s in order to generate the profits.

Thus, production, marketing and finance are the operational areas in case of any manufacturing activity out a f which the finance le most crucial area. It is so because the functions of production and marketing are o related to finance ultimately. If the decisions relating of funds or money fail, it may may n the death of the organization. The decisions regarding moneylf~~nds malrc estroy the organization. The interests of so many persons may be directly affected to the success or failure of a n organization. g. : Owners (shareholders) Creditors Suppliers, Lenders of moneylfunds Employees Public a t large As such an organization has to be very careful while dealing with funds or money.
Approaches t~ the term Finance :

The concept of finance has changed markedly with the change -in times and' circumstances. The various views on the finance can be categorized as stated below: .I.

This approach towards finance was criticized on various grounds. (a) It is too narrow and restrictive in nature. Procurement of the funds is only on of the functions of finance and other functions are ignored by this approach. (b) It considers the financial problems only of corporate enterprises. In that sense, concerns, partnership firms etc. (c) It considers only the basic and non-recurring problems relating to the business.

a business.

INTRODUCTION

Financing Decisions (11) Investmeilt Decisions (c) Dividend Policy Decisions

(;I )

Pinancing Decisions :

'~'Ircsedecisions are basically concerned with the process of acquiring the funds. Any'
J ~ \ ~ ~ i n e s s is basically, concerned with raising of the funds, whenever required, activity gp~ploying these funds for manufacturing and selling the products in the market and qfir'ning the profits out of the same. Thusobtaining the funds for their deployment in $!I(? business is the starting point of any business activity. Further, the funds required by tihe business may be raised either by own sources (Equity Capital) or by outside gburces (Debt Capital) The financing decisions are basically concerned with the (1)What should be the amount of the funds that should be raised?

[nvestment Decisions :

T11e second area with which the finance deals is the utilisation of the funds raised and

(li) C u r r e n t Assets : These are those properties which a r e created during the course
of business and are capable of getting converted into cash usually within a year.

(i) a p i t a l B u d g e t i n g : C

made under situation of risk and uncertainty?

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(ii) Working C a p i t a l M a n a g e m e n t : The investment decision in this areas are basically concerned with deciding the . optimum extent to which the funds should be invested in current assets. If the company

INTRODUCTION

Both the proposals A a.nd B involve same amount of profits and hence ideally should be treated on par. But i t will not be proper a s proposal A involves higher amount of returns in the earlier years, while proposal B involves t h e r e t u r n s in the later years. 1 t makes proposal. A more profitable ultimately as the returns received earlier are more valuable than the returns received later. The objectives and the returns received later. t4) Proflt maximization a s t h e objective doesn't take into consideration the social

Ali such, profit maximization can't be a prime objective of the finance function. The
ol3,jective has to be one having more broad a base, which is more precise, which

I..)ue to the limitations attached with the profit maximization a s a n objective of the I'inance function, i t is no more accepted a s the basic objective. As against it, i t is now iiccepted t h a t the objedtive of the business should be to i~~axirrlize wealth and value its

tnaximization due to following reasons.

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earlier a r e more valuable t h a n those generated l a t e r . T h a t is why while computing value of total benefits, the cash flows are discounted a t a certain discounting rate. At t h e same time, it recognises the concept of risk also, by

BASIC FINANCIAL MANAGEMENT

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making necessary adjustments in discounting rate. As such, cash flows of ;if project involving higher risk are discounted a t a higher discounting rate and8 vice versa. Thus, the discounting rate used to discount future cash flows reflects the concepts of both time and risk.
Due to the above reasons, the wealth maximization is considered to be superior to profil maximization a s a n objective or goal of finance function. However, i t should be noted that wealth maximization goal is only an extension of profit maximization goal. If tho time period is too short and risk elements is minimum, both wealth maximization and profit maximization will mean the same thing.
Organization of Finance Function :

At the outset, it must be cleared that there is no standard pattern for the organization of finance function. I t varies from the enterprise to enterprise and its characteristics in terms of nature, size, convention etc. In smaller concerns, where the operations arc relatively less complicated and simple, there may not be seperate executive to look after finance function. In fact, the proprietor or partners only will be looking after all the functional areas like production, marketing, finance etc. In bigger concerns, the execution of finance function becomes a specialised task and may be handled by a n executive who may be i n the form t h e Treasurer, Finance Controller, Finance Manager, Vice-President (Finance) and so on. He is generally given the charge of credit and collection accounting, investment and audit departments. He is responsible for preparing annual financial reports. He reports directly to the President and Board of Directors. Secondly, it should be noted t h a t generally the organisation of finance is centralized one, unlike other businesss functions. Board of Directors takes the main 'financial decisions. Board of Directors may delegate the powers to the executive committee. comprising of managing director, other one or two directors and finance officer of the company. This executive committee takes all the financial decisions. Routine financial matters mav delegated to lower level officers. The reasons for finance beine hiehlv centralized function arc very obvious. (1)Financial decisions are the most crucial ones on which survival or failure on the organization depends. ( 2 ) Financial decisions affects the solvency position of the organization and a wrong decision i n this area may land the organization in to crisis. ( 3 ) The organization may gain economies of centralization in the form of reduced cost of raising the funds, acquisition of fixed assets a t the competitiveprices etc. Though there is not standard pattern for organization of finance function, in general terms, the organization of finance function takes the following form.
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Executive Committee Vice President Vice President (Marketing)

Finance Controller (1)Accounting and Costing

Duties and Responsibilities of Finance ~ k e c u t i v e :

On the basis of thescope of the finance, which has already been discussed, the various,

(1).Recurring Duties. (2) Non-recurring Duties.

executive should assess this need of funds properly.

BAS!@ FINANCIAL MAWAGEMEN

in the form of shares or debentures, h e has to arrange for the un.derwriting list,ing of the same. If the co!n.pany decides to go in for borrowed. capital, he has negotiate with the lenders of the funds.
(c) A l I o c a ~ i o n Funds : The financial executive has to ensure proper allocation of funds. lie can allocate the funds basically for two purposes.

company should invest the funds. He has to ensure t h a t the fixed ass acquired or to be acquired satisfy the present a s well a s future needs of t company. He has to ensure t h a t the funds i~ivested the fixed assets justify t i11 investments in terms of the expected cash flows generated by them i n future. there are more than one proposals for lnakirig in fixed assets, the finan F o r this purpose, he may be required to take the help of various techniques

in order to facilitate the replacement of fixed assets after their economic life i~ over, proper depreciation policies are formulated. The wrong policies in the area of providing for the depreciation may result into over-capitalisation or undercapitalisation. (ii) Working Capital Management : The finance executive h a s to ensure the sufficient funds are made vaailable for investing in current assets a s it is the lifeblood of the business activity. Non-availability of funds to invest in curreni, assets i n the form of' say cash, receivables, inventory etc. may halt the business operations. At the same time, h e has to ensure t h a t there is no blocking of funds in the current assets, a s it may prove to be costly i n terms of cost of these funds and also in terms of opportunity cost of their use. 'Thus, the finance manager has to ensure t h a t investme'nts in the current assets is minimum without affecting . the operations of the company. ( d ) Allocation of Income : Allocation of the income of the company is the exclusive responsibility of the finance executive. For this purpose, basically the income may be distributed among the sharehlders by way of dividend or i t may be retained in taken i n the light of financial position, present and future cash requirements, preferences of the shareholders etc. (e) Control s f Funds :The finance executive is responsible to cont,rol the use of funds committed in the business so as to ensure t h a t cash is flowing as per the plan and if there is any deviation between estimates and plans, proper corrective action lnay be taken in the light of financial position of the company. For this purpose, he lnay b e required to supervise the cash receipts and disbursements, ensure the safety of cash receipts and disbursements, ensure the safety of cash balances, expediate receipts and delay the payments h her ever possible etc.

llJ1110DUCTION
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1') ICvaluation of P e r f o r m a n c e -: The financial executive may be required to c:vnluate and interpret the financial statements, financial position and operations ol' Ihe company. For this purpose, he may be required to ensure that proper books rind records are maintained in proper way so that whatever data is required for this

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Ilow statments etc.

i g ) C o r p o r a t e T a x a t i o n : As the company is a separate legal entity, it is subjected to l,he various direct and indirect taxes like income tax, wealth'tax, excise and custolns

duty, sales tax etc. The finance executive may be expected to deal with the various t,ax planning and tax saving devices in order to minimize the tax liability.
(,

11) O t h e r D u t i e s : In addition to all the above duties, the financial executive may be
required to prepare annual accounts, prepare and present financial reports to top management, carrying out internal audit, get done statutory and tax audit, safeguarding securities and assets of company by properly insuring them etc;

c!~ieis,valuation of the enterprise a t the time of acquisition and merger thereof etc.
Plelds of Finance :

'llhere can be various fields in which the finance function.may operate. In each field,

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finance can be stated as. below. term. I t covers all the activities carried on with the intention of earning profits. Thus, business finance covers the study of finance function in the area of business which includes both trade as well as industry.

(2)C o r p o r a t i o n F i n a n c e : Corporation Finance is a p a r t of business finance and

deals with the financial practices, policies and problems of corporate enterprises or companies to describe in simple words. The corporation finance studies the financial operations carried on by a coporate enterprise from the stage of i t s inception to the stage of its growth and expansion. between invididuals and,organizations beyond national boundaries and developing the methods to handle these funds more effectively. This study may become crucial as it involves exchange of currencies, and also as the governments of either of the

becomes crucial as the-Governments deal with huge sums of money ivhich can be

BASIC FINANCIAL MANAGEMENT

raised through the sources like taxes or other methods and are required to bc utillised within the statutory and other limitations. Further, the Governments don't operate with the objectives similar to that of the private organization, i.c., earning the profits is not the intention with which the Governments operate, but they operate with the intention of accomplishing social or economic objectives.
( 5 ) Private Finance : I t deals with the financial matters of non-governenl organizations.
Finance Function in relation with other functions :

Other than finance, every business generally operates in these main functional are;l viz. Production, Marketing and Personnel. A 1 these functions are closely related to 1 finance function due to the simplest reason that for executing these functions, fund^ are required which is the area covered by finance function. For example to produce good quality of finished goods, the business needs gootl infrastuctural facilities like building, machineries etc. A regular flow of productioll requires facilities like quality raw material, work in progress, consuinable storefl, quality control equipmerits, good maintenance facilities etc. All these activities need t 1 ~ 1 investment to be made either in terms of fixed capital and/or working capital which i~ the area of finance function. To market the finished goods and guarantee regular flow of goods in the market, it may be rquired to have good distribution systems which may call for investment in terms of fixed assets or labour force. A 1 these activities need th(r 1 investments to be made either in terins of fixed capital and/or working capital which iti the area of finance function. The Personnel function deals with the availability ol' proper kinds of labourers a t proper time, training them properly and fixing their jol) responsibilities. All these activities needs funds, e.g., to pay salaries, wages and othol$ facilities to workers, funds are needed. To provide training facilities to workers, it may be necessary to invest in some fixed assets like building or equipments etc. To conclude, it may be stated t h a t all the functions or activities of the business an1 ultimately related to finance. The success of the business depends on how best all thew functions can be coordinated.

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1. Describe the scope and importance of the finance function in the management o corporation. 2.

Explain the meaning, nature and scope of Finance Function.

3. Explain the organizational framework of finance function. State the relation o finance to other functions of a business enterprise.
4.

What are the duties discharged by the financial executive in a large busin organization.

5. (a) Explain the traditional and modern concept of finance function.

The finance function of the organization if greatly affectcd by the forms of orgai~ization. In practical circumstances, we come across basically three forms of business organisations.

(a) P r o p r i e t a r y F i r m s

(b) P a r t n e r s h i p F i r m s
(c) J o i n t S t o c k C o m p a n i e s

Advantages : ( a ) Proprietory Firms is the easiest and most economical form of business organization to form and operate. Not many of the government regulations are applicable to the Proprietory Firms. (b) This form of organization is a very- silit,able where business operations are small in <---size and less complex in nature.
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Disadvantages : ( a ) 'This form of organization does not have any legal status. The proprietory firms exist firm ceases to be in existence.
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I SIRMS OF BUSINESS ORGANIZATION

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1,) A s only one person is the owner and the manager, the capacity of the business t o raise the funds and to cope up with the comnplex busine ... . mparatively- -l in2ited. ..-

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l'roprietory firm is always a. unlimited liability organization. In the sense, if the assets of the firm are insufficie~t meet its liabilities, ~ e r s o n a l to prowcirtv of the proprietor is always a t stake. proprietor. As such, effective rate of income tax which the proprietor may be required to pay is likely to be higher.

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((1) The income of the proprietory firm is clubbed with the individual income of the

((1)

It is not possible to transfer the ownership of the business to somebody else without affecting the basic constitution of the business.

I'lrrtnerskip firms
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this case, more than two persons but less than twenty persons come together and

I'orm a partnership firm. Each of these partners is the owner of the business in the
j)~$oportion decided among themselves. Partnership is a contract among the partners trlrd the relationship among the partners is governed on the basis of terms and clonditions laid down in a official and written document called as "Partnership Deed" or "l'tlrtnership Agreement". Advantages
(11)

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This form of organization is also reasonably easy and economical to form and operate.

ih) As resources of more than one person are pooled together, capacity of the business to handle more complex business operations or operations requiring more amount of funds is better as compared to the proprietory firms.
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The tax structure applicable to the partnership firms is fairly reasonable. At present, profit of the partnership firm is taxed a t a flat rate of 30%. While calculating the profit of the partnership firm, following amounts can be claimed by the Grm as the allowable expenditure. (i) The Firm' can pay interest on capital to the partners on the amount of capital introducted by them in the business but the rate of interest can not exceed 12% per annum. This interest on capital can be paid by the firm to all the partners. (ii) The firm can remunerate the partners in the form of salary, bonus, commission etc. provided that the partners are ""working partners". A working partner is a partner who is capable of participating in the day-to-day affairs of the firm by virtue of experience or qualifications. However, the firm can not remunerate the partners to any extent it wants. The maximum amount of remuneration which the firm can pay to all the working partners taken together is prescribed in Income Tax Act, 1961. Section 44AA of the said act provides the maximum amount of remuneration w h i c h ' m m can pay to its working ~ a x decided on the basis of the "bool; p r o f i t s b h ? c r 6 e a n s t

BASIC FINANCIAL MANAGEMENT

per its profitability statelllent after calculating the interest on capital paid to the partners. After deciding the amount of book profit, the remuneration is decided as below:
If the firm is carrying on a profession : (a) On the first Rs.1,00,000 of the book profit or in case of a loss - Rs. 50,000 or 90% of the bboi profit whichever is more. j (b) In the next Rs. 1,00,000 of the book profit, at the rate of 60%. (c) On the balance amount of book profit, a t the rate of 40%. In case of any other firm : (a) On the first Rs. 75,000 of the book profit or in case of a loss - Rs. 50,000 or 90% of the book profit whichever is, more. (b) On the next Rs. 1,00,000 of the book profit, a t the rate of 60%. (c)' On the balance amount of book profit, a t the rate of 40%. However, i t should be remembered t h a t the amount of interest on capital paid by the firm and the remuneration paid to the partners is taxable in the hands of individual partners. After charging the above amaunts, the balance amount of profits are transferred to the capital account of the partners which is referred to as "share of profit" and this share of profit is not taxable in the hands of individual partners. (d) Not many of the government regulations are applicable to the partnership Disadvantages :

( a ) This form of organisation also-does.not-l?av~any,lega~stat.~1s. Thepartnership firms the exist due to the exSf~iZe~-of partners. If the partners cease to be in existence, . t h e firm ceases to be in existence. The retirement or death of a partner leads to the
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partners i s always a t stake.

Joint Stock Companies

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people can be pooled t o g e t h ~ ~ this case, the total requirement of funds of the In

F@[PMSOF BUSINESS ORGANIZATION

[yiy~~nixation split into smaller units, each of such units being called as a <Share1. is I___-_ ... .. i&ac!l'l ~;uch h ~ c a ~ i e X ~ Z ~ d e r i o m i ~ a t1 o n~ E ~ is h s oa im c called a s 'face v~fici;; nominal or' v b i l ~ l ( ~An individual can participate in the capital requirement of a n organization '. ~ ? t ~ r c l ~ a s i n gshare of the company and he be'cTmenthe_par.t_.aurner the company the of is[? extent of his shareholding. in... ~ergI13zmount capital - the company. Such t;Ilcj .. . -. the of --- of gl~tiroholder can exercise his ownership rights through the voting rights offered to him. _ f.i'))(3 joint stock companies have theToYlowing characteristc features.
~

shareholders. They gain the legal status by being registered under Companies Act,, 3956, which governs and regulates the operations o f a u o i n t stock companies in ..-1:ndia.As legal enti'ties, the joint stock camp-anies &n own .___. incurre liabilities, _ _ assets, onl;er into contracts, sue a n d b e s u e d . Similarly, shareholders of the company can not be held liable for the actions of the company.
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(2) Generally all joint stock companies are limited liability organizations and the
liability of the members, i.e., shareholders is limited to the extent of amount of share t1.iey undertake to purcFase. E.g..If Mr. A undertakes to purchase 100 share of a -' company' of Rs. 100 each, his liability ceases once he pays Rs. 10,000 to the company. His personal is never in danger despite thZl6sses and-liabilities

BASK FBIdANCIAL MANAGEMENT

the comlnon seal and witi~essed atlcast two directois is bindil-ie on thr comnanv bv

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Advantages :

possible to raise large arnounk of funds.

( 2 ) As the company has a separate legal enlity, apart G*omits owners, viz., shareholders, the personal property of the shareholders is generally not in dangom-.

( 3 ) Transferability of shares is a facility available to the sllareholders. i f the shareholders want to release their investment in shares, they call transfer their shares to any other person. However, i t should be re~n?inberedt h a t in case of private limited companies, the shares are not freely transferable.

Disadvantages :
(1)The company form of organizatioils a r c subjected to elaborate legal a i d procedural formalities to be completed not only for ,,he purpose of forrnatioil but also for thc regular operation. The basic applicable law in this connection is in the form of'

(2) Till the recent past, double taxa1,ion used to be a typical characteristic feature of a company form of organization. 'The company wzs supposed to pay the tax on t.hc

not be treated as a taxable income. However, the company is requir'ed to pay additional tax on the amount of dividend payable by it. This t a x i s referred to as "Tax on distributable profits" or in more simple language "dividend tax". At, present, t the rate of dividend tax is 15% of the a ~ n o u n of dividend payable and this is over and above the normal corporate tax payable by the company. This imposes additional tax burden on the company.

Types of Companies :I n practical circumstances, we find mainly two types of' limited liability companies. ( a ) Private Limited Company (b) Public Limited Company.

Private Limited Company

In non-technical language, operations of a private limited company, affect the fate o smaller number of people. As such, Conipanies Act, 1956 is very liberal towards thc ~rivate limited c o m ~ a n i e s . Private Limited C o m ~ a n v entitled to manv ~rivilerresl is

PI1IjMS OF BUSINESS ORGAMlZPirleBN

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r r r ~ Minimum number of shareholders is 2 and the maximum number is 50.

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Private Limited Company can not approach public in general for subscribing to l,llc sharesldebentures of the company. The funds requried by the compXnT are)-oquiredto be collected through the private circulation only.

In case of a Private Limited Company, right of the shareholders to transfer the ~ l ~ a r is srestricted. These restrictions are usually in two forms e --- __ ( i that the shares to be transferred should be offered to the existing members on
priority basis and if the existing members do not want to take up those share, they can be transferred to anybody else. (ii) that the directors will have the power to refuse to register the transfer of shares provided that such power should be exercised by the directors in good faith and in the interest of the company.

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I d l A Private Limited Company can not invite or accept deposits from persons other than its members, directors or their relatives.
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ie) A Private Limited Company needs to have a minimum paid up share capital of Rs. 1 Lakhs or any higher amount as may be prescribed.

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l*\rl>licLimited Company

In lion-technical language, a public limited compnay affects the fate of larger number
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~l\rblic limited company is characterized by the f o l l o w i n g ~ ~ u - x e s .

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The shareholders of a public limited company can freely transfer their shares to any other person. As such, shares of only a public limited company can be listed on the

1, Explain the following fornls of organization in which business can be carried out ( a ) Proprietary Firms (b) Partnership Firms (c) Company

2, Write short notes on (a) Taxation of Partnership Firms (b) Private Limited Company (c) Public Limited Company