Financial Management

Srinivas university Financial Management III B.
Com
SRINIVAS UNIVERSITY
COLLEGE OF MANAGEMENT & COMMERCE
CITY CAMPUS, PANDESHWAR, MANGALORE-575 001.
BACKGROUND STUDY MATERIAL
FINANCIAL MANAGEMENT-II
B.COM
V Semester
Compiled By
Mrs. Meghashree
Faculty
Srinivas university Financial Management III B.Com
BLUEPRINT
Class: III B.COM
Exam: 18BCMHN56
Subject: FINANCIAL MANAGEMENT II
Maximum Marks: 50
Maximum Time: 2 HOURS
Objectives TOTAL
Knowledge Understanding Application/Skill
Content S S S
Areas O E O E O E
A A A
(Chapters)
1 1(1) 1(1) 1(8) 10
2 1(1) 1(1) 1(8) 10
3 1(1) 1(1) 1(8) 10
4 1(1) 1(8) 1(1) 10
5 1(1) 1(1) 1(8) 10

50
Sub total 13 13 24
Please Note: Questions are entered in numbers & marks are represented by numbers in
brackets
Paper : 40 Hours
17BCMHN/CA/AM56 FINANCIAL MANAGEMENT -II IA : 50
Theory/Week:4 Hours Exam: 50
Credits:4
UNIT I- WORKING CAPITAL MANAGEMENT 8 Hours
Meaning of Working Capital: Gross, Net, Permanent and Temporary - Concept of Operating
Cycle -Gross Operating Cycle and Net Operating Cycle. - Estimation of Working Capital
Requirement - Estimation of Components Method - Percentage of Sales Method - Operating
Cycle Method - Factors Determining the Size of Working Capital
UNIT II- CASH AND RECEIVABLES MANAGEMENT 8 Hours

Cash Management - Meaning - Objectives - Need for Cash - Motives for Holding Cash -
Cash Planning - Cash Forecasting - Preparation of Cash Budget –Introduction to Receivables
Management- Significance And Purpose Of Receivable Management
UNIT III- FINANCIAL STATEMENT ANALYSIS 8 Hours

Introduction, Meaning, Definition, Types and Techniques of Financial Analysis,
Comparative Financial statement analysis, Common – size Balance Sheet and Income
Statement - Problems
UNIT IV- STOCK EXCHANGE AND REGULATION 8 Hours

Meaning and Characteristics- Role and Function- Cash Market- Options and Futures:
Meaning and Settlement of Contracts- Listing of Shares- Meaning, Listing Procedure-
Speculators : Bulls, Bears and Arbitrager- Securities and Exchange Board of India (SEBI)-
functions-Powers
UNIT V- EMERGING ISSUES IN FINANCIAL MANAGEMENT 8 Hours
Derivatives, Mergers and Acquisitions, Behavioural Finance, Financial Modelling, Financial

engineering, risk management.
Books for Reference:
1. Khan M.Y & Jain P.K -Financial Management, Text & Problems
2. Prasanna Chandra -Financial Management. Theory & Practice
3. I.M. Pandey -Financial Management
4. Van Horne lc. -Fundamentals of Financial Management
5. Prasanna Chandra - Investment analysis & Portfolio Management
6. R K Sharma and Shashi K Gupta - Financial Management
TEACHING PLAN
FINANCIAL MANAGMENT –II
FACULTY- Mrs. Meghashree

Unit-1: Working Capital Management 8 hours
Session.1: Meaning of Working Capital 1hr
Session.2: Gross, Net Permanent and Temporary. 1hr
Session.3: Concept of Operating Cycle 1hr
Session.4: Gross operating cycle and Net operating cycle 1hr
Session.5: Estimation of working capital Requirement. 1hr
Session.6: Estimation of component methods, Percentage sales Method 1hr
Session.7: Operating cycle Method 1hr

Session.8: Factors determining the size of working capital 1hr
Unit – II Cash and Receivable Management 8 hours

Session.9: Meaning of cash Management 1hr
Session 10: Objectives of cash 1hr
Session 11: Need of cash management 1hr
Session 12: Motives of Holding Cash 1hr
Session 13: Cash Planning, Cash forecasting 1hr
Session 14: Preparation of cash Budget 1hr
Session 15: Introduction to receivable management 1hr

Session 16: Significance and purpose of receivable management 1hr
Unit – III: Financial Statement Analysis 8 hours
Session 17: Introduction, Meaning, Definition 1 hr
Session 18: Types of Financial Statements 1hr
Session 19: Techniques of Financial Analysis 1hr
Session 20: Comparative Financial statement analysis 1hr
Session 21: Common – size Balance Sheet and Income Statement 1 hr
Session 22: Problems on Financial statement analysis 1 hr
Session 23: Problems on Comparative Financial statement analysis 1 hr

Session 24: Problems on Common – size Balance Sheet and Income Statement 1 hr
Unit IV: Stock exchange and policies 8 hours
Session 25: Meaning and Characteristics 1 hr
Session 26: Role and function of stock exchange 1 hr
Session 27: Cash market -option and future market 1 hr
Session 28: Meaning and settlement of contract 1 hr
Session 29: Listing of shares – Meaning, 4 hr

Session 30: Listing Procedures 1 hr
Session 31: Speculators: Bull, Bear and Arbitrager 1hr
Session 32: SEBI – function, Powers 1hr
Unit V: Emergency Issue in Financial Management 8 hours
Session 33: Derivatives 1hr
Session 34: Mergers and Acquisition 1 hr
Session 35: Behavioral Finance 1hr
Session 36: Financial Modelling 1hr

Session 37: Financial Engineering 1hr
Session 38: Financial Engineering 1hr
Session 39: Risk Management 1hr
Session 40: Risk Management 1hr
Total: 40 Hours
Semester Examination
University examination : 50 marks

Internal marks : 50 marks
Total : 100 marks
Chapter -1 WORKING CAPITAL MANAGEMENT
The modern organization incurs a huge amount of expenses for its daily operation. Some of
the expenses are basic and traditional like cost of material, labor and other usual overheads. Many
new expenses have cropped up recently like telephone expenses, broadband services, and network
maintenance, maintenance of computers and other IT systems, fee-based services of banks etc.
The capital needed for meeting these expenses is called Working Capital. Cash or near-cash items
like cash at bank or investment in money market mutual funds, commercial paper or certificate of
deposit are needed for meeting these expenses. Cash in hand and the balances at bank do not bring
in any returns. However, they are needed to meet the daily expenses. Hence, a minimum amount
of cash should be maintained without running short of it at any time.
Meaning of Working Capital:

Four different objectives are added to the expression Working Capital yielding 4 different
meanings.
1) Gross Working Capital: This represents the total investment made by the firm in the current
assets. Current Assets include cash in hand, cash at bank, money market instruments,
investments in units of money market mutual funds, Accounts Receivable (debtors),
Inventory, Prepaid Expenses and Accrued Income. The total of all these current Assets
represents Gross Working Capital.
Gross Working Capital is partially financed by current liabilities. The remaining part is
financed by long-term securities like equity shares, debentures, bonds or any other such
security.
2) Net Working Capital: It is the excess of current assets over current liabilities. Current
liabilities include Accounts Payable (Creditors), Bank Overdraft, Customer Deposit, Dealers
Deposit, Outstanding Expenses and Short -Term Provisions.
Net Working Capital= Current Assets-Current Liabilities
Net Working Capital is fully financed by long-term sources of finance.
3) Permanent Working Capital: It is the working Capital needed throughout the year, and
also from one year to another. It finances the normal activity of the firm. Then, it becomes
the basic component of the working capital. It is advisable to finance such working capital
out of long-term sources of finance.
4) Temporary or Fluctuating working Capital: A sudden increase in the activity may call for
more working capital temporarily. This may be due to seasonality in demand, getting
unexpected orders, temporary rise in the price of raw material, a temporary rise in wage bill
due to overtime work etc. This is generally financed by short-term sources like Trade
Creditors & Bank Overdraft.
Factors Determining the Size of Working Capital:

The size of working capital of a firm depends upon a myriad of factors. So much so, the working
capital is determined more by experience than by any scientific method of estimation. The
following factors generally affect the size of working capital of a firm.
1) Nature of Business: Certain business or industries need large working capital either due to
employing a large labour force or buying huge quantity of raw material or components. The
following types of undertaking need huge working capital.
(a) Heavy Industries like Steel Industry, Cement Industry etc.(Raw material & Labour)
(b) Public Utilities like Railway, Airway, Electricity producing or distributing companies etc
(labour)
(c) Mines like coal mines, copper mines, gold mines etc (labour)
(d) Automobiles (labour and components)
2) Scale of Operation: Large-scale industries need huge working capital for employing more
people and buying large quantity of raw material. Therefore, scale of operation is also an
important factor.
3) Length of Operating Cycle: The size of working capital varies directly with the length of
operating cycle. In case of longer operating cycle like shipbuilding, aircraft manufacturing,
construction of dams, executing turnkey projects, larger investment is there in work in
progress, and hence large working capital is needed.
4) Rapidity of Turnover: If goods get sold quickly, lesser capital is needed. In case of FMCG
Goods (Fast Moving Consumer Goods) like soaps, toothpastes, cosmetics, the turnover
is quick. Hence, lesser working capital is needed.
5) Nature of Demand: If the demand is stable, the working capital is predictable. It can be
maintained relatively at a lower level. Where the demand is highly fluctuating as in the case
of readymade dresses, jewellery, automobiles etc., higher size of working capital is needed.
6) Level of Automation: Higher level of automation in the industry reduces the labour force.
Hence, lesser size of working capital is needed. Lower level of automation requires larger
labour force, larger payment of wages, and thus larger working capital.
7) Reliability of Supply: The nature of supply of raw material and components also decide the
size of working capital. If the supply is not certain, a larger inventory should be carried
resulting in larger working capital.
8) Operative Efficiency: Highly efficient companies carry on production with minimum raw
material and minimum labour force. Naturally, they can carry on with lesser working capital.
9) Credit Policy: Companies that sell the goods only on cash basis need minimum working
capital. When credit sale is allowed, the length of period of credit allowed determines the size
of working capital. Longer the period, more will be the size of working capital.
10) Suppliers' Credit: Companies buying only on cash basis need a large size of working
capital. If credit purchase is possible, the period of credit decides the size of working capital.
Longer the period less will be the working capital.
11) Prices of Inputs: If costly inputs like diamonds, gold and platinum are used as in the case
of watch- manufacturing, jewellery industry etc., working capital needed is large.
12) Level of Profits: industries that are highly profitable like computer software need lesser
working capital. Their profits themselves contribute to the working capital.
13) Banking Norms: Banks may prescribe the norms to be followed by the industry in order to
lend for the working capital requirements. If so, such norms have a great effect on the size of
working capital.
14) Taxes: Heavily taxed industries like cigarette manufacturing, breweries etc, need larger
working capital just to pay the excise duty to the government.
15) Dividend Policy: Some companies like Castrol, Punjab Tractors etc, declare three to four
interim dividends in a year Naturally, it will call for a larger working capital.
Concept of Operating Cycle:
Operating cycle is the time involved in converting cash into raw material, raw material into work-
in-progress, work-in-progress into finished goods, finished goods into debtors and debtors into
cash.
Cash
Raw
Debtors
Materials
Cash
sales
Work in
Credit sale
progress
Finished
Goods
The length of the operating cycle determines the size of working capital of a firm. Sometimes, the
production process is long, as in plantations (coffee, tea, rubber), ship building, air-craft
manufacturing, assembling satellites etc. Investment in work-in-progress is high leading to higher
working capital. Compared with them, manufacturing cosmetics, personal care products like soaps
involve shorter operating cycles. Thus, working capital needed is less.
There are four components for an operating cycle of a manufacturing firm.

a. Raw Material Conversion Period (RMCP): It is the length of the period needed for buying raw
material and converting raw material into work-in progress.
b. Work-ln-Progress Conversion Period: It is the length of the period required to convert work-in-
progress into Finished Goods.
c. Finished Goods Conversion Period (FGCP): It is the period needed for selling the finished goods to
the customers (Debtors) The total of the above three periods is called Inventory Conversion Period.
Inventory Conversion Period: RMCP+WIPCP+FGCP
d. Book Debt Conversion Period (BDCP): It is the period needed for collecting cash from debtors.
Gross Operating Cycle and Net Operating Cycle

Gross Operating Cycle is the period needed for buying raw material, producing the goods, selling them
and collecting cash from debtors. In other words, it is the total of RMCP, WIPCP, FGCP and BDCP.
Gross Operating Cycle=RMCP+WIPCP+FGCP+BDCP
If the firm is buying raw material from its supplier on credit, the payment need not be made
immediately. It is postponed to the future. This period is called Payment Deferral Period. It is the
period between date of purchase and date of payment. If this period is deducted from Gross Operating
Cycle, we get Net Operating Cycle.
Net Operating Cycle= Gross Operating Cycle-Payment Deferral Period
Estimation of Working Capital Requirement: Working Capital Requirement can be estimated by any
one of the following three methods
i. Components of Working Capital Method
ii. Percentage of Sales Method
iii. Operating Cycle method.
l) Components of Working Capital Method:

Under this, every component of Current Assets and Current Liabilities will be estimated. The total of
current assets will yield Gross Working Capital. When current liabilities are subtracted, Net Working
Capital is arrived at.
Statement of Estimation of Working Capital
Particular RS
A) Current Assets
1) Inventory XXX
(a)Raw Material XXX
(b) Work in Progress: (i)100% Raw Material
(ii) x% of Labour
(iii) y% of Overheads
XXX
(c)Finished Goods
XXX
2) Debtors
XXX
3) Cash in hand & Cashat bank
XXX
4) Prepaid Expenses & Accrued Income
GrossWorking Capital:
XXX
(B) Current Liabilities
XXX
(—) Creditors/Bills Payable
(—) Expenses Outstanding/Deferred
XXX
(Incl. lag in expenses)
Net Working capital:
Note: If details of completion of work-in-progress are not given, it is assumed to be 100% complete
in respect of material, 50% regarding labor & 50% regarding overheads.
Il) Percentage of Sales Method: As sales determine production & production determines the size of
working capital, a relation is established between sales and working capital. For e.g., 10% of the
sale is required for working capital. If the estimated sale is Rs. 2 crores, working capital needed
is Rs. 20 lakhs i.e., 10% of Rs. 2 crores. The relation is determined based on experience.
III) Operating Cycle method: Under this method, Gross Operating Cycle and Net Operating Cycle
are calculated. Step 1
Particulars No of days
I. RMCP =Average stock of raw material XXX

Raw material consumed per day
II. WIPCP= Average stock of WIP

XXX
Cost of Production per day
III. FGCP= Average Stock of Finished Good
Cost of Goods Sold per day XXX
Inventory Conversion Period XXX

IV. BDCP= Book Debts
XXX
Average Credit Sale per day
XXX
Gross Operating Cycle
XXX
(-) Payment deferral period = Creditors
Credit purchase per day
XXX
NET OPERATING CYCLE
STEP-2
365
Calculate number of Net Operating Cycle in a year =
Net perating cycle
STEP-3
Cost of sales
Calculating working capital requirement =
Number of Net perating cycle∈a year
Note: If cost of sales in not given the sales figure itself can be considered.
1. Prepare an estimate of working capital requirement from the following information of a trading
concern.
(i) Estimated Sales (in units) 80,000
(ii) Selling Price per unit Rs. 10
(iii) Percentage of Net Profit on sales 10
(iv) Average Credit Period allowed to Customers 3 months
(v) Average Credit Period allowed by Suppliers 1 month
(vi) Average period of Inventory 2 months
Solution:
Sales 80000X10 800000
(-) Net Profit @ 10% 800000 80000
Cost of Sales 720000
Particulars Amount
A) Current Assets
(i) Debtors 7,20,000X3/12) 180000
(ii) Inventory (7,20,000x 2/12) 120000
Gross working capital 300000
B) Current liabilities
Sundry Creditors (7,20,000x 1 /12) 60000
Net Working Capital 240000
2. Prepare an estimate of working capital requirement from the following data of a manufacturing
concern.
Sales (Credit Period 3 months) 40,00,000
Raw materials 12,00,000
Wages paid-15 days in Arrears 9,60,000
Manufacturing Expenses- 1 month in Arrears 6,00,000
Administrative Expenses-I month in Arrears 1,20,000
Sales Promotion Expenses payable in advance for 3 months 1,00,000
Income Tax Payable 25,000

The company enjoys one month's credit from supplier of raw materials. It maintains two months stock
of raw materials and two months stock of finished goods. Cash balance is maintained at Rs. 50,000 as
a precautionary balance. Assume 10% for contingencies
Solution
Statement of estimation of working capital
Particulars Amount Amount
A. Current Assets
a. cash balance 50000
b. Inventory
i. Raw material 1200000X2/12 200000
ii. Work in progress

480000 680000
iii. Finished goods 2880000X2/12
745000
c. Debtors 2980000X 3/12
25000
d. Prepaid expenses 100000X3/12
1500000
Gross working capital
B. Current Liabilities
100000
Creditors 1200000X1/12
50000
Manufacturing expenses 6,00,000X1/12
10000
Administration expenses 120,000X1/12
25000
Income tax payable 225000
40000
Wages in Arrears 960000X0.5/12 12,75,000
Working capital 127500
(+) 10% contingency(1275000x10%) 1402500
Net working capital
Working Note:-
1) Opening stock is considered to be equal to be closing stock in value; hence inventory value
does not affect cost of production or cost of sale.
2) Inventory of finished goods is valued at cost of production i.e,

12,00,000 + 9,60,000 +6,00,000 + 1,20,000 = Rs.28,80,000/-
3) Debtors are valued at cost of sales i.e,

28, 80,000 + 1, 00,000 = 29, 80,000
3. Estimate the Working Capital requirement from the following information. You are instructed to
add 20% for contingencies. Amount
1. Amount Blocked up in Stock:
Stock of Finished Goods 6,000
Stock of materials 10,000
2. Average Credit Sales:
Inland Sales- 8 weeks' credit Rs. 3,00,000
Export Sales- 2 weeks' Credit Rs. 80,000
3. Lag in Payment and Outgoings: Wages (2 weeks) Rs. 2,50,000
Purchase of materials- 2 months 50,000
Rent & Royalties - 6months 10,000
Clerical Staff- 1 month 5,000
Miscellaneous Expenses -2 months 50,000
4. Payment in Advance:
Sundry Expenses Paid Quarterly 10,000
Solution
A. Current Assets
a. Inventory
i. Raw material 10000
ii. work in progress -

6000 16000
iii. finished goods
b. Debtors
Inland sale 3,00,000X8/52 46154
3077 49231
Export sale 80,000X2/52
2500
c. Prepaid expenses 10000X3/12
61731
B. Current Liabilities 8333

Creditors 50,000X2/12 9615
Wages 250000X2/52 5000
Rent and Royalty 10000X6/12 417
31698
Clerical staff 5000X1/12 8333
36033
Miscellaneous expenses 50000X2/12
7207
(+) 20% contingency 43240
Net working capital
4. A steel manufacturing concern presents the following particulars for the year 2004-05. You are
required to estimate the working capital requirement of the concern for the year 2005-06.
Direct sale to Automobile manufacturer 30lakh

Sale to dealer 12 lakh
Direct Local Supply to consumers 6 lakh
Raw material:
Iron Ore (3 months credit) 6 lakh
Scrap Iron (2 months credit) 720000
Wages Paid (1-month lag) 9 lakh
Other manufacturing overheads (3 months lag) 440000

Office & Administration Overheads (1-month lag) 120000
Selling & Distribution Expenses (3-month lag) 280000
Advertisement Expenses (Payable 3 months in advance) 300000
Stock of Iron Ore 3months Requirement

Stock of Scrap Iron 2months Requirement
Stock of Finished Goods 3months Requirement
Estimated Cash at Bank Rs. 3 lakhs
For all the categories the company sells at a uniform 30% profit. However, credit period allowed was 1
month for the automobile manufacturers, 2 months to the Dealers and ½ a month credit for the Direct
Local Supply to consumers.
SOLUTION
A. Current Assets
a. Inventory
i. Raw material
Iron ore 600000X3/12 150000
120000 270000
Scrap iron 720000X2/12
ii. work in progress
iii. finished goods
cost of production= RM +wages +Manufacturing
OH + Administration OH
= 1320000+900000+440000+120000
695000
= 2780000X3/12
b. Debtors 175000
Automobile Manufacturer 300000X70/100X1/12 140000
Sale to dealer 1200000X70/100X2/12 17500
Sale to local supplier 600000X70/100X0.5/12 300000
c. Cash in hand 75000
d. Prepaid expenses 300000X3/12 1672500

120000
a. Creditors 9000
Iron ore 600000X3/12 110000
Scrap iron 720000X2/12 10000
270000
b. O/S Expenses 70000
wages 900000X1/12
Manufacturing OH 440000X3/12 265000
Administration OH 120000X 1/12 1137500
S&D OH 280000X2/12
Net working capital
5. You are supplied with the following information respect of Bright India Ltd for the year 1999
Production for the year 69000 units
Finished Goods in Store 3 months
Raw material in stores 2 months
Production Process 1 month
Credit allowed by Creditors 2 month
Credit given to Debtors 3months
Selling Price per Unit 50
Raw materials 50% of selling price
Direct wages 10% of selling price
Overheads 20% of selling price
There is a regular production and sales cycle. Wages and overhead accrue evenly. Wages are paid in
the next month of accrual. Materials are introduced at the beginning of the production cycle.
You are required to calculate the working capital requirement.
SOLUTION
A. Current Assets
a. Inventory
i. Raw material 69000X50X2/12X50% 287500

Raw material 69000X25X1/12X100% 143750
Wages 69000X5X1/12X50% 14375
Overhead 69000X10X1/12X50% 28750
iii. finished goods

cost of production= RM +wages +Overhead
690000
= 69000X40X3/12
b. Debtors Cost of production = cost of sales
690000
69000X40X3/12
c. Cash at bank
d. Prepaid expenses 1854375

a. Creditors 69000X25X2/12 28750 316250
b. O/S Expenses 69000X5X1/12 1538125
Net working capital
6. A Proforma Cost sheet of a company provides the following:

Elements of cost Value as a Percentage of Selling price
Materials 50%
Direct Labour 10%
Overheads 10%
The following further particulars are available.
1) It is proposed to maintain a level of activity at 100000 unit.
2) Selling Price is Rs. 20 per unit
3)Raw materials are expected to be in the stores for an average of 2 months
4)Materials will be in process on an overage of one month.
5)Finished goods are expected to be in the stores for an average of 2 months
6)Credit allowed to debtors is three months
7) Credit allowed by suppliers is two months.
Calculate working capital requirement
Solution
Working note
Selling Price per unit = Rs. 20
Unit material price = 20X50% Rs. 10.
Unit Labour Cost = 20x10% RS 2
Overheads per unit = 20X10% RS 2
Cost of Production/Cost of sale per unit = 14
SOLUTION
A. Current Assets
a. Inventory
i. Raw material 100000X10X2/12 166667

Raw material 100000X10X1/12X100% 83333
Direct labour 100000X2X1/12X50% 8333
99999
Overhead 100000X2X1/12X50% 8333
iii. finished goods
233333
= 100000X14X2/12
350000
100000X14X3/12
c. Cash at bank
a. Creditors 100000X10X2/12
6,83,332
b. O/S Expenses
Net working capital
7. Foods Ltd is presently operating at 60% level producing 36,000 packets of snacks and proposes to
increase its capacity utilization in the coming year by 33.33% over the existing level of production.
(i)Unit cost structure of the product at current level.
Raw material 4
Wages (variable) 2
Overheads (variable) 2
Fixed overhead 1
Profit 3
Selling Price 12
ii) Raw materials will remain in stores for one month before being issued to production. Material will
remain in process for further one month. Suppliers grant 3 months' credit to the company.
iii) Finished goods remain in godown for one month
iv) Debtors are allowed credit for 2 months
v) Average time lag in wages and overheads payment is one month and these expenses accrue evenly
throughout the production cycle.
vi) No increase in cost of inputs or selling price is envisaged.
Prepare a projected profitability statement and a statement showing working capital requirement at the
new level, assuming that minimum cash balance of Rs. 19500 has to be maintained.
Solution:
calculation of estimated increase in the % of output:
60x33.33% OR 60X1/3 = 20%
SO TOTAL PRODUCTION AT PRESENT IS 60%+20% =80%
60% - 36000
80% - ? =48,000
(1) Calculation of Estimated Output
Units
Existing Output = 36,000
(+) Hike (36000x1/3) = 12 000
(36000x33.33%=11,999.8)
Estimated Output = 48 000
(2) Calculation of Total overheads
Fixed Overhead per Unit at 36,000 units = Re. 1

Total Fixed Overhead (36,000X1) = Rs. 36,000
Total Variable Overhead (48,000x2) = Rs. 96 000
Total Overheads 1 32 000
Statement of projected profitability

Particular
Sales 48000X12 576000
Less: variable Overhead
Raw material 48000X4 192000
Wages 48000X2 96000
Overheads 48000X2 96000 384000
Contribution 192000
Less: Fixed overhead 36000
EBIT 156000
.
A. Current Assets
a. Inventory
i. Raw material 48000X4X1/12 16000

16000
Raw material 48000X4X1/12X100%
4000
Direct labour 48000X2X1/12X50%
5500 25500
Overhead 132000X1/12X50%
iii. finished goods
35000
576000-156000=420000X1/12
70000
b. Debtors 420000X2/12
19500
c. Cash at bank
-
d. Prepaid expenses
166000

67000
wages 48000x2x1/12 11000
overhead 132000X1/12 99000
Net working capital
8. From the following information compute the length of operating cycle

No of days 365
Average period credit allowed by supplier 16days
Average total debtors 480000
Raw material consumed 4400000
Total production cost 10000000
Total cost of sales 10500000
Sale of the year 16000000
Value of average stock maintained

Raw material 320000
Work in progress 350000
Finished goods 260000
Calculate net operating cycle
Solution
Statement of operating cycle
Raw material 320000 27
conversion period = Avg stock of RMX365 4400000X365
RM consumed
350000 13
WIPCP= Avg stock of WIP 10000000X365
Cost of productionX365
260000
FGCP= Avg stock of FG 10500000X365 9
Cost of goods sold per day X365
49
Inventory conversion period
4800000
16000000X365 11
Book debts conversion period = Debtors X 365
Credit sales
Gross operating cycle 60

Less Payment deferred= creditors
Credit purchase 16
Net operating cycle 44
9. Structural Manufacturers Ltd. provides the following particulars for the year 1999
(a)Average Debtors Rs. 7,00,000
(b)Average Period of Credit Allowed 20 days
(c)Raw material consumedRs. 48 lakhs
(d)Cost of Production Rs. 1.08 crore
(e)Cost of Goods sold Rs. 2.25 crore
(f)Credit Sales Rs. 2.10 crore
Average Inventory:
Raw materials -Rs. 4 lakhs;
Work in Progress Rs. 3 lakhs;
Finished Goods - Rs. 5 lakhs.
Calculate working capital requirement based on operating cycle assuming 360 days for a year.
Solution
Raw material= Avg stock of RMX360 400000 30
RM consumed 4800000X360
WIP= Avg stock of WIP 300000

Cost of productionX360 10800000X360
10
FG= Avg stock of FG 5000000

Cost of goods sold per day X360 22500000X360
8
Inventory consumed period

7000000
Debtor consumed = Debtors 201000000X360 48
Credit sales X360
Gross sale 12

Credit purchase 60
Net operating cycle

20
40
No of operating cycle in year= 360

Net operating cycle
= 360
40
= 9 times
Working capital requirement= cost of sales

No of operating cycle in year
22500000
9
= 2500000
10. From the following data pertaining to a company, compute operating
Particulars I year (Rs.) II year (Rs.)

stocks: Raw materials 20,000 27,000
Work in Progress 14,000 18,000
Finished Goods 21,000 24,000

Purchase of Raw materials 96000 135000
Cost of Goods Sold 1,40,000 1,80,000
Sales 1,60000 200000
Debtors 32,000 50,000
Creditors 16,000 18,000
Also, calculate number of operating cycles in a year and use it to estimate the size of working capital
you can assume 360 days in a year for the purpose of calculation.
Solution
Statement of operating cycle I year

36

54

32000
165
Debtor consumed = Debtors 160000X360
Credit sales X360
72
Gross sale 32000
Less Payment deferred= creditors 96000X360

237
Credit purchase
60
Net operating cycle
177
Net operating cycle = 360

Net operating cycle
= 360
177
= 2cycle

140000
2
= Rs.70,000
Statement of operating cycle II year


36

48

50000
156
Credit sales X360
90
Gross sale 18000

246
Credit purchase
48
Net operating cycle
198

Net operating cycle
= 360
198
= 2cycle

180000
2
= Rs. 90,000
Answer the following

1. Define working capital? Explain different objective of working capital (K)
Meaning of Working Capital:
Four different objectives are added to the expression Working Capital yielding 4 different
meanings.
3) Gross Working Capital: This represents the total investment made by the firm in the current
assets. Current Assets include cash in hand, cash at bank, money market instruments,
investments in units of money market mutual funds, Accounts Receivable (debtors),
Inventory, Prepaid Expenses and Accrued Income. The total of all these current Assets
represents Gross Working Capital.
Gross Working Capital is partially financed by current liabilities. The remaining part is
financed by long-term securities like equity shares, debentures, bonds or any other such
security.
4) Net Working Capital: It is the excess of current assets over current liabilities. Current
liabilities include Accounts Payable (Creditors), Bank Overdraft, Customer Deposit, Dealers
Deposit, Outstanding Expenses and Short -Term Provisions.
Net Working Capital= Current Assets-Current Liabilities
Net Working Capital is fully financed by long-term sources of finance.
3) Permanent Working Capital: It is the working Capital needed throughout the year, and
also from one year to another. It finances the normal activity of the firm. Then, it becomes
the basic component of the working capital. It is advisable to finance such working capital
out of long-term sources of finance.
5) Temporary or Fluctuating working Capital: A sudden increase in the activity may call for
more working capital temporarily. This may be due to seasonality in demand, getting
unexpected orders, temporary rise in the price of raw material, a temporary rise in wage bill
due to overtime work etc. This is generally financed by short-term sources like Trade
Creditors & Bank Overdraft.
2. Explain factors determining size of working capital (U)
Factors Determining the Size of Working Capital:

The size of working capital of a firm depends upon a myriad of factors. So much so, the working
capital is determined more by experience than by any scientific method of estimation. The
following factors generally affect the size of working capital of a firm.
1) Nature of Business: Certain business or industries need large working capital either due to
employing a large labour force or buying huge quantity of raw material or components. The
following types of undertaking need huge working capital.
(e) Heavy Industries like Steel Industry, Cement Industry etc.(Raw material & Labour)
(f) Public Utilities like Railway, Airway, Electricity producing or distributing companies etc
(labour)
(g) Mines like coal mines, copper mines, gold mines etc (labour)
(h) Automobiles (labour and components)
2) Scale of Operation: Large-scale industries need huge working capital for employing more
people and buying large quantity of raw material. Therefore, scale of operation is also an
important factor.
3) Length of Operating Cycle: The size of working capital varies directly with the length of
operating cycle. In case of longer operating cycle like shipbuilding, aircraft manufacturing,
construction of dams, executing turnkey projects, larger investment is there in work in
progress, and hence large working capital is needed.
4) Rapidity of Turnover: If goods get sold quickly, lesser capital is needed. In case of FMCG
Goods (Fast Moving Consumer Goods) like soaps, toothpastes, cosmetics, the turnover
is quick. Hence, lesser working capital is needed.
5) Nature of Demand: If the demand is stable, the working capital is predictable. It can be
maintained relatively at a lower level. Where the demand is highly fluctuating as in the case
of readymade dresses, jewellery, automobiles etc., higher size of working capital is needed.
6) Level of Automation: Higher level of automation in the industry reduces the labour force.
Hence, lesser size of working capital is needed. Lower level of automation requires larger
labour force, larger payment of wages, and thus larger working capital.
7) Reliability of Supply: The nature of supply of raw material and components also decide the
size of working capital. If the supply is not certain, a larger inventory should be carried
resulting in larger working capital.
8) Operative Efficiency: Highly efficient companies carry on production with minimum raw
material and minimum labour force. Naturally, they can carry on with lesser working capital.
9) Credit Policy: Companies that sell the goods only on cash basis need minimum working
capital. When credit sale is allowed, the length of period of credit allowed determines the size
of working capital. Longer the period, more will be the size of working capital.
10) Suppliers' Credit: Companies buying only on cash basis need a large size of working
capital. If credit purchase is possible, the period of credit decides the size of working capital.
Longer the period less will be the working capital.
11) Prices of Inputs: If costly inputs like diamonds, gold and platinum are used as in the case
of watch- manufacturing, jewellery industry etc., working capital needed is large.
12) Level of Profits: industries that are highly profitable like computer software need lesser
working capital. Their profits themselves contribute to the working capital.
13) Banking Norms: Banks may prescribe the norms to be followed by the industry in order to
lend for the working capital requirements. If so, such norms have a great effect on the size of
working capital.
14) Taxes: Heavily taxed industries like cigarette manufacturing, breweries etc, need larger
working capital just to pay the excise duty to the government.
15) Dividend Policy: Some companies like Castrol, Punjab Tractors etc, declare three to four
interim dividends in a year Naturally, it will call for a larger working capital.
3. Prepare an estimate of working capital requirement from the following information of a trading
concern.
(i) Estimated Sales (in units) 80,000
(ii) Selling Price per unit Rs. 10
(iii) Percentage of Net Profit on sales 10
(iv) Average Credit Period allowed to Customers 3 months
(v) Average Credit Period allowed by Suppliers 1 month
(vi) Average period of Inventory 2 months
Solution:
Sales 80000X10 800000
(-) Net Profit @ 10% 800000 80000
Cost of Sales 720000
Particulars Amount
A) Current Assets
(i) Debtors 7,20,000X3/12) 180000
(ii) Inventory (7,20,000x 2/12) 120000
B) Current liabilities
Sundry Creditors (7,20,000x 1 /12) 60000
Net Working Capital 240000

4. Prepare an estimate of working capital requirement from the following data of a manufacturing
concern.
Sales (Credit Period 3 months) 40,00,000
Raw materials 12,00,000
Wages paid-15 days in Arrears 9,60,000
Manufacturing Expenses- 1 month in Arrears 6,00,000
Administrative Expenses-I month in Arrears 1,20,000
Sales Promotion Expenses payable in advance for 3 months 1,00,000
Income Tax Payable 25,000
The company enjoys one month's credit from supplier of raw materials. It maintains two
months stock of raw materials and two months stock of finished goods. Cash balance is
maintained at Rs. 50,000 as a precautionary balance. Assume 10% for contingencies
Solution
Statement of estimation of working capital
A. Current Assets
a. cash balance 50000
b. Inventory
i. Raw material 1200000X2/12 200000
ii. Work in progress

480000 680000
iii. Finished goods 2880000X2/12
745000
c. Debtors 2980000X 3/12
25000
d. Prepaid expenses 100000X3/12
1500000
100000
Creditors 1200000X1/12
50000
Manufacturing expenses 6,00,000X1/12
10000
Administration expenses 120,000X1/12
25000
Income tax payable 225000
40000
Wages in Arrears 960000X0.5/12 12,75,000

Working capital 127500
(+) 10% contingency(1275000x10%) 1402500
Net working capital
Working Note:-
4) Opening stock is considered to be equal to be closing stock in value; hence inventory value
does not affect cost of production or cost of sale.
5) Inventory of finished goods is valued at cost of production i.e,

12,00,000 + 9,60,000 +6,00,000 + 1,20,000 = Rs.28,80,000/-
6) Debtors are valued at cost of sales i.e,

28, 80,000 + 1, 00,000 = 29, 80,000
5.Estimate the Working Capital requirement from the following information. You are instructed to
add 20% for contingencies. Amount
1. Amount Blocked up in Stock:
Stock of Finished Goods 6,000
Stock of materials 10,000
2. Average Credit Sales:
Inland Sales- 8 weeks' credit Rs. 3,00,000
Export Sales- 2 weeks' Credit Rs. 80,000
3. Lag in Payment and Outgoings: Wages (2 weeks) Rs. 2,50,000
Purchase of materials- 2 months 50,000
Rent & Royalties - 6months 10,000
Clerical Staff- 1 month 5,000
Miscellaneous Expenses -2 months 50,000
4. Payment in Advance:
Sundry Expenses Paid Quarterly 10,000
Solution

A. Current Assets
a. Inventory
i. Raw material 10000
ii. work in progress -

6000 16000
iii. finished goods
b. Debtors
Inland sale 3,00,000X8/52 46154
3077 49231
Export sale 80,000X2/52
2500
c. Prepaid expenses 10000X3/12
61731
8333
Creditors 50,000X2/12
9615
Wages 250000X2/52
5000
Rent and Royalty 10000X6/12
417
Clerical staff 5000X1/12 31698
8333
Miscellaneous expenses 50000X2/12 36033
7207
(+) 20% contingency 43240
Net working capital
6. A steel manufacturing concern presents the following particulars for the year 2004-05. You are
required to estimate the working capital requirement of the concern for the year 2005-06.
Direct sale to Automobile manufacturer 30lakh

Sale to dealer 12 lakh
Direct Local Supply to consumers 6 lakh
Raw material:
Iron Ore (3 months credit) 6 lakh
Scrap Iron (2 months credit) 720000
Wages Paid (1-month lag) 9 lakh
Other manufacturing overheads (3 months lag) 440000

Office & Administration Overheads (1-month lag) 120000
Selling & Distribution Expenses (3-month lag) 280000
Advertisement Expenses (Payable 3 months in advance) 300000
Stock of Iron Ore 3months Requirement

Stock of Scrap Iron 2months Requirement
Stock of Finished Goods 3months Requirement
Estimated Cash at Bank Rs. 3 lakhs
For all the categories the company sells at a uniform 30% profit. However, credit period
allowed was 1 month for the automobile manufacturers, 2 months to the Dealers and ½ a month
credit for the Direct Local Supply to consumers.
SOLUTION
A. Current Assets
a. Inventory
i. Raw material
Iron ore 600000X3/12 150000
120000 270000
Scrap iron 720000X2/12
iii. finished goods
cost of production= RM +wages +Manufacturing
OH + Administration OH
= 1320000+900000+440000+120000
695000
= 2780000X3/12
b. Debtors 175000
Automobile Manufacturer 300000X70/100X1/12 140000
Sale to dealer 1200000X70/100X2/12 17500
Sale to local supplier 600000X70/100X0.5/12 300000
c. Cash in hand 75000
d. Prepaid expenses 300000X3/12 1672500


120000
a. Creditors 9000
Iron ore 600000X3/12 110000
Scrap iron 720000X2/12 10000
270000
wages 900000X1/12
Manufacturing OH 440000X3/12
265000
Administration OH 120000X 1/12
1137500
S&D OH 280000X2/12
Net working capital
7. You are supplied with the following information respect of Bright India Ltd for the year 1999
Production for the year 69000 units
Finished Goods in Store 3 months
Raw material in stores 2 months
Production Process 1 month
Credit allowed by Creditors 2 month
Credit given to Debtors 3months
Selling Price per Unit 50
Raw materials 50% of selling price
Direct wages 10% of selling price
Overheads 20% of selling price
There is a regular production and sales cycle. Wages and overhead accrue evenly. Wages are
paid in the next month of accrual. Materials are introduced at the beginning of the production
cycle.
You are required to calculate the working capital requirement.
SOLUTION
A. Current Assets
a. Inventory
i. Raw material 69000X50X2/12X50% 287500
Raw material 69000X25X1/12X100% 143750
Wages 69000X5X1/12X50% 14375
Overhead 69000X10X1/12X50% 28750
iii. finished goods

690000
= 69000X40X3/12
690000
69000X40X3/12
c. Cash at bank

a. Creditors 69000X25X2/12 316250
28750
b. O/S Expenses 69000X5X1/12 1538125
Net working capital
8. A Proforma Cost sheet of a company provides the following:

Elements of cost Value as a Percentage of Selling price
Materials 50%
Direct Labour 10%
Overheads 10%
The following further particulars are available.
1) It is proposed to maintain a level of activity at 100000 unit.
2) Selling Price is Rs. 20 per unit
3) Raw materials are expected to be in the stores for an average of 2 months
4) Materials will be in process on an overage of one month.
5) Finished goods are expected to be in the stores for an average of 2 months
6) Credit allowed to debtors is three months
7) Credit allowed by suppliers is two months.
Calculate working capital requirement
Solution
Working note
Selling Price per unit = Rs. 20
Unit material price = 20X50% Rs. 10.
Unit Labour Cost = 20x10% RS 2
Overheads per unit = 20X10% RS 2
Cost of Production/Cost of sale per unit = 14
SOLUTION
A. Current Assets
a. Inventory
i. Raw material 100000X10X2/12 166667

Raw material 100000X10X1/12X100% 83333
Direct labour 100000X2X1/12X50% 8333
99999
Overhead 100000X2X1/12X50% 8333
iii. finished goods
233333
= 100000X14X2/12
350000
100000X14X3/12
c. Cash at bank
6,83,332
b. O/S Expenses
Net working capital
9. Foods Ltd is presently operating at 60% level producing 36,000 packets of snacks and proposes
to increase its capacity utilization in the coming year by 33.33% over the existing level of
production.
i. Unit cost structure of the product at current level.
Raw material 4
Wages (variable) 2
Overheads (variable) 2
Fixed overhead 1
Profit 3
Selling Price 12
ii. Raw materials will remain in stores for one month before being issued to production. Material
will remain in process for further one month. Suppliers grant 3 months' credit to the company.
iii. Finished goods remain in godown for one month
iv. Debtors are allowed credit for 2 months
v. Average time lag in wages and overheads payment is one month and these expenses accrue
evenly throughout the production cycle.
vi. No increase in cost of inputs or selling price is envisaged.
Prepare a projected profitability statement and a statement showing working capital
requirement at the new level, assuming that minimum cash balance of Rs. 19500 has to be
maintained.
Solution:
calculation of estimated increase in the % of output:
60x33.33% OR 60X1/3 = 20%
SO TOTAL PRODUCTION AT PRESENT IS 60%+20% =80%
60% - 36000
80% - ? =48,000
(2) Calculation of Estimated Output
Units
Existing Output = 36,000

(+) Hike (36000x1/3) = 12 000
(36000x33.33%=11,999.8)
Estimated Output = 48 000
(2) Calculation of Total overheads
Fixed Overhead per Unit at 36,000 units = Re. 1

Total Fixed Overhead (36,000X1) = Rs. 36,000
Total Variable Overhead (48,000x2) = Rs. 96 000
Total Overheads 1 32 000
Statement of projected profitability

Particular
Sales 48000X12 576000
Less: variable Overhead
Raw material 48000X4 192000
Wages 48000X2 96000
Overheads 48000X2 96000 384000
Contribution 192000
Less: Fixed overhead 36000
EBIT 156000
.
A. Current Assets
a. Inventory
i. Raw material 48000X4X1/12 16000

16000
Raw material 48000X4X1/12X100%
4000
Direct labour 48000X2X1/12X50%
5500 25500
Overhead 132000X1/12X50%
iii. finished goods 35000

576000-156000=420000X1/12 70000
b. Debtors 420000X2/12 19500
c. Cash at bank -
48000
a. Creditors 48000X4X3/12 67000
8000
b. O/S Expenses
11000
wages 48000x2x1/12
99000
overhead 132000X1/12
Net working capital
10. From the following information compute the length of operating cycle. No of days 365
Average period credit allowed by supplier 16days
Average total debtors 480000
Raw material consumed 4400000
Total production cost 10000000
Total cost of sales 10500000
Sale of the year 16000000
Value of average stock maintained

Raw material 320000
Work in progress 350000
Finished goods 260000
Calculate net operating cycle
Solution
Raw material 320000 27
conversion period = Avg stock of RMX365 4400000X365
RM consumed
350000 13
WIPCP= Avg stock of WIP 10000000X365
Cost of productionX365
260000
FGCP= Avg stock of FG 10500000X365 9
Cost of goods sold per day X365
49
4800000
16000000X365 11
Book debts conversion period = Debtors X 365
Credit sales
60
Gross operating cycle
16
Credit purchase
44
Net operating cycle
11. Structural Manufacturers Ltd. provides the following particulars for the year 1999
(a)Average Debtors Rs. 7,00,000
(b)Average Period of Credit Allowed20 days
(c)Raw material consumed Rs. 48 lakhs
(d)Cost of Production Rs. 1.08 crore
(e)Cost of Goods sold Rs. 2.25 crore
(f)Credit Sales Rs. 2.10 crore
Average Inventory:
Raw materials -Rs. 4 lakhs;
Work in Progress Rs. 3 lakhs;
Finished Goods - Rs. 5 lakhs.
Calculate working capital requirement based on operating cycle assuming 360 days for a year.
Solution

10

8
Inventory consumed period

7000000
48
Credit sales X360
12
Gross sale
60
Credit purchase
Net operating cycle
20
40
No of operating cycle in year= 360

Net operating cycle
= 360
40
= 9 times

22500000
9
= 2500000
12. From the following data pertaining to a company, compute operating
Particulars I year (Rs.) II year (Rs.)

stocks: Raw materials 20,000 27,000
Work in Progress 14,000 18,000
Finished Goods 21,000 24,000
Purchase of Raw materials 96000 135000
Cost of Goods Sold 1,40,000 1,80,000
Sales 1,60000 200000
Debtors 32,000 50,000
Creditors 16,000 18,000
Also, calculate number of operating cycles in a year and use it to estimate the size of working
capital you can assume 360 days in a year for the purpose of calculation.
Solution
Statement of operating cycle I year

36

54

32000
160000X360 165
Debtor consumed = Debtors
Credit sales X360
32000 72
Gross sale 96000X360
Less Payment deferred= creditors 237
Credit purchase
60
Net operating cycle
177

Net operating cycle
= 360
177
= 2cycle

140000
2
= Rs.70,000
Statement of operating cycle II year


36
48
50000
Debtor consumed = Debtors 200000X360 156
Credit sales X360
Gross sale 18000 90

246
Credit purchase
48
Net operating cycle
198

Net operating cycle
= 360
198
= 2cycle

180000
2
= Rs. 90,000
Multiple Choice Questions

1. Gross working capital refers to capital invested total of (U)
A. Current Assets
B. Fixed Assets
C. Both (a) and (d)
D. Circulating Assets
2. Cash discount is allowed to the customers to (K)

A. Speed up sales
B. Minimize the level of average debtors
C. Speed up collection
D. Minimize bad debts.
3. Purpose of holding inventory is _________ (U)

A. Avoid lost sales
B. Benefits of cash discount
C. Reduction in ordering
D. All of these
4. Fixed working capital is (K)

A. Minimum stock of raw material
B. Minimum bank balances
C. Salaries of workers
D. All of these
5. Net working capital is the excess of current assets over _________(U)

A. Current Liabilities
B. Liquid Assets
C. Long Term Liabilities
D. Capital Employed
6. With the shortage of working capital, the rate of return on investments will (K)
A. Larger
B. Falls
C. Adequate
D. None of these
7. The fixed proportion of working capital generally financed from the _________ (U)
A. Fixed capital resources
B. Govt. assistance
C. Private loans
D. Reserve & provisions
8. Permanent working capital is also termed as __________ (K)

A. Regular working capital
B. Fixed working capital
C. Core working capital
D. All of these
9. The ideal standard for liquid ratio is _________(U)

A. 2: 1
B. 1: 2
C. 1: 1
D. 2: 3
10. Which of the following item is not included in current ratio? (K)
A. Goodwill
B. Sundry Debtors
C. Sundry Creditor
D. Bill Receivable
11. Working capital management is primarily concerned with the management and(U)
financing of:
A. cash and inventory.

B. current assets and current liabilities.
C. current assets.
D. receivables and payables.
12. Which of the following would not be financed from working capital? (U)
A. Cash float.
B. Accounts receivable.
C. Credit sales.
D. A new personal computer for the office
13. Quick assets do not include (U)

A. Govt-bond
B. Book debts
C. Advance for supply of raw materials
D. Inventories.
14. Current ratio is 4:1.Net Working Capital is Rs.30,000.Find the amount of current
Assets. (U)
A. Rs.10,000
B. Rs.40,000
C. Rs.24,000
D. Rs.6,000
15. Which of the following would be consistent with a more aggressive approach to (K)
financing working capital?
A. Financing short-term needs with short-term funds.

B. Financing permanent inventory build-up with long-term debt.
C. Financing seasonal needs with short-term funds.
D. Financing some long-term needs with short-term funds.
16. Working capital is also known as (K)

A. Circulating capital
B. Revolving capital
C. Operating capital
D. Both (a) and (b)
17. Operating cycle method is also known as (U)

A. Cash working capital method
B. % of sales method
C. % of purchase method
D. None of these
18. The gross working capital is a...................... (K)

A. Business entity
B. Dual aspect
C. Going concern
D. Money measurement
19. Liquid ratio is also termed as (U)

A. Turnover Ratio
B. Acid Test Ratio
C. Gross Profit Ratio
D. Proprietary Ratio
20. Inventory is a part of- (U)

A. Current Assets
B. Fixed Assets
C. Non-Current Assets
D. Liquid Assets
21. Safety stock is also called as - (K)

A. Minimum Inventory
B. Buffer Stock
C. Reserve Stock
D. All of these
22. Inventory control is the function relating to (U)

A. Production Mgt.
B. Material Mgt.
C. Marketing Mgt.
D. Both (a) and (b)
23. According to ABC classification 'C' indicates (U)

A. Value high and quantity low
B. Quantity high and value low
C. Both (a) and (b)
D. None of these
24. Cash planning and control is possible by using (K)

A. Cash flow analysis
B. Cash budget
C. Ratio analysis
D. All of these
25. Commercial paper is an instrument of - (U)

A. Short term money market
B. Long term capital market
C. None of these
D. Both (a) and (b)
Unit -II Cash and Receivable Management
INTRODUCTION
The objectives of cash management are straightforward – maximise liquidity and control cash
flows and maximise the value of funds while minimising the cost of funds. The strategies for meeting
such objectives include varying degrees of long-term planning requirements. Also, like everywhere in
the world, much treasury activity in the Czech Republic is concentrated on cash management. This
includes financing the corporation, administration of debts (loans, bonds, commercial papers, etc.),
good relationships with the banks, payments to suppliers and collections from customers, control of
foreign currency and interest positions according to the company’s needs for finance, and finally the
reporting and technical support of all these functions. The use of cash pooling as a global standard for
concentrating cash into the main bank account of the firm has very quickly found favour in
corporations in the Czech Republic.
Globally, cash pooling is a bank product that enables a group to collect money and use it for either
further investment or lending. The product is available to companies, which are part of a group of
economically related parties (We cannot use the word ‘concern’ because the Czech codes do not
recognise this word in the legal sense.). Related parties are business entities that are related by share
ownership. For cash pooling business, it is necessary for them to sign a collective agreement to operate
a so-called major (master) bank account. Other bank accounts are settled toward this master account.
There could be an overdraft agreement with a bank, but this is not possible for either a master account
or the other bank accounts in the pooling system. Nevertheless, credit or debt interest rates have to be
defined for all accounts. There has to be an agreed level of interest rates between the bank and the
companies involved in the cash pooling system and between each of those companies, too.
Definition: Cash management is the efficient collection, disbursement, and investment of cash in an
organization while maintaining the company’s liquidity. In other words, it is the way in which a
particular organization manages its financial operations such as investing cash in different short-term
projects, collection of revenues, payment of expenses, and liabilities while ensuring it has sufficient
cash available for future use.
What is the definition of cash management?

In the real world, organizations have strict cash management controls to monitor its inflows and
outflows while retaining a sufficient amount in order to take advantage of attractive investments or
handle unforeseen liabilities. Efficient management of cash prevents loss of money due to theft or error
in processing transactions. Numerous best practices are adopted to enhance management of company’s
funds.
This involves shortening of cash collection periods, regular follow ups for collections, negotiation of
favourable terms with suppliers allowing delay in payment periods, and preparation of cash flow
forecasts. Businesses also use of technology to speed up cash collection process. They must do all of
this while maintaining adequate amount of funds to meet daily operations.
Receivable management
Receivable management incorporates is all about ensuring that customers pay their invoices. Good
receivables management helps prevent overdue payment or non-payment. It is therefore a quick and
effective way to strengthen the company’s financial or liquidity position. This Wiki explains the
importance of receivables management, the benefits and how to prepare a good receivables process.
The importance of receivables management

Every company wants to buy low and sell high. But they can lose everything with poor receivables
management during the last phase of the sales process (payment). Over half of all bankruptcies can be
attributed to poor receivables management, which demonstrates its importance. Receivables
management involves much more than reminding customers to pay. It is also about identifying the
reason for non-payment. Perhaps a product or service was not delivered? Or there was an
administrative error in the invoice? Good receivables management is a comprehensive process
consisting of:
a. Determining the customer’s credit rating in advance
b. Frequently scanning and monitoring customers for credit risks
c. Maintaining customer relations
d. Detecting late payments in due time
e. Detecting complaints in due time
f. Reducing the total balance outstanding (DSO)
g. Preventing any bad debt in receivables outstanding
Receivables Cash Management

Any amount which the company has earned however not yet received, i.e. its outstanding and is
expected to be received in future, is known as receivables. An organization must manage its
receivables to maintain the surplus cash inflow. It helps the firm to fulfil its immediate cash
requirements. The cash receivables must be planned in such a way that the organization can
realise its debts quickly and should allow a short credit period to the debtors.
Payables Cash Management

The payables refer to the payment which is unpaid by the organization and is to be paid off
shortly. The organization should plan its cash outflow in such a manner that it can acquire an
extended credit period from the creditors. This helps the firm to retain its cash resources for a
longer duration to meet the short-term requirements and sudden expenses. Even the
organization can invest this cash in a profitable opportunity for that particular credit period to
generate additional income.
Objectives
a. Fulfil Working Capital Requirement: The organization needs to maintain ample

liquid cash to meet its routine expenses which possible only through effective cash
management.
b. Planning Capital Expenditure: It helps in planning the capital expenditure and
determining the ratio of debt and equity to acquire finance for this purpose.
c. Handling Unorganized Costs: There are times when the company encounters
unexpected circumstances like the breakdown of machinery. These are unforeseen
expenses to cope up with; cash surplus is a lifesaver in such conditions.
d. Initiates Investment: The other aim of cash management is to invest the idle funds in
the right opportunity and the correct proportion.
e. Better Utilization of Funds: It ensures the optimum utilization of the available funds
by creating a proper balance between the cash in hand and investment.
f. Avoiding Insolvency: If the business does not plan for efficient cash management, the
situation of insolvency may arise. It is either due to lack of liquid cash or not making a
profit out of the money available.
Functions of cash management

Cash management is required by all kinds of organizations irrespective of their size, type and location.
Following are the multiple managerial functions related to cash management:
a. Investing Idle Cash: The company needs to look for various short term investment
alternatives to utilize surplus funds.
b. Controlling Cash Flows: Restricting the cash outflow and accelerating the cash inflow
is an essential function of the business.
c. Planning of Cash: Cash management is all about planning and decision making in
terms of maintaining sufficient cash in hand and making wise investments.
d. Managing Cash Flows: Maintaining the proper flow of cash in the organization
through cost-cutting and profit generation from investments is necessary to attain a
positive cash flow.
e. Optimizing Cash Level: The organization should continuously function to maintain
the required level of liquidity and cash for business operations.
Limitations of Cash Management

Cash management is an inevitable part of business organizations. However, it has a few shortcomings
which make it unsuitable for small organizations; these are as follows:
Time consuming Cash management is a very time consuming and skilful activity which is required
to be performed regularly.
Administrative charges: As it requires financial expertise, the company may need to hire consultants
or other experts to perform the task by paying administrative and consultation charges.
Small business entities: which are managed solely, face problems such as lack of skills, knowledge,
time and risk-taking ability to practice cash management.
Motives for Holding Cash
The Motives for Holding Cash is simple, the cash inflows and outflows are not well synchronized, i.e.
sometimes the cash inflows are more than the cash outflows while at other times the cash outflows
could be more. Hence, the cash is held by the firms to meet the certain as well as uncertain situations.
Motives for Holding Cash
Majorly there are three motives for which the firm holds cash.
1. Transaction Motive: The transaction motive refers to the cash required by a firm to meet the day
to day needs of its business operations. In an ordinary course of business, the firm requires cash to
make the payments in the form of salaries, wages, interests, dividends, goods purchased, etc.
Likewise, it also receives cash from its sales, debtors, investments. Often the firm’s cash inflows
and outflows do not match, and hence, the cash is held up to meet its routine commitments.
2. Precautionary Motive: The precautionary motive refers to the tendency of a firm to hold cash, to
meet the contingencies or unforeseen circumstances arising in the course of business Since the
future is uncertain, a firm may have to face contingencies such as an increase in the price of raw
materials, labour strike, lockouts, change in the demand, etc. Thus, in order to meet with these
uncertainties, the cash is held by the firms to have an uninterrupted business operation.
3. Speculative Motive: The firms hold cash for the speculative purposes to avail the benefit of
bargain purchases that may arise in the future. For example, if the firm feels the prices of raw
material are likely to fall in the future, it will hold cash and wait till the prices actually fall. Thus, a
firm holds cash to exploit the possible opportunities that are out of the normal course of business.
These opportunities could be in the form of the low-interest rate charged on the borrowed funds,
expected fall in the raw material prices or favourable change in the government policies. Thus, the
cash is the most significant and liquid asset that the firm holds. It is significant as it is used to pay
off the firm’s obligations and helps in the expansion of business operations.
Cash Budget. This budget represents the amount of cash receipts and payments, and a balance
during the budgeted period. it is prepared after all the functional budgets are prepared by the chief
accountant either monthly or weekly giving the following hints
(l) It ensures sufficient cash for business requirements.
(2) It proposes arrangements to be made overdraft to meet any shortage of cash.
(3) It reveals the surplus amount, and the effect of the seasonal fluctuations on cash position. The
objective of cash budget is the proper co-ordination of total working capital, sale, investment and
credit.
Cash forecasting
Cash forecasting can be a valuable aid to the cash manager if it is prepared well and used properly.
Where it is prepared badly, it can be a significant waste of time to all involved. In companies that
make good use of cash forecasting it may be used as an aid for some, or all, of the following
▪ to set borrowing limits and minimise cost of funds;
▪ to maximise interest earnings;
▪ for liquidity management;
▪ for foreign exchange risk management;
▪ for setting and monitoring longer term investment and
funding strategies;
▪ for financial control;
▪ to monitor and set strategic objectives;
▪ for monitoring various lender and investor ratios
Set borrowing limits and minimising cost of funds

The knowledge that funds are required in advance gives the cash manager time to ensure adequate
funds and borrowing limits are available, to look for surpluses from other parts of the group that can
be used via inter-company loans to fund the shortages and to look for the cheapest source of funds
from the financial markets. Having to provide liquidity at short notice, or even immediately if a
deficit occurs, often means paying a premium as there may not be time to put the most appropriate
borrowing facilities in place or identify the cheapest sources of funds.
Maximising interest earnings

This is a similar exercise to minimising the cost of funds; knowing that a surplus will occur in
advance enables the cash manager to look for the most effective ways to invest funds. This is
achieved first by looking internally for parts of the group that could use this potential source of
cheaper funds. This may be a group company needing funds for a similar period to that of the
identified surplus, or it may be able to be used to refinance more expensive external financing
resources (e.g. bank borrowings) and, if not needed internally, notice will enable the cash manager to
identify higher yielding instruments in which to invest, to maximise returns.
Liquidity management
It is the cash manager’s basic job to provide the company with sufficient liquidity to enable the
operating units to function. When assessing potential surpluses and deficits of cash it is necessary not
only to assess amounts and currencies, but also the periods for which the surpluses or shortages will
arise. Some companies build in a cushion into their calculations in case of unexpected cash calls.
Intra-group funding, practised by most large groups, is always carried out more effectively if it is
based on planned and expected positions rather than being a reaction to short-term
situations. This is particularly important where cross-currency and/or cross-border liquidity
management are concerned. Moving money cross-border can be expensive. As well as bank costs,
‘hidden’ elements such as losses of value while the funds are in transit, the imposition of ‘lifting
charges’ or ‘beneficiary deductions’ in some countries also add to costs. Cross-currency swaps are
increasingly being used for this purpose (i.e. to move funds from one location where subsidiaries
may have surpluses to locations in deficit). Again, these work best where amounts and tenors can be
identified in advance. The swap ‘locks in’ exchange rates and provides an automatic hedge. Some
companies fund subsidiaries for very short periods using swaps based on equally short-term cash
forecasts. They may be for periods as short as one or two days.
Foreign exchange risk management

Some companies require their business units to produce both local currency (home currency to the
unit) and foreign currency cash forecasts. This enables treasury to identify the size and timings of
currency flows and either ‘match’ them against opposite flows within the company, or hedge them in
the currency markets. Identification of currency flows will enable the company to identify where
currency accounts may be necessary (or no longer necessary) and should form the second stage of an
annual plan, following on from an operating plan and operating budget. Like all forecasting,
currency cashflow forecasting is only useful for risk management purposes if it is regularly updated
and refined, as potential flows, currencies and estimated timings become more certain.
Setting and monitoring longer-term investment and

funding strategies
In this case cash forecasting techniques can be used as modelling tools. These should be able to
identify future structural cash shortages and surpluses. Generally, this will be for periods in excess of
one year.
Financial control
Cash forecasting can often be used to model payables and receivables against known sales and
purchases. This type of forecasting identifies mismatches between credit periods
granted to customers and the amount of credit actually taken (Days Sales Outstanding). It can also
enable comparison with credit taken from suppliers (Days Purchases Outstanding) and hence to
identify working capital financing requirements. Such forecasts may be reconciled against actuals to
ensure that subsidiary companies are managing their cashflows in line with plans and corporate
policy (see also below section on working capital management).
Monitoring and setting strategic objectives
Various corporate strategies and objectives can be planned using cash forecasting and reviewed or
monitored by comparing actual cashflows relating to specific products, projects, or business units,
against those planned.
Monitoring various lender and investor ratios
Borrowers normally have to comply with covenants set by lenders, or the company itself may either
impose ratios on itself or use them to benchmark itself against peer groups. Cash forecasting would
be one of the techniques used within the company to monitor and even plan certain types of ratios.
Management of Receivables
Concept of Receivables Management
The receivables are normally arising out of the credit sales of the firm.
What is meant by the accounts receivable?

It is an asset owed to the firm by the buyer out of the credit sales with the terms and conditions of
repayment on an agreed time period.
Meaning of the receivables management: The receivables out of the credit sales crunch the
availability of the resources to meet the day today requirements. The acute competition requires the
firm to sustain among the other competitors through more volume of credit sales and in the intention
of retaining the existing customers. This requires the firm to sell more through credit sales only in
order to encourage the buyers to grab the opportunities unlike the other competitors they offer in the
market.
Objectives of Accounts Receivables
a. Achieving the growth in the volume of sales

b. Increasing the volume of profits
c. Meeting the acute competition
d. Cost of Maintaining the Accounts Receivables
Capital cost: Due to in sufficient amount of working capital with reference to more volume of credit
sales which drastically affects the existence of the working capital of the firm. The firm may be
required to borrow which may lead to pay certain amount of interest on the borrowings. The interest
which is paid by the firm due to the borrowings in order to meet the shortage of working capital is
known as capital cost of receivables.
Administrative cost: Cost of maintaining the receivables.
Collection cost: Whatever the cost incurred for the collection of the receivables are known as
collection cost.
Defaulting cost: This may arise due to defaulters and the cost is in other words as cost of bad debts
and so on.
Factors Affecting the Accounts Receivables

a. Level of sales: The volume of sales is the best indicator of accounts receivables. It differs
from one firm to another.
b. Credit policies: The credit policies are another major force of determinant in deciding the
size of the accounts receivable. There are two types of credit policies viz lenient and stringent
credit policies.
c. Lenient credit policy: Enhances the volume of the accounts receivable due to liberal terms of
the trade which normally encourage the buyers to buy more and more.
d. Stringent credit policy: It curtails the motive buying the goods on credit due stiff terms of
the trade put forth by the supplier unlike the earlier.
e. Terms of trade: The terms of the trade are normally bifurcated into two categories viz credit
period and cash discount
f. Credit period: Higher the credit period will lead to more volume of receivables, on the other
side that will lead to greater volume of debts from the side of buyers.
g. Cash discount: If the discount on sales is more, that will enhance the volume of sales on the
other hand that will affect the income of the enterprise.
1. From the following forecasts of income and expenditure prepare a cash budget for the three
months commencing 1st June, when the bank balance was Rs. 1,00,000.
Particulars Sales Purchase Wages Factory Administration

expenses and selling
expenses
April 80000 41000 5600 3900 10000
May 76500 40500 5400 4200 14000
June 78500 37000 5400 5100 15000
July 90000 37000 4800 5100 17000
August 80000 35000 4700 6000 13000
A sales commission of 5 per cent on sales, due two months after sales, is payable in
addition to selling expenses. Plant valued at Rs. 65,000 will be purchased and paid for in August,
and the dividend for the last financial year of Rs. 15,000 will be paid in July. There is a two-
month credit period allowed to customers and received from suppliers. Wages and other expenses
accrued for one month.
Solution
Cash Budget
For three months to 31st August
Particulars June July August
Receipts:
Opening balance 100000 111400 102600
Sundry debtors 80000 76000 78500
180000 187960 181575
(-) Payments:
Sundry creditors 41000 40500 37000
Wages 5400 5400 4800
Factory expenses 4200 5100 5100
Adm. & selling expenses 14000 15000 17000
Sales commission 4000 3800 3925
Purchase of plant - 65000
Payment of dividend - 15000
Closing balance / cash budget 111400 102600 48275

2. A company expects to have Rs. 37,500 cash in hand on 1st April, and requires you to prepare an
estimate of cash position during the three months, April, May and June. The following information is
supplied to you
Particulars Sales purchase Wages Factory Administration Selling

expenses and selling expense Other
expenses
Feb 75000 45000 9000 7500 6000 4500
Mar 84000 48000 9750 8250 6000 4500
April 90000 52500 10500 9000 6000 5250
May 120000 60000 13500 11250 6000 6510
June 135000 60000 14250 14000 7000 7000
information:
l. Period of credit allowed by suppliers 2 months.
2. 20% of sales is for cash and period of credit allowed to customers for credit is one month.
3. Delay in payment of all expenses — I month.

4. Income tax of Rs. 57,500 is due to be paid on June 15th.
5. The company is to pay dividends to shareholders and bonus to workers of Rs. 15,000 and
Rs. 22,500 respectively in the month of April.
6. Plant has been ordered to be received and paid in May. It will cost Rs. 1,20,000.
Solution
Cash Budget
For three months till June
Particulars April May June
Receipts:
Opening balance 37500 11700 -91050
cash sales 90000X20% 18000 24000 27000
Sundry debtors 84000X80% 67200 72000 96000
122700 107700 31950
(-) Payments:

Wages 9750 10500 13500
Selling expenses 4500 5250 6510
Income Tax - - 57500
Payment of dividend 15000 - -
Bonus 22500 - -
Purchase of plant - 120000 -
Closing balance / cash budget 11700 -91050 -115310
Note: The company needs overdraft facilities in May and June to the extent of Rs. 91,050 and Rs. 1,
15,310 respectively
3. A company is expecting to have Rs. 25,000 cash in hand on 1st April 2010 and it requires you to
prepare an estimate of cash position during the three months, April to June 2010. The following
information is supplied to you.
Months Sales Purchase wages Expenses

Feb 70000 40000 8000 6000
Mar 80000 50000 8000 7000
April 92000 52000 9000 7000
May 100000 60000 10000 8000
June 120000 55000 12000 9000
Other Information: —
(a) Period of credit allowed by suppliers two months
(b) 25% of sale is for cash and period of credit allowed to customers for credit sale one month
(c) Delay in payment of wages and expenditure one month
(d) Income Tax of 25000 is to be paid in June 2010
Solution:
Cash Budget

Receipts:
Opening balance 25000 53000 81000
cash sales 92000X25% 23000 25000 30000
credit sale 80000X75% 60000 63000 75000
108000 147000 186000
(-) Payments:
Wages 8000 9000 10000
Expenses 7000 7000 8000
Income Tax - 25000
4. A Company wishes to arrange overdraft facilities with its Bankers during the period April to June
when it will be manufacturing most for stock. Prepare cash budget for the above period from the
following data, indicating the extent of bank facilities the company will require at the end of each
month
Months Sales Purchase wages

Feb 180000 124800 12000
Mar 192000 144000 14000
April 108000 243000 11000
May 174000 246000 10000
June 126000 268000 15000
a) 50% of credit sales are realised in the month following sales and the remaining 50% in the
second month following.
b) Creditors are paid in the month following the month of purchase.
c) Wages are paid on 1st of very next month
d) Cash at bank on 1st April Rs. 25,000
Solution:
Cash Budget
Receipts:
Opening balance 25000 53000 -51000
cash sales 180000X50% 90000 96000 54000
credit sale 192000X50% 96000 54000 87000
211000 203000 90000
(-) Payments:
Wages 14000 11000 10000
Closing balance / cash budget 53000 -51000 -166000
Note: The company needs overdraft facilities in May and June to the extent of Rs. 51000 and Rs.
166000 respectively
5.A company expects to have Rs. 47,500 cash in hand on 1st April, and requires you to prepare an
estimate of cash position during the three months, April, May and June. The following information is
supplied to you
Particulars Sales purchase Wages Factory Administration Selling

expenses and selling expense
expenses
Feb 85000 55000 10000 8500 7000 5500
Mar 94000 58000 10750 9250 7000 5500
April 90000 62500 11500 10000 7000 6250
May 130000 70000 14500 12250 7000 7510
June 145000 70000 15250 15000 8000 8000
Other information:
l. Period of credit allowed by suppliers 2 months.
7. 20% of sales is for cash and period of credit allowed to customers for credit is one month.
8. Delay in payment of all expenses — I month.

9. Income tax of Rs. 57,500 is due to be paid on June 15th.
10. The company is to pay dividends to shareholders and bonus to workers of Rs. 15,000 and
11. Plant has been ordered to be received and paid in May. It will cost Rs. 1,20,000.
Solution
Cash Budget
Receipts:
Opening balance 47500 -33800 -148550
cash sales 90000X20% 18000 26000 29000
Sundry debtors 94000X80% 75200 72000 104000
140700 64200 -15550
(-) Payments:
Wages 10750 11500 14500
Selling expenses 5500 6250 7570
Income Tax - - 57500
Payment of dividend 37500 - -
Bonus - -
Purchase of plant - 120000 -
Closing balance / cash budget -33800 -148550 -176870
Note: The company needs overdraft facilities in April, May and June to the extent of Rs.
33800,148550 and Rs. 1,76870 respectively
6. A company is expecting to have Rs. 35,000 cash in hand on 1st April 2015 and it requires you to
prepare an estimate of cash position during the three months, April to June 2015. The following
information is supplied to you.

Feb 80000 50000 9000 7000
Mar 90000 60000 9000 8000
April 102000 62000 10000 8000
May 110000 70000 10000 9000
June 130000 65000 14000 10000
Other Information:
—
(d) Income Tax of 30000 is to be paid in June 2015
Solution:
Cash Budget
Receipts:
Opening balance 35000 61000 87000
cash sales 102000X25% 25500 27500 32500
credit sale 90000X75% 67500 76500 82500
128000 165000 202000
(-) Payments:
Wages 9000 10000 10000
Expenses 8000 8000 9000
Income Tax - 30000

1. What do you mean by receivable management? Explain its objectives (R)
2. Explain the functions and limitation of cash management (U)
3. What do you mean by cash forecasting? Explain its objectives (R)
4. What do you mean by receivables and payables cash management? Explain the objectives of
cash management (U)
5. Write a note on Receivable Management (R)
6. Explain the factors influencing size of receivable management (U)
7. From the following forecasts of income and expenditure prepare a cash budget for the three
months commencing 1st June, when the bank balance was Rs. 1,00,000.
Particulars Sales purchase wages Factory Administration

expenses and selling
expenses
April 80000 41000 5600 3900 10000
May 76000 40500 5400 4200 14000
June 78500 37000 5400 5100 15000
July 90000 37000 4800 5100 17000
August 80000 35000 4700 6000 13000
A sales commission of 5 per cent on sales, due two months after sales, is payable in addition
to selling expenses. Plant valued at Rs. 65,000 will be purchased and paid for in August, and
the dividend for the last financial year of Rs. 15,000 will be paid in July. There is a two-
month credit period allowed to customers and received from suppliers. (S)
8. A company expects to have Rs. 37,500 cash in hand on 1st April, and requires you to prepare
an estimate of cash position during the three months, April, May and June. The following
information is supplied to you
Particulars Sales Purchase wages Factory Administration Selling

expenses and selling expense
expenses
Feb 75000 45000 9000 7500 6000 4500
Mar 84000 48000 9750 8250 6000 4500
April 90000 52500 10500 9000 6000 5250
May 120000 60000 13500 11250 6000 6510
June 135000 60000 14250 14000 7000 7000
Other information:
a) Period of credit allowed by suppliers 2 months.
b) 20% of sales is for cash and period of credit allowed to customers for credit is one month.
c) Delay in payment of all expenses — I month.
d) Income tax of Rs. 57,500 is due to be paid on June 15th.
e) The company is to pay dividends to shareholders and bonus to workers of Rs. 15,000 and Rs.
22,500 respectively in the month of April.
f) Plant has been ordered to be received and paid in May. It will cost Rs. 1,20,000. (S)
9. A company is expecting to have Rs. 25,000 cash in hand on 1st April 2010 and it
requires you to prepare an estimate of cash position during the three months, April to June
2010. The following information is supplied to you.

Feb 70000 40000 8000 6000
Mar 80000 50000 8000 7000
April 92000 52000 9000 7000
May 100000 60000 10000 8000
June 120000 55000 12000 9000
(d) Income Tax of 25000 is to be paid in June 2010 (S)
10. A Company wishes to arrange overdraft facilities with its Bankers during the period April to
June when it will be manufacturing most for stock. Prepare cash budget for the above period from
the following data, indicating the extent of bank facilities the company will require at the end of
each month
Months Sales Purchase Wages

Feb 180000 124800 12000
Mar 192000 144000 14000
April 108000 243000 11000
May 174000 246000 10000
June 126000 268000 15000
a. 50% of credit sales are realised in the month following sales and the remaining 50% in the
second month following.
b. Creditors are paid in the month following the month of purchase.
c. Wages are paid on 1st of very next month
d. Cash at bank on 1st April Rs. 25,000 (S)
11. .A company expects to have Rs. 47,500 cash in hand on 1st April, and requires you to prepare
an estimate of cash position during the three months, April, May and June. The following
information is supplied to you
Particulars Sales Purchase wages Factory Administration Selling

expenses and selling expense Other
expenses
Feb 85000 55000 10000 8500 7000 5500
Mar 94000 58000 10750 9250 7000 5500
April 90000 62500 11500 10000 7000 6250
May 130000 70000 14500 12250 7000 7510
June 145000 70000 15250 15000 8000 8000
information:
a. Period of credit allowed by suppliers 2 months.
b. 20% of sales is for cash and period of credit allowed to customers for credit is one month.
c. Delay in payment of all expenses — I month.
d. Income tax of Rs. 57,500 is due to be paid on June 15th.
e. The company is to pay dividends to shareholders and bonus to workers of Rs. 15,000 and
f. Plant has been ordered to be received and paid in May. It will cost Rs. 1,20,000. (S)
12. A company is expecting to have Rs. 35,000 cash in hand on 1st April 2015 and it requires
you to prepare an estimate of cash position during the three months, April to June 2015. The
following information is supplied to you.

Feb 80000 50000 9000 7000
Mar 90000 60000 9000 8000
April 102000 62000 10000 8000
May 110000 70000 10000 9000
June 130000 65000 14000 10000
(d) Income Tax of 30000 is to be paid in June 2015. (S)
Multiple choice question

1. The measurement of cash on hand classified as a current asset would include each of the
following, except: (U)
a. bank drafts.
b. negotiable checks.
c. certificates of deposit.
d. unrestricted funds on deposit with a bank.
2. Use of the direct write-off method in accounting for bad debts would in most instances
violate which of the following accounting principles? (U)
a. objectivity
b. consistency
c. materiality
d. matching
3. The method of estimating bad debts that most closely matches current expenses with current
revenues is one that obtains the estimate from: (K)
a. a percentage of total sales.
b. a percentage of total credit sales.
c. a percentage of accounts receivable.

d. an aging of accounts receivable.
4. A company determined that $10,600 of existing accounts receivable may not be collected
by aging its accounts receivable. At this date, the Allowance for Doubtful Accounts account
had a credit balance of $1,200. Based on this information, an adjusting journal entry should
involve a debit to Bad Debt Expense for: (K)
a. $11,800.
b. $10,600.
c. $9,400.
d. $1,200.
5. The equity that a company has in trade accounts receivable that it has assigned should
be disclosed in its financial statements as a: (U)
a. separate component of the stockholders’ equity section of the balance sheet.
b. contra asset account.
c. current liability.
d. current asset.
6. Cash management is a broad term used for collecting and managing cash. Speculative
motive of holding cash refers to (U)
a. Holding the cash to utilize it in internal projects
b. Holding the cash for any future loss the company is expecting
c. Holding the cash to avail any future investment opportunity
d. Holding the cash to utilize it for international project
7. Companies hold cash time to time. Transitionary motive of holding cash means (U)
a. Keeping a cash reserve for purchasing goods and services to balance out the cash inflows and
outflow
b. Keeping the cash for all the transactions made during a periodic term
c. Keeping the cash for transactions mandatory for day to day activities
d. Keeping the transactions for foreign trading
8. Every organization have its own strengths, weaknesses, opportunities and threats. Two
of these belong to inside of organization whereas other two belongs to outside. Identify
where strength and opportunity belongs? (K)
a. Both belongs to outside
b. First belongs to inside and the second belongs to outside
c. First belongs to outside and the second belongs to inside
d. Both belongs to inside.
9. Credit management is an important tool used by finance managers. Credit management means(K)
a. Managing the cash of the organization for the operational activities
b. To lend money to the borrower for more than a year
c. Granting money on credit basis while considering all the terms on which it is being granted on
d. Managing the credit system.
10. Company's ratios are compared with industry's ratio to get a clear view about company's
performance. recommended current ratio is (K)
a. (1:3)
b. (3:1)
c. (1:2)
d. (2:1)
11. Cash is life blood of any business. Cash flow is defined as (U)
a. The ability to pay off the bills on time
b. The system in which the cash is handled in an organization
c. A system in which cash is distributed among the departments
d. The ability to generate cash by utilizing the assets
12. Assets are revenue generators in a company. Amount received from selling an asset is
an example of (U)
a. Asset cost
b. Cash inflows
c. Cash outflows
d. Cash reserves
13. Current assets are life blood in an organization. Current asset means (K)
a. Assets that have physical existence

b. Assets that are readily convertible to cash
c. Assets that are available in the premises
d. Assets that generate major cash inflows for the entity
14. Over-trading or undercapitalization in an organization refers to (K)

a. Spending more in trade than the estimated budget
b. Investing small amount of working capital in a comparatively bigger operational trade setup
c. Trading more goods or services than expected
d. Investing less capital than the budgeted amount
15. Successful organizations manage their time well. Choose characteristics of time from
Following (U)
a. Time is money, It has different value of success for everyone, It can be managed
according to your
b. Time is unbiased, It can be dragged according to use, It is as worthy as money
c. Time is impartial, It cannot be kept for future use, It is as appreciated as currency
d. Time is manageable, it can be dragged according to need, It is as valuable as currency
16. Routine tasks of management/administration would include (U)

a. Creating and planning
b. Planning and advertisement
c. Planning and leading
d. Leading and controlling
17. Assets are revenue generators of company. most liquid asset in any organization is (K)
a. Receivable
b. Stock and inventory
c. Cash
d. Prize bond
18. Marketing plays an important role in increasing sale of a product. Poor marketing of a product
could lead to (K)
a. Bad publicity of the organization
b. Cash flow problems

c. Less sale of the product
d. Lower growth of the organization
19. Maintaining an optimum cash level is mandatory for every organization but it varies from one
organization to other. reason could be (U)
a. Size of the entity, reasons behind holding cash and time
b. Availability of cash, assets of the company and its liabilities
c. Efficiency of its employees, size of the entity and working capacity of assets
d. Time period, efficiency of operational staff and assets of the organization
20. Paying habits of customer is considered an important factor of (U)

a. Trading more goods or services than expected
b. Determining cash discounts
c. Determining credit policy for the organization
d. Creating good will of the organization
21. A company whose primary motive is to earn profit for its shareholders is said to be
a. Non-profit oriented company (K)
b. Public company
c. Private company
d. Profit oriented company
22. Cash ratio is another tool for measuring liquidity of company. Current liabilities are
compared against the (K)
a. Cash readily available in possession
b. Cash in hand and cash at bank
c. Cash, Cash equivalents and the funds invested
d. Cash in bank and short-term investments
23. Cash paid when acquiring an asset would be an example of (U)

a. Cash inflows
b. Asset cost
c. Cash outflows
d. Cash deposit
24. When a company gets an increase in their bank overdraft facility, its an example of (U)
a. Cash outflows
b. Banking threats
c. Cash outflows
d. Cash inflow
25. Cash budget comprises of all inflows and outflows of cash of organization. Time period
for this kind of budget comprises of (K)
a. Whole tenure from the commencement of business till date
b. A year, Half a year or quarter year
c. Five years or above
d. One year or above
Unit- III
Financial Statement Analysis
1.1: Introduction: A financial statement is an organized collection of data according to logical and
consistent accounting procedures. Its purpose is to convey an understanding of some financial aspects
of a business firm.
The term 'Financial Statement' refers to a package of financial statement such as Balance sheet, income
statement, Statement of retained earnings, Statement of sources of funds and uses of funds. The
financial statement provides a summarized view of the financial position and operations of a firm.
Financial statement is the end products of financial accounting. They support to reveal the financial
positions of the firm which show the results of its recent activities and an analysis of what has been
done with the earnings.
1.2: Income Statement: It explains what has happened to a business as a result of operations between
two balance sheet dates. For this purpose it matches the revenues and costs incurred in the process of
earning revenue and shows the net profit earned or loss suffered during a particular period.
1.3: Balance Sheet: It represents all assets owned by the business at a particular moment of time and
the claims (or equities) of the owners and outsiders against those assets at that time.
1.4: Statement of Retained Earnings: The term retained earnings means the accumulated excess of
earnings over losses and dividends. The statement of retained earnings is a connecting link between the
balance sheet and income statement. It is also termed as Profit and Loss Appropriation account.
1.5: Statement of changes in Financial Position : the balance sheet shows the financial condition of
the business at a particular moment of time while the income a statement discloses the results of
operations of business over a period of time. However, for a better understanding of the affairs of the
business, it is essential to identify the movements of working capital or cash in and out of the business.
This information is available in the statement of changes in financial position of the business.
1.6: Nature of the financial statements:
a. Recorded facts: Recorded facts convey the data brought in statement that have been written in
accounting records such as figures, relating to cash in hands, cash at bank, sales, purchase,
debtors, creditors, etc. the financial statement do not disclose such facts which are not and
cannot be recorded in the accounting books.
b. Accounting conventions: Accounting principles, concepts and conventions also influence the
constructions of financial statements, e.g., the principle of matching cost and revenue,
allocation of expenditure between capital and revenues in different accounting periods etc.
c. Personal judgment: The application of the concepts and conventions depend upon the
personal judgment of the accountant.
1.7: Objectives of Financial Statement:
The objectives of financial statements are:
i. To provide adequate information about the financial performance and to know the asset
liability position.
ii. To predict, compare and evaluate the earning capability of the firm.
iii. To provide the reliable information to the end users of the financial information such as share
holder, employees, management, government etc.
1.8: Limitations of Financial Statement:
a. Historical cost: The financial statements are prepares on the basis of historical cost and
original cost. They do not reveal the current value.
b. Interim Report: When the business is sold or liquidated, the financial statement cannot show
the actual position of the business. It shows only the interim position of the business and the
data entered are all approximated figures.
c. Non-monetary factors ignored: The factors which cannot be calculated in monetary terms are
not included in the financial statement.
d. 1.9:Financial Analysis:
e. The analysis of financial statements is a process of evaluating the relationship between
component parts of financial statements to obtain a better understanding of the firm's position
and performance. In other words, financial analysis refers to the process of determining
financial strength and weakness of the firm by establishing strategic relationship between the
items of the balance sheet, profit and loss account and other operative data.
f. The first step of financial analysis is to select the information relevant to decision under
consideration from the total information contained in the financial statement.
g. The second step is methodical classification of the data given in the financial statements i.e., to
arrange the information in a way to highlight significant relationships.
h. The final step is comparison of the various inter-connected figures with each other by different
' Tools of financial Analysis'.
1.10: Objectives of Financial Statement Interpretation:
 To estimate the profitability or earning capacity of the firm.
 To determine the measures of efficiency of operations.
 To determine the future prospects of the firm.
1.11: Types of Analysis:
I. Internal Analysis: The analysis conducted by persons who have access to the internal
accounting records of the business firm is known as Internal analysis.
II. External Analysis: The analysis based upon the published statements i.e., Profit and loss
account and balance sheet are known as external analysis.
III.Horizontal Analysis: It refers to the comparison of financial data of a company for several
years. The analyses are presented horizontally over a number of columns. The figures of
various years are compared with the standard or base year.
IV. Vertical Analysis: It refers to the study of relationship of various items in the financial
statements of one accounting period. In this type of analysis, the figures from financial
statement of a year are compared with a base year selected from the same year's statement.
1.12:Methods/Tools/Techniques of Financial Analysis:
Financial analysis Techniques
Cash Ratio
Flow Analysis
Analysis
Comparati Common- Trend Fund CVP

ve Size Percentage Flow Analysis
Financial Financial Analysis
Statement Statement
i. Comparative Statements
ii. Common Size Statements
iii. Trend Analysis
iv. Fund Flow Analysis
v. Cash Flow Analysis
vi. Ratio Analysis
vii. Cost Volume Profit Analysis(CVP)
COMPARATIVE STATEMENTS
Comparative financial statement is those statements which have been designed in a way so as to
provide time perspective to the consideration of various elements of financial position. In these
statements figures for two or more periods are placed side by side to facilitate comparison.
Comparative financial statements are those statements which have been designed in a way so as to
provide time perspective to the consideration of various elements of financial position embodied in
such statements. In these statements figures for two or more periods ire placed side by side to facilitate
comparison.
Comparative Income Statement: The Income Statement discloses Net profit or Net Loss on account
of operations. A Comparative Income statement will show the absolute figures for two or more
periods, the absolute change from one period to another and if desired the change is of percentages.
Since the figures for two or more periods are by side, the reader can quickly ascertain whether sales
have increased or decreased, whether cost of sales has increased or decreased etc. Thus, only a reading
of data included in Comparative Income Statements will be helpful in deriving meaningful
conclusions.
Comparative Balance Sheet: Comparative Balance Sheet as on two or more different dates can be
used for comparing assets and liabilities and finding out any increase or decrease in those items. Thus,
while in a single Balance Sheet the emphasis is on present position, it is on change in the comparative
Balance Sheet. Such a Balance Sheet is very useful in studying the trends in an enterprise.
Comparative Financial Statements can be prepared for more than two periods or on more than two
dates. However, it becomes very cumbersome to study the trend with more than two period’s data.
Trend percentages are more useful in such cases
The American Institute of Certified Public Accountants has explained the utility of preparing the
Comparative Financial Statements as follows:
"The presentation of comparative financial statements in annual and other reports enhances the
usefulness of such reports and brings out more clearly the nature and trend of current changes affecting
the enterprise. Such presentation emphasizes the fact that statement for a series of periods is far more
significant than those of a single period and that the accounts of one period are but an installment of
what is essentially a continuous history. In any one year, it is ordinarily desired that the Balance Sheet,
the Income Statement and the Surplus Statement be given for one or more preceding years as well as
for the current year."
The utility of preparing the Comparative Financial Statements has also been realized in our country.
The Companies Act, 1956, provides that companies should give figures for different items for the
previous period, together with current period figures in their Profit and Loss Account and Balance
Sheet.
Common-Size Statement Analysis
The common size statements are shown in analytical percentages. The amounts (figures) are converted
into percentage to some common base.
Common Size Balance Sheet: A statement in which balance sheet items are expressed as the ratio of
each assets to total assets and the ratio of each liability to total liabilities. The total assets are taken as
100 and different assets are expressed as a percentage of total liabilities.
Common Size Income Statement: In the income statement the sales is assumed to be 100 and all
other expenses are expressed as the percentage of sales.
Comparative Utility of Common Size Financial Statements
The comparative common-size financial statements show the percentage of each item to the total in
each period but not variations in respective items from period to period. In other words, common-size
financial statements when read horizontally do not give information about the trend of individual items
but the trend of their relationship to total. Observation of these trends is not very useful because there
are no definite norms for the proportion of each item to total. For example, if it is established that
inventory should be 30% of total assets, the computation of various ratios to total assets would be very
useful. But since there are no such established standard proportions, calculation of percentages of
different items of assets or liabilities to total assets or total liabilities is not of much use. On account of
this reason common size financial statements are not much useful for financial analysis. However,
common size financial statements are useful for studying the comparative financial position of two or
more businesses. However, to make such comparison really meaningful, it is necessary that the
financial statements of all such companies should be prepared on the same pattern, e.g., all the
companies, should, be more or less of the same age, they should be following the same accounting
practices, the method of depreciation on fixed assets should be the same.
Trend Analysis
It is a horizontal analysis of financial statement. It is acomparison of past data over a period of time
with the base year. The method of calculating trend percentage involves the calculation of percentage
relationship that each item bears to the same item in the base year.
The information for a number of years is taken up and one year usually the first year is taken as a base
year. The figure of the base year is taken as 100 and trend ratios for other year are calculated on the
basis of the base year.
This method of financial analysis determines the direction upward or downwards from the base year.
Trend percentages are immensely helpful in making a comparative study of the financial statements for
several years. The method of calculating trend percentages involves the calculation of percentage
relationship that each item bears to the same item in the base year. Any year may be taken as the base
year. It is usually the earliest year. Any intervening year may also be taken as the base year. Each item
of base year is taken as 100 and on that basis the percentages for each of the items of each of the years
are calculated. These percentages can also be taken as Index Numbers showing relative changes in the
financial data resulting with the passage of time.
The method of trend percentages is a useful analytical device for the management since by substituting
percentages for large amounts; the brevity and readability are achieved. However, trend percentages
are not calculated for all of the items in the financial statements. They are usually calculated only for
major items since the purpose is to highlight important changes.
1.13: Fund Flow Analysis
Funds flow analysis has become an important tool in the analytical kit of financial analysts, credit
granting institutions and financial managers. This is because the Balance Sheet of a business reveals
financial status at a particular point of time. It does not sharply focus those major financial transactions
which have been behind the Balance Sheet changes.
For example, if a loan of Rs. 2,00,000 was raised and paid during the accounting year, the balance
sheet will not depict this transaction. However, a financial analyst must know the purpose for which
the loan was utilized and the source from which it was obtained. This will help him in making a better
estimate about the company's financial position and policies.
Funds flow analysis reveals the changes in working capital position. It tells about the sources from
which the working capital was obtained and the purposes for which it was used. It brings out in open
the changes which have taken place behind the Balance Sheet. Working capital being the life-blood of
the business, such an analysis is extremely useful. The technique and the procedure involved in funds
flow analysis has been discussed in detail later in the book
1.14: Cash Flow Analysis & Ratio Analysis
This is the most important tool available to financial analysts for their work. An accounting ratio
shows the relationship in mathematical terms between two interrelated accounting figures.
This is the most important tool available to financial analysts for their work. An accounting ratio
shows the relationship in mathematical terms between two interrelated accounting figures. The figures
have to be interrelated [e.g.. Gross Profit and Sales, Current Assets and Current Liabilities), because no
useful purpose will be served if ratios are calculated between two figures which are not at all related to
each other, e.g., sales and discount on issue of debentures.
A financial analyst may calculate different accounting ratios for different purposes.
1.15: Cost-Volume-Profit Analysis
Cost-Volume-Profit Analysis is an important tool of profit planning. It studies the relationship between
cost, volume of production, sales and profit. Of course, it is not strictly a technique used for analysis of
financial statements. However, it is an important tool for the management for decision making since
the data is provided by both cost and financial records. It tells the volume of sales at which the firms
will break-even, the effect on profit on account of variation in output, selling price and cost, and
finally, the quantity to be produced and sold to reach the target profit level.
It studies the relationship between cost, volume of production, sales and profit, break-even, the effect
on profit on account of variation in output, selling price and cost, and finally, the quantity to be
produced and sold to reach the target profit level.
1.16: LIMITATIONS OF FINANCIAL ANALYSIS
Financial analysis is a powerful mechanism which helps in ascertaining the strengths and weaknesses
in the operations and financial position of an enterprise. However, this analysis is subject to certain
limitations. Most of these limitations are because of the limitations of the financial statements
themselves. These limitations are as follows:
1. Financial Analysis is only a Means
Financial analysis is a means to an end and not the end itself. The analysis should be used as a starting
point and the conclusion should be drawn not in isolation but keeping in view the overall picture and
the prevailing economic and political situation.
2. Ignores Price Level Changes
Financial statements are normally prepared on the concept of historical costs. They do not reflect
values in terms of current costs. Thus, the financial analysis based on such financial statements or
accounting figures would not portray the effects of price level changes over the period.
3. Financial Statements are Essentially Interim Reports
The profit shown by Profit and Loss Account and the financial position as depicted by the Balance
Sheet is not exact. The exact position can be known only when the business is closed down. Again, the
existence of contingent liabilities, deferred revenue expenditure make them more imprecise.
4. Accounting Concepts and Conventions
Financial statements are prepared on the basis of certain accounting concepts and conventions. On
account of this reason the financial position as disclosed by these statements may not be realistic. For
example, fixed assets in the balance sheet are shown on the basis of going concern concept. This
means that value placed on fixed assets may not be the same which may be realized on their sale. On
account of convention of conservatism the income statement may not disclose true income of the
business since probable losses are considered while probable incomes are ignored.
5. Influence of Personal Judgment
Many items are left to the personal judgment of the accountant. For example, the method of
depreciation, mode of amortization of fixed assets, treatment of deferred revenue expenditure all
depend on the personal judgment of the accountant. The soundness of such judgment will necessarily
depend upon his competence and integrity. However, the convention of consistency acts as a
controlling factor on making indiscreet personal judgments.
6. Disclose only Monetary facts
Financial statements do not depict those facts which cannot be expressed in terms of money. For
example, development of a team of loyal and efficient workers, enlightened management, the
reputation and prestige of management with the public, are matters which are of considerable
importance for the business, but they are nowhere depicted by financial statements.
1.17: Methodical Classification(Format)
In order to have a meaningful analysis it is necessary that figures should be arranged properly. Usually,
the statements are prepared in single (vertical) column form.
Income Statement for the year ending........
Rs. Rs.
Sales
Less: Sales Return
Sales Tax/Excise
Net sales for the year
Less: Cost of sales
Raw Materials consumed
Direct Wages
Manufacturing expenses
Add: Opening stock of finished goods
Less: Closing stock of finished goods

Gross Profit
Less: Operating Expenses
Administration Expenses
Selling and Distribution expenses
Net operating Profit
Add: Non-Trading income( such as discount on issue of shares
written off)
Less: Non-Trading expenses( such as discount on issue of shares
written off)
Income or Earnings before Interest and Tax (EBIT)
Less: Interest
Net income or Earnings before Tax(EBIT)
Less: Tax
Income or profit after Tax (PAT)
BALANCE SHEET as on ......
Particulars Rs.
Assets
Current Assets:
1. Cash in hand and at bank
2. Bills Receivable
3. Sundry Debtors
4. Stock
5. Prepaid Expenses
6. Outstanding and accrued incomes
7. Short term investments
A. TOTAL CURRENT ASSETS

Fixed Assets:
1. Land and building
2. Plant and machinery

3. Furniture and fixtures
4. Motor vehicles
5. Lease hold premises
6. Patents and trade marks
B. TOTAL FIXED ASSETS
TOTAL ASSETS (A+B)
Current Liabilities:
1. Bills Payable
2. Sundry Creditors
3. Bank Overdraft
4. Cash credit
5. Outstanding Expenses
6. Income received in advance
7. Unclaimed Dividends
8. Proposed Dividend
9. Provision for income tax
TOTAL CURRENT LIABILITIES(X)
Long term liabilities:
1. Debentures
2. long term loan on Mortgage
TOTAL LONG TERM LIABILITIES(Y)
Proprietors Fund:
a. Equity share capital
b. Reserves and Surplus
TOTAL PROPRIETORS FUND(Z)
TOTAL LIABILITIES (X+Y+Z)
Specimen of a Comparative Statement
Comparative Income Statement for the years ending........

Increase or Increase or
Year ending decrease decrease
Particulars (amounts) (Percentage)
Previous Current + or – + or –
year year (Rs) (%)
Sales
Less: Sales Return
Sales Tax/Excise
Net sales for the year
Less: Cost of sales
Raw Materials consumed
Direct Wages
Manufacturing expenses
Add: Opening stock of finished goods
Less: Closing stock of finished goods

Gross Profit
Less: Operating Expenses
Administration Expenses
Selling and Distribution expenses
Net operating Profit
Add: Non-Trading income( such as
discount on issue of shares written
off)
Less: Non-Trading expenses( such as
discount on issue of shares written
off)
Income or Earnings before Interest
and Tax (EBIT)
Less: Interest
Net income or Earnings before
Tax(EBT)
Less: Tax
Income or profit after Tax (PAT)
Comparative Balance Sheet as on ......
Increase or Increase or
Year ending decrease decrease
Particulars (amounts) (Percentage)
Previous Current + or – + or –
year year (Rs) (%)
Assets
Current Assets:
1. Cash in hand and at bank
2. Bills Receivable
3. Sundry Debtors
4. Stock
5. Prepaid Expenses
6. Outstanding and accrued
incomes
7. Short term investments
8. Pre-paid expenses
A. TOTAL CURRENT ASSETS
Fixed Assets:
1. Land and building
2. Plant and machinery
3. Furniture and fixtures
4. Motor vehicles
5. Lease hold premises
6. Patents and trade marks
B. TOTAL FIXED ASSETS

TOTAL ASSETS (A+B)
Current Liabilities:
1. Bills Payable
2. Sundry Creditors
3. Bank Overdraft
4. Cash credit
5. Outstanding Expenses
6. Income received in advance
7. Unclaimed Dividends
8. Proposed Dividend
9. Provision for income tax
TOTAL CURRENT
LIABILITIES(X)
Long term liabilities:
1. Debentures
2. Along term loan on Mortgage
TOTAL LONG TERM
LIABILITIES(Y)
Proprietors Fund:
a. Equity share capital
b. Reserves and Surplus
TOTAL of PROPRIETORS FUND
(Z)
TOTAL LIABILITIES (X+Y+Z)
Working out the problems:
Illustration 1
Convert the following statement of profit and loss into the comparative statement of profit and loss of
BCR Co. Ltd.: (S)
Particulars Note 2013-14 2014-15

No.
Rs. Rs.
(i)Revenue from operations 60,00,000 75,00,000
(ii) Other incomes 1,50,000 1,20,000
(iii) Expenses 44,00,000 50,60,000
(iv) Income tax 35% 40%
Solution:
Comparative statement of profit and loss
for the year ended March 31, 2014 and 2015:
Particulars 2013-14 2014-15 Absolute Percentage
Increase (+) Increase (+)

or or
Decrease (–) Decrease (–)
Rs. Rs. Rs. %
I. Revenue from operations 60,00,000 75,00,000 15,00,000 25.00

(60,00,000-100%)
(15,00,000-? 25%)
II. Add: Other incomes

1,50,000 1,20,000 (30,000) (20.00)
III. Total Revenue I+II

61,50,000 76,20,000 14,70,000 23.90
IV Less: Expenses
44,00,000 50,60,000 6,60,000 15.00
Profit before tax
17,50,000 25,60,000 8,10,000 46.29
V Less: Tax 6,12,500 10,24,000 4,11,500 67.18
Profit after tax 11,37,500 15,36,000 3,98,500 35.03
Illustration 2
From the following statement of profit and loss of Madhu Co. Ltd., prepare comparative statement of
profit and loss for the year ended March 31, 2014 and 2015: (A)

No.
Rs. Rs.
(ii) Employee benefit expenses 8,00,000 10,00,000
(iii) Other Expenses 2,00,000 1,00,000
(iv) Tax rate 40 %
Solution:
Comparative statement of profit and loss of Madhu Co. Limited
for the year ended March 31, 2014 and 2015:
Particulars 2013-14 2014-15 Absolute Percentage

or or

Rs. Rs. Rs. %
I. Revenue from operations 16,00,000 20,00,000 4,00,000 25

(16,00,000-100%)
(4,00,000-? 25%)
II. Less: Expenses
a) Employee benefit 8,00,000 10,00,000 2,00,000 25

expenses
b) Other expenses
Profit before tax 2,00,000 1,00,000 (1,00,000) (50)
III Less: Tax @ 40% 6,00,000 9,00,000 3,00,000 50
Profit after tax 2,40,000 3,60,000 1,20,000 50
3,60,000 5,40,000 1,80,000 50
Illustration 3
The following are the Balance Sheets of J. Ltd. as at March 31, 2014 and 2015.
Prepare a Comparative balance sheet. (A)
Particulars Note March 31, 2015 March 31, 2014

No.
Rs. Rs.
I. Equity and Liabilities

1. Shareholders’ Funds
a) Share capital
20,00,000 15,00,000
b) Reserve and surplus

3,00,000 4,00,000
2. Non-current Liabilities
Long-term borrowings 9,00,000 6,00,000
3. Current liabilities
Trade payables 3,00,000 2,00,000
Total 35,00,000 27,00,000
II. Assets
1. Non-current assets
a) Fixed assets
20,00,000 15,00,000
- Tangible assets
9,00,000 6,00,000
- Intangible assets
2. Current assets
3,00,000 4,00,000
- Inventories
3,00,000 2,00,000
- Cash and cash equivalents
35,00,000 27,00,000
Total
Solution:
Comparative Balance Sheet of J. Limited
as at March 31, 2014 and March 2015: (Rs. in Lakhs)
Particulars March 31, March 31, Absolute Percentage

2014 2015
or or

Rs. Rs. Rs. %
I. Equity and
Liabilities
a) Share capital
15 20 05 33.33
04 03 (01) (25)
a) Long-term borrowings
06 09 03 50
a) Trade payables
02 03 01 50
Total
27 35 08 29.63
II. Assets
a) Fixed assets
- Tangible assets
15 20 05 33.33
- Intangible assets
06 09 03 50
2. Current assets
04 03 (01) (25)
- Inventories
02 03 01 50
27 35 08 29.63
Total
Illustration 4
From the following Balance Sheets of Amrit Limited as at March 31, 2014 and 2015, prepare a
comparative balance sheet: (S)

No.
Rs. Rs.

a) Share capital
20,00,000 15,00,000

13,00,000 14,00,000
Total 55,00,000 47,00,000
II. Assets
a) Fixed assets
- Tangible assets 20,00,000 15,00,000
- Intangible assets 19,00,000 16,00,000
2. Current assets
- Inventories 13,00,000 14,00,000
- Cash and cash equivalents 3,00,000 2,00,000
Total 55,00,000 47,00,000

Solution:
Comparative Balance Sheet of Amrit Limited
as at March 31st, 2014 and March 31st , 2015 (Rs. in Lakhs)
Particulars March 31, March 31, Absolute Percentage

2014 2015
or or
Rs. Rs. Rs. %
I. Equity and
Liabilities
15 20 05 33.33
a) Share capital
1500000-100%
500000-?
14 13 (01) (7.14)
16 19 03 18.75
a) Long-term borrowings
02 03 01 50
a) Trade payables
47 55 08 17.02
Total
II. Assets
a) Fixed assets 15 20 05 33.33
- Tangible assets 16 19 03 18.75
- Intangible assets
14 13 (01) (7.14)
2. Current assets
02 03 01 50
- Inventories
47 55 08 17.02
Total
Illustration 5
From the following information, prepare a Common size Income Statement for the year ended March
31, 2014 and 2015: (A)
Particulars 2014-15 Rs. 2013-14 Rs.
Net sales 18,00,000 25,00,000
Cost of good sold 10,00,000 12,00,000
Operating expenses 80,000 1,20,000
Non-operating expenses 12,000 15,000

Depreciation 20,000 40,000
Wages 10,000 20,000
Solution:
Common Size Income Statement

for the year ended March 31, 2013 and March 31, 2014
Particulars Absolute Amounts Percentage of Net Sales
2013-14 Rs. 2014-15 Rs. 2013-14 (%) 2014-15 (%)
Net Sales 25,00,000 18,00,000 100 100
(Less) Cost of goods Sold* 12,00,000 10,00,000 48 55.56

(1800000-
2500000-100%
100
1200000-?
1000000-?)
Gross Profit
13,00,000 8,00,000 52 44.44
(Less) Operating
1,20,000 80,000 4.80 4.44
Expenses**
(2500000- (1800000-
100 100
Operating Income 120000-?)

80000-?)
(Less) Non-Operating
expenses 11,80,000 7,20,000 47.20 40
15,000 12,000 0.60 0.67
2500000-100 1800000-100
15000-? 12000-?
Profit 11,65,000 7,08,000 46.60 39.33
* Wages is the part of cost of goods sold;

** Depreciation is the part of operating expenses.
Illustration 6
From the following information, prepare Common size statement of profit and loss for the year ended
March 31, 2014 and March 31, 2015: (S)
Particulars 2013-14 Rs. 2014-15Rs.
Revenue from operations 25,00,000 20,00,000
Other income 3,25,000 2,50,000
Employee benefit expenses 8,25,000 4,50,000
Other expenses 2,00,000 1,00,000
Income tax (% of the profit before tax) 30% 20%
Solution:
Common size statement of Profit and Loss
for the year ended March 31, 2014 and March 31, 2015:
Particulars Absolute Amounts Percentage of Net Revenue

from operations
2013-14 Rs. 2014-15 Rs. 2013-14 (%) 2014-15 (%)
Revenue from operations 25,00,000 20,00,000 100 100

(Add) Other income 13
Total revenue 3,25,000 2,50,000 12.5
(less) expenses 28,25,000 22,50,000 113 112.5
a) Employee benefit
expenses 8,25,000 4,50,000 33 22.5
b) Other expenses
Profit before tax 2,00,000 1,00,000 8 5
(Less) taxes 18,00,000 17,00,000 72 85
5,40,000 3,40,000 21.60 17
Profit after tax 12,60,000 13,60,000 50.4 68
2014 2015
2500000-100 13% 2000000-100 12.5%
325000-? 250000-?
Illustration 7
Prepare common size Balance Sheet of XRI Ltd. from the following information: (A)

No.
Rs. Rs.
1. Shareholders’ Fund
a) Share capital 15,00,000 12,00,000

b) Reserves and surplus 5,00,000 5,00,000
2. Non-current liabilities
Trade Payable 15,50,000 10,50,000
Total 41,50,000 32,50,000
II. Assets
a) Fixed assets
- Tangible asset
14,00,000 8,00,000
Plant & machinery
- Intangible assets
16,00,000 12,00,000
Goodwill
10,00,000 10,00,000
b) Non-current investments
2. Current assets
1,50,000 2,50,000
Inventories
41,50,000 32,50,000
Total
Solution:
Common size Balance Sheet
as at March 31, 2014 and March 31 , 2015:
Particulars March 31, March 31, Absolute Absolute

2014 2015
or or
Rs. Rs. % %
a) Share capital 15,00,000 12,00,000 36.14 36.93
b) Reserves and surplus 5,00,000 5,00,000 12.05 15.38
Long-term borrowings 6,00,000 5,00,000 14.46 15.38
15,50,000 10,50,000 37.35 32.31
Trade Payable
41,50,000 32,50,000 100 100

Total
II. Assets
a) Fixed assets
- Tangible asset
14,00,000 8,00,000 33.73 24.62
Plant & machinery
- Intangible assets
16,00,000 12,00,000 38.55 36.92
Goodwill
b) Non-current investments 10,00,000 10,00,000 24.10 30.77
2. Current assets
Inventories 1,50,000 2,50,000 3.62 7.69
Total 41,50,000 32,50,000 100 100
Working Note:
Item/Total AssetsX100
Inventories = 1,50,000/41,50,000X100 = 3.62%
Illustration 8
Calculate the trend percentages from the following figures of sales, stock and profit of X Ltd., taking
2010 as the base year and interpret them. (Rs. in lakhs) (A)
Year Sales (Rs.) Stock (Rs.) Profit before tax
(Rs.)
2010 1,881 709 321
2011 2,340 781 435
2012 2,655 816 458
2013 3,021 944 527
2014 3,768 1,154 627
Solution:
Trend Percentages (base year 2010 = 100)
(Rs. in lakhs)
Year Sales Rs. Trend % Stock Rs. Trend % Profit Rs. Trend %
2010 1,881 100 709 100 321 100
2011 2,340 124 781 110 435 136
2012 2,655 141 816 115 458 143
2013 3,021 161 944 133 527 164
2014 3,768 200 1,154 163 627 195
1881-100
2340-?
Interpretation :
1. The sales have continuously increased in all the years up to 2014, though in different proportions.
The percentage in 2014 is 200 as compared to 100 in 2010. The increase in sales is quite satisfactory.
2. The figures of stock have also increased over a period of five years. The increase in stock is more in
2013 and 2014 as compared to earlier years.
3. Profit has substantially increased. The profits have increased in greater proportion than sales which
implies that the company has been able to reduce their cost of goods sold and control the operating
expenses.
Illustration 9
From the following data relating to the assets of Balance Sheet of ABC Ltd., for the period ended
March 31, 2011 to March 31, 2014, calculate trend percentages. (Rs. in Lakhs) (A)
Particulars 2010-11 2011-12 2012-13 2013-14
Cash 100 120 80 140
Debtors 200 250 325 400
Stock 300 400 350 500
Other current assets 50 75 125 150

Land 400 500 500 500
Buildings 800 1000 1200 1500
Plant 1000 1000 1200 1500

Solution:
Trend Percentages
(Rs. in lakhs)
Assets 2010-11 Trend 2011-12 Trend 2012-13 Trend 2013-14 Trend

% % % %
Current Assets
Cash 100 100 120 120 80 80 140 140
Debtors 200 100 250 125 325 162.5 400 200
Stock 300 100 400 133.33 350 116.67 500 166.67
Other Current 50 100 75 150 125 250 150 300

Assets
650 100 845 130 880 135.38 1,198 183.08

Non-current
Assets
Land
Buildings 400 100 500 125 500 125 500 125
Plant 800 100 1,000 125 1,200 150 1,500 187.5
1,000 100 1,000 100 1,200 120 1,500 150
2,200 100 2500 113.64 2,900 131.82 3,500 159.00
Total Assets 2,580 100 3,345 117.36 3,780 132.63 4,690 164.56
Interpretation:
1. The assets have exhibited a continuous increasing trend over the period.
2. The current assets increased much faster than the Non-current assets.
3. Sundry debtors and other current assets and buildings have shown higher growth.
Illustration 10
From the following data relating to the Equity and liabilities of balance sheet of X Ltd., for the period
March 31, 2010 to 2013, calculate the trend percentages taking 2010-11 as the base year.
(Rs. in lakhs) (A )
Particulars 2010-11 2011-12 2012-13 2013-14
Equity Share Capital 1,000 1,000 1,200 1,500

800
General Reserve 1,000 1,200 1,500
400
12% Debentures 500 500 500
300
Bank Overdraft
40 550 500
Trade Payable 100
Sundry Creditors 120 80 140
300
Outstanding Liabilities 400 500 600
50
75 125 150
Solution:
Trend Percentages
(Rs. in Lakhs)
Equity and 2010-11 Trend 2011-12 Trend 2012-13 Trend 2013-14 Trend
Liabilities % % % %
Shareholder
Funds
Equity Share
Capital 1,000 100 1,000 100 1,200 120 1,500 150
General Reserve
800
100 1,000 125 1,200 150 1,500 187.5
1,800 100 2,000 111.11 2,400 133.33 3000 166.67
Long-term
400 100 500 125 500 125 500 125
Debts
12% Debentures 400 100 500 125 500 125 500 125
300 100 40 133.33 550 183.33 500 166.67

Current
100 100 120 120 80 80 140 140
Liabilities
Bank Overdraft 300 100 400 133.33 500 166.67 600 200
50 100 75 150 125 250 150 300

Trade Payable
Sundry Creditors
Outstanding
Liabilities
750 100 995 132.67 1,255 167.33 1,390 185.33

Total 2,950 100 3,495 118.47 4,155 140.85 4,890 165.76
Working note:
Equity share capital = (2013-14)
Present year/ Base yearX100
= 1500/1000X100 = 150
Interpretation:
1. Shareholders’ funds have increased over the period because of retention of profits
in the business in the form of reserves, and the share capital has also increased,
may be due to issue of fresh shares or bonus shares.
2. The increase in current liabilities is more than that of long-term debt. This may
be due to expansion of business and/or availability of greater credit activities.
Question Bank:
1. Convert the following statement of profit and loss into the comparative statement of profit and loss
of BCR Co. Ltd.: (A)

No.
Rs. Rs.
(ii) Other incomes 1,50,000 1,20,000
(iii) Expenses 44,00,000 50,60,000
(iv) Income tax 35% 40%
2. From the following statement of profit and loss of Madhu Co. Ltd., prepare comparative statement
of profit and loss for the year ended March 31, 2014 and 2015: (S)

No. Rs. Rs.
(ii) Employee benefit expenses 8,00,000 10,00,000
(iii) Other Expenses 2,00,000 1,00,000
(iv) Tax rate 40 %
3. The following are the Balance Sheets of J. Ltd. as at March 31, 2014 and 2015.
Prepare a Comparative balance sheet. (A)

No.
Rs. Rs.

a) Share capital
20,00,000 15,00,000

3,00,000 4,00,000
Total 35,00,000 27,00,000
II. Assets
a) Fixed assets
- Tangible assets 20,00,000 15,00,000
2. Current assets
- Inventories 3,00,000 4,00,000
Total 35,00,000 27,00,000
4. From the following Balance Sheets of Amrit Limited as at March 31, 2014 and 2015, prepare a
comparative balance sheet: (S)

No.
Rs. Rs.
I. Equity and
Liabilities
20,00,000 15,00,000
a) Share capital
13,00,000 14,00,000
19,00,000 16,00,000
Long-term borrowings
3,00,000 2,00,000
Trade payables
55,00,000 47,00,000
Total
II. Assets
a) Fixed assets
- Tangible assets 20,00,000 15,00,000
2. Current assets
- Inventories 13,00,000 14,00,000
Total 55,00,000 47,00,000
5. From the following information, prepare a Common size Income Statement for the year ended
March 31, 2014 and 2015: (A)
Particulars 2014-15 Rs. 2013-14 Rs.
Net sales 18,00,000 25,00,000
Cost of good sold 10,00,000 12,00,000
Operating expenses 80,000 1,20,000
Non-operating expenses 12,000 15,000
Depreciation 20,000 40,000
Wages 10,000 20,000
6. From the following information, prepare Common size statement of profit and loss for the year
ended March 31, 2014 and March 31, 2015: (S)
Particulars 2013-14 Rs. 2014-15Rs.
Revenue from operations 25,00,000 20,00,000
Other income 3,25,000 2,50,000
Employee benefit expenses 8,25,000 4,50,000
Other expenses 2,00,000 1,00,000
Income tax (% of the profit before tax) 30% 20%
7. Prepare common size Balance Sheet of XRI Ltd. from the following information: (A)

No.
Rs. Rs.
a) Share capital 15,00,000 12,00,000
b) Reserves and surplus 5,00,000 5,00,000
15,50,000 10,50,000
Trade Payable
41,50,000 32,50,000
Total
II. Assets
a) Fixed assets
- Tangible asset 14,00,000 8,00,000
Plant & machinery
Goodwill 10,00,000 10,00,000
b) Non-current investments
2. Current assets 1,50,000 2,50,000
Inventories 41,50,000 32,50,000
Total
8. Calculate the trend percentages from the following figures of sales, stock and profit of X Ltd.,
taking 2010 as the base year and interpret them. (Rs. in lakhs) (S)
Year Sales (Rs.) Stock (Rs.) Profit before tax
(Rs.)
2010 1,881 709 321
2011 2,340 781 435
2012 2,655 816 458
2013 3,021 944 527
2014 3,768 1,154 627
9. From the following data relating to the assets of Balance Sheet of ABC Ltd., for the period ended
March 31, 2011 to March 31, 2014, calculate trend percentages. (Rs. in Lakhs) (A)
Particulars 2010-11 2011-12 2012-13 2013-14

Cash 100 120 80 140
Debtors 200 250 325 400
Stock 300 400 350 500
Other current assets 50 75 125 150
Land 400 500 500 500
Buildings 800 1000 1200 1500
Plant 1000 1000 1200 1500
10. From the following data relating to the Equity and liabilities of balance sheet of X Ltd., for the
period March 31, 2010 to 2013, calculate the trend percentages taking 2010-11 as the base year.(Rs.
in lakhs) (S)
Particulars 2010-11 2011-12 2012-13 2013-14
Equity Share Capital 1,000 1,000 1,200 1,500

800
General Reserve 1,000 1,200 1,500
400
12% Debentures 500 500 500
300
Bank Overdraft
40 550 500
Trade Payable 100
Sundry Creditors 120 80 140
300
Outstanding Liabilities 400 500 600
50
75 125 150
11. Explain the methods or techniques of Financial Analysis. (U)

12. What are the objectives of Financial Statement? Explain the limitations of Financial Analysis.
(A)
Multiple choice questions:
1. Comparison of financial statements highlights the trend of the _________ of the business. (U)
a) Financial position
b) Performance
c) Profitability
d) All of the above
2. Analysis of any financial Statement comprises (U)

a) Balance sheet
b) P&L Account
c) Trading account
d) All of the above
3. Which of the following are techniques, tools or methods of analysis and interpretation of
financial statements? (U)
a) Ratio Analysis
b) Average Analysis
c) Trend Analysis
d) All of the above
4. Interpretation of accounts is the (U)

a) Art and science of translating the figures
b) To know financial strengths and weaknesses of a business
c) To know the causes for the prevailing performance of business
d) All of the above
5. The major device for measuring the profitability of a firm over a defined period of time is the
a) income statement. (U)
b) balance sheet.
c) statement of cash flow
d) none of the above.
6. The ________ does not represent continuing operations in any way, but is simply a snapshot of the
total worth of a firm at a given point in time. (K)
a) income statement
b) balance sheet
c) sources and uses of funds statement
d) none of the above
7. The statement of cash inflows and outflows shows all of the following except. (K)
a) How the firm's balance sheet changed from one period to another.
b) How funds from operations were used to finance the company's assets.
c) How the firm has matched short-term and long-term sources of funds with short-term and
long-term uses of funds.
d) The firms cost of new borrowing.
8. Cash inflows arise from _____ assets, ________ liabilities, and ___________ stockholders' equity.
(K)
a) increasing; increasing; decreasing
b) increasing; decreasing; decreasing
c) decreasing; increasing; increasing
d) decreasing; increasing; decreasing
9. Which of the following is NOT a key ratio in the prediction of bankruptcy as developed by Edward
Altman? (K)
a) debt to equity
b) current ratio
c) retained earnings as a percent of total assets
d) total assets
10. ______________ ratios measure the ability of a firm to earn an adequate return on sales, total
assets and invested capital. (K)
a) Asset utilization
b) Liquidity
c) Profitability
d) Debt utilization
11. The method of calculating return on assets which highlights the importance of sales, profit margin
and asset turnover is known as (U)
a) the sales method
b) DuPont analysis
c) the Altman model
d) the Gordon model
12. Asset utilization ratios measure all of the following except (K)
a) productivity of fixed assets in terms of sales
b) the relationship of the income statement to cash of the asset groups on the balance
sheet.
c) how many times per year the inventory is sold and accounts receivable collected.
d) the firm's ability to pay off short-term obligations as they come due.
13. The primary purpose of the liquidity ratios is to determine (U)
a) how much working capital is tied up in inventory.
b) the relative level of short-term debt.
c) how well a firm is able to pay off short-term obligations.
d) more than one of the above.
14. Which of the following statements about liquidity ratios is true? (K)
a) The higher the current ratio, the more likely a firm is able to pay its short-term
obligations.
b) The lower the quick ratios relative to the current ratio, the safer a firm is in terms of
liquidity.
c) The ratio of net working capital to total assets always lies between 0 and 1.
d) Relatively high current ratios are usually a sign of efficient working capital
management.
15. The ________ ratios help determine the degree of financial risk and earnings volatility present in a
firm. (U)
a) profitability
b) asset utilization
c) liquidity
d) none of the above.
16. ___________ ratios measure the impact of external market forces on the internal performance of a
firm. (K)
a) Price
b) Profitability
c) Liquidity
d) Asset utilization
17. A high payout ratio indicates (U)

a) a firm is investing heavily in plant and equipment.
b) a firm has high current obligations
c) the firm is probably in the mature phase of its life cycle and does not have many
growth opportunities available.
d) the firm is probably in Stage II of its life cycle.
18. __________ analysis is the process of studying a series of ratios for a company and/or industry
over time. (K)
a) DuPont
b) Trend
c) Common size
d) all of the above.
19. The statement of cash flows tells us (U)
a) accounting profit or loss
b) how cash was created
c) actual profit or loss
d) two of the above
20. The major device that indicates what the firm owns and how these assets are financed in the form
of liabilities or ownership interest: (K)
a) the balance sheet.
b) the statement of cash flows.
c) the income statement.
d) the general ledger.
21. Financial ratios are used to weigh and evaluate: (U)
a) the operating performance and capital structure of the firm.
b) which stocks are the "gold mine" stocks when investing in the market.
c) which stocks are about to file for bankruptcy.
d) the net present value of the company.
22. Which report gives a review on the profitability of a business (K)
a) Statement of changes in equity
b) Cash flow statement
c) Balance sheet
d) Income statement
23. When assets are subtracted from liabilities it will be equal to (U)
a) Capital
b) Net income
c) Working capital
d) Goodwill
24. Goodwill is categorised under which assets? (K)

a) Intangible
b) Current
c) Long term
d) Fixed
25. Current assets are also known as (U)
a) Cash
b) Assets
c) Invested capital
d) Working capital
26. The main operation expenses of a business are termed as
a) Operating expenses
b) Non-administration expense
c) Selling expenses
d) Administration expense
27. A method used in a comparative analysis of financial statement is
a) Returning analysis
b) Common size analysis
c) Preference analysis
d) Graphical analysis
IV Stock Exchange and Regulation
Introduction: Stock Exchange, a market for second-hand corporate securities, remained a supreme
symbol of capitalism or of private enterprise. The presence of a market where securities issued for
giant sized industries in be traded made large-scale industries a possibility.
Though small in individual size, total domestic savings amounted to a huge fund. This can be tapped
by joint stock companies, only when there is a market through which the shareholders can sell their
holdings. Started as a western concept, it gained importance slowly and steadily. It has outgrown the
confines of capitalism or socialism as also the eastern or western business practices.
Many local bodies like New York Municipal Corporation float bonds that are listed on the New York
Stock Exchange. In addition, many Government Bonds and other securities are listed on Stock
Exchange. Besides, many public sector undertakings like BHEL, BEL, and SAIL it their shares on the
Stock Exchange.
No longer, the Stock Exchange 'owns the preserve of private industries. It also represents public
finance old public sector undertakings. The stock exchanges regulate the issue of shares to the public
by private companies so as to ensure that the shares are widely-held by small shareholders all over the
country. In Ail respect, stock market has become more socialistic than any other institution.
Stock exchanges in recent times came to represent quick deployment and movement of funds all over
the world. Many stock exchanges absorbed the Information Technology and Networking resulting in
quick moment and movement of funds. Thus, stock exchanges facilitate Nick entry and quick exit.
Market-savvy companies are able to raise min from every developed overseas market based on their
image in the domestic stock exchange.
Meaning and Definition:

The Securities Contracts (Regulation) Act, 1956 defines a stock Changes as, "an association,
organisation or body of individuals, Other incorporate or not, established for the purpose of assisting,
regulating and controlling business in buying, selling and dealing in unties
Characteristics of Stock Exchange: Certain common characteristics are possessed by stock exchange
all over the world. Depending upon the basic purpose of establishment certain variations can exist in
the operations and structure.
1) Organised Market: It is a market where the trading takes place per predetermined rules. The
provisions of byelaws of the Exchange, Securities Contracts (Regulation) Act, 1956, of Companies
Act, 19 of SEBI Act, 1992 etc., govern the trading in a Stock Exchange. Ap from the Governing Body
of the Exchange. SEBI and Ministry of Finance have the powers to intervene in the trading of a stock
exchange.
2) Securities Market: The document executed by the user of funds favour of owner of funds is called
an instrument. If the instrument ha ready and continuous market, it is called a security. In the Stock
Exchange, securities like equity shares, debentures, bonds etc., a traded.
3) Secondary Market: For the transactions taking place in the mark the concerned company is neither
the buyer nor the seller. Trading takes place between investors. This is different from the primary
market, whet a company sells its securities to the investors directly as in the case public issue of
securities.
4) Part of Capital Market: Stock Exchange is a part of capital mark Capital Market is a market for
long-term funds. By facilitating trades. long-term securities like equity shares, bonds and debentures
automatically becomes a part of the capital market.
5) Listed Securities: To be traded in a stock exchange, a security should be included in the official
trading list. For this purpose, the concern company should make an application, enter into an
agreement, and p the listing fees to the stock exchange annually. However, by taking special
permission, the unlisted securities can also be traded.
6) Restricted Membership: In order to become a member of a Stock exchange a person can purchase
the membership from an existing member Alternatively, he can apply for it when the Exchange is
selling the membership. There is an Admission Committee, which scrutinizes each application, and
evaluates the character and integrity, educational qualification and net worth of the applicant. Only
when it is satisfactory, membership is given.
7) Dealing only by Members: Only a member of the Stock Exchange on Trade in the shares on the
exchange. A non-member or the public cannot deal directly. Every investor intending to buy or sell has
to do it through a member of the Exchange.
8) Standardised Practices: The practices like settlement, brokerage and emission, form of contract
etc., are standardised and predetermined. By-laws of the Stock Exchange and SEBI Regulation
standardise the trading practices.
9) Stock Exchange as a Facilitator: For every transaction, Stock lunge is neither the buyer nor the
seller. The trade takes place teen one member and another. The role of Stock Exchange is like a referee
and not as a player. Only in futures contracts, the Stock exchange becomes the counter-party. Where a
separate entity is established for settlement of the transactions like the National Clearing Corporation,
then the clearing entity becomes the counter-party.
10) Scope for Speculation: The trading practices are moulded to accommodate speculations apart
from investment. Stock exchanges 1 large volume of transactions in order to provide the necessary
liquidity and a continuous market for securities. If genuine investor’s shy y because of unfavourable
investment climate, at least speculation will provide the volumes for making the stock exchange a
continuous Therefore, the stock exchanges provide facilities either in the lot Badla or by way of
derivatives. Speculation is essential, in spite of many scams taking place because of the facility for
speculation.
Role and Functions of a Stock Exchange:
Stock Exchange plays a significant role in the modern economy. In fact the extent of development of
an economy is accompanied by an equally developed stock market Stock market is considered to be
the meter of economic well-being of a country. Apart from enabling huge funds, it also causes creation
of numerous financial me diaries, many investment avenues and innovative securities. The
liberalisation of any economy starts from
the reforms of the stock market. specific functions of a stock exchange is narrated below:
1. Ready Market: Stock Exchange acts as a ready and continuous market for the listed securities.
Thus, the trade in investment securities is greatly facilitated. Apart from enabling trading in the
securities every day the continuous market helps in setting the price trend and also E n ha the
confidence of the investors in the listed securities.
2) Liquidity for Securities: The investors invest in corporate government securities because they can
convert the investment cash through sale in the stock market. As the investors may live away from the
companies, lack of liquidity will drive them away-investment in corporate securities. The speed and
the quickness which the investor can sell and get the money decide the attractive of corporate
securities
3) Evaluation: The securities are traded every second during the w hours. The demand and supply
determine the price of the securities. The price at which the securities are traded can be known online
TV Channels likes CNBC, NDTV etc. Besides, the prices are available on real-time basis from the
computer terminals of brokers. Mobile Providers like Airtel, Reliance Communications and
Vodaphone the stock prices available through SMS. The closing rates of prices are available in all
leading newspapers the next day. This e taking loans on the value of securities and also valuation of e
case of mergers and take-overs.
4)Price Stability: There are many operators who buy from a cheaper stock exchange and sell in other
stock exchanges, where the price the same securities are higher. Known as arbitrageurs, they bring
stability in the prices of the securities among various stock ma Moreover, computerised stock
exchanges like Bombay Stock Exchange and National Stock Exchange use a mechanism called circuit
baits or circuit-filters. A maximum percentage of variation is prescribing each share, say 10%. If the
closing price for the previous day is Rs, variation allowed is 10% of Rs. 50 either way. The price is
allow vary between Rs. 45 to Rs.
5 For the next day. If the price rea he, 45 (called lower circuit), buying is allowed but selling is not
allow the price reaches Rs. 55 (called upper circuit), selling is allow buying is not allowed. In this way,
price stability is ensured.
6) Capital Formation: A large number of companies raise huge fun issuing securities to the public.
The public subscribes mainly be there is a secondary market in which these securities can be Thus,
stock exchanges help in the capital formation of the count the volume of securities traded is huge, the
stock exchanges ensure quantum jump in the capital formation in a big way.
7) Promotion of Saving Habits: Stock exchanges provide liquidity wide variety of securities like
equity shares, bonds, debentures, Bonds, Treasury Bills etc. As a result, the public is offered many
investment avenues, leading to promotion of saving habits. Saving habits are encouraged well, where
there is a wide choice to the investors on Is suiting to the different requirements of the investors.
8) Investor Protection: Stock exchanges have a grievance redressal mecahnism for the investors. Any
investor can complain against the Iles in which he is holding shares. In additions, funds are had to meet
contingency arising out of defaults by brokers. Thus, stock exchanges protect the interest of the
investors. In addition to this, gook exchanges undertake programmes to educate the investors about
their rights.
9) Corporate Governance: Companies are required to observe certain healthy practices to protect the
interest of shareholders. The agency changed with the role of ensuring the corporate governance is the
Stock we Clause 49 of the Listing Agreement between the company and the stock Exchange puts the
burden on the company to have healthy s The Stock Exchange becomes the enforcing authority.
10) Public finance: Govt. Bonds and securities are traded on stock exchanges apart from municipal
bonds floated by local bodies. Thus, $changes help the government in raising funds by providing a for
their securities. In fact, the National Stock Exchange has a separate segment to trade in the government
bonds and other government securities.
11) Growth of Joint Stock Companies: The existence of joint stock Iles is closely tied to the
existence of stock exchanges. Large like automobile manufacturing, airlines, aircraft manufacturing,
manufacturing, metals and minerals industry etc., need huge Only the participation of lakhs of
investors in the form of joint enterprises makes it possible. They, in turn, depend on the co. stock
exchanges.
12) Enabling Book -Building Route: Issue of shares through book building is a national level IT
network. Both BSE and NSE provide their IT for the issue of shares through book building. Graphical
presentation of applications received is also made in the trading terminals members of the exchange
for the benefit of the applicants. [
13) Capital Mobility: The trading of various investment products enables investor to move his funds
from one sector to another. Funds can be easily among equity, debentures, bonds, Govt. Securities,
Wry, Bills 'etc., very easily. Even among the equities, funds can be from one industry to another and
from one company to another.
14) Foreign Funds: Foreign institutional investors invest mainly in securities traded in stock
exchanges. They also seek to invest only in Prime where Stock Exchanges are well-developed and
settlements Outdo quickly.
15) Index Compilation: Every Stock Exchange compiles general indices and sectoral indices like
Bank Index, FMCG Index, and IT Index. These indices help in showing the health of the economy and
also 1 outlook of various industries.
16) Technical Analysis: Statistical models are used for predicting t movement in prices of shares. It
also forms the basis for develop) buying and selling strategies. This technical analysis can be used a
prediction technique regarding economic indicators.
17) Economic Development: Stock Exchanges contribute to the economic developments of the
country. There is a linear relation and posit correlation between the development of stock exchanges in
the country and the development of the economy.
Members of a Stock Exchange

It is an organised market. There is a set procedure subject to which trading can take place in the
market. Only the members of a stock exchange can trade either on behalf of their clients or on their
own behalf. The membership can be obtained from an existing member by paying the premium.
Otherwise, application has to be made to Stock Exchange, when the Exchange advertises for receiving
member applications. Before admitting anyone as a member, the Exchange examines the personal
integrity and financial net worth of the applicants.
Category of Members:
There are essentially two categories of members: Jobbers Brokers. Jobber is a dealer acting on his own
behalf and the broke an agent trading on behalf of his clients. Any market requires two elements for its
success. The first one is volume of transactions, and these one is stability in the market.
The brokers have wide contacts large body of investors and help in bringing the orders for buying sale
of securities. Jobbers create stability in the market by match demand and supply and varying the price
to correct the miss match between the demand and supply. Together, the jobber and brokers make the
Stock Exchange a viable and stable market.
Types of Dealings
The dealings in a stock exchange can be classified into categories, with each category forming a
separate market. Dealings in the cash segment (payment of cash and delivery of shares being on the
day of transaction itself) constitute Cash Market. Dealings in derivative segment (settlement in the
future) constitute Derivative Market. The Derivative Market is popularly known as Futures and
Options Market (shortly known as F&O Market).
(1): Cash Market: It is a market that is meant for straight forward transactions of payment and
delivery. When long period of settlements was there before 2001, there was a fixed period of
settlement once in 15-day date was fixed as date of settlement. All the transactions that taken place
during the previous 15 days had to be settled on that d fixed date of settlement were unfair. A buyer
who purchases immediately after a settlement day has 15 days to make the payment, whereas buyer on
the previous date of settlement has to make the payment immediately. Therefore, the concept of
Rolling Settlement was introduced by SEBI.
The date of settlement depended upon the date of transaction E transaction had the same period given
for settlement. Initially, it was T+5 settlements. It stood for 'Trading Day plus Five Days'. It meant that
if will get the shares in five days, and the seller will get the payment one five day period.
Progressively, the settlement period was reduced so that at present, it is T+2. Many foreign investors
were demanding a shorter settlement cycle so that stock market investment becomes more liquid. The
buyer can get the shares quickly and the can get the payment quickly.
T +2 means 'Trading Day plus Two Days.' The day on which the suction takes place is called the
Trading Day. On this day, let us Monday, the buyer makes the payment to his broker (Buying Broker)
the seller delivers the shares to his broker (Selling Broker). The next day i.e. Tuesday is called the Pay
in Day.
On this day, the Buying broker makes the payment to the Clearing House. The Selling Broker VIPS
the shares to the Clearing House. One day after that i.e. on One’s Day is called Pay out Day. On this
day, the Buying Broker lives the shares from the Clearing House and the Selling Broker lives payment
from the same Clearing House. The buying broker sits the Demat Account of his client with the shares
and the selling her credits the Trading Account of his client with the money.
As the shares are immediately deliverable and the payment to be $ on the day of transaction, the scope
for speculation is brought considerably in the Cash Market. The speculation can be made intra-day. A
speculator can buy during the trading hours (9.55 am I 30 pm), but should sell it before 3.30 pm. In the
same way, a collator can sell during trading hours, but should buy before 3.30 pm. speculator can take
a risk by borrowing shares or money and stretch settlement by a few days by delivering the borrowed
shares or rowed money.
Futures and Options Market (Derivatives Market):

Both Futures and Options are exchange traded. They are used mainly to manage the risk arising out of
transactions in the Cash Market. Big investors like mutual fund insurance companies, pension funds
etc would like to see that manage the risk arising out of the market or share price moving in opposite
direction. Apart from buying and selling of shares, the Funds hold a large chunk of shares also takes a
position in the F&O market preserve the value of their holdings. However, F&O are mainly used
speculation rather than risk management.
A) Futures:
Future is a Contract to buy or sell a specified quantity of stocks or indices at a specified price at a
predetermined or standardised date. Many aspects of the future transactions are standardised. Futures
Contracts provide the scope of predicting the price movement in the future and protecting the
investments or making profit out of prediction. Of all the derivative transactions, future contracts claim
a lion's share of the transactions. Futures are exchange traded contracts to buy or sell financial
instruments at an agreed price.
Features of Futures Contracts:

Some of the features are similar to that of other contracts. There certain distinct features of futures
contracts:
1 Standardised Features: The Stock Exchange standardises the features like the quantity, initial
payment, subsequent payment, broker settlement, price etc. As these are well-known in the ma
transactions take place quickly without the need to determine them the buyers and the sellers.
2. Counter- party: For every transaction, the counterparty is the Clear) House of the Stock
Exchange. Clearing House is the institution t settles the transactions taking place in the Stock
Exchange. We have National Securities Clearing Corporation Ltd. that settles the transactions. In NSE.
If X buys a futures contract to buy from Y, for X Clearing H is the Seller, and for Y Clearing House is
the Buyer. This way, Exchange avoids the problem of default by buyer or seller at the time settlement.
3. Margin Requirement: In the cash market, the buyer is required to the full value of transaction. In
the Futures market, he is required to a small percentage like 15% of the value of the transaction as I
margin. Every day, the movement in the price of the underlying sec or index requires payment of other
margins called marked-to-market. An additional margin can be imposed in order to curb speculation
4. Time Spread: Future Price is more than the Spot Price determine by the Exchange taking into
account the interest and cost of carry. Dividend receivable is deducted. At every time, there are three
count for settlement .If it's August, there are August Futures, September Future and October Future.
Once August future is settled on the Thursday in August (every future contract is settled on the last
Thursday of the concerned month), there are three futures: September, October and November.
Considering the interest and other cost of carry fact the Exchange determines the prices.
Trading Mechanism in the futures market:

Initial procedure: - An investor who wants to trade in futures should open an account with a broker
specifically for this purpose. A client agreement from is to be signed by the investor. Since only a part
of value of transaction is collected as margin money, the broker may insist $ bank guarantee for
deposit of securities.
Trading: The investor can take a contract to buy or sell. This is the position of the investor. If the
contract is to buy, he is taking position. If it is to sell, he is taking a short position. The contract he is
taking may relate to any of the three immediate months, i.e., in which transaction is taking place, the
next month and one after. Once the investor takes a contract, he has to pay a stage of value of
transaction as initial margin. When the prices keep on going up, the buyer has to pay the differential
margin as market margin.
On the settlement day, the buyer can take delivery of shares and the delivering the shares. Or the buyer
can square up the transaction by selling the same quantity of the same stock. In case the future relates
to the index, there is no delivery, it is cash settled. The buyer square up transaction on any day before
the settlement day (the Thursday).
Strategies: The strategy is as in the cash market. Expecting an increase in the price, the buyer takes a
long position (Bull). Where a fall a price is anticipated, the investor takes a short position (Bear).
Increase in the price may be expected in the same month, next month) month after. Depending upon
that, the future contract is selected bull expects an increase in the price in August, he buys that. If the
station is in September, the long position relates to September future.
The investor can settle the contract at any time before the Settlement by squaring up the transaction. If
he is expecting a fall in the price, he can sell the futures. Subsequently, certain developments may
make to reverse the opinion. He can immediately contract to buy the corned month's future and settle
it. The bull, after buying may reverse opinion. In such a case he can sell the same at any time before
the lament day.
Contracting for one month can be switched over to next month. E.g., In August, buys August Future
for 500 shares of Bajaj Auto expecting Increase in the price before the last Thursday (the Settlement
Day) August. When the settlement day reaches, he realises his expectation not likely to happen in
August, but only in September. He can sell gust Future and buy September Future. If it doesn't happen
in September, he can sell September Future before the settlement days buy October Future.
Uses of Futures Contract:
Future Contracts are used for three different purposes by three different categories of investors.
However, the investors can operate and indulge in all types of future trading: Hedging, Speculation,
and Arbitrage.
1. Hedging: Hedging involves entering into two contra transactions at the same time in the same stock.
One position in Cash Market and opposite in the Future Market. E.g., Arun sells 1000 shares of Z
Telefilms in the Cash market in August. He can buy 1000 shares August Future, September Future or
October Future. In this way, profit from a possible increase in the price subsequent to the sale in Cash
Market can be realised by Arun.
On the other hand buying of the same shares in the Cash Market can be hedged by way of selling in
the futures market. Hedging essentially to protect the investor against any subsequent decline increase
in the prices. Mutual Funds investing huge amounts in stock market can protect themselves through
hedging.
2. Speculation: Future contracts can be used in varied strategies speculate. A bull speculator can buy
the stock future expecting increase in price and a bear speculator can sell the future expecting a fall.
August future can be purchased by selling September future or vice- versa (known as Calendar spread
trading). Between stocks expect to increase and another stock expected to lose value, future can bought
in the first stock and sold in the second stock (known as trading). Speculation can also be between cash
market, futures mar and options market. The scope for speculation is unlimited in case of existence of
future market, options market and cash market.
3. Arbitrage: Arbitrage involves buying in low priced market and s in high priced market. If the price
in cash market is considered chew it can be bought in the cash market and sold in the futures market.
This way, selling and buying can take place among all the three segment of the stock market: Cash
market, futures market and options mark Arbitrage results in stabilising price among different markets.
It rest) in removing the price differential between one market and the other futures, scope for arbitrage
exists to a very high extent.
Types of futures:
There are two types of future contracts. Stock future and index future. In case of stock future, future
contracts are bought and sold in the shares of individual companies identified for this purpose.
However, Index Future involves buying and selling of Stock index like Sensex and Nifty. Index based
mutual funds invest in all the ties included in the index. To protect the investment against the
subsequent decline or increase they buy or sell index futures. In this y, the trouble of taking position in
numerous stocks is avoided.
B. Options: Option is a financial derivative whereby the buyer of the option gets right to buy or sell
the underlying asset in a specified quantity at or ore a specified date in the future. The underlying asset
may be individual ire or a stock index like Sensex or Nifty. Unlike in Futures, there is obligation to
settle the transaction. The buyer can exercise the Ion if it is profitable to him. If not, he allows the
option to expire.
For getting this right, the buyer has to pay a fixed amount per share led option premium. Option
premium is the income to the seller of option (called option writer).
Nature of Settlement:
Depending upon the nature of exercise of the options, options can be classified into: European Option
and American ption. In case of European Option, the buyer can exercise it only on Win last date
specified for exercising the right [known as expiration date]. It is the last Thursday of the concerned
month. Even if the buyer stands make a hefty profit, he cannot exercise it before the expiration date.
India, index options are European.
After buying an index option, the per can exercise it only on the expiration date (as in a Badla
transaction).
In case of an American Option, the buyer can exercise it at any ID before the expiration date. If he
takes an option to buy, he can exercise it the very next day if the price shoots up substantially. If it is
not move up even up to or on the expiration date, he allows it to see and does not exercise it.
Call and Put Option: Where the option gives a right to the option buyer to buy the underlying $$net
at the predetermined price, it is called Call Option. If the option is 10 sell, it is called Put Option. In
both call option and put option, the buyer has no obligation. He has only a right to exercise. But, the
lion seller has the obligation.
E.g. If an investor buys one option to buy Wipro at Rs.730 by paying premium of Rs.10, his total cost
is Rs.740. At any time before the Oration date, the investor will exercise the option if the price goes
above Rs.740 in the cash market. If it does not go up even on the expiration date, he does not do
anything and allows the option to expire. This is a Call Option.
When it is a put option at Rs.730 with a premium of Rs.10, the option holder will exercise if the price
goes below Rs.740. If it does no he allows the option to expire.
Some investors take both a call option and put option in the same stock or index at the same time this
is sometimes called doubt option. He makes profit irrespective of the direction in which the stock price
or index moves. If it remains stable, he allows both the contracts to expire. The risk involved in double
option is the huge premium paid by the buyer on both the call option and put option.
Uses of Options: Option is used for the following three different activities: Hedging; Speculation and
Arbitrage.
a) Hedging: Any two contra transactions taking place at the same time in the same underlying
asset is called hedging. A buyer in the cash market takes a put option on the same day to
protect himself against fall in the price in the near future. A seller in the cash market takes a
call option to avoid the dissatisfaction of selling at the lower, price. E.g.: An investor buying
5000 shares of Gujarat Abuja Cement' at Rs.65 in the cash market takes a put option for the
same quantity and the same price paying a premium of Rs.3 per share. Before expiration date,
any fall in the price can make the investor to buy the shares agate and sell as per the put option.
Cash Market Operation:

01-08-2005 Purchase of 5000 shares @ 65 = Rs. 3, 25,000
11-08-2005 Subsequent Price 5000 shares @ 58 = Rs. 2, 90 000
Loss in the value of investment =Rs. 35,000
Options Market:
1-8-05 Taking a Put option: Premium paid (500 x 3) = Rs. 15,000

11-8-2005 Buy 5000 shares @ 58 =Rs.2,90,000
Exercise Put Option (sale) 500 x 65 =Rs.325,000
Profit =Rs.35,000
Thus, his loss in the cash market is wiped out by profit in the options market. The option
premium is the cost he paid for reducing the loss of Rs.35, 000.
b) Speculation: There is a vast scope for speculation in the options market. While expecting an
increase in the price, the bull speculator takes a call option. A bear speculator anticipating a
fall, purchase put option. A speculator expecting fluctuations in both the sides takes call option
and a put option at the same time in the same underlying asset. Speculators studying individual
stocks take positions in stock options. Speculators who anticipate overall movements (changes)
in all ill index stocks take positions in the index options.
c) Arbitrage: Arbitrageur buys in a low priced market and sells in a high co market. In this way,
he contributes to the stability of the market can buy and sell between cash market and options
market, between options market and futures market. Wherever there is a price mismatch,
arbitrager makes a profit.
Advantages of Option-Trading
Option trading is similar to taking an insurance policy. In case of a fire insurance policy, we get the
benefit in case of fire accidents. Similarly, Ion trading benefits when the prices move as per our
anticipation or apprehension. The following advantages accrue out of option trading.
1. No Big Investment: In cash market, entire value of transaction is payable In futures market, a
margin as a percentage of value of as actions is payable. In options, a fixed nominal amount is
payable as premium.
2. No Margin as in Futures: In a Futures contract, initial margin, mark-In market margin and
additional margin are payable. Here in the option oiling, only a small premium is payable at the
beginning of contract.
3. No Obligation: The buyer of the option has only a right to buy or sell. He has no obligation to
do so. If it doesn't benefit him, he allows the contract to expire.
4. No Marked-to-Market: As in future market, he need not watch the price movement every day
to pay the marked to market margin to the broker. Once he pays the premium, next transaction
is to exercise it. Otherwise there is nothing else the option buyer has to do.
5. More Gain than Risk: The possibility of gain for the option buyer is very high compared with
the premium. Only the option seller's risk is unlimited
Disadvantages
The main disadvantage is the premium paid. If no major change takes once in the prices, the option
paid becomes an unnecessary wastage. Moreover, there is less liquidity in the options market than in
the future market.
5.9: Listing of Shares
Listing is the process of including a security in the official trading list of a stock exchange. Every stock
exchange establishes a continuous elation with the companies whose shares are traded regularly. For
this purpose, it maintains a list, which includes the names of companies whose securities are allowed
for trading.
Just as there is restriction for the membership, there is also res ne of shares to be traded. The company
whose securities are to be traded should agree to conditions and provisions as per the byelaws of
exchange. It should agree to inform the Stock Exchange any sensitive development of the company
regarding convening Board Meeting, AGM, merger proposal etc. The securities of these companies are
allowed for trading. By taking special permission, unlisted securities can also be traded on a stocks
exchange.
Listing Procedure:
The Listing procedure aims at ensuring the listed companies to follow the guidelines prescribed for
protecting the interest of the invest primarily regulated by the byelaws the Exchange, it came to
assume lot of importance in the recent time. The Stock Exchange is being viewed as the regulator of
listed companies. To ensure this, Securities Contracts Regulations Act 1956, Securities and Exchange
Board of India 1992 and Companies Act, 1956, also regulate the listing procedure.
1. Initial Public Offer: Listing is to make the securities tradable with large number of buyers and
sellers at every point of time. To ensure this, companies seeking listing should make a public offer of
shared that they are widely held.
2) Size of Public Offer: The size of public offer should not be less 25% of the issued capital. The paid
up capital of the company after public issue should not be less than Rs. 10 Crores.
3) Filing Application. The Company seeking listing should make application to the stock exchange.
The application should accompany by the following documents:
(i) Certified copies of Memorandum of Association, Articles Association, Prospectus, Director's

Report, Balance Sheet Underwriting Agreement etc.
(ii) Specimen copies of share certificates or debenture certificate
(iii)Particulars of capital structure of the company.
(i) Statement showing distribution of shares. The shares shout widely held. For every Rs. 1
Lakh of capital, at least 5 shareholders should be there.
Payment of Listing Fees. The listing fees should be paid along with the application. The listing fee is
payable annually. Besides, any new le of equity shares or bonus shares needs fresh listing of such
Securities.
Speculators
The distinct feature of an organised market is providing tacit speculation. Speculation is buying or
selling securities for making a quick profit in the near future. The jobbers, brokers and the quite often
speculate in the Stock Market. The mode of spec changes with the system of trading in the Stock
Exchange. However basically we can identify the following types of speculators in the Market.
1. Bull: Bull is a speculator who buys the shares of one or more companies expecting an increase in
the prices in the near future. H an optimist and is considered to be on the long side of the mar
Subsequent to buying, he tries to push up the price by spreading positive information about the
company and overall outlook of the Stock Mark Bull speculators increase the confidence level of the
investors. Be 1995, bulls had 15% days’ time to realise his expectation. Under Badla system, he could
also postpone the settlement to the next settlement day by paying Badla charges. However, in the
present-day T+2 Rolling System of Settlement, parties are required to deliver by the end of the day or
the begin in next day. In this background, an investor can operate as a bull in one of the following
ways:
a) In the Cash Market, after buying the shares during the work hours, starting at 9.55 a.m. the bull has
the time until the closure of trading at 3.30 p.m. Before the closure, he can sell the share and settle the
transaction. If he manages to sell at a higher price he makes a profit. Otherwise, he incurs the loss.
b) He can take delivery of shares by making payment for dui transaction. The shares can be held until
the price goes up and can be sold at that point.
c) In the Futures Market, he can buy the shares for future delivery. On the expiration date or before, if
the share prices go up makes a profit by selling them. He has to pay only the ma money and not the
entire volume of the transaction.
d) In the Options Market, he purchases a call option. On the expiration date or before, if the price goes
up he exercises the right. Otherwise he does not do anything. His loss will be limited to the option
premium.
2. Bear: Bear is a speculator who sells the shares expecting a fall in the price in the near future. He is
considered to be on the short side the market, and also is considered to be a pessimist. He tries to
depress the price by conveying negative information about the company, Industry the economy and
also a negative outlook for the Stock Market.
Quite often, he sells the shares without possessing them. Therefore, he assumes a higher risk than the
bull his hopes of buying the shares in future at lower prices may become difficult. Before 1995, the
bear speculator had about 15 days’ time to hope for decline in the prices. However, in the T+2
settlement system, he has the following option:
In the Cash Market, he can sell shares at any time during the working hours i.e., between 9.55 a.m. and
3.30 p.m. However, he should buy the shares before the closure of the market at 3.30 p.m. on the same
day. If he succeeds in buying at a lesser rate, he makes a profit.
He can borrow shares from stock lenders like Stockholding Corporation of India and settle the
transaction. In the subsequent days, he can buy the shares and repay the shares to the lender.
In the Futures Market, he can take a contract to sell. The advantage here is that he has to pay only a
margin money to cover the transaction. If, before the expiration date, the price falls down he can buy
the shares at the lower price and settle the transaction. If it rises, he incurs a loss.
In the Options Market, he can buy a put option. By the expiration date, if the price does fall down, he
buys the shares in the Cash Market and exercises the option. If the price goes up, he doesn't do
anything and allows the option to expire. His loss in such a case is limited to the option premium
payable by him for the transaction.
3. Lame Duck: Lame Duck is a bear speculator who is not able to settle his transaction. He may sell
the shares in the cash market hoping to buy them before the closure. However, if the price is in the
upper Circuit subsequent to his sale, he will not be able to buy the shares before the closure. In such a
case, he will not be able to settle the transaction. However, now with the availability of borrowing and
lending facilities in the shares, this situation can be tackled by borrowing the shares from any of the
stock lending agencies like Stockholding Corporation of India Ltd.
4. Arbitrageur: He is a speculator who searches for opportunities in the form of price differential. If
the price of the same security is traded at different prices in different Exchanges, he buys from the
Exchange where the price is low and sells them in the Exchange where the price is high.
THE SECURITIES AND EXCHANGE BOARD OF INDIA

In the middle of 1980s, there was a need to have a regulatory but the stock exchange. Though stock
exchanges were expected to be self- regulatory agencies, they failed in curbing malpractices. Investor’s
interest was not protected. A lot of vested interest became do leading to wide spread manipulation of
share prices and exploit investors. The Controller of Capital issues confined themselves to primary
issues.
Ministry of Finance found the regulation of stock exchange specific for a Ministry. Except in the cases
of outrageous development like scams, the ministry chose to be an indifferent spectator. Thus in 1988,
the Government set up Securities and Exchange 13 of India as a regulator of capital market in the
country.
As it was the time that such a body was set up, Government was not certain specific powers that could
be conferred on SEBI and the sp functions expected of it. No statutory power was given. Until April it
provided advisory services to the Government, and help government in drafting the SEBI Act.
Though it tried to regulate financial intermediaries like merchant bankers, brokers etc., it f its efforts
due to lack of statutory powers. In 1992, Government the Securities & Exchange Board of India Act
by which SEBI required statutory powers.
Functions of SEBI
In order to achieve its various objectives, SEBI is given a lot of to perform various functions in
regulating the market and intermediaries.
The following powers and functions can be attributed to SEBI
1) Regulation of Securities Market: It regulates both the primary ma and secondary markets. When
companies issue securities to the every such issue is subject to clearance from SEBI. It vets the pros
and issues directions to provide additional information. The business stock exchanges (Secondary
Market) are also regulated regarding time settlement, nature of transactions, speculation etc.
2) Registration of Financial Intermediaries: Every financial intermediary should register with SEBI.
On the registration, SEBI allots a distinct number, which should be quoted by the intermediary in all
transactions. All the forms used by the financial intermediary have this number printed. The following
intermediaries are included within the purview of registration.
Powers of SEBI:
In discharge of its functions, SEBI is vested with the following
1. Levying Fees: SEBI can levy the registration fee on all intermediary and the foreign institutional
investors. This has been important source of income for SEBI. After meeting all the SEBI invests the
surplus amount in the securities listed in exchanges. ++As a result, it does not depend upon the
government finance.
2. Approving Byelaws of Stock Exchanges: SEBI, like any o securities market regulator tries to
achieve certain level of uniform) the trading practices in different stock exchanges. The byelaws of
stock exchanges are approved by SEBI in order to achieve this objective. In addition, it also ensures
that the byelaws promote the interest investors and no clause or provision contained is against the
investors.
3. Power to Order Amendment of Byelaws: SEBI can order any s exchange to amend the provisions
of the byelaws. This power is whenever SEBI brings in a new set of guidelines for the company
requiring the stock exchanges to amend the byelaws, SEBI can the listed companies to comply with
the new guidelines.
4. Inspection: SEBI can inspect the books of accounts of any exchange. It can also inspect the books
of accounts of any fins intermediaries. In addition, it can also call for periodical returns from stock
exchanges and financial intermediaries.
1. Define stock exchange? Explain the characteristics of stock exchange (K)
2. Define stock exchange? Explain role and functions of stock exchange (K)
3. Explain the members of stock exchange and types of dealing (U)
4. What do you mean by cash market? Write a note on it. (K)
5. What is future contract? Explain its features. (K)
6. Explain the uses of future contract (U)
7. What do you mean by option market? Write a short note on option market (K)
8. Explain the advantages and disadvantage of option trading (U)
9. Define listing of share explain its procedure (K)
10 Define speculator? Explain the types of speculator (K)
11. Define SEBI? Explain its functions (K)
12.Explain the powers of SEBI (U)
Multiple Choice questions

1. Companies that have a market capitalization in the range of up to ______are small cap stocks. (U)
a. Rs. 50 crores
b. Rs. 350 crores
c. Rs. 250 crores
d. Rs. 200 crores
2. Analysts measure risk – called (K)

a. Beta
b. Alpha
c. Alpha-Beta
d. None of the above
3. Capital Market also known as (K)

a. small cap
b. Mid cap
c. Large cap
4. Global Market also known as (U)

a. Mid cap
b. Small cap
c. Large cap
5. NASDAQ, trading of shares/stocks is done through a dealer called __________ (U)

a. Money Market
b. Market Maker
c. Stock market
d. All the above
6. The cost involved in listing a company in NASDAQ is ____compared to that of NYSE (K)
a. Very high
b. Economical
c. Very low
d. Same
7. NASDAQ is where the trading happens. (K)

a. Physically
b. Electronically
c. Both are used
8. Hybrid stocks ______voting rights like common stocks. (U)

a. May or may not have
b. Compulsorily
c. May not have
d. none of the above
9. securities Contracts (Regulation)Act _______ (U)

a. 1956
b. 1999
c. 1998
d. 1965
10. Category of Members of Stock Exchange___________ (K)

a. Jobbers
b. Brokers
c. Both a) & b)
11. Price at which stock is sold to investors by investment banks is called (K)
a. Gross proceeds
b. Cumulative proceeds
c. Non-cumulative proceeds
d. Net proceeds
12. Stock markets in which already issued stocks are resold and re-bought are classified as (U)
a. Red herring stock market
b. Pre-emptive stock market

c. Silence stock market
d. Secondary stock markets
13. When was Nifty established? (U)

a. 1952
b. 1965
c. 1991
d. 1996
14. Where is the New York Stock Exchange located? (K)

a. Broadway
b. Empire State Building
c. Times Square
d. Wall Street
15. Which of the following might be a reason for a stock market to lose value suddenly? (K)
a. A big company going bankrupt
b. Fear of a global recession
c. A terrorist attack
d. All of these
16. Which term most accurately describes selling shares at a higher price than the price at which
they were bought? (U)
a. Loss
b. Asset
c. Dividend
d. Profit
17. Which term is used to describe a pay-out made to shareholders representing their share of a
Corporation & profit? (U)
a. Jackpot
b. Dividend
c. Lovely Jubbly
d. Coupon
18. Which is the oldest Stock Exchange in Asia? (K)

a. Bombay Stock Exchange
b. National Stock Exchange
c. New York Stock Exchange
19. Which one is the World’s First Electronic Stock Exchange? (K)
a. NASDAQ (National Association of Securities Dealers Automated Quotations)
b. Bombay Stock Exchange
c. National Stock Exchange
d. New York Stock Exchange
20. Which Stock Exchange has the nick name “Big Board”? (U)
a. New York Stock Exchange (NYSE)
b. NASDAQ (National Association of Securities Dealers Automated Quotations)
c. Bombay Stock Exchange
d. National Stock Exchange
21. A stock market is also called (U)

a. Free market
b. Open market
c. Equity market
d. Sports market
22. What is done in the stock market? (K)

a. Trading
b. Dispatch
c. Warehousing
d. Financing
23. Which financial body has asked intermediaries and companies to make regulatory payments in
digital mode? (K)
a. SEBI
b. RBI
c. NSE
d. BSE
24. SEBI has just set up plans for a special court in the national capital. Where else is the special
court located in India? (U)
a. Mumbai
b. Hyderabad
c. Cochin
d. Agartala
25. Mid-cap stocks are typically stocking of _____________companies (K)

a. medium-sized
b. Large-sized
c. Small-sized
V- Emerging issues in financial Management

What Is a Derivative?
A derivative is a financial security with a value that is reliant upon or derived from, an underlying
asset or group of assets—a benchmark. The derivative itself is a contract between two or more parties,
and the derivative derives its price from fluctuations in the underlying asset.
The most common underlying assets for derivatives are stocks, bonds, commodities, currencies,
interest rates, and market indexes. These assets are commonly purchased through brokerages.
The Basics of a Derivative

Derivatives can be used to hedge a position, speculate on the directional movement of an underlying
asset, or give leverage to holdings. Their value comes from the fluctuations of the values of the
underlying asset.
Originally, derivatives were used to ensure balanced exchange rates for goods traded internationally.
With the differing values of national currencies, international traders needed a system to account for
differences. Today, derivatives are based upon a wide variety of transactions and have many more
uses. There are even derivatives based on weather data, such as the amount of rain or the number of
sunny days in a region.
For example, imagine a European investor, whose investment accounts are all denominated in euros
(EUR). This investor purchases shares of a U.S. company through a U.S. exchange using U.S. dollars
(USD). Now the investor is exposed to exchange-rate risk while holding that stock. Exchange-rate risk
the threat that the value of the euro will increase in relation to the USD. If the value of the euro rises,
any profits the investor realizes upon selling the stock become less valuable when they are converted
into euros.
To hedge this risk, the investor could purchase a currency derivative to lock in a specific exchange
rate. Derivatives that could be used to hedge this kind of risk include currency futures and currency
swaps.
A speculator who expects the euro to appreciate compared to the dollar could profit by using a
derivative that rises in value with the euro. When using derivatives to speculate on the price movement
of an underlying asset, the investor does not need to have a holding or portfolio presence in the
underlying asset.
KEY TAKEAWAYS
1. Derivatives are securities that derive their value from an underlying asset or benchmark.
Common derivatives include futures contracts, forwards, options, and swaps.
2. Most derivatives are not traded on exchanges and are used by institutions to hedge risk or speculate
on price changes in the underlying asset.
3. Exchange-traded derivatives like futures or stock options are standardized and eliminate or reduce
many of the risks of over-the-counter derivatives
4. Derivatives are usually leveraged instruments, which increases their potential risks and rewards.
Common Forms of Derivatives

There are many different types of derivatives that can be used for risk management, for speculation,
and to leverage a position. Derivatives is a growing marketplace and offer products to fit nearly any
need or risk tolerance.
1. Futures
A futures contract—also known as simply a future—is an agreement between two parties for the
purchase and delivery of an asset at an agreed upon price at a future date. Futures trade on an
exchange, and the contracts are standardized. Traders will use a futures contract to hedge their risk or
speculate on the price of an underlying asset. The parties involved in the futures transaction are
obligated to fulfil a commitment to buy or sell the underlying asset.
For example, say that Nov. 6, 2019, Company-A buys a futures contract for oil at a price of $62.22 per
barrel that expires Dec. 19, 2019. The company does this because it needs oil in December and is
concerned that the price will rise before the company needs to buy. Buying an oil futures contract
hedges the company's risk because the seller on the other side of the contract is obligated to deliver oil
to Company-A for $62.22 per barrel once the contract has expired. Assume oil prices rise to $80 per
barrel by Dec. 19, 2019. Company-A can accept delivery of the oil from the seller of the futures
contract, but if it no longer needs the oil, it can also sell the contract before expiration and keep the
profits.
In this example, it is possible that both the futures buyer and seller were hedging risk. Company-A
needed oil in the future and wanted to offset the risk that the price may rise in December with a long
position in an oil futures contract. The seller could be an oil company that was concerned about falling
oil prices and wanted to eliminate that risk by selling or "shorting" a futures contract that fixed the
price it would get in December.
It is also possible that the seller or buyer—or both—of the oil futures parties were speculators with the
opposite opinion about the direction of December oil. If the parties involved in the futures contract
were speculators, it is unlikely that either of them would want to make arrangements for delivery of
several barrels of crude oil. Speculators can end their obligation to purchase or delivery the underlying
commodity by closing—unwinding—their contract before expiration with an offsetting contract.
For example, the futures contract for West Texas Intermediate (WTI) oil trades on the CME represents
1,000 barrels of oil. If the price of oil rose from $62.22 to $80 per barrel, the trader with the long
position—the buyer—in the futures contract would have profited $17,780 [($80 - $62.22) X 1,000 =
$17,780]. The trader with the short position—the seller—in the contract would have a loss of $17,780.
Not all futures contracts are settled at expiration by delivering the underlying asset. Many derivatives
are cash-settled, which means that the gain or loss in the trade is simply an accounting cash flow to the
trader's brokerage account. Futures contracts that are cash settled include many interest rate futures,
stock index futures, and more unusual instruments like volatility futures or weather futures.
2. Forwards
Forward contracts—known simply as forwards—are similar to futures, but do not trade on an
exchange, only over-the-counter. When a forward contract is created, the buyer and seller may have
customized the terms, size and settlement process for the derivative. As OTC products, forward
contracts carry a greater degree of counterparty risk for both buyers and sellers.
Counterparty risks are a kind of credit risk in that the buyer or seller may not be able to live up to the
obligations outlined in the contract. If one party of the contract becomes insolvent, the other party may
have no recourse and could lose the value of its position. Once created, the parties in a forward
contract can offset their position with other counterparties, which can increase the potential for
counterparty risks as more traders become involved in the same contract.
3. Swaps
Swaps are another common type of derivative, often used to exchange one kind of cash flow with
another. For example, a trader might use an interest rate swap to switch from a variable interest rate
loan to a fixed interest rate loan, or vice versa.
Imagine that Company XYZ has borrowed $1,000,000 and pays a variable rate of interest on the loan
that is currently 6%. XYZ may be concerned about rising interest rates that will increase the costs of
this loan or encounter a lender that is reluctant to extend more credit while the company has this
variable rate risk.
Assume that XYZ creates a swap with Company QRS, which is willing to exchange the payments
owed on the variable rate loan for the payments owed on a fixed rate loan of 7%. That means that XYZ
will pay 7% to QRS on its $1,000,000 principal, and QRS will pay XYZ 6% interest on the same
principal. At the beginning of the swap, XYZ will just pay QRS the 1% difference between the two
swap rates.
If interest rates fall so that the variable rate on the original loan is now 5%, Company XYZ will have
to pay Company QRS the 2% difference on the loan. If interest rates rise to 8%, then QRS would have
to pay XYZ the 1% difference between the two swap rates. Regardless of how interest rates change,
the swap has achieved XYZ's original objective of turning a variable rate loan into a fixed rate loan.
Swaps can also be constructed to exchange currency exchange rate risk or the risk of default on a loan
or cash flows from other business activities. Swaps related to the cash flows and potential defaults of
mortgage bonds are an extremely popular kind of derivative—a bit too popular. In the past. It was the
counterparty risk of swaps like this that eventually spiraled into the credit crisis of 2008.
4. Options
An options contract is similar to a futures contract in that it is an agreement between two parties to buy
or sell an asset at a predetermined future date for a specific price. The key difference between options
and futures is that, with an option, the buyer is not obliged to exercise their agreement to buy or sell. It
is an opportunity only, not an obligation—futures are obligations. As with futures, options may be
used to hedge or speculate on the price of the underlying asset.
Imagine an investor owns 100 shares of a stock worth $50 per share they believe the stock's value will
rise in the future. However, this investor is concerned about potential risks and decides to hedge their
position with an option. The investor could buy a put option that gives them the right to sell 100 shares
of the underlying stock for $50 per share—known as the strike price—until a specific day in the future
—known as the expiration date.
Assume that the stock falls in value to $40 per share by expiration and the put option buyer decides to
exercise their option and sell the stock for the original strike price of $50 per share. If the put option
cost the investor $200 to purchase, then they have only lost the cost of the option because the strike
price was equal to the price of the stock when they originally bought the put. A strategy like this is
called a protective put because it hedges the stock's downside risk.
Alternatively, assume an investor does not own the stock that is currently worth $50 per share.
However, they believe that the stock will rise in value over the next month. This investor could buy a
call option that gives them the right to buy the stock for $50 before or at expiration. Assume that this
call option cost $200 and the stock rose to $60 before expiration. The call buyer can now exercise their
option and buy a stock worth $60 per share for the $50 strike price, which is an initial profit of $10 per
share. A call option represents 100 shares, so the real profit is $1,000 less the cost of the option—the
premium—and any brokerage commission fees.
In both examples, the put and call option sellers are obligated to fulfill their side of the contract if the
call or put option buyer chooses to exercise the contract. However, if a stock's price is above the strike
price at expiration, the put will be worthless and the seller—the option writer—gets to keep the
premium as the option expires. If the stock's price is below the strike price at expiration, the call will
be worthless and the call seller will keep the premium. Some options can be exercised before
expiration. These are known as American-style options, but their use and early exercise are rare.
Advantages of Derivatives
1. Derivatives can be a useful tool for businesses and investors alike.
2. They provide a way to lock in prices, hedge against unfavourable movements in rates, and
mitigate risks—often for a limited cost.
3. derivatives can often be purchased on margin—that is, with borrowed funds—which makes
them even less expensive.
Downside of Derivatives
On the downside, derivatives are difficult to value because they are based on the price of another asset.
The risks for OTC derivatives include counter-party risks that are difficult to predict or value as well.
Most derivatives are also sensitive to changes in the amount of time to expiration, the cost of holding
the underlying asset, and interest rates. These variables make it difficult to perfectly match the value of
a derivative with the underlying asset.
Mergers and Acquisitions

What is Mergers & Acquisitions?
Mergers and acquisitions (M&A) are defined as consolidation of companies. Differentiating the two
terms, Mergers is the combination of two companies to form one, while Acquisitions is one company
taken over by the other. M&A is one of the major aspects of corporate finance world. The reasoning
behind M&A generally given is that two separate companies together create more value compared to
being on an individual stand. With the objective of wealth maximization, companies keep evaluating
different opportunities through the route of merger or acquisition.
Mergers and Acquisitions

Mergers & Acquisitions can take place:
a. by purchasing assets
b. by purchasing common shares
c. by exchange of shares for assets
d. by exchanging shares for shares
Types of Mergers and Acquisitions:

Merger or amalgamation may take two forms: merger through absorption or merger through
consolidation. Mergers can also be classified into three types from an economic perspective depending
on the business combinations, whether in the same industry or not, into
a. horizontal ( two firms are in the same industry),
b. vertical (at different production stages or value chain) and
c. conglomerate (unrelated industries).
From a legal perspective, there are different types of mergers like
i. short form merger,

ii. statutory merger,
iii. subsidiary merger and
iv. merger of equals.
Reasons for Mergers and Acquisitions:

a. Financial synergy for lower cost of capital
b. Improving company’s performance and accelerate growth
c. Economies of scale
d. Diversification for higher growth products or markets
e. To increase market share and positioning giving broader market access
f. Strategic realignment and technological change
g. Tax considerations
h. Undervalued target
i. Diversification of risk
Principle behind any M&A

There is always synergy value created by the joining or merger of two companies. The synergy value
can be seen either through the Revenues (higher revenues), Expenses (lowering of expenses) or the
cost of capital (lowering of overall cost of capital).
Three important considerations should be taken into account:

a. The company must be willing to take the risk and vigilantly make investments to benefit fully
from the merger as the competitors and the industry take heed quickly
b. To reduce and diversify risk, multiple bets must be made, in order to narrow down to the one that
will prove fruitful
c. The management of the acquiring firm must learn to be resilient, patient and be able to adopt to
the change owing to ever-changing business dynamics in the industry
Stages involved in any M&A:

Phase 1: Pre-acquisition review: this would include self-assessment of the acquiring company with
regards to the need for M&A, ascertain the valuation (undervalued is the key) and chalk out the growth
plan through the target.
Phase 2: Search and screen targets: This would include searching for the possible apt takeover
candidates. This process is mainly to scan for a good strategic fit for the acquiring company.
Phase 3: Investigate and valuation of the target: Once the appropriate company is shortlisted
through primary screening, detailed analysis of the target company has to be done. This is also referred
to as due diligence.
Phase 4: Acquire the target through negotiations: Once the target company is selected, the next step
is to start negotiations to come to consensus for a negotiated merger or a bear hug. This brings both the
companies to agree mutually to the deal for the long term working of the M&A.
Phase 5: Post merger integration: If all the above steps fall in place, there is a formal announcement
of the agreement of merger by both the participating companies.
Reasons for the failure of M&A – Analysed during the stages of M&A:
a. Poor strategic fit: Wide difference in objectives and strategies of the company
b. Poorly managed Integration: Integration is often poorly managed without planning and
design. This leads to failure of implementation
c. Incomplete due diligence: Inadequate due diligence can lead to failure of M&A as it is the
crux of the entire strategy
d. Overly optimistic: Too optimistic projections about the target company leads to bad decisions
and failure of the M&A Example: Breakdown in merger discussions between IBM and Sun
Microsystems happened due to disagreement over price and other terms.
Recent Mergers and Acquisitions

Mergers and Acquisitions Case Study:
Case Study 1: Sun Pharmaceuticals acquires Ranbaxy:
The deal has been completed: The companies have got the approval of merger from different
authorities.
This is a classic example of a share swap deal. As per the deal, Ranbaxy shareholders will get four
shares of Sun Pharma for every five shares held by them, leading to 16.4% dilution in the equity
capital of Sun Pharma (total equity value is USD3.2bn and the deal size is USD4bn (valuing Ranbaxy
at 2.2 times last 12 months sales).
Reason for the acquisition: This is a good acquisition for Sun Pharma as it will help the company to fill
in its therapeutic gaps in the US, get better access to emerging markets and also strengthen its presence
in the domestic market. Sun Pharma will also become the number one generic company in the
dermatology space. (currently in the third position in US) through this merger.
Objectives of the M&A:
a. Sun Pharma enters into newer markets by filling in the gaps in the offerings of the company,
through the acquired company
b. Boosting of products offering of Sun Pharma creating more visibility and market share in the
industry
c. Turnaround of a distressed business from the perspective of Ranbaxy
This acquisition although will take time to consolidate, it should in due course start showing results
through overall growth depicted in Sun Pharma’s top-line and bottom-line reporting.
Case Study 2: CMC merges with TCS:

This is an example where there is a merger in the same industry (horizontal). It was done to
consolidate the IT businesses. The objective of this merger, as indicated by the management of CMC,
was that the amalgamation will enable TCS to consolidate CMC’s operations into a single company
with rationalised structure, enhanced reach, greater financial strength and flexibility. Further it also
indicated that, it will aid in achieving economies of scale, more focused operational efforts,
standardisation and simplification of business processes and productivity improvements.
Conclusion:
M&A’s are considered as important change agents and are a critical component of any business
strategy. The known fact is that with businesses evolving, only the most innovative and nimble can
survive. That is why, it is an important strategic call for a business to opt for any arrangements of
M&A. Once through the process, on a lighter note M&A is like an arranged marriage, partners will
take time to understand, mingle, but will end up giving positive results most of the times.
What is Behavioural Finance?
Behavioural finance is the study of the influence of psychology on the behavior of investors or
financial analysts. It also includes the subsequent effects on the markets. It focuses on the fact that
investors are not always rational, have limits to their self-control, and are influenced by their own
biases.
Traditional Financial Theory
In order to better understand behavioural finance, let’s first look at traditional financial theory.
Traditional finance includes the following beliefs:
a. Both the market and investors are perfectly rational

b. Investors truly care about utilitarian characteristics
c. Investors have perfect self-control
d. They are not confused by cognitive errors or information processing errors
Behavioural Finance Theory
Now let’s compare traditional financial theory with behavioural finance.

Traits of behavioural finance are:
a. Investors are treated as “normal” not “rational”

b. They actually have limits to their self-control
c. Investors are influenced by their own biases
d. Investors make cognitive errors that can lead to wrong decisions
Decision-Making Errors and Biases
Let’s explore some of the buckets or building blocks that make up behavioural finance.
Behavioural finance views investors as “normal” but as subject to decision-making biases and errors.
We can break down the decision-making biases and errors into at least four buckets.
1 Self-Deception
The concept of self-deception is a limit to the way we learn. When we mistakenly think we know more
than we actually do, we tend to miss information that we need to make an informed decision.
2 Heuristic Simplification
We can also scope out a bucket that is often called heuristic simplification. Heuristic simplification
refers to information-processing errors.
3 Emotion
Another behavioural finance bucket is related to emotion, but we’re not going to dwell on this bucket
in this introductory session. Basically, emotion in behavioural finance refers to our making decisions
based on our current emotional state. Our current mood may take our decision making off track from
rational thinking.
4 Social Influence
What we mean by the social bucket is how our decision making is influenced by others.
Top 10 Biases in Behavioural Finance
Behavioural finance seeks an understanding of the impact of personal biases on investors. Here is a list
of common financial biases.
Common biases include:
1. Overconfidence and illusion of control

2. Self-Attribution Bias
3. Hindsight Bias
4. Confirmation Bias
5. The Narrative Fallacy
6. Representative Bias
7. Framing Bias
8. Anchoring Bias
9. Loss Aversion
10. Herding Mentality
Overcoming Behavioural Finance Issues
There are ways to overcome negative behavioural tendencies in relation to investing. Here are some
strategies you can use to guard against biases.
1. Focus on the Process
There are two approaches to decision-making:
Reflexive – Going with your gut, which is effortless, automatic and, in fact, is our default option
Reflective – Logical and methodical, but requires effort to engage in actively
Relying on reflexive decision-making makes us more prone to deceptive biases and emotional and
social influences.
Establishing logical decision-making processes can help protect you from such errors
Get yourself focused on the process rather than the outcome. If you’re advising others, try to
encourage the people you’re advising to think about the process rather than just the possible outcomes.
Focusing on the process will lead to better decisions because the process helps you engage in reflective
decision-making.
2. Prepare, Plan and Pre-Commit

Behavioural finance teaches us to invest by preparing, by planning, and by making sure we pre-
commit. Let’s finish with a quote from Warren Buffett. “Investing success doesn’t correlate with IQ
after you’re above a score of 25. Once you have ordinary intelligence, then what you need is the
temperament to control urges that get others into trouble.”
Overview of financial modelling
What is a financial model?
A financial model is simply a tool that’s built in Excel to forecast a business’ financial performance
into the future. The forecast is typically based on the company’s historical performance, assumptions
about the future, and requires preparing an income statement, balance sheet, cash flow statement, and
supporting schedules (known as a 3 statement model). From there, more advanced types of models can
be built such as discounted cash flow analysis (DCF model), leveraged-buyout (LBO), mergers and
acquisitions (M&A), and sensitivity analysis. Below is an example of financial modelling in Excel.
What is a financial model used for?
The output of a financial model is used for decision making and performing financial analysis, whether
inside or outside of the company. Inside a company, executives will use financial models to make
decisions about:
a. Raising capital (debt and/or equity)

b. Making acquisitions (businesses and/or assets)
c. Growing the business organically (i.e. opening new stores, entering new markets, etc.)
d. Selling or divesting assets and business units
e. Budgeting and forecasting (planning for the years ahead)
f. Capital allocation (priority of which projects to invest in)
g. Valuing a business
1.What is derivatives? Explain common form of derivatives (K)
2. Write a short note on (K)

a. Future derivatives
b. Forward derivatives
3. Write a short note on (K)
a. Swap derivatives
b. option derivatives
4. Explain the type’s merger and acquisition (U)
5. What are the reasons for mergers and acquisition? (K)
6. Explain the steps involved in mergers and acquisition (U)
7. Explain reasons for failure mergers and acquisition (U)
8. What is behavioural finance? Explain the traits and decision-making errors? (K)
9. Explain Top Biases in Behavioural Finance (U)
10. What is a financial model used for? (K)
11. Explain briefly how to overcome Behavioural Finance Issues (U)
12. Explain the difference between behavioural and traditional theory (U)
Multiple choice question
1. An acquisition is the same thing as (K)

a. a merger
b. an amalgamation
c. a spin-off
d. a takeover
2. The ways in which mergers and acquisitions (M&As) occur do not include: (U)
a. conglomerate takeover
b. vertical integration
c. horizontal integration
d. diversification
3. The ‘good’ reasons for M&As do not include: (K)

a. stopping a competitor merging or taking over
b. complementing business strategies
c. supporting value-added growth
d. increasing earnings per share
4. Justifications for M&As do not include: (U)

a. to increase risk
b. to enter new markets
c. to achieve synergy
d. to gain economies of scale.
5. Financial motives for M&As do not relate to: (K)

a. earnings per share
b. corporation tax
c. value added tax
d. unemployed tax shields
6. Managerial motives for M&As do not relate to: (U)

a. job security
b. emoluments
c. power
d. dividends
7. The three broad approaches to company valuation do not include: (K)

a. asset valuation
b. stock market valuation
c. inventory valuation
d. future earnings valuation
8. Asset-based company valuations do not include the: (U)

a. realisable value method

b. book value method
c. replacement cost method
d. marginal cost method
9. Earnings-based company valuations do not include the: (K)

a. ARR method
b. ABC method
c. P/E method
d. DCF method
10. Other reasons for company valuations do not include: (U)

a. inheritance tax assessment
b. capital gains tax assessment
c. security for loans
d. tax evasion
11. Which of the following factors influence the choice between merger and an acquisition of stock?
(K)
(I) Shareholders are dealt with directly to bypass target management and board of directors
(II) In a tender offer, usually some minority shareholders do not tender stopping complete firm
absorption
(III) Target management may be unfriendly and resist an offer. Resistance usually makes the
stock
price higher
a. I only
b. II only
c. III only
d. I, II, and III
12. What are the tax consequences of a taxable merger? (U)

a. Selling shareholders can defer any capital gain until they sell their shares in the merged
company
b. Depreciation tax shield is unchanged by merger
c. Selling shareholders must recognize any capital gain

d. Depreciable value of assets will remain unchanged
13. Firm A has a value of $200 million, and B has a value of $120 million. Merging the two would
allow a cost savings with a present value of $30 million. Firm A purchases B for $130 million.
What is the cost of this merger? (K)
a. $30 million
b. $20 million
c. $15 million
d. $10 million
14. Walt Disney's acquisition of ABC television network is an example of: (U)
a. Horizontal merger
b. Vertical merger
c. Conglomerate merger
d. Cross-border merger
15. The following reasons are good motives for mergers except: (K)
a. Economies of scale
b. Complementary resources
c. Diversification
d. Eliminating Inefficiencies
16. Market for corporate control includes the following: (U)

(I) Mergers
(II) Spin-offs and divestitures
(III) Leveraged buyouts (LBOs)
(IV) Privatizations
a. I only
b. I and II only
c. I, II, and III only
d. I, II, III, and IV
17. Pfizer's acquisition of Pharmacia is an example of: (K)

(I) Horizontal merger

(II) Vertical merger
(III) Conglomerate merger
A) I only
B) II only
C) III only
D) None of the given ones
18. Which of the following are commonly cited reasons for M&As? (U)
a. Synergy
b. Market power
c. Strategic realignment
d. All of the above
19. A merger is a combination of businesses in which (K)

a. two businesses combine to form a new business.
b. the participants are necessarily comparable in size, competitive position, profitability, and
market capitalization.
c. one of the two firms become a wholly owned subsidiary of the other firm.
d. none of the above.
20. Vertical mergers are those in which the participants are (U)
a. in the same industry.
b. in different industries
c. in different phases of the value chain.
d. none of the above.
21. An employee stock ownership plan (ESOP) is a trust that (K)

a. can be used as alternative to a divestiture.
b. can be used to purchase the shares of the owners of a privately held firm in a leveraged buyout.
c. can be used as a means of placing a firm’s stock in “friendly” hands to help dissuade an
unwanted takeover attempt.
d. all of the above.
22. All of the following are common motives for a merger or acquisition except for (U)
a. operating synergy
b. financial synergy
c. raising the cost of capital.
d. buying undervalued assets.
What is the gain from this merger? (K)
a. $30 million
b. $20 million
c. $15 million
d. $75 million
What is the cost of this merger? (U)
a. $30 million
b. $20 million
c. $5 million
d. $10 million
25. The following are good reasons for mergers: (K)

(I) Economies of scale
(II) Economics of vertical integration
(III) Complementary resources
(IV) Surplus funds
(V) Eliminating inefficiencies
(VI) Industry consolidation
a. I only
b. I, II, and III only
c. I, III, IV, and V only
d. I, II, III, IV, V, and VI

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Srinivas university Financial Management III B.

COLLEGE OF MANAGEMENT & COMMERCE

CITY CAMPUS, PANDESHWAR, MANGALORE-575 001.

BACKGROUND STUDY MATERIAL

Subject: FINANCIAL MANAGEMENT II

Maximum Time: 2 HOURS

5 1(1) 1(1) 1(8) 10

UNIT II- CASH AND RECEIVABLES MANAGEMENT 8 Hours

UNIT III- FINANCIAL STATEMENT ANALYSIS 8 Hours

UNIT IV- STOCK EXCHANGE AND REGULATION 8 Hours

UNIT V- EMERGING ISSUES IN FINANCIAL MANAGEMENT 8 Hours

Derivatives, Mergers and Acquisitions, Behavioural Finance, Financial Modelling, Financial

Books for Reference:

FINANCIAL MANAGMENT –II

FACULTY- Mrs. Meghashree

Session.1: Meaning of Working Capital 1hr

Session.2: Gross, Net Permanent and Temporary. 1hr

Session.3: Concept of Operating Cycle 1hr

Session.4: Gross operating cycle and Net operating cycle 1hr

Session.5: Estimation of working capital Requirement. 1hr

Session.6: Estimation of component methods, Percentage sales Method 1hr

Session.7: Operating cycle Method 1hr

Unit – II Cash and Receivable Management 8 hours

Session 14: Preparation of cash Budget 1hr

Session 15: Introduction to receivable management 1hr

Session 16: Significance and purpose of receivable management 1hr

Unit – III: Financial Statement Analysis 8 hours

Session 17: Introduction, Meaning, Definition 1 hr

Session 18: Types of Financial Statements 1hr

Session 19: Techniques of Financial Analysis 1hr

Session 20: Comparative Financial statement analysis 1hr

Session 21: Common – size Balance Sheet and Income Statement 1 hr

Session 22: Problems on Financial statement analysis 1 hr

Session 23: Problems on Comparative Financial statement analysis 1 hr

Unit IV: Stock exchange and policies 8 hours

Session 25: Meaning and Characteristics 1 hr

Session 26: Role and function of stock exchange 1 hr

Session 27: Cash market -option and future market 1 hr

Session 28: Meaning and settlement of contract 1 hr

Session 29: Listing of shares – Meaning, 4 hr

Unit V: Emergency Issue in Financial Management 8 hours

Session 33: Derivatives 1hr

Session 34: Mergers and Acquisition 1 hr

Session 35: Behavioral Finance 1hr

Session 36: Financial Modelling 1hr

Session 37: Financial Engineering 1hr

Session 38: Financial Engineering 1hr

Session 39: Risk Management 1hr

Session 40: Risk Management 1hr

University examination : 50 marks

Chapter -1 WORKING CAPITAL MANAGEMENT

Meaning of Working Capital:

represents Gross Working Capital.

Net Working Capital is fully financed by long-term sources of finance.

Factors Determining the Size of Working Capital:

There are four components for an operating cycle of a manufacturing firm.

Gross Operating Cycle and Net Operating Cycle

l) Components of Working Capital Method:

Statement of Estimation of Working Capital

I. RMCP =Average stock of raw material XXX

II. WIPCP= Average stock of WIP

Inventory Conversion Period XXX