Management of Funds and Assets

8/9/2019 Management of Funds and Assets

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LESSON - 1

FINANCIAL PLANNING OF FUNDS

OBJECTIVES

The objectives of the lesson are to impart adequate knowledge pertaining to basics ofmanagement of funds, namely meaning have funds, importance of funds and allocationof funds.

STRUCTURE

1.1 Introduction

1.2 Financial planning

1.3 Meaning of funds

1.4 Importance of funds

1.5 Planning for funds

1.6 Raising of funds

1.7 Allocation of funds

1.8 Benefits of effective allocation of funds

1.9 Dangers of misallocation of funds

1.10 Summary

1. 11 Review Questions

1.12 Assignment Questions

1.13 Key concepts

1.1 INTRODUCTION

Finance refers to the use and the control of money. In fact the term fund has amarvelous ability to evoke different concepts in the minds of different persons. For the


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convenience of analysis, different viewpoints on finance have been categorized intothree major groups.

a) The first approach incorporates the views of all those who contend that financeconcerns with acquiring funds on reasonable terms and conditions to settle bills. This

approach covers study of financial institutions and instruments from which funds can besecured, the types and duration of obligations to be issued, the timing of the borrowings,the amounts required and cost.

b) The second category holds that finance is concerned with cash as almost all businesstransactions are expressed ultimately in terms of cash. Every activity within the firm isthe concern of the financial manager.

c) The third approach to finance looks on finance as being concerned with acquisitionsof funds and wise utilization of these funds. As money involves cost, the central task ofthe fund manager while allocating resources, is to match the advantages of potentialuses against the cost of alternative sources to maximize the value of the firm. This is themanagerial approach, known as problem-centered approach, as it emphasises that fundsmanager, to his endeavor to maximize the value of the firm has to deal with keyproblems of the firm, namely, what capital expenditures should the firm make? Whatvolume of funds should the firm invest? How should the desired funds be financed?How can the firm maximize its profitability from existing purpose commitments?According to Bonneville and Dewey financing consists of the raising, providing andmanaging of all the money, capital or funds any kind to be used in connection with thebusiness.

Financial planning includes the planning and the management of funds. It consists ofthe determination of total amount of capital required and selecting the best possible

source of funds any kind to be used in connection with the business.

1.2 FINANCIAL PLANNING

Financial planning includes the planning and the management of funds. It consists ofthe determination of total amount of capital required and selecting the best possiblesource of funds after considering set of alternate sources, the management of fundsthrough the techniques of financial analysis, budgets, standard costs, forecastingestablishment of financial objectives and arranging the financial procedures.

Meaning of funds

The term funds has been defined to the following ways:

i) Cash

ii) Cash and marketable securities (short term investments)

iii) Cash and marketable securities and Accounts Receivables minus current liabilities.


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iv) Current assets minus current liabilities while some view fund as mere cash, othersview fund as all asset items of balance sheet representing use of Funds .The workingcapital concept of funds lied in between these two extremes an is operational in ameaningful way.

1.3 IMPORTANCE OF FUNDS

According to J. Batty, an adequate balance and flow of cash is essential; at all times abusiness must be able to meet its commitments. More than this a business cannot affordto stand still. In any competitive field it will be essential to affect Improvements tointroduce new products and to expand. Experience has shown that a business does notremain static; there is a tendency to go forward or backward, but not to stagnate. Ifexpansion is to take place, then there must be adequate financial resources. The need formanagement of funds arises to ensure the following:

i) Availability of sufficient cash for meeting expenditure, emergencies and fluctuationsin the level of working capital

ii) To maintain liquidity throughout the year

iii) To indicate the surplus resources available for expansion or external investments.

iv) To judge the timing for requirement of funds

v) To provide ahead for any more funds needed

Presently, the fund manager is expected to see that a firm has sufficient funds to carryout its plans as well as to ensure wise application financial activities of planning, raising,allocating, and controlling of funds.

Recurring Finance function encompasses all such financial activities as are carried outregularly for the efficient conduct of a firm. Planning for and raising of funds, allocationof funds and income and controlling the uses of funds are contents of recurring financefunctions.

1.5 PLANNING FOR FUNDS

The initial task of the manager of funds in a new or going concern is to formulate afinancial plan for the company. Financial plan is the act of deciding to advance the

quantum of fund requirements and its duration and the make-up of such requirementsto achieve the primary goal of the enterprise. While planning for funds requirements thefund manager has to aim synchronizing the cash inflows with cash outflow so that thefirm does not have any resources lying unutilized.

Since in actual practice such a synchronization is not possible, the financial mangermust maintain some amount of working capital in reserve so as to ensure solvency of thefirm. The magnitude of this reserve is the function of the amount of risk that the firm


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can safely assume in given economic and business conditions. Keeping in view the long -term goals of the company the fund manager has to determine the total fundrequirements, duration of such requirement and the forms in which the required fundswill be obtained. Decision with respect to fund requirements is reflected incapitalization. While determining fund requirements for the enterprise the financial

manager must keep in mind the various considerations, viz, purpose of the business,state of economic and business conditions, management attitude towards risks,magnitude of future investment programmes, state regulation, etc.

Broadly speaking there are two methods of estimating funds requirements:

Balance sheet methodand cash budget method. In balance sheet method, totalcapital requirements are arrived at after totaling the estimates of current, fixed andintangible assets. In contrast with this, a forecast of cash inflows and cash outflows ismade month-wise and cash deficiencies are calculated to find out the financial needs.With the help of cash budget amount, funds requirements at different time intervals canbe calculated. Having estimated total funds requirements the financial executive decidesas to how here requirements will be met, viz, forms of financing funds requirements,such decisions are taken under 'capital structure'. While there may be various patternsof capital structure, the manager of funds must select the one that best suits theenterprise. Keeping in mind the cardinal principles of cast, risk, control, flexibility andtiming, the fund manager should decide upon the most suitable pattern of capitalstructure for the enterprise.

1.6 RAISING OF FUNDS

The second responsibility of manager of funds is that of procurement of necessarycapital to meet the business requirements. If the company decides to raise the needed

funds by means of security issues, the manager of funds has to arrange the issue of theprospectus for the flotation of issues. In order to ensure quick sales of securitiesgenerally the stock brokers, who deal in securities in the stock and who are in constanttouch with the clients are approached.

Even after the issues are floated in the stock market, there is no certainty that thesecurity issues will bring in the desired amount of capital because public response tosecurity issues is difficult to estimate. If a business entrepreneur fails to assemble thedesired amount of funds through security issues, the enterprise is plunged into gravefinancial trouble. In order to overcome this problem the fund manager has to make suchan arrangement as may protect the issue against its failure. For that matter he has to

approach underwriting firms whose main job is to provide the guarantee of buying theshares placed before the public in the event of non-subscription of the shares. For theseservices, they charge underwriting commission.

Thus if an underwriter is satisfied with the issuing company, an underwriting agreementis entered into between the company and the issuing company. The obligation of theunderwriter as per the agreement arises only when the event of non-subscription ofissues by the public takes place. Where the size of the security issue is too large to be


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handled by a single underwriter, the issuing company may enter into agreement with anumber of underwriting firms.

Where the company decides to borrow money from financial institutions includingcommercial banks and special financial corporation, the fund manager had to negotiate

with the authorities. He has to prepare the project for which the loan is sought anddiscuss it with the executives of the financial institutions along with the prospects ofrepayment of the loan. If the institution is satisfied with the desirability of the proposalan agreement is entered buy the financial executive on behalf of the company.

1.7 ALLOCATION OF FUNDS

The third major responsibility of the manager of funds is to allocate funds amongdifferent assets. In allocating the funds consideration must be given to the factors suchas competing uses, immediate requirements, management of assets profit prospects andoverall management plans. It is true that the management of fixed assets is not thedirect responsibility of the fund manager. However, he has to acquaint the productionexecutive who is primarily seized with the task of acquiring fixed assets withfundamentals of capital expenditure projects and also about the availability of capital inthe firm, but the efficient administration of the manager of funds.

The financial executive has also to see that only that much of fixed assets are requiredthat could meet the current as well as the increased demand of the company's products.But at the same time he should take steps to minimize the level of buffer stock of fixedassets that the company is required to carry for the whole year to satisfy the expandeddemands. While managing cash, the fund manager should prudently strike a goldenmean between these two conflicting goals of profitability and liquidity of thecorporation. He has to set minimum level of cash so that the company's liquidity is not

jeopardized and at the same time its profitability is maximised. Alongside this, the fundmanager has to ensure proper utilization of cash funds by taking such steps as help inspeeding up the cash inflows, on the one hand and slowing such outflows, on the other.

1.8 BENEFITS OF EFFECTIVE ALLOCATION OF FUNDS

1. The economy in which the modern firm operated is marked by cut throat competitionand the consequent narrow margin of profit. Proper allocation of funds to the requiredheads would enhance better utilisation of funds leading to profitability.

2. Proper allocation of funds would result in elimination of waste of operations by

providing closer coordination of different operative functions.

3. Planned allocation of funds would enable implementation of expansion /diversification of enterprise in time. As expansion/diversification calls for morefinancial resourced, i.e. funds, allocation of funds well in advance, would facilitate themanagement to start implementing the projects.


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4. When funds are allocated to fixed assets and current assets, it would be possible forthe enterprise to carry on the work smoothly without any paucity of funds.

5. If funds are not allocated, certain areas, projects, proposals, would not deserveattention, which are otherwise important for the smooth functioning of the enterprise.

1.9 DANGER OF MIS-ALLOCATION OF FUNDS

1. The survival and growth of an enterprise is possible only when the enterpriseapportion its funds in an optimum manner.

2. Misallocation of funds would result many times result in closing down of business.

3. Non-allocation of funds to vital project proposals and ms-allocation of funds to wrongproject proposals would result In mismanagement of funds and the consequences wouldfollow.

4. Misallocation of funds would mean pursuing wrong policies of financial plan andwould result in improper utilization of funds. This would damage the credit worthinessof the enterprise. Allocation of income of the company as between different uses is theexecutive responsibility of the fund manager. Income may be retained for financing ofexpansion of business or it may be distributed to the owners as dividend as a return ofthe capital. Decision in these regards is taken on the basis of financial position of thecompany, present and future fund requirements of the firm, and the like.

The fund manager is required to control the uses of funds to ensure that cash is flowingas per plan. The fund manager has to look into deviation between actual and estimated.He is required to evaluate performance of receivables management to judge how thecredit department is carrying out credit and collection policies laid down by the firmeffectively. Important tools that are employed to control the uses of funds are BudgetaryReports, Projected Financial Statements, Funds and Statement and Break-evenAnalysis.

1.10 SUMMARY

The term 'fund' has a marvelous ability to evoke different concepts in the minds ofdifferent persons. There are mainly three views on finance, while the first approachincorporates the views of all those who contend that finance concerns with acquiringfunds the second approach views that finance is concerned with mere cash. The third

approach looks at finance as being concerned with acquisition of funds and wiseutilization of these funds. Financial planning includes the planning and themanagement of funds.

The term 'funds' has been defined in the following ways:

i) Cash


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ii) Cash and marketable securities

iii) Cash and marketable securities and accounts receivables must current liabilities.

iv) Current assets mines current liabilities while some view fund as a more cash, others

view fund as all asset items of balance sheet representing use of funds.

The need for management of funds arises to ensure the following:

i) Availability of sufficient cash for meeting expenditure, emergencies and fluctuation inthe level of working capital.

ii) To maintain liquidity throughout the year.

iii) To indicate the surplus resources available for expansion or external investments.

iv) To judge the timing for requirement of funds.

v) To provide ahead for a more funds needed.

The fund manager is expected to ensure that a firm has sufficient funds to carry out itsplan as well as to ensure wise application of funds in the productive process. Themanager of funds is concerned with all financial activities of planning, raising, allocatingand controlling of funds. Finally the fund manager is required to control the used offunds to ensure that cash is flowing as per plan and if there is any deviation between theactuals and estimates, the same is dealt with a manner compatible with the continuedfinancial health of the enterprise.

KEY CONCEPTS

i) Bonds - long time debt instrument

ii) Equity capital - long term finds provided by the owners of an enterprise and consistsof ordinary share capital and retained earnings.

iii) Financial Risk of not being able to cover fixed financial costs the use of debt exposesthe ordinary shareholders to financial risk.

iv) Retained Earnings - the portion of the after-tax profits that are no paid out to theshareholders as dividends.

v) Cash Flows - the actual receipts and payments by a firm.

vi) Financial Planning - it is the art of deciding in advance the financial activities thatare necessary if the firm is to achieve its primary and long-term goal of wealthmaximization.


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1.11 REVIEW QUESTIONS

1. Define the term 'funds. Explain the concept of management of funds.

2. Critically analyse the function of manager of funds in a large-scale industrial

establishment.

3. Explain the objectives and significance of management of funds.

4. What are the broad areas of management of funds? Explain.

1.12 ASSIGNMENT QUESTION

1. What are the precautions to be taken by the fund manager, while making fund relateddecisions.

1.13 KEYWORDS

Bonds, Equity capital, Retained Earnings, Securities, Underwriter.

- End of Chapter -

LESSON - 2

MANAGEMENT OF FUNDS

OBJECTIVE

The objective of the lesson is to know the varied aspects of management of funds and tostudy its relationship with other financial areas of the enterprises.

STRUCTURE

2.1 Introduction

2.2 Management of Funds

2.3 Summary

2.4 Review Questions


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2.5 Assignment Question

2.6 Key words

2.1 INTRODUCTION

The basic objectives of management of funds are to ensure that enough capital isprocured at the minimum cost to maintain adequate cash on hand to meet the requiredcurrent and capital expenditure and to put it into most productive channels so as tomaximize profits.

2.2 MANAGEMENT OF FUNDS

In order to achieve these basic objectives, the fund manager is required to concentrateon the following aspects of management of funds.

i) Estimating the capital requirement of the various functions involved

ii) Determining its capital structure

iii] Finalising the choice of source of finance

iv) Taking decisions regarding investing of funds m the most productive channels

v) A judicious distribution of surplus

vi) A wise and efficient management of funds

vii) Implementation of effective control of funds.

The various aspects of management of funds are discussed below.

2.2.1 Estimating the Capital Requirements of the Concern

The fund manager is expected to exercise maximum care in estimating the financialrequirement of this enterprise. In order to ensure long-term financial stability, growthand progress, he has to make use of long-range planning techniques. This is inevitable,because every business enterprise calls for funds, not only for long term purposes forinvestment in fixed assets, but also for short-term so as to have sufficient workingcapital He can do this job properly if he can prepare budgets of various activities forestimating the fund requirement of his enterprise. If his enterprise is suffering onaccount of paucity of funds, it cannot successfully meet its commitments in time. On theother hand if it has acquired excess funds, the task of managing such excess capital maynot only prove very costly but also tempt the management to spend unwisely.

2.2.2 Determining the Capital Structure of the Enterprise


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The capital structure finalized by the management decides the final choice between thevarious sourced of finance. The fund manager can decide the kind and proportion ofvarious sources of capital only after the requirement of capital funds has been decidedThe decisions regarding an ideal mix of equity and debt as well as short-term and long-term debt ratio will have to be taken in the light of cost of meeting such funds from

various sources, the period for which the funds are required and so on. Care should beexercised to arrange sufficient long-term capital in order to finance the fixed assets.

2.2.3 Finalising the Choice as to the Sourced of Finance

The capital structure finalized by the management decides the final choice between thevarious sources of finance. The important sources are shareholders, debenture-holders,bank and other financial institutions, public deposits and so on. The final choice actuallydepends upon a careful evaluation of the costs and other conditions involved in thesesources. For instance, although public deposits carry higher rate of interest than ondebentures, certain enterprises prefer them to debentures, as they do not involve thecreation of any charge on any of the company's assets. Likewise, companied that are notwilling to dilute ownership, may prefer other sources instead of investors in its sharecapital.

2.2.4 Deciding the Pattern of Investment of Funds

The manager of fund must prudently invest the funds procured, in various assets in sucha judicious mariner as to optimize the return on investments without jeopardizing thelong-term survival of the enterprise. Two important techniques i) capital budgeting;and ii) opportunity cost analysis - can guide him in finalising the investment of long-term funds by helping him in making a careful assessment of various alternatives. Aportion of the long-term funds of the enterprise should be earmarked for investment in

the company's working capital also. He can take proper decisions regarding theinvestment of funds only when he succeeds in striking an ideal balance between theconflicting principles of safety, profitability and liquidity. He should not attach all theimportance only to the canon of profitability. This is particularly because of the fact thatthe company's solvency will be in jeopardy, in case major portion of its funds are hookedin highly profitable but totally unsafe projects.

2.2.5 Distribution of Surplus Judiciously

The manager of funds should decide the extent of the surplus that is to be retained forpushing back and the extent of the surplus to be distributed as dividend to shareholders.

Since decisions pertaining to disposal of surplus constitute a very important area ofmanagement of funds, he must carefully evaluate such influencing factors as (a] thetrend of earnings of the company; (b] the trend of the market price of its shares; (c] theextent of funds required for meeting the self financing needs of the company; (d] thefuture prospectus; e] the cash flow position, etc.

2.2.6 Efficient Management of Cash


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Cash is absolutely necessary for maintaining enough liquidity. The company requirescash to (a] pay off creditors; (b] buy stock of materials; (c] make payments to labourers;and (d] meet routine expenses. It is the responsibility of the Fund manager to make thenecessary arrangements to ensure that all the departments of the Enterprise get therequired amount of cash in time for promoting a smooth flow of all operations. Shortage

on any particular occasion is sure to damage the creditworthiness of the enterprise. Atthe same time, it is not advisable to keep idle cash flow. Idle cash should be invested innear cash assets that are capable of being converted into cash quickly without any lossduring emergencies. The exact requirements of cash during various periods can beassessed by the manager of funds by preparing a cash-flow statement in advance.

If we try to classify the need for funds of an enterprise on the basis of time, we mayconveniently divide it among long-term, medium-term; it is very difficult to define.According to R.H.Vessel, the line of demarcation between long-term and medium termis very vague, thin and invisible. Generally, the need of funds not more than for 1 yearare included in short-term needs, for more than one year but not exceeding five yearsare included in medium-term and over five years they are included in long-term needs.Some authorities on finance include the need of fund between 3 to 10 years in medium-term needs and over ten years as long-term while below three years as short-termrequirement. But as far as the relevancy is concerned, the first clarification seems to bemore sound. Actually, the need for funds is not informally distributed over time. Thefluctuations in fund requirements are of varying character hence different methods areresorted to meet them.

Long-term needs of funds: Long-term funds are needed by the firm either to replaceexisting capital assets or to add its existing capacity or both. The nature of long-termneeds of fund it static and permanent. As a matter of fact, this is the capital bearing theultimate risk of the business. That's why, a major portion of long-term capital is

collected through the sale of equity shared, preference shares and obtaining the ling-term loans, Equity share constitute the first source of funds to a new business and thebase of support for existing firm's borrowing. After some time, the radiated earning mayalso be good source of firm's long-term requirements of funds. As we saw that long-termneeds are not satisfied only with the shares, the long-term loans are also utilized. So thereal basis for the division of fund requirements is the time, conditions of its use and thedegree of risk attached to it.

If management gets ample time to plan and provide for the repayment of funds, ifmanagement can appropriate this funds for a very long time, it must be certainlyincluded in long-term financing no matter it is ownership claim or a creditorship claim.

Medium-term Financing: It is defined as debt originally scheduled for repayment inmore than one year but less than five years. Anything shorter is a current liability andfalls in the class of short-term sourced of funds, while obligations due in more than fiveyear are thought of as long-term debt. Though this distinction is arbitrary, of course, butgenerally popular. The major sources of medium-term financing include [1] term-loans,[2] conditional sales contracts, [3] redeemable preference shares of debentures, and [4]lease financing. A term loan is a business loan with a maturity of more than one year.


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Ordinarily, systematic repayments often called amortization procedure over the life ofthe loan retire these term loans. The primary lenders on term credit are commercialbanks, insurance companies, pension and provident funds of employees. In India, thereis one more popular source of medium-term funds, i.e., public deposits. Now-a-days, ithas become very attractive and popular, from borrower and leader is point of view.

Short-term Financing: It is popularly known as short-term credit also. It is definedas debt originally scheduled for repayment within one year. In other words, short-termcredit is equal to liabilities minus the current maturities of long-term debt. There arethree main sources of short-term funds: [1] trade credit between firms, [2] short-termloans from commercial banks, and [3] commercial papers. This pattern of fundsrequirements is determined on the basis of considerations relating to the long-termfinancial planning. The problem of pattern of funds can be conveniently divided intofour main groups-the determination of its scope, the factors determining its urgency asvaluation of possible resource and finally developing an optimum, balanced as well asflexible capital structure of the firm. Each aspect of this problem has its own importanceand needs careful consideration. In addition, to these factors, the nature of industry,technological innovations, expected volume of sales general financial, position of thefirm, business circles, general price level and state policies are also some importantconfederations to be taken into account. This analysis of fund requirements issignificant from the various points of views - cost of funds, timing and prices of issued,the balancing of income, risk and control of the enterprise, etc.

2.3 SUMMARY

Management of short-term assets and liabilities are important taste of the financemanager. The basic objectives of management of funds are to ensure that enough capitalis procured at the minimum cost to maintain adequate cash on hand to meet the

required current and capital expenditure. Efficient management of cash is classified bylong term management of funds, medium term and short-term financing.


1. Explain the various aspects of management of funds.

2. Write a note on Long-term, medium term and short-term financing


Discuss elaborately about the estimation of capital requirement of a large scale industry.

2.6 KEYWORDS

Paucity of funds, jeopardy, debenture, term loans lease financing, redeemable, equityshares, demarcation


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- End of Chapter -

LESSON - 3

ORGANISATION OF FUNDS MANAGEMENT AND ITS RELATIONSHIP

WITH OTHER FUNCTIONAL AREAS OF ENTERPRISE

OBJECTIVE

This lesson discusses about the organization's of funds management and its relationshipwith other functional areas of an enterprise.

STRUCTURE

3.1 Introduction

3.2 Functions of Fund Manager

3.3 Key functions

3.4 Summary



3.7 Keywords

3.1 INTRODUCTION

In every organization, funds are required for various ventures are project. The quantumof allocation (how much), the timing of allocation (when) and manner of allocation(how) of funds to a particular project deserves special mention in the case of every firm.The management has to look into the pros and cons of each project, the amount of fundsnecessary for them and the sources from which to raise or augment the requiredresources. In the present competitive changing corporate scenario, the fund manager isrequired to act as an intermediary, standing between the firm's operations and capitalmarkets, where the firm's securities are traded. The Fund manager is expected to knowwell the mechanism of capital markets. The market timings for resource mobilization,the uses of funds in the firm's operations, the generation of funds by the firm'soperations and the investment of funds in the most profitable channel are importantaspects of management of funds.


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3.2 FUNCTION OF FUND MANAGER

The Fund manager cannot avoid coping with time and uncertainty. Concern often havethe opportunity to invest in assets which cannot pay their way in the short run andwhich exposes the concern and its shareholders to considerable risk. The investment, if

undertaken, may have to be financed by debt, which cannot be fully repaid for manyyears. The concern cannot walk away from such choices - someone has to decidewhether the opportunity is worth more than it costs and where the additional debtburden can be safely borne. In fact the Fund Managers are subject to the scrutiny ofspecialists. Their actions are monitored by the Board of Directors; they are also reviewedby banks and financial institutions, which keep an eye on the progress of fir receivingtheir loans. The Fund manager is required to take the role of a financial planner.Financial planning is necessary because investment and financing decisions interact andshould not be made independently. In fact, financial planning helps to establishconcrete goals 0 motivate the fund managers and provide standards for measuringperformance. Financial planning is a process of:

1. Analyzing the financing and investment choices open to the firm

2. Projecting the future consequences of present decisions in order to avoid surprisesand understand the link between present and future decisions

3. Deciding which alternatives to undertake

4. Measuring subsequent performance against the goals set

A completed financial plan for a large company is an important document. The planshould present proforma balance sheets, income statements and statementsenumerating sources and used of cash. The plan must describe planned capitalexpenditure and by division or line of business. Most plans contain a summary ofplanned financing together with narrative backup as necessary. This part of the planshould logically include discussions on areas where funds are to be used and specifyvaried avenues for generation of funds. Of course, there is no theory or model that leadsstraight to the optimal financial strategy. Many different strategies may be projectedunder a range of assumptions about the future before one strategy is finally chosen.

3.3 KEY FUNCTIONS

Along with planning and procurement of funds, the fund manager is expected to

coordinate the finance function with other functions of the enterprise. A close andproper co-ordination between the functional heads is as important as the financialdepartment alone. The key functions that are usually performed by fund managers aresummarized below.

i) Estimation of capital requirements

ii) Ensuring a fair rate of return to investors


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iii) Determining the suitable source of funds

iv) Laying down the optimum and suitable capital structure for the enterprise.

v) Co-coordinating the operations of various departments

vi) Preparation, analysis and interpretation of financial statements

vii) Negotiating for outside financing

Because of the vital importance of the fund decision, it is essential to set up a sound andefficient organization for the finance functions. The ultimate responsibility of carryingout the fund decision lies with top management. With the growth in the size of theorganization degree of specialization of finance function increases. In medium sizedundertakings funding activities are handled by senior management executive. He isgenerally given the change of credit and collection departments and accountingdepartment, investment departments and auditing department. He is also responsiblefor preparing annual financial reports. He reports directly to the President and Board ofDirectors. However, in large concerns the Fund manager is a top management executivewho participates in various decision making function like raising of funds, acquisition offirms, refinancing of matured debt, floating public issues, entering into sale and leaseback arrangements. In most of the cases, the fund manager holds the rank of VicePresident reporting directly to the president and the board of directors. The reason forentrusting the fund related matters to the hands of top management is attributed to thefollowing factors:

1. Fund decisions are crucial for the survival of the firm. The growth and development ofthe enterprise is directly influenced by the decisions taken by the fund manager.

2. The decisions of a fund manager determine the solvency of the enterprise. As solvencyis determined by the flow of funds, which is the result of the various financial activities,top management being in a position to coordinate these activities retains funds relatedfunctions in its control.

3. The nature of the organization of management of funds will differ from firm to firm. Itdepends on factors like size of the firm, nature of business, funding operation, andfunding philosophy of the firm. The designation of the manager of funds also differsfrom firm to firm. While in some cases he may be known as manager of funds, in othercases be is known as Vice President of finance or Director (Funds operations). The main

function of the fund manager is to manage the firm's funds. His principal duties includeplanning of funds, administering the flow of funds, managing credit floating corporatesecurities for generation of funds, maintaining relations with financial institution andprotecting funds and securities. The management of funds - a very valuable resource - isa business activity calling for extra-ordinary skill and aptitude on the part of fundmanager.

3.4 SUMMARY


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The basic purpose of management of funds is to ensure that sufficient capital isprocured at the minimum cost of maintaining adequate cash on hand to meet therequired current and capital expenditure and to put it in to most productive channels soas to maximize profits. The carried aspects of management of funds include

(i) estimating the capital requirement of the various functions involved,

(ii) determining its capital structure, (iii) finalising the choice of source of finance,

(iv) taking decisions regarding investment of funds in the productive channels,

(v) a wise and efficient management of funds, (vi) implementation of effective financialcontrol.

In every origination, funds are required for various ventures and projects. The quantumof allocating the timing of allocation and manner of allocating of funds to a particularproject deserves special mention in the case of every firm. The management has to loaninto the pros and cons of each project, the amount of funds necessary for them and thesources from which to raise/augment the required resources. In the present competitivechanging corporate scenario, the fund manager is required to act as intermediary,standing between the firm's operations and capital markets. The market timings forresource mobilization, the use of funds in the firm's operations, the generation of fundsby the firm's operations and the investment of finds in the most profitable channel areimportant aspects of management of funds.

The Funds manager is required to take the role of a financial planner. Financialplanning is necessary because investment and financing decisions interact and shouldnot; be made independently. In fact, financial planning helps to establish concrete goalsto motivate the fund managers and provide standards for measuring performance. Thekey functions that are usually performed by fund managers are summarized below:

i) Estimation of capital requirements

ii) Ensuring a fair rate of return to investors

iii) Determining the suitable source of funds

iv) Laying down the optimum and suitable corporal structure for the enterprise.

v) Coordinating the operations of various departments

vi) Preparation, analysis and interpretation of financial statements

vii) Negotiating for outside financing.

The reason for entrusting the fund related matters in the hands of top management isattributed to the following factors:


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3.7 KEYWORDS

Optional, interpretation, vital, public issues solvency, negotiating, opportunity cost,market value.

- End of Chapter -

LESSON - 4

FINANCIAL SYSTEM AS A BAROMETER OF BUSINESS CONDITIONS

OBJECTIVES

The objective of the lesson is to understand the nature of financial system and its role asa barometer of business of business conditions.

STRUCTURE

4.1 Introduction

4.2 Meaning of financial system

4.3 Structure of financial system

4.4 Financial system and economic developments

4.5 Changing trends in financial sector

4.6 Fund utilization

4.7 Summary


4.9 Assignment Question

4.10 Keywords

4.1 INTRODUCTION


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Savings mobilization and promotion and promotion of investment are functions of thestock and capital markets, which are a part of the organized financial system in India. Itwill be art to start with the nature and function of the financial system. The objective ofall economic activity is to promote the well being and standard of living of the people,which depends on the income and distribution of income in terms of real goods and

services in the economy. The production of output, which is vital to the growth processin the economy, is a function of the many inputs used in the productive process. Theseinputs are material inputs (in the form of physical materials, viz. raw materials, plant,machinery, etc.), human inputs (in the form of labour and enterprise) and financialinputs (in the form of capital, cash and credit). The easy availability of financial inputspromotes the growth process through proper co-ordination between human andmaterial inputs. The financial inputs emanate from the financial system while real goodsand services are part of the real system. The interaction between the real system (goodsand services) and the financial systems (money and capital) is necessary for theproductive process. Trading in money and monetary assets constitute the activity in thefinancial markets and are referred to as the financial system.

4.2 MEANING OF FINANCIAL SYSTEM

The financial system of any country consists of specialize and non-specialized financialinstitutions, of organized and unorganized financial markets, of financial instrumentsand services which facilitate transfer of funds. Procedures and practices adopted in themarkets and financial inter-relationships are also part of the system. These parts are notalways mutually exclusive. For example, financial institutions operate in financialmarkets and are, therefore a part of such markets.

Financial institutions are business organizations that act as mobilizes and depositoriesof savings and as purveyors of credit or finance. They also provide various financial

services to the community. They differ from non-financial (industrial and commercial)business organisations in respect of their wares, i.e., while the former deal in financialassets such as deposits, loans, securities and so on, the latter deal in real assets such amachinery equipments stocks of good, real estates and so on. The activities of differentfinancial institutions may be either specialized or they may overlap; quite often theyoverlap.

Yet, we need to clarify financial institutions and this is done on such bases as theirprimary activity or the degree of their specialisation with relation to savers or theborrowers with whom they customarily deed to the manner of their creation. In otherwords, the functional, geographic sectorial scope of activity or the type of ownership are

some of the criteria which are often used to classify a large number and variety offinancial institutions which exist in the economy.

4.3 STRUCTURE OF FINANCIAL SYSTEM

Financial institutions are also classified as intermediaries and non-intermediaries. Asthe term indicates, intermediaries intermediate between savers and investors, they lendmoney as well as mobilize savings; their liabilities are towards the ultimate savers, while


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their assets are from the investors or borrowers. Non-intermediaries institutions do theloan business but their resources are not directly obtained from the savers. All bankinginstitutions are intermediaries. Many nonbanking institutions also act as intermediariesand when they do so they are known as non-banking financial intermediaries (NBFI,UTI, LIC, and GTC) are some of the NBFI's in India. Non-intermediary institutions like

IDBI, IFCI and NABARD have come into existence because of governmental efforts toprovide assistance for specific purposes, sectors and regions; their creation as a matterof policy has been motivated by the philosophy that the credit needs of certainborrowers might not be otherwise adequately met by the usual private institutions.

4.4 FINANCIAL SYSTEM AND ECONOMIC DEVELOPMENT

The role of money and finance in economic activities is a much-discussed topic amongeconomists. The issue has been looked at differently in various branches of economics.Is it possible to influence the level of economic activities than the level of nationalincome, employment, and so on, through variations in the supply and volume of moneyand credit? How far can economic fluctuations or business cycles be controlled bymanipulating the period of production on the one hand and the monetary factors on theother? How far is development a matter of financing capital formation? The role offinancial system is to accelerate the rate of economic development and thereby improvethe general standard of living and increase the social welfare. This is achieved throughthe mobilization and increase of savings and investment, i.e., by stimulating theaccumulation of capital and by allocating capital efficiently for socially desirable andproductive purposes. This, in turn, is achieved by financial markets by performing anumber important and useful proximate functions or by; providing a number of servicessuch as (i) enabling economic units to exercise their time preference, (ii) separation,distribution, diversification and reduction for risk, (iii) efficient operation of paymentmechanism, (iv) transformation of financial claims so as to suit preferences of the savers

and borrowers, (v) enhancing liquidity of financial claims through securities trading and(vi) portfolio management.

Economic development is to a very great extent dependent on the rate of investment orcapital formation, which, in turn, depends on, whether finance is made available in timeand the quantity of it and the terms on which it is made available. In any economy, in agiven period of time, there are some people whose urgent expenditures are less thantheir current incomes, while there are others whose current expenditures exceed theircurrent incomes.

A financial system also directly helps to increase the volume and rate of savings by

supplying diversified portfolio of financial instruments, offering investmentinducements and choices, which are in keeping with the array of savers preferences. Itbecomes possible for the deficit spending units to undertake more investmentexpenditure because the financial system enables them to command more capital.


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Financial System

As Schum Peter has said, without the transfer of purchasing power to him, anentrepreneur cannot become the entrepreneur.

A financial system not only encourages investment, it also efficiently allocates resourcesin different investment channels. It helps to sort out and investment projects bysponsoring, encouraging and selective supporting of business units or borrowersthrough projects appraisal, feasibility studies, monitoring and generally keeping a watchover the execution and management of projects. It plays a positive and catalytic role byproviding finance or credit through creation of credit in anticipation of savings. This to acertain extent ensures the independence of investment from saving in a given period of

time.

Another contribution of a well-developed financial system is to facilitate the normalproduction process and exchange of goods and to enlarge markets over space and time.In other words, financial system enhances the efficiency of the function of medium ofexchange and thereby helps in economic development. The relationship betweeneconomic development and financial development is symbiotic or mutually reinforcing.In the words of Schum Peter, 'the money markets is always... the head quarters of thecapitalist system, from which orders go out to its individual divisions, and that which isdebited and decided there is always in I essence the settlement of plans for furtherdevelopment. All kinds of credit requirements come to this market; all kinds ofeconomic project are first brought into relation with each other and contend for theirrealization in it; all kinds of purchasing power flows to it to be sold. This gives rise to anumber of arbitrage operations and intermediate maneuvers, which may easily veil thefundamental thing.... Thus, the main function of the money or capital market is tradingin credit for the purpose of financial development. Development creates and nourishesthis market. In the course of development, it becomes the market for sources of incomethemselves.


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The Indian Financial System was fairly well developed even on the eve of planning. Thepolitico-economic background of the financial development in India had beendetermined by the nature of our planned, mixed economic system. Some of the markedfeatures of Indian economy during the past forty years are continuous inflation,increasing internal (fiscal) and external deficits, industrialization, urbanization and

significant structural transformation. Functioning within these parameters all sectors ofthe economy has undergone significant changes including the financial markets.

The average maturity period of financial claims in India has tended to increase over aperiod of time. This has been due to

a) An increase in savings in the ling-term claims like life policies provident funds,National savings, Certificates National Savings Scheme and a variety of papers.

b) Lengthening of the average maturity period of the marketable debt of the governmentand

c) Lengthening of the average maturity period of bank deposits.

The financial system has now become much more integrated than ever before. Thedividing lines between the so-called organized and unorganized sectors between thebusy and slack seasons are getting increasingly imperceptible. Among the factors thatare behind greater integration are:

a) The government entry in a very big way in the wholesale trading of a large number ofcommodities

b) An unprecedented expansion of the network of rural branches of banksc) The transformation in the perception of the role of financial institutions.

4.5 CHANGING TRENDS IN FINANCIAL SECTOR

The financial sector in India today, is almost entirely owned and controlled by thegovernment. The policies of public ownership administrative regulations and controlsand consolidation have led to the growth of monopolistic/oligopolistic market structuresin the Indian Financial sector. The unparalleled government control of financialinstitutions can hardly be said to have served the objectives of social justice. Thegovernment-owned and government controlled financial system has in fact promotedthe interests of large private business organizations; it has helped rather than curbed the

concentration of economic power in the hands of the powerful. The authorities gaveremoved certain regulations in respect of the stock market and the interest rate ceilingin the call money market. Banks have been relieved from ceiling on their lending rates;the credit Authorization Scheme has been discontinued.

The Indian Financial System is still far away from being internationalized andglobalized. But there has been an increase in the extent of participation by India in theinternational financial markets. This was possible through flows of funds to India from


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abroad on many levels. The foreign business of domestic commercial banks and foreignbanks business in India have increased. Institutions have Unit Trust of India havecreated funds to mobilize financial resources abroad. The numbers of foreigncollaborations and joint ventures abroad have contributed to the establishment oflinkages between Indian and foreign financial markets. There has been a remarkable

transformation in the perception regarding the roles of different financial institutions.Statutory financial institutions which have been established to provide long term findsto the private sector, medium and large-sized units, how to provide funds includingworking capital funds to the small-scale units. The public sector units now raise largeamount of funds directly from the capital market through bonds and deposits.

The growth of the financial system would appear to have the following elements:

i) Sometimes it has taken place in sports, cycles, temporary booms and unusual waysand had not been long-lasting

ii) It has taken place at the initiative so the government

iii) It has been boosted by fiscal concessions

iv) It had an element of internal contradiction

4.6 FUND UTILISATION

Many companies used to boost their profits with the help of trading income cheap fundswere raised abroad and invested in the local financial markets and quick profits weremade rather than to invest in projects. Foreign investors have started voicing theirconcern about how funds raised through GDRs are often misused by Indian companies.Now that such investments have turned illiquid, companies are unable to convert thefunds back to productive investments. The demand for funds from government throughad hoc treasury bills has considerably reduced funds available for private sector.According to statistics, in April, 1995, the Central Government borrowed Rs.11,050crores which is 4-times the Rs.2,524 crores borrowed in April 1994. The level of adheretreasury bills issued by the Government crossed the 'within the year ceiling' of Rs 9000crores forcing the Reserve Bank to issue fresh Government paper to bring down theadhoccreation.

Privatisation and Liberalisation

The India corporate sector is now experiencing a new kind of transition and it is gearingwell to adopt this transaction smoothly and without disturbing the pace of progress.Experts fear that long-term damage of Asia's environment and warn that failure to inputenvironmental costs into infrastructure and development may harm the quality of life.Many Asian countries are too busy trying to catch up with richer neighbors and the westand often leave environmental issues to be dealt with after becoming richer. Thispollute-now-pay later principle is turning farms into commercial property, while rice,paddy fields, plantations and hillsides are being turned into sugar highways and


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shopping malls. Getting Du Pont out of Goa on environmental ground is a welcome stepbut is a unwelcome step as far as Tamilnadu is concerned.

We have to avoid our traditional approach of "end of the pope solution" and adopt"womb to tomb" approach where every aspects right from the conceptual stage to

disposal stage are studied carefully to avoid environment pollution and try recycling ofwastes to produces useful products from them.

Rating

The foreign investors who can be classified into equity investors and debt financiers areguided by the overall rating by established agencies like 'Moody's and 'Standard andPoor', it is to be pointed out that India has maintained its BBT long-term foreigncurrency rating according to 'Standard and poor'.

Financial Services

India's gain in the recently concluded negotiations in Financial Services under theUruguay Round, especially in movement of personnel is yet to be assessed. According toour Finance Minister, Mr. P. Chidambaram, the rule-banded World Trade Organizationwill help developing countries. Thus in the emerging global scenario, there could be nobarriers to the flow of goods, services and capital between countries.

The IMF is focusing its attention on the health and viability of financial systems becauseall national economies are integrating into one global financial network. For this, oneneeds to integrate national policies with the rest of the world and this is important bothin trade in goods and services and financial services. In most industrialized countriescapital moves very freely and in order to survives in such an environment countries haveto focus on monetary policies and mechanisms through which they are implemented.

According to statistics, the revenue deficit stayed at around 2.6 to 2.7% of GDP duringthe entire period of 1985-90 while it ranged lower between 0.2 - 1.8% of GDP in 1980-85whereas it has set to sharp increase now. Hence, while many of the financial suchreforms are desirable, one should not come to a negative conclusion against the policy ofeighties just because it does not suit no According to IMF," the continuing large deficitand high level of public debated less raise concerns about the sustainability of fiscalpolicy. Increasing pressures on real interest rates have already emerged and thesethreaten to crow out private investment. These fiscal pressures underscore the need tostrengthen State finances given the risk that fiscal adjustment at the central level could

be undermined by expansionary policies by states". Social welfare schemes such as foodand fertilizer subsidy, higher government wages will add to the burden. Foreignexchange reserve has come down by two billion. FIIs are expected to wait and watchbefore sloughing further fund into the capital market in the wake of sharp depreciationin the value of rupee against US dollar. Market experts feel that inflow of money fromFIIs might come down in the near future. This development will enhance theinflationary rate, which can be controlled only by RBI taking stringent measures withthe objective of maintaining the value of the rupee. The RBI can emulate its counterpart


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in Germany, the Bundles bank, which could address itself firmly to its Central objectivesof maintaining the value of the Deutschemark. In the 1992 currency crisis in Europe, theDM stood strongly in its place because the Bundles bank helps on to a high interest ratein spite of the large borrowing programmed of government to finance reconstruction inEastern Germany.

According to Dr. Sukhamoy Chakravarthy, "The Indian Planning and Fiscal System arefragile and may not be able to stomach sky high interest rates, especially for theinfrastructure". This holds good even today.

4.7 SUMMARY

This term financial system is a set of complex and closely intermixed financialinstitutions, markets, instruments, services, practices and procedures. The financialinputs emanate from the financial system while real goods and services are part of thereal system. The interaction between the real system (goods and services) and thefinancial systems (money and capital is necessary for the productive process. Trading inmoney and monetary assets constitute the activity in the financial markets and arereferred to as the financial system. The financial system of any country consists ofspecialised and non-specialized financial institutions, of organized and unorganizedfinancial markets, of financial instruments and services, which facilitate transfer offunds. Procedures and practices adopted in the markets, and financial inter-relationships are also part of the system. These parts are not always mutually exclusive.For example, financial institutions operate in financial markets and are therefore a partof such markets. The word 'System, so the term 'financial system' implies a set ofcomplex and closely connected are intermixed institutions, agents, practices, markets,transactions, claiming and liabilities in the economy.

Financial institutions are business organizations that act as mobilizes and depositoriesof savings and as purveyors of credit or finance. They differ from non-financial(industrial and commercial) business organizations in respect of their wares, i.e., whilethe former deal in financial assets such as deposits, loans, securities, and so on, thelatter deal in real assets such as machinery equipment, stocks of good, real estates andso on. The activities of different financial institutions may be either specialized or theymay overlap; quite often they overlap.

The role of financial system is to accelerate the rate of economic development andthereby improve the general standard of living and increase the social welfare. This isachieved through the mobilization and increase of savings and investment, i.e., by

stimulating the accumulation of capital and by allocating capital efficiently for sociallydesirable and productive purposes. This, in turn, is achieves by financial markets byperforming a number of important and useful proximate functions or by providing anumber of services such as (i) enabling economic units to exercise their time preference,(ii) separation, distribution, diversification and reduction of risk, (iii) sufficientoperation of payment mechanism, (iv) transmutation or transformation of financialclaims so as to suit preferences of the savers and borrowers, (v) enhancing liquidity offinancial claims through securities trading and (iv)port folio managements.


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A financial system not only encourages investment, it also efficiently allocates resourcesin different investment channels. It helps to sort out and investment projects bysponsoring, encouraging and selective supporting of business units or borrowersthrough projects appraisal, feasibility studies, monitoring and generally keeping a watchover the execution and management of projects. The financial system has now become

much more integrated than ever before. The dividing lines between the so-called'organised' and unorganized sectors between the busy and slack seasons are gearingincreasingly imperceptible. The growth of the financial system would appear to have thefollowing elements:

i) Sometimes it has taken place in sports, cycles, temporary booms and unusual waysand has not been long-lasting

ii) It has taken place at the initiative of the government

iii) It has been boosted by fiscal concessions

iv) It had an element of internal contradiction

KEY CONCEPTS

Financial System: It is a set of complex and closely intermixed financial institutions,markets instruments, services, practices, and procedures.

Financial Markets: they are centers or arrangement that provides facilities for buyingand selling of financial claims and services.

Financial Integration: It refers to the establishment of close and close inter-linkagesbetween various parts and subparts of the financial system so that interest ratesdifferentials are minimized.

Financial Liberalization: It refers to the policy so reducing or removing completelythe legal restrictions, physical to administrative or direct controls, restrictions on flowsof funds etc.


1. Define Financial System" system.

2. Explain the nature and structure of financial

3. Explain the role of financial system in business conditions. Bring out the relationshipbetween financial system and economic development.

4. Write short notes on:

a) Financial markets


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b) Financial integration

c) Financial liberalization


1. Explain the part played by Indian financial system in economic development of India.

4.10 KEYWORDS

Surplus, deficit, mobilization NABARD, institution diversification, liberalization, fiscalpolicy, foreign investors.

- End of Chapter -

LESSON - 5

FINANCIAL PLANNING, ANALYSIS AND CONTROL

OBJECTIVES

The main objective of the lesson is to acquire adequate knowledge on financial planning,financial analysis and control.

STRUCTUE

5.1 Introduction

5.2 Financial Planning - Meaning

5.3 Need for financial planning

5.4 Steps involved in financial planning

5.5 Financial analysis - Meaning

5.6 Significance of financial analysis

5.7 Object of analysis


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5.8 Procedure of analysis

5.9 Main tools/techniques of financial analyses

5.10 Financial control - meaning

5.11 Aims of control

5.12 Techniques of financial control

5.13 Summary



5.16 Keywords

5.1 INTRODUCTION

Management of funds is properly viewed as an integral part of overall managementrather than as a staff especially concerned with the fund-raising operations only.Though, the financial executive is deeply involved in this process, his mainresponsibility in respect of such decisions is to provide all the necessary accountinginformation analysis and discuss the various alternatives and to suggest suitablesolutions.

5.2 FINANCIAL PLANNING MEANING

Financial planning involves the determination of objectives policies and proceduresrelating to the function of finance. The financial policy and procedure that areincorporated in sound financial planning act as broad guides in the procurement,administration and disbursements of funds. Financial planning is an essential functionthat is to be performed by the financial manger not only in the case of an entirely newenterprise, but also in the case of an established one. This is because financial planningis part of the overall planning of any business. An ideal financial planning is expected toensure not only the simply of adequate and proper funds at minimum possible cost, but-also take the necessary steps for its proper utilization and administration. The functionof financial planning is first performed by the promoter at the time of the flotation of the

company, which is later on taken care of by the financial manager and the topmanagement in subsequent stages. Financial planning is the question of a firm's long-term growth and profitability and investment and financing decisions. It focuses onaggregative capital expenditure programmes and debt - equity mix rather than theindividual projects and sources of finance.

5.3 NEED FOR FINANCIAL PLANNING


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The need for financial planning in a concern cannot be over emphasized. As a short-term aspect of financial planning, it ensures the balanced flow of funds so that the firmmay be able to meet its commitments. As a long-term aspect of planning, it becomes atool of efficient use of financial resources. The need for financial planning arises toensure the following.

i) Availability of sufficient cash for meeting expenses, emergencies and contingencies.

ii) To maintain the necessary liquidity throughout the year.

iii) To indicate the point of time when funds will be required and how much.

iv) To indicate the surplus resources available for expansion or external investments.

v) To provide ahead for any more funds, if required

vi) To increase the confidence in the minds of the suppliers of funds by adoptingsuitable financial policies.

Financial Forecasting and Planning

1. Financial forecasting and planning calls for a considerable expertise and special skillon the part of the financial manager/controller. It involves three major aspects(activities), viz.

2. Making a clear-cut and reliable financial analysis so as to ascertain the capabilitiesand needs of the enterprise.

3. Making systematic prediction of the needs for funds over the short-run operatingperiod, including (a) cash flow (b) cash budgets (c) sources of current capital.

4. Ascertaining the actual need for funds over along run period including (a) investmentfund flow (b) capital budgets (c) alternative capital expenditure proposals (d) cost ofcapital and (e) conditions of the capital market.

Financial forecasting and planning involves two major activities, viz. (1) FinancialAnalysis and (2) Evaluation of investment opportunities.

Financial planners are not concerned solely with forecasting for they need to worry

about unlikely events as well as likely ones. If you think ahead about what could gowrong, then you are less likely to ignore the danger signals and you can react faster totrouble. Financial planning does not attempt to minimize risk. Instead it is a process ofdeciding which risks to take and which are unnecessary or not worth taking.

5.4 STEPS IN FINANCIAL PLANNING

The following steps are involves in financial planning:


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1. Analysis of the firm's past performance to ascertain the relationship between financialvariables, and the firm's financial strengths and weaknesses.

2. Analyses of the firm's operating characteristics product, market, competition, andproduction and marketing policies, control systems, operating risk etc. to decide about

its growth objective.

3. Determining the firm's investment needs and choices, given its growth objective andoverall strategy.

4. Forecasting the firm's revenues and expenses and need for funds based on itsinvestment and dividend policies.

5. Analysis financial alternatives within its financial plans for the long-term health andsurvival to firm.

6. Evaluating the consistency of financial policies with each other and with the corporatestrategy.

5.5 FINANCIAL ANALYSIS

Financial Analysis is concerned with the analysis of financial statements such asbalance sheet profit and loss account, etc. Broadly, the term financial analysis is appliedto almost any kind of detailed inquiry into profitability of the firm and to plan for futureoperations. For all this, they have to study the relationship among various financialvariables in a business as disclosed in various financial statements. The analysis offinancial statements is an attempt to determine the significance' and meaning of thefinancial statements data so that the forecast may be made of the future prospects forearnings, ability to pay interest and debt maturities (both current and long term) andprofitability.

5.6 SIGNIFICANCE OF FINANCIAL ANALYSIS

Users of financial statements can get better insight about financial strengths andweaknesses of the firm it they properly analyses information reported in thesestatements. Management should be particularly interested in knowing financialstrengths of the firm to make their best use and to be able to spot out financialweaknesses of the firm to take suitable corrective actions. The future plans of the firmshould be laid down in view of the firm's financial strengths and weaknesses. Thus,

financial analyses is the starting point for making plans, before using and sophisticatedand planning procedures.

The first task of the financial analysis is to select the information relevant to thedecisions under consideration from the total information contained in the financialstatement. The second step involved in financial analysis is to arrange the informationin a way to highlight significant relationships. The final step is interpretation anddrawing of inferences and conclusions.


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5.7 OBJECTS OF FINANCIAL ANALYSIS

The following are the main objectives of the analysis of financial statements.

1. To estimate the earning capacity of the firm.

2. To gauge the financial position and financial performance of the firm.

3. To determine the long-term liquidity of the funds as well as solvency.

4. To determine the debt capacity of the firm.

5. To decide about the future prospects of the firm.

5.8 PROCEDURE OF ANALYSIS

A common procedure of analysis of financial statements, whether done by anyinterested party, will be as follows:

1. Deciding upon the Extent of Analysis

First of all the depth, object and extent of analysis will be determined by the analyst.The determination of these basic facts determines the scope of analysis, tool of analysisand the amount and quality of financial data to be required. For example, to measurethe financial position of the firm, the balance sheet of the firm will be analyzed.

2. Going through the Financial Statements

Before analyzing and preparing any statements or composing financial ratios, it isnecessary for the analyst to go through the various financial statements of the subjectfirm.

3. Collection of Necessary Information

The analyst should collect other useful information from the management, which isuseful for analysis but not being revealed from the published financial statements.

4. Rearrangement of Financial Data

Before making actual analysis and interpretation, the analyst must rearrange the dataprovided by these statements in useful manner. The approximation of figures, re-classification of items, etc. is done in this step.

5. Analysis

Now the actual analysis is made. For analysis any of the above technique may be used.


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6. Interpretation and Presentation

After analyzing the statements the statements the interpretation is made and theinferences drawn from these analyses are presented in the shape of reports to themanagement, etc.

Financial Analysis

It involves three things, viz.,

1. Arriving at financial ratios to make effective comparative evaluation of several aspecthaving bearing on the financial requirements of the enterprise.

2. Making funds flow analysis including the preparation of a cash flow statementdetermining the requirements of

i) Working capital for short - range, and

ii) Fixed capital for long range and

3. Assessing cost of capital and return on investment.

The analysis gives an indication of i) the operating weaknesses of the firm; ii) itspotential capacity as well as, iii) the volume and types of financing required for enablingthe enterprise in question to accomplish the management's objectives. Let us try toknow more about these aspects.

5.9 MAIN TOOLS OF ANALYSIS (TECHNIQUES OF ANALYSIS)

To analysis the financial statements of a firm the popular tools of analysis are as follows:

1. Construction of Financial Ratios or Ratios Analysis

2. Preparation of comparative statements

3. Preparation of fund flow statement

4. Study of average

5. Trend study

Ratio Analysis

Financial analysis can be made very effectively on the basis of (i) the historicalaccounting records of the enterprise and (ii) the appropriate industry standards.Financial ratios are to be arrived at in this regard because they serve as guide - posts forthe management by enabling it to identify the areas requiring financial attention. The


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Financial Manager can prepare a check-list to make an effective comparison of theperformance of his enterprise with the norms that are applicable to the concernedindustry as a whole. For instance an imaginary check - list which is given below in thefollowing table can give same minimum idea to the financial manger in his attempt tomake an effective financial analysis. He can, of course strengthen the utility of these

comparisons with the appropriate data applicable for several consecutive accountingperiods. It should, however, be remembered that norms that are made use of in thefollowing Table are jest for illustrative purposes only. As such, in practice, he shouldobtain the norms from sources that collect information on the specific industry withwhich he is concerned.

Measures for Evaluating Financial Performance:

Name of the Ratio and Suggested Formula:

1. Liquidity Ratio:They measure the ability of the firm to meet its maturingobligations. They are also called Measures of solvency. They include:

(A 2:1 ratio of current assets to current liabilities is generally accepted as satisfactory)

(A 1:1 ratio of cash and its equivalent to current liabilities is generally acceptable assatisfactory)

2. Leverage Ratios:They measure the contribution of financing by owners comparedwith financing provided by creditors.

Total debt

i) Debt to Equity Ratio = -----------------

Equity


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Net profit before fixed charges

ii) Coverage of Fixed Charges Ratio = ---------------------------------------

Fixed charges

Current Liability

iii) Current Liability to Equity Ratio = -----------------------

Equity

3. Activities Ratio:Measure of inventory turnover, they measure the effectiveness ofemployment of resources and include:

Cost of goods sold (sales)

i) Inventory Turnover Ratio = -----------------------------------------------

Inventory i.e. coverage annual inventory

Sales

ii) Net Working Capital Turnover Ratio = ----------------------------

Net working capital

Sales

iii) Fixed Assets Turnover Ratio = ----------------------

Fixed Assets

Receivable

iv) Average Collection Period Ratio = -------------------------

Average sales per day


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Sales

v) Equity Capital Turnover Ratio = ------------

Equity

4. Equity Capital / Common Stock Ratios: They are measures regarding equityshares / stock and include:

Net income

i) Earnings Per Equity Share Ratio = ------------------------------------------

No. of outstanding Equity shares

Average market price of equity share

ii) Price Earnings Ratio = --------------------------------------------------

Earning per Equity share

5. Profitability Ratio:They include the degree of success in achieving the desiredprofit levels. This group includes:

Gross operating profit

i) Gross Operating Margin Ratio = ---------------------------------

Sales

Net operating profit

ii) Net Operating Margin Ratio = -------------------------------

Sales


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Net profit (income) after taxes

iii) Sales Margin Ratio = --------------------------------------------

Net sales

Net income less tax

iv) Assets Productivity Ratio = --------------------------

Total assets

Net profit after taxes

v) Rate of Return on Equity capital = ------------------------------

Equity capital

Net income (profit) after losses

vi) Rate of Return on Total Invested Capital = --------------------------------------------

Total invested capital

Funds Flow Analysis is a technique of determining the working and fixed capitalrequirements. The operating weaknesses as well as potential capacity of the enterprisecan be clearly understood only when the financial manager succeeds in making aneffective funds flow analysis. Funds flow analysis refers to the analysis of the financialstatements of an enterprise (i.e. its profit and loss account or income and expenditureaccount and balance sheet) for assessing its funds flow and cash flow movements. Thefund flow analysis indicates the changes in the company's financial requirements duringthe current periods besides giving an idea of the sources that were used to meet thesame. In other words, it indicates the net changes in the assets, liabilities and the networth of the enterprise. Besides this it points out the effect of the same upon theenterprise's financial condition pertaining to various types of transactions involved. Forinstance, an increase in the net value of fixed assets hints at an application of funds,whereas an increase in the liabilities drives our attention towards the sources of fundsfrom which the additional liabilities might have resulted.


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The manager of funds may have to establish some measure of quantitative economicrelationships in order to succeed in properly evaluating the relative merits of thealternative investment projects. In other words, he has to establish a criterion, whichcan help him in deciding the ranking of these alternative investment projects so that hecan successfully take a final decision so that he can successfully take a final decision to

select the best. Following are the important methods/approaches that can be made useof by the financial manager in evaluating the investment opportunities and measuringthe productivity of capital.

Whatever the approach or methods be, he should find the difference between the netbenefits that accrue from each alternative and the financial burden incurred, and securesuch benefits.

Among others, those methods or criteria that are regarded as popular can be groupedunder the following two categories, viz.,

Traditional Criteria

1. Payback Period

2. Accounting rate of return

3. Discounted Cash Flow (DCF) Criteria

a) Net present value

b) Internal rate of return

c) Profitability index or benefit -cost ratio.

5.10 FINANCIAL CONTROL

Financial control techniques essentially deal with the execution of the financial plan. Itreveals and measures the extent to which the plan has been pursued and points out thedeviations well in time so that the needed action may be taken. It can therefore betreated as an essential ingredient of a successful financial plan.

By its nature financial control is a thorough control over the cash flows cash accountand other items, which have a direct bearing over the cash position. As in the business

enterprise, every activity directly or indirectly is bound to have its repercussion over thecash resources. So broadly speaking the term financial control can fairly cover the entireoperating activity. Basically it is expenditure control technique and like managementcontrol. It has the following phases:

1. Establishing financial standards:These standards will be set up after financialcosting and engineering studies. The ratios and budgets or past historical data etc, canbe used for this purpose.


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2. Evaluation of performance:It relates with the measuring of actual expenditurewith the planned expenditure. The cost trend in relation to the volume of activity isstudied.

3. Reporting:These reports points out the causes for deviations and suggest the

possible corrective action.

It is exercised through various techniques involving budgets, ratios, statements, chartsand other non-financial procedures. It ensures that the income earned and expenditureincurred conforms to the financial plan as laid down.

5.11 AIMS OF FINANCIAL CONTROL

Financial control makes it possible to attain the financial objective of the businessenterprise as set by its financial plan. Its objectives are therefore the same as that offinancial plan. It has to serve faithfully like a servant to its master. The maintenance ofsolvency calls for a thorough control over the cash flow. Cash must be available to meetthe liabilities as and when they mature. This cash flow control requires control over theinvestments in all types of assets, and expenditures incurred. Any deviation in the cashreceipts from the budgeted level is also to be brought under strict vigilance, cashbudgeted is usually used as an instrument of control for this purpose.

5.12 TECHNIQUES OF FINANCIAL CONTROL

Financial control can be secured by applying techniques of budgeting, ratio analysis,statements, control charts and reports etc.

As all income and expenditure flow through the cash, cash budget serves as one of themajor instruments of control. It lays down the standard to be achieved, measures theperformance with the standards thus asset through budget variations, reports thesevariations and suggests the corrective action proposed. To convert cash budget as aninstrument control, monthly budgets are prepared to show the receipts and expenditure.Thus the monthly budgets are prepared to show the receipts and expenditure. Thus -themonthly budgets will show the change in the cash position. It will also depict theamount of cash, which is available to meet the projected needs or the expectedborrowing needed. Besides cash budget flexible budget can also be used as aninstrument of financial control. It most widely recognized method of financial controlbased on the ratio analysis is Du Pont System. This is very much popular in America. Itensures the realization of the major enterprise objective-profitability as if uses return on

investment as a technique of control.

In this connection the Du Pont organization has developed a series of charts as a part ofits technique of financial control. These carts provide a framework for working backfrom return on investment so as to check at, each critical control point in the operativeactivity of the business firm.


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The net income of the firm, often expressed as a return on capital investment, dependsupon two factors: Turnover of investment and the Margin of profit on sales. This can bedepicted below in the form of a formula:

The investment turnover ratio measures the relationship of total investment as shownby total assets to the total sales. It is virtually the contribution of total assets employedtowards sales. Each item of investment is to be properly controlled. The profit margin isthe ratio of profit to sales. It calls for control of each item the expense on the one handand vigilance on the sales volume on the other hand.

5.13 SUMMARY

Financial planning involves the determination of objective policies and procedurerelating to the function of finance. The financial policy and procedure that areincorporated in sound financial planning act as broad guides in the procurement,administration and disbursements of funds. Financial planning is an essential functionthat is to be performed by the financial manager not only in the case of an entirely newenterprise, but also in the case of an established one.

Financial forecasting and planning involves two major activities, viz., 1. FinancialAnalysis is concerned with the analysis of financial statements such as balance sheet,profit and loss account etc. Broadly, the term financial analysis is applied to almost anykind of detailed inquiry into financial data. A financial executive has to evaluate the pastperformance, present financial position, liquidity situation, enquire into profitability ofthe firm and to plan for future operations.

Financial control techniques essentially deal with the execution of the financial plan. Itreveals and measures the extent to which the plan has been pursued and points out thedeviations well in time so that the needed action may be taken. It can therefore betreated as an essential ingredient of a successful financial plan as without it, a plan willbe pious with but a dead letter. Financial control makes it possible to attain the financialobjective of the business enterprise as set by its financial plan. Financial control can besecured by applying techniques of budgeting ratio analysis, statements, control charts

and reports etc.


1. Explain the need for the financial analysis.

2. How does the ratio technique helpful in financial analysis?


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6.2 Investment Proposals/profitable Opportunities

6.3 Factors Influencing Investment Proposals

6.4 Investment Evaluation Criteria

6.5 Methods Assessing Profitability of Investment Proposals

6.6 Summary



6.9 Keywords

6.1 INTRODUCTION

The selection of the most profitable assortment of capital investment can be consideredone of the important functions of the manager of funds. Decisions taken by themanagement in this area affect the operations of the firm for many years to come. Inmost of the business enterprises, there are innumerable investment proposals for acapital project than the firm is able and willing to fund them. The paucity of resourcescompels the management to choose the most profitable proposal. By choosing the mostprofitable capital project, the management can maximize the worth of equityshareholder's funds. The significance of allocation of funds to most pro

Documents

Management of Funds and Assets