preference capital may be preferred m. Cost of flotation: Cost of floatation of debt is generally less than the cost of floatation of equity capital. n. Personal consideration: Personal considerations and abilities of the management will have impact on the capital structure of the firm. O. Corporate tax rate: High corporate taxes on profits may compel the companies to prefer debt financing, because interest is allowed to be deducted while computing taxable profits. On the other hand dividend of shares is not an allowable expense for that purpose. P. Legal requirements: The legal restrictions are very significant as these lay down a framework within which capital structure decision has to be made. The reasons for necessitating changes in capitalization are To restore balance in the Financial plan To simplify the capital structure To suit investor needs To fund current liabilities To write off the debt To capitalize the retained earnings To clear default of fixed cost securities To fund accumulated dividends To facilitate merger and expansion To meet legal requirements TRADING ON EQUITY

In finance, equity trading is the buying and selling of company stock shares. Borrowing funds to increase capital investment with the hope that the business will be able to generate returns in excess of the interest charges. Equity trading can be performed by the owner of the shares, or by an agent authorized to buy and sell on behalf of the share's owner. Proprietary trading is buying and selling for the trader's own profit or loss. In this case, the principal is the owner of the shares. Trading on equity occurs when a corporation uses bonds, other debt, and preferred stock to increase its earnings on common stock. For example, a corporation might use long term debt to purchase assets that are expected to earn more than the interest on the debt. The earnings in excess of the interest expense on the new debt will increase the earnings of the corporations common stockholders. The increase in earnings indicates that the corporation was successful in trading on equity. Shares in large publicly traded companies are bought and sold through one of the major stock exchanges, such as the New York Stock Exchange, London Stock Exchange or Bombay Stock Exchange, which serve as managed auctions for stock trades. Stock shares in smaller public companies are bought and sold in over-the-counter (OTC) markets. COST OF CAPITAL Capital: Financial capital represents obligations, and is liquidated as money for trade, and owned by legal entities. It is in the form of capital assets, traded in financial markets. Its market value is not based on the historical accumulation of money invested but on the perception by the market of its expected revenues and of the risk entailed. Capital accumulation in classical economic theory is the production of increased capital. In order to invest, goods must be produced which are not to be immediately consumed, but instead used to produce other goods as a means of production. Capital (money) used for funding a business should earn returns for the capital providers who risk their capital. For an investment to be worthwhile, the expected return on capital must be greater than the cost of capital. In other words, the ''risk-adjusted'' return on capital (that is, incorporating not just the projected returns, but the probabilities of those projections) must be higher than the cost of capital. Measuring Cost of Capital It will depend upon: The components of financing: Debt, Equity or Preferred stock The cost of each component Significance of the cost of capital:

The cost of capital is a term used in the field of financial investment to refer to the cost of a company's funds (both debt and equity), or, from an investor's point of view "the shareholder's required return on a portfolio company's existing securities".[1] It is used to evaluate new projects of a company as it is the minimum return that investors expect for providing capital to the company, thus setting a benchmark that a new project has to meet. 1. Evaluating investment decisions The primary purpose of measuring the cost of capital is its use as a financial standard for evaluating the investment projects. Using NPV method or IRR method, a project may be accepted or rejected. It may be noted that the cost of capital represents a financial standard for allocating the firms funds, supplied by owners and creditors, to the various investment projects in the most efficient manner. 2. Designing Debt policy: The debt policy of a firm is significantly influenced by the cost consideration. In designing the capital structure, the firm aims at maximizing the firm value by minimizing the overall cost of capital. The cost of capital can also be useful in deciding about the methods of financing at a point of time. For eg., cost may be compared in choosing between leasing and borrowing. 3. Performance Appraisal: The cost of capital framework can be used to evaluate the financial performance of top management. Such an evaluation will involve a comparison of actual profitability of the investment projects undertaken by the firm with the projected overall cost of capital and the appraisal of the actual costs incurred by management in raising the required funds. Concept of Cost of Capital Capital refers to the funds invested in a business. The capital can come from different sources such as equity shares, preference shares, and debt. All capital has a cost. However, it varies from one sources of capital to another, from one company to another and from one period of time to another. Cost of capital may be defined as the company's cost of collecting funds. This is equal to the average rate of return that an investor in a company will expect for providing funds. It is the minimum rate of return that the project must earn to keep the value of the company intact. The minimum rate of return is equal to cost of capital. The cost of capital in always expressed in terms of percentage. Proper allowance is made for tax purposes. This is done to get a correct picture of the cost of capital. The cost of capital is a guideline for determining the optimum capital structure of a company. Calculation of Cost of Capital In order to calculate the overall cost of capital, a finance manager has to take the following steps:-

1. Determine the type of funds to be raised and their share in the capital structure. 2. Determine cost of each type of funds. 3. Calculate combined cost of capital of the company by giving weights to each type of funds in terms of proportion of funds raised to total funds. CALCULATION OF INDIVIDUAL AND COMPOSITE COST / weighted average cost of capital OF CAPITAL. MEANING: The term Cost of Capital refers to the over-all composite cost of capital. It is defined as the Weighted Average Cost of Capital (WACC). The percentage or proportion of various sources of finance used by a company is different. A company's cost to borrow money given the proportional amounts of each type of debt and equity a company has taken on. A company's debt and equity, or its capital structure, typically includes common stock, preferred stock and bonds. A high composite cost of capital, indicates that a company has high borrowing costs; a low composite cost of capital signifies low borrowing costs. Also referred to as "weighted average cost of capital" or WACC. Each of these components is given weightage on the basis of the associated interest rate and other gains and losses with it. It shows the cost of each additional capital as against the average cost of total capital raised. The process to compute this is first computing the weighted average cost of capital which is the collection of weights of other costs summed together. In this the cost of debt is calculated in the beginning and it is used to find out the cost of capital and other weights of cost is been calculated after the calculation each and every individual weight of the component is added and then it gives the final composite cost.. DEFINITION: Weighted average of the component costs of common stock (ordinary shares), preferred stock (preference shares), and debt. Each component of capital is given a relative importance (weight) on the basis of its associated interest rate, management's loss of control, risk exposure, etc., to compute weighted average cost of capital. It shows the cost of each additional dollar of capital, as opposed to the average cost of the total capital raised. Factors affecting Weighted Average Cost of Capital: 1. Factors outside a firms control: a. Interest rate levels b. Market risk premium c. Tax rates

2. Factors within a firms control: a. Investment policy b. Capital structure policy c. Dividend policy Essential features of a sound capital mix: Maximum possible use of leverage Flexible capital structure Avoid undue financial or business risk with the increase of debt Use of debt should be within the capacity of the firm Should involve minimum possible risk of loss of control Must avoid undue restrictions in agreement of debt.

Calculation of WACC for a company with a complex capital structure: The formula for a simple case is E C= K Where K= D+E c =weighted average cost of capital y =required or expected rate of return on equity, or cost of equity b=required or expected rate of return on borrowings, or cost of debt t=corporate tax rate D=total debt and leases (including current portion of long-term debt and notes payable) E=total market value of equity K=total capital invested in the going concern This equation describes only the situation with homogeneous equity and debt. If part of the capital consists, for example, of preferred stock (with different cost of equity y), then the formula would include an additional term for each additional source of capital. Since we are measuring expected cost of new capital, we should use the market values of the components, rather than their book values (which can be significantly different). In addition, other, more "exotic" sources of financing, such as convertible/callable bonds, convertible preferred stock, etc., would normally be included in the formula if they exist in any significant amounts - since the cost of those financing methods is usually different from the plain vanilla bonds and equity due to their extra features. Factors influence a companys composite WACC Market conditions. .Y + K D .b (1-tc)

The firms capital structure and dividend policy. The firms investment policy. Firms with riskier projects generally have a higher WACC.

To calculate the Cost of Capital The cost of capital is simply a weighted average of the cost of the individual sources (i.e., bonds, preferred stock, retained earnings, and sale of new common stock). For example, assume that you raise 40% of your money in the form of debt, 20% in preferred stock, and 40% in common equity. Few details for calculating the cost of each component. Cost of Debt Debt is special in the sense that its interest payments are tax-deductible. While this is a good thing, it does present a problem when comparing its cost with the cost of the other components, whose costs are not tax-deductible. Cost of Preferred Stock The cost of money raised by selling preferred stock is, generically, the dollar cost divided by the amount of money raised. Cost of Retained Earnings Stockholders let the companys management keep some of the earnings and reinvest them back into the company (rather than paying it to them in the form of dividends). This does not mean that these retained earnings are free however the stockholders still expect to earn a rate of return on the companys investment of this money. The rate of return that the company must earn on the investment of this money (in order to keep the shareholders happy) is called the cost of retained earnings. Cost of New Equity The cost of raising money through the sale of new common stock is the same as the cost of retained earnings, with one exception: flotation costs. Money earned in the companys operations (i.e., retained earnings) is readily available with paying any outside agency; money raised from outside the company often comes with commissions and fees (i.e., flotation fees) attached. Weighted Marginal Cost of Capital Assume that Genuine Products, Inc. is raising money for expansion of its operation. It has part of the money already set aside in the form of cash from this year's addition to retained earnings. In order to stay at its optimal capital structure, it has decided to raise the money in the following proportions: 40% debt, 10% preferred stock, 20% retained earnings, and 30% from the sale of new common stock. Section A 1. The term ------- refers to all financial sources sought by company. 2. Concepts of ---------- is very useful in capital budgeting decisions.

3. Cost of capital serves as --------------- rate for capital investment decisions. 4. Ratio of debt equity mix is called -------5. Cost of capital compromises both business risk and ----------6. Interest Net proceeds = -------------7. Under net income approach, there will be an assumption of -----8. ------- is the permanent financing of the company represented primarily by long term debt and shareholders funds. 9. The optimum capital structure is obtained when the met value per equity share is the maximum. True / False. 10. ------- is when the companys rate of return on total capital employed is more than the rate of interest/ dividend on debenture/preference shares. 11. Cost of capital is the minimum rate of return that will maintain the value of a firms ----------12. Tradig on equity is beneficial only for the companies which have ------- in their earnings 13. There is no need for calculating separate cost for retained earnings when cost of equity capital is calculated on basis of ------------ of equity shares. 14. Cost of capital compromises both business and ------------ risks. 15. Determination of a firms cost of capital is important from the point of view of both -------------- as well as ------------ planning decisions. Section B 1. State the importance of capital structure. 2. Explain the concept of cost of capital. 3. What are the essentials of a sound capital structure. 4. What are the components of cost of capital. 5. List out the principles of capital structure. 6. Factors determining cost of capital. 7. What are the patterns of capital structure. 8. State the capital structure theories. 9. What is meant by explicit and real cost of capital. 10. Why should a company aim at balanced capital structure? 11. What are the qualities of a capital structure management. 12. What do you mean by trading-on-equity? 13. What is trading on equity of capital structure. 14. State the classifications of cost of capital. 15. What is the meaning of capital structure and financial structure in detail. Section C 1. Discuss on what capital structure management is? 2. What are the various forms of capital structure? 3. State the approaches for computing the cost of equity of capital. Explain 4. What is cost of capital and state the importance? 5. What are the internal and external factors influencing capital structure? 6. What are the characters of a balanced capital structure? 7. What do you understand by capital structure of a corporation? Discuss the qualities which a sound capital structure should possess

8. What are the theories of capital structure? 9. What is individual and composite cost of capital. 10. Define the concept of cost of capital. How will you determine the weighted average cost of capital of a firm? 11. How would you calculate the individual cost with composite cost of capital. 12. What are the principles involved in capital structure? 13. Brief on cost of capital theory. 14. Discuss on the important approaches to the different theories of capital structure. 15. The capital structure and after tax cost of different sources of funds are given below: Compute the weighted average cost of capital. Sources of funds Amount Proportion to total After tax cost % a. Equity capital 72,000 0.30 15 b. Retained earnings 60,000 0.25 14 c. Preference capital 48,000 0.20 10 d. Debentures 60,000 0.25 8

Unit V Sources and Forms of Finance: Equity Shares, Preference Shares, Bonds, Debentures and Fixed Deposits Features Advantages and Disadvantages-Lease Financing: Meaning Features Forms Merits and Demerits. SOURCES AND FORMS OF FINANCE In our present day economy, finance is defined as the provision of money at the time when it is required, without adequate finances, no enterprises can possibly accomplishes its objectives. Capital required for a business can be classified under two categories, 1. Fixed capital 2. Working capital Every business needs funds for 2 purposes- for its establishment and to carry out its day-to-day operations. Long-term funds required creating production facilities through purchases of fixed assets. Investment in these assets represents that part of firms capital that is blocked on a permanent or fixed basis and it is called fixed capital. Funds are also needed for short-term purposes for the purchase of raw materials, payment of wages and other day-to-day expenses, etc. these funds are known as working capital. The various sources of finance have been classified in many ways, such as: 1. According to period a. Short term sources- bank credit, customer advances, trade credit, factoring, accruals, commercial paper, etc b. Medium term sources-issue of preference shares, debentures, bank loans, public deposits, fixed deposits, etc c. Long term sources-issue of shares, debentures, plugging back of profits, loans from specialized financial institutions, etc. FINANCIAL REQUIREMENTS

SHORT TERM

MEDIUM TERM

LONG TERM

Bank Credit Customer Advances Trade Credit Factoring Accruals Deferred Incomes Commercial Paper 2.Instalment Credit According to ownership

Issue of Debentures Issue of Preference Shares Bank Loans Public Deposits / Fixed Deposits Loans From Financial Institutions

Issue of Shares Issue of Debentures Ploughing-Back of Profits Loans From Specialized Financial Institutions

a. Owned capital-share capital, retained earnings, profit and surplus, etc b. Borrowed capital such as debentures, bonds, public deposits,loans,etc 3. According to sources of finance a. Internal sources such as plugging back of profits, retained earnings, profits, surpluses and depreciation funds, etc. b. External sources- shares, debentures, public deposits, loans, etc 4. According to mode of financing a. Security financing or external financing- financing through rising of corporate securities such as shares, debentures, etc b. Internal financing-m financing through retained earnings, capitalization of profits and depreciation of finds, etc c. Loan financing through rising of long term and short term loans. I. Security financing: Corporate securities can be classified under two broad categories: Ownership securities or Capital stock Creditorship securities or Debt capital CLASSIFICATION OF CORPORATE SECURITIES

OWNERSHIP SECURITIES

CREDITORSHIP SECURITIES

DEBENTURES

ORDINARY OR EQUITY SHARES

PREFERENCE SHARES

NO PAR STOCK

DEFERRED SHARES

OWNERSHIP SECURITIES 1. Equity shares: Equity shares also known as ordinary share or common shares represent the owners capital in a company. Then holders of these shares are real owners of the company. They have a control over the working of the company. Equity shareholders are paid dividend after paying it to the preference shareholders. These shareholders take a more risk as compared to preference shareholders. Equity share capital is paid after meeting all other claims including that of

preference shareholders. They take risk both regarding dividend and return of capital. Equity share capital cannot be redeemed during the lifetime of the company. Advantages of equity shares 1. Equity shares do not create any obligations to pay a fixed rate of dividend 2. Equity shares can be issued without creating any charge over the assets of the company 3. It is a permanent source of capital and the company has not to repay it expect under liquidation 4. Equity shareholders are the real owners of the company who have the voting rights 5. In case of profits, equity share ho9lders are the real gainers by way of increased dividends and appreciation in the value of shares. Disadvantages of equity shares 1. If only equity shares are issued, the company cannot take the advantage of trading on equity 2. As equity capital cannot be redeemed there is a danger of over capitalization. 3. Equity shareholders can put obstacles in management by manipulation and organization themselves 4. During prosperous periods higher dividends have to be paid leading to increase in the value of shares in the market and speculation 5. Investors who desire to invest in safe securities with a fixed income have no attraction for such shares. 2. Preference shares: As the name suggests, these shares have certain preference as compared to other types of shares. These shares are given two preferences. There is a preference for the payment of dividend. Whenever the company has distributable profits, the dividend is first paid on preference share capital. The second preference is that the repayment of capital at the time of liquidation of company. After paying outside creditors, preference share capital is returned. Preferences share holders so no have voting rights; however they can vote if their own interest is affected. Types of preference shares 1. Cumulative preference shares 2. Non cumulative preference shares 3. Redeemable preference shares 4. Irredeemable preference shares 5. Participating preference shares 6. Non participating preference shares 7. Convertible preference shares 8. Non convertible preference shares Advantages of preference shares To companys point of view: 1. There is no legal obligation to pay dividend on preferences shares 2. Preference shares provide long term capital for the company

3. There is no liability of the company to redeem preference shares during the life time of the company 4. Preference share capital as regarded as the part of companys net worth, it enhances the credit worthiness of the company. To share holders point of view: 1. It earns fixed rate of dividend 2. It is a superior security over equity shares 3. It provides preferential right in regard to payment of dividends an repayment of capital on time 3. DEBENTURES or bonds: A company may raise long-term finance through public borrowings. The issue of debentures raises these loans. A debenture is an acknowledge of debt. According to Thomas Evelyns, the debenture is a document under the companys seal which provides for the payment of a principle sum and interest thereon at regular intervals, which is usually secured by a fixed or floating charge on the companys property or undertaking and which acknowledges a loan to the company. A debentures holder is a creditor of the company. A fixed rate of interest is paid on debentures. When the debentures are secured they are paid on priority in comparison to all other creditors. Types of debentures 1. Simple, naked or unsecured debentures 2. Secured or mortgaged debentures 3. Bearer debentures 4. Registered debentures 5. Redeemable debentures 6. Irredeemable debentures 7. Convertible debentures 8. Zero interest bonds/debentures 9. First and second debentures 10. Guaranteed debentures Importance of debentures as a source of finance 1. Debentures provide long-term funds to the company 2. The rate of interest payable on debentures is usually; lower than the rate of dividend paid on shares. 3. The interest on debentures is a tax deductable expense 4. Debentures provide flexibility in the capital structure of a company 5. Debentures provide a fixed, regular and stable source of income 6. A debenture is usually more liquid investment. II. Internal financing 1. Retained earnings or plugging back of profits. 2. Depreciation as a source of finance. 1. Retained earnings or plugging back of profits

It is a technique of financial management under which all profits of a company are not distributed amongst the share holders as dividend, but a part of the profits is retained or reinvested in the company. This processes of retained profits year after year and their utilization in the business is also known as ploughing back of profits. Under this method a part of total profits is transferred to various reserves such as general reserve, REPLACEMENT fund, reserve fund, reserve for repairs and renewals, etc.. Sometimes secret reserves are also created without the knowledge of the shareholders. Merits of ploughing back of profits: A. Advantage to company: 1. A cushion to absorb the stocks of economy 2. Economical method of financing 3. Aids in smooth and undisturbed running of the business 4. Helps on following stable dividend policy 5. Flexible financial structures 6. Makes the company self-dependent or no dependent ion fair weather friends 7. Helps in making food the deficiencies of depreciation, etc. 8. Enables to redeem long-term liabilities B. Advantages to the shareholders: 1. Increase in the value of shares 2. Safety of investments 3. Enhanced earning capacity 4. No dilution of control C. Advantages to the society or Nation 1. Increase the rate of capital formation 2. Stimulates industrialization 3. Increases productivity 4. Decreases the rate of industrial failure 5. Higher standard of living Limitations of ploughing back of profits: 1. over capitalization 2. Creation of monopolists 3. Depriving the freedom of the investors 4. Misuse of retrained earnings 5. Manipulation in the value of shares 6. Evasion of taxes 7. Dissatisfaction among the share holders 2. DEPRECIATION AS A SOURCE OF FINANCE Depreciation may be regarded as the capital cost of assets allocated over life of the assets. In real sense, depreciation is simply a book entry having the effect of reducing the book value of the assets and the profits of t eh current year for the same amount. It does not affect the current assets or current liabilities and does not result in the flow of funds or to say more precisely it is a not a fund item. Hence although depreciation is an operating cost there is no actual outflow of cash and so the amount of depreciation charged during the year is added back to profits while

finding funds form operations. it is in the sense that depreciation can be regarded as a indirect sources of funds. In case a concern earns a huge profits and excessive depreciation is permitted under income tax act is charged to profit and loss account, it is still result in the generation of funds through savings in the payment of dividends. III. SHORT TERM LOANS AND CREDITS The third important mode of financing is raising both 1. Short-term loans and credits 2. Term loans including medium and short-term loans. These sources of finance have been discussed in the following pages of this chapter. A firm raises the short-term loans and credits or meeting its working capital requirements, these include 1. Indigenous bankers Private money leaders and other country bankers used to be only sources of finance prior tom the establishment of commercial banks. They used to charge very high rates of interest and exploited the customers to larger extent. But even today, some business houses have to depend on Indigenous bankers for obtaining loans to meet their working capital requirements. 2. Trade credit Trade credit refers to the credit extended by the suppliers of goods in the normal course of business. The credit worthiness sofa firm and the confidence of tits suppliers are the main basis of securing trade credit. It is mostly granted on an open account basis whereby supplier sends goods to the buyer for the payment to be received in future as per the terms of sales invoice. It may also take the form of bills payable whereby the buyer the buyer signs the bills of exchange payable on a specified future date. 3. Installment credit The assets are purchased and the possession of goods is taken immediately but the payment is made in installments over a pre determined period of time. Generally interest is charged on the unpaid amount or it may be adjusted in the price. But in any case, the provided funds for sometimes and is used as a sources of short term working capital by many business houses which have difficult funds position. 4. Advances Some business houses grant advances from their customers and agents against orders and this source is a short term sources of finance for them. It is cheap source especially for the firms manufacturing industrial products prefer to advance from their customers. 5. Account receivable credit or factoring A factor is financial institution which offers services relating to, management and financing of debts arising out of credit sales. Factoring is recombining popular all over the world on account of various services offered by the institutions engaged in it. 6. Accrued expenses

Accrued expenses are the expenses which have been incurred but not yet due and hence not yet paid also. The most popular items of accruals are wages, salaries, interest and taxes. Even income taxes are paid after collection and in the intervening period serve as a good source of finance. 7. Deferred incomes Deferred incomes are incomes received in advance before supplying goods and Services, they represent funds received by a firm for which it has to supply goods or services in future. These funds increase the liquidity of a firm and constitute an important source of short term finance. 8. Commercial paper Commercial paper represents unsecured promissory notes issued by the firms to raise short term fund s. it is an important money market instrument in advanced countries like USA. In India, the RBI introduced commercial papers in the Indian money market on the recommendations of the working group on Money market (Vaghul committee). The maturity period for commercial paper, in India is 91 to 180 days. It is sold at discount from its face value and redeemed at face value n its maturity. A credit rating agency, called CRISIL, has been setup in India by ICCCI and UTI to rate commercial papers. 9. Commercial banks Commercial banks are the most important sources of short term capital. They provide a wide variety of loans and advances follows; a. Loans b. Cash credits c. Overdrafts d. Purchasing and discounting bills In addition to the above-mentioned form of direct finance, commercial banks help their customers in obtaining credit from their suppliers through the letter of credit arrangement.

Letter of creditIt helps the customers tom obtain credit from the suppliers because it ensures that there is no risk of nonpayment .L/C is a simple guarantee by the bank to the suppliers that their bills up to a specified amount would be honored, in case the customer fails to [pay the amount ion the due date, to its suppliers, the banks assumes the liability of its customers for the purchase made under the letter of credit arrangement. The letter of credit may be of many forms, such as 1. Clean letter of credit 2. Documentary letter of credit 3. Revocable letter of credit 4. Irrevocable letter of credit 5. Revolving letter of credit 6. Fixed letter of credit The most important modes of the security required in bank finance are 1. Hyphothecation

2. Pledge 3. Mortgage 10. Public deposits. The public sector(Government companies) have also started accepting public deposits since June 1980.Acceptance of public deposits by corporate sector, in many cases, has been found to encourage non priority sectors of production and defeat the very purpose of the restrictive credit policy of the RBI. TERM LOANS In our country there are two major sources of term lending are 1. Specialized financial institutions At present there are four major financial institutions at national level a. Industrial finance corporation of India IFCI b. Industrial development bank of India IDBI c. Industrial credit and investment corporation of India ICICI d. Industrial reconstructions corporation of India IRCI e. State financial corporations SFCs and f. State industrial development investment corporations 2. Commercial banks 3. Industrial cooperatives 4. Unit trust of India 5. Life insurance corporation 6. National industrial development corporations Also provide finance for the development of industries in the country. There are some international financing institutions like WORLD BANK and its affiliates such as international bank for reconstruction and development IBRD, international development association IDA, international finance corporation IFC and Asian development bank ADB. All these institutions also provide industrial finance through member countries while others directly to the enterprises. The help rendered by all such institutions has accelerated the pace of industrialization.

Industrial Finance Corporation of India (IFCI)


IFCI Ltd. was set up in 1948 as Industrial Finance Corporation of India, a Statutory Corporation to provide medium and long term finance to industry. After repeal of IFCI Act in 1993, IFCI became a Public Limited Company registered under the Companies Act, 1956. IFCI is now a Government controlled company subsequent to enhancement of equity shareholding to 55.53% by Government of India on December 21, 2012. IFCI is also registered with Reserve Bank of India (RBI) as a systemically important non-deposit taking Non-Banking Finance Company (NBFC-ND-SI). The primary business of IFCI is to provide medium to long term financial assistance to the manufacturing, services and infrastructure sectors. Through its subsidiaries and associate organisations, IFCI has diversified into a range of other businesses including broking, venture capital, financial advisory, depository services, factoring etc. As part of its development

mandate, IFCI was one of the promoters of National Stock Exchange (NSE), Stock Holding Corporation of India Ltd (SHCIL), Technical Consultancy Organizations (TCOs) and social sector institutions like Rashtriya Gramin Vikas Nidhi (RGVN), Management Development Institute (MDI) and Institute of Leadership Development (ILD). In order to promote entrepreneurship among the scheduled castes and to provide concessional finance to them, IFCI has been entrusted with the setting up of a Venture Capital Fund by IFCI for Scheduled Castes in the Interim Budget for FY 2014-15. The Fund would have an initial capital of Rs. 200 crore, which can be supplemented every year.

Functions of IFCI
1) For setting up a new industrial undertaking. 2) For expansion and diversification of existing industrial undertaking. 3) For renovation and modernization of existing concerns. 4) For meeting the working capital requirements of industrial concerns in some exceptional cases. 5) Direct financial support (by way of rupee term loans as well as foreign currency loans) to industrial units for under taking new projects, expansion, modernization, diversification etc. 6) Subscription and underwriting of public issues of shares and debentures. 7) Guaranteeing of foreign currency loans and also deferred payment guarantees. 8) Merchant banking, leasing and equipment finance. 9)Provides financial assistance towards balance regional development and development of management education in the country Financial Resources The main financial resources of Industrial Finance Corporation of India Ltd. are as follows:

Share Capital: The authorized capital of the corporation is Rs. 1,000 corers divided into 2 lakhs shares of Rs. 5,000 each. Its paid-up capital on 31st March, 1997 was Rs. 352.81 crores. Debentures: The corporation is also authorized to issue debentures and bonds. But their total amount should not exceed ten times of its paid-up share capital plus reserve funds. Loans: The Corporation has the power to borrow funds (loans) from Industrial Development Bank of India. Foreign investment Institutions, Central Government and Reserve Bank of India. Public Deposits: The Corporation can accept public deposits for a maximum period of five years. Further, the amount of public deposits cannot exceed Rs. 10 crores. Reserve Fund: It is another sources of finance of the Corporation.

Foreign Currency Loans: The Corporation can also accept loans in foreign currency with the prior approval of the central government, such as, loans from International Bank and other International Financial Institutions.

Critical Evaluation Although the Corporation has been an important source of long-term finance to the large-sized and medium-sized industrial units of the country, yet it has been criticized on several grounds. The main points of criticism are as follows:

Nepotism and favoritism in granting loans. Undue preference to well-established large business concerns. Overlooking interests of small business and development of backward regions almost ignored. Granting loans to business unit not covered by Five year Plans. Very high interest rate. Delay in sanctioning loans. No participation in equity capital. Most of the loans sanctioned to those industrial units which are already organized and financially strong. Lays greater emphasis upon giving assistance to consumer goods industries as against basic and capital goods industries. The corporation has failed in regional and territorial economic development. The assistance is insignificant as compared to the requirements of the industrial unit and hence it has knocked at the doors of other financial institutions. The recurring expenses of the corporation are quite high.

INDUSTRIAL CREDIT AND INVESTMENT CORPORATION OF INDIA LIMITED (ICICI)


Industrial Credit and Investment Corporation of India Limited (ICICI) was established in 1955 as public limited company to encourage and assist industrial units in the country. Its objectives, inter alia, include providing assistance in the creation, expansion and modernisation of industrial enterprises, encouraging and promoting participation of private capital both internal and external, in such enterprises, encouraging and promoting industrial development and helping development of capital markets.It provides term loans in Indian and foreign currencies, underwrites issues of shares and debentures, makes direct subscriptions to these issues and guarantees payment of credit made by others.
Broad objectives of the ICICI are:

(a) to assist in the creation, expansion and modernisation of private concerns; (b) to encourage the participation of internal and external capital in the private concerns; (c) to encourage private ownership of industrial investment.

Functions of the ICICI

(i) It provides long-term and medium-term loans in rupees and foreign currencies. (ii) It participates L* the equity capital of the industrial concerns. (iii) It underwrites new issues of shares and debentures. (iv) It guarantees loans raised by private concerns from other sources. (v) It provides technical,managerial and administrative assistance to industrial concerns.
Capital Initially:

The Corporation started with the authorised capital of Rs. 25 crore. At the end of June 1986, the authorised capital was Rs. 100 crore and the paid-up capital was 49.5 crore. Various sources of financial resources of the Corporation are Indian banks, insurance companies and foreign institutions, including the world Bank, and the public. The government and the IDBI have also provided loans to the Corporation.
Financial Assistance:

The performance of the ICICI in the field of financial assistance provided to the industrial concerns has been quite satisfactory. Over the years, the assistance sanctioned by the Corporation has grown from Rs.14.8 crore in 1961-62 to Rs. 43.0 crore in 1970-71 and Rs. 36229 crore in 2001-02. Similarly the amount disbursed has increased from Rs.8.6 crore in 196162 to Rs.29.8 crore in 1970-71 and to Rs. 25831 in 2001-02. Cumulatively, at the end of March 1996, the ICICI has sanctioned and disbursed financial assistance aggregating Rs. 66169 crore and Rs. 36591 crore respectively.
Features of ICICI

The important features of the functioning of the ICICI arc as given below: (i) The financial assistance as provided by the ICICI includes rupee loans, foreign currency loans, guarantees, underwriting of shares and debentures, and direct subscription to shares and debentures. (ii) Originally, the ICICI was established to provide financial assistance to industrial concerns in the private sector. But, recently, its scope has been widened by including industrial concerns in the public, joint and cooperative sectors. (iii) ICICI has been providing special attention to financing riskier and non-traditional industries, such as chemicals, petrochemicals, heavy engineering and metal products. These four categories of industries have accounted for more than half of the total assistance.

(iv) Of late, the ICICI has also been providing assistance to the small scale industries and the projects in backward areas. (v) Along with other financial institutions, the ICICI has actively participated in conducting surveys to examine industrial potential in various states. (vi) In 1977, the ICICI promoted the Housing Development Finance Corporation Ltd. to grant term loans for the construction and purchase of residential houses. (vii) Since 1983, the ICICI has been providing leasing assistance for computerisation, modernisation and replacement schemes; for energy conservate; for export orientation; for pollution controller balancing and expansion: etc. (viii) The ICICI has not contributed much to reduce regional disparities. About three-fifth of the total assistance given by the ICICI has been received by the advanced states of Maharashtra, Gujrat and Tamil Nadu. (ix) With effect from April 1, 1996, Shipping Credit and Investment company of India ltd, (SCICI) was merged with ICICI. (x) The ICICI Ltd. was merged with ICICI Bank Ltd. effective from May 3, 2002.

State Financial Corporations (SFCs)


The State-level financial institutions are the one which play a crucial role in the development of small and medium enterprises in the concerned States. They provide financial assistance in the form of term loans, direct subscription to equity/ debentures, guarantees, discounting of bills of exchange and seed/ special capital, etc. A Central Industrial Finance corporation was set up under the industrial Financecorporations Act, 1948 in order to provide medium and long term credit to industrialundertakings which fall outside normal activities of commercial banks.The State governments expressed their desire that similar corporations be set up in states tosupplement the work of the Industrial financial corporation. State governments alsoexpressed that the State corporations be established under a special statue in order to make it possible to incorporate in the constitutions necessary provisions in regard to majority control by the government, guaranteed by the State government in regard to the payment principal.In order to implement the views Expressed by the State governments the State FinancialCorporation bill was introduced in the Parliament. Statement of objects and reasons In order to provide medium and long term credit to industrial undertaking, which falloutside the normal activities of commercial banks, a central industrial finance corporationwas set up under the industrial Finance Corporations act, 1948.The state governments wished that similar corporations should be set up in their states tosupplement the work of industrial financial corporation.The intention is that the State corporations will confine to financing medium and smallscale industrial and will , as far as possible consider only such access which are outside the perview of industrial fianc corporation .The main features of the State financial Corporations Act 1951:i.The bill provides that the state government may, by notification in the

officialgazette, establish a financial corporation for the state.ii.The share capital shall be fixed by the State government but shall not exceed Rs 2crores . The issue of the shares to the public will be limited to 25 % of the sharecapital and the rest will be held by the State Governments, The Reserve Bank,Scheduled Banks, Insurance Companies, Investment Trusts, Co- operative banks andother financial institutions.iii.Shares of the corporation will be guaranteed by the Sate government as to the re payment of principal and the payment of a minimum dividend to be prescribed inconsultation with the central government.iv.The corporation will be authorized to issue bonds and debentures for amounts whichtogether with the contingent liabilities of the corporations shall not exceed five times the amount of the paid up share capital and the reserve fund of thecorporations. These bonds and debentures will be guaranteed as to payment of the principal and payment of interest at such rate as may be fixed by the Stategovernment.v.The corporation may accept deposits from the public repayable after not less thanfive years, subject to the maximum not exceeding the paid up capital.vi.The corporation will be managed by a board consisting of a majority of Directorsnominated by the Sate governments , The Reserve banks and the industrial Finance corporation of India

vii. The corporation will be authorized to make long term loans to industrial concernswhich are repayable within a period not exceeding 25 years. The Corporation will befurther authorized to underwrite the issue of stocks, shares, bonds or debentures byindustrial concerns, subject to the provision that the corporation will be required todispose of and shares etc. Acquired by it in fulfillment its underwriting liabilitywithin a period of 7 years.viii.Until a reserve fund is created equal to the paid up share capital of the Corporationand until the State Governments has been repaid all amounts paid by them, if any, infulfillment of the guarantee liability, the rate of dividend shall not exceed the rateguaranteed by the state government. Under no circumstances shall the dividendexceed 5 % p.a. and surplus profits will be re payable to the State governments.ix.The corporation will have special privileges in the matter of enforcement of itsclaims against borrowers. Financial resources of the SFCs The SFCs mobilize their financial resources from the following sources1.Their own Share capital2.Income from investment and repayment of loans3.Sale of bonds4.Loans from the IDBI ( To some extent )5.Borrowings from the Reserve Bank of India6.Deposits from the Public7.Loans from State Governments.In the act Financial corporations are Financial corporations established under section 3 andincludes a Joint Financial Corporation established under section 3 A of the Sate financialCorporations Act of 1951.

The functions of SFCs are as follows

a. To advance term loans to small scale and medium scale industrial units. b. It underwrites the issue of stocks, shares, debentures and bonds of industrial units. c. It grants loans to the industrial concerns which is repayable within a period not more than 20 years. d. It subscribes to debentures floated by industrial concerns. e. It provides financial assistance to small road transport operators, tour operators, hoteliers, hospitals, nursing homes, etc. SFCs have been set up with the objective of catalyzing higher investment, generating greater employment and widening the ownership base of industries. They have also started providing assistance to newer types of business activities like floriculture, tissue culture, poultry farming, commercial complexes and services related to engineering, marketing, etc. There are 18 State Financial Corporations (SFCs) in the country: Andhra Pradesh State Financial Corporation (APSFC) Himachal Pradesh Financial Corporation (HPFC) Madhya Pradesh Financial Corporation (MPFC) North Eastern Development Finance Corporation (NEDFI) Rajasthan Finance Corporation (RFC) Tamil Nadu Industrial Investment Corporation Limited Uttar Pradesh Financial Corporation (UPFC) Delhi Financial Corporation (DFC) Gujarat State Financial Corporation (GSFC) The Economic Development Corporation of Goa ( EDC) Haryana Financial Corporation ( HFC ) Jammu & Kashmir State Financial Corporation ( JKSFC)\ Karnataka State Financial Corporation (KSFC) Kerala Financial Corporation ( KFC ) Maharashtra State Financial Corporation (MSFC ) Orissa State Financial Corporation (OSFC) Punjab Financial Corporation (PFC) West Bengal Financial Corporation (WBFC)

LEASE FINANCE Leasing is similar to rental, in that you avoid having to pay the full cost of an expensive item (e.g. Machinery and vehicles), and instead pay the leasing company each month for use of the equipment. This allows you to get essential equipment that you may not be able to afford in one go. A lease contract can last from 2 to 10 years depending on the details of the product, such as usable life and cost. Advantages of Leasing

With leasing you do not have to pay the full cost of the item in one go, this may allow you to buy better equipment (e.g. Bigger capacity, faster, more efficient, etc) that you otherwise could not afford. Security is less of an issue with leasing, as the finance can be secured on the item you are leasing; so you are less likely to need additional security as you would with a loan. Leasing costs are often tax deductible (depending on the cost and type of equipment you are leasing), or if you pay minimal taxes the leasing company may be able to claim the allowance on your behalf, reducing the leasing costs.

Disadvantages of Leasing You do not own products that you lease, making upgrading and replacing the equipment more difficult, and you can only gain a portion of the item costs back if you sell it after the lease expires. Over the long term leasing can work out quite expensive, you avoid paying a lump sum but end up paying more than the cost of the equipment without actually owning it. Although you do not own the leased equipment, you are usually responsible for the maintenance and repair costs. You either pay for the costs as they occur, or pay the leasing company or an insurer for a policy to cover them. Other Lease Based Finance Options Asset Finance (Sale and Leaseback) Asset finance allows you to sell equipment that you already own, and then lease it back for a monthly fee. This gives you finance quickly on significant items that have a long working life, with leasing terms usually lasting between 2 and 10 years. Remember though that many asset finance contracts will make the finance company owner of the product even after you have completed the lease. You may need to look for an Asset Loan contract if you wish to keep the product after the agreement has ended. OPERATING LEASE An operating lease works on a similar basis to standard leasing, except that it is based on shorterterm contracts; and one item may be leased several times over its lifespan. Although it is not as tax efficient as standard leasing, it does make it easier if your business needs to regularly update its equipment; or has varying levels of demand and often needs quick capacity increases. An operating lease is similar to a standard leasing agreement, however it is usually based on much shorter terms. The idea of an operating lease is that the product is sold or re-leased to another company at the end of the agreement; this means that they do not need to recover the full cost of the item (meaning cheaper monthly payments). This type of lease is less common, but is often available for products where there is a strong market for second hand equipment (Mainly vehicles). The length of an operating lease is shorter than a standard lease, it can run for a number of years, but will normally be for considerably less than the lifespan of the product to ensure re-selling or re-leasing. Section A

Raising funds through ------- is cheaper as compared to raising through shares. Preference shares have preferential right as to ----------------- shares are not preference shares, they do not carry preferential rights. -------- may be cumulative and non-cumulative, participating and non- participating, redeemable and non- redeemable. 5. Preference shares add to the equity base of the company and thereby strength to its --------6. The rate of dividend on equity shares is not ----------7. Shares can be issued at par, premium or -----------8. Debenture is a certificate issued by a company under its seal acknowledging a debt due by it, to its ----------9. A lease agreement grants lessee the right to --------10. The expenditure in capital asset is a ----------- investment 11. ------- lease is favored by lessee in respect of asset. 12. Debenture can be purchased and redeemed by the company unless they are -----------or ----------13. The term ------- stock is similar to share stock 14. Basic lease period refers to the period during which lease is ----------15. ---------- serves as a source of long term funds that can be used for acquisition. Section B 1. Write a note on debenture. 2. What is preference shares? 3. What are the types of leasing? 4. What are the concepts of leasing? 5. Can you explain the types of preference shares. 6. What is direct leasing and primary/secondary leasing? 7. Give the types of debentures. 8. Essential elements of leasing. 9. Can you state the advantages and disadvantages of leasing? 10. Finance is the life blood of the business explain 11. What are the types of shares. 12. Compare Financing through equity shares and financing through debentures. 13. What are the features of preference shares. 14. Is debenture same as bond? Explain. 15. What is lease financing? Section C 1. Explain the various forms of long term finance. 2. What are the merits, demerits and features of leasing. 3. What is debenture and what are the types of debentures. 4. Leasing is beneficial to both the lessee as well as lessor. Examine 5. What are the advantages and disadvantages of equity shares? 6. Explain in detail about what do you understand on the term lease financing? 7. How will you differentiate about debentures and bonds? 8. What are the two main categories of financial requirements of business? 9. Explain in detail about the types of shares. 10. What are the merits and demerits of equity shares?

1. 2. 3. 4.

11. Give short notes about bonds, debentures and fixed deposits. 12. What is financial lease and how does it differ from other types of leasing. 13. How do you compare Financing through equity shares and financing through debentures. 14. What is fixed deposits and what are the advantages and disadvantages. 15. Give short note about preference shares.

BUSINESS FINANCE Unit I Business Finance: Introduction Meaning Concepts -Scope Function of Finance Traditional and Modern Concepts Contents of Modern Finance Functions. Unit II Financial Plan: Meaning -Concept Objectives Types Steps Significance Fundamentals. Unit III Capitalization -Bases of Capitalization Cost Theory Earning Theory Over Capitalization Under Capitalization: Symptoms Causes Remedies Watered Stock Watered Stock Vs. Over Capitalization. Unit IV Capital Structure Cardinal Principles of Capital structure Trading on Equity Cost of Capital Concept Importance Calculation of Individual and Composite Cost of Capital. Unit V Sources and Forms of Finance: Equity Shares, Preference Shares, Bonds, Debentures and Fixed Deposits Features Advantages and Disadvantages-Lease Financing: Meaning Features Forms Merits and Demerits.

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