1.
Explain the objectives of financial management, interphase between finance
and other functions.
Financial Management means planning, organizing, directing and controlling the financial
activities such as procurement and utilization of funds of the enterprise. It means applying
general management principles to financial resources of the enterprise.
In simple terms objective of Financial Management is to maximize the value of firm, however it
is much more complex than that. The management of the firm involves many stakeholders,
including owners, creditors, and various participants in the financial market. The same is shown
in below diagram:
Effective procurement and efficient use of finance lead to proper utilization of the finance by the
business concern. It is the essential part of the financial manager. Hence, the financial manager
must determine the basic objectives of the financial management
The objectives of financial management are given below:
1. Profit maximization
Main aim of any kind of economic activity is earning profit. A business concern is also
functioning mainly for the purpose of earning profit. Profit is the measuring techniques to
understand the business efficiency of the concern.
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 long-term, if:
The Finance manager takes proper financial decisions
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 maximize 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 mobilization
Mobilization (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 utilization of finance
Proper utilization of finance is an important objective of financial management. The finance
manager must make optimum utilization 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-to-day 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:
To invest finance only in productive areas. This will bring high returns (profits) to the company.
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 minimized.
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.
2. Explain the Indian Financial Systems?
Introduction:
Economic growth and development of any country depends upon a well-knit financial system.
Financial system comprises, a set of sub-systems of financial institutions financial markets,
financial instruments and services which help in the formation of capital. Thus a financial system
provides a mechanism by which savings are transformed into investments and it can be said that
financial system play an significant role in economic growth of the country by mobilizing
surplus funds and utilizing them effectively for productive purpose.
The financial system is characterized by the presence of integrated, organized and regulated
financial markets, and institutions that meet the short term and long term financial needs of both
the household and corporate sector. Both financial markets and financial institutions play an
important role in the financial system by rendering various financial services to the community.
They operate in close combination with each other.
Financial System;
The word "system", in the term "financial system", implies a set of complex and closely
connected or interlined institutions, agents, practices, markets, transactions, claims, and liabilities
in the economy. The financial system is concerned about money, credit and finance-the three
terms are intimately related yet are somewhat different from each other. Indian financial system
consists of financial market, financial instruments and financial intermediation
Role/ Functions of Financial System:
A financial system performs the following functions:
* It serves as a link between savers and investors. It helps in utilizing the mobilized savings of
scattered savers in more efficient and effective manner. It channelises flow of saving into
productive investment.
* It assists in the selection of the projects to be financed and also reviews the performance of
such projects periodically.
* It provides payment mechanism for exchange of goods and services.
* It provides a mechanism for the transfer of resources across geographic boundaries.
* It provides a mechanism for managing and controlling the risk involved in mobilizing savings
and allocating credit.
* It promotes the process of capital formation by bringing together the supply of saving and the
demand for investible funds.
* It helps in lowering the cost of transaction and increase returns. Reduce cost motives people to
save more.
* It provides you detailed information to the operators/ players in the market such as individuals,
business houses, Governments etc.
Financial institutions are the intermediaries who facilitates smooth functioning of the financial
system by making investors and borrowers meet. They mobilize savings of the surplus units and
allocate them in productive activities promising a better rate of return. Financial institutions also
provide services to entities seeking advises on various issues ranging from restructuring to
diversification plans. They provide whole range of services to the entities who want to raise
funds from the markets elsewhere. Financial institutions act as financial intermediaries because
they act as middlemen between savers and borrowers. Were these financial institutions may be of
Banking or Non-Banking institutions.
Financial Markets:
Finance is a prerequisite for modern business and financial institutions play a vital role in
economic system. It's through financial markets the financial system of an economy works. The
main functions of financial markets are:
1. to facilitate creation and allocation of credit and liquidity;
2. to serve as intermediaries for mobilization of savings;
3. to assist process of balanced economic growth;
4. to provide financial convenience
Another important constituent of financial system is financial instruments. They represent a
claim against the future income and wealth of others. It will be a claim against a person or an
institutions, for the payment of the some of the money at a specified future date.
Efficiency of emerging financial system largely depends upon the quality and variety of financial
services provided by financial intermediaries. The term financial services can be defined as
"activites, benefits and satisfaction connected with sale of money, that offers to users and
customers, financial related value".
Pre-reforms Phase
Until the early 1990s, the role of the financial system in India was primarily restricted to the
function of channeling resources from the surplus to deficit sectors. Whereas the financial system
performed this role reasonably well, its operations came to be marked by some serious
deficiencies over the years. The banking sector suffered from lack of competition, low capital
base, low Productivity and high intermediation cost. After the nationalization of large banks in
1969 and 1980, the Government-owned banks dominated the banking sector. The role of
technology was minimal and the quality of service was not given adequate importance. Banks
also did not follow proper risk management systems and the prudential standards were weak. All
these resulted in poor asset quality and low profitability. Among non-banking financial
intermediaries, development finance institutions (DFIs) operated in an over-protected
environment with most of the funding coming from assured sources at concessional terms. In the
insurance sector, there was little competition. The mutual fund industry also suffered from lack
of competition and was dominated for long by one institution, viz., the Unit Trust of India. Non-
banking financial companies (NBFCs) grew rapidly, but there was no regulation of their asset
side. Financial markets were characterized by control over pricing of financial assets, barriers to
entry, high transaction costs and restrictions on movement of funds/participants between the
market segments. This apart from inhibiting the development of the markets also affected their
efficiency.
Financial Sector Reforms in India
It was in this backdrop that wide-ranging financial sector reforms in India were introduced as an
integral part of the economic reforms initiated in the early 1990s with a view to improving the
macroeconomic performance of the economy. The reforms in the financial sector focused on
creating efficient and stable financial institutions and markets. The approach to financial sector
reforms in India was one of gradual and non-disruptive progress through a consultative process.
The Reserve Bank has been consistently working towards setting an enabling regulatory
framework with prompt and effective supervision, development of technological and institutional
infrastructure, as well as changing the interface with the market participants through a
consultative process. Persistent efforts have been made towards adoption of international
benchmarks as appropriate to Indian conditions. While certain changes in the legal infrastructure
are yet to be effected, the developments so far have brought the Indian financial system closer to
global standards.
The reform of the interest regime constitutes an integral part of the financial sector reform. With
the onset of financial sector reforms, the interest rate regime has been largely deregulated with a
view towards better price discovery and efficient resource allocation. Initially, steps were taken
to develop the domestic money market and freeing of the money market rates. The interest rates
offered on Government securities were progressively raised so that the Government borrowing
could be carried out at market-related rates. In respect of banks, a major effort was undertaken to
simplify the administered structure of interest rates. Banks now have sufficient flexibility to
decide their deposit and lending rate structures and manage their assets and liabilities
accordingly. At present, apart from savings account and NRE deposit on the deposit side and
export credit and small loans on the lending side, all other interest rates are deregulated. Indian
banking system operated for a long time with high reserve requirements both in the form of Cash
Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR). This was a consequence of the high
fiscal deficit and a high degree of monetisation of fiscal deficit. The efforts in the recent period
have been to lower both the CRR and SLR. The statutory minimum of 25 per cent for SLR has
already been reached, and while the Reserve Bank continues to pursue its medium-term objective
of reducing the CRR to the statutory minimum level of 3.0 per cent, the CRR of SCBs is
currently placed at 5.0 per cent of NDTL.
As part of the reforms programme, due attention has been given to diversification of ownership
leading to greater market accountability and improved efficiency. Initially, there was infusion of
capital by the Government in public sector banks, which was followed by expanding the capital
base with equity participation by the private investors. This was followed by a reduction in the
Government shareholding in public sector banks to 51 per cent. Consequently, the share of the
public sector banks in the aggregate assets of the banking sector has come down from 90 per cent
in 1991 to around 75 per cent in2004. With a view to enhancing efficiency and productivity
through competition, guidelines were laid down for establishment of new banks in the private
sector and the foreign banks have been allowed more liberal entry. Since 1993, twelve new
private sector banks have been set up. As a major step towards enhancing competition in the
banking sector, foreign direct investment in the private sector banks is now allowed up to 74 per
cent, subject to conformity with the guidelines issued from time to time.
Conclusion: The Indian financial system has undergone structural transformation over the past
decade. The financial sector has acquired strength, efficiency and stability by the combined
effect of competition, regulatory measures, and policy environment. While competition,
consolidation and convergence have been recognized as the key drivers of the banking sector in
the coming years.
3.Explain debentures as instruments for raising long-term debt capital
Debt capital is funds supplied by lender that is part of a company’s capital structure. Debt
capital usually refers to long-term capital, specifically bonds, rather than short-term loans
to be paid off within one year. Debt capital differs from equity or share capital because
subscribers to debt capital do not become part owners of the business, but are merely
creditors, and the suppliers of debt capital usually receive a contractually fixed
annual percentage return on their loan, and this is known as the coupon rate. Debt refers
to capital that is loaned by a lender to a borrower, who is in turn obligated
(1) To repay the original amount loaned–or the principal–within a specified time
period, and
(2) To pay interest on the principal. The various instruments of debt can be classified
into long term, medium term and short term debt depending on the tenure for which the
amount has been raised or the period of repayment.
Apart from term loan and credit facilities, the various instruments of debt are mentioned
below. Classification of Debenture Debentures are classified into various types. These
are redeemable, irredeemable, perpetual , convertible, non-convertible, fully, partly,
secured, mortgage, unsecured, naked, first mortgaged, second mortgaged, bearer, fixed,
floating rate, coupon rate, zero coupon, secured premium notes, callable, potable, etc.
Debentures are classified into diffe rent types based on their tenure, redemption,
mode of redemption, convertibility, security, transferability, type of interest rate,
coupon rate, etc. Following are the various types of debentures vis-a-vis their basis of
classification. Redemption / Tenure Redeemable and Irredeemable (Perpetual) Debentures:
Redeemable debentures carry a specific date of redemption on the certificate. The company is
legally bound to repay the principal amount to the debenture holders on that date. On
the other hand, irredeem able debentures, also known as perpetual debentures, do not
carry any date of redemption. This means that there is no specific time of redemption of these
debentures. They are redeemed either on the liquidation of the company or when the
company chooses to pay them off to reduce their liability by issues a due notice to the
debenture holders beforehand .Convertibility Convertible and Non-Convertible Debentures:
Convertible debenture holders have an option of converting their holdings into equity
shares. The rate of conversion and the period after which the conversion will take effect are
declared in the terms and conditions of the agreement of debenture sat the time of issue. On the
contrary, non-convertible debentures are simple debentures with no such option of getting
converted into equity. Their state will always remain of a debt and will not become equity at any
point of time.
4 What are Inventories? Explain.
Inventory is the collection of unsold products waiting to be sold. Inventory is listed as a
current asset on a company's balance sheet.
There are generally five reasons companies maintain inventories:
To meet an anticipated increase in demand;
To protect against unanticipated increases in demand;
To take advantage of price breaks for ordering raw materials in bulk;
To prevent the idling of a whole factory if one part of the process breaks down; and,
To keep a steady stream of material flowing to retailers rather than making a single
shipment of goods to retailers.
Inventory can also be used as collateral to obtain financing in some cases.
The basic requirement for counting an item in inventory is economic control rather than physical
possession. Therefore, when a company purchases inventory, the item is included in the
purchaser's inventory even if the purchaser does not have physical possession of those items.
Inventory is usually classified in its own category as an asset on the balance sheet,
following receivables. It is important to note that the balance sheet's inventory account should
also reflect costs directly or indirectly incurred in making an item ready for sale, including the
purchase price of the item as well as the freight, receiving, unpacking, inspecting, storage,
maintenance, insurance, taxes, and other costs associated with it.
5.Explain the different sources of cash
Cash is a resource readily available for use. It includes currency (one-dollar bills, five-dollar
bills, etc.), coins, and deposits in bank checking and savings accounts. Cash may be in the form
of many different currencies, such as dollars, marks, and yen. Although companies use many
different currencies, cash is reported in the financial statements in terms of one currency. For
example, Exxon Mobil Corporation uses many forms of currency in its world-wide operations,
but reports cash on its balance sheet in terms of United States dollars. DaimlerChrysler AG, on
the other hand, reports cash and cash equivalents in Euros.
Sources of Cash: Companies obtain cash through borrowing, owners' investments, management
operations, and by converting other resources. Each of these sources of cash is examined below.
Borrowing cash: Companies borrow cash primarily through short-term bank loans and by
issuing long-term notes and bonds. For example, assume that on June 16, a company
borrows $12,000 for 90 days. Show the effects of borrowing on the company's resources
and sources of resources.
Sources of
Sources of Sources of Management
Total Borrowed Owner Invested Generated
Resources = Resources + Resources + Resources
Assets = Liabilities + Stockholders' Equity
+ $12,000 = + $12,000
cash notes payable
When the company receives $12,000 cash, its resources (assets) increase. Since the cash
was borrowed, the company's sources of borrowed resources, liabilities, also increase by
$12,000.
Remembering that assets increase with debits and that debits equal credits, prepare the
journal entry to record the $12,000 borrowing.
Post.
Date Description Ref. Debits Credits
June 16 Cash 12,000
Notes Payable 12,000
Bank loan, 90 days
Cash was debited in the above journal entry because cash increased, cash is an asset, and
assets increase with debits. The credit required because debits must equal credits was to
the liability account notes payable, short-term. If you remember that liabilities increase
with credits, you support this credit to notes payable, short-term because this liability did
increase when the cash was borrowed.
The cost of borrowing cash: When borrowed cash is used, there is a cost associated with
it, called interest expense. For example, assume on June 16 the $12,000 was borrowed for
90 days at an annual interest rate of 10%. The total cost of borrowing the $12,000 would
be calculated as follows.
Interest = principal x interest rate x time.
Interest = $12,000 x .10 x 90/365.
Interest = $295.89.
The 90/365 represents the number of days (90) in the year (365) for which the money was
borrowed. If the interest is to be paid to the bank at the end of 90 days, the company
would pay the bank $12,295.89 ($12,000 + $295.89).
At the end of June, however, the company would recognize that it had used the bank's
money for only 15 days (June 16 through June 30). Thus, the company would recognize a
$49.32 ($12,000 x .10 x 15/365) increase in its sources of resources for its liability to the
bank (interest payable). The company would also recognize a decrease in its sources of
resources because it used up the bank's services provided in June (interest expense).
These effects could be seen as follows.
Sources of
Sources of Sources of Management
Total Borrowed Owner Invested Generated
Resources = Resources + Resources + Resources
Assets = Liabilities + Stockholders' Equity
+ $49.32 + - $49.32
interest payable interests expense
Remembering that assets increase with debits and that debits equal credits, prepare the
journal entry to record June's cost of borrowing the $12,000
