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Functions of Finance Manager & How They Have Changed in Recent Years
Functions of Finance Manager & How They Have Changed in Recent Years
Recent Years
The twin aspects procurement & effective utilization of funds are the
crucial tasks, which the finance manager faces. The financial manger is
required to look into financial implications of any decision in a firm. The
finance manager has to manage funds in such a way as to make their
optimum utilization & to ensure that their procurement is in a manner so
that the risk, cost & control considerations are properly balanced under a
given situation.
Cash Management : Finance manager has to ensure that all sections & units
of organization are supplied with adequate funds. Sections, which have an
excess of funds, have to contribute to the central pool for use in other
sections, which needs funds. Even if one of the 200 retail branches
does not have sufficient funds whole business may be in danger. Hence
the need for laying down cash management & cash disbursement policies
with a view to supply adequate funds at all times is an important function
of a finance manager.
In the last few years, the complexion of the economic and financial
environment has altered in many ways. The important changes has been as
follows:
The industrial licensing framework has been considerably relaxed.
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The Monopolies and Restrictive Trade Practices (MRTP) Act has
been virtually abolished.
The Foreign Exchange Regulation Act (FERA) has been
substantially liberalized.
Considerable freedom has been given to companies in pricing their
equity issues.
The scope for designing new financing instruments has
been substantially widened.
Interest rate ceilings have been largely removed.
The rupee was devalued and, in two stages, has been made
fully convertible on the current account.
Investors have become more demanding and discerning.
The system of cash credit is being replaced by a system of
syndicated loans.
A number of new investment opportunities have emerged in the
money market.
The relative dependence on the capital market has increased.
These changes have made the job of the finance manager more
important, complex and demanding. Here is a sampling of views
expressed by leading finance professionals:
Bhaskar Banerjee of the Duncan Group states, “There has been a
total attitudinal change owners towards the finance manager. He is no
longer referred at as ‘my accountant’. Instead of being a commodity,
the finance manager is now a part of the top management.”
Anand Rathi of Indian Rayon proclaims, “The finance manager’s job
has vastly changed. Earlier it was a support function, now it’s mainline.
And finance itself has been a profit centre.”
Bhaskar Mitter, Corporate Finance Director of ITC asserts, “Today and
in the future, finance heads will face a tremendous challenge to shape
their organisations. A challenge to upgrade accounting practices,
improve reporting systems, utilize the international market for
sourcing finance,
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operate adeptly in the forex market, as well as aid companies to
compete
internationally.”
N. Gopalkrishnan, of Shriram Fibres avows, “The finance man’s job
has become more creative and cerebral than just juggling with
figures. Accounting is no longer means just maintaining log books.”
Hemany Luthra of Ballarpur Industries Limited says, “In the paper
business, the returns may be 16 per cent while in the Agri-business
it may be 20 per cent. So how much to invest in which sector becomes
very crucial. The finance department tells the management where
it should increase its presence and where it should get out from.”
The key challenges for the finance manager in India appear to
be in Investment planning, financial structure, Treasury operations,
Foreign exchange, Investor communication and Management control.
According to Feroz Ahmed and Dilip Maitra in “Money from
Money”, Business Today, September 22, 1992, “Clearly, the clout of
the finance manager is growing along with the change in his role. And
as the reforms in the financial sector gather pace, this trend will
only increase. If the
1970s were the age of the Organization Man and the 1980s that of
the
Marketing Man, the 1990s will be the age of the Finance Man.”
Profit Maximization
It means the rupee income of firms. Firms may function in the market
economy or government economy. In market
economy prices are determined in competitive markets
and those are expected to produce goods and services desired by the
society.
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maximize within socially acceptable limits, profit from the funds use of
funds employed to them.
Wealth Maximization
Accounts receivables
When goods are sold on credit, finished goods get converted into
accounts receivables in the books of the seller. A firm’s investment
in accounts receivables depends upon how much a firm sells on credit and
how long it will take to collect receivable. For example, if a firm sells
Rs. 1 million worth of goods on credit a day and its average collection
period is 40 days, its accounts receivables will be Rs. 40 million. Accounts
receivables (or sundry debtors) constitute the third most important asset
category for business firms after plant equipment and inventories. Hence, it
behoove a firm to mange its credit well.
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Contro l of receivables : Monitoring and controlling of accounts receivables
is often neither very thorough nor systematic. Very few firms have well-
defined systems for monitoring and controlling accounts receivables. The
measures generally adopted by firms for judging whether accounts
receivables are in control are:
Bad Debt Losses
Average Collection Period
Ageing Schedule.
Net Worth
While there is no doubt that the preference shareholders are the owners of
the firm, the real owners are the ordinary shareholders who bear all
the risk, participate in the management and are entitled to all the profits
remaining after all possible claims of preference shareholders are met in full.
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It is probably the single most important ratio to judge whether the firm
has earned satisfactory return for its equity shareholders or not. Its
adequacy is judge by
Comparing with the past records of the same firm
Inter-firm comparison
Comparison with the overall industry average
Capital Employed
Total resources are also known as total capital employed and sometimes as
gross capital employed or total assets before depreciation. Thus total
capital consists of all assets fixed and current. In other words, the total of
the assets side of the balance sheet is considered as total assets
employed.
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ROI = Net Profit X 100
Capital Employed
Thus, the statement prepared to bring out the ratio of each assets or liability
to the tool of the balance sheet and the ratio of each item of expense or
revenue to net sales is known as common size statement.
It has been said that you must measure what you expect to manage
and accomplish. Without measurement, you have no reference to work
with and thus, you tend to operate in the dark.
Advantages
They indicate the direction of the movement of the financial position.
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They can be used to compare the position of the firm every
month or quarter.
It presents a review of the past activities and their cumulative effect.
Disadvantages
They lose their purpose and significance and tend to mislead if
the accounting principle is not applied consistently.
Constant changes in price levels render accounting statements useless
Inter-firm analysis cannot be made, unless the firm is of the same
size, age, and follow the same accounting principles
In this, the figures shown in the financial statements viz. Profit and
loss account and balance sheet are converted in to percentages so as to
establish each element to the total figure of the statement and these
statements are called common size statements. It is useful in analysis of the
performance of the company by analyzing each individual element to
the total figure of the statement. These statements will also assist in
analyzing the performance over the years and also with the figures of the
competitive firm in the industry for making analysis of relative efficiency.
Advantage s:
It reveals the sources of capital and all other sources of funds
and distribution or use or application of the total funds in the assets.
Comparison of common size statement over a period will clearly
indicate the changing proportions of the various components of assets,
liabilities, costs etc.
Comparisons of two or the firms v/s industry as a whole helps in
corporate evaluation and ranking.
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Disadvantages:
It does not show variations in the various account item from period
to period.
It is regarded by many as useless as there is no established
standard proportion of an asset to the total assets or of an item of
expense to net sales.
If the statements are not followed consistently for years then the
common size statement would mislead.
It presents a review of the past activities and their cumulative effect.
Objectives of
Financial Statement Liquidity Analysis
Analysis
Solvency Analysis
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Solvenc y Analysis : It refers to analysis of long-term financial position
of a company. This analysis helps to test the ability of a company to repay its
debts. For this purpose, financial structure, interest coverage are analyzed.
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changes. As a result, balance sheet figures are distorted and profits
are misreported. Hence financial statement analysis can be vitiated.
Variations in accountin g policies : business firms have some latitude
in the accounting treatment like depreciation, valuation of stocks,
research and developmental expenses, foreign exchange transactions
installment sales, preliminary and pre-operative expenses, provision of
reserves, and revaluation of assets. Due to diversity of accounting
policies comparative financial statement analysis may be vitiated.
Interpretation of ratio s: though industry averages and other
yardsticks are commonly used in financial ratios, it is somewhat
difficult to judge whether a certain ratio is good or bad. E.g. a
high current ratio may indicate a strong liquidity position. Likewise,
a high turnover of fixed assets may mean efficient utilization of
plant and machinery. Another problem is that, in interpretation
when a firm has some favorable and some unfavorable ratios. In
such a situation, it may be somewhat difficult to form an overall
judgment about its financial strength and weakness.
Correlatio n amon g ratio s: in view of ratio correlations it is
often confusing to employ a large number of ratios in financial
statement analysis. Hence it is necessary to choose a small
group of ratios, consisting of say six to nine ratios, from the large
set of ratios. Such a selection requires a sharp understanding of the
meaning and limitations of various ratios and a good judgment about
the business of the firm.
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Explain Various Components Of The Given Ratios With Illustrative
Examples
Current Rat io
1. Inventories of Raw Materials, Finished goods, work in progress,
stores and spares
2. Sundry Debtors
3. Short-term loans, Deposits & advances
4. Cash in hand and Cash at bank
5. Prepaid Expenses & Accrued Income
6. Bills Receivable
7. Marketable Investments and short-term securities
Liquid Ratio
Quick Assets and quick liabilities are the two elements of this ratio. All
current assets with the exception of inventories and prepaid expenses are
considered as quick assets. Deposits with customs, excise are not quick
assets. All current liabilities with an exception of bank overdraft and
incomes recd in advance are regarded as quick liabilities.
Proprietar y Ratio
Proprietary Ratio includes equity share capital, preference share capital,
capital reserves, revenue reserves, securities premium, surplus and
undistributed profits.
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Debt equit y Ratio
Shareholders’ funds consist of preference share capital, equity share
capital, capital reserves, revenue reserves and reserves representing
earmark surplus. The amount of fictitious assets is deducted from the above.
Debts represent long-term debts. It includes mortgage loans and debentures.
Operatin g Ratio
The components of this ratio are operating cost and net sales. Net sales is
gross sales less returns, allowances and trade discounts on sales. Operating
cost is the total of cost of goods sold and other operating expenses like
office and administrative expenses and selling & distribution expenses.
They do not include finance expenses & other non-operating cost like taxes
on income, loss on sale of asset etc.
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What is Common Size Statement, Comparative Statement & Trend
Until about the turn of the century, preparation of financial statements was
a part of the work to be done by a bookkeeper. In due course of time,
bankers began to request balance sheets of applicants obviously with a view
to consider the desirability of granting credit. In spite of this, the
statements were hardly used, analyzed and interpreted in the real sense
of these terms. However, in due course of time, they started to
prescribe certain minimum current and liquid ratios for the purpose of
lending and which eventually led to the practice of analysis and
interpretation of financial statements. The growth and
development of management as a science and decision –making accepted as
the most important function of management, have contributed to the
extensive use of analysis of financial statements.
Profitability Analysis
Objectives of
Financial Statement Liquidity Analysis
Analysis
Solvency Analysis
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Method s and device s used in analysi s of financia l statements
1. Comparative Financial Statement
2. Common Size Statement
3. Trend Analysis
4. Cash Flow
5. Fund Flow And Many More
The common size statements are prepared to bring out the ratio of each asset
or liability to the total of the balance sheet and the ratio of each item of
expense or revenue to net sales is know as the common-size statements.
Trend Analysis
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The trend will reveal whether the unit is prospering or deteriorating year
after year. Such analysis of the trend is known as trend analysis. For
example by comparing the sales figures of last 5-6 years one can find
out what is the growth pattern of the sales and what is the percentages of
increase year after year. Similarly by studying trend of cost of sales, cost of
production and other parameters one can infer whether the business is
progressing or deteriorating.
As per the banking norms, the minimum current ratio should be 1:3:1.
It means the current ratio should be 1.33 times more than current liability, to
pay for the current liability in the short-term period.
But in this question its not mentioned which type of industry is to be taken,
so we will take as general and all the banking norms applies on it.
Firstly, the current ratio was 1:1, which means that the current assets
are equal to current liabilities, which is less than the limit mentioned by the
RBI. So, it indicates that company wont be able to pay its short-term creditors
in due course and it may face problem of liquidity in near future. This bad
ratio will also pose negative impression on the creditors and they may not
give any credit facility. Even if the company applies to bank for loan
facility to fund their working capital requirement, they may not give the loan
due to bad ratio i.e. 1:1
Now the ratio of the company has improved to 2.5:1 i.e. current asset are
2.5 times more than current liability which is approximately double of 1:3:1,
as per the banking norms.
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By 2.5:1, we can say that company would be easily able to pay its creditors
in due course of time. Company is solvent and liquid. Company won’t be
able to face any problem of liquidity if its creditors demand for money,
as current assets are 2.5 times more than current liability. If the company
ants to increase its operation or want to go for expansion, them to fund
its working capital requirement, bank would without any problem will shell
out money from their surplus to fund the working capital requirement.
So, at last this improvement in ration is good for the company, which
shows that company is trying to improve their short-term solvency. This
improvement in current ration also indicates that company’s operations are
increasing day- by-day.
Metho d of Calculation
Any of the statements is taken as the base.
Every item in the base statement is stated as 100.
Trend ratios are computed by dividing each amount in the
statement with the corresponding item in the base statement and
the result is expressed as a percentage.
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Precaution s to be taken
While calculating trend percentages, following precautions should be taken:
There should be consistency in the principles and practices followed
by the organization through out the period for which analysis is made.
The base should be normal i.e. representative of the items shown in
the statement.
Trend percentages should be calculated only for the items which
are having logical relationship with each other.
Trend percentages should be studied after considering the
absolute figures on which they are based.
Figures of the current year should be adjusted in the light of price
level changesas compared to the base year
before calculating trend percentages.
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The acid test ratio is a fairly stringent measure of liquidity. It is based on
those current assets which are highly liquid inventories are excluded
from the numerator of this ratio because inventories are deemed to be
the least liquid component of current assets.
By Anonymous MP FAN 21
However, unlike interest payments on debt, dividend payable on
preference shares is not tax-deductible because preference dividend is
not charge on earnings or an item of expenditure; it is an appropriation of
earnings. In other words, they are paid out of after-tax earnings of the
company. Therefore, no adjustment is required for taxes while computing
the cost of preference capital. There are two types of preference shares: i)
irredeemable and ii) redeemable.
Cost Of Debt
The cost structure of a firm normally includes the debt component also.
Debt may be in the form of debentures, bonds, term loans from financial
institutions and banks etc. The debt is carried a fixed rate of interest
payable to them, irrespective of the profitability of the company. Since upon
rate is fixed, the firm increases its earnings through debt financing. Then
after payment of fixed interest charges more surplus is available for the
equity shareholders and hence EPS will increase. An important point to be
remembered that dividends payable to equity shareholders and preference
shareholders is an appropriation of profit, where as the interest payable
on debt is a charge against profit. Therefore any payment towards
interest payable on debt is a charge against profit. Therefore, any
payment towards interest will reduce the profit and ultimately the
company’s liability would decrease. This phenomenon is called
‘Tax shield’. The tax shield is viewed as a benefit accrued to the company
which is geared. To gain the full tax shield the following conditions apply:
If the company makes loss, the tax shield goes down and cost
borrowings increases.
By Anonymous MP FAN 22
Discuss Cash Budget As A Management Tool With Illustrative
Examples
The principle aim of cash budget as a tool to predict cash flows over a
given period of time is to ascertain whether at any point of time there is likely
to be an excess or shortage of cash.
The second element of cash budget is the selection of the factors that
have a bearing on cash flows. The items included in the cash budget
are only cash items. The factors that generate cash flows are
generally divided for the purposes of preparing cash budget into two broad
categories: (a) operating
(b)
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financial. While the former category includes cash flows generated by
the operations of the firms and are known as operating cash flows.
Meaning
Cash budget is a statement showing the estimated cash inflows and
cash outflows over the planning horizon in other words. The net cash
position of a firm as it moves from one budgeting sub period to another is
highlighted by the cash budget.
Objectives
Cash Budget
To coordinate the timing of cash need.
It pinpoints the period when there is likely to be excess cash.
It enables the firm which has sufficient cash to take the
advantage of cash discount on its account payable to pay the
obligations when due to formulate the dividend policy.
It help to arrange needed funds so that the most favourable terms
and prevents the accumulation of excess funds.
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State The Need For Preparing A Cash Budget
Cost of Capital
The cost of capital is the rate of return the company has to pay to
various suppliers of funds in the company. There are variations in the costs
of capital due to the fact that different kinds of investment carry
different levels risk which is compensated for by different levels of return on
the investment.
Financial Leverage
This ratio indicates the effects on earnings by rise of fixed cost funds. It
refers to the use of debt in the capital structure. Financial leverage arises
when a firm deploys debt funds with fixed charge.
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Operating Leverage
Combined Leverage
The operating leverage has its effects on operating risk and is measured by
the percentage change in EBIT due to percentage change in sales. The
financial leverage has its effects on financial risk and is measured by
the percentage change in EPS due to percentage change in EBIT. Since
both these leverages are closely concerned with ascertaining the ability to
cover fixed charges, if they are combined, the result is total leverage and the
risk associated with combined leverage is known as total risk.
By Anonymous MP FAN 26
The market value approach is more realistic for the reasons given below:
The cost of funds invested at market prices is familiar with the investors.
Investments are generally rated by the reference to their earnings
yield, and the company has a responsibility to maintain that yield.
Historic book values have no relevance in calculation of real cost
of capital.
The market value represents near to the opportunity cost of capital.
The funds required for the project are raised from the equity
shareholders, which are of permanent nature. These funds need not be
repayable during the lifetime of the organization.
Hence it is a permanent source of funds. The
equity shareholders are the owners of the company. The main objective of
the firm is to maximize the wealth of the equity shareholders. Equity share
capital is the risk capital of the company. If the company’s business is doing
well the ultimate beneficiaries are the equity shareholders who will get the
return in the form of dividends from the company and the capital
appreciation for their investment. If the company comes for
liquidation due to losses, the ultimate and worst sufferers are the equity
shareholders. Sometimes they may not get their investment
back during the liquidation process.
Profits after taxation, less dividends paid out to the shareholders, are
funds that belong to the equity shareholders which have been
reinvested in the company and therefore, those retained funds should be
included in the category of equity, the cost of retained earnings is
discussed separately from cost of equity capital. The cost of equity may be
defined as the minimum rate of return that a company must earn on the
equity financed portion of an investment project so that market price of
the shares remain unchanged. The
following methods are used in calculation of cost of Equity.
Dividend yield method: The dividend yield per share is expected on the
current market price per share
By Anonymous MP FAN 27
KE = Dividend X 100
Market price
By Anonymous MP FAN 28
Types of Risk
Risk
Market Risk
Inflation Risk
Internal External
Systematic Risk
When the stock market is bullish, prices of all stocks indicate rising trend
and in the bearish market, the prices of all stocks will be falling. The
systematic risk cannot be eliminated by diversification of portfolio,
because every share is influenced by general market trend. This type of
risk will arise due to the following reasons.
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Marke t Risk
Variations in price sparked off due to real social, political and economic
events is referred to as market risk.
Inflation Risk
Uncertainties of purchasing power is referred to as risk due to inflation.
If investment is considered as consumption sacrificed, then a person
purchasing securities foregoes the opportunity to buy some goods or services
for so long as he continues to hold the securities. In case, the prices of
goods and services, increases during this period, the investor actually looses
purchasing power.
Unsystematic Risk
Unsystematic risk refers to that portion of the risk which is caused due
to factors unique or related to a firm or industry. The unsystematic risk is
change in the price of stocks factors unique or related to a firm or
industry. The unsystematic risk is the change in the price of stocks due to
the factors which are particular to the stock. For example, if excise duty
or customs duty on viscose fibre increases, the price of stocks of synthetic
yarn industry declines. The unsystematic risk can be eliminated or
reduced by diversification of portfolio. The unsystematic risk will arise due
to the following reasons:
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Interna l Business Risk
Internal business risk is associated with the efficiency with which a
firm conducts its operations within the broader environment imposed upon it.
Financia l Risk
Financial Risk is associated with the capital structure of a firm. A firm with
no debt financing has no financial risk. The extent of financial risk depends on
the leverage of the firm’s capital structure.
Collection Cost
Default Cost
The firm may not be able to recover the over dues because of the mobility of
the customers. Such debts are created as bad debts and have to be written
off, as they cannot be realized. Such costs are known as default costs
associated with credit sales and accounts receivable.
Capital Cost
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employees and suppliers of raw materials, thereby implying that the
firm should arrange for additional funds to meet its own obligations while
writing for payment from its customers. The cost on the additional capital to
support credit sales, which alternatively could be profitably employed
elsewhere, is, therefore, a part of the cost of extending credit or receivables.
Delinquency Cost
This cost arises out of the failure of the customers to meet their
obligations when payment on credit sales becomes due after the expiry of the
credit period. Such costs are called delinquency costs. The important
components of this cost are: (1) blocking up of funds for an extended
period, (2) cost associated with steps that have to be initiated to collect
the over dues, such as, reminders and other collection efforts, legal charges,
where necessary, and so on.
Del-Credre Commission/Agent
Sometimes a customer fails to pay on the due date. The following procedure
will help in efficient collection of overdue receivables:
A reminder
A personal letter
Several telephone calls
Personal visit of sales man
A telegram
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A visit from salesman responsible to customer
A reminder to the sales person that commission is based on
cash received not on invoiced sales.
Restriction of credit
Use of collection agencies
Legal action, as a last resort
Treasury Bills
Bills Discounting
Under this system, a borrower can obtain credit from the bank against the
bills. The amount provided under this system is covered within the
overall cash credit or overdraft limit. Before purchasing or discounting the
bills, the bank satisfies itself as to the creditworthiness of the drawer.
Though the term “bills payable” implies that the bank becomes owner of
the bills but in practice the bank holds bills as security for the credit. A
bill discounted, the borrower is paid the discounted amount of the bill. A
bank collect full amount of maturity.
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Three Month s Deposit : These are more popular in practice.
These deposits are taken from borrowers to tide over a short
term cash inadequacy that may be caused by one or more of the
following factors: disruption in production, excessive
imports of raw materials, tax
payment, delay in collection, dividend payment and unplanned
capital expenditure. The interest rate on such deposits is around 18%
p.a.
Six Month s Deposits: Normally, lending companies do not
extend deposits beyond this time frame. Such deposits usually made
with first class borrowers. These deposits carry an interest rate of
around 20% p.a.
Phase 3 Receivables
Cash
Phase 2
Inventory
Phase 1
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The operating cycle consists of three phases. In phase 1, cash gets
converted into inventory. This includes purchase of raw materials,
conversion of raw materials into work-in-progress, finished goods and finally
the transfer of goods to stock at the end of the manufacturing process.
In the case of trading organizations, this phase is shorter as there would be
no manufacturing activity and cash is directly converted into inventory. This
phase is totally absent in the case of service organizations.
The last phase, phase 3 represents the stage when receivables are
collected. This phase completes the operating cycle. Thus, the firm has
moved from cash to inventory, to receivables and to cash again.
The term “Cash” with reference to cash management is used in two senses.
In a narrower sense it includes coins, currency notes, cheques, bank drafts
held by a firm with it and the demand deposits held by it in banks. In a
broader sense it includes “near-cash assets” such as marketable securities
and time deposits with banks. Such securities or deposits can immediately
be sold or converted into cash if the circumstances require.
By Anonymous MP FAN 36
firm enters into a variety of transactions to accomplish its objectives,
which have to be paid for in the form of cash. For example, cash payments
have to be made for purchases, wages, operating expenses, financial
charges like interest, taxes, dividends and so on. Similarly, there is a
regular inflow of cash to the firm from sales operations, returns on outside
investments, etc.
By Anonymous MP FAN 37
Options For Investing In Surplus Funds
Companies often have surplus funds for short periods of time before they
are required for capital expenditures, loan repayment, or some other
purpose. These funds may be deployed in a variety of ways. At one end of the
spectrum is the term deposit (to be made for the minimum period of 46
days) in a bank, virtually a risk free investment that offers a relatively
modest rate of interest: at the other end of the spectrum is the
investment in equity shares, which can produce highly volatile returns.
In between lie units, public sector bonds, treasury bills, Intercorporate and
bill discounting.
By Anonymous MP FAN 39
(3) Commercia l paper
It refers to a short-term unsecured promissory note sold by large business
firms to raise cash. As they are unsecured, the issuing side of the
market is dominated by large companies, which typically maintain sound
credit ratings. Commercial paper can be sold either directly or through
dealers.
(6) Units
The units of Unit Trust of India (UTI) offer a reasonably convenient
alternative avenue for investing surplus liquidity as (a) there is a very
active secondary market for them, (b) the income form units is tax-
exempt up to a specified amount and (c) the units appreciate in a fairly
predictable manner.
Transactio n costs associated with raising cash to tide over the shortage.
This is usually the brokerage incurred in relation to the sale of some
short-term near-cash assets such as marketable securities.
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complete accuracy. The first requirement is a precautionary cushion to
cope with irregularities in cash flows,
unexpected delays in collections and disbursement, defaults
and unexpected cash needs.
Working Capital
The value represented by these assets circulates among several items. Cash
is used to buy raw materials, to pay wages and to meet other
manufacturing expenses. Finished goods are produced. These are held as
inventories. When these are sold, accounts receivables are created. The
collection of accounts receivables brings cash into the firm. The cycle starts
again.
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Current liabilities are the debts of the firms that have to be paid
during the current accounting period or within a year. These include:
Creditors for goods purchased
Outstanding expenses i.e., expenses due but not paid
Short-term borrowings
Advances received against sales
Taxes and dividends payable
Other liabilities maturing within a year
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assets will be financed by the long-term sources and any fluctuations over
the minimum level of current assets will be financed by the short-term
financing. Sometimes core current assets are also referred to as ‘hard
core working capital’.
Net Working Capital is the excess of current assets over current liabilities,
i.e. current assets less current liabilities.
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This concept of working capital is widely accepted. This approach,
however, does not reflect the exact position of working capital due to
the following factors:
Valuation of inventories include write-offs
Debtors include the profit element
Debts outstanding for more than a year likewise debtors which
are doubtful or not provided for are included as asset are also placed
under the head ‘current assets’
Non-moving and slow-moving items of inventories are also
included in inventories, and
Write-offs and the profits do not involve cash outflow
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The period required to complete this flow is called ‘the operating period’ or
‘the operating cycle’.
Bills Discounting : Under this system, a borrower can obtain credit from
the bank against the bills. The amount provided under this system is
covered within the overall cash credit or overdraft
limit. Before purchasing or discounting the bills, the
bank satisfies itself as to the creditworthiness of the drawer. Though the
term “bills payable” implies that the bank becomes owner of the bills but in
practice the bank holds bills as security for the credit. A bill discounted, the
borrower is paid the discounted amount of the bill. A bank collect full
amount of maturity.
iv. Investors who intend holding it till its maturity usually buy
commercial paper. Hence, there is no
well-developed secondary market for
commercial paper.
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Inte r Corporate Deposits: A deposit made by one company with
another, normally for a period up to six months, is referred to as inter
corporate deposit. Such deposits are usually of three types;
a) Call Deposits : A call deposit is withdrawable by the lender on giving
a days notice. In Practice, however the lender has to wait for at
least three days. The interest rate on such deposit may be around
16% p.a.
b) Three Month s Deposit: These are more popular in practice.
These deposits are taken from borrowers to tide over a short
term cash inadequacy that may be caused by one or more of the
following factors: disruption in production, excessive imports of
raw materials, tax payment, delay in collection, dividend payment
and unplanned capital expenditure. The interest rate on such deposits
is around 18% p.a.
c) Six Month s Deposits: Normally, lending companies do not
extend deposits beyond this time frame. Such deposits usually made
with first class borrowers. These deposits carry an interest rate of
around 20% p.a.
Other features of the preference capital include the call feature, wherein
the issuing company has the option to redeem the shares, (wholly or partly)
prior to the maturity date, at a certain price. Prior to the Companies
Act, 1956 companies could issue preference shares with voting rights.
However, with the commencement of the Companies Act, 1956 the issue of
preference shares with voting rights has been restricted only to the following
cases:
Term loans: Term loans are directly from the banks and financial
institutions in India. Term loans are generally obtained for financing
large expansions, modernization, and diversification projects. Therefore, this
method of financing is also called as project financing. Term loans have
majority of more than one year. Financial institutions provide term loans for
the period of six to ten years
By Anonymous MP FAN 50
and in some cases a grace period of one to two years is also
granted. Commercial banks advance term loans for the period of three to five
years.
Types of Debentures:
1. Registered Debentures
2. Bearer
3. Mortgage or Secured
4. Simple
5. Redeemable
6. Irredeemable
7. Convertible
8. Non-Convertible
Features:
The hiree purchases the assets and gives it on hire to the hirer.
The hiree pays regularly the hire purchase installments cover interest
as well as repayment of the principle amount. When the hiree pays the
last installments, the title of the asset is transferred to the hirer.
The hiree charges interest on a flat basis. This means a certain rate
of interest usually around 14% is charged on the initial investment and
not on diminishing balance.
The total interest collected by the hiree is allotted over various years.
For
this purpose ‘sum of years digits’ method is commonly employed.
Retaine d Earnings : Retained earnings represent the internal sources of
finance available to the company. Retained earnings represent the only
internal source of financing, expansion and growth. Infact they are an
important source of long- term finance for corporate enterprises.
A bank in Europe acquires the shares of such a company and then issues its
own “receipts” or “certificates” to the investors. This bank is also
called
“depository” and such certificates are called “GDR”. These GDR’s can be
traded on the European exchange or in private placement in USA. A GDR is
a dollar denominated instrument tradable on a stock exchange in Europe
or private placement in USA. A GDR represents one or more shares of
the issuing company.
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Reliance was the first Indian company to issue GDR’s in May 1992. To raise US
$100 million. The bookings were about five times the size of issue and
reliance retained US $150 million.
Arvind mills issued GDR’s worth US $125 million in February 1994. The issue
price of GDR was $9.78. One GDR represent one share of Arvind mills.
In this case the issuing company actively promotes the company’s ADR in
USA. A single depository bank is normally chosen and the ADR are routed
through this bank.
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investor for which extra interest of 2% is charged in addition to the
principle amount.
Corporate fixed deposits are the fixed deposits given by the companies.
Interest is depending upon the company policy and regulations.
Generally, it differs from company to company.