ABFM 4 PER PAGE - Compressed

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ABFM MODULE - A INTRODUCTION:
Chapter 1: Basics of Management (PART-I) Management is necessary for making our life or any task or
venture we undertake successful, including any industrial,
What we will study? business or service activity.
*What is Management? All of us are aware that the modern-day Banking has become
*What is Management Process? a significant component of the Indian Financial System
because of the increasingly important role played by banks in
the economic development of the country.
In fact, the role of the entire financial sector for optimum
allocation and utilisation of financial resources has been
continuously growing.
It is therefore, very important for bankers to understand the
process of management and the functions performed by
managers along with their importance.
This understanding shall help the bankers face the short-term,
as well as the long-term, challenges being faced by them and
shall also help the banking system become stronger and more
and more resilient, which is highly important for growth with
financial stability and for protecting the interests of the
investors and customers.
DEFINITION OF MANAGEMENT: His contemporary, Frederick Winslow Taylor, introduced
methods to improve the industrial efficiency.
The term ‘Management’ could be defined in a variety of ways.
Taylor’s book ‘The Principles of Scientific Management’,
It could be referring to the persons running an organisation
published in the year 1911, was voted as the most influential
collectively, who are responsible for decision making.
management book of the twentieth century.
The Cambridge Dictionary refers to Management as ‘the
Scientific management, also known as ‘Taylorism’, is a
activity or job of being incharge of a company, organization,
management theory which was used for analysing and
department, or team of employees.
synthesizing workflows with the main objective of
We could even say that the three components of management improvement of economic efficiency and labour productivity.
refer to their organising skills, their skills as an entrepreneur
Several parts of the theory, relating to industrial engineering
and getting the best out of their team members.
and management, are still relevant.
The skills for organising would obviously include the
To quote Henri Fayol,
traditional skills, principles and the techniques of
management which have evolved over a period of time and “To manage is to forecast and plan, to organize, to command,
are continuously evolving. to coordinate and to control.
Henri Fayol, widely acknowledged as the founder of modern To foresee and plan means examining the future and drawing
management methods, was an early management writer who up the plan of action.
was instrumental in contributing immensely to ‘formal
To organize means building up the dual structure, material
organisation theory’.
and human, of the undertaking.
The theory propounded by Henri Fayol included the six types
To command means binding together, unifying and
of organisational activities, which also included management.
harmonizing all activity and effort.
It also explained the various functions and principles of
To control means seeing that everything occurs in conformity
management.
with established rule and expressed demand”.
Peter Drucker, the famous Management Guru, in his book And this process is a continuous process as developments on
"Management: tasks, responsibilities, practices" has written various fronts, viz. economic, social, political, regulatory etc.
that "Frederick W. Taylor' was the first man in recorded are taking place all the time.
history who deemed work deserving of systematic
You solve a problem and a new problem crops up.
observation and study.
A manager is supposed to deal with multiple problems at the
Management is not common sense alone but a discipline, a
same time, each of which could be at a different resolution
culture and an art and science at the same time.
stage.
It represents people, and their achievements or failures
The complexity of management has laid down the foundation
denote the effectiveness of management or mismanagement
of breaking down each activity into various parts or sub-
of the organisation’s affairs.
activities so that we can understand the complete significance
of each activity.
THE MANAGEMENT PROCESS: This is the reason for division of management tasks into
different elements: planning, organizing, staffing, directing
Productivity is very important in any business organisation,
and controlling.
and there is a continuous demand on the people at the helm
of affairs to increase productivity for increasing profits to Although all these elements are inter-connected, each of
meet the expectations of the stakeholders and the society. these can be analysed as a sub-process and each element
contributes to the success of an organisation, irrespective of
The process of management involves multiple actions
its size-big or small; type of ownership-public or private;
performed in a series to achieve the objectives of the business
constitution-sole proprietor, partnership, company; or type of
enterprise.
organisation-industrial, business, service, non-profit.
The process of management can be classified as a social
process as it involves relationships and co-operation between
people and their team effort.
ABFM MODULE - A FUNCTIONS OF MANAGEMENT:
Chapter 1: Basics of Management (PART-II) The functions of management are multifarious and encompass
each and every activity of an organisation.
What we will study?
The responsibility of a manager may differ based on his
*What are the functions of Management? hierarchy level in an organisation but nevertheless, he or she
is responsible for planning, for directing and leading the
workers and other staff, and for monitoring and controlling
performances at work, through proper governance and risk
management.
Planning:
Planning involves taking a call on future and deciding about it,
in line with the objectives of the organisation.
This involves setting of goals, determining the objectives of organisation, viz. the people employed by the organisation,
the organisation and selecting the future course of action the materials, capital and technology used for achieving the
required to be taken for accomplishing the objectives of the objectives of the enterprise.
organisation.
Organising involves taking decisions about division of work,
When you plan, you decide in advance about what needs to allocation of responsibility and authority and task
be done, when and where it needs to be done, how it shall be coordination.
done and who would be doing it.
Organising becomes a more and more complex function, and
The activities of a business entity get the desired direction more and more important, with the business growth.
with planning.
Building an effective and formal organisation structure
Planning helps the managers to manage changes. assumes greater significance when the business grows, as this
involves defining, classifying, arranging and coordinating the
Planning helps managers to review and monitor the progress
different types of work activities, performed by the
made for achieving the business objectives and take the
organisation.
necessary corrective measures if the progress made is
considered unsatisfactory. Thus, the organising function is highly dynamic.
Planning is a fundamental function to be performed by It also involves the following areas:
management and has considerable influence on all other
a) Task Management: What is to be done? Who will do it?
functions of management.
How the grouping of tasks shall be done?
b) The Reporting Structure: Who shall be reporting to whom?
Organising:
c) Decision Making: Who shall make the decisions? At what
Organising is another important function performed by level, decisions shall be made?
management of an organisation and deals with the
organisational structuring and arranging the resources of the
Staffing: (a) Leadership:
A successful organisation needs to have suitable human The process of leading a team involves influencing a person’s
capital for achieving its objectives, a function made easy by or group’s actions to meet the pre-defined and desired
staffing. objectives.
The major staffing activities include recruitment, selection, A manager has to play an important role in getting the
training, development and motivation of the various assigned work done from the people being managed by him.
categories of employees and fixation of their compensation
The quality of leadership, displayed by managers of an
and reviewing it from time to time.
organisation, forms the very foundation of its success.
Staffing also takes care of promotions, job rotations, job
(b) Motivation:
enrichment, transfers, termination and retirement activities.
A manager’s function includes inspiring, encouraging and
urging them to take the action, required for achieving the
Directing: objectives of an organisation.
Directing covers the functions of guiding and supervising the This process is known as motivation and also involves
activities performed by subordinates. providing the desired stimulus to otherwise indifferent people.
It is not enough to recruit and place people on jobs. Healthy, congenial and pleasant surroundings, along with
incentives for performing, have to be provided by an effective
They have also to be directed towards the achievement of
manager for achieving business goals.
organisational goals.
This function comprises of the following four important
elements: (c) Communication:
(a) Leadership (b) Motivation Communication is the back bone of how effectively a manager
performs.
(c) Communication (d) Supervision
It is very important that instructions flow speedily and clearly to deliver quality services and to achieve the targets laid down
from top to bottom, and information and suggestions flow by the top management.
from lower levels to top speedily and without any hindrance.
Supervision helps in ensuring that subordinates perform their
Everyone in an organisation has to be on the same page to functions properly and do their work in time and as per the
translate ideas into action. laid down norms and standards.
Effective two-way communication is the very basis of transfer
of thoughts and facts.
Controlling:
Effective communicators have always been in a position to
Proper controls are required to ensure that actions taken by
strike a chord with their subordinates and perform as per the
the management help in achievement of organisational goals.
expectations of the top management.
An effective controlling function will always be preceded by
Without effective communication, managers shall not be able
proper planning.
to accomplish much.
It is very important that the activities undertaken by the
(d) Supervision:
management remain on the right track and are in line with the
Continuous monitoring and supervision of work, assigned to plans, targets and objectives of the organisation.
the subordinates, is also important for any organization.
The control function deals with monitoring and measuring of
Telling the subordinates about what they are required to do performances of people and comparing them with the pre-
may not always be sufficient. decided standards and projections.
For getting any work done, it is equally important that there is This also involves variance analysis and taking remedial
adequate supervision too. measures for achieving the planned targets.
The activities of the subordinates need to be watched and Thus, controlling would necessarily involve course correction
supervised to ensure proper quality of goods manufactured, measures and alteration of plans, wherever deviations are
observed.
Controlling involves the following four steps: ABFM MODULE - A
(a) Establishing performance standards. Chapter 1: Basics of Management (PART-III)
(b) Measurement of actual performance. What we will study?
(c) Comparison of actual performance against the established
*What are the importance of Management?
standards.
(d) Taking corrective actions to achieve the desired objectives.
Active participation by managers, in all the above functions, is

desirable to achieve the business goals of an organisation.
Since all the above functions of management are interrelated,
managers must take a holistic view and use a combination of
the above management functions to solve the challenges and
problems faced by them for meeting their business goals.
IMPORTANCE OF MANAGEMENT: It also helps improvement of the quality of decisions taken
and improves control over the functioning of various
All businesses need proper direction for achieving the
departments of the business unit, thereby making
objectives for which they are established.
achievement of group goals possible.
This function is performed by Management.
c) Optimum utilization of resources:
Let us take the example of a manufacturing company.
Proper management and efficient allocation of resources
All planning, organising, staffing, co-ordination, control helps efficient and optimum utilisation of scarce resources.
revolves around the manufacturing activity.
d) Improved functioning of business:
Funds are raised with the ultimate objective of producing
Management helps a business function effectively:
quality goods meeting the requirements of the customers, for
capturing market share and for adding value for the (i) By improving the understanding, ability and morale of the
stakeholders. human capital employed in the business.
An efficient and effective management shall make the (ii) By achieving higher coordination.
realisation of this objective possible.
(iii) By creating an environment of mutual respect and trust.
The following points highlight the importance of management:
(iv) By increasing motivation levels and
a) Effective Change Management Tool:
(v) By effective supervision.
An efficient management works as an effective change
management tool and helps the transition of an organisation
from good to great. e) Development of various resources:
b) Helps achieve group goals: Management helps in all round development of various
resources, viz. human resources, machines, materials and
Management helps an organisation plan and continuously
capital, at the disposal of the business entity.
adjust with the ever-changing external business environment.
f) Contributes towards better organisation: k) Inculcation of team spirit:
Management helps better structuring of the organisation by Management helps inculcation of team spirit among different
properly defining the authority and responsibility of departments of an organisation by improving coordination.
employees at various levels, and by ensuring the right job fit
l) Problem solving:
for the employees.
Effective management acts as a friend, philosopher and guide
g) Proper Direction to the organization:
to the employees and helps them to better their performance,
Management provides proper direction to the organisation to by supporting them to solve their day-to-day problems in a
achieve its goals and the laid down roadmap. proactive manner.
h) Integration of various interests: m) Helps Employee Growth:
Integration of the interests of various groups, in an Introduction of latest management techniques, new
organisation, is an important role played by management. production methods, new service delivery systems, new
training methodologies and new team building techniques
i) Management of fluctuations:
help employee growth to a large extent.
Management of ups and downs, caused by business cycles and
other external factors, is an important function of
management.
j) Innovation:
Creativity and innovation on the part of management of an
enterprise play an important role in the growth of the
organisation.
This helps the organisation to stay ahead of its competition.
ABFM MODULE - A MANAGEMENT THOUGHTS & APPROACHES:
Chapter 1: Basics of Management (PART-IV) Management Practitioners and Academicians have been
contributing to the theory and practice of management for
What we will study? more than a century now and have come out with a variety of
*What are the different management thoughts and approaches to management, based on intensive research and
approaches. analysis.
Harold Koontz, an eminent Management Expert, has even
*All about Classical or Traditional School?
coined the term ‘the management theory jungle’ for the
*All about Neoclassical or Behavioural School? various management approaches.
*All about Maslow’s hierarchy of needs?

*All about Douglas McGregor’s X and Y Theory? The various management thoughts can be classified as under:
*All about Motivation-Hygiene Theory? Classical or Traditional School:

The classical school believes in the use of technology for
increasing efficiency of the employees, and lays down more
emphasis on the organisation, looks at the organisation as a
machine and the employees as its parts, who are important
only as a means of production.
Main contributors: Frederick Taylor , Henry Fayol & Max
Weber.
The salient features of the classical or traditional school
include:
(a) Having an integrated and centralised system.
(b) Greater emphasis on production. This School of Thought had the following salient features:
(c) Concentration on errors and their rectification. a) Focus on motivation.
(d) Assuming employees’ continuity irrespective of b) Different persons get motivated diversely for satisfying
organisational changes. their specific needs.
(e) Based on an accounting model and c) For efficiency measurement, communication is a critical
input.
(f) Giving equal weightage to different types of jobs and
employees. d) For organizational performance, team-work is essential.
e) The thought has two different perspectives, viz. Human
Relations perspective and Psychological perspective.
Neoclassical or Behavioural School:
This school of thought was also the originator of
This school is an extended version of the traditional school
and developed because of the weaknesses observed in the ➢ Maslow’s hierarchy of needs.
classical theory.
➢ Douglas McGregor’s X and Y Theory.
The behavioural thought process attempted to solve the
➢ Motivation-Hygiene Theory.
problems faced by the classical theorists.
This school of thought propounded the influence of human
actions on the very existence of an organisation. Please refer ABM Chapter 12 for full details.
According to this theory, an organisation, comprises of both

formal and informal forms of organization, a fact which was
overlooked by the Classical theorists (formal organization).
Main contributor: Elton Mayo.
MASLOW’S HEIRARCHY OF NEEDS: DOUGLAS MCGREGOR’S X AND Y THEORY:
This theory gave an insight into the two aspects of human
behaviour.
Theory X stated that humans do not work without close
supervision, while Theory Y propounded that humans love to
work and there is no need of coercing them to work for
achieving organisational goals.
The theory can be summarized as follows: Theory X Assumptions:

Human beings have wants and desires which influence their The average human being is inherently lazy by nature and
behaviour. desires to work as little as possible.
Only unsatisfied needs influence behaviour, satisfied needs do He dislikes the work and will like to avoid it, if he can.
not.
He avoids accepting responsibility and prefers to be led or
Since needs are many, they are arranged in order of directed by some other.
importance, from the basic to the complex.
He is self-centred and indifferent to organizational needs.
The person advances to the next level of needs only after the
He has little ambition, dislikes responsibility, prefers to be led
lower-level need is at least minimally satisfied.
but wants security.
The further the progress up the hierarchy, the more
He is not very intelligent and lacks creativity in solving
individuality, humanness and psychological health a person
organizational problems.
will exhibit.
He, by nature, resists change of any type.
Theory Y Assumptions: MOTIVATION-HYGIENE THEORY:
Work is as natural as play, provided the work Also known as Two-Factor Theory or Satisfier - Dissatisfier
environment is favourable. Theory of Motivation and behaviour.
Work may act as a source of satisfaction or punishment. It was the brainchild of Fredrick Herzberg, a psychologist and
behavioural scientist.
An average man is not really against doing work.
Frederick Herzberg’s two-factor theory, aka intrinsic/extrinsic
People can be self-directed and creative at work if they are
motivation, concludes that certain factors in the workplace result
motivated properly.
in job satisfaction, but if absent, lead to dissatisfaction.
Self-control on the part of people is useful for achieving
The factors that motivate people can change over their
organizational goal.
lifetime, but “respect for me as a person” is one of the top
External control and threats of punishment alone do not bring motivating factors at any stage of life.
out efforts towards organizational objectives.
People have capacity to exercise imagination and creativity.
He distinguished between:
People are not by nature passive or resistant to organizational
Motivation: (e.g., challenging work, recognition,
needs.
responsibility) which give positive satisfaction, but, if absent,
They have become so as a result of experience in does not result in demotivation and
organisations.
Hygiene factors: (e.g., status, job security, salary and other
benefits) that do not motivate if present, but, if absent, result
in demotivation.
ABFM MODULE - A Quantitative School or Management Science:
Chapter 1: Basics of Management (PART-V) the Quantitative School of Management developed mainly
after World War II and emphasises use of mathematical and
What we will study? statistical models for finding solutions to managerial problems.
*What is Quantitative School? The scientific management techniques, laid down by Fredrick
*What is System School of Management? Winslow Taylor, also helped in laying down the foundations of
this approach.
*What is Contingency School of Management?
Management is studied as science under this approach, with
*What is Contemporary School of Management? special emphasis on operations and management information
systems.
The main characteristics of the quantitative approach to
management include:
a) Creation of models, theories and hypotheses.
b) Collection of empirical data.
c) Development of mathematical and statistical models.
d) Data analysis.
e) Experimenting in controlled environment.
f) Testing with changes in variables.
g) Development of various instruments.
h) Development of quantitative techniques.
The System School of Management: The Contingency School of Management:
This school of management thought was propounded by This school of management thought was an offshoot of the
Daniel Katz, an American Psychologist, and Ludwig Von scientific, behavioural and systems approaches to
Bertillon, an Australian Biologist. management, and stated that there cannot be a unique way
of managing an organisation and which can be labelled as the
They advocated the concept of management being an open
best way to manage or lead a business.
system, which is required to interact with the environment
constantly for getting resources, which are both valuable and The best or the optimal way shall always depend or be
limited. contingent on the internal and external environment.
The main objective of the research undertaken by the systems In other words, there cannot be a standard solution to various
school was to understand the external environment and business situations faced by the management.
conditions faced by an organisation and finding ways of
Each leader might deal with the same situation in different
handling such conditions.
ways, depending on his/her leadership style.
The open system approach is important because of the
Studies on the behaviour of leaders were conducted in 1950’s
interaction between an organisation and the outside forces
by researchers in Ohio State University and University of
and the outside influence impacting the actions taken by the
Chicago (University of Michigan Survey Research Centre).
organisation.
The findings of scholars from both universities, though similar,
For example, a bank provides financial services and products
were given different names, which is detailed below:
to its customers and the customers react by liking or rejecting
the product.
The concepts of ‘Total quality management’ and ‘Learning
organization’ are quite relevant in this context.
Total Quality Management:

Total Quality Management focuses on the management of an
organisation for delivering high quality goods and services to
its customers.
The approach originated in Japan after the Second World War.
The contingency school of management thought is criticised
for being reactive and for failure to be proactive and for not
providing some standard principles and procedures to be
The four main elements of this approach are:
applied in specific situations.
1- Employee involvement:
This approach can turn out to be expensive in terms of money
and time and development of a proper theory of management A high degree of involvement of employees is instrumental in
principles becomes almost impossible. preventing quality issues, before they occur.
The Contemporary School of Management: 2- Customer focus:
Management theory continues to advance because of To improve quality, an organisation needs to focus fully on the
constant evolution of business practices and management requirements of its customers, and understand their business
techniques, especially in the wake of technological and what they want, with the objective of delivering products
advancements. and services suitable to them.
Further, continuous research is giving rise to new approaches

to management.
3- Standardisation: ABFM MODULE - A
It is very important to use the industry standards as Chapter 1: Basics of Management (PART-VI)
benchmarks for comparison with competitors and for
evaluating your own performance. What we will study?
Comparison of your own performance with your competitors, *What is learning Organisation?
especially those who perform similar functions or processes
more effectively and efficiently, can certainly help improve on
the organisation’s functions or processes.
4- Continuous Monitoring:
There should be continuous thrust on monitoring and
changing for the better, so as to achieve improvement in all
the areas of an organization.
Deming, Juran and Crosby were three main contributors to

the Total Quality Management approach.
William Edwards Deming considered the quality of people
more important than the quality of products and accorded
greater importance to how efficiently the management
planned, implemented and improved the projects.
Learning Organisation: aspiration is set free, and where people are continually
learning to see the whole together.’
The present-day organisations face continuous environmental
and technological changes. Learning Organisations was introduced in the 90’s and was
seen as a new concept which advocated the adaptive and
An organisation cannot survive if it does not adapt itself to the
generative learning, with thrust on out of the box thinking and
dynamic competitive environment, which continues to be the
finding the best solutions to problems jointly with other
biggest challenge faced by any organisation, which wants to
employees.
grow.
A learning organisation may be defined as an organisation
where all the employees take part in identifying and solving The five disciplines of a learning organisation are:
the problems which it faces, and which permits the
1- Personal Mastery:
organisation to continuously enhance its capacity to grow and
learn, so as to achieve the organisational goals. This is considered as the cornerstone of a learning
organisation which involves developing a capacity to achieve
Thus, a learning organisation shall be organised from the
personal goals by creating an environment conducive to the
angle of problem-solving and not from the perspective of
growth of an employee’s personal vision, which further leads
efficiency and shall have a structure which is based on
to a shared vision.
teamwork, employees who are empowered and shall have an
open information system. 2- Shared vision:
The major contributor to this school of thought, Peter Senge, This can be made possible when you trust people and
has defined Learning Organisations in his book,The Fifth collaborate, instead of only complying instructions of higher-
Discipline: The Art & Practice of Learning Organization as ups.
‘organizations where people continually expand their capacity Business Leaders work together with employees to achieve a
to create the results, they truly desire, where new and joint vision.
expansive patterns of thinking are nurtured, where collective
They create an environment where employees feel that they 5- Systems Thinking:
are participating in the growth of the organisation and where
The idea of ‘systems thinking’ envisages that everything is
management encourages employees to take risk.
interrelated and interconnected.
We cannot act as a disjointed set of personal silos.
3- Mental Models:
We need to look at the whole picture and understand how
A mental model assists us in developing our understanding each part is connected.
about the impact of the assumptions and generalisations,
In his book, The Fifth Discipline, Senge has stated that
deeply ingrained in our minds, on our interactions with people,
and the decisions taken by us. “Systems thinking is a sensibility—for the subtle
interconnectedness that gives living systems their unique
To quote Senge:
character.”
“Understanding the difference between hearing what
A learning organisation is important because:
someone said, and truly understanding what they said, and
understanding the gap between what happened and what we a) It always tries to find improved and innovative ways of
perceived happening, requires reflection. In a non-reflective doing things and staying ahead of the competition.
environment, we take what we see as truth.” b) The effectiveness and efficiency of a learning organisation
is very high.
4- Team learning: c) A learning organisation has higher productivity and output.
According to Senge, humility is the very basis of team learning. d) A learning organisation helps in enhancing the image of the
company.
The Team members have to be ever willing to reflect and
consider views of other people and should always be
prepared to forget their personal biases for creating a
collaborative work environment.
ABFM MODULE - A INTRODUCTION TO STRATEGIC MANAGEMENT:
Chapter 1: Basics of Management (PART-VII) Introduction:
What we will study? Banking industry is the backbone of the financial sector.
The Indian Banking industry has witnessed several stages of
*What is Strategic Management?
growth over time.
The growth has been exponential since nationalization of
banks, liberalization of the Indian economy in the early 1990’s
and the entry of Private Sector Banks.
The private sector banks, from the beginning, had adopted a
technology driven model and have been quite aggressive.
Due to this, over time, the monopolistic hold of the public
sector banks in the financial space underwent some changes.
This is borne out by the fact that the share of Public Sector
Banks (PSBs) in total advances, as well as in deposits, has been
declining since 2010-11, while Private Sector Banks have been
improving their share.
In 2020-21, PSBs constituted 59.9% of the total assets of
Scheduled Commercial Banks (SCBs).
Private Sector Banks 32.8%, Foreign Banks 6.5%, and Small
Finance Banks 0.8% of the total assets of the SCBs.
The growth of the banking industry has been driven by A study of the definitions given above shows that a strategy
different strategies adopted by them, based on existing and combines explicit statements and implicit beliefs and
emerging situations. understandings in and around an organization about:
Strategic Management has been, is and will continue to be a Mission:
key driver for shaping banking operations.
Its core purpose (mission) and how, if at all, its mission will (or
Strategic Management Defined: must) change in future.
“Strategic management is defined as the process by which a Example SBI: Committed to providing simple, responsive, and
firm manages the formulation and implementation of its innovative financial solutions.
strategy” (Carpenter, M. A., & Sanders, W. G. ).
Vision: An image of its future direction and what it intends to
The word strategy comes from the Greek word, strategus, achieve.
meaning the “General’s views”.
Example SBI: Be the Bank of choice for a transforming India.
Strategy is the pattern of decisions in a company that
Clientele:
determines or reveals its objectives, purposes or goals and
plans for achieving those goals, and defines the range of Its scope, meaning, thereby, its main clientele(customer) now
business the company is to pursue, the kind of economic and and those in the future (and consequently the potential
human organization it is or intends to be, and the nature of clienteles that are and will remain outside its scope).
the economic and noneconomic contribution it intends to
make to its shareholders, employees, customers, and
Resources:
communities.
The resources and competences that create value for its
This definition links strategy to such activities as setting
clientele and how these will (or must) change to maintain and
objectives, determining policies, and the formation of action
enhance the future value created.
plans.
Present and Future: The various elements of strategic management include
scanning of the external and internal environment,
The foundations of its present competitive standing and
formulation of long-term strategic plans, implementation of
future sustainability.
strategy and the evaluation and control process.
Hambrick and Fredrickson define strategy as “the central,
Difference between Plan and Strategy:
integrated, externally oriented concept of how a firm will
achieve its objectives.” Quite often, the words “plan” and “strategy” are used
interchangeably.
A strategy, then, encompasses the pattern of organizational
actions that have been taken and those that are to be taken However, there are significant differences between these
by an organization, in pursuing its objectives. terms.
Strategy outlines the means by which a firm intends to create A plan is an arrangement, a pattern, a programme, or a
unique value for customers and other important stakeholders. scheme for a definite purpose.
Alfred Chandler Jr. suggests strategy as: A plan is very concrete in nature and does not allow for
deviation.
“The determination of the basic long-term goals and
objectives of an enterprise, and the adoption of the courses of If “Plan A” doesn’t work, you don’t alter “Plan A” and try
action and the allocation of resources necessary for carrying again.
out these goals”.
Rather, you move to “Plan B” which may be totally different.
Porter relates strategy to the success of a company “obtaining
A plan is most useful when staying well organized and on-
a competitive position or series of competitive position that
track is the highest priority.
lead to superior and sustainable financial performance”.
A strategy, on the other hand, is a blueprint, layout, design, or
To conclude, we may say that Strategic Management involves
idea used to accomplish a specific goal.
those decisions and actions of the management that
determine the long-term performance of a business entity.
A strategy is very flexible and open for adaptation and change increasing the assets under its management and its net profits
when needed. in 2021, without making a major change in strategy.
Strategy is most useful when creativity, collaboration, and The Management gave importance to investment and risk
innovation are of the utmost importance. management and decided to increase its presence by opening
new branches and by having a robust marketing strategy,
A strategy encourages openness and debate from every side
increasing use of technology, and improving performance of
of the equation.
funds managed by the company.
A strategy embraces questions and out-of-the-box, effective
A typical business entity normally considers three different
answers.
types of strategies, as under:
A strategy allows for a natural flow of thought and continual
a) Corporate strategy of a company covers the overall
momentum that builds, till success is reached.
direction followed by the company.
Strategies:
It would spell out the general attitude of the company
The strategy followed by a business entity can be equated towards growing and managing its different business lines,
with a master plan, which contains details as to how the products and services.
mission and business goals of the entity shall be achieved.
A corporate strategy may be classified under the three
The purpose of the strategy of the organization is maximizing different categories of stability, growth, and retrenchment.
the competitive advantages and, at the same time, minimizing
TCS, for example, followed a corporate strategy of
the competitive disadvantages.
retrenchment by selling its marginally profitable Tata EX
For example, even though SBI Funds Management Limited, Accounting Software business and concentrating on its highly
the Asset Management Company for SBI Mutual Fund, was a successful consultancy business.
major competitor in mutual fund business, it was not likely to
achieve its challenging objective of achieving the number one
position in the Indian Mutual Fund Industry, by significantly
b) Business strategy would normally be prepared at the level For example, the functions of research and development and
of the business unit or at the level of product or service. technology may turn out to be the prime contributors to the
functional strategy.
It normally highlights the improvement in the specific industry
or market ranking of the business entity’s products or services Certain companies do not spend much on research and grow
produced or delivered by that business unit. just by imitating and improving the products launched by their
competitors.
A business strategy could be competitive or cooperatives.
Another example is the marketing function.
Under a competitive strategy, a company might try to
differentiate its services whereas, a company following a Demand may be created by spending huge amounts on
cooperative strategy may form an alliance with other advertising and creating awareness about the distinct
companies to extend its reach to global markets and get a advantage of using the advertised products.
competitive advantage.
In practice, a business entity may use all the three types of
For instance, Intel, which manufactures computer strategies at the same time.
microprocessors, has allied with Microsoft to differentiate
itself from AMD, its main competitor.
c) Functional strategy refers to the approach adopted by

functional areas for achieving the objectives of the business
unit and the company by maximizing the productivity of
available resources.
It involves the development and fostering a distinctive
capability to create a competitive advantage.
ABFM MODULE - A Elements of Strategic Management:
Chapter 1: Basics of Management (PART-VIII) Strategic management has the following four basic elements:
What we will study?

*What are the Elements of Strategic Management?
1. The Context (Environmental Scanning):

This refers to monitoring, evaluation and dissemination of
information received from the internal and external
environments.
The information is provided to the key people in the
organisation with the overall objective of identifying both
internal as well as external strategic factors, which can impact
the future of the organisation.
SWOT Analysis is one of the easiest ways of conducting
environment scanning.
The acronym SWOT refers the Strengths(S), Weaknesses(W),
Opportunities(O), and Threats(T).
Strengths and Weaknesses form part of the internal strategic objectives to reach there, and generate, evaluate
environment of an organisation and could cover the and select corporate, business and functional strategies to
organisation structure, the resources available to an pursue.
organisation and the overall organisational culture.
Creating vision is the essential act of leadership.
The core competencies of an organisation depend on its
The vision must relate to the expectations of its customers,
strengths.
while being grand enough and imaginative enough to fuel the
The internal environment can usually be controlled by the top employees’ spirit.
management in the short run.
The vision gives the organization its energy. The vision usually
The Opportunities and Threats form part of external factors requires a “leap of faith” and an “act of courage”.
and are generally outside the ambit of the top management’s
A vision is an optimistic, inspiring picture that brings with it
short-term control.
the responsibility to make it happen.
These factors could be general, as well as specific factors.
A vision is a dream of greatness!
The general factors generally impact the entire economy or an
Vision is a simple statement or understanding of what the
industry whereas the specific factors might impact a specific
firm will be in the future.
industry or an organisation.
A vision is forward looking and identifies the desired long-
The internal and external environmental factors form the
term status.
context within which an organisation exists.
A vision statement should answer the basic question,
“What do we want to become?”
2. The Strategy Formulation:
A clear vision provides the foundation for developing a
Strategy formulation requires, on the basis of information
comprehensive mission statement.
gathered from situation analysis, to set strategic direction
through business mission and vision statements, and establish
Many organizations have both a vision and a mission 3. Strategy Implementation:
statement, but the vision statement should be established
Successful strategies are dependent on effective
first and foremost.
implementation.
Ideally, vision statement should be short, preferably one
Strategy implementation is the fine art of detailing: what all is
sentence, and as many managers as possible should
to be done, when various tasks are to be performed, where
contribute to developing the statement.
are they to be performed, how they are to be performed and
The mission statement is usually depicted as the starting point who will perform.
in the strategic planning process.
Strategy implementation is the process of executing the
The mission statement spells out the underlying motivation strategy of taking the actions that put the strategy into effect
for being in business in the first place - the contribution to and ensure that organizational decisions are consistent with it.
society that the firm aspires to make.
While strategy formulation is the process of deciding what to
A mission statement is called a statement of purpose, a do, strategy implementation is the process of performing all
statement of philosophy, a statement of beliefs, a statement the activities necessary to do what has been formulated.
of business principles, or a statement “defining our business,”.
A mission statement reveals what an organization wants to be
4. Strategy Evaluation and Control:
and whom it wants to serve.
Strategy evaluation is a logical step to obtain feedback from
Organizational mission statements should include ten
strategy’s performance and taking corrective actions, if
components:
needed, in the light of constant external and internal changes.
customers, products or services, markets, technology, concern
Strategy evaluation is needed because success today does not
for survival, growth and profitability, philosophy, self-concept,
guarantee success tomorrow.
concern for public image, and concern for employees.
Chapter 2: PLANNING (PART-I) We are involved in various activities in our life, some of which
are routine activities but some are such that their results have
What we will study? important bearing on us.
*What is Planning? Such activities are often not carried out it a casual way but in
a carefully decided manner.
In other words, we may say that we have planned these
activities.
If an activity is well planned, the probability of achieving the
desired results increases.
In business organisations also, the important activities are
well planned to increase the likelihood of achieving the set
goals.
FUNDAMENTALS OF PLANNING:
Planning is the process of engaging in thoughtful discussion
before undertaking a task, which entails engaging in in-depth
contemplation about that task and going into all the details
meticulously to be ready with an execution and
implementation plan, to save both effort and time.
Planning involves doing an objective analysis of future
requirements, to facilitate the modification of ongoing
activities considering the objective that has been set.
It involves research that is done deliberately and consciously STEPS IN PLANNING:
to formulate the design and the orderly series of actions,
The process of planning consists of the following steps:
through which it is anticipated to succeed in accomplishing
goals. 1. Opportunity Analysis:
During the planning, each possibility, both present and future, Opportunity analysis entails analysing the opportunity, being
that is even remotely connected to the goals, will be taken aware of the opportunity, and basing the development of the
into consideration. business plans on this opportunity.
The planning process also incorporates consideration of every This exercise also involves comprehending the existing
conceivable risk, including losses, defections, and so on. circumstances of the available opportunity and having a
general understanding of its future prospects.
It engages deeply in various activities to give directions,
prescribe methods, evolve procedures, and transform 2. Objective Establishment:
activities, to decide to accomplish the business goals in an Without knowing the objective, it is impossible to develop a
efficient and effective manner. strategy for its accomplishment.
The process of planning is based not only on the finances, Objectives are, therefore, the initial step in the
time frame, infrastructure, and resources, but also since planningprocess, which is typically a political endeavour.
decisions and particular or directional plans, which might be
3. Developing Planning Premises:
strategical, tactical, or operational, are made based on those
considerations. The collection of future forecasting-derived assumptions is
known as the planning premises determination.
Planning covers
The predicting must be based on a realistic assessment of the
environment in which the plans are to be executed, as well as
• What is to be done?
a creative understanding of the surroundings.
• Where it is to be done?
• How it is to be done?
• When it is to be done?
• Who will execute?

The premises must be constantly monitored and upgraded. When comparing the various approaches, the use of statistical
The premises cover the following areas: methods and computers proves to be extremely beneficial.
i. Forecasting One of the processes might be less desirable or effective
ii. Basic Policies compared to the others, while another might be more suited
iii. Existing Plans. to the immediate goal.
It’s possible that one of the processes would be very
4. Alternatives Identification: profitable, but the other would be extremely expensive.
The process of determining the availability of various means 6. Selecting the Best Alternative:
to attain goals is referred to as “identifying alternative At this stage, the plan is to be adopted, and the numerous
means.” options are to be evaluated, so that it can be determined
It is essential to make a written record of the total number of which plan can best assist in the accomplishment of the
alternatives available, that should initially be narrowed down business objectives.
to the most enticing and satisfying options, through a The stage is called “selecting the best alternative.”
preliminary examination, based on one’s trials, experiences,
and study. At this juncture, the question that must be resolved is
whether the initial plan is superior or whether the alternate
5. Evaluating Alternatives: strategy is going to be effective.
Following the discovery of additional methods and an 7. Formulating Derivative Plan:
examination of both their strong and weak points, the planner
should assess the alternative methods. The time required to formulate derivative plans, i.e., sub plans
or secondary plans, includes the time needed to implement
Because there is such a wide variety of options and a wide the plan in accordance with the decision, which would
range of possible outcomes, this task is not an easy one. comprise the procedures below:
• Development of the new policies and procedures ABFM MODULE - A
• Coordination of the activities of the derivative plans
Chapter 2: PLANNING (PART-II)
• Working in accordance with the targets of the main plan
What we will study?
8. Follow-up and Reviewing the Plan:
*What are the importance of planning?
Planning is a continuous process for ensuring attainment of
*What are the advantage and disadvantage of planning?
business objectives.
It is very important for a business entity to continuously
monitor the implementation of the plans and keep adjusting
and amending the plans as required.
Planning is, in its most fundamental sense, the administration
of all the functions associated to the work on which you spend
your valuable time, engaging in in-depth deliberation.
IMPORTANCE OF PLANNING: Provides Direction:
The clear objective of the plan is to provide the directions
where efforts should be channeled in as efficient manner as
possible, to achieve the desired results.
The objectives of the organizations are defined in
unpretentious and clear terms while communicating the
established plan.
Tackles Uncertainty:
The planning process makes predictions with the help of
existing information.
Planning is one of the most important pillars of management If it anticipates some risk or the possibilities of the losses in
and helps an organisation to achieve its laid down objectives. future, then it avoids the risk and creates another path to
attain the anticipated goals.
The following points highlight the importance of planning:
Discards overlapping and wasteful activities:
Helps Goal Creation:
As already discussed, the purpose of the planning is to
Planning involves the process of the achieving actual goals execute the future tasks in as efficient manner as possible.
and so it makes business goal oriented.
So, the questions - what, how, why, where, when are
The fact that everyone clearly knows about his/her goals, addressed in advance and the chaos, which might occur at a
helps the achievement of goals in an effective manner. later stage, is taken care of.
Thus, planning becomes the very basis of all other Best decision-making planning always helps to prevent the
management functions. unwanted risk and overlapping and helps avoiding duplication
of efforts and wastage of resources.
Promotes Innovative Ideas: A SMART goal is a carefully planned, clear and track able
objective.
In today’s world, markets are becoming more and more
dynamic every day. SMART is an acronym that stands for Specific, Measurable,
Achievable, Realistic, and Timely.
As such, out-of-the-box ideas are needed for managing the
operations of the enterprise, to beat the competition.
Decision Making Facilitation: ADVANTAGES AND DISADVANTAGES OF PLANNING:
Planning is a vital part in the decision-making process. In today’s dynamic world, short-term planning may not be
enough for any organisation, aspiring for growth.
It acts as a guide for efficient and valid decision making,
whenever a manager must take a decision. Arbitrary actions rarely result in progress.
With the help of planning, a manager can give a deep thought An organisation which does not plan properly and
to all processes and predict the future scope. scientifically, would be vulnerable to the ever-changing
environment.
Controlling:
Effective planning, therefore, helps an organisation to face
To facilitate the functions of coordination and control,
such situations in an efficacious manner.
planning plays a vital role.
Advantages of Planning:
The extension of the planning process is considered as control,
due to the interdependence of the controlling on the plan and The main advantages of planning are as follows:
vice-versa.
Coordination of Various Activities:
Without a concrete objective build upon a plan, a business will
The coordination of efforts of various functionaries and
not be able to investigate where it went wrong and will not be
departments of a business entity to achieve the goals, set out
able to take the right action and endorse its success.
in the plan, is facilitated by planning.
When actions are planned with specific results in mind and The milestones serve as a reference point for determining
centred on those plans, the level of success experienced by whether things are moving as planned and, if not, when
such actions considerably increases. adjustments are necessary.
Optimization of Resources:
Planning enables managers to determine which activities have Basic advantages of the planning process:
the maximum demand for resources, and further helps them
a) Planning reduces uncertainty.
in the optimum allocation of these resources to the areas that b) Planning is focused on objectives.
will provide the maximum possible return on investment. c) Planning facilitates control.
Inspirations and Responsibilities: d) Planning encourages creativity and innovation.
e) Planning anticipates problems and copes with change.
People are unable to reach a consensus when they do not f) Planning limits vulnerabilities.
have well-defined goals for themselves and do not have a g) Planning works with co-appointment.
concept of what is commonly expected of them. h) Planning works on worker’s moral.
Planning lessens the likelihood of risk and outlines the i) Planning helps in accomplishing economies.
accomplishments that are commonly anticipated of everyone. j) Planning works with controlling.
k) Planning gives the upper hand to the managers.
Individuals are compelled to work for a goal that they are l) Planning empowers development.
familiar with and can comprehend and relate to.
Disadvantages of Planning:
Establishment of Execution Principles:
There is not an iota of doubt that planning is beneficial to an
The planning process is distinguished by milestone positions, organisation but planning also has the potential to be
which are used to mark progress along the way to the detrimental to an organisation if it is not carried out as
intended result. intended.
Some of disadvantages of planning are as under:
Forestalls Activity: what, even if their experience demonstrates that the
arrangement is not working.
It is possible that managers will become so immersed in the
process of planning and getting ready for every possibility, They will continue to devote their time and resources to
that they won’t have time to put their plans into action. activities that are not adequate rather than bringing issues to
the attention of higher heads so that changes can be made.
It is sometimes referred to as “death by plan.”
Hinders Innovativeness:
Lack of Concern:
People working for the organisation may get the impression
If an Organisation has solid systems in place, its managers
that they are required to carry out the activities outlined in
may be led to believe that they are aware of the path the
the plans because only that is expected of them and, how well
Organisation will take and how it will accomplish its objectives.
they complete the systematic tasks assigned to them is what
Because of this, it is possible that they won’t be able to matters.
monitor the system’s progress or recognise shifts in the
They might be prevented from engaging in invention, drive,
external circumstances.
and learning via trial and error.
Planning is not a one-and-done kind of process, as was
Achieving goals requires not just careful planning but also
established earlier in our discussions.
consistent progress, and the planning process in any
Plans ought to be subject to continuous modification, as they organisation, if not executed well, might stifle creative
are carried out in the real world. thoughts.
Forestalls Adaptability: Basic Disadvantages of the planning process:
Even though well-laid plans have the potential to encourage a) The process of planning takes a significant amount of time.
adaptability, sometimes the opposite occurs.
b) The planning process may result in lack of trustworthy data.
Middle and lower-level supervisors may have the mentality
c) The process of planning could end up being very expensive.
that they are required to stick to an arrangement no matter
d) The act of planning results in rigidity. ABFM MODULE - A
e) Planning is an exercise in fighting against change as the Chapter 2: PLANNING (PART-III)
environment in which an organisation operates is ever-
changing and dynamic. What we will study?
f) Planning could give a false impression of the organisation’s *What is Management by Objective (MBO)?
strength.
g) The plan may be adapted to fit the interests of individual
participants rather than the goals of the overall endeavour.
h) Inter-departmental rivalries may impact the effectiveness
of planning.
i) Human errors can result in bad planning.
j) Problems associated with under or over fixation of targets
could always crop up.
k) An erroneous impression, that everything is well, might be
created giving a false sense of security to the management.
l) A rapidly changing environment may make planning harder.
m) A manager’s daily work schedule may be affected by his
involvement in planning process.
MANAGEMENT BY OBJECTIVES: Establish goals and desired outcomes for each
subordinate in a conference between the management
The phrase “management by objective” (MOB) was coined by and the concerned subordinate.
Peter F. Ducker and first appeared in his book “The Practice of
Set performance standards.
Management,” which was published in 1954.
MBO Assess performance achieved against goals set for the
Management by Objectives is the term given to the process
process: employee through frequent performance review
that is used for goal planning and the establishment of clear meetings between the manager and the subordinate.
parameters for those goals (MBO).
Identify reasons for shortfall and give feed-back for
The MBO technique, in its most fundamental form, refers to a improvement.
procedure that involves the management and the employees
Establish new goals and new strategies for the coming
working together to jointly establish, record, and then year.
monitor the goals for a particular period of time.
Although it is a theoretical framework for management, it has
recently been fashionable due to the necessity for Key Concepts of Management by Objectives:
management consultants to base their work on the need to Planning is the central idea behind the ‘Management by
manage a business and the goals of that business. Objectives’ and it implies that an Organisation and the people,
The goals of MBO are adapted to match the requirements of who make up that Organisation, aren’t just responding to
today’s organisations, which are expanding their work spaces incidents and issues; rather, they are being pro-active and are
to accommodate their expanding workforces. taking preventative measures.
Employees are allowed to define measurable personal goals in
accordance with the corporate goal, to fulfil the criteria of
‘Management by Objectives’.
Example: Management by Objective in Practice:
The Housing Division of an Infrastructure Company might The five steps that make up the management by objectives
assign the Civil Engineering Sub-Division, headed by a Chief technique are as follows:
Engineer, with the target of completing the infrastructure of a
i. The first thing to do is either establish or alter the
housing project within the next twelve months.
organisational goals for the whole company.
The individual goals in this case must align with the
The company’s mission and vision should serve as the basis
organizational goal of accomplishing the subdivision’s targets
for developing this comprehensive overview.
and need to be coordinated to work with the overall
organizational goals which are managed and supervised by ii. The second step is to communicate to employees the goals
the process called Management by Objectives. and priorities of the organisation.
An individual personal goal is a piece of a puzzle that needs to In 1981, George T. Doran used the acronym SMART to express
be fitted with the other pieces of the puzzle to make it a the concept.
complete puzzle, which is the organisational goal. This acronym stands for “specific, measurable, acceptable,
Managers need to sit down to write down their goals realistic, and time bound”.
periodically and should continue to monitor the goals closely iii. The third step is to encourage participation from the staff
to track progress. members in the process of setting individual goals.
This is also important because, in modern-day organisations, After sharing the goals of the organisation with the employees
achievement of goals is normally linked with performance from the top down, the employees should be encouraged to
incentives and rewards. help them set their own goals to achieve the larger
organization’s goals.
This will help ensure that the goals of the organisation are
met.
Because of this, the employees have greater empowerment, c) As a potential driver of success, managers will frequently
which increases their level of motivation. place a greater emphasis on goal setting than they will on
issues pertaining to operations.
iv. The monitoring of the progress made by the staff members
is the focus of the fourth step. d) The MBO approach does not place a strong emphasis on
the significance of the environment in which objectives are
We have to determine how well we have met the managers’
formulated.
and employees’ needs by measuring the performance of both
groups; which is one of the most important parts and a key The context encompasses everything from the availability of
component of management by objective. resources and their efficiency to the buy-in associated with
the leadership and the stakeholders.
V. The fifth step is to evaluate and then reward the progress
that employees have made. e) As a final point to consider, many managers have the habit
of viewing management by objectives as a comprehensive
This step is based on the honest feedback given by each
system that, once implemented, can address any and all
worker regarding what was accomplished and what was not
management concerns.
accomplished.
Overdependence can bring problems into the MBO system
Limitations of Management by Objectives:
that the system is not prepared to deal with, and it
a) The management by objectives approach frequently discourages any potential positive impact that could be made
disregards the culture of the organisation as it exists today as on the issues that the system is supposed to deal with.
well as its working conditions.
Advantages of MBO:
b) Goals and targets receive a greater amount of attention.
a) It provides a means for determining one’s goals and
When managers forget about participation, employees’ planning to achieve those goals.
willingness to contribute, and the value of MBOs for
If you don’t have a clear idea of what you want to accomplish,
management’s professional growth, they put constant
you won’t ever be able to get there.
pressure on workers to achieve their objectives.
b) Planning enables one to behave in a proactive manner and Disadvantages of MBO:
to approach the accomplishment of goals in a disciplined
a) The process of setting goals can be time-consuming, which
manner.
means that both the managers and the employees have less
c) It also gives you the ability to plan for unforeseen time to get their actual work done.
circumstances and limitations that could make planning more
b) The MBO programme requires elaborate written goals,
difficult.
careful communication of goals, and detailed performance
The reason why goals are measurable is that they can be appraisals, all of which contribute to an increase in the
evaluated and modified in an easy manner. amount of paperwork an organisation generates.
d) The process of MBOs also enables the preparation of c) To achieve success, it is necessary for all of the employees
contingency plans and strategies for overcoming roadblocks, to work together.
which may be obstacles to the plan.
d) Goals can become out of date and put a damper on
e) Objectives should be measurable so that progress can be employees’ ability to take initiative and be creative.
monitored and altered as necessary.
e) Too much multi-tasking can result in inefficiencies.
If goals are effectively set, managed, and accomplished,
f) The inability of the subordinate to feel at ease.
organisations have the potential to improve their overall
efficiency, thereby conserving resources and boosting g) Inflexibility.
employee morale. h) It might make the workers’ lives more difficult and
f) A more effective use of the available resources frustrating.
g) An emphasis on the most important aspects of the results. i) MBO is an approach based on rewards and sanctions.
j) MBO, sometimes, might lack appreciation by the employees
and workers.
ABFM MODULE - A PLAN COMPONENTS:
Chapter 2: PLANNING (PART-IV) For an organisation to achieve the goals, Planning is essential.
What we will study? The key components of Planning include:

i. Objectives/ Goals.
*What are the plan components?
ii. Policies/ Overviews.
*What is environmental Analysis?
iii. Procedures/ Directions/ Rules.
*What is PESTLE analysis?
iv. Programs/ Methods.
v. Budgets/Funding.
vi. Time Schedule.
vii. Core values/ Mission/ Vision.
viii. SWOT Analysis.
ix. Management.
Environmental Analysis:
“Environmental Analysis” refers to the process of examining
all of the factors, both internal and external, that have an
impact on the performance of the organisation.
This can be done both systematically and qualitatively.
The opportunity and the threats, that are external to the f) Helps recognition of potential dangers and potential
organisation, are portrayed by the external components, benefits.
whereas the strength and the vulnerability of the business
entity are shown by the internal components.
Environmental Analysis Steps:
The information gathered from conducting an environmental
analysis is what strategic planners use when trying to make i. Identifying.
predictions about future trends. ii. Scanning.
The information can also be utilised to conduct an operational iii. Analysing.
environment analysis and to establish organisational goals.
iv. Forecasting.
The results of environmental analysis can be used to evaluate
PESTLE Analysis:
the state of the Organisation at the present time as well as to
make projections about the future. It is an indispensable resource for the development of
business strategies and plans.
Advantages of the Environmental Analysis:
It is a method for evaluating the business environment and
a) Contributes to the accomplishment of goals.
the potential impact that it could have on the performance of
b) Identifies and analyses potential dangers. the organization.
c) Helps understand the developments in the commercial The acronym PESTLE refers to the following six internal factors
environment. that can have an impact on your company:
d) Creates awareness of impending dangers of every a) Political. (P)
prospective opportunity.
b) Economic. (E)
e) Makes predictions about the future.
c) Social. (S)
d) Technological. (T)
e) Legal. (L) Advantages of PESTLE analysis:
f) Environmental. (E) a) Cost effectiveness.
b) Easy framework.
c) Deep understanding.
d) Development alertness.
e) Opportunities exploitation.
Political Factors:
Political factors reflect such elements as the stability in the
These factors have a significant and profound impact on
political environment.
business, and may also have varied implications on the
business over a brief or an extended period of time. This is especially critical for companies entering new markets.
These factors may also impact changes, both positive and The banking sector looks all powerful — but it’s susceptible to
negative, as well as any others and might also result in a bigger giant i.e., the government.
positive or negative changes in credit ratings.
Government laws affect the state of the banking sector.
The government can intervene in the matters of banking
PESTEL analysis involves three steps: whenever they want to, leaving the industry susceptible to
political influence.
1. Identify the relevance of each of the PESTEL factors to the
firm. This includes corruption amongst political parties, or specific
legislative laws such as labour laws, trade restrictions, tariffs,
2. Identify and categorize the information for each factor.
and political stability.
3. Analyze the data and draw conclusions.
Economic Factors: Consumers seek information from bank staff regarding saving
accounts, bank related credit cards, investments, and more.
Economic factors have a direct impact on the potential
attractiveness of various strategies. Consumers desire a seamless banking experience.
For example, if interest rates rise, then funds needed for And technology is developing to allow consumers to buy
capital expansion become costlier or unavailable. products easier, without requiring assistance directly from
banks.
Macroeconomic factors will have short and long-term effects
on the success of their strategies. Technological Factors:
Economic factors include inflation rates, interest rates, tariffs, Technological forces play a key role.
growth rates of the local and foreign economies, exchange
The Internet is changing the very nature of opportunities and
rates, unemployment, and availability of critical labour.
threats by altering the life cycles of products, increasing the
The banking industry and the economy are closely tied. speed of distribution, creating new products and services,
erasing reach of traditional geographic markets.
Socio-cultural Factors:
Technology may lower production costs and/or improve
The socio-cultural factors vary from country to country.
quality; create product and service innovations; reduce
These may include local languages, dominant religions, leisure communication costs and increase remote working; and alter
time, age, lifespan demographics, attitudes toward distribution.
consumerism, environmentalism, and the roles of men and
In short, these factors may change the face of the business
women.
landscape.
Cultural influences, such as buying behaviours and necessities,
Environmental Factors: Environmental factors now go beyond
affect how people see and use banking options.
access to raw materials.
People turn to banks for advice and assistance for loans
Today these factors may include the firm’s footprint on its
related to business, home, and education.
respective environments.
With the use of technology — particularly with mobile ABFM MODULE - A
banking apps — the use for paper is being reduced.
Chapter 2: PLANNING (PART-V)
Additionally, the need to drive directly to a branch to handle
affairs is minimized as well. What we will study?
Many issues are taken care of through mobile apps and online *What is internal environment analysis?
banking services. *What are the tools available for internal environment
Consumers can apply for credit cards online, buy gift cheques analysis?
and gift cards online, and have many of their banking
*What is SWOT analysis?
questions answered online or on phone by chatbots.
All these measures help in reducing individual environmental
footprints.
Legal Factors:
Legal factors reflect the laws and regulations relevant to the
region and the organization.
These factors include whether or not the rule of law is well-
established, how they change, and the costs of regulatory
compliance.
The banking industry follows strict laws regarding privacy,
consumers and trade.
Internal Environment Analysis: An internal environment analysis is a tool that allows for a
comprehensive review of all aspects of a company’s
The internal environment of a company can be classified into
operations, internal guidance, and mission.
the following broad categories, based on its resources and
assets: This review is done in order to identify opportunities and
threats.
a) Physical resources like plant and machinery, technology, etc.
This internal analysis, which is initiated by the management of
b) Financial resources.
the company, is an attempt to identify the areas of risk and
c) Distribution network. opportunity in the business.
d) Possession of strategic assets, such as access to raw An organization’s capabilities, resources, and competitive
material, locational advantage, regulatory protection, etc.; advantages are examined in depth as part of an internal
e) Network/contacts with outside organizations (suppliers, analysis, which reveals both the organization’s strengths and
customers, government, distributors, etc.); its weaknesses in these areas.
f) Intangibles, like brand equity, goodwill, reputation, etc.; After the project is finished, the organisation should have a
crystal clear idea of the areas in which it excels, the areas in
g) Human resources-profile, skill, managerial competencies;
which it is doing well, as well as the areas in which it currently
and organizational structure and administrative system,
lacks and has gaps.
culture and values, and employee motivation/relationship.
The analysis equips management with the knowledge
In the case of a bank, this would be in the form of its branch
necessary to make the most of the opportunities, strengths,
and IT infrastructure, availability of capital, strategic
and expertise offered by the organisation.
advantages like strength in a particular geographical region,
its brand equity and goodwill and, of course, the quality and This enables the management to develop strategies that
quantity of its human resources. mitigate threats and compensate for vulnerabilities and
drawbacks that have been identified.
You will be convinced that you are making effective and Strategy Evaluation:
efficient use of your resources, time, human capital, and focus
The process of analysing the outcomes brought about by the
if the business strategy is based on the actual findings rather
execution of a strategic plan is referred to as strategy
than on your imagination or assumptions.
evaluation.
There are many tools available to assist in making the decision
In the process of carrying out the evaluation, it is very useful
about which framework to use, and each tool has the
and helpful to check that everybody understands the business
potential to have its own value, as well as being the tool that
strategy and works well with it.
is most effective for a particular purpose.
SWOT Analysis:
Internal Analysis tools:
SWOT stand for
o Strengths
GAP Analysis:
o Weaknesses
The Gap Analysis is a tool for conducting assessments that
gives organisations the ability to analyse and identify internal o Opportunities
weaknesses as well as performance deficiencies. o Threats
It is easier to come up with a series of steps to bridge the gaps The SWOT analysis is a useful model for conducting
between the various scenarios when you have a tool that evaluations because it takes into account both internal and
helps you distinguish and comprehend the differences external factors simultaneously.
between them.
It is especially helpful to conduct a SWOT analysis to obtain a
It is very easy to understand and put into practice, and it is comprehensive overview of a company, its products, its brand,
helpful to compare the current position of the organisation to or a new project at any stage in the project life cycle.
its projected position in the future.
The SWOT diagram not only helps you think about all the Take a moment to reflect on your organization’s advantages
potential processes, opportunities, and threats that may have and give some serious thought to the opposite of the
an effect on the performance of your Organisation, but it also questions on the SWOT template.
gives you access to think about your organization’s eternal
strengths and weaknesses.
Opportunities:
Strengths:
The term “opportunity” refers to any factor that has the
Give yourself some time to reflect on what you did well, what
potential to confer competitive advantages to the
tasks that were within your comfort zone that was good, and
Organisation.
any instance in which you exceeded expectations or achieved
great outputs. Your capabilities have the potential to improve the situation,
which increases the likelihood that a favourable outcome will
This will help you recognise your strengths.
result from the situation.
Your strong points are your excellent areas; in other words,
You need to focus your attention on the more advantageous
you do something noticeably better than everyone else, and
opportunities that are available to you right away and give
as a result, people praise you for it.
them careful consideration.
Weaknesses:
These do not have to be game-changing in any way.
The next step is to determine the areas in which you need to
The competitiveness of your company can be improved by
improve.
even relatively minor benefits.
To do this, think about the things that are challenging for you
Threats:
to acquire; for example, when you must work hard to achieve
something that you want but you don’t feel confident about it. In terms of threats that are looming large over an
Organisation, one factor to consider is the potential for harm
that could be caused to the Organisation.
Threats can be thought of as either processes or activities that ABFM MODULE - A
have the potential to have a negative effect on an
Chapter 2: PLANNING (PART-VI)
Organisation.
You will need to overcome these obstacles to achieve your What we will study?
targets. *What is Contingency Planning?
*What is Forecasting?
CONTINGENCY PLANNING: Contingency planning is a response to risk faced by an
organisation, however, in certain circumstances, it may be
Contingency plans can be defined as alternative plans that can
safer or more cost-effective to deal with it in other ways and
be put into effect if certain key events do not occur as
to avoid risk, such as by investing in new equipment or to
expected.
share the risk by purchasing an insurance policy.
Regardless of a firm’s strategies being formulated,
Alternatively, one can choose not to formally plan for certain
implemented and evaluated, unforeseen events could make
low priorities risk but to manage the risk when it does occur.
the strategy unsuitable.
The COVID-19 epidemic illustrated how quickly entire
The contingency plan minimises the risk associated with such
organisations may change how they work, such as everybody
unforeseen unpredictable events.
working from home all of a sudden.
The contingency plans are referred to as “Plan B” because
Contingency Planning begins with the identification of both
they always work as an alternative course of action if things
beneficial and unfavourable events that could possibly derail a
do not go as planned.
strategy or strategies.
A contingency plan is also defined as an action of designing to
It involves the following:
assist the company in responding to an event that may or may
not occur. • Specifying trigger points.
The term “contingency planning” refers to more than • Estimating when contingent events are likely to occur.
preparing for major catastrophes and natural disasters.
• Assessing the impact of each contingent event.
It can also put you in a position where you are susceptible to
• Estimating the potential benefit or harm of each
more prevalent concerns, such as the loss of data, staff, clients,
contingent event.
or commercial relationships.
• Developing alternate plans.
• Being sure that the contingency plans are compatible Forecasting:
with current strategy and that they are financially
The process of predicting or estimating the future based on
feasible.
the evidence from the past and the present is referred to as
When you are formulating your backup plan, you need to forecasting.
keep this information in mind.
The scope of forecasts may be comprehensive or limited.
It is necessary for contingency planning to function properly in
*The process of forecasting gives knowledge about the
any workplace setting, whether there are people physically
possible occurrences of the future as well as the implications
present, people working remotely, or a combination of the
those events will have for the business.
two.
*It is not possible for forecasting to lessen the complexities
It is essential to ensure that the contingency plan is adequate
and unpredictability of the future. Having said so, it boosts the
for its intended use in order to reduce the risk of the
management’s confidence in their ability to make a decisive
company’s failure to continue operating in the event that essential decision.
unanticipated circumstances take place.
*Managers at different levels may be given the responsibility
The following points should be included for each potential risk:
of making forecasts, or external or internal economists and
a) Landscape. statisticians may be employed for the task.
b) Trigger. *Since forecasting makes use of a wide variety of methods,

another name for the discipline is statistical analysis.
c) An overview of the feedback.
Types of Forecasts:
d) Make people aware of it.
1. Long Term Forecasts:
e) Important responsibilities.
Forecasting for the long term typically covers a period of time
f) Timeline.
ranging from three to five years.
It gives an overarching perspective of the company’s 2. Medium Term Forecasts:
monetary requirements as well as the availability of the
For making relatively minor strategic decisions pertaining to
investable surplus in the foreseeable future.
the functioning of the firm, projections over the medium term
Advantages of long-term forecasting: are generated.
The following are some advantages of making long-term They play a crucial role in the operational budgeting as well as
forecasts: the business budgeting, and the budget of the firm is formed
based on these projections.
*Improved asset management.
3. Short Term Forecasts:
*Systematic leveraging and deleveraging.
The term “short term forecasting” refers to planning that is
*Multiplication of earnings through the maintenance of cash
done for a period that is relatively brief, with the planning
reserves.
period being less than one year and the duration ranging from
*Evaluation of variances in order to monitor performance. one to six months.
Disadvantages of long-term forecasting: Advantages of short-term forecasting:
The following are some of the drawbacks of making long-term The following are some advantages of making short-term
forecasts: forecasts:
*The unpredictable nature of the economy. a) Reduced need for both time and money to complete the
*The absence of historical knowledge. project.
*The deficiency of the appropriate range of technologies. b) Assessing the current state of the company’s finances.
*The limits imposed by silent data on excel. c) Conducting a performance scenario analysis in order to take
preventative action.
Disadvantages of short- term forecasting: It calls for analysing the internal and external factors and
discovering relations between them.
Short-term forecasting has the following disadvantages:
Knowing the trend of each of them is of great help in
a) The technology has a very high starting price tag due to its
forecasting.
complexity.
2. Estimating future Course of Business:
b) The payable account and the receiver account are both
quite difficult to understand. Having prepared the ground and structure on which to base
different estimates, the next step is to make rational forecasts.
c) Precision down to the granular level is required.
Those responsible for forecasting make use of statistical and
d) Late decision owing to limited collaboration.
other techniques while projecting future business.
Forecasting process and its elements:
The experience, clairvoyance and participation of
Different situations will have different steps and elements of management are important determinants of the quality of
forecasting process. forecasts.
However, some of the common steps in most of the situations 3. Analysis of Deviations in previous forecasts:
may be mentioned as under:
We should thoroughly analyse the major deviations from past
1. Identifying and Developing the Structure: predictions and find reasons for the same.
Factors affecting future events are so complex and It should be used to refine the existing procedure of
innumerable that it is neither feasible nor desirable to study forecasting to improve the quality of our present forecasts.
and discover all of them.
The manager and forecaster should, therefore, identify the
strategic factors that materially bear upon the forecasts in
hand.
ABFM MODULE - A Decision Making:
Chapter 2: PLANNING (PART-VII) Actual selection of one course of action, from among several
alternatives, is called decision-making.
What we will study?
Decision-making is considered to one of the most prominent
*All about Decision Making? functions of the management.
Decision-making is not confined to planning alone but also
embraces other aspects of management like organising,
staffing, controlling etc.
Because of several constraints faced by the organisation, the
management must consider several alternatives and choose
the one that is expected to be most appropriate for achieving
the goals.
Decision making is regarded as part of the planning process as
it involves selection from among various alternatives.
Decision-making is a rational process and, to have a high
degree of effectiveness, should be based on systematic
analysis of all the relevant facts and not based on just
intuition.
Decision making plays an important role in enhancing the
efficiency of the organisation as decisions relating to future
course of action, are taken in advance.
Hierarchy of Decision makers: Advantages of Group Decisions:
The importance of various decisions, required to be taken in Decision making by groups, generally, results in the following
an organisation, is not equal. advantages:
Generally, the top management concentrates on crucial and Thorough evaluation:
strategic decisions and formulating broad policies.
When a group is involved, the alternatives are evaluated more
Decisions, relating to routine matters are normally delegated thoroughly compared to that when individuals take decisions.
to middle and lower-level management.
This increases the probability of decisions being better and
This helps the organisation to decide on the kind of analysis practical.
and research required to arrive at a conclusion, depending on
Implemention of decisions is easier:
its importance.
As the feeling of involvement is more widespread, it is not
Decision Making by Groups:
taken as an imposed decision and so, implementation is easier.
Whenever a group of people makes decisions, the process
Enhanced team spirit:
becomes more comprehensive compared to the way decisions
are made by individuals. The members of an organization, which involves groups in
decision making, are better motivated and have a better
Whether a particular decision is to be made by an individual
sense of unity of purpose amongst them, as they make
or a group depends on the policy of the organisation and
decisions collectively.
thinking of top management.
Before the task is assigned to a group to decide on a particular
matter, the exact scope of the group’s authority to make that
decision should be clearly spelt out.
Disadvantages of Group Decisions: Various Conditions for Decision-Making:
Some of the disadvantages of group decisions may be as The conditions prevailing for decision making may be different
mentioned below: for different organisations.
Time consuming and costly: Even for the same organisation, the conditions may not
remain same all the time.
As many persons are involved and they have to consulted, the
process becomes time consuming and prompt decision is These situations may be classified broadly into three scenarios,
difficult to come by. as under:
Also, the cost involved in the process may be more as a Certainty:
number of meetings are to be held more and more data from
If the decision maker knows exactly what is going to happen,
different sources is be collected.
it is the condition of certainty, and he is able to precisely
Disagreements and indecisions: forecast the outcome.
Different persons in the group may have their own different However, such conditions can be rarely expected to exist, in
point of view, resulting in conflicts and blame-games. real business environment.
Unanimous decisions are difficult and sometimes, the group is Risk:
not able to take any decision.
When information is available only partially or it is insufficient
No-participation or domination: to estimate the outcome precisely, the decision is to be taken
under the conditions of risk.
Sometimes, one or more members in the group may shirk
their responsibility resulting in lack of contribution by them. In real life, managerial decisions are mostly made under risk
conditions.
Also, if one group member is of dominating nature, the views
of others do not get reflected in the result. As the outcome is not certain, a probability is assigned to each
estimated outcome.
When a probability estimate is assigned to expected outcome Principle of Definition:
based on the past experience, it is called objective probability,
Correct identification of issues involved goes a long way in
and if it is assigned on the basis of intuition, it is called
arriving at a better decision.
subjective probability.
It is, therefore, important to be aware of the exact problems.
Various methods can be used in assigning probabilities to
various expected outcomes. After the exact problems have been correctly identified and
defined, the work of the decision maker becomes easier.
Uncertainty:
When the decision maker feels that probabilities for various
estimated outcomes cannot be assigned, it is called the Principle of Evidence:
situation of uncertainty. Whenever a decision is based on evidence, it is likely to be
In such a situation, there is no way of measuring the better compared to decisions taken on the details which are
likelihood attached to each estimate. not backed by evidence.
Principles of Decision Making:

The effectiveness of the process of decision making mainly Principle of Identity:
relies on quality of data available, analytical, and judgmental In a decision-making process, it is important to consider, with
skills and experience of the decisionmakers. an open mind, the viewpoints of all the people involved,
However, there are a few principles which, if followed by the before taking a final decision.
decision makers, will be helpful in enhancing the probability
of the decision being correct.
These principles of decision making can be summarised as
under:
ABFM MODULE - A FUNDAMENTALS OF ORGANISING:
Chapter 3: ORGANISING (PART-I) Planning is the first step in the process of managing an
organisation, and the second step is organising, which is the
What we will study? function of management that comes after planning.
*All about the fundamentals of organising? Organising entails assigning tasks, grouping tasks into
departments, and assigning authority with adequate
responsibility, as well as allocating resources within an
organisation to achieve common goals.
Organising is the process of establishing or organising
effective authority relationships between selected tasks,
individuals, and workplaces to group work together in an
efficient manner, as well as the process of separating work
into sections and departments.
It is one of the most crucial functions of management.
If managerial planning is concerned with establishing what
tasks should be performed, then organising is concerned with
determining how those tasks should be performed.
As a result, the subsequent action that a manager must take
after establishing objectives and developing a strategy that is
feasible, is to organise individuals and teams to carry out the
plan.
In a nutshell, organising entails grouping activities and In conclusion, the design of an organisation needs to consider
resources in a way that makes sense. how individuals and groups make their decisions.
Classical closed systems and open systems are the two Steps in Organising:
primary classifications that can be used to classify various
1- Identification and division of work.
strategies for the division and coordination of work activities
as well as the distribution of resources. 2- Departmentalization.
Organising Capabilities Management is the capacity to 3- Assignment of duties.

develop systematic use of resources inside the system and 4- Establishing reporting relationship.
organising skills are very necessary for management.
The term “organisation” is used to describe the final product
IMPORTANCE OF ORGANISATION:
of the organising process.
The various departments of the organisation need to
Any manager needs to have a fundamental grasp of
communicate and coordinate with one another, and one of
organisation as it is an essential topic for comprehending the
the most significant ways to do this, is by organising.
inner workings of any firm or organisation in general, and it is
also a component of the fundamental knowledge that every Structured relationships connect all of the different functions
manager should have. and positions in the organisation.
The way labour is subdivided, and the way coordination is It outlines the channels and channels that can be used for
guaranteed between the various tasks and the persons communication between the various participants.
conducting them independently, are both referred to as the
The management is helped in many different ways by an all-
“design” of the organisation.
encompassing approach to organisation.
In addition, the design of organization's tries to consider the
Organising brings together a variety of resources to work
interdependencies that exist between the activities that
towards a shared goal.
people perform daily (also known as processes).
The most important factors considered in organising are as It enables the completion of the most work in the shortest
under: amount of time while maintaining the benefit of experience.
Efficiency in Administration: Promoting Effective Communication:
Efficiency in administration can be achieved by collapsing jobs Organising is an essential technique of fostering collaboration
that are comparable and linked into a single area of expertise, and communication among the many departments that make
which brings together formerly separate departments. up an organisation.
It leads to integration of efforts and coherence in the work by Structured relationships connect all of the different functions
establishing coordination among the various departments. and positions in the organisation.
An efficient administration describes the activities that It outlines the channels and channels that can be used for
distinct departments engage in and the authority connections communication between the various participants.
between those activities and the departments themselves
Creating Transparency:
inside the organisational structure.
The tasks, activities, duties and responsibilities that are
Resource Optimization:
expected of workers in each position are detailed in a written
Organising ensures that each worker in the organisation has a document known as the job description.
role and job that are a good fit for them.
This document specifies in great detail what is expected of
This helps to reduce misunderstanding and delays, as well as workers in each position.
duplication of labour and overlap of effort, both of which can
The personnel are assigned their appropriate levels of power
be avoided as a result of doing this.
and responsibility by the organisation.
Gaining Expertise:
This contributes to the organisation’s attainment of clarity
The process of creating groups and subdividing various and transparency.
activities and jobs based on the principle of the division of
labour is referred to as the division of labour process.
Expansion and Development: ABFM MODULE - A
When resources are utilised to their full potential and there is Chapter 3: ORGANISING (PART-II)
an appropriate division of labour between departments and
personnel, management is able to increase its strength and What we will study?
carry out a greater number of operations. *What are the five stages in orginising?
In such situations, it is easy for organisations to rise to the *All about organizing Process?
occasion and extend their operations in a methodical and
organised fashion.
STAGES IN ORGANISING PROCESS: An organisation is a whole that consists of integrated pieces
that work together in harmony to carry out duties in order to
There are five stages in the organising process, which are as
achieve goals in a manner that is both effective and efficient.
follows:
If an organising process successfully conducted, the end result
➢ Defining and reviewing the plans and objectives of the
should be a working atmosphere in which every member of
company.
the team is aware of their respective tasks.
➢ Determining the work activities needed to accomplish the
In the event that the process of organising is not managed
objectives.
well, the outcomes may cause confusion, frustration, a loss of
➢ Categorising and grouping essential work activities into efficiency, and a reduction in effective output.
manageable units.
The ability of a manager to organise the work of all of his or
➢ Assigning activities and delegating authority. her employees is one of the most important functions of
➢ Designing a hierarchy of relationships. management.
The management duty of organising is both one of the most
difficult and one of the most crucial tasks.
THE ORGANISING PROCESS:
Delegating tasks and responsibilities to employees and
The process of organising, much like the process of planning,
providing them with the authority they need to successfully
ought to be carefully designed and carried out.
carry out these responsibilities and tasks is another aspect of
The process entails determining what tasks must be organising a business.
completed in order to achieve the laid down objectives,
Delegating responsibilities and assigning the appropriate level
delegating those tasks to specific individuals, and then
of power are two essential components of an effective
organising those specific individuals into a decision-making
organisation.
framework, also known as an organisational structure.
An organisation is the end result of the organising process.
In general, the process of organisation can be broken down 3. Categorising and grouping essential work activities into
into five stages, which are as follows: manageable units:
1. Review of plans and objectives: A manager might choose to group activities using one of these
four departmentalization models:
To accomplish one’s goals, one must first complete one
‘specified tasks'. functional, geographic, product, or customer.
The plans formulated by the management determine the 4. Assigning activities and delegating authority:
activities that are required to achieve the objectives of the
Managers delegate particular duties and responsibilities to
organisation.
particular employees.
The initial step for managers should be to review the plans,
In addition to this, they grant the authority (right) to each
and they should continue to do so even after the plans have
individual to carry out the responsibilities that have been
been modified and new goals established.
given to them.
5. Designing a hierarchy of relationships:
2. Determining the work activities needed to accomplish the
It is the responsibility of a manager to analyse the vertical
objectives:
(decision making) and horizontal (coordinating) relationships
Determining the work activities for achieving the laid down that exist throughout the organisation.
objectives is not that daunting a task as it could initially
The manager should then use organisational charts to draw
appear to be to some managers.
the relationships between the different departments.
Managers need to simply compile a list and conduct an in-
depth analysis of all of the tasks and activities that must be
completed to realise the organisation’s objectives.
The Process of organising also includes: Assigning of Duties:
Determining Objectives: After analysing and classifying all the tasks that take place in
specific departments, the employees who work in those
A goal in mind is typically behind the formation of a new
departments are given only one job within that department
organisation.
that is tailored to their particular set of skills, capabilities, and
This objective will be accomplished through the completion of abilities.
the various projects or activities that have been planned by
A document known as a “Job Description” that explicitly
the organisation.
defines an employee’s duties and responsibilities is used to
For instance, if the organisation is interested in exporting assign those duties and responsibilities to the employee and
goods, it must first determine the nature and type of goods give them to the employee.
that will be exported, the sources from which the raw
materials will be obtained, the countries to which the goods
will be exported, the number of foreign buyers that will need
to be coordinated, etc.
The first step in the process of organising an organisation is to
calculate the complete amount of work that needs to be done.
Classifying Activities:
A single person cannot be made responsible for managing all
of the activities of a medium or large organisation.
As such, the total work is broken down into smaller units and
distributed among the workers and employees in accordance
with their skills and capabilities and also in accordance with
their aptitude.
ABFM MODULE - A TYPES OF ORGANISATIONS:
Chapter 3: ORGANISING (PART-III) Setting strategic goals within a business is a necessary step
that should not be ignored.
What we will study?
The strategic goals of a company address all areas of the
*What are the different types of organization? business, such as deciding which markets to operate in, what
*What is centralized organization? products and services to offer clients, and how to find and
keep outstanding employees.
*What are the advantages of centralized organization?
Setting strategic goals for the organisation and ensuring that
*What are the disadvantages of centralized all business operations contribute toward meeting those goals
organization? are the responsibilities of the management of the
organisation.
*What is decentralized organization?
When a company has determined its strategic objectives, the
*What are the advantages of decentralized organization? next step is to put those objectives into action.
*What are the disadvantages of decentralized Communication and the provision of plans that direct the
organization? activities of those in the organisation are required for the
organisation to realise its strategic goals and put those goals
into action.
Based on the nature of authority and its flow, the basic types
of organisations may be classified as follows:
➢ Centralised and decentralized organisation.
➢ Line and Staff Organisation.
➢ Functional Organisation.
➢ Committee Organisation. These are two of the key disadvantages of centralised
organisations.
Centralised and Decentralised Organisation:
Disadvantages of Centralised Organisation:
Centralised Organisation:
Many times, centralised organisational systems are less
A centralised business structure is one in which key decisions,
responsive to the localised demands that are applied from the
such as those on resource allocation, are made by a single
outside.
individual, and that individual also provides the primary
strategic direction for the company. Employees who are not provided the opportunity to
participate in the decision-making process may also feel
Most small firms are run in a centralised manner, in which the
disenfranchised as a result of this factor.
business owner is responsible for making all essential choices
concerning products, services, strategic direction, and other Decentralized Organisation:
crucial areas.
Most of the time, centralised organisational structures are less
On the other hand, the size of an Organisation is not responsive to locally focused environmental challenges.
necessary for it to be centralised.
Additionally, it may be discouraging to employees if they are
Advantages of Centralised Organisation: not given the opportunity to participate in the decision-
making process.
Organisations that are centralised have greater clarity in their
decision-making processes, more efficient implementation of Advantages of Decentralised Organisation:
policies and projects, and greater control over the
A decentralised management structure offers a variety of
organisation’s overall strategic direction.
benefits as follows:
Centralised organisations typically provide less possibilities for
Fast decision making and response times:
staff members to respond, and they run a greater danger of
being rigid as a result. It is critical that decisions be taken and put into action in a
timely way.
It is essential for enterprises, if they wish to maintain their Link between compensation and Responsibility:
competitive edge, to seize chances that are consistent with
When working for a decentralised company, a pay raise will
the overall strategic direction of the firm.
frequently be accompanied by an increase in the duties
An improved capacity to expand the company: associated with learning new skills, having additional decision-
making authority, and supervising other employees.
It is essential for businesses to always investigate new
avenues through which they may supply their clients with the A more effective utilisation of lower and middle management:
products and services they require.
In order to achieve success in an organisation, a great number
Skilled and/or specialised management: of tasks need to be completed.
Organisations have a responsibility to make investments in Lower and middle management are frequently relied upon by
the training of highly skilled workers who can make decisions decentralised companies to carry out a significant portion of
that are in the best interest of the organisation and will assist their responsibilities.
it in achieving its objectives.
As a result, managers can develop significant knowledge and
Improvement in the morale of employees: competence in a variety of fields.
The ability of a business to recruit, train, and keep highly Disadvantages of Decentralised Organisation:
motivated workers is critical to that organisation’s long-term
Difficulties in coordinating activities:
success.
It is essential for an organisation to be working toward a
One strategy for boosting employee morale is to give workers
unified objective.
more say in the decisions that affect them.
Because decision-making is delegated in a decentralised
organisation, it is frequently difficult to ensure that all
divisions of the company are working in a consistent manner
to achieve the organisation’s strategic goals.
This is one of the challenges that comes with having a Self-cantered ways of functioning:
decentralised organisation.
It is not uncommon for individual divisions within an
Increase in administrative costs due to duplication of efforts: organisation to be measured on the success of the division
rather than the performance of the entire firm.
Decentralised organisations are more likely to engage in
duplication of efforts, which leads to inefficiency as well as an This is due to the fact that each department or division tends
increase in costs, because similar decisions and activities need to be self-centred and acts as its their own fiefdom (जागीर).
to be carried out across all divisions of an organisation.
It is feasible for division managers in a decentralised
Inconsistency in operations:
organisation to give priority to the goals of their division
When autonomy is distributed throughout an organisation, as rather than the goals of the company.
it is in decentralised organisations, division managers may be
The leaders of decentralised organisations have the
tempted to customise or alter the operations of their division
responsibility of ensuring that the organisation’s goals
in an effort to maximise productivity and serve the best
continue to be the top priority for the accomplishment of all
interest of the division.
division.
This can lead to inconsistency in operations.
Within the context of this structure, it is essential to make
certain that the timesaving measures used by one department
of the company do not interfere with or otherwise interrupt
the work of another department located within the
organisation.
ABFM MODULE - A Line and staff Organisation:
Chapter 3: ORGANISING (PART-IV) In the context of management, the term "line-staff

organisation" refers to the method by which authorities (such
What we will study? as managers) formulate objectives and instructions, which are
*What is Line and Staff organization? subsequently carried out by employees and other workers.
*What are the advantages and disadvantages of Line A large and complicated business may use a line-staff
organisational structure in an effort to increase their level of
and Staff organization?
adaptability without giving up their managerial authority.
Line and staff organisation is a modification of line
organisation that is more complicated than line organisation.
Line organisation is the foundation of line and staff
organisation.
Line executives always hold the authority of command, and
the primary responsibilities of staff supervisors are to guide,
advise, and counsel line executives.
A member of the workforce, the Private Secretary to the
Managing Director acts in the capacity of staff executive.
Formal organisations were characterised as collective
enterprises characterised by a clear division of labour and
authority according to the classical theory of organisation,
which was associated with Henry Fayol, Frederick W.
Taylor, and others who pioneered new administrative The line executive retains control of the commanding role,
strategies in the late 1800s and early 1900s. while staff members are limited to advisory roles.
According to these hypotheses, the authority to make
decisions is distributed throughout a hierarchical organisation.
Advantages of Line and Staff Organisation:
Lines of authority serve as the foundation for all interactions
Providing relief to line of executives:
that take place between individuals, organisations, and
divisions. In an organisation structured along lines of both line and staff,
the advice and counselling that is given to line executives by
Most of the time, tasks are carried out in accordance with
staff is one way in which the job is divided between line and
particular functions, and power is exercised in a hierarchical
staff.
fashion.
The line executive can focus on the implementation of plans,
A small number of executives or managers make decisions in
which frees them from the need to divide their attention
an organisation that is highly centralised, and those decisions
among several different areas.
are then implemented further down the chain.
Professional counsel:
However, as an organisation expands in both scope and
complexity, it becomes increasingly important for The line and staff organisation are responsible for providing
management to maintain a flexible approach to the degree to the line executive with access to expert advice whenever it is
which central coordination and control are exercised. required.
Features of Line and Staff Organisation: Staff specialists can handle the planning and investigation
work that is associated with a variety of issues, which frees up
There are two different channels through which authority
line officers to focus on carrying out the plans instead.
might flow simultaneously in a company or organisation:
1. Line Authority.
2. Staff Authority.
Benefits of Specialisation: The existence of specialists on staff makes this
accomplishment feasible.
One of the many advantages of specialisation is that it allows
the firm to be segmented into parts and functional regions. Training:
This is accomplished by the partition of the entire concern Because of the existence of staff specialists, the line officials
into two distinct sorts of authority. can receive expert advice and get trained on the job.
In this way, all officers or officials can focus their attention As such, line executives can take proper and informed
solely on their assigned sector. decisions.
Improvement in coordination: Balanced decisions:
Through specialisation, line and staff organisation can provide The level of specialisation that can be attained by line
superior decision making, while authority remains with only a personnel is one component that contributes to the
few people. achievement of coordination.
As a result of this feature, each official can concentrate on Because of this relationship, the line official will always be
their own domain, which contributes to improved work able to make decisions that are more reasonable and fairer.
coordination.
Unity of action:
Benefits of Research and Development:
Unity of action comes about as a direct outcome of having
The advice of specialised staff members allows line executives unified control.
more time to execute plans and make productive decisions
When there is coordination inside a concern, control and its
that are helpful for a concern.
successful implementation can take place.
This opens a lot of doors for the line executive in terms of
Every single official who has a position of line or staff
bringing new ideas to the table and conducting research in
authority is given the autonomy to make choices on their own.
those specific areas.
This serves as an efficient control mechanism for the entirety Conflicts between line and staff:
of the organisation.
Line and staff are two different authorities that are both
flowing at the same time.
Disadvantages of Line and Staff organisation: Conflicts between line and staff might arise.
A fundamental misunderstanding: The factors such as designations and prestige influence
attitudes that are related to their relation might be stressful
There is a simultaneous flow of two different authorities in an
for employees' thoughts.
organisation structured along line and staff lines.
Because of this, there is less coordination, which makes it
Because of this, there is a lot of confusion between the two.
more difficult for a business to function effectively.
Because of this, the workers are unable to comprehend who
Expensive:
the controlling power in their midst actually is.
To keep costs in line with staff concerns, the concerns have to
As a result, the issue of comprehension may present a barrier
keep the high remuneration of staff expert employees.
to efficient operations.
This ends up being expensive for a company that has limited
Lack of reliable guidance:
financial resources.
The staff's experience and guidance become second nature to
the line official.
Assumption of authority:
There are situations when the staff specialist may provide line
executive advice resulting in incorrect decisions. Although the power of concern lies with the line official, the
staff does not like this arrangement because they are the ones
The smooth operation of the business may be hampered
who are more involved in mental work.
because of this.
Staff steals the show: ABFM MODULE - A
In a line and staff concern, the higher returns are thought to Chapter 3: ORGANISING (PART-V)
be the result of the expert staff advice and counseling.
What we will study?
The officials on the line are upset and concerned about the
situation and their dissatisfaction sometimes creates *What is Functional Organization?
problems. *What are the advantages and disadvantages of
It is critical to the achievement of productive results that line functional organization?
officials feel satisfied in their jobs.
Based on the nature of authority and its flow, the basic types It is an organisation that we can define as a system in which
of organisations may be classified as follows: functional departments are developed to deal with the
difficulties of the business at various levels.
➢ Centralised and decentralized organisation.
This organisation is something that we can call a functional
➢ Line and Staff Organisation.
department organisation.
➢ Functional Organisation.
FW Taylor was the one who initially proposed the idea of a
➢ Committee Organisation. functional organisation and advocated for the placement of
knowledgeable individuals in key roles.
Functional Organisation: Illustratively, the functional heads and marketing directors in

a functional organisation are responsible for providing
A functional organization is a type of organizational structure
direction to subordinate employees throughout the
that groups employees into different departments based on
organisation in their respective fields.
their areas of expertise.
This indicates that subordinates receive commands from
This type of structure is one of the most common types in
multiple specialists, who serve as managers above them in the
business, especially in larger companies.
organisational chart.
In a functional organization, people with similar skills or roles
Features of Functional Organisation:
are put into separate departments.
All the activities of a functional organisation are broken down
Each department focuses on one specific area, like: Marketing,
into their respective functions, which include functions like
Finance, Operations, Production, Sales, HRM, Accounting,
operations, finance, marketing, and personal relations.
Research & Development.
A more complex form of administrative organisation than the
A functional organisation is segregated within the company so
other two (Centralised and decentralized organization & Line
that specialists can maintain their positions at the highest
and Staff Organisation).
levels.
There are three different authorities: line, staff, and function. Efficiency:
Each functional area is assigned to functional specialists who The fact that each function is responsible for a constrained
are vested with the authority to make all decisions pertaining number of other tasks contributes to the overall improvement
to that function anytime that function is carried out anywhere in efficiency.
within the organisation.
Cost-Effectiveness:
When combined, specialisation and standardisation make it
possible to achieve maximum output at the lowest possible
cost.
Advantages of Functional Organisation:
Expansion:
Specialisation:
The expert knowledge of the functional manager makes for
A better division of labour takes place, which leads to the
greater control and monitoring of the business.
specialisation of functions and the profit that follows from
that specialisation.
Efficient Control: Disadvantages of Functional Organisation:

The management control process is made more Confusion:
straightforward by separating the mental processes from the
The functional system is difficult to put into operation,
manual functions.
particularly when it is carried out at low levels.
The authority is kept within defined bounds using checks and
This is especially true when it is carried out at higher levels.
balances.
Because of this, coordination becomes more challenging.
It is possible that specialists will be called to evaluate the
work of several departments.
Lack of coordination: ABFM MODULE - A
When a worker is controlled not by one person but by a huge Chapter 3: ORGANISING (PART-VI)
number of people, disciplinary control becomes weak.
What we will study?
As a result, there is no cohesive command structure.
*What is Committee Organization?
*What are the advantages and disadvantages of
Difficulty in determining accountability:
Committee Organization?
Due to the existence of many authorities, determining blame
can be challenging.
Conflicts:
It's possible for members of the supervisory staff with equal
positions to have disagreements with one another.
On some topics, they could have different opinions.
Expensive:
It is expensive for a company to maintain a staff of specialists
of the highest degree.
Committee Organisation: Advantages of committee organisation:
A group of individuals who have come together to solve issues Improved Quality of Decisions:
that are experienced by the organisation as a whole form
One of the most significant benefits of using a committee
what is known as a committee organisation.
organisation is the improved quality of decisions.
Individuals are provided with the option to discuss the
Members with expertise and experience gleaned from a wide
difficulties they have in committee through this approach.
range of domains come together in this space.
The term "committee organisation” refers to a group of
They arrive at the best decision for resolving the difficult
individuals who possess various forms of knowledge and who
issues by first collecting the ideas of a collective group and
have been properly organised to address the challenges faced
then analysing those suggestions.
by the organisation.
Establishing goals, plans, and policies:
A committee can assist in the gathering of collective ideas and
information, as well as the accurate analysis of these items, Every organisation is started with specific goals in mind, and
which can assist in the making of sound managerial decisions to reach those goals, it is necessary to establish goals as well
and the resolution of challenging situations. as plans and policies.
Throughout the course of operations, the company may face a The committee serves as the organisational structure that
variety of challenges, to address these challenges, the underpins the goal-setting process.
management establishes committees by recruiting members In addition to this, it offers recommendations and information
from the relevant functional areas. that can be used to formulate strategies and policies to
And the management makes judgments and finds solutions to accomplish the goals that have been set.
the issues based on the facts and ideas that are offered by the Participatory Management:
members of the committee.
The arrangement of work into committees assures that
competent people will take part in management activities.
In this setting, each member has the opportunity to In situations like these, committees are formed by collecting
contribute their thoughts, ideas, and opinions to the process specialists from the relevant fields in order to make it simpler
of making decisions. to find methodical solutions to the challenges at hand.
In the process of decision making, the democratic procedure is Commitment to Implementation:
taken into consideration.
To handle complicated and challenging issues, a committee is
Decrease Prejudice and Conflicts: established.
The committee helps enable the development of ties among All the committee's members have significant prior expertise
members and their interaction with the line management, and are recognised authorities in their respective disciplines.
which in turn helps reduce prejudices and conflicts.
In addition, committees are comprised of knowledgeable
They contribute to the authorities' ability to keep in close people from the highest levels of management.
communication with one another and share information with
They reach their decision after having an in-depth debate and
one another.
analysing the potential consequences of several different
As a result, the likelihood of making biased decisions or errors decisions.
in judgement is reduced.
Disadvantages of committee organisation:
Dealing with Complicated Problems:
Creating Conflict:
The arrangement of problems into committees makes it easier
The presence of more heads in a committee increases the
to deal with complicated and tough sorts of issues.
likelihood of conflict.
In certain circumstances, during an organisation's functioning,
In certain circumstances, the organisation of the committee
a great number of difficult or crucial challenges may surface.
contributes to the confusion and contention that exists during
It is far more difficult for those in line of authority, or even the decision-making process.
upper management, to address difficulties of this nature.
There is a possibility that the ideas held by one member are in The Shifting Tendency:
direct opposition to those held by other members.
The tendency to delegate decision making to several
Delay in Decisions: committees is a standard operating procedure in many
organisations.
Committee members take extra time to discuss various
aspects of a problem. When leaders are unable to conclude regarding significant
issues, they frequently defer the decision-making process to a
This causes the decision-making process to be delayed.
committee.
Discussion take up a significant amount of the members of the
This attitude of line executives hinders the initiative and
committee's time.
inventiveness of their employees, which in turn has a
The management might have to shoulder an additional detrimental effect on the performance of the firm.
financial burden if the decision is delayed.
Lack of Secrecy:
The Possibility of Diversion:
It is difficult to keep the secrecy of internal matters in the
The conversation that is taking place within the committee structure of the committee, which makes it difficult to
may in some instances be redirected to another topic. preserve the committee's credibility.
Within the allotted amount of time, the members of the The issues are dissected in detail by each member of the
committee are unable to arrive at any kind of decision when committee, and in the course of doing so, they learn more
faced with a scenario like this. about the workings of the organisation as a whole.
They will need to get together more than once to reach a As a result, there is a greater chance that the organisation's
satisfactory conclusion. secret plans and strategies will become public.
Distribution of Responsibilities: ABFM MODULE - A
Most members of the committee are concerned about the Chapter 3: ORGANISING (PART-VII)
process of decision making.
What we will study?
It is possible that the committee will make an incorrect
judgement in certain circumstances; but, in such a scenario, *What is Organizational Change?
no one member will assume personal responsibility for the *What is Management of Change?
incorrect decision made on behalf of the committee.
*What is Resistance to Change?
Everyone on the committee is eager to pass on their
responsibilities to the other members of the group.
Division of Accountability:
In a committee-based organisation, no one is held responsible
for the decisions that are reached by a committee.
This results in a split in accountability.
The decision reached by a committee is referred to as “one's
decision" because it affects everyone equally.
If there is even the slightest error in the way decisions are
made, there is a possibility that the company will experience
difficulties.
No one is willing to accept the whole blame for the error that
was made by the entire committee, and this is the situation
we find ourselves in.
ORGANISATIONAL CHANGE: a) New management at the helm of the business entity or in
other areas or departments within the organization.
The term "organisational change" refers to the actions that
are taken by a company or business to modify a significant b) Alterations to the organisational structure of teams.
aspect of their organisation.
c) The introduction of innovative technologies.
These aspects may include the company's culture, the
d) The adoption of novel business models.
underlying technologies or infrastructure that it makes use of
to function, or their internal procedures.
The transition of an organisation from one state to another is There are three primary categories of organisational changes,
what is meant by the term "organisational change". which are as follows:
Alterations to an organisation can take on a variety of forms. Developmental Change:
Changes could be made to the organisation's structure, Any modification to an organisation that results in an
strategy, rules, processes, technology, or culture as part of improvement to the processes and procedures that have
this process. already been established.
The process of utilising change to bring about a successful

resolution is referred to as organisational change Changes during Transition:
management, and it typically involves three primary steps:
This type of change moves an organisation away from its
planning, implementation, and follow-up.
existing state and into a new state to address a problem, such
The need for organisational transformation is driven by a as implementing a merger and acquisition or automating a
variety of variables. task or process.
The following are some of the most typical ones that Examples of this type of change include merging and acquiring
managers are confronted with: other companies or automating a task or process.
Transformational changes: Examining how a change in one part of the project may affect
other parts of the project as well as the impact that change
Such changes refer to the transformation of an organisation's
may have on the project is the responsibility of project
culture and way of doing business that is both drastic and
managers as well as senior executives who oversee change
fundamental in nature.
control.
When undergoing transformative change, it is possible that
Included on the list of facets of the project that require
the final effect will not be known.
specific attention from specialists in change control are the
For instance, a company might branch out into whole new following:
product categories or market niches.
Scope:
Change requests should be examined to determine how they
Management of Change: will affect the scope of the project.
A methodical and systematic strategy for addressing the This evaluation should take place with regard to the scope of
transition or change of an organisation's objectives, the project.
procedures, or technologies, is referred to as “change
Timing:
management".
When evaluating change requests, it is important to consider
The goal of change management is to put into action tactics
how such requests will affect the overall timing of the project.
that will bring about change, control change, and assist
individuals in becoming accustomed to change. Costing:
The evaluation of each change request in terms of its potential Change requests need to be examined to establish how they
effect on the project is an essential part of project will affect the overall cost of the project.
management, and thus plays an important part in change
Since the cost of labour is often the single highest expense
management.
associated with a project, rushing through the completion of
project activities can result in significant and immediate shifts Risk:
in the total cost of the endeavour.
Change requests need to be assessed in order to determine
Evaluation of Change Requests Regarding Quality: the risks that are posed by the requests.
Change requests should be examined to determine how they Even very insignificant alterations might have a cascading
will affect the overall quality of the project once it is finished. effect on the project and increase the danger of logistical,
financial, or even physical complications.
An acceleration of the project timetable in particular has the
potential to impair quality, as does the rapid completion of Recovery:
work, which can lead to flaws.
If the scope of the project changes, it may be necessary to re-
Human Resources: evaluate the procurement and contract personnel.
In the area of human resources, change requests should be
assessed to see whether requirement for additional or
Resistance to Change:
specialised labour.
The act of rejecting or battling against modifications or
When the timeline of the project needs to be adjusted, the
changes that affect the status quo is what we mean when we
project manager runs the risk of losing valuable resources for
talk about change resistance.
use on other tasks.
This resistance may show itself in a single worker or in the
Communications:
entire workplace.
Change requests that have been approved should, in the
A lack of readiness to adjust one's behaviour in response to
appropriate amount of time, be notified to the relevant
changing conditions can be defined as resistance to change.
stakeholders.
It can be done in an indirect or direct manner, organised or on
a personal level.
Employees may come to the realisation that they do not like
ABFM MODULE - A
or desire change and protest it publicly, which can be a very
disruptive action. Chapter 3: ORGANISING (PART-VIII)
There is a clear indication of resistance to change in functions What we will study?
such as:
*All about Organizational Structure?
➢ Denunciation or Fault Finding.
*What is Formal Organization?
➢ Nit-picking over tiny details.
*What is Informal Organization?
➢ Offensive or Insulting remarks.
➢ Absence in meetings.
➢ Dishonouring commitments.
➢ Continuous arguments.
➢ Disruptive behaviour.
ORGANISATION STRUCTURE: Salient Features of Formal Organisation:
There are, broadly, two types of Organization Structures: In a formal organisation, each member is given a specific amount
of authority or decision-making power, depending on the nature of
1. Formal Organization.
the organisation.
2. Informal Organization.
The establishment of hierarchical connections between superiors
and subordinates is a direct consequence of a formal
A. Formal Organization: organisational structure.
The formal organisational structure describes in detail the

functions that should be carried out by everyone, the authority Advantages of Formal Organization:
that should be delegated to everyone, the responsibilities that
1. With formal organizational structure business operations are
should be assigned to each individual, the superior-subordinate
more organized and run more efficiently.
relationship, and the designation that should be given to each
person within the organisation. 2. Formal structure accomplishes the goals of the organization.
Formal organization is that type of organization structure where 3. Work is distributed in a well-organized way which avoids the
the authority and responsibility are clearly defined. overlapping of labour.
The organization structure has a defined delegation of authority 4. This structure enables the different departments to coordinate
and roles and responsibilities for the members. their work.
For example: 5. Work is more important over personal connections in this
structure, which prioritizes productivity.
Businesses and governments are examples of formal organizations.
6. The superior-subordinate relationship, often known as who
reports to whom, is delineated in an unmistakable manner by the
formal organisational structure.
Disadvantages of Formal Organization: In an informal organization, there may be no clear lines of
authority or communication, and individuals may have multiple
1. Under this structure chains of command are followed which
roles and responsibilities.
delays the work.
If there is no formal structure, then there won't be any job
2. It does not consider the employees' psychological and social
positions, which means there won't be any people working in
needs which leads to decline in employee morale and this may
those job positions and there won't be any informal organisation.
lead to fall in productivity.
For example:
3. Only the task itself is given value by formal organisational
structures; human relations, creativity, ability, and other such Clubs or social networks are examples of Informal Organization.
things are disregarded.
B. Informal Organization:
Individuals while working in organization create some social and
friendly groups within the organisation because of the interactions
that take place between them while working in various
employment positions.
Due to this one more structure exists within the company and is Salient Features of Informal Organisation:
referred to as the informal organisational structure.
• The managers don't have to make any conscious efforts to
This structure is formed by a network of social and friendly groups. construct the unofficial organisational structure; rather, it just
happens naturally.
Informal organizational structure refers to the unwritten, unofficial • Employees often build their own informal organisational
relationships and networks within an organization. structures to achieve greater psychological fulfilment.
Advantages of Informal Organization: Disadvantages of Informal Organization:
1. There is effective and rapid communication because this 1. The informal organizational structure mostly spread rumors,
structure does not follow a chain of command. which might lead employees in the wrong direction.
2. Informal communication gives the psychological and social 2. An organization cannot run efficiently by an informal
needs of the employees the necessary consideration they need, organizational structure.
which in turn encourages those individuals.
3. If the informal organization disagrees with the decisions and
3. The highest-level managers can learn the actual input that their changes made by management, it will be extremely challenging to
employees have on the numerous policies and strategies. put such decisions into action inside the organization.
4. Through collaboration with informal groups, managers can 4. The informal structure used to focus on fulfilment of individual
effectively exploit both formal and informal organizations for their interests rather than organization’s interest.
own purposes.
5. Grapevine can swiftly communicate significant information to
one another.
Grapevine communication is a term that refers to the indirect way
in which information is passed from one person to another. This
type of communication often relies on gossip and rumors as a
means of spreading information.
Chapter 4: STAFFING (PART-I) People working in an organization play a vital role in achieving
its goals or objectives.
What we will study?
It is not only the number of people which matters but also
*What is Staffing? their skill level and motivation.
*What are the objectives of Staffing? Proper recruitment and training policies of the organization
play an important role in ensuring that right quality of people
*What is the nature of staffing?
in right number are put for carrying out a particular type of
assignment.
Appropriate career development policies should also be
adopted to tackle the problem of attrition of skilled staff.
The effective administration of human resources is the
foundation of the managerial function of staffing.
A method or procedure, such as recruiting, selection,
placement, training, and development, giving remuneration,
etc., are all examples of activities that fall under the purview
of effective human resource management.
The process of recruiting and training suitable individuals to
fill the available jobs in a company is an important part of
staffing.
One definition of this process is as follows: "It entails making It may also be noted that the hiring process is the most
an estimate of the quantity and type of personnel that will be important part of any other managerial role.
required, as well as recruiting and developing the said
It is beneficial to an enterprise's efforts to keep a workforce at
personnel, in addition to maintaining and increasing the
a decent level.
competence and performance of said personnel".
In other words, the process of locating, analyzing, placing,
cultivating, and reviewing persons for employment FUNCTIONS OF STAFFING:
opportunities may be referred to as staffing. The primary functions of the staffing are:
The process of staffing an organisation entails determining the *Obtaining qualified individuals for various job positions
manpower requirements of the business and then providing it inside the organization is the primary objective of the staffing
with sufficient and competent individuals at all its levels. function, which has several other responsibilities as well.
Staffing therefore encompasses activities such as personnel *The process of staffing ensures that the most qualified
planning, procurement (also known as selection and candidates are selected for open positions, which results in
placement), training and development, performance greater levels of both productivity and performance.
evaluation, and compensation of workers.
*It contributes to the promotion of the most effective and
Managers are responsible for building an organization through efficient usage of human resources in a variety of ways.
the process of recruiting, selection, and development of
*The successful recruitment of the right person raises the
individuals as capable employees. This process is known as
level of job satisfaction and morale experienced by workers.
staffing.
*The process of staffing serves to guarantee that human
The process of staffing plays an important part in the planning
resources are used more effectively.
of human resources.
*Staffing secures the organization's continued existence as
It guarantees that the organization is making the greatest
well as its continued expansion using development managers.
possible use of its human resources.
*Proper people can be placed in the right jobs with the help of OBJECTIVES OF STAFFING:
staffing services.
The important objectives of staffing are:
*Staffing is a function that is used in many different contexts.
1. To get the appropriate employees for the appropriate
It is the responsibility of managers at every level of
positions.
management to carry it out.
2. To educate and cultivate the available human resources.
The process of management includes staffing as one of its
essential components. 3. To design policies for personnel matters, such as transfer,
promotion, and other related work.
It is possible to define it as the process of recruiting and
cultivating the necessary personnel to fill the available roles in 4. To effectively shape the available human resources and to
an organization's numerous departments. motivate those resources toward better levels of performance.
This is so because when it comes to effective and efficient 5. To create a positive and productive working connection
management of the business, every business entity is between employers and employees as well as between
extremely concerned with the quality of the people available different groups of employees.
to them. 6. To ensure that the demands of the workers are met to the
According to Peter Ducker, "man, of all the resources workers' satisfaction so that they will become dedicated and
accessible to man can grow and develop." loyal to the organization.
It is concerned with the recruitment, selection, placement, 7. To keep positive human interactions in place in order to
utilization, and development of an organization’s staff foster strong morale among the workforces.
members. NATURE OF STAFFING:
Concentrated on Individuals:
The process of Staffing is concerned with the effective
utilization of an organization’s Human Resources.
It encourages and incentivizes each worker to contribute to It is necessary for all personnel at all levels of the business,
the fullest extent possible toward the accomplishment of the regardless of their type.
organization's goals and objectives.
An ongoing procedure:
Oriented Towards Development:
The process of hiring new employees is an ongoing one that
This means that the focus is on maximizing the potential of never comes to a conclusion.
the employees working for the organization.
It involves constant vigilance and an acute awareness of the
Their interests, personality, and talents will all mature as a significance of human relations in every aspect of the
result of this. operation.
It makes it possible for workers to derive the greatest possible Human objectives:
satisfaction from their employment.
This helps employees reach their full potential so that they
Employees are given the tools they need to reach their full can experience the greatest amount of satisfaction from the
potential as a result. work that they do.
Employees are given the opportunity to enhance their careers It fosters an environment in which workers are willing to
through various educational and training programmers collaborate voluntarily toward the accomplishment of the
provided by the company. organization’s stated objectives.
Focused on both individuals and groups to achieve goals:
An all-pervasive function: Staffing is concerned with employees in both their individual
and group capacities in order to achieve goals.
Staffing is essential to the operation of every business.
It creates the appropriate organizational framework to meet
It is a significant component of the overall management
the requirements of both individual efforts and collective
system that has the capability of being implemented in both
endeavors.
for-profit and not-for-profit businesses.
It does this by combining the pursuit of individual goals with Effective people administration skills are required of each
those of the group in such a way that the employees member of the management group, from the most senior
experience a sense of involvement with the organization. member on down.
Creating an environment conducive to productive work: It is helpful to other functional areas of management and
provides support for them.
It creates an environment conducive to productive work
inside the firm, one in which every worker puts his or her best A blend of art and science:
efforts for the accomplishment of organizational goals.
The process of hiring new employees is grounded in the field
It makes for an atmosphere that is not just physically but also of human engineering.
mentally pleasant to be in while at work.
It can be thought of as an organized body of knowledge that is
It's multidisciplinary character: made up of principles and methods.
Staffing is a field that originated in the social sciences. It is also an art because it requires the ability to interact with
different types of individuals.
It incorporates theories and ideas derived from a variety of
academic fields, including sociology, anthropology, Because it handles employees and finds solutions to their
management, and psychology. problems in a methodical manner, it is considered one of the
creative arts.
In addition to this, it has taken some ideas from the
behavioral sciences. It is considered a management philosophy because of its
emphasis on the dignity and worth of individual human beings.
It might be thought of as the science of "human engineering".
An essential component of general management:
The hiring and firing of employees are essential components
of general management.
ABFM MODULE - A FACETS OR ASPECTS OF STAFFING:
Chapter 4: STAFFING (PART-II) There are three primary facets of staffing, which are as follows:
What we will study? Recruitment, Selection, Training.

Recruitment:
*What are facets of staffing?
Recruitment is a positive process that seeks to attract a bigger
*What is the significance of staffing?
number of people with ideal profiles to apply for positions
that are empty in the business.
The organization's goal with recruitment is to fill positions as
quickly as possible.
The more people that apply for a job, the better your chances
are of finding an applicant who meets your requirements.
Selection:
Selection is a procedure that eliminates candidates by
carefully reviewing their applications and choosing those who
are the best fit for the open position.
The selection process is different from the recruitment
process in that it rejects applications.
Training:
Training is another constructive activity that improves the
employees' knowledge and abilities, as well as their capacity
to do their jobs more effectively.
The processes of recruitment, selection, and training are organization in order to keep up with the continuously
followed by organizations to ensure that all positions in the advancing technology, changing human behavior, and growing
organizational hierarchy are filled with people who are size of the business.
competent and talented in their respective fields.
This is required in order for staffing to be effective.
The caliber of an organization’s workforce is directly
SIGNIFICANCE OF STAFFING: proportional to the company's level of success.
Finding the appropriate candidates for open positions in an Thus, staffing is an important managerial function and its
organization’s hierarchy is the responsibility of the staffing significance can be further explained as under:
department.
Because the human resource is what propels a company to
Recognizes Competent Staff:
greater heights, it is imperative for management to ensure
that they have the appropriate kind of personnel in place. The process of determining the number of workers needed to
fill positions in an organizational structure and assigning those
Staffing is the most fundamental and important job of
positions to the appropriate individuals is referred to as
management.
"staffing".
In the past, "staffing" meant appointing individuals to get
It makes certain that only those individuals with the necessary
things done.
skills are hired.
However, as a result of the rapid changes that have taken
For instance, the HR Head of your Company identifies the
place in the corporate environment, “staffing" has taken on a
departments that are facing shortage of staff at various levels
higher role as a management function.
and then works toward finding people who are suitable for
Staffing must appoint people who not only have the those departments.
specialized knowledge but also the appropriate attitude,
aptitude, commitment, and sense of loyalty for the
Enhancement of Overall Performance: The Optimal Employment of the Available Human Resources:
When businesses put the right people in charge of the right The needs of the workforce are determined during the staffing
jobs, they are able to use their physical resources in the most process, and appointments of individuals are planned
effective way possible, which ultimately results in increased accordingly.
productivity, enhanced efficiency, and enhanced performance.
This ensures that there are sufficient personnel available to
For instance, in the interest of achieving the best possible avoid underutilization of workers or disruptions to work
outcomes, the Purchase Department should only appoint caused by inadequate staffing levels.
persons who have integrity, understand the material and
For instance, if there are enough teachers working in each
capital goods acquisition procedures and have knowledge
department, then each individual class will have a teacher
about the industry and the Suppliers.
assigned to it.
Ongoing Capability for Survival and Development:
Increases Job Satisfaction and Contributes to a Positive
Training and development programmers for employees that Morale:
are done correctly keep managers up to date on the changes
Staffing recognizes the value of its employees' contributions
that have occurred in the business environment.
and expresses gratitude and appreciation for those
The continuity of the business's survival and expansion can be contributions through ongoing performance reviews and
ensured by conducting succession planning for managerial evaluations.
positions.
For instance, after the financial year is closed, a company
For instance, whenever there is a change in the systems, might plan evaluations for each individual employee in order
procedures and the technology used by the Company or the to select an "employee of the year." This not only rewards the
organization is restructured, staff needs to be trained and hard-working employee with a sense of satisfaction but also
educated so that they are aware of the modifications and are encourages others to work even more diligently.
able to incorporate them into their working.
ABFM MODULE - A RECRUITMENT:
Chapter 4: STAFFING (PART-III) Staffing refers to the process of hiring individuals who are the
most qualified for a job whereas recruiting is the process of
What we will study? finding potential applicants for a job and encouraging them to
*What is Recruitment? apply for the vacant post.
Recruiting and staffing are two different processes but are
often used interchangeably.
The process of recruitment and staffing is what constitutes the
method by which companies find employees to fill open
positions.
Recruitment takes place at a variety of stages throughout a
company's existence, although it is at its most intense when a
new business is launched or when an existing business
undertakes expansion or new directions.
The procedure starts with extensive planning that occurs
behind closed doors and continues with the recruitment,
interviewing, and selection of staff members.
There are a few different paths that can be taken by small
businesses during the process of recruitment and staffing.
The following is a rundown of the primary stages involved in
the recruitment process:
* Determining the need for hiring.
* Conceiving a recruitment strategy. Retained Recruiting: (using a firm, upfront payment)
* Drafting a job description. When a company engages a recruiting firm, they can do so in
numerous different ways; one of the most prevalent ways is
* Publicizing the position.
retained recruiting.
* Recruiting candidates for the position.
When an organization hires a recruiting firm to fill a vacant
* Examining applications. position, the organization is responsible for paying an upfront
* Conducting a phone interview or initial screening. fee to the recruiting firm.
* Conducting interviews. Up to the point that the post is filled, the company is
responsible for locating potential candidates.
* Evaluating candidates.
In addition, the organization commits to forming an exclusive
* Conducting a background check.
partnership with the company.
* Making a decision.
In other words, companies are unable to use multiple
* Checking references. recruiting agencies for the purpose of filling the same vacancy.
* Making an offer of employment. Contingency Recruiting: (using a firm, NO upfront payment)
* Hiring candidates. This type of recruiting, like retained recruiting, requires the
assistance of an outside firm.
* On boarding of candidates.
In contrast to retained recruiting, contingency hiring does not
Types of Recruitment:
require an upfront payment.
Internal Recruiting: (within firm)
Instead, the recruitment company is only compensated when
The process of filling open positions within a company with one of the candidates they represent is offered and accepts a
current staff members from that organization is known as position within an organization.
internal recruiting.
Recruiting for Staffing Agencies: Method for Conducting Successful Recruitment Procedure:
Staffing recruiters are employed by staffing agencies. When it comes to producing high-quality personnel on a
consistent basis, recruitment is a sophisticated process that
Staffing and recruiting involve pairing skilled job seekers with
demands significant research, comprehensive processes, and
open positions that meet their qualifications.
finesse.
In addition, most of the jobs that staffing companies fill are
Keeping this in mind, the following are the three most
either temporary or only available for a limited time.
important pieces of advice for successful recruitment:
Outplacement Recruiting:
Search within your organization before looking outside:
When it comes to recruitment, outplacement is a type of
There is a significant probability that the most qualified
advantage that is often sponsored by employers and assists
individual for the post is already employed by your company.
former employees in making the transition into new jobs.
Candidates from within your company are already aware with
The purpose of outplacement recruiting is to equip people
your company's culture and goals, and they contribute to
who have lost their jobs with the tools necessary to locate
achieving those goals.
new employment or pursue other lines of work.
It is reasonable to anticipate that, given their history of
Reverse Recruiting:
accomplishments inside your organization, they will continue
This is a procedure in which an employee is urged to seek to be successful in their new role.
employment with a new business that offers a better fit for
Contact applicants considered passive:
their skill set.
There is a good probability that the person who would be
This process refers to the practice of encouraging an employee
perfect for your open position is not currently seeking for a
to seek employment with a different organization.
new job and will not react to the advertisement that you post
on the job board. Why?
Because it is most likely that they are working somewhere ABFM MODULE - A
else already.
Chapter 4: STAFFING (PART-IV)
After all, there might not be any reason that your competitors
should not also be interested in hiring your perfect applicant. What we will study?
Therefore, if you want to be successful in recruiting, you need *What is Selection?

to hunt for elite talent outside of your current candidate pool. *All about Selection Process?
It is crucial to create contacts with local university business
schools (or other relevant departments), checking social
media sites like LinkedIn for strong resumes from applicants
who might not be explicitly looking for a new job, encouraging
your employees to suggest people they know or are linked to.
All of these are important avenues through which we can
grow our recruitment network.
Hire the person already excelling in similar jobs:

Several Management Gurus and Experts are of the view that
we should hire a person who is the sure thing and has already
made a name in similar jobs.
To put it another way, a history of success is the single best
predictor of future achievement.
SELECTION: 1. Preliminary Interview:
The phase of the staffing process known as selection is the This is a very generic and basic interview that is held to
component of the hiring procedure that entails selecting an exclude the candidates who are utterly unfit to work in the
employee to hire from a shortlist of exceptional applicants organization.
who have been reduced.
The purpose of this interview is to determine who will move
Throughout the process of recruiting, there are multiple on to the next stage of the interview process.
opportunities for selection to take place.
As a result, the company now has access to a pool of
Manager’s shortlist the applicants to be contacted based on applicants who could be suitable for open positions in the
the credentials of their applications and decide about the company.
applicants who are to be called for interviews, and ultimately
2. Taking Applications:
which applicants to be hired for available positions.
Candidates for open positions submit their resumes and cover
If you have a good understanding of the many levels of letters to the business in order to be considered for
selection and what to look for at each level, you will be better employment.
able to choose the right job candidates for your company's
The application provides the interviewers with information
long-term success. about the candidates, such as their biographical data, their
The Selection Process: work experience, their hobbies and interests.
It is necessary for an organization to develop its own selection

procedures because each company has its own standards and 3. Examining the Applications:
requirements. Once the applications have been received, a special screening
Nevertheless, the most important steps are as follows: committee examines them in order to select potential
candidates from among the applications who will then be
contacted to schedule interviews.
Candidates could be chosen based on specific criteria such as Interviews are an essential part of the hiring process because
their qualifications, previous work experience, and so on. they help employers choose the most qualified candidates for
open positions.
4. Employment Tests:
6. Verification of References:
For a company to determine whether or not an individual is
qualified for a certain job, the company must first evaluate The individual who provides a possible employees reference is
the individual's abilities. also a very important source of information, so we must check
with them.
This is accomplished by the administration of numerous job
exams, including IQ tests, aptitude tests, competence tests, The referee will be able to provide information regarding the
personality tests, and so on. individual’s capabilities, experience in the prior firms,
leadership, and managerial skills, and more.
5. Formal Interview:
The Human Resources department is responsible for
The fifth and last stage of the selection process is the
maintaining the confidentiality of the information provided by
employee interview.
the referee.
This stage is the next step in the selection process.
Interviews for jobs are conducted to determine in great depth
7. Medical Tests:
a candidate's skill set and whether they have the capacity to
work in the business. The seventh and final step in the selection process is the
medical examination, which is another highly essential part of
The purpose of an employment interview is to determine
the procedure.
whether the candidate is suitable for the position, as well as
to provide the candidate with information regarding the work Employers can determine whether or not any of the potential
profile and the responsibilities that would be expected of the applicants are physically and psychologically fit to undertake
potential employee. the tasks associated with their professions with the help of
medical examination.
There would be fewer incidents of absenteeism, accidents, Importance of the Selection Process:
and employee turnover if there is an effective system of
➢ The expansion and success of the company are directly
medical check-ups in place.
attributable to the careful selection and placement of staff.
Additionally, the health standards of the employees will be In a similar vein, the capabilities of the company's
greater. workforce are the only real measure of how successful the
company can be.
8. Final Selection and Appointment:
➢ The rapid accomplishment of company goals is directly
This is the last phase in the selection process, and it consists of
attributable to the recruitment of workers who are talented
a letter announcing the final selection and appointment.
and skilled.
An appointment letter is delivered or emailed to the
➢ Industrial accidents will substantially fall in numbers when
employee to advise his selection for the job once the
the right technical staff is engaged for the right jobs.
candidate has demonstrated that they are qualified for the
position by passing all written tests, interviews, and medical ➢ People's levels of job satisfaction, as well as the quantity
examinations. and quality of their output, tend to rise when they find
employment in fields in which they excel since this leads to
The terms of employment, including working hours,
more personal fulfillment.
remuneration, and leave benefits, are listed in their entirety in
the letter of appointment. ➢ People that are content with their jobs frequently tend to
have good morale and motivation to do better.
It is common practice to hire workers on a conditional basis or
on probation, with the understanding that they will be hired
permanently or confirmed in service if the company is
satisfied with their performance.
Chapter 5: DIRECTING (PART-I) The management functions in an organisation broadly involve,

in varying degree, functions of planning, organising, staffing,
What we will study? directing and controlling.
*What is Directing? Directing is an important function as people, working in the
*What are the characteristics of Directing? organisation, are guided, motivated, counselled, supervised,
and led towards the achievement of organisation's goals
*What is the importance of Directing? through the practice of directing.
*What are the elements of Directing? It is called a directing process when the process lasts
throughout the entirety of the company's existence, meaning
that it is an ongoing part of the continuous managerial
process.
CHARACTERISTICS OF DIRECTING:
The following is a list of the primary characteristics of the
process of directing:
The initiator of action:
In order to fulfil their responsibilities inside the organisation,
managers are responsible for functions such as planning,
staffing, organising, and controlling, in addition to guiding.
While other verbs prepare the ground for action, "directing"
actually gets things moving.
All-encompassing function: Therefore, directing is a crucial role since it ensures that the
work is completed by the employees, and contributes to the
Direction is present at every level of an organisation when
expansion of the firm.
there is a hierarchy of superiors and subordinates.
This means that guidance is always present.
IMPORTANCE OF DIRECTING:
Every manager is responsible for supplying his staff with
direction and inspiration. There is evidence that leadership, as a notion, dates back
thousands of years.
Constantly occurring activity:
Management science, on the other hand, didn't come into
It is considered as a continuous function since it continues
existence until the 20th century.
even after new managers or employees have been hired or
removed from their positions within the firm. It was sparked by the rise of enormous companies and the
necessity to provide order and consistency in their operations.
Descending order of hierarchical:
The process of management and leadership are not at all
The process of guiding flows down from higher levels of
similar, despite what the vast majority of people believe to be
management to lower levels of management.
the case.
Every manager is responsible for performing this role for his
Leadership is not magical nor mysterious, nor does it require
or her own immediate subordinate.
remarkable talent or charisma on the part of its followers.
The human factor:
Complex businesses can become hopelessly unorganised in
As a result of the fact that every worker is unique and the absence of capable management, which poses a risk to the
responds in a manner that is specific to the circumstances in companies' very existence.
which they find themselves, it is essential for managers to
handle problems in an appropriate manner.
ELEMENTS OF DIRECTING: It can also be seen as the capacity to exert influence over a
group in order to bring about the desired outcome.
Directing has following four main elements:
It is necessary to have leaders in order to generate visions of
1. Leadership.
the future and to motivate people of an organisation to
2. Motivation. accomplish those ambitions.
3. Communication. Leadership is Important Because it:
4. Supervision. Begins or starts the action:
The subordinates comprehend their work and perform it in
LEADERSHIP: accordance with the instructions that have been provided.
The term "leadership" refers to both a set of behaviours and a No matter what plans are developed, they won't be able to be
set of attributes that can be acquired through training and put into action until after the real work has begun.
development respectively. At this point, the guidance can be of great use.
Leadership is the process of inspiring other people to work
toward a common goal and organising their resources to make
Coordinates efforts:
that objective a reality.
Directing subordinates at work enables supervisors to advise,
It has been stated by Keith Davis that “The capacity to
motivate, and instruct them to do their assigned tasks.
convince other people to eagerly pursue predetermined goals
is an essential leadership skill. The human element is what Every single person's contribution is necessary if we are going
ultimately holds a group together and drives its members to to be successful in achieving our aims.
achieve their objectives."
The integration of efforts is going to bring about efficiency and
The ability to mould the actions of others is essential to uniformity in the way that concerns are handled.
effective leadership.
Provides motivation: For instance, if a company goes from using handlooms to
power looms, this represents a significant transition in the
Having a sense of direction is beneficial to the achievement of
technology used in the manufacturing process.
one's goals.
The factors that have resulted from this include less
The purpose of a manager is to improve the performance of
manpower and more machinery.
their subordinates by providing incentives or compensation,
whether this would be monetary or non-monetary, and this Makes effective use of available resources:
can act as a morale booster for their subordinates as well as
The only way that resources may be used effectively is if there
help in development.
is a minimal amount of waste, duplication of efforts, overlap
A manager uses the element of motivation here. of performance, etc.
When a manager uses his talents in supervision, guiding,
directing, and motivation in order to motivate subordinates,
Adapts to changing circumstances:
the function of subordinates becomes clearer as a result.
It is inherent to human nature to display a consistent level of
resistance to change.
The ability to adapt lets a company withstand the planned
growth and become the market leader despite the constant
shifting environment.
This is the directing function that is utilised in order to
accomplish the changes that are produced in the environment,
both inside and outside.
It is the responsibility of the management to explain the
context and specifics of the adjustments to the employees
under their supervision.
ABFM MODULE - A Leadership Roles and Responsibilities:
Chapter 5: DIRECTING (PART-II) Direction at all levels:
What we will study? The ability to effectively lead others is a skill that is essential
in all facets of management.
*What are the roles and responsibilities of Leaders?
At the highest possible level, it is critical to secure cooperation
*What are the qualities of leaders? in the process of formulating plans and policies.
It is necessary for the understanding and execution of plans
and programmes developed by the top management at the
intermediate and lower levels of the organisation.
When it comes to carrying out a strategy, leadership can be
demonstrated through the provision of direction and advice to
subordinates by higher-ups.
Representative of the Organisation:
The leader or manager of the business is the enterprise's
representative and is responsible for doing things like
representing the concern at meetings, conferences, and other
events.
The leader is responsible for conveying to the general public
the reasons why the enterprise should be supported.
The leader of a department also serves as its representative
because he is in charge of the department.
Helping Integration and Reconciliation of Personal Goals with Acts as Friend, Philosopher and Guide:
Business Goals:
A good leader should have these three characteristics.
A person who possesses leadership abilities contributes to the
He can also be a friend to his subordinates by being open and
process of reconciling or integrating the personal aspirations
honest about his emotions, ideas, and desires with them.
of employees with the aims of the business.
He can play the role of a philosopher by drawing on his
The goal of a leader is to direct the activities of their followers
intellect and life experiences to provide direction to the
toward the achievement of shared goals, and they do this by
employees in times of crisis.
coordinating those efforts.
Sometimes, he will also play the part of a counsellor, both
This is only possible if the leader is able to exert enough
from the perspective of providing therapy and of finding
influence to win over the other party's cooperation and
solutions to problems.
convince them of the necessity of achieving the goals.
After listening to the employees' complaints, you should make
Garners support:
an effort to find solutions.
A leader is someone who manages others and, in addition to
Leadership Qualities:
that, he is someone who encourages the support and
collaboration of subordinates and entertains them. A leader possesses many different attributes, which combine
to make him appealing to followers and effective in their work.
He is able to do this because of his intelligence, maturity, and
experience, which are the factors that contribute to successful The following characteristics are necessary for a person to be
outcomes. considered a good leader:
A leader is someone who not only follows but also suggests Outward Look:
and carries out his organisation's ideas and programmes. A leader is expected to have a physically appealing
appearance. Both physical and mental fortitude are essential
qualities in a successful leader.
Vision and foresight: Objective:
In order to continue to be effective as a leader, one must be A leader is required to have an objective approach that is free
able to show that they are looking into the future. from bias and does not represent his favour for a specific
individual.
It is necessary for him to visualise the scenarios before he can
create logical programmes. Instead, a leader should form his judgement and make
decisions based on facts and reasoning.
Intelligence:
Knowledge of work:
A leader needs to be intelligent enough to explore difficult
situations and challenges. In order to gain the faith and confidence of his subordinates, a
leader needs to have a thorough understanding of the job that
In a nutshell, the scenario calls for a leader who is analytical
is performed by those under his or her supervision.
and can balance the benefits and drawbacks of several
options.
Because of this, having a mature mindset and thinking Sense of responsibility:
positively are highly crucial.
Having a sense of accountability and responsibility toward
Capabilities in Communication: one's work is highly crucial if one wishes to feel that they have
made an influence.
The capacity to communicate plays an important role in
clearly communicating the policies and processes, terms and Only when a leader feels a feeling of responsibility toward the
conditions, and other relevant information. accomplishment of corporate goals is he able to truly
maximise the talents of those under his command.
It is highly useful in convincing people and stimulating them in
an accurate and efficient manner. Only when they are able to motivate themselves and insist on
contributing to their greatest talents can a leader effectively
motivate their followers to do their finest work.
Self-confidence and the ability to exert one's will: ABFM MODULE - A
Self-assurance is necessary in order to win the trust of Chapter 5: DIRECTING (PART-III)
subordinates.
What we will study?
It is expected of him to be dependable and to face challenges
with full determination. *What are the various leadership models?
Humanist: *What is Authoritarian leadership?

A leader must have the ability to be present at all times since *What is Participative Leadership?
he deals with people on a daily basis and has direct
*What is Delegative Leadership?
interaction with them.
When a leader is dealing with the personal issues of his
*What is Transactional Leadership?
subordinates, he needs to exercise extreme caution and focus. *What is Transformational Leadership?
For this reason, it is essential to treat human beings on the
basis of humanitarian concerns in order to establish an
atmosphere that is favourable to growth.
Compassion:
There is an old adage that goes, "Put yourself in the shoes of
those around you."
This is of the utmost importance since only after this can
judgement and fairness be considered.
A leader is required to have an understanding of the issues
and complaints that are brought up by employees.
Leadership Models: Leadership methods based on authoritarianism are utilised
whenever the members of a team require guidance.
A leadership model that is grounded in theory and serves as a
theoretical framework for how to best manage personnel. Advantages of the authoritarian leadership style:
One way to characterise leadership models is, as guides that The authoritarian leadership style has a number of benefits,
indicate various leadership behaviours that should be applied including the following:
in a particular context or place.
It is possible to cut down on the amount of time needed to
The leadership model is utilized in order to provide a helpful reach an important conclusion.
methodology and structure for defining management
It is possible to clear the command chain and punctuate.
practices that are suitable to the work style and personality of
the individual. The amount of repetition that occurs during the execution of
the plans can be reduced.
Explanation of the leadership model in broad terms, can be
broken down into the following groups: Implementing an authoritarian paradigm of leadership lead to
the production of consistent results.
Authoritarian Leadership:
Disadvantages of the authoritarian leadership style:
A leader has the ability to set results and enforce expectations
through the use of authoritarian leadership methods. The following are some of the drawbacks of adopting an
authoritarian style of leadership:
It's possible to have success with a one-man show in
circumstances where one leader is the most knowledgeable Management style that is overly authoritarian might provoke
member of the team. discontent among workers.
Creativity would suffer as a result of limited input from the By utilizing this paradigm, you run the risk of stifling the
team if this method is implemented, despite the fact that it is originality and innovation of your workforce.
effective in a short period of time. It is detrimental to the coordination and cooperation of the
group.
The amount of input from the group stands severely cut back. Advantages of the participative leadership style:
The utilization of this model significantly contributes to an Participative leadership has many benefits, including the
increase in the employee turnover rate. following:
Employee turnover is the percentage of employees that leave The inspiration of workers and the gratification they got from
your organization during a given time period. their jobs rose.
Participative Leadership: It allows for a more efficient utilization of the employees'
creative potential.
The democratic ideal can be traced back to the origins of the
participative leadership style. The use of participative leadership approaches assists in the
development of powerful teams.
The most important thing is to have everyone on the team
involved in the decision-making process. It is possible to achieve high levels of productivity.
Therefore, members of the team feel satiated and encouraged Disadvantages of the authoritarian leadership style:
to contribute to the cause.
The following are some of the drawbacks of adopting an
In most cases, the leader has the final say when it comes to authoritarian style of leadership:
the decision-making process.
The process of making decisions takes some time.
If members of a group continue to have divergent opinions,
Leaders are more inclined to apologise to their employees
however, it is possible that reaching a decision will take more
than employees themselves.
time.
There would on occasion be problems with communication.
Because of the openness with which information is shared,
potential security problems may emerge.
If staff lack the necessary skills, poor decisions may be made.
Delegative Leadership: Disadvantages of the delegative leadership style:
Delegative leadership is a representative leadership style that The following are some disadvantages of adopting a
focuses on delegating initiative to team members and the delegative style of leadership:
style is also known as "laissez-faire leadership".
There is a lack of clarity regarding command accountability.
This strategy has the potential to be successful provided the
The representative leadership struggled to adjust to the
members of the team are knowledgeable, willing to accept
changes that were occurring.
responsibility, and like the opportunity to work on their own.
Despite this, friction among the members of the team might
cause the group to break apart and go in a different direction, Transactional Leadership:
which can result in a lack of inspiration and low morale. Transactions between a leader and his followers, including
Advantages of the delegative leadership style: incentives, admonition, and other commutations, are utilised
by the transactional leadership model to accomplish the goal
The benefits of adopting a leadership style based on
of getting the work done.
delegation are as follows:
The leader makes sure that everyone is aware of the
Employees with more experience are eligible for perks that
objectives, and everyone on the team is aware of how they
are determined by their level of experience and credentials.
will be rewarded for meeting the requirements.
The originality of the concepts and the inventiveness are very
This type of giving and taking is more concerned with
much appreciated.
adhering to existing routines and procedures in an
A productive working atmosphere that is the result of accomplished manner, as opposed to creating any radical
leadership that emphasizes delegation. changes inside an organisation.
Advantages of the transactional leadership style: Transformational Leadership:
Transactional leadership has a number of advantages, In this paradigm, the leader inspires his or her followers by
including the following: providing them with a clear vision and then the leader
encourages and empowers the followers to work toward
Time-bound, measurable, and detailed objectives that are
achieving the goal.
within the employees' reach, which has been developed by
the leaders. The leader is also responsible for serving as an example of the
vision.
Enhanced levels of motivation and output from staff members.
Advantages of the transformational leadership style:
Transactional leadership can oust chaos in the chain of
command or at least bring it to a manageable level. Transactional leadership has a number of advantages,
including the following:
Employees have the ability to choose their own reward
system. A decrease in the number of employees who leave their jobs
as a result of utilizing this methodology.
Disadvantages of the transactional leadership style:
A strong emphasis by the transformational leadership on the
The following is a list of disadvantages associated with the
importance of the business vision.
transactional leadership style:
When utilizing this technique, you will see that your
There is a possibility of inhibiting inventiveness and
employees have a good morale.
creativeness.
It uses several methods of motivation and inspiration in order
Having empathy does not add any value.
to gain the support of the personnel.
It fosters the development of more followers than leaders
This style to leadership is not one of compulsiveness.
among the workforce.
The transformational leadership style places a high priority on
the interaction between parties.
Disadvantages of the transformational leadership style: ABFM MODULE - A
The following is a list of disadvantages associated with the Chapter 5: DIRECTING (PART-IV)
transactional leadership style:
What we will study?
It is possible for leaders to lie to their employees.
*What is Motivation?
It's possible that you'll need continuous encouragement and
continuous feedback. *What is Intrinsic Motivation and Extrinsic Motivation?
The works cannot move further until the staff give their * Alderfer's ERG Theory of Motivation?
approval. *Herzberg's Theory of Motivation?
The transformational leadership paradigm has the potential to
sometimes lead to a divergence of protocols and principles.
MOTIVATION: Social psychological research has indicated that extrinsic
rewards can lead to over justification and a subsequent
The word "motivation" is derived from the Latin word
reduction in intrinsic motivation.
"motive", which can be translated as "necessity", "incline" or
"drive" within a person. In one study demonstrating this effect, children who expected
to be (and were) rewarded with a ribbon and a gold star for
People are motivated to take action so that the goal can be
drawing pictures spent less time playing with the drawing
achieved.
materials in subsequent observations than children who were
It is possible that psychological factors are what drives assigned to an unexpected reward condition and to children
people's behaviour during the course of the task they are who received no extrinsic reward.
trying to accomplish.
Intrinsic Motivations (Motivations That Come from Within):
Although it is uncommon to be able to directly observe the
The motivation that arises from within an individual, such as
goals that motivate people to take certain actions, motivation
the desire to solve a difficult puzzle for the purpose of
encompasses not only the factors that initially lead to the
attaining the personal satisfaction that comes from doing so.
behaviour in question but also those that guide and maintain
that behaviour over time. In other words, the motivation to engage in a behaviour arises
from within the individual because it is intrinsically rewarding.
Types of Motivations:
This contrasts with extrinsic motivation, which involves
It is common practice to classify the various forms of
engaging in a behaviour in order to earn external rewards or
motivation into two categories - extrinsic and intrinsic.
avoid punishments.
Extrinsic Motivation (Motivation Derived from Outside
Uses of Motivation:
Sources):
Understanding the approach to work is very important, but
The motivation that originates from factors external to the
there are main factors that can affect motivation in many
individual and typically results in positive outcomes such as
different ways.
praise, trophies, financial gain, or social recognition.
Motivation is very important for our day-to-day life because it The capacity to persevere in the face of challenges and the
provides the right guidance to finish a task for all human stamina to press onward in spite of difficulties are both
behaviours. prerequisites for accomplishing such a goal.
The study of motivation involves the following: The following are the three primary components of
motivation:
Assisting people in taking action, which is very helpful.
Conformational Changes:
Assisting individuals in increasing their productivity while
working toward a goal. This is when the choice is made to carry out a behaviour, such
as enrolling in a science course.
Inspiring people to engage in activities that are beneficial to
their health. Perseverance:
Encouraging people to take chances while guiding them away It is a persistent effort in the direction of a goal, in spite of the
from behaviours that are harmful or undesirable, such as presence of obstacles.
addiction.
One way to demonstrate perseverance is by continuing one's
Assisting individuals in regaining a sense of mastery over their education by enrolling in additional science classes, despite
own lives. the fact that doing so requires a significant investment of
one's time, energy, and resources.
Enhancing your sense of well-being and pleasure in general.
Intensity:
Impact of Motivation:
Intensity is a visible manifestation of the dedication and
Anyone who has ever tried to accomplish something (like
enthusiasm with which one pursues a goal.
losing 10 kilograms of weight or running a marathon) has
probably had the sudden realization that the desire to do so As an illustration, a student might coast by making fewer
alone is not enough to make it happen. efforts, whereas another student might study on a consistent
basis, participate actively in every discussion, and take
advantage of the resources provided by research done outside Existence (E), relatedness (R), and Growth (G) or development
the classroom. are the three distinct types of needs that are represented by
the letters E, R, and G in this paradigm.
While the other student pursues his educational goals with a
greater level of intensity, the first student lacks intensity in his According to Alderfer's paradigm, the three demands listed
efforts. above are what drive every single human being.
Alderfer's ERG Theory of Motivation: Existence, which essentially refers to both a person's physical
and mental well-being, is the most tangible and motivating of
Alderfer's three requirements, and it is also the need that
comes first.
The need for relatedness, a sense of community, and a
healthy relationship with oneself are the next levels of
importance.
The need for growth, which essentially refers to self-
development, fulfilment, and the feeling of realising your
potential, is the one of Alderfer's wants in the ERG model that
is the least tangible, but it is still very important.
Herzberg's Theory of Motivation:

According to Herzberg's theory of motivation, the two factors
The ERG model was established by Clayton Alderfer, who took known as the "Hygiene factor" and the "Motivating factor"
Maslow's Hierarchy of Needs and turned it into a three-factor have an impact on one's level of motivation in the workplace.
model of what motivates people.
If the hygiene factors are not present, the employee will put in Responsibility:
less effort into their work. When present, motivation factors
Employees are required to take ownership of the work they
will inspire an employee to put forth their best effort in their
do.
work.
They should not have the perception that they are being
The following factors are considered to be motivational
subtly managed and should instead hold themselves
factors:
accountable for absolute perfection.
A Sense of Accomplishment:
Promotion:
An employee's job should provide them with a sense of
There should be opportunities for promotion available to the
accomplishment.
employee at all times.
It will fill the employee with a sense of accomplishment for
Growth:
having accomplished something challenging but worthwhile.
Employees should be given the opportunity to learn new skills
Recognition:
through the course of their employment.
An employee's successes on the job should result in
This can be accomplished either through training on the job or
recognition and appreciation from his or her superiors as well
through more formal education.
as from his or her peers.
The following are examples of factors related to hygiene:
This recognition should come from both groups.
The policies of the Company:
The nature of the task itself:
The Company Policies are quite fair and clearly communicated
In order to keep workers motivated, the nature of the task
to each and every employee.
should be interesting, varied, and present a sufficient amount
of a challenge. Additionally, they should be on par with the other
competitors.
Supervision:
ABFM MODULE - A
The supervision conducted ought to be reasonable and fair.
Chapter 5: DIRECTING (PART-V)
The worker ought to be granted as much autonomy as is
consistent with reasonable expectations. What we will study?
Relationships: *All about Supervision?
There should be no tolerance for bullying or factionalism, and *All about Importance of Supervision?
there should be a healthy, kind, and appropriate relationship
between peers, superiors, and subordinates.
Working Conditions:
Both the tools and the environment in which they are used
need to be free of hazards, and they should be easy to
understand.
Compensation Policies:
The wage structure needs to be reasonable and fair.
Additionally, it should be able to compete favourably with
other businesses operating in the same sector.
Status:
The organisation is responsible for keeping track of the status
of each individual employee working for the company.
Working on meaningful projects can help build one's
reputation.
SUPERVISION: Requisite Qualities of an Effective Supervisor:
Supervision is a Latin Word. Effective supervision requires many desired qualities of the
supervisor. Some of these are mentioned below:
Super means 'from the above' and vision means 'to see'.
1. Leadership qualities: Through the leadership qualities, the
In normal sense of the term, supervision means overseeing the
supervisor can influence the work behavior of subordinates, and
activities of others.
direct it towards the attainment of organization's goals.
According to Vitiates - "Supervision refers to the direct and
2. Knowledge and Skills: The technical, human relations and
immediate guidance and control of subordinates in the
conceptual skills and knowledge of the supervisor result in more
performance of their task."
effective discharge of his duties and achieving better results.
George R. Terry and Stephen G. Franklin have defined supervision
3. Personal traits: Social skills, Technical competence, Empathy,
as "Supervision is guiding and directing efforts of employees and
Honesty, Courage, Self-confidence, Communication skills, Teaching
other resources to accomplish stated work outputs."
and guiding ability and Strong common sense are the personal
Supervision is the process of interaction, guidance and control of qualities of a supervisor, which go a long way deciding how
subordinates by meeting them regularly about the performance of effective his supervision is. The morale and productivity of
their work. subordinates may be impacted if the supervision is too tight.
A supervisor plays two important roles: 4. Degree of Supervision: The supervisor should be able to decide
1. Supervisor communicates the plans, policies, decisions and the level of supervision i.e. whether it should be general or close
strategies of management to the subordinates. supervision.
2. A supervisor also acts as a guide to the subordinates. He helps 5. Promoting Cohesiveness of the group: Group cohesiveness (the
them in their professional development by enhancing their quality of being structured or organized in a unified way) is
knowledge and skills relating to their assigned jobs. represented by the level of attraction that each member has for
the group.
6. Rapport with Superiors: Supervisor's relations with his superiors 5. Improved Motivation, Discipline, and group cohesiveness:
must be such that he can present his views and suggestions related
The process of supervision and guidance of supervisor results in
to his subordinates and their work performance, without any
better discipline of the subordinates.
hesitation.
Supervisor also plays a key role in maintaining group cohesiveness
Importance of Supervision:
and harmony among his subordinates.
The importance of supervision can be explained as follows:
6. Provides vital link between Workers and Management:
1. Issue of Orders and Instructions:
A supervisor is a representative of the management when he deals
A subordinate can give better performance when he knows the with his subordinates.
work he is supposed to do. The supervisor makes sure that all the
He, therefore, becomes and important figure in communicating the
instructions are properly communicated to every concerned
policies of the management to workers.
employee.
2. Planning and Organizing the Work:
A supervisor acts as a planner and a work schedule is prepared by
him, so as to ensure an even and steady flow of work.
3. Proper Assignment of Work:
A supervisor makes systematic allotment of activities and
resources and delegate's authority to each worker in his group.
4. Better Utilization of Resources:
Effective supervision leads to minimum wastage as the
subordinates are constantly monitored or observed and, therefore,
they use the resources in the best possible manner.
ABFM MODULE - A BASICS OF CONTROLLING:
Chapter 6: CONTROLLING (PART-I) Controlling is the last function of the management process
which involves other functions of planning, organising,
What we will study? staffing and directing.
*What is Controlling? Within an organisation, "Controlling Process" refers to a
*What are the characteristics of controlling? method that can be implemented to check whether or not
certain criteria are being met.
*What are the advantages of controlling?
It entails gathering information about a system, process,
*What are the limitations of controlling? person, or group of people in a thoughtful manner, in order to
arrive at decisions that are necessary regarding each of these
entities.
When something is controlled, it is ensured that the activities
within an organisation are carried out in accordance with the
plans.
The controlling function determines the degree to which
actual performance varies from pre-determined benchmarks.
It investigates the factors that led to such deviations and
makes an effort to make adjustments in accordance with
those findings.
It is essential for the success of an organisation that the
management control function is carried out in an accurate and
efficient manner.
Following the establishment of plans, management is to increased effort and labour from the employees within the
obligated to carry out a series of steps in order to guarantee organisation.
that the plans will be followed.
(f) Controlling ensures accurate planning for the future by
The steps that make up the basic control process are ones that reevaluating the previously establish standards.
can be followed for almost any application, including boosting
(g) The results of an organisation as a whole will improve as a
product quality, cutting down on waste, and expanding
result of control.
customer base.
(h) The exercise of control reduces the number of errors that
CHARACTERISTICS OF CONTROLLING:
occur.
The characteristics of controlling are broken down into their
ADVANTAGES OF CONTROLLING:
component parts, point by point, in order to provide a more
in-depth understanding of the concept. The following are the The management function of controlling provides the
characteristics: following advantages to the organisation:
(a) Controlling is beneficial to the accomplishment of 1. Assists in accomplishing Organisational Goals.

organisational goals. 2. Helps in minimising errors.
(b) The procedure makes the most efficient use of the 3. Making Efficient and effective use of resources.
available resources.
4. Validates accuracy of standards.
(c) Controlling judges ensuring the correct application of the
5. Improves order and disciple and motivates staff.
standard.
6. Results in better coordination within the organisation.
(d) Discipline and order are also established as a result of the
process. 7. Simplifies supervision and helps in delegation and
decentralisation.
(e) The process of controlling the employees motivates the
employees and boosts employee morale, which, in turn, leads
8. Provides feedback for data improvement for future 7. The organisation may be exposed more errors and frauds if
planning. wrong controls are executed.
LIMITATIONS OF CONTROLLING:
While providing various benefits, as mentioned above, we TYPES OF CONTROL MANAGEMENT:
have to keep in mind that controlling has a few limitations
Broadly, the control management can be of 3 types:
also.
Feedback control:
Following are the main limitations:
These controls are based on the feedback received after the
1. It may be costly to implement, especially in smaller firms.
activity has taken place.
2. It is difficult to compare the actual performance with the
So, the corrective action can be taken only for carrying out
accepted standards, specially in case of standards not
similar activity in future.
expressed in quantitative terms, like job satisfaction, team
spirit and employee morale etc. Proactive control:
3. There is little or no control on external factors like These are future-directed controls which anticipate problems
government policies, changes in consumer behaviour, well in advance and the corrective action is taken accordingly.
technological changes, competition, etc. Concurrent control:
4. There may be resistance from employees as they may These controls are based on the real-time engagement of the
consider it as restricting their freedom. controller as the activity is being carried out.
5. Over-dependence on controls may lead to laxity in So, the corrective action can be taken simultaneously with
supervision. carrying out the activity, to take care of any deficiencies
6. The operations of the organisation may slow down if the observed.
rules are implemented rigidly.
ABFM MODULE - A CONTROL PROCESS:
Chapter 6: CONTROLLING (PART-II) The management process of control ensures that every
activity within an organisation working toward the company's
What we will study? desired outcomes.
*What is Control Process? The managers of an organisation can evaluate how well their
*What are the Steps in Control Process? company is doing with the assistance of this process.
Taking into account all of this information, they are in a
position to choose whether to adjust their plans or to carry on
with them in their current state.
Basic Elements and Steps of the Control Process:
It is essential to the success of an organisation that the
management control function is carried out in an accurate and
efficient manner.
Following the establishment of plans, management is
obligated to carry out a series of steps in order to guarantee
that the plans will be followed.
The steps that make up the basic control process are ones that
can be followed for almost any application, including boosting
product quality, cutting down on waste, and expanding
customer base.
The following procedures are included in the fundamental
control process:
The process of establishing goals and standards: For instance, the achievement of a sales target of one hundred
crores of rupees within one year is an example of a concrete
Although the process of establishing goals and standards is
goal.
part of the planning process, it also plays a significant part in
the controlling process. Comparing the actual performance to the predetermined
goals and criteria:
This is due to the fact that the primary objective of control is
to steer the activities of a company in the direction of those Once managers have a clear understanding of their objectives,
goals. they should measure and evaluate their actual performance
before making comparisons.
It is very important for managers to communicate their
organization's goals, standards, and objectives as clearly as This step basically helps them know if their plans are working
possible. as intended.
If the members of an organisation are aware of their goals, Once a plan has been put into action, managers are required
they will devote their full attention to achieving those goals. to continuously monitor and assess its effectiveness.
In this regard, there should never be any room for employees' If things are not functioning as they should, then they should
interpretations to vary. always be prepared to take the necessary corrective actions.
An organisation has a greater chance of succeeding if all of its In order to accomplish this, they must continually assess their
members work together to achieve shared objectives. current performance in relation to the goals they have set for
themselves.
Managers are required to set goals and take action based on
those goals, and those goals can either be tangible and First, managers need to measure actual performance before
specific or intangible and abstract. they can compare it to past performance.
Those goals are considered to be tangible which can be easily They can do this by measuring results in a monetary context,
quantified in terms of numbers. seeking feedback from customers, and so on.
They can also hire financial experts.
When managers want to measure intangible standards like Continuing to monitor the effects of corrective actions:
market reputation, industrial relations, and other such things,
It is not enough for managers to simply implement corrective
this can often be a difficult task to accomplish.
measures; they must also bring these measures to their
Taking steps to make necessary corrections: inevitable and inevitable logical conclusion.
Managers are obligated to take immediate corrective action Even this step requires thorough evaluation and comparison.
whenever there are gaps between actual performance and
Managers have an obligation to work on finding a solution to
the goals that they have set for their teams.
the problem until they do.
When taken prompt corrective action can not only mitigate
They are obligated to stay nearby and monitor the
the existing damage but also prevent it from occurring again
subordinate's progress even if they delegate the responsibility
in the future.
to someone else.
There are times when companies and other business
They can also refer to him on a personal level so that in the
organisations will implement corrective actions as the default
future he will be able to handle similar issues on his own.
in their policies.
However, this can be a challenging task to accomplish when
dealing with more involved issues.
When this happens, managers are responsible for figuring out
how severe the issue is and coming up with a plan to quantify
it.
They could be forced to resort to extraordinary means on
occasion in order to solve unforeseen problems.
ABFM MODULE - A RELATION BETWEEN PLANNING AND CONTROL:
Chapter 6: CONTROLLING (PART-III) The processes of planning and controlling are inextricably
linked to one another.
What we will study?
The objectives of the organisation are determined through the
*What is the relationship between Planning and planning process, and the controlling process ensures that
Controlling? they are met.
The planning phase determines the control process, and the
controlling phase lays a solid foundation for the planning
phase.
In practice, planning and controlling are inextricably
intertwined and mutually reliant on one another.
Control is an aspect of planning as well as a projection of
planning.
Whereas planning determines the course to be taken, control
monitors deviations from the course and then takes action to
either return to the originally planned course or to a course
that is more suitable.
Planning is the foundation for control because it provides the
entire spectrum on which control functions are based.
This makes planning the basis for control.
The twin pillars of management that are planning and
controlling cannot be separated.
These management functions are inextricably linked to one The relationship between planning and control may be
another and depend on one another. explained as under:
The controlling function is built on top of planning because The Planning Stage is the Originator of Control:
controlling requires measuring performance against standards
During the planning phase, objectives and targets are
in order to analyse deviations and take corrective action.
established. A control process is required in order to
Planning is the foundation of the controlling function. successfully meet these objectives. Therefore, planning comes
before controlling.
Therefore, control cannot be exercised without prior planning.
Controls help Planning Sustain for Long-Term:
Planning without controlling is pointless because without
controlling, it is impossible to monitor the progression of The path that planning takes can be influenced by controlling.
plans and ensure that they are being carried out in the correct
The act of controlling draws attention to the parts of the
manner.
process that require planning.
Therefore, planning will not be successful in achieving goals if
The control process supplies information that can be used for
it does not include controlling.
planning:
The process of planning is considered thinking, while
During the controlling process, the actual performance is
controlling is considered an executive function.
compared to the standards that were established, and any
While planning requires imaginative and innovative thought deviations that are found are recorded. The data gathered for
as well as sound judgement, controlling ensures that decisions the purpose of exercising control are also utilised in the
made during planning are translated into the actions that are planning process.
desired.
Planning and controlling are interconnected in the following
Therefore, planning is more of an evaluative activity, while ways:
controlling is more of a prescriptive one.
The first function that management is responsible for is
planning.
For the purpose of putting plans into action, the other ABFM MODULE - A
functions, such as organising, staffing, and directing, are
Chapter 6: CONTROLLING (PART-IV)
organised.
Control keeps a record of the actual performance and What we will study?
evaluates it in relation to predetermined standards. *All about Control Techniques?
In the event that the performance is lower than the standards *All about Traditional Control Techniques?
that were established, deviations will be determined.
In order to enhance the performance going forward, the
appropriate corrective actions have been taken.
The first step in any process should be planning, and the last
step should be control.
Both must have the other in order to function properly.
Planning and control involve looking into the future:
Both planning and control are concerned with the activities
that will take place in the future within the business.
Planning is always done with an eye toward the future, and
control also looks ahead.
The only thing that can be controlled is the future; the past
cannot be changed in any way.
CONTROL TECHNIQUES: The two broad categories under which techniques of
controlling fall are:
Control techniques give managers access to the specific
information as well as the volume of data they need to 1. Traditional Techniques and
measure and monitor performance.
2. Modern Techniques.
The information that is gathered from the various controls
needs to be adapted so that it is relevant to a particular
management level, department, or operation. Traditional Techniques:
Controlling techniques are the tools that are used to establish The term "traditional management techniques" suggests that
control over business activities, monitor those activities, and these methods have been developed and utilised by managers
take any necessary corrective actions. for an extended period of time.
Controlling a business effectively can be accomplished using The companies believe that these strategies are effective and
any number of methods, both traditional and modern. continue to use them.
The selection of the methods absolutely needs to be done in a The following is a list of the traditional methods of control
strategic manner. that are utilised the most frequently:
When deciding on the approach that will be most effective, Personal Observation:
the organisation needs to take into consideration: It is the most time-honored and traditional approach there is
• The Character of the Company or the type of business. to carrying out the controlling function.
• Specific Clientele or Users to Aim For. The manager does this by personally observing the employees
or workers at the location of the business.
• The challenges that the Organizations are currently facing.
On-the-Spot Observation is another name for this method,
Within the realm of management, there is a wide variety of and it is also known as Direct Observation.
approaches to controlling that can be implemented.
The employees are pressured and motivated to perform at It forecasts the profits and losses that will result from changes
their highest level of productivity when they are directly in the amount of output that is produced.
observed.
The break-even point refers to the point at which the
However, a significant amount of time is required for purchase price and the selling price are equal to one another.
supervision when utilising this method.
Break-even Point Formula:
One of the advantages of utilising it is the ability to acquire
Break Even Point =
genuine and first-hand information for the analysis.
In the event that the operations are not performing as Total cost involves two types of costs, i.e. Fixed Costs and
expected, the managers have the ability to make adjustments Variable Costs.
there and then. Profits and Losses are affected by the proportional changes in
In addition to the benefits discussed above, it allows both.
employees to discuss issues or problems simultaneously. Under the Break-Even Analysis technique, the evaluation is
Additionally, it improves the employees' overall sense of well- based on:
being and morale. • Break-even Point.
• Angle of Incidence.
Break-even Analysis:
• Contribution Margin.
This control method illustrates the relationship between cost
• Margin of Safety.
and volume at varying levels of production output.
The Cost, Volume, and Profit analysis is another name for this
approach.
Statistical Reports: Budgetary Control:
Information is gathered by the manager so that performance The traditional control method of budgetary control is an
can be evaluated across functional areas. important component of the planning and controlling
functions of an organisation.
The information that is gathered is then utilised for the
purpose of comparison. It begins with the planning of the fundamental operations and
continues with comparisons of that planning to the
In this process we do the examination of numerical
performance that actually occurred.
information in the form of:
Comparing and analysing the actual performance with the
• Averages.
planned performance is an integral part of the budgeting
• Percentages. process.
• Coefficient of determination. In general, the following are included among the steps in
• Ratios, etc. budgeting:
The aforementioned information is presented by the (a) Establishing criteria by subdividing the overarching goals of
organisation in the form of charts, graphs, tables, and so on. the company into those of individual departments.
The data can be more easily visualised with the help of these (b) A comparison of the actual performance to the budget and
reports, and the areas that require attention can be located. standards that were previously defined.
As a result, it is the method for data analysis that is utilised (c) Determine the logical deviations from the plan and take
the most and provides the most benefit. corrective actions after you have calculated them.
(d) Having control over one's budget makes it easier to have
control over one's day-to-day activities. Consideration must
also be given to the number of resources and labour that will
be required to accomplish the goals.
(e) There is a possibility that the final budget that was ABFM MODULE - A
formulated will turn out to be inaccurate and costly.
Chapter 6: CONTROLLING (PART-V)
What we will study?
The following is a list of the various types of budgets that are
typically prepared by organisations: *All about Modern Control Techniques?
• Cash Budget.
• Sales Budget.
• Production Budget.
• Capital Budget.
• Material Budget.
Modern Techniques: According to the method, there are two ways in which we can
increase our return on investment:
The management literature has been expanded to include
contemporary control techniques. 1. By increasing the volume of sales in a manner that is
proportionally greater than the overall investment.
These are relatively new developments that offer novel
approaches to the evaluation and management of 2. By lowering the total investment while maintaining the
organizational operations. same level of sales volume.
Return on Investment (ROI): Therefore, we can interpret it as the utilisation of committed
capital for the purpose of producing returns.
Return on Investment, abbreviated as "ROI," refers to the
profit made from capital that has been invested. In addition, companies need to work toward the goal of
earning a satisfactory return on investment.
In order to achieve greater financial control over the company,
it is analyzed. It is useful for:
The Du-Pont Method of financial analysis is another name for 1. Examining the differences and similarities in terms of
this methodology. wealth between the two eras and companies.
Calculating the rate of return on investment (ROI) allows us to 2. Finding areas that have a negative impact on return on
measure the return that was generated. investment.
Using this rate, one can better evaluate the company's current 3. Attracting investors and enhance the company's reputation.
financial situation.
4. Comparison among departments.
ROI Formula:
Financial Statement and Ratio Analysis:
Return on Investment = x Calculating a variety of Ratios is made easier, which in turn
contributes to better financial management of the
organization.
In order to accomplish this goal, data is compiled from the In general, there are four distinct categories of responsibility
financial statements of the companies. centres:
The following ratios are used the most frequently: 1. Revenue Centre.
➢ Profitability Ratios. 2. Cost Centre.
➢ Liquidity Ratios. 3. Profit Centre.
➢ Solvency Ratios. 4. Investment Centre.
➢ Turnover Ratios. Project Evaluation and Review Technique (PERT) & Critical
Path Method (CPM):
The acronym CPM stands for the Critical Path Method, while
Responsibility Accounting:
PERT refers to the Program Evaluation and Review Technique.
It is a method of accounting in which the amount of
The management of projects and their overall quality are
responsibility placed on the individual employee is taken into
directly impacted by the application of these control
consideration.
techniques.
Therefore, businesses will conduct an assessment to
Project Evaluation and Review Technique (PERT) is a
determine whether or not the employee is capable of carrying
procedure through which activities of a project are
out the responsibility in accordance with the criteria that have
represented in its appropriate sequence and timing.
been established.
It is a scheduling technique used to schedule, organize and
This method of command and control works well for large
integrate tasks within a project.
organisations that have a number of different departments.
The critical path method (CPM) is a technique where you
identify tasks that are necessary for project completion and
determine scheduling flexibilities.
A critical path in project management is the longest sequence In addition to this, it helps manage a massive quantity of data
of activities that must be finished on time in order for the and delivers information at precisely the right moment.
entire project to be complete.
The information that is obtained from MIS is reliable and aids
The amount of time spent on the activity or project and the in the process of making decisions.
number of steps involved are two of the most important
MIS is comprised of two primary parts:
factors affecting its outcome.
➢ The Collection of Data.
Therefore, it is in the managers' best interest to reduce the
total amount of time and money required to complete the ➢ The Management of Data.
activity.
The effective completion of the project is the primary focus of Management Audit:
this approach.
Auditing, whether it be Management Audit or Internal Audit,
However, the execution has to be completed within the is the process of examining how a company uses its resources.
allotted amount of time and at the predetermined cost.
It is started by the top level of management in order to
guarantee that the management will perform effectively.
Management Information System (MIS): While internal audit may be a continuous affair and
The Management Information System, or MIS, is essentially periodicity may depend on the size of the organisation,
responsible for providing information that facilitates the management audit may be conducted at intervals decided by
making of sound decisions. the Board of the Company which may be more than a year,
say every two or three years.
Managers are able to retrieve any data whenever it is
required. So, we can say that after the conclusion of the financial audit,
the next step is the management audit.
It is one of the techniques for cost-effectively controlling that
managers have at their disposal.
During the course of the audit, the overall management ABFM MODULE - A
process will be subjected to close scrutiny.
Chapter 6: CONTROLLING (PART-VI)
Nevertheless, it is not required of the organisations that they
necessarily perform management audits. What we will study?
*All about IT Control Techniques?
Selection of the Techniques of Controlling:

When choosing an appropriate method of control, managers
have a responsibility to take into account the following factors:
a) Geographical scope of activities.
b) The overarching management philosophy of a more senior
level of management.
c) Control's goal or primary area of concentration.
d) The accessibility of methods and their ability to meet
requirements.
e) All the associated costs.
f) Patterns seen in industry.
g) The necessary personnel for the procedure.
h) The amount of time that was spent on the entire process.
i) The dependability of the findings that were acquired.
CONTROL TECHNIQUE AND INFORMATION TECHNOLOGY: Every worker has a predetermined agenda that he or she is
responsible for regulating.
In the fields of business and accounting, information
technology controls, also known as IT controls, are discrete Who will be responsible for the actual security?
activities carried out by individuals or systems with the
Who is going to monitor the safety of the website?
intention of ensuring that business goals accomplished.
Who is going to make sure the data is secure?
They are a component of the internal control system of an
organization. There will be a set job description in place prior to the
recruitment of new employees for the information systems
The objectives of IT control relate to the confidentiality,
department.
integrity, and availability of data, as well as the general
management of the enterprise's IT function as a whole. If an employee quits his or her job, having this information on
hand will make it easier to fill the vacancy quickly.
The techniques of control are listed below:
Because maintaining control of information systems will be
1) Organisational Controls Techniques:
the top priority for the company.
When a company installs significant amounts of hardware and
2) Management Control Techniques:
software and also appoints human resources, the company
must first establish the co-ordination between the newly The company may utilize management controls techniques in
installed information system and the newly appointed human order to maintain control over its information systems.
resources. Appointing an expert committee is one of the important
The company has now moved on to the next step, which is to techniques that can be used.
establish organizational control. This committee will include a team of experts from all fields,
Fixing the responsibilities of the manager, senior managers, not just the accounting and finance fields like other
and every employee in the team who handles information committees do.
systems is how this organizational control is implemented.
Everyone will apply their specialised knowledge and (b) Authorization:
experiences to examine the IT system of the organisation and
An employee needs to be authorised before being able to
report back if they find any errors or fraudulent activity in it.
access the login page of a system, asset, or entry.
It is necessary for him to identify himself and establish that he
3) Financial Control Techniques: has the requisite authority to access the system.
One of the problematic aspects of information systems is the Unauthorized access will no longer be possible once this is
department whose job it is to record financial transactions implemented. It is very simple.
made using information systems.
Suppose you purchase a ticket for the metro.
There is a significant possibility that the company will suffer a
You will be given the plastic coin, after which you will be
loss of assets in the event that any member of this team
required to scan it in order to gain access to the metro train.
hatches a malicious and harmful plot.
In this manner, you are responsible for conducting your own
As a result, the company must implement financial control
verification of authorization.
procedures within the IT system in order to eliminate this
unwelcome risk. (c) Budgetary Control:
The following methods can be utilised for various forms of A budget needs to be created for any supply of money that
financial control: will be used for a variety of projects and expenses.
(a) Delegation of financial powers: The time limit and the financial ceiling will be determined by
the budget.
Delegation of Financial Powers means the instructions with
regard to the delegation of financial authority, issued by the Additionally, the difference between the standardized amount
from time to time, relating to the conduct of business or sub- of time and money and the actual amount of time and money
delegation of financial powers under such delegation. spent will be displayed.
Accountability can be determined using this information.
(d) Cancellation of documents: It is necessary for him to take on additional responsibilities
within the same IT system department.
There is a possibility that the cancelled document or invoice
will be used again in the future. Because of this, there will be a reduced risk of fraudulent
activity in the financial sector.
A unique sign indicating the cancellation of these documents
should be placed on it in order to stop it. 4) Data Processing Environment Controls Techniques:
(e) Dual control: The company ought to appoint some specialists for the control
of the data processing environment.
Dual control is when two employees check one asset or one
entry to make sure its accurate. Recently, I noticed that one of my electric wires was sparking.
Because of this, there is a lower probability of making Because I acted quickly, I was able to save not only my
mistakes. inverter but also all of the other electrical equipment that was
in the area.
(f) Input and output verification:
Therefore, the environment in which data is processed today
Before accepting an input or output record, it needs to be
is composed of electronic and electrical components.
checked for accuracy once more.
Therefore, a specialised supervisor who checks it at regular
(g) Safekeeping:
intervals is required for it.
Each and every safe that contains the login passwords for
5) Physical Access Controls techniques:
servers and information technology systems needs to be
locked. The term "physical access" refers to an unauthorised third
party reaching into your database.
(h) Segregation of Duties:
In recent days, you have been listening to the news about
The separation of duties requires that after a predetermined
scams involving banks and the internet.
amount of time, each employee should switch roles.
This was all the result of unauthorised access being gained to
ABFM MODULE - A
the bank's database.
Chapter 6: CONTROLLING (PART-VII)
You need to create security layers so that you can thwart any
attempts of gaining unauthorised access in the data centre. What we will study?
6) Logical Access Controls Techniques: *All about techniques of control continued..?
The malicious hacking and virus will be used to gain *All about application control technique?
unauthorised access to the logical system.
*All about COSO?
Therefore, you should use malicious hacking and antivirus
software to put a stop to it at any cost.
7) SDLA Controls Techniques:
SDLA means system development life cycle. It is also essential
that it be controlled.
The standardisation of the system development life cycle is
one way that this can be accomplished.
8) BCP Controls Techniques:
The abbreviation “BCP" refers to the "business continuity
process"
Maintaining control of it won't be impossible if you have a
sufficient number of backups and a solid recovery strategy in
place in case the system is destroyed.
9) Application Controls Techniques: (next video)
The techniques of control are listed below: IT general controls (ITGC):
9) Application Controls Techniques: ITGC, or IT general controls, are a set of policies and procedures
If you want accurate results from your information system, you that govern how a company’s IT systems operate and ensure the
need to make sure that you are following the application controls. confidentiality, integrity, and availability of data.
It is necessary to block unauthorized access to the recorded Controls over the Information Technology (IT) environment,
database in every computer-based system so that changes cannot computer operations, access to programmers and data, as well as
be made and data cannot be removed. programmer development and programmer changes, are all
included in ITGC.
The two widely used application systems that an auditor needs to
keep an eye on SAP and Quick Book. Functions of ITGC:
The IT Governance Council (ITGC) serves as the structure's primary
SAP stands for Systems, Applications and Products in Data
pillar.
Processing.
They support the assertion that systems operate as intended and
It is a popular Enterprise Resource Planning (ERP) system used for
that output is reliable, in addition to helping to ensure the
various business applications.
accuracy of the data that is produced by information technology
QuickBooks is an accounting software package created by Intuit, systems.
which offers solutions for managing personal, business, and tax
The following categories of controls are typically included in ITGC:
finances.
a) Change management procedures are controls that are designed
to make sure that changes are authorized and that they meet the
The following two categories are frequently used to describe IT requirements of the business.
controls:
b) Procedures for controlling the versions of source code and
1. IT general controls (ITGC). 2. IT application controls. documents, which are controls designed to preserve the
programmers' original intent.
c) Software development life cycle standards are controls that are The controls of an IT application or programmer are fully
intended to guarantee that information technology projects are automated, which means that they are performed automatically by
managed efficiently. the systems.
d) Policies and procedures for incident management are a set of The following are examples of different categories of IT application
controls designed to address errors that occur during operational controls:
processing. a. Checks for completeness are controls that ensure all records
e) Disaster recovery/backup and recovery procedures, to enable have been processed from the beginning to the end of the
processing to continue despite the presence of unfavorable procedure.
conditions. b. Validity checks are controls that ensure only valid data is input
f) Controls to ensure the information technology's physical safety or processed. These checks look for errors in the data.
from both individuals and environmental hazards. This type of c. Identification controls that make sure every user can be
security is referred to as "physical security." definitively and unmistakably pinned down as who they are.
d. Authentication refers to the controls within the application
2. IT application controls: system that offer a method for user authentication.
Transaction processing controls, also known as "input-processing- e. Authorization refers to the controls that ensure the application
output" controls, are what are meant when someone talks about system is only accessible to business users who have been pre-
IT application controls. approved.
By virtue of the Sarbanes-Oxley Act (SOX Act) 2002, controls Authentication verifies a user's identity, while authorization
related to IT have been given a greater level of importance in verifies what they have access.
American corporations that are publicly traded.
Sarbanes-Oxley (SOX) Act of 2002 helps to protect investors from
fraudulent financial reporting by corporations.
3. IT Control and the CIO/CISO: What does COBIT do?
Usually, the Chief Information Officer (CIO) or the Chief COBIT is a framework that is widely used that contains best
Information Security Officer (CISO) of an organization is the one practices for the governance and management of information and
who is accountable for the safety, accuracy, and dependability of technology, and it is directed toward the organization as a whole.
the systems that manage and report the company's data, including It is made up of different domains and processes.
its financial data.
The fundamental structure reveals that business requirements are
Financial accounting and enterprise resource planning (ERP) satisfied by IT processes, which are made possible by particular IT
systems are integrated in the initiating, authorizing, processing, activities.
and reporting of financial data.
COBIT outlines the design considerations that need to be made by
an organization before constructing a governance system that is
4. Internal Control Framework: optimal for its needs.
COBIT: Control Objectives for Information and Related Technology. COBIT in Governance:
COBIT is a framework created by the ISACA (Information Systems COBIT addresses governance problems by combining the various
Audit and Control Association). relevant governance components into governance and
This framework defines a variety of ITGC (general control) and management objectives that can be managed to the necessary
application control objectives as well as recommended evaluation capability levels.
approaches.
The Chief Information Officer (CIO) of an organization is typically 5. COSO:
the person in charge of the IT department. In 1992 the Committee of Sponsoring Organizations of the
This individual is accountable for ensuring that efficient Treadway Commission (COSO) published Internal Control-
information technology controls are utilized. Integrated framework which has become commonly known as
COSO framework.
The Committee of Sponsoring Organizations of the Treadway Internal Control Principles of COSO:
Commission (COSO) identifies five components of internal control: In order to accomplish the goals of financial reporting and
1. Control Environment. disclosure, it is necessary to have these components in place.
2. Risk Assessment. COBIT offers comparable and detailed guidance for information
3. Control Activity. technology, while the IT focuses on higher-level IT governance and
value-for-money concerns.
4. Information and Communication.
The five aspects of COSO can be represented mentally as the
5. Monitoring.
horizontal layers of a three-dimensional cube, and the objective
domains of COBIT can be thought of as applying both to each one
Control Environment - The control environment is the foundation separately and to the whole.
for all other components of internal controls and provides
discipline and structure.
Risk assessment - the entity must be aware of and deal with the
risks it faces. Both internally and externally.
Control activities - Policies and procedures must be established and
executed to help ensure the actions identified by management to
address risk are effectively carried out.
Information and Communications - This is the identification,
retention and transfer of information in a timely manner enabling
personnel to execute their tasks. The four COBIT major domains are:
Monitoring - The entire control process must be monitored, and 1. Planning and organizing. 2. Acquiring and implementing.
modifications made as necessary. 3. Delivering and supporting. 4. Monitoring and evaluating.
ABFM MODULE - B INTRODUCTION:
Chapter 7: SOURCES OF FINANCE AND FINANCIAL All businesses need finance. Basically, finance is required for
STRATEGIES (PART-I) establishing businesses and also for running them
subsequently.
What we will study?
The finance to start the business is generally provided by the
*What are the various sources of funds? persons who moot the idea of business. These persons are
known as owners or promoters.
*All about Equity Capital?
Since the owners are going to stay with the project, their
finance is long term finance.
However, if the project is too big and the promoters do not
have enough money, normally long-term borrowing is
preferred.
Since at times, processing of term loans takes time, promoters
also go in for bridge finance which is a temporary funding to
fill the time gap between the fund requirement and the actual
release by the long-term lenders.
Term finance is provided by banks and financial institutions.
There is a norm called debt equity ratio which means how
much ideally promoters should contribute as equity and how
much they should borrow for long term.
This depends on various factors but the general and safe norm
is if equity is Rs. 100, one can safely borrow up to Rs. 200.
The entire requirement of long-term funds will depend on the However, the bankers will always insist on the borrower to
size and capital requirement of the project. provide his contribution towards the gap.
The finance required for running a business is called working The quantum of working capital finance varies from time to
capital finance and is based on the gap between the current time based on the level of business activities and the gap.
assets and current liabilities.
It also depends on how you manage and minimize the gap.
Current assets are those which are created and extinguished
Financial strategies are those permutations and combinations
in an operational cycle.
which a business adopts or avails to satisfy its funds
An operational cycle is the time or period in which cash, after requirements, whether these are long-term or short-term.
going through various forms is converted back into cash.
Strategies are so worked out as to maximise the advantages
For example, with cash you buy raw materials that are and minimise the cost of funds.
converted into finished goods through work in process and
A clean finance is the costliest, because the lender who has no
later when the finished goods are sold, they are converted
assets to fall upon in case of a default and runs higher risks
into debtors or receivables and upon realisation or debt
which he would cover by charging higher rate of interest.
collection, the cash comes back into the business.
Equity is a clean finance and although it appears to be cheap,
Clearly, you need funds for all these activities and functions
the cost of servicing is very high because the equity
before you realise profits.
shareholders will expect good returns over the years in the
Like in any business, and depending on the creditworthiness form of dividend, which is always distributed after the
of the business entity and the established norms, credit is company pays its taxes.
generally available for procuring goods.
They also expect increase in the market price of shares.
Therefore, to that extent, fewer funds are required.
The other examples of clean finance are preference shares
The gap between these assets and the said liabilities is the and unsecured debentures, the issue of which is fairly
working capital gap which can be financed by a bank. regulated.
The other sources of finance are borrowings for long term as A corporate has hordes of investors who come from various
well as short term purposes by offering security such as fixed walks of life and who may neither know one another nor may
and current assets. be related to each other.
The rate of interest a corporate pay depends on how strong is It was at the time of arrival of corporates, that the term Equity
its balance sheet, performance, profitability, track record of got coined.
past servicing and repayment, and last but not the least, the
Equity means a quality of being fair or impartial, something
rating the business gets from a reputed and approved credit
that is fair and just.
rating agency.
Equity capital has the following features as well as advantages:
Therefore, now a day, most large borrowers go for a regular
rating exercise to avail the best deals. 1. It is divided into units called Equity Shares.
2. Each unit has the same value called nominal value.
EQUITY CAPITAL: 3. Equity holder has two types of financial rights; the right to
income (dividend) and the right to retaining surplus assets in
Capital generally means the amount invested for establishing
case of liquidation. Additionally, they also have voting rights
a business which is owned by the promoter.
(except in case of Differential Voting Right shares), whenever
In accounting terms, it means the amount remaining after so required by the governing act viz. Companies Act, 2013.
selling all the assets and paying off all the liabilities.
4. Anyone can buy or subscribe to any number of Equity
It also represents the money the owner brought in at the time Shares subject the terms and conditions prescribed in the
of setting up the business and the profits he earned but did Articles of Association of the Company.
not take away over a period of time.
5. All subscribers to the Equity Shares are governed by a
Over a period of time, as business developed, various forms of common document called Memorandum and Articles of
organisations or entities evolved with the arrival of corporates. Association.
6. All subsequent transferees of such shares also have to abide This is prescribed by the Memorandum and Articles of
by the above document. Association of the company and in case of any change, the
company has to go to the shareholders as prescribed in the
7. The Equity Shareholder can exit at will by following the
Act.
prescribed rules.
Issued Share Capital: The part of authorised capital which is
8. If the company is listed on a stock exchange, the liquidity of
issued to public for subscription.
the Equity Shares increases since the holder can sell it to
anyone through the exchange. This includes shares issued for cash and for consideration
other than cash to promoters of a company or other people.
9. Equity Shares can be priced by the issuer at the nominal
value or at a premium or discount subject to extant
regulations and guidelines.
Subscribed Share Capital: It is the portion of the issued share
10. Also, subject to extant regulations and guidelines, Equity capital that is subscribed to by the public, i.e., applied for and
Capital can be enhanced, reduced, subdivided, bought back or allotted by the company.
issued free of cost.
It also includes the face value of the company's shares issued
11. Equity Shareholder can also pledge and borrow against the for consideration other than cash.
shares because an equity share is a marketable and valuable
It is possible that all the shareholders, who have been called
security.
upon to subscribe to the capital, may not respond and
therefore the actual subscribed capital may be less than the
called up one.
Some other terms related to the equity capital are:
Called-up Share Capital: This is that part of the Issued Capital
Authorised Capital or Nominal Capital: This represents the
that the company has called up from the shareholders.
maximum amount of capital that the company is authorised
to issue which can be in any instalments as the Board decides. The call can be one or more subject to the extant regulations
and need of funds by the company.
Paid up Share Capital: Paid up capital is the amount of money ABFM MODULE - B
a company has received from shareholders in exchange of
Chapter 7: SOURCES OF FINANCE AND FINANCIAL
shares.
STRATEGIES (PART-II)
However, even after subscription, some may skip or delay the
actual payment and, in such case, the paid-up capital can still What we will study?
be lesser than the subscribed capital. *All about Internal Accruals?
Calls in Arrears: are a part of the called up or subscribed
*All about Prefernce Capital?
capital which the company can follow up and rightfully collect
when the shareholders fail to pay the full or part amount.
Unpaid Share Capital: is, as the name suggests, the amount
finally determined as unpaid for which the management can
take suitable decision.
Forfeited Shares: are that part of the subscribed capital which
is not fully paid as required and as a final resort, the company
forfeits the amount so that it can be reissued as the Board
decides, subject to the regulations.
INTERNAL ACCRUALS: These reserves such as dividend equalisation reserve,
redemption reserve fund and other mandatory reserves under
As a measure of financial prudence, no company can or would
certain statutory provisions, cannot be utilised as free or
like to distribute the entire earnings after tax to the
general reserves until transferred to free reserves after the
shareholders.
expiry period or before fulfilment of the laid down conditions.
There are also dividend distribution rules which the regulators
Internal accruals or the ploughed back profits belong to the
want the management to follow.
equity holders and become equity if these are converted in to
As a result, part of the Profit After Tax (PAT) is retained in the bonus shares for which regulations exist.
company, which usually reflected in the general reserve.
Let's now see what advantages and limitations internal
These retained profits are internal accruals of the company. accruals represent.
These arise out of the cash profits i.e. (1) PAT, (2) non-cash Advantages:
profits charged to the Profit & Loss account, in the form of
➢ There is no restriction on the use of internal accruals,
provisions or reserves and (3) depreciation charged to the
except as mentioned above.
Profit & Loss account.
➢ These can be used for long term as well as short term
If the company has preference shares on which dividend is
purposes.
cashed out, the same will reduce the retained earnings.
➢ Internal accruals do not have any cost for use or servicing.
Depreciation is part of internal accruals as it results in
increasing the cash balance available to the company even ➢ Internal accruals are readily available.
though it does not affect the general reserves and, therefore,
➢ Internal accruals are as liquid as the form in which these
cannot be used for declaring dividend and issue of bonus
remain invested.
shares.
➢ The use or availing of internal accruals does not change the
Internal accruals can also include other reserves which are
ownership structure or results in the dilution of control.
created out of current profits but post tax.
➢ There is no cost of raising these funds. which is one of the major monetary considerations for any
investor.
Disadvantages:
It is a quasi-risk capital because it is not as safe as secured
➢ Just because internal accruals are readily and easily
debts which get payment priority over preference shares in
available, there is tendency of indiscriminate application of
case of liquidation of a company.
retained earnings.
Host regulations with regard to the issue of preference shares
➢ The cost of these funds in reality is higher because these
exist.
represent undeclared dividend. These funds, therefore,
belong to the equity shareholders and they expect If equity is a common stock, preference share is preferred
reasonable return on these. stock.
➢ Retained earnings are deprivation of dividend and over-use Let's now see what are the main features of the preference
of such earnings may hurt the shareholders particularly the capital:
minority shareholders.
➢ It is a stock which is preferred over equity shares with
➢ The company cannot build a good dividend track record regards to the payment of dividend and repayment in case
resulting into lesser interest by investing public. of liquidation.
➢ Safety cover provided by the retained earnings is reduced ➢ Unlike equity capital, the dividend rate of preference share
by the use of it. is fixed just like debentures.
PREFERENCE CAPITAL: ➢ Generally speaking, the preference shares are entitled to
dividend if distributable profits are available and hence
This is that part of the capital which provides lesser risk to the
dividend distribution is not obligatory like equity capital.
investor compared to that which is taken by the equity
investors. ➢ Like equity capital, preference shares are paid dividend, out
of post-tax profits and hence the dividend on preference
As the name suggests, the holder gets a preference with
shares is not a tax-deductible expense.
respect to dividend as well as payment is case of liquidation,
➢ There are cumulative preference shares where the dividend Why companies raise preference capital and the reasons are
is guaranteed. In other words, if in a year the company does not far away to find:
not have enough profits to declare dividend, it is
➢ It is a good source of funds for very long period up to 20
accumulated to the credit of the shareholders and paid
years.
when, in a subsequent year, the distributable surplus is
available. ➢ In case of infrastructure companies, the period can even be
more than 20 years.
➢ Redeemable Preference Shares are those which get repaid
as per the terms of issue. Under the current provisions of ➢ Mostly such securities are privately placed and hence the
the Companies Act, 2013, companies are prohibited from cost of raising such funds is not high.
issuing Preference Shares which are not redeemable. All the ➢ Private placement (or non-public offering) is a funding
preference shares are required to be redeemed within a round of securities which are sold not through a public
period not exceeding 20 years. Redemption has to be made offering, but rather through a private offering, mostly to a
out of profits or out of the proceeds of fresh share issue for small number of chosen investors.
such redemption purpose. However, in case of banks,
➢ There is no compulsion to pay dividend unless cumulative
perpetual debt instruments can be issued.
preference shares are issued.
➢ Preference shareholders have a limited right to participate
➢ The recurring cost in the form of dividend is fixed and
in voting only on some of the resolutions as specified in the
known beforehand unlike dividend on equity shares.
Companies Act, 2013. Where dividend on preference shares
has not been paid for two years or more, such shareholders ➢ The current owners do not have to dilute their equity
get a right to vote on all company resolutions. holding and hence they retain the present level of control
over management.
➢ It is a part of the net worth of the company and hence it
helps is improving the debt equity ratio.
➢ Absence of voting rights, unless the company skips dividend ABFM MODULE - B
for two or more years, gives a comfort to the management
who generally does not like interference.
STRATEGIES (PART-III)
➢ No security is provided to the preference shareholder
unlike in case of debentures. What we will study?
However, there are certain drawbacks, from the point of view *All about Debentures?
of the management and the equity shareholders, which are
enumerated below:
➢ Possibility of management interference in case of non-
payment of dividends for more than 2 years.
➢ Dividend paid is a non-deductible expenditure which
increases the real cost of funding.
➢ Equity shareholders feel side-lined when the preference for
dividend payout is given to preference shareholders.
➢ In case of liquidation, these shareholders get prior charge
over the residual assets compared to the equity
shareholders.
DEBENTURES: Regulations:
Section 2(30) of the Companies Act, 2013 defines "debenture" Section 71 of the companies Act, 2013 contains provisions
which includes debenture stock, bonds or any other relating to issue of debentures covering the points such as
instrument of a company evidencing a debt, whether manner, procedures, convertibility, voting rights, redemption,
constituting a charge on the assets of the company or not. creating reserves, prospectus or invitation, trust etc.
In other words, it is a written instrument acknowledging debt Fixed tenure:
by the company promising repayment at a certain future date.
Loans are repaid in instalments over a period of time.
This is another form of long-term borrowing targeted at
On the other hand, debentures are repaid on a fixed date on
various individuals or institutions that subscribe to the issue
expiry of the term.
and pay to the company.
Repayment on maturity is also called redemption.
The terms of issue like tenure, rate of interest, denomination,
minimum subscription, total issue size etc. all form part of the Perpetual bonds are also permitted to be issued.
issue document. Fixed rate of interest:
The following are the main features of debentures: The rate of interest is also prefixed.
An instrument: In case of so called, Zero-Coupon bonds also, a fixed rate of
Debenture is an instrument issued by the borrower company interest, payable at the time of redemption, is involved as
promising to pay, at fixed future date, a certain amount to the these are issued at a discount to their redemption value.
holder. Call options with the issuer:
Agreement or deed: The company issuing debentures can incorporate an option
If debentures are issued to more than 500 persons, Trustees like call option where it can repay the principal before due
are required to be appointed to look after interest of the date at a fixed price. This is called call option.
debenture holders.
Put option with the investor: Based on security:
The company issuing debentures can incorporate an option Many a times, to offer lower rate of interest and a sense of
like put option where the investor has the option to demand security to the investor’s, secured debentures are issued
redemption before due date at a fixed price. providing first or second charge over the fixed assets of the
company and appointing trustees if the number of holders
This is called put option.
exceeds 500.
No voting rights:
Based on Convertibility:
Section 71(2) of the Companies Act,2013 prohibits giving any
To provide additional incentive to the investors, the
voting rights to a debenture holder.
companies issue partly or fully convertible debentures so that
Stake in the company: at a future date, upon conversion, the debentures holders can
In case of convertible (wholly or partly) debentures, which are be growth participants and also have voting rights.
permitted to be issued, the debenture holder gets an equity Based on negotiability:
stake in the company after conversion in the equity followed
The debenture is a debt instruments and mostly transferable
by voting rights.
by way of a registered transfer form.
The ratio of conversion as well as the price at which shares
However, in case of bearer debentures the transfer takes
will be valued is indicated in the offer document.
place by mere delivery.
Types of debentures:
Such debentures are rare due to concerns such as money
Based on tenure: laundering and benami transactions.
There are debentures specifying redemption with call options, Advantages and disadvantages:
put options, or with fixed tenure under this kind.
Advantages emanate from the features of debentures such
Perpetual bonds with call option, are also permitted to be low cost of raising of funds, known and fixed future interest
issued. liability, known date of redemption liability facilitating
planning of fund management, no dilution of owners' equity ABFM MODULE - B
and management powers, flexibility to provide negotiated
cost of servicing and redemption period beforehand, some of
which are not available in Institutional Long Terms where the STRATEGIES (PART-IV)
company does not have as much bargaining power. What we will study?
Disadvantages are that once issued, no negotiation of terms is *What is Alternative Financing Strategy?
possible, rating requirement may create some unanticipated
problems, statutory requirement of creating reserve funds *What is Private Equity (PE)?
and investment thereof and finally you deal with numerous *What is Foreign Direct Investment (FDI)?
investors as against one lender in case of Long-Term Loan.
Conclusions:
If we summarise the long-term funding, we find that as we
move from equity to debentures, we find reduction in cost of
raising funds; control dilution is only in the case of equity
issue except when loan or debentures are converted, the
dilution follows.
The issuer incurs lowest risk while issuing equity which
increases as he moves to other long-term sources of financing.
With regard to management freedom equity is the least
preferable.
ALTERNATIVE FINANCING STRATEGIES IN THE CONTEXT OF A businessman has a number of alternatives available today
REGULATORY REQUIREMENTS: who looks for finances.
Financing is considered to be an important part of any However, since these are not within the banking or NBFC
business study. sector, they do not and cannot replicate activities carried on
by banks and NBFCs.
It relates to money, the most valuable asset and also the most
liquid. It is also subject to great risk. These cater to funds requirements which are tailor made for
SMEs, start-ups, reality sectors etc.
Whoever deals with it, whether a lender or borrower, has to
be not only extra careful but also has to be brought under Some of these are crowd funding, peer to peer lending,
supervision and some desired control. Alternate Finance Funds, mutual funds, angel investors,
venture capital funds, boot strapping, Real Estate Investment
Therefore, there have been various regulatory efforts by
Trusts (RIETs), Infrastructure Investment Trusts( InvIT) etc.
statutory authorities, the major being Reserve Bank of India.
All these deal with all sorts of finance from micro to long term
The entire banking sector has been regulated by Banking
to extra-long term as well as equity.
Companies Act, 1949 (changed to Banking Regulation Act,
1949 from March 1, 1966), which has been always evolving. SEBI had come out with a consultation paper on crowd
funding but later decided not to pursue it.
We have also guidelines issued by RBI for those Companies
engaged in financing activities which are non-banking. Private Equity (PE):
These are known as non-banking financing companies that are Private equity industry has emerged as a potential source of
also regulated by RBI. capital for the corporate sector today.
Since most of these are in the corporate sector, SEBI also Lerner has broadly defined private equity organization as
comes out with guidelines to regulate activities directly, partnerships specializing in venture capital, leveraged buyouts
indirectly or remotely connected with finical advice including (LBOS), mezzanine investments, build-ups, distressed debt
lending. and other related investments.
The European Venture Capital Association defines private Second-stage:
equity as the provision of equity capital by financial investors -
Providing working capital funding and required financing for
over the medium or long-term to non-quoted companies with
young firms during growth period.
high growth potential.
Third-stage:
It is also called 'patient capital' as it seeks to profit from long
term capital gains rather than short term regular Financing the expansion of growth of companies.
reimbursements. Bridge financing:
Private equities are generally less liquid than publicly traded Last financing round prior to an initial public offering of a
stocks and are thought of as a long-term investment. company.
Pratt has tried to categories types of private equity activities PIPE deals:
in terms of the stages of corporate development, where PE
A private investment in public equity, often called a PIPE deal,
financing is called for.
involves the selling of publicly traded common shares or some
Seed Financing: form of preferred stock or convertible security to private
Providing small sums of capital necessary to develop a investors.
business idea. Leveraged Buyout (LBO):
Start-up financing: It entails the purchase of a company by a small group of
Providing capital required for product development and initial investors, especially buyout specialists, largely financed by
marketing activities. debt.
First-stage: Management Buyout (MBO):
Financing the commercialization and production of products. It is a subset of LBO whereby incumbent management is
included in the buying group and key executives perform an
important role in the LBO transactions.
Foreign Direct Investment (FDI): amount and maturity, end use stipulations, etc. will apply to
such issues.
Foreign Investment in India is governed by the FDI policy
announced by the Government of India and the provisions of A foreign investor can invest in an Indian company which is a
the Foreign Exchange Management Act (FEMA) 1999. small-scale industrial unit provided it is not engaged in any
activity which is prohibited under the FDI policy.
Foreign investment is freely permitted in almost all sectors.
Such investments are subject to a limit of 24% of paid-up
Foreign Direct Investments (FDI) can be made under two
capital of the Indian company/ Small-scale industries (SSI) Unit.
routes- Automatic Route and Government Route.
The policy and procedures in respect of FDI in India is
Under the Automatic Route, the foreign investor or the Indian
available in the Manual on Investing in India, 'Foreign Direct
company does not require any approval from RBI or
Investment, Policy & Procedures'.
Government of India for the investment.
Under the Government Route, prior approval of the
Government of India, Ministry of Finance, Foreign Investment
Promotion Board (FIPB) is required.
Indian companies can freely issue equity shares / convertible
debentures and preference shares subject to valuation norms
prescribed under FEMA Regulations.
Issue of other types of preference shares such as non-
convertible, optionally convertible or partially convertible are
considered as debt.
As such, the guidelines applicable for External Commercial
Borrowing (ECB), viz. eligible borrowers, recognised lenders,
ABFM MODULE - B TERM LOANS:
Chapter 7: SOURCES OF FINANCE AND FINANCIAL STRATEGIES This is another major source of long-term finance by which a
(PART-V) company can obtain term loans from banks or financial
institutions.
What we will study?
While banks also give working capital finance, the Financial
*What is Term Loan? Institutions are allowed to give only such loans which are
repayable over the years as per the terms and conditions of
the sanction.
This source is different from equity and relatively, cheaper to
service.
The equity forms are either a permanent source where
repayment is not there or a very long period like 20 years is
available for repayment in the case of preference shares or
capital.
Term loans can be for long to medium terms stretching to
about ten years.
Term loan may not be as costly a source of finance as taking
working capital finance because rates are determined based
on medium to long term prospects of the project where
cyclical movements in the business fortune are more or less
evened out.
Generally, term loans are resorted to finance setting up or If the project is already running and loan is taken for capacity
expansion of the projects. build up, a shorter period up to 5 years will suffice as cash
flows are already there.
The main features of Term Loans are described below:
Short to medium term loans are preferred for other tangible
Period:
assets such computers, peripherals, furniture, renovations etc.
All loans, except demand loans, are term loans and are
Loans are also granted for housing and soft furnishing.
generally granted for short terms to long terms.
Interest:
Short term loans are repaid within a year.
Term loans carry a fixed and predetermined rate of interest.
Long term is period from 5 to 10 years and medium term is a
range from 1 to 5 years. The rate to be charged is negotiated and depends upon
factors such as period, risk, rating of the borrower or
This is the period within which the loans are to be fully repaid.
creditworthiness as well as the purpose.
Loans granted for housing are generally for long period
Interest is payable either monthly or quarterly and sometimes
ranging from 5 years to 30 years.
it is embedded into the equal monthly instalment (EMI) which
Purpose: combine both interest and principal.
Term loans are granted to acquire assets like land, buildings, In certain regulated sectors, there are floor and ceiling rates of
plant and machinery to establish a factory or set up a project interest prescribed.
which are tangible and have a long useful life.
Rates also depend on the market conditions and competition.
For the reasons such as long gestation period, slow start to
Sometimes, the relationship with borrower and future
cash generation cycle and longer life, a longer period is
business opportunity are also taken into account while
granted for repayment.
determining the rate of interest.
Penal, additional or higher rates are generally provided for Currency:
delays beyond the agreed repayment period.
In many large projects, the import component of assets is
In case moratorium is granted for repayment of principal, quite large where the loans are granted in foreign currency to
interest is required to be paid as per the schedule. facilitate proper requirement, since the quotations are foreign
currency denominated and by the time the actual import
Whether the interest is paid separately or is embedded in EMI,
takes place the INR element may be a different amount.
the interest keeps reducing depending on the outstanding
principal amount due. Repayments are also done in foreign currency where the
borrower buys the foreign exchange from the market at the
Repayment:
then prevailing rate.
Loans are generally repaid over the granted period and
Security:
generally in instalments which are monthly, quarterly, half
yearly or yearly. Uncertainty over a long period obviously enhances risk
perception and so also insecurity in the mind of the lender.
In some specific but time bound acquisition of assets, there is
recovery by bullet payment in one shot. Even otherwise, no lender can or will lend without securing
the term loan by creating charge over the primary assets, i.e.,
Moratorium is granted for principal repayments where
the assets purchased through the term loan.
projects are large and cash generations are likely to take time.
Sometimes collateral securities are also obtained which
In cases like EMI, the financial burden is evenly spread out
generally comprise of personal assets of the promoters,
though the interest component gradually goes down.
especially to keep the promoters highly committed.
From every instalment, the accrued interest is carved out first
Tangible securities are always preferred.
and only the remaining amount is apportioned towards
principal. A proper and independent valuation is carried out by the
lender. Titles to the mortgaged assets and liquidity or sale
ability are also examined.
Amount of loan: To mitigate these temporary liquidity problems, the bank
agrees to provide a short-term loan under the head Working
In case of purchase of existing assets, the lender carries out an
Capital Term Loan. The bank fixes the instalments for
independent valuation and after providing a margin to cover
repayment.
value fluctuation and borrower's margin or contribution, the
loan amount is determined. WCTL was more relevant in pre-liberalization era when the
credit was restricted and the concept of MPBF (Tondon
In cases where the term loan is for creation of fixed assets by
committee) was strictly implemented.
the borrower, the loan amount is arrived at by the debt /
equity ratio, as decided by the lender. Banks were required to ensure the required current ratio,
depending upon whether they have used 1st (1:1) or 2nd
Appraisal:
(1:1.33) method of lending in assessing the working capital
The appraisal process of a term loan by the lender depends on requirements.
the size and complexity of the project financed.
However, no term loan is granted without examining the
economic viability and technical feasibility.
Working Capital Term Loan (WCTL):
This is not a type of normal term loan given by any bank or
Financial Institution. It is a term loan against the current
assets.
It is used in the banking industry when a working capital loan,
given by a bank, is not being properly serviced by the
borrower due to temporary liquidity constraints.
Due to these liquidity constraints, the cash credit account
remains generally overdrawn.
Conversion: Moratorium:
Conversion of loan into equity is generally not a planned It takes time for any project to start generating cash flows,
action except when the banks and the borrower agree upfront positive cash flows and profits. Bigger the project, longer the
to convert loans into equity at a later stage. time.
In such a case, at the expiry of the agreed term, the loan is Therefore, till such time the borrower starts generating
converted into the equity of the borrower. The valuation required cash flows, the lenders give time to start the
mechanism is pre-agreed. Sometimes, it is optional for the repayment. This grace period is called moratorium.
lender to convert.
Moratorium is generally for the principal repayment and
Many times, the loan quality deteriorates and the borrower interest is required to be paid as and when due.
expresses inability to pay interest or instalments of
It is mutual to agree for the moratorium for the interest
repayment.
payments.
In such a scenario, left with no better option, the loan is
restructured and as a part of the scheme, conversion of full or
a part of the outstanding is done into equity of the borrower
at an agreed price.
Marketability of such shares is generally poor and these give
no return to the lender except a seat on the board which
helps the bank to better monitor the running of the project or
business of the borrower.
ABFM MODULE - B INTRODUCTION:
Chapter 8: Financial and Operating Leverages (PART-I) We use a lever to enhance the impact or force to push or
move an object.
What we will study?
*What is Leverage?
The simplest example of a lever is the see-saw which has a

long bar with a fulcrum and two children sit on the bar, one
on each side of the fulcrum.
A light-weight child can lift a heavier child on the other side if
his distance from the fulcrum is more than the distance of the
heavier child.
This property of lever prompted Galileo to say, "Give me a
point of support and I can lift the earth". Same principle is
applied in business.
When you apply it to the operations, it is called operating Example 1: [EBIT 50% = EPS 50%]
leverage and when you apply it to the finance functions, it
Particulars Scenario 1 Scenario 2
amounts to financial leverage.
EBIT 1,00,000 1,50,000
Profitability Statement:
Tax@50% 50,000 75,000
PARTICULARs ₹
PAT 50,000 75,000
Sales xxx
No. of shares 10,000 10,000
(-) Variable Cost (xx)
EPS 5 7.5
CONTRIBUTION xxx
(-) Fixed Cost (xx)
Example 2: [EBIT 50% = EPS 62.5%]
EARNING BEFORE INTEREST & TAX [EBIT] xxx
Particulars Scenario 1 Scenario 2
(-) Interest (xx)
EBIT 1,00,000 1,50,000
EARNING BEFORE TAX [EBT] xxx
Interest 20,000 20,000
(-) Tax (xx)
EBT 80,000 1,30,000
EARNING AFTER TAX [EAT] xxx
Tax @ 50% 40,000 65,000
𝐄𝐀𝐓 PAT 40,000 65,000

EARNING PER SHARE [EPS] =𝑵𝒐 𝒐𝒇 𝒆𝒒𝒖𝒊𝒕𝒚 𝒔𝒉𝒂𝒓𝒆𝒔
No of shares 10,000 10,000
EPS 4 6.5
ABFM MODULE - B TYPES OF LEVERAGE:
Chapter 8: Financial and Operating Leverages (PART-II) 1-Operating Leverage
What we will study? 2-Finanacial Leverage

3- Combined Leverage
*Types of Leverage?
*What is DOL,DFL,DCL?
1-Operating Leverage:
Taking advantage of operations of business i.e., Operating
Fixed Cost.
We can measure the operating leverage using degree of
leverage i.e., Degree of Operating Leverage (DOL).
By increasing the SALES by a certain %, we want to increase
EBIT by a greater %.
% 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐄𝐁𝐈𝐓
Degree of Operating Leverage (DOL) =
% 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐒𝐚𝐥𝐞𝐬
In other words, we are measuring the impact of Fixed Cost.
𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧
DOL =
𝐄𝐁𝐈𝐓
2-Finacial Leverage: In other words, we are measuring the impact of Interest Cost
and fixed cost.
Taking advantage of financial structure of business i.e., Fixed
Cost of finance = interest. 𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧
DCL =
𝐄𝐁𝐓
We can measure the financial leverage using degree of
Formula:
leverage i.e., Degree of Financial Leverage (DFL).
𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐄𝐁𝐈𝐓
By increasing the EBIT by a certain %, we want to increase EPS DOL = DFL =
𝐄𝐁𝐈𝐓 𝐄𝐁𝐓
by a greater %. 𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐄𝐁𝐈𝐓 𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧
DCL = DOL * DFL = * =
% 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐄𝐏𝐒 𝐄𝐁𝐈𝐓 𝐄𝐁𝐓 𝐄𝐁𝐓
Degree of Financial Leverage (DFL) =
% 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐄𝐁𝐈𝐓 𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧
DCL =
𝐄𝐁𝐓
In other words, we are measuring the impact of Interest Cost.
𝐄𝐁𝐈𝐓
Summary:
DFL =
𝐄𝐁𝐓 Degree of % 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐄𝐁𝐈𝐓 𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧
DOL= DOL =
3-Combined Leverage: % 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐒𝐚𝐥𝐞𝐬 𝐄𝐁𝐈𝐓
Operating
Taking advantage of operations and financial structure of Leverage (DOL)
business. Degree of % 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐄𝐏𝐒 𝐄𝐁𝐈𝐓
DFL = DFL =
% 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐄𝐁𝐈𝐓 𝐄𝐁𝐓
We can measure the combined leverage using degree of Financial
leverage i.e., Degree of Combined Leverage (DCL). Leverage (DFL)
Degree of % 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐄𝐏𝐒 𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧
By increasing the Sales by a certain %, we want to increase DCL = DCL =
% 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐒𝐚𝐥𝐞𝐬 𝐄𝐁𝐓
EPS by a greater %. Combined
Leverage (DCL)
% 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐄𝐏𝐒
Degree of Combined Leverage (DCL) =
% 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐒𝐚𝐥𝐞𝐬
ABFM MODULE - B Example 1:
Chapter 8: Financial and Operating Leverages (PART-III) Calculate Degree of Operating Leverage when, a company
sells 1000 units of product X at Rs. 50 having variable cost of
What we will study? Rs. 30 per unit and fixed cost of Rs. 15,000.
*How to calculate DOL? Solution:
Particulars Product X (Rs.)
Sales (50 x 1000 units) 50,000
Less: Variable Cost (30 x 1000 units) (30,000)
Contribution 20,000
Less: Fixed Cost (15,000)
Profit (EBIT) 5,000
𝑪𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏
Degree of Operating Leverage (DOL)= 𝑬𝑩𝑰𝑻
𝟐𝟎,𝟎𝟎𝟎
= 𝟓,𝟎𝟎𝟎
= 4 times
Example 2: Illustration 3:
A Company ABC Ltd produces and sells 20,000 shirts. The Calculate the degree of operating leverage for each of the four
selling price per shirt is Rs. 500. Variable cost is Rs. 200 per Companies A Ltd, B Ltd, C Ltd and D Ltd from the following
shirt and fixed operating cost is Rs. 40,00,000. price and cost data:
Calculate degree of operating leverage. Company
Solution: A Ltd (Rs.) B Ltd (Rs.) C Ltd (Rs.) D Ltd (Rs.)
Sale price 20 32 50 70
Variable cost per unit 6 16 20 50

Particulars Rs.
Fixed operating cost 60,000 40,000 1,00,000 Nil
Sales Revenue (20,000 x 500) 1,00,00,000
Less: Variable Cost (20,000 x 200) 40,00,000
Company
Contribution 60,00,000
A Ltd B Ltd C Ltd D Ltd
Less: Fixed Cost 40,00,000
Sale(units) 5,000 5,000 5,000 5,000
EBIT 20,00,000
Seles revenue (Units x sale 1,00,000 1,00,000 2,50,000 3,50,000
price per unit)
𝑪𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏 Less: Variable cost (Unit x (30,000) (80,000) (1,00,000) (2,50,000)

Degree of Operating Leverage =
𝑬𝑩𝑰𝑻 variable cost per unit)
𝟔𝟎,𝟎𝟎,𝟎𝟎𝟎 Contribution
= 𝟐𝟎,𝟎𝟎,𝟎𝟎𝟎 = 3 times 70,000 80,000 1,50,000 1,00,000
Less: Fixed operation costs (60,000) (40,000) (1,00,000) Nil (0)
EBIT 10,000 40,000 50,000 1,00,000

𝑪𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏 𝟕𝟎,𝟎𝟎𝟎 Say we sell total 1000 units:
DOL A Ltd = = = 7 times
𝑬𝑩𝑰𝑻 𝟏𝟎,𝟎𝟎𝟎
𝑪𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏 𝟖𝟎,𝟎𝟎𝟎 Particulars Product A Product B

DOL B Ltd = = = 2 times
𝑬𝑩𝑰𝑻 𝟒𝟎,𝟎𝟎𝟎
(Rs.) (Rs.)
𝑪𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏 𝟏,𝟓𝟎,𝟎𝟎𝟎
DOL C Ltd = = = 3 times
𝑬𝑩𝑰𝑻 𝟓𝟎,𝟎𝟎𝟎 Selling Price p.u. 40 20
𝑪𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏 𝟏,𝟎𝟎,𝟎𝟎𝟎
DOL D Ltd = = = 1 times Total Selling cost 40*1000= 40,000 20*1000=20,000
𝑬𝑩𝑰𝑻 𝟏,𝟎𝟎,𝟎𝟎𝟎
Variable Cost p.u. 20 12
Break-Even Analysis: Total Variable Cost 20*1000= (20,000) 12*1000=(12,000)
Particulars Product A Product B Contribution 20,000 8,000
(Rs.) (Rs.) Fixed Cost (15,000) (5,000)
Selling Price p.u. 40 20 Profit (EBIT) 5000 3000
Variable Cost p.u. 20 12 DOL 20000/5000 = 4 8000/3000 = 2.67
Fixed Cost 15,000 5,000

𝐅𝐢𝐱𝐞𝐝 𝐂𝐨𝐬𝐭
Break-even Point = 𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐩𝐞𝐫 𝐮𝐧𝐢𝐭
Now calculate DOL and Break-even point for Product A and
Product B?
𝟏𝟓𝟎𝟎𝟎
Break-even Point for A = 𝟐𝟎
= 750 units
𝟓𝟎𝟎𝟎
Break-even Point for A = 𝟖
= 625 units
Solution:
Chapter 8: Financial and Operating Leverages (PART-IV) A firm's details are as under:
What we will study? ➢ Sales (@100 per unit) Rs. 24,00,000.

➢ Variable Cost 50%.
*How to calculate DFL? ➢ Fixed Cost Rs. 10,00,000.
➢ It has borrowed Rs. 10,00,000 @ 10% p.a. and its equity
share capital is Rs. 10,00,000 (Rs. 100 each).
➢ Consider tax @ 50%.
Calculate its Degree of Financial Leverage.
SOLUTION:
➢ Variable cost (50% of Sales) = 50% of 24,00,000
= 12,00,000
➢ It has borrowed Rs. 10,00,000 @ 10% p.a.

So, Interest = 10% of 10,00,000 = 1,00,000
➢ its equity share capital is Rs. 10,00,000 (Rs. 100 each)

𝟏𝟎,𝟎𝟎,𝟎𝟎𝟎
So, Number of shares = = 10,000
𝟏𝟎𝟎
Sales 24,00,000 Example 2:
Less: Variable cost (50% of Sales) 12,00,000 The following information is related to XYZ Company Ltd. for
the year ended 31st March, 2022:
Contribution 12,00,000
Equity share capital (of Rs. 10 each) Rs. 50 lakhs
Less: Fixed cost 10,00,000
12% Bonds of Rs. 1,000 each Rs. 37 lakhs
EBIT 2,00,000
Sales Rs. 84 lakhs
Less: Interest 1,00,000
Fixed cost (excluding interest) Rs. 6.96 lakhs
EBT 1,00,000
Profit-volume Ratio 27.55%
Less: Tax (50%) 50,000
Income Tax Applicable 40%
EAT 50,000
Calculate its Degree of Financial Leverage?
No. of equity shares 10,000
SOLUTION:
EPS 5
➢ Equity share capital (of Rs. 10 each) = Rs. 50 lakhs
𝟓𝟎,𝟎𝟎,𝟎𝟎𝟎
So, Number of shares = = 5,00,000
𝐄𝐀𝐓 𝟓𝟎,𝟎𝟎𝟎 𝟏𝟎
EPS = 𝐍𝐨 =
𝐨𝐟 𝐞𝐪𝐮𝐢𝐭𝐲 𝐬𝐡𝐚𝐫𝐞 𝟏𝟎,𝟎𝟎𝟎
=5
➢ 12% Bonds of Rs. 1,000 each = Rs. 37 lakhs

𝐄𝐁𝐈𝐓 𝟐,𝟎𝟎,𝟎𝟎𝟎
Degree of Financial Leverage (DFL) = 𝐄𝐁𝐓
= 𝟏,𝟎𝟎,𝟎𝟎𝟎 = 2 times So, Interest on Bond = 12% of 37,00,000 = 4,44,000
➢ Contribution = Sales × P/V ratio = 84 Lac * 27.55% =

23,14,200
Particulars Amount (Rs.) ABFM MODULE - B
Sales 84,00,000 Chapter 8: Financial and Operating Leverages (PART-V)
Contribution (Sales × P/V ratio) 23,14,200 What we will study?
Less: Fixed cost (excluding Interest) (6,96,000) *How to calculate DCL or DTL?
EBIT 16,18,200
Less: Interest on debentures (4,44,0000)
(12% Rs.37 lakhs)
EBT 11,74,200
Less: Tax (40%) 4,69,680
EAT 7,04,520
No. of equity shares 5,00,000
𝐄𝐀𝐓 𝟕,𝟎𝟒,𝟓𝟐𝟎
EPS = 𝐍𝐨 = 𝟓,𝟎𝟎,𝟎𝟎𝟎 = 1.41
𝐨𝐟 𝐞𝐪𝐮𝐢𝐭𝐲 𝐬𝐡𝐚𝐫𝐞
𝐄𝐁𝐈𝐓
Degree of Financial Leverage (DFL) =
𝐄𝐁𝐓
𝟏𝟔,𝟏𝟖,𝟐𝟎𝟎
= 𝟏𝟏,𝟕𝟒,𝟐𝟎𝟎 = 1.38 times
Degree of Combined leverage: SOLUTION 1:
DTL: Degree of Total leverage. Statement of Profit (Amt in Rs.)
DCL: Degree of Combined leverage. Sales 10,00,000
Less: Variable Cost 7,00,000
𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 Contribution 3,00,000
DCL =
𝐄𝐁𝐓
Less: Fixed Cost 2,00,000
Formula:
𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐄𝐁𝐈𝐓 EBIT 1,00,000
DOL = DFL =
𝐄𝐁𝐈𝐓 𝐄𝐁𝐓
Less: Interest @ 10% on 5,00,000 50,000
Earnings before tax (EBT) 50,000
𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐄𝐁𝐈𝐓 𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧
DCL = DOL * DFL = * =
𝐄𝐁𝐈𝐓 𝐄𝐁𝐓 𝐄𝐁𝐓
𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝟑,𝟎𝟎,𝟎𝟎𝟎
Operating Leverage = = =𝟑
𝐄𝐁𝐈𝐓 𝟏,𝟎𝟎,𝟎𝟎𝟎
DCL =
𝐄𝐁𝐓
𝐄𝐁𝐈𝐓 𝟏,𝟎𝟎,𝟎𝟎𝟎
Financial Leverage = = =𝟐
𝐄𝐁𝐓 𝟓𝟎,𝟎𝟎𝟎
Example 1:
A firm has sales of Rs. 10,00,000, variable cost of Rs. 7,00,000
𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝟑,𝟎𝟎,𝟎𝟎𝟎
and fixed costs of Rs. 2,00,000 and debt of Rs. 5,00,000 at 10% Combined Leverage: = = =𝟔
𝐄𝐁𝐓 𝟓𝟎,𝟎𝟎𝟎
rate of interest.
What are the operating, financial and combined leverages?
Example 2: 𝐅𝐢𝐱𝐞𝐝 𝐂𝐨𝐬𝐭
Break-even Point =
𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐩𝐞𝐫 𝐮𝐧𝐢𝐭
Z Ltd. has estimated that for a new product, the break-even
𝐅𝐢𝐱𝐞𝐝 𝐂𝐨𝐬𝐭
point is 2,000 units, if the items are sold for ₹ 14 per unit. 2000 =
𝟓
The Cost Accounting department has currently identified Fixed Cost = 2000*5 = 10000
variable cost of Rs. 9 per unit.
Calculate the degree of operating leverage for sales volume of
2,500 units and 3,000 units. Degree of Operating Leverage = 𝐄𝐁𝐈𝐓
What do you infer from the degree of operating leverage at 𝟏𝟐𝟓𝟎𝟎

Degree of Operating Leverage (2500 unit) = =5
𝟐𝟓𝟎𝟎
the sales volumes of 2,500 units and 3,000 units and their
𝟏𝟓𝟎𝟎𝟎
difference if any? Degree of Operating Leverage (3000 unit) = =3
𝟓𝟎𝟎𝟎
SOLUTION 2:
Particulars 2,500 Units 3,000 Units

Sales @ Rs. 14 per unit 35,000 42,000
Variable cost @ Rs.9 per unit 22,500 27,000
Contribution 12,500 15,000
Fixed cost Rs. [2,000 x (14-9)] 10,000 10,000
EBIT 2,500 5,000

ABFM MODULE - B CAPITAL INVESTMENT DECISIONS:
Chapter 9: CAPITAL INVESTMENT DECISIONS (PART-I) The Investment decision is concerned with the selection of
assets in which funds will be invested by a firm.
What we will study?
Where to invest the Money?
*How to make capital investment decision?
The Investment of funds has to be made after
*What are the methods available to evaluate your
CAREFUL ASSESSMENT
investment decision?
Of various projects Through
*How to calculate Payback period?
CAPITAL BUDGETING
Capital Budgeting refers to the PROCESS of making

decision regarding capital investment in fixed assets such as
machinery, land, building etc.
PROJECT A PROJECT B PROJECT C

₹ 20,00,000 ₹ 40,00,000 ₹ 60,00,000
EVALUATION TECHNIQUES
𝐈𝐧𝐢𝐭𝐢𝐚𝐥 𝐈𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭
No. of years to recover =
𝐀𝐧𝐧𝐮𝐚𝐥 𝐂𝐚𝐬𝐡 𝐈𝐧𝐟𝐥𝐨𝐰
𝟏𝟎𝟎
Initial Investment = = 5 years
𝟐𝟎
NON – DISCOUNTING DISCOUNTED
PAY BACK PERIOD: When cash inflow is same every year
PAY BACK PERIOD NET PRESENT VALUE (NPV)

Ques 1. Initial Investment = 30,00,000, Annual cash inflow =
5,00,000 for 10 years. Calculate the payback period?
ACCOUNTING RATE OF PROITABILITY INDEX (PI) Sol 1:
RETURN (ARR)
𝐈𝐧𝐢𝐭𝐢𝐚𝐥 𝐈𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭
INTERNAL RATE RETURN Pay back Period = 𝐀𝐧𝐧𝐮𝐚𝐥 𝐜𝐚𝐬𝐡 𝐈𝐧𝐟𝐥𝐨𝐰
(IRR)
𝟑𝟎,𝟎𝟎,𝟎𝟎𝟎
= = 6 years
𝟓,𝟎𝟎,𝟎𝟎𝟎
MODIFIED IRR
Ques 2. Suggest the management using Payback Period which

PAY BACK PERIOD: machine they should buy?
How soon can we get our CASH BACK?
MACHINE A MACHINE B
₹ 1000
Initial Investment = 15,00,000 20,00,000
1 2 3 4 5 6 7
Cash inflow (per year) =5,00,000 5,50,000
200 200 200 200 200 200 200

Sol 2: Sol:
Calculate the payback period of each machine: Initial Investment: ₹ 6,00,000
MACHINE A MACHINE B Years Cash flows Cumulative Cash
𝟏𝟓,𝟎𝟎,𝟎𝟎𝟎 𝟐𝟎,𝟎𝟎,𝟎𝟎𝟎 1 1,20,000 1,20,000
= 𝟓,𝟎𝟎,𝟎𝟎𝟎
= 𝟓,𝟓𝟎,𝟎𝟎𝟎
2 1,40,000 2,60,000
= 3 years = 3.6 years
3 1,80,000 4,40,000
So, buy Machine A because you will get your money back 4 2,00,000 6,40,000
sooner than Machine B. 5 2,50,000
PAY BACK PERIOD: When cash inflow is NOT same every year In 4th year we need only 6,00,000 - 4,40,000 = 1,60,000 ₹
If cash inflow of every year is not the same, we have to add up In 4th year the actual cash inflow is = 2,00,000
Net Cash Inflows from the first year till the total is equal to the
So, the question is in how much time you will earn ₹ 1,60,000
amount invested initially. (Cumulative cashflow is calculated)
if you earn total ₹ 2,00,000 in a year.
Ques 3. An Industry is considering investment in a project
which cost ₹ 6,00,000 and Cash Inflows are ₹ 120,000,
𝟏𝟔𝟎,𝟎𝟎𝟎
₹ 140,000, ₹ 180,000, ₹ 2,00,000, ₹ 2,50,000. Payback Period = 3 years + 𝟐𝟎𝟎,𝟎𝟎𝟎
Now calculate the Payback Period? = 3 years + 0.8 = 3.8 years
ABFM MODULE - B Calculation of Cash Inflow After Tax (CFAT):
Chapter 9: CAPITAL INVESTMENT DECISIONS (PART-II) Particulars (Rs.)
What we will study? Sales value XXX
*How to calculate Cash Inflow After Tax (CFAT)? Less: Variable Cost (XX)
Contribution XXX
*How to calculate Payback Period?
Less: Fixed Cost (XX)
(a) Fixed Cash Cost
(b) Depreciation
Earning Before Tax (EBT) XXX
Less: Tax (XX)
Earning After Tax (EAT) XXX
Add: Depreciation XXX
Cash Inflow After Tax (CFAT) XXX
EXAPLE 1:
XYZ Ltd is evaluating the purchase of a new machinery with a
depreciable base of Rs. 1,00,000 and expected economic life
of 4 years and change in earnings before taxes and
depreciation of Rs. 45,000 in 2021, Rs. 30,000 in year 2022, Rs. Numerical based on Payback period:
25,000 in year 2023 and Rs. 35,000 in year 2024.
Example 1: Suppose a project costs Rs. 20,00,000 and yields
Assume straight-line depreciation and a 20% tax rate. annually a profit of Rs. 3,00,000 after depreciation (@ 10%
(straight line method) but before tax at 50%.
You are required to compute net cash flows.
Solution: The cash inflow is calculated as follows:
SOLUTION 1:
Depreciation = 1,00,000 and life of machine = 4 years.
𝟏,𝟎𝟎,𝟎𝟎𝟎 Particulars (Rs.)
So, Depreciation in each year = = 25,000.
𝟒
Profit before depreciation and tax
Amount in (Rs.)
Profit before tax [EBT] 3,00,000
Year
Less: Tax @ 50% 1,50,000
2021 2022 2023 2024
Profit after tax [EAT] 1,50,000
Earnings before 45,000 30,000 25,000 35,000
depreciation and tax Add: Depreciation written off 2,00,000
(EBIDT) or (EBDT) Total cash inflow 3,50,000
Less: Depreciation (25,000) (25,000) (25,000) (25,000)
EBT 20,000 5,000 0 10,000

The payback period of the project shall be:
Less: Tax @20% (4,000) (1,000) 0 (2,000) 𝐑𝐬.𝟐𝟎,𝟎𝟎,𝟎𝟎𝟎
Payback period = 𝐑𝐬.𝟑,𝟓𝟎,𝟎𝟎𝟎
= 5.71 Years
EAT 16,000 4,000 0 8,000
Add: Depreciation 25,000 25,000 25,000 25,000 While calculating cash inflow, depreciation is added back to
profit after tax since it does not result in cash outflow.
Net Cash flow 41,000 29,000 25,000 33,000
Example 2: In 3rd year, cumulative cash inflows equal to initial cash
outlay i.e., Rs. 2,00,000. Hence, payback period is 3 years.
Suppose ABC Ltd. is analyzing a project requiring an initial
cash outlay of Rs. 2,00,000 and is expected to generate cash Suppose if in above example, the initial outlay is Rs. 2,05,000
inflows as follows: then:
Year Annual Cash Inflows (Rs.) Payback period shall lie between 3 to 4 years.
1 80,000 Since up to 3 years, a sum of Rs. 2,00,000 shall be recovered

and balance of Rs. 5,000 shall be recovered in the part
2 60,000
(fraction) of 4th year, computation is as follows:
3 60,000
4 20,000 𝐁𝐚𝐥𝐚𝐧𝐜𝐞 𝐜𝐚𝐬𝐡 𝐨𝐮𝐭𝐥𝐚𝐲 𝟓,𝟎𝟎𝟎
Part of 4th year = 𝐂𝐚𝐬𝐡 𝐈𝐧𝐟𝐥𝐨𝐰 𝐢𝐧 𝟒𝒕𝒉 𝐘𝐞𝐚𝐫 = 𝟐𝟎,𝟎𝟎𝟎 = 𝟎. 𝟐𝟓 𝒚𝒆𝒂𝒓
It’s payback period shall be computed by using cumulative

cash flows as follows: Thus, total cash outlay of Rs. 2,05,000 shall be recovered in
3.25 years' time.
Year Annual Cash Inflows Cumulative Cash
(Rs.) Inflows (Rs.)
1 80,000 80,000
2 60,000 1,40,000
3 60,000 2,00,000
4 20,000 2,20,000
ABFM MODULE - B Payback Period:
Chapter 9: CAPITAL INVESTMENT DECISIONS (PART-III) Example:
What we will study? Rs. 30,000 cash outlay for a project with annual cash inflows
of Rs. 6,000. What will be payback period?
*How to calculate Discounted Payback Period?
Solution:
𝟑𝟎𝟎𝟎𝟎
Payback Period = 𝟔𝟎𝟎𝟎
= 5 years
Discounting:
Discounting is the process by which a cash flow, which is
expected to occur in future, is converted to its present value.
i.e, converting future value into present value is called
discounting.
F = P * (𝟏 + 𝐫)𝐧
Example: If you will get ₹1000 after 2 years and rate of

interest 10% then find the present value of this cashflow?
Solution:
𝟏𝟎
F = 1000 & r= = 0.1 & n = 2
𝟏𝟎𝟎
F = P * (𝟏 + 𝐫)𝐧 𝟏 𝟏
PVF for year one = (𝟏+𝒓)𝟏 = (𝟏+𝟎.𝟏𝟓)𝟏 = 𝟏.𝟏𝟓 = 0.870
𝟏
1000 = 𝐏 ∗ (𝟏 + 𝟎. 𝟏)𝟐 𝟏 𝟏 𝟏
PVF for year two = = = = 0.756
1000 = 𝐏 ∗ (𝟏. 𝟏)𝟐 (𝟏+𝒓)𝟐 (𝟏+𝟎.𝟏𝟓)𝟐 𝟏.𝟑𝟐𝟐𝟓
𝟏 𝟏 𝟏
1000 = 𝐏 ∗ 1.21 PVF for year three = (𝟏+𝒓)𝟑 = (𝟏+𝟎.𝟏𝟓)𝟑 = 𝟏.𝟓𝟐𝟎𝟗 = 0.658
𝟏𝟎𝟎𝟎
P= = 826.45 ₹
𝟏.𝟐𝟏
PVF or PVIF for 2 years: Discounted Payback Period:

𝟏 𝟏 𝟏 The problem with the Payback Period is that it ignores the
PVF = (𝟏+𝒓)𝒏 = (𝟏+𝟎.𝟏)𝟐 = 𝟏.𝟐𝟏 = 0.826
time value of money.
So, PVF for 3 years:
In order to correct this, we can use discounted cash flows in
𝟏 𝟏 𝟏
PVIF = (𝟏+𝒓)𝒏 = (𝟏+𝟎.𝟏)𝟑 = 𝟏.𝟑𝟑𝟏 = 0.751 so 1000*0.751 = ₹751 calculating the payback period.
Referring back to our example, if we discount the cash inflows
So, PVF for 4 years:
at 15% required rate of return, we have:
𝟏 𝟏 𝟏
PVIF = (𝟏+𝒓)𝒏 = (𝟏+𝟎.𝟏)𝟒 = 𝟏.𝟒𝟔𝟒𝟏 = 0.683 so 1000*0.683 = ₹683
Year Cash Flow PVF@15% PV (Rs.) Cumulative

Example: If rate of interest is 15% then find the present value (Rs.) PV (Rs.)
factor (PVF) for 0 year (same year), 1 year, 2 years, 3 years. 1 6,000 0.870 5,220 5,220
𝟏𝟓
r = 𝟏𝟎𝟎 = 0.15 2 6,000 0.756 4,536 9,756
3 6,000 0.658 3,948 13,704
𝟏 𝟏 𝟏
PVF for year zero = (𝟏+𝒓)𝟎 = (𝟏+𝟎.𝟏𝟓)𝟎 = 𝟏 = 1 4 6,000 0.572 3,432 17,136
5 6,000 0.497 2,982 20,118 ABFM MODULE - B
6 6,000 0.432 2,592 22,710 Chapter 9: CAPITAL INVESTMENT DECISIONS (PART-IV)
7 6,000 0.376 2,256 24,966 What we will study?
8 6,000 0.327 1,962 26,928 *How to calculte NPV?
9 6,000 0284 1,704 28,632
10 6,000 0.247 1,482 30,114
The cumulative total of discounted cash flows after ten years

is Rs. 30,114, discounted payback is approximately 10 years as
opposed to 5 years under simple payback.
Net Present Value (NPV): Example 1: Compute the net present value for a project with a
net initial investment of Rs. 1,00,000.
The meaning of NPV: A bird in hand is better than two in the
bush! A rupee now is more valuable than the same rupee a The net cash flow for year one is Rs. 55,000; for year two is Rs.
year later. 80,000 and for year three is Rs. 15,000.
This is what the present value means. Further, the company's cost of capital is 10%.
Net present value used in terms of cash flow means the [PVIF @ 10% for three years are 0.909, 0.826 and 0.751]
present value of all future cash flows.
Cash flows mean net flow; difference between the inflow and SOLUTION:
outflows. Year Net Cash Flows (Rs) PVIF @ 10% Discounted Cash Flows (Rs.)
If the NPV is equal to 0, then the project will neither add value 0 (100000) 1.000 (100000)
nor are you likely to lose.
1 55000 0.909 49995
Positive NPV means project can be given go ahead and the
negative is red signal. 2 80000 0.826 66080
Net present value (NPV) = 3 15000 0.751 11265
Present value of net cash inflow - Total net initial investment. Net Present Value 27340
Decision Rule:
Since the net present value of the project is positive, the
If NPV ≥ 0 Accept the Proposal company should accept the project.
If NPV ≤0 Reject the Proposal
The NPV method can be used to select between mutually

exclusive projects:
The one with the higher NPV should be selected.
Example 2: Project 1 PV factor PV
(Rs.)
XYZ Ltd. is analysing capital expenditure proposals for the Initial Investment 200000 1.000 (200000)
purchase of equipment, the company uses the net present Year 1 50000 0.893 44650
value technique to evaluate projects. 2 50000 0.797 39850
The capital budget is limited to Rs. 5,00,000 which XYZ Ltd. 3 50000 0.712 35600
believes is the maximum capital it can raise. 4 50000 0.636 31800
5 50000 0.567 28350
The initial investment and projected net cash flows for each Net Present Value (19750)
project are shown below.
The cost of capital of XYZ Ltd is 12%. Project 2 PV factor PV
(Rs.)
You are required to compute the NPV of the different Initial Investment 190000 1.000 (190000)
projects. Year 1 40000 0.893 35720
[PVIF @ 12% for 5 years are 0.893, 0.797, 0.712, 0.636, 0.567] 2 50000 0.797 39850
3 70000 0.712 49840
4 75000 0.636 47700
Project 1 Project 2 Project Project 4 5 75000 0.567 42525
Net Present Value 26635
(Rs.) (Rs) 3(Rs) (Rs)
Initial Investment 200000 190000 250000 210000
Year 1 50000 40000 75000 75000 Project 3 PV factor PV
(Rs.)
2 50000 50000 75000 75000
Initial Investment 250000 1.000 (250000)
3 50000 70000 60000 60000
Year 1 75000 0.893 66975
4 50000 75000 80000 40000
2 75000 0.797 59775
5 50000 75000 100000 20000 3 60000 0.712 42720
4 80000 0.636 50880
SOLUTION: 5 100000 0.567 56700
Net Present Value 27050
Calculation of net present value:
Project 4 PV factor PV ABFM MODULE - B
(Rs.)
Initial Investment 210000 1.000 (210000) Chapter 9: CAPITAL INVESTMENT DECISIONS (PART-V)
Year 1 75000 0.893 66975
2 75000 0.797 59775 What we will study?
3 60000 0.712 42720
*How to calculate ARR?
4 40000 0.636 25440
5 20000 0.567 11340
Net Present Value (3750)
We can accept project 2 and project 3 because NPV is positive.

If we need to select only one project then we will select Project 3
because its' NPV is very high.
Accounting Rate of Return (ARR): Example 1:
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐀𝐧𝐧𝐮𝐚𝐥 𝐍𝐞𝐭 𝐄𝐚𝐫𝐧𝐢𝐧𝐠 𝐚𝐟𝐭𝐞𝐫 𝐓𝐚𝐱𝐞𝐬 Suppose A Ltd. is going to invest in a project a sum of Rs.
ARR = 𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐈𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭
× 100%
3,00,000 having a life span of 3 years. Salvage value of
machine is Rs. 90,000. The profit before depreciation for each
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐏𝐫𝐨𝐟𝐢𝐭 year is Rs. 1,50,000. Calculate ARR?
ARR = × 100%
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐈𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭
Solution:
𝐓𝐨𝐭𝐚𝐥 𝐏𝐫𝐨𝐟𝐢𝐭
Average profit made yearly = 𝐍𝐨. 𝐨𝐟 𝐘𝐞𝐚𝐫𝐬 𝐏𝐫𝐢𝐜𝐞 𝐨𝐟 𝐌𝐚𝐜𝐡𝐢𝐧𝐞 − 𝐒𝐚𝐥𝐯𝐚𝐠𝐞 𝐕𝐚𝐥𝐮𝐞
Deprecation per year = 𝑳𝒊𝒇𝒆 𝒐𝒇 𝑴𝒂𝒄𝒉𝒊𝒏𝒆(𝒚𝒆𝒂𝒓)
Where, Yearly Profit = Profit after Depreciation and Tax
𝟑,𝟎𝟎,𝟎𝟎𝟎 − 𝟗𝟎,𝟎𝟎𝟎 𝟐,𝟏𝟎,𝟎𝟎𝟎
𝐈𝐧𝐢𝐭𝐢𝐚𝐥 𝐈𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭−𝐒𝐜𝐫𝐚𝐩 Deprecation per year = = = 70,000/-
𝟑 𝟑
Average Investment = + Scrap Value
𝟐
𝐈𝐧𝐢𝐭𝐢𝐚𝐥 𝐈𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭 + 𝐒𝐜𝐫𝐚𝐩 𝐕𝐚𝐥𝐮𝐞
Average Investment = 𝟐 Year Profit Before Depreciation Profit after
Depreciation (Rs.) (Rs.) Depreciation (Rs.)
1 1,50,000 70,000 80,000

Version 1: Annual Basis:
2 1,50,000 70,000 80,000
𝐏𝐫𝐨𝐟𝐢𝐭 𝐀𝐟𝐭𝐞𝐫 𝐃𝐞𝐩𝐫𝐞𝐜𝐢𝐚𝐭𝐢𝐨𝐧
𝐀𝐑𝐑 = × 𝟏𝟎𝟎 3 1,50,000 70,000 80,000
𝐈𝐧𝐯𝐞𝐭𝐦𝐞𝐧𝐭 𝐢𝐧 𝐭𝐡𝐞 𝐛𝐞𝐠𝐢𝐧𝐧𝐢𝐧𝐠 𝐨𝐟 𝐭𝐡𝐞 𝐲𝐞𝐚𝐫
Version 2: Total Investment Basis:

Value of Investment In (Rs.)
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐀𝐧𝐧𝐮𝐚𝐥 𝐏𝐫𝐨𝐟𝐢𝐭
𝐀𝐑𝐑 = × 𝟏𝟎𝟎
𝐈𝐧𝐯𝐞𝐭𝐦𝐞𝐧𝐭 𝐢𝐧 𝐭𝐡𝐞 𝐛𝐞𝐠𝐢𝐧𝐧𝐢𝐧𝐠 𝐨𝐟 𝐭𝐡𝐞 𝐲𝐞𝐚𝐫 Beginning Depreciation (Rs.) End
Version 3: Average Investment Basis: 3,00,000 70,000 2,30,000
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐀𝐧𝐧𝐮𝐚𝐥 𝐏𝐫𝐨𝐟𝐢𝐭 2,30,000 70,000 1,60,000

𝐀𝐑𝐑 = 𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐈𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭
× 100
1,60,000 70,000 90,000
𝟖𝟎𝟎𝟎𝟎+𝟖𝟎𝟎𝟎𝟎+𝟖𝟎𝟎𝟎𝟎
Version 1: Annual Basis: 𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐀𝐧𝐧𝐮𝐚𝐥 𝐏𝐫𝐨𝐟𝐢𝐭 = = 80,000
𝟑
𝐏𝐫𝐨𝐟𝐢𝐭 𝐀𝐟𝐭𝐞𝐫 𝐃𝐞𝐩𝐫𝐞𝐜𝐢𝐚𝐭𝐢𝐨𝐧 𝟑,𝟎𝟎,𝟎𝟎𝟎+𝟗𝟎,𝟎𝟎𝟎
𝐀𝐑𝐑 = × 𝟏𝟎𝟎 Average Investment = 𝟐
= 1,95,000
Year ARR
𝐈𝐧𝐢𝐭𝐢𝐚𝐥 𝐈𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭 − 𝐒𝐚𝐥𝐯𝐚𝐠𝐞 𝐕𝐚𝐥𝐮𝐞
1 𝟖𝟎𝟎𝟎𝟎
× 𝟏𝟎𝟎 = 26.67% Average Investment = 𝟐
+ Salvage Value
𝟑𝟎𝟎𝟎𝟎𝟎
𝟑,𝟎𝟎,𝟎𝟎𝟎 − 𝟗𝟎,𝟎𝟎𝟎 𝟐,𝟏𝟎,𝟎𝟎𝟎
2 𝟖𝟎𝟎𝟎𝟎
× 𝟏𝟎𝟎 = 34.78% = 𝟐
+ 90,000 =
𝟐
+ 90,000
𝟐𝟑𝟎𝟎𝟎𝟎
3 𝟖𝟎𝟎𝟎𝟎 = 1,05,000 + 90000 = 1,95,000

× 𝟏𝟎𝟎 = 50%
𝟏𝟔𝟎𝟎𝟎𝟎
𝟖𝟎,𝟎𝟎𝟎
ARR = 𝟏,𝟗𝟓,𝟎𝟎𝟎 × 100 = 41.03%
Version 2: Total Investment Basis:

𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐀𝐧𝐧𝐮𝐚𝐥 𝐏𝐫𝐨𝐟𝐢𝐭 EXAMPLE 2:
𝐀𝐑𝐑 = × 𝟏𝟎𝟎
A project, requiring an investment of Rs. 10,00,000, yields
profit after tax and depreciation which is as follows:
𝟖𝟎𝟎𝟎𝟎+𝟖𝟎𝟎𝟎𝟎+𝟖𝟎𝟎𝟎𝟎
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐀𝐧𝐧𝐮𝐚𝐥 𝐏𝐫𝐨𝐟𝐢𝐭 = = 80,000 Years Profit after tax and depreciation (Rs)
𝟑
1 5000
𝟖𝟎,𝟎𝟎𝟎
𝐀𝐑𝐑 =
𝟑,𝟎𝟎,𝟎𝟎𝟎
× 𝟏𝟎𝟎 = 26.67% 2 75000
Version 3: Average Investment Basis: 3 125000
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐀𝐧𝐧𝐮𝐚𝐥 𝐏𝐫𝐨𝐟𝐢𝐭 4 130000

𝐀𝐑𝐑 = × 100
5 80000
Total 460000
Suppose further that at the end of the 5th year, the plant and Example 3: Determine the accounting or average rate of
machinery of the project can be sold for Rs. 80,000. return from the following date of two machine A & B:
Determine the Accounting Rate of Return. Machine A Machine B
SOLUTION: Cost 56,125 56,125
Version 2: Total Investment Basis: Estimated life in year 5 5
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐀𝐧𝐧𝐮𝐚𝐥 𝐏𝐫𝐨𝐟𝐢𝐭 Estimated Salvage Value 3000 2000
𝐀𝐑𝐑 = × 𝟏𝟎𝟎
Tax rate 25% 25%
𝟒,𝟔𝟎,𝟎𝟎𝟎
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐀𝐧𝐧𝐮𝐚𝐥 𝐏𝐫𝐨𝐟𝐢𝐭 = = 92,000
𝟓
Annual estimated income after Depreciation and Tax:
𝟗𝟐,𝟎𝟎𝟎 Year Income A Income B

𝐀𝐑𝐑 =
𝟏𝟎,𝟎𝟎,𝟎𝟎𝟎
× 𝟏𝟎𝟎 = 9.2%
1 3,375 11,375
2 5,375 9,375
Version 3: Average Investment Basis:
3 7,375 7,375
𝐀𝐑𝐑 = × 100
4 9,375 5,375
5 11,375 3,375
𝟒,𝟔𝟎,𝟎𝟎𝟎
𝟓 36,875 36,875
𝟏𝟎,𝟎𝟎,𝟎𝟎𝟎+𝟖𝟎,𝟎𝟎𝟎
Average Investment = 𝟐
= 5,40,000
𝟗𝟐,𝟎𝟎𝟎
ARR = 𝟓,𝟒𝟎,𝟎𝟎𝟎 × 100 = 17.04% Depreciation has been charged on straight line method.
Solution: Example 4: Determine the average rate of return from the
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐀𝐧𝐧𝐮𝐚𝐥 𝐏𝐫𝐨𝐟𝐢𝐭 following two machine A:
𝐀𝐑𝐑 = 𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐈𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭
× 100
Machine A
Machine A:
Cost 56,125
𝟑𝟔,𝟖𝟕𝟓
𝟓 Estimated life in year 5
𝟓𝟔,𝟏𝟐𝟓+𝟑𝟎𝟎𝟎 𝟓𝟗,𝟏𝟐𝟓
=
𝟐
= 29,562.50 Estimated Salvage Value 3000
𝐀𝐑𝐑 = × 100 Tax rate 25%
𝟕𝟑𝟕𝟓
𝐀𝐑𝐑 = × 100 = 24.95%
𝟐𝟗𝟓𝟔𝟐.𝟓
Annual estimated income before Depreciation and Tax:
Machine B:
Year Income A
𝟑𝟔,𝟖𝟕𝟓
𝟓
1 15,125
𝟓𝟔,𝟏𝟐𝟓+𝟐𝟎𝟎𝟎 𝟓𝟖,𝟏𝟐𝟓
Average Investment = = = 29,062.50
𝟐 𝟐 2 17,792
𝐀𝐑𝐑 = × 100 3 20,458
𝐀𝐑𝐑 =
𝟕𝟑𝟕𝟓
× 100 = 25.38% 4 23,125
𝟐𝟗𝟎𝟔𝟐.𝟓
5 25,792
36,875
Depreciation has been charged on straight line method.

Solution: ABFM MODULE - B
𝐏𝐫𝐢𝐜𝐞 𝐨𝐟 𝐌𝐚𝐜𝐡𝐢𝐧𝐞 − 𝐒𝐚𝐥𝐯𝐚𝐠𝐞 𝐕𝐚𝐥𝐮𝐞
Deprecation per year = 𝑳𝒊𝒇𝒆 𝒐𝒇 𝑴𝒂𝒄𝒉𝒊𝒏𝒆(𝒚𝒆𝒂𝒓)
Chapter 9: CAPITAL INVESTMENT DECISIONS (PART-VI)
Deprecation per year =

𝟓𝟔,𝟏𝟐𝟓 − 𝟑,𝟎𝟎𝟎
=
𝟓𝟑,𝟏𝟐𝟓
= 10,625/-
What we will study?
𝟓 𝟓
*How to calculate Profitability Index (PI)?
Calculating of earnings after Deposit tax:
EBDT Depreciation EADBT TAX PADT
1 15,125 10,625 4500 1125 3375
2 17,792 10,625 7167 1792 5575
3 20,452 10,625 2458 2458 7375
4 23,125 10,625 3125 3125 9375
5 25,792 10,625 3792 3792 11375
Total 36,875
𝟑𝟔,𝟖𝟕𝟓
Machine A: 𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐀𝐧𝐧𝐮𝐚𝐥 𝐏𝐫𝐨𝐟𝐢𝐭 =
𝟓
= 7,375
𝟓𝟔,𝟏𝟐𝟓+𝟑𝟎𝟎𝟎 𝟓𝟗,𝟏𝟐𝟓
=
𝟐
= 29,562.50

𝐀𝐑𝐑 = × 100
𝟕𝟑𝟕𝟓
𝐀𝐑𝐑 = 𝟐𝟗𝟓𝟔𝟐.𝟓
× 100 = 24.95%
NPV: Profitability Index:
𝟏 𝑪 𝟐 𝑪 𝟑 𝟒𝑪 𝑪 This is an index that either explains or represents the
NPV = (𝟏+𝒓) 𝟏 + (𝟏+𝒓)𝟐 + (𝟏+𝒓)𝟑 + (𝟏+𝒓)𝟒 .... − 𝑪𝟎
relationship between the cost and the benefit of a project
proposal.
Example 1: Compute the net present value (NPV) for a project It is also called value investment ratio or profit investment
with a net initial investment of Rs. 1,00,000. ratio.
The net cash flow for year one is Rs. 55,000, for year two is Rs. PI is calculated by dividing the present value of future
80,000 and for year three is Rs. 15,000.
expected cash flows by the initial investment amount in the
Further, the company's cost of capital is 10%. project.
Solution: Higher the Index better is profitability of the project.
𝑪𝟎 = 1,00,000 𝑪𝟏 = 55000 𝑪𝟐 = 80000 𝑪𝟑 = 15000 Anything below 1 indicates that the project is unprofitable.
𝟏 𝑪 𝟐 𝑪 𝟑 𝑪
NPV = (𝟏+𝒓) 𝟏 + (𝟏+𝒓)𝟐 + (𝟏+𝒓)𝟑 + − 𝑪𝟎
𝐒𝐮𝐦 𝐨𝐟 𝐝𝐢𝐬𝐜𝐨𝐮𝐧𝐭𝐞𝐝 𝐜𝐚𝐬𝐡 𝐢𝐧𝐟𝐥𝐨𝐰
Profitability Index (PI) =
𝐈𝐧𝐭𝐢𝐚𝐥 𝐜𝐚𝐬𝐡 𝐨𝐮𝐭𝐥𝐚𝐲
𝟓𝟓𝟎𝟎𝟎 𝟖𝟎𝟎𝟎𝟎 𝟏𝟓𝟎𝟎𝟎
NPV = (𝟏+𝟎.𝟏)𝟏 + (𝟏+𝟎.𝟏)𝟐 + (𝟏+𝟎.𝟏)𝟑 - 1,00,000 𝐏𝐕 𝐨𝐟 𝐜𝐚𝐬𝐡 𝐢𝐧𝐟𝐥𝐨𝐰
=
𝐈𝐧𝐭𝐢𝐚𝐥 𝐜𝐚𝐬𝐡 𝐨𝐮𝐭𝐥𝐚𝐲
𝟓𝟓𝟎𝟎𝟎 𝟖𝟎𝟎𝟎𝟎 𝟏𝟓𝟎𝟎𝟎
NPV = + + - 1,00,000
(𝟏.𝟏)𝟏 (𝟏.𝟏)𝟐 (𝟏.𝟏)𝟑
𝟓𝟓𝟎𝟎𝟎 𝟖𝟎𝟎𝟎𝟎 𝟏𝟓𝟎𝟎𝟎 𝐒𝐮𝐦 𝐨𝐟 𝐝𝐢𝐬𝐜𝐨𝐮𝐧𝐭𝐞𝐝 𝐜𝐚𝐬𝐡 𝐢𝐧𝐟𝐥𝐨𝐰

NPV = + + - 1,00,000 Profitability Index (PI) =
𝟏.𝟏 𝟏.𝟐𝟏 𝟏.𝟑𝟑𝟏
𝐓𝐨𝐭𝐚𝐥 𝐝𝐢𝐬𝐜𝐨𝐮𝐧𝐭𝐞𝐝 𝐜𝐚𝐬𝐡 𝐨𝐮𝐭𝐟𝐥𝐨𝐰
NPV = 50,000 + 66,116 + 11,270 - 1,00,000
NPV =1,27,386 - 1,00,000 = ₹27,386 𝐏𝐕 𝐨𝐟 𝐜𝐚𝐬𝐡 𝐢𝐧𝐟𝐥𝐨𝐰
=
𝐓𝐨𝐭𝐚𝐥 𝐝𝐢𝐬𝐜𝐨𝐮𝐧𝐭𝐞𝐝 𝐜𝐚𝐬𝐡 𝐨𝐮𝐭𝐟𝐥𝐨𝐰
Example 2: Profitability Index:
Suppose we have three projects involving discounted cash 𝟏 𝑪 𝟐 𝑪 𝟑 𝑪 𝟒 𝑪
NPV = (𝟏+𝒓) 𝟏 + (𝟏+𝒓)𝟐 + (𝟏+𝒓)𝟑 + (𝟏+𝒓)𝟒 .... − 𝑪𝟎
outflow of Rs. 5,50,000, Rs. 75,000 and Rs. 1,00,20,000
𝑪𝟏 𝑪𝟐 𝑪𝟑 𝑪𝟒
respectively. Suppose further that the sum of discounted cash 𝐏𝐕 𝐨𝐟 𝐚𝐥𝐥 𝐟𝐮𝐭𝐮𝐫𝐞 𝐜𝐚𝐬𝐡 𝐢𝐧𝐟𝐥𝐨𝐰 (𝟏+𝒓)𝟏
+
(𝟏+𝒓)𝟐
+
(𝟏+𝒓)𝟑
+
(𝟏+𝒓)𝟒
....
inflows for these projects are Rs. 6,50,000, Rs. 95,000 and Rs. PI = =
𝐈𝐧𝐭𝐢𝐚𝐥 𝐜𝐚𝐬𝐡 𝐨𝐮𝐭𝐥𝐚𝐲 𝑪𝟎
1,00,30,000 respectively.
Calculate the respective Profitability Index (PI) for the three
Previous Example 1:
projects.
𝟏 𝑪 𝟐 𝑪 𝟑 𝑪
SOLUTION:
NPV = (𝟏+𝒓) 𝟏 + (𝟏+𝒓)𝟐 + (𝟏+𝒓)𝟑 + − 𝑪𝟎
The respective Profitability Index for the three projects would NPV = 50,000 + 66,116 + 11,270 - 1,00,000
be as follows: NPV = 1,27,386 - 1,00,000
𝟔,𝟓𝟎,𝟎𝟎𝟎
PI = = 1.18 𝟏,𝟐𝟕,𝟑𝟖𝟔
𝟓,𝟓𝟎,𝟎𝟎𝟎 PI = = 1.27
𝟏,𝟎𝟎,𝟎𝟎𝟎
𝐑𝐬.𝟗𝟓,𝟎𝟎𝟎
PI = = 1.27
𝐑𝐒.𝟕𝟓,𝟎𝟎𝟎
𝐑𝐬.𝟏𝟎𝟎𝟑𝟎𝟎𝟎𝟎
PI = = 1.001
𝐑𝐒.𝟏𝟎𝟎𝟐𝟎𝟎𝟎𝟎
Example 3: The initial cash outlay of a project is Rs 1,00,000

It can be seen that in absolute terms, project 3 gives the and it can generate cash inflow of Rs 40,000, Rs 30,000, Rs
highest cash inflows yet its Profitability index is low. This is 50,000 and Rs 20,000 in year 1 through 4.
because the outflow is also very high. The Profitability index Assume a 10 % rate of discount. Calculate PI?
factor helps us in ranking various projects.
SOLUTION:
𝑪𝟏 𝑪𝟐 𝑪𝟑 𝑪𝟒
(𝟏+𝒓)𝟏
+
(𝟏+𝒓)𝟐
+
(𝟏+𝒓)𝟑
+
(𝟏+𝒓)𝟒
.... ABFM MODULE - B
PI =
𝑪𝟎
Chapter 9: CAPITAL INVESTMENT DECISIONS (PART-VII)
𝑪𝟎 = 1,00,000 𝑪𝟏 = 40000 𝑪𝟐 = 30000 𝑪𝟑 = 50000 𝑪𝟒 = 20000
What we will study?
𝟏 𝟐 𝟑 𝑪 𝟒 𝑪 𝑪 𝑪
PV of all future cash inflow = (𝟏+𝒓) 𝟏 + (𝟏+𝒓)𝟐 + (𝟏+𝒓)𝟑 + (𝟏+𝒓)𝟒
*How to calculate IRR?
𝟒𝟎𝟎𝟎𝟎 𝟑𝟎𝟎𝟎𝟎 𝟓𝟎𝟎𝟎𝟎 𝟐𝟎𝟎𝟎𝟎
= (𝟏+𝟎.𝟏)𝟏 + (𝟏+𝟎.𝟏)𝟐 + (𝟏+𝟎.𝟏)𝟑 + (𝟏+𝟎.𝟏)𝟒
𝟒𝟎𝟎𝟎𝟎 𝟑𝟎𝟎𝟎𝟎 𝟓𝟎𝟎𝟎𝟎 𝟐𝟎𝟎𝟎𝟎

= + + +
(𝟏.𝟏)𝟏 (𝟏.𝟏)𝟐 (𝟏.𝟏)𝟑 (𝟏.𝟏)𝟒
𝟒𝟎𝟎𝟎𝟎 𝟑𝟎𝟎𝟎𝟎 𝟓𝟎𝟎𝟎𝟎 𝟐𝟎𝟎𝟎𝟎

= + + + 𝟏.𝟒𝟔𝟒𝟏
𝟏.𝟏 𝟏.𝟐𝟏 𝟏.𝟑𝟑𝟏
= 36,363.64 + 24,793.39 + 37,565.74 + 13,660.27= 1,12,383.04
𝑪𝟏 𝑪𝟐 𝑪𝟑 𝑪𝟒
+ + + ....
(𝟏+𝒓)𝟏 (𝟏+𝒓)𝟐 (𝟏+𝒓)𝟑 (𝟏+𝒓)𝟒 𝟏,𝟏𝟐,𝟑𝟖𝟑.𝟎𝟒
PI = = = 1.1238
𝑪𝟎 𝟏,𝟎𝟎,𝟎𝟎𝟎
Internal Rate of return (IRR): However, the formula is such that the resultant IRR will not be
generated easily and therefore permutations and
In the context of investment, an Internal Rate of Return
combinations through excel sheet on trial and error basis will
means an annual rate of growth in investment a business is
give you the result which finally can be tested by simple
going to generate.
calculations.
The concept of calculating NPV and IRR is the same.
If this rate of return is higher than basic or required RR(RRR),
However, while calculating IRR, the NPV is set to zero. then only the investment is worth.
The formula and calculation used to determine this figure are RRR is equivalent to the cost of funds.
as follows:
The following is the decision rule that should be used for IRR:
𝟏 𝑪 𝟐 𝑪 𝟑 𝟒𝑪 𝑪
NPV = (𝟏+𝒓) 𝟏 + (𝟏+𝒓)𝟐 + (𝟏+𝒓)𝟑 + (𝟏+𝒓)𝟒 .... − 𝑪𝟎
Accept: If the IRR is greater than the cost of capital.
Reject: If the IRR is less than the cost of capital.
𝑪𝟏 𝑪𝟐 𝑪𝟑 𝑪𝟒
Now NPV = 0 So, 𝑪𝟎 = + (𝟏+𝒓)𝟐 + (𝟏+𝒓)𝟑 + (𝟏+𝒓)𝟒 Example 1:
(𝟏+𝒓)𝟏
Or The following example will illustrate the calculations involved

in arriving at the IRR. Following are the cash flows of the
𝑪𝒕
NPV = 0 => ∑𝐓𝐭=𝟏 − 𝐂𝟎 = 0 project of XYZ Ltd.
(𝟏+𝐈𝐑𝐑)𝐭
Where: Year 0 1 2 3 4
Cash Flow (200000) 60000 60000 80000 90000

𝑪𝒕 = Net cash inflow during the period t.
𝐂𝟎 = Total initial investment costs.
The IRR is the value of r which satisfies the following
IRR the internal rate of return.
equation:
T= the number of time periods.
𝟔𝟎𝟎𝟎𝟎 𝟔𝟎𝟎𝟎𝟎 𝟖𝟎𝟎𝟎𝟎 𝟗𝟎𝟎𝟎𝟎 Since this value is now less than 200,000, we conclude that
200000 = (𝟏+𝒓)𝟏 + (𝟏 + 𝒓)² + (𝟏+𝒓)³ + (𝟏 + 𝒓)𝟒
the value of r lies between 15%and 16%.
The calculation of r involves a process of trial and error.
If a single point estimate of r is needed, the following
We try different values of r till we find that the right-hand side interpolation procedure is to be used:
of the above equation is equal to 2,00,000.
1. Determine the net present value of the two closest rates of
Let us, to begin with, try r = 14%. return.
This makes the left-hand side equal to: NPV @ 15 percent = 1,601
𝟔𝟎𝟎𝟎𝟎 𝟔𝟎𝟎𝟎𝟎 𝟖𝟎𝟎𝟎𝟎 𝟗𝟎𝟎𝟎𝟎
+ + (𝟏.𝟏𝟒)𝟑 + (𝟏.𝟏𝟒)𝟒 = 2,06,085 NPV@ 16 percent = (2,728)
(𝟏.𝟏𝟒)𝟏 (𝟏.𝟏𝟒)𝟐
This value is slightly higher than our target value, 2,00,000. 2. Find the sum of the absolute values of the net present
values obtained in step 1:
So, we increase the value of from 14% to 15%.
1,601 + 2,728 = 4,329
(In general, a higher r decreases and a lower r increases the
left-hand side value). 3. Calculate the ratio of the net present value at the smaller
discount rate, identified in step 1, to the sum obtained in step
The lefthand side becomes: 𝟏𝟔𝟎𝟏
2: 𝟒𝟑𝟐𝟗 = 0.37
𝟔𝟎𝟎𝟎𝟎 𝟔𝟎𝟎𝟎𝟎 𝟖𝟎𝟎𝟎𝟎 𝟗𝟎𝟎𝟎𝟎
+ (𝟏.𝟏𝟓)𝟐 + (𝟏.𝟏𝟓)𝟑 + (𝟏.𝟏𝟒𝟓)𝟒 = 2,01,601
(𝟏.𝟏𝟓)𝟏 4. Add the number obtained in step 3 to the smaller discount
This value is still slightly higher than our target value, 200,000. rate:
So, we increase the value of r from 15% to 16%. 15 +0.37 = 15.37%
The left-hand side becomes: When done in this manner, the internal rate of return that is
determined is an approximation of the actual internal rate of
𝟔𝟎𝟎𝟎𝟎 𝟔𝟎𝟎𝟎𝟎 𝟖𝟎𝟎𝟎𝟎 𝟗𝟎𝟎𝟎𝟎
(𝟏.𝟏𝟔)𝟏
+ (𝟏.𝟏𝟔)𝟐 + (𝟏.𝟏𝟔)𝟑 + (𝟏.𝟏𝟔)𝟒 = 1,97,272 return that is extremely near to being accurate.
ABFM MODULE - B Definition and explanation of MIRR:
Chapter 9: CAPITAL INVESTMENT DECISIONS (PART-VIII) MIRR: Modified internal Rate of Return
What we will study? Under this approach, any negative cash flow in any period,
during the life of the project, is treated as the cost of the
*How to calculate MIRR? project and added to the initial cost of the project by
discounting at the cost of the capital.
This is called the Present Value of Costs (PVC).
Also, the project inflows are compounded at the cost of
capital to arrive at the total compounded terminal value (TV)
of the inflows.
Then an appropriate rate of discount for this compounded
terminal value is found out so that this discounted terminal
value is equal to the total present value of the cost of the
project (PVC). This discount rate is called MIRR.
Example 1: Consider the following cash flow for a project.

Find out the MIRR for the project. The project's cost of the
capital is 10%. [Company expect 15% return].
Year 0 1 2 3
Cash Flow (100) 10 60 80
0 1 2 3 PV of Cash outflows = PV of Terminal Value of cash inflow
𝐅𝐕
FV = PV * (𝟏 + 𝐫)𝐧 => PV = (𝟏+𝐫)𝐧
-100 10 60 80 𝟏𝟓𝟖.𝟏𝟎
100 = (𝟏+𝒓)𝟑
𝟏𝟓𝟖.𝟏𝟎 𝟏
(𝟏 + 𝒓)𝟑 = 𝟏𝟎𝟎
= 1.581 => 1+r = (𝟏. 𝟓𝟖𝟏)𝟑
r = 10 % (1+r) = 1.165 => r = 1.165 - 1 = 0.165 => 16.5%
r is cost of the capital. MIRR = 16.5% (> 15% so accept it).
Step 1: Find the present value of cost (PVC): How to calculate nth root?
PVC = 100 Step 1: √ -> 12 times.

Step 2: - 1 [subtract 1].
Step 2: Calculate the terminal value (TV) i.e., future value of Step 3: ÷ power(n) [here n =3]
each cash inflows expected from the project:
Step 4: +1 [add 1]
TV = FV1 + FV2 + FV3
Step 5: x = -> 12 times. [multiply then equal]
= PV1 (1+r)𝒏𝟏 + PV2 (1+r)𝒏𝟐 + PV3 (1+r)𝒏𝟑
= 10 (1.1)𝟐 + 60 (1.1)𝟏 + 80 (1.1)𝟎

TV = 10*1.21 + 60*1.1 + 80*1 = 12.1+66+80 = = 158.10
Example 2:
Step 3: Obtain the MIRR by solving the following equation:
The calculation of MIRR can be illustrated through the
𝑇𝑉 𝟏𝟓𝟖.𝟏𝟎 following example. Square Limited is evaluating a project
PVC = (1+𝑀𝐼𝑅𝑅)𝑛 => 100 = (𝟏+𝒓)𝟑 or
which has the following initial investment and cash inflows:
Year 0 1 2 3 4 5 6 𝑇𝑉 𝟗𝟑𝟒.𝟎𝟕
PVC = (1+𝑀𝐼𝑅𝑅)𝑛 => 379.13 = (𝟏+𝒎𝒊𝒓𝒓)𝟔
Cash -240 -160 40 120 160 200 240
Flow
𝟗𝟑𝟒.𝟎𝟕
(𝟏 + 𝒓)𝟔 = = 2.464
𝟑𝟕𝟗.𝟏𝟑
The cost of capital for Square Ltd is 15%. 𝟏
(𝟏 + 𝒓)𝟔 = 2.463 => 1+r = (𝟐. 𝟒𝟔𝟑)𝟔
Solution:
1+r = 1.162
Step 1: Find the present value of cost (PVC):
r = 0.162 => 16.2%
𝟏𝟔𝟎 𝑭𝑽
PVC = 240 + 𝟏.𝟏𝟓 = 379.13 [PV =(𝟏+𝒓)𝒏 ]
Conclusion: As the MIRR is higher than the cost of capital, the

Step 2: Calculate the terminal value (TV) i.e., future value of project is acceptable.
each cash inflows expected from the project:
TV = FV1 + FV2 + FV3 + FV4 + FV5
TV = PV1 (1+r)𝒏𝟏 + PV2 (1+r)𝒏𝟐 + PV3 (1+r)𝒏𝟑 + PV4 (1+r)𝒏𝟒
+ PV5 (1+r)𝒏𝟓
= 40(1.15)𝟒 + 120(1.15)³ + 160(1.15)² + 200(1.15) + 240

= 40 * 1.7490 + 120 * 1.5208 + 160 * 1.3225 + 240
= 69.96 + 182.51 +211.60 +230 + 240 = 934.07
Step 3: Obtain the MIRR by solving the following equation:
ABFM MODULE - B Capital Asset Pricing Model (CAPM):
Chapter 10: CAPTIAL BUDGETING FOR The term CAPM describes the relationship between the risk
and the returns or specifically, between the systemic risk and
INTERNATIONAL PROJECT INVESTMENT DECISIONS expected returns.
(PART-I)
The returns are always based on the risk and the time value of
What we will study? money.
*What is Capital Asset Pricing Model (CAPM)? For pricing of a particular security or investment product, one
has to undertake quite a few analyses.
*What is Arbitrage Pricing Theory (APT)?
CAPM is one such method.
This is generally done for risky assets, so that the price paid is
appropriated to generate expected returns.
Basically, one would like to find out risk free return over a
time.
A beta is generated, which is a measure of volatility or the
systemic risk compared to the market as a whole.
A security beta is calculated by dividing the product of the co-
variance of the security's returns and the market returns.
If it was possible to accurately forecast future cash flows, this
type of derivative method would not be necessary.
However, that not being the case, an investor would like to
depend on such pricing method.
Calculation of CAPM: Market Risk Premium (𝑹𝒎 − 𝑹𝒇 or mrp):
Cost of Equity (𝑹𝒆 ) or (𝑲𝒆 ). The difference between the expected return on an investment
Cost of Equity (𝑹𝒆 ) = Risk-Free Rate + Levered Beta × Market Risk and the risk-free rate is known as the market risk premium.
Premium Beta (ß):
Cost of Equity (𝑹𝒆 ) = 𝑹𝒇 + ßL × (𝑹𝒎 – 𝑹𝒇 ) The S&P 500 index has traditionally been used as a stand-in
for the market when calculating beta, which is a measure of
Where:
the co-variance between the rate of return on a company's
𝑹𝒇 = risk-free rate stock and the return on the overall market (systematic risk).
ßL= levered beta Example 1:
𝑹𝒎 = expected return on the market An investor is considering buying stocks priced at Rs. 367,
𝑹𝒎 − 𝑹𝒇 = Market Risk Premium(mrp) which offer annual returns of 4%. If beta factor of 1.1 is
associated with this particular stock, one can calculate the
Risk-Free Rate (𝑹𝒇 ): expected dividend earnings by considering the risk-free
premium as 3% and investor expectation of market
The expected rate of return on an investment in a security appreciation by 7% annually. Calculate the cost of equity?
considered to have no inherent risks is referred to as the risk-
free rate. Solution 1:
The actual risk-free rate that is used in CAPM shifts depending 𝑹𝒇 = 4% , ßL = 1.1, 𝑹𝒎 – 𝑹𝒇 = 7% - 3% = 4%
on the yields that are currently available for the selected
security. Cost of Equity (𝑹𝒆 ) = 𝑹𝒇 + ßL × (𝑹𝒎 – 𝑹𝒇 )
𝑹𝒆 = 4% + 1.1 x (7% – 3%)
𝑹𝒆 = 8.4%
Example 2: The investor is all set to buy stocks worth Rs. 455. It uses the linear relationship between the asset's expected
Annual returns from such an investment are expected to be return and a number of macroeconomic factors or variables
around 9%. Beta factor, in this case, is 0.8. Risk-free rate is 5%. that affect or capture the systemic risk. GDP, Domestic
This investor expects the market to increase in value by 8% Inflation Rate, Stock Indices, Gold Prices, risk free rate of
within this next year. Calculate 𝑲𝒆 . interest are such factors.
Solution 2: Expected Return E(x) = 𝑹𝒇 + ß𝟏 * 𝐑𝐏𝟏 + ß𝟐 * 𝐑𝐏𝟐 + ß𝟑 * 𝐑𝐏𝟑
RP = 𝑹𝒎 – 𝑹𝒇
𝑹𝒇 = 9% , ßL = 0.8, 𝑹𝒎 – 𝑹𝒇 =8% - 5% = 3%
Cost of Equity (𝑹𝒆 ) = 𝑹𝒇 + ßL × (𝑹𝒎 – 𝑹𝒇 )

Example 3:
𝑹𝒆 = 9% + 0.8 x (8% – 5%)
The following 4 factors have been identified as explaining a
𝑹𝒆 = 11.4% stock's return and sensitivity to each factor and the risk
premium associated with each factor have been calculated:
(RP means Risk Premium)
Arbitrage Pricing Theory (APT): *Gross domestic product (GDP) growth: ß = 0.6, RP = 4%
This is an alternative method to CAPM. * Inflation rate: ß = 0.8, RP = 2%
While CAPM takes into account security returns and market * Gold prices: ß= -0.7, RP = 5%
returns, this method or theory goes beyond it, thinking that
* Sensex index return: ß= 1.3, RP = 9%
market sometimes misprices securities.
* The risk-free rate is 3%
APT, therefore, tries to take advantages of any or many
arbitrage opportunities or derivatives in the market or the
economy.
Solution 3:
Using the APT formula, the expected return is calculated as: ABFM MODULE - B
Expected Return E(x) = 𝑹𝒇 + ß𝟏 * 𝐑𝐏𝟏 + ß𝟐 * 𝐑𝐏𝟐 + ß𝟑 * 𝐑𝐏𝟑 + ß𝟒 Chapter 10: CAPTIAL BUDGETING FOR
* 𝐑𝐏𝟒 +
INTERNATIONAL PROJECT INVESTMENT DECISIONS (PART-II)
Expected return
What we will study?
= 3% + (0.6 × 4%) + (0.8 × 2%) + (-0.7 × 5%) + (1.3 × 9%)
*How to calculate risk adjusted discount rate?
= 3% + (2.4%) + (1.6%) + (-3.5%) + (11.7%) = 15.2%
*If Spot rate of USD is given then how to calculate
future rate of USD?
Example 4:
Let’s consider our asset as a commodity stock called GOLD
123. The stock has two risk factors associated with it –
inflation and the price of the U.S Dollar currency.
𝑹𝒇 (Risk free rate) = 2%
Inflation – Risk Premium = 2%, Beta = 0.2
U.S Dollar – Risk Premium =10%, Beta = 0.5
Solution 3:
E(x) = Rf + β1 *(RP1) + β2 *(RP2) + …+ βn *(RP n)
E(x) = 2% + 0.2 * (2%) + 0.5 * (10%)
= 2% + 0.4% + 5% = 7.4%
ISSUES INVOLVED IN EVALUATION OF OVERSEAS PROJECTS: Solution:
While the methods of evaluation of overseas projects are the The formula used is, (𝟏 + 𝒓𝒂 ) = (𝟏 + 𝒓𝒇 ) × (𝟏 + 𝒓𝒑 )
same as for the domestic projects, the following issues are
Where, 𝒓𝒂 is the risk-adjusted discount rate.
involved:
𝒓𝒇 is the risk-free discount rate and
Calculation of Risk Adjusted Discount rate:
𝒓𝒑 is the risk premium
Arriving at an appropriate discount rate is essential for
applying the discounting methods of project evaluation. Applying this formula to the rupee discount rates, we
While the risk-free interest rate or discount rate is readily calculate the risk premium, required by the company, as
under:
available in both India and the foreign country, we have to
arrive at the relevant risk-adjusted discount rate. (𝟏 + 𝟎. 𝟏𝟐) = (𝟏 + 𝟎. 𝟎𝟕) × (𝟏 + 𝒓𝒑 ) or,
The method applied for this will be clear from the following 𝟏. 𝟏𝟐
(𝟏 + 𝒓𝒑 ) = = 𝟏. 𝟎𝟒𝟔𝟕
Illustration: 𝟏. 𝟎𝟕
ILLUSTRATION:
Applying the same formula and using the value of 𝒓𝒑 , as
* The following data is provided:
arrived above, we can calculate the risk adjusted discount rate
* The risk-free discount rate in USA is 4% for US$, as under:
* The risk-free discount rate in India is 7% (𝟏 + 𝒓𝒂 ) = (𝟏 + 𝒓𝒇 ) × (𝟏 + 𝒓𝒑 ) or,
* The risk-adjusted discount rate, required by the company in (𝟏 + 𝒓𝒂 ) = (𝟏 + 𝟎. 𝟎𝟒) × 𝟏. 𝟎𝟒𝟔𝟕 = 𝟏. 𝟎𝟖𝟖𝟖
India is 12%
𝒓𝒂 = 0.0888 => 𝒓𝒂 = 0.0888*100 = 8.88%
We have to calculate the risk-adjusted discount rate in USA,
So, the risk-adjusted discount rate, applicable for cash flows in
which will be acceptable to the company.
US$, will be 8.88%
Estimating the exchange rate in future years of the project's Solution:
life:
𝐡(𝟏+ 𝐫 ) 𝐭
The formula used is, 𝐒𝐭 = 𝐒𝟎 × [ ]
While evaluation of a domestic project is same as cash flows (𝟏+ 𝐫𝐟 )
are in rupees and the discounted value is also calculated in Where, 𝑺𝒕 is the spot rate of US$ at time t,
rupees.
𝑺𝟎 is the spot rate today.
But, in case of an overseas project, the cash flows are in
𝒓𝒉 is the notional risk-free interest rate in India,
foreign currency.
𝒓𝒇 is the risk-free interest rate in Foreign Country
So, before discounting, we will have to convert these cash
flows in to rupees at the prevailing exchange rate, to arrive at (USA in this case)
the present value.
Applying this formula, we calculate the estimated spot rate
This is because our initial investment in the project is valued for 1 US$, as under:
at the present spot rate.
For first year:
The method applied for this will be clear from the following (𝟏+ 𝟎.𝟎𝟕)
𝐒𝟏 = 𝟖𝟎 × or
Illustration: (𝟏+𝟎.𝟎𝟒)
( 𝟏.𝟎𝟕)
Example: 𝐒𝟏 = 𝟖𝟎 × (𝟏.𝟎𝟒)
= 𝟖𝟎 × 𝟏. 𝟎𝟐𝟖𝟖 = 𝐑𝐬. 𝟖𝟐. 𝟑𝟏𝟎
The following data is provided: For second year:

* The notional risk-free interest rate in USA is 4% 𝐒𝟐 = 𝟖𝟎 × (𝟏. 𝟎𝟐𝟖𝟖)𝟐 = 𝟖𝟎 × 𝟏. 𝟎𝟓𝟖𝟓 = 𝟖𝟒. 𝟔𝟖𝟐𝟎
* The notional risk-free interest rate in India is 7% For third year:
* Current Spot rate of 1 US$ is Rs. 80 𝐒𝟑 = 𝟖𝟎 × (𝟏. 𝟎𝟐𝟖𝟖)𝟑 = 𝟖𝟎 × 𝟏. 𝟎𝟖𝟖𝟗 = 𝟖𝟕. 𝟏𝟏𝟑𝟎
* We have to calculate the estimated spot rate of US$ at the For fourth year:
end of each of the years of the project life. 𝐒𝟒 = 𝟖𝟎 × (𝟏. 𝟎𝟐𝟖𝟖)𝟒 = 𝟖𝟎 × 𝟏. 𝟏𝟐𝟎𝟑 = 𝟖𝟗. 𝟔𝟐𝟓𝟎
ABFM MODULE - B APPROACHES FOR EVALUATION OF OVERSEAS PROJECT:
Chapter 10: CAPTIAL BUDGETING FOR There are, basically, two approaches for foreign project
evaluation, viz.
INTERNATIONAL PROJECT INVESTMENT DECISIONS (PART-III)
1. Home Currency Approach and
What we will study?
2. Foreign Currency Approach.
*What are the two approaches for foreign project
evaluation?
Home Currency Approach:
1. Home Currency Approach.
Under this approach, all the cash flows of the project are
2. Foreign Currency Approach.
converted in to home currency (rupee) by applying the
actual/estimated spot rate at the time of the cash flow.
These cash flows are then discounted using the domestic risk-
adjusted discount rate.
This approach will be clear from the following Illustration:
ILLUSTRATION:
The following data is provided:
* The cash flows of the project are as under (in US$, lakh):
* Initial investment 100
* First year net cash inflow 30
* Second year net cash inflow 40
* Third year net cash inflow 50 For third year:
* Fourth year net cash inflow 50 𝐒𝟑 = 𝟖𝟎 × (𝟏. 𝟎𝟐𝟖𝟖)𝟑 = 𝟖𝟎 × 𝟏. 𝟎𝟖𝟖𝟗 = 𝟖𝟕. 𝟏𝟏𝟑
* The risk-adjusted rupee discount rate, required by the For fourth year:
company which is envisaging project in USA, is 12% 𝐒𝟒 = 𝟖𝟎 × (𝟏. 𝟎𝟐𝟖𝟖)𝟒 = 𝟖𝟎 × 𝟏. 𝟏𝟐𝟎𝟑 = 𝟖𝟗. 𝟔𝟐𝟓
* The notional risk-free interest rate in USA is 4%
* The notional risk-free interest rate in India is 7% Therefore, the cash inflows, converted in to rupees, will be,
* Current Spot rate of 1 US$ is Rs. 80 Cash Inflow ($) US $ Rates Cash Inflow (₹)
We have to calculate the PV of the cash inflows of the project (a) (b) (a)*(b)
which has a useful life of 4 years, using the Home Currency
30 82.310 2469
approach.
40 84.682 3378
Solution:
50 87.113 4356
We have to first calculate the estimated spot rate for 1 US$,
for year 1 , 2 , 3 and 4 as under: 50 89.625 4481
(𝟏+ 𝟎.𝟎𝟕)
𝐒𝟏 = 𝟖𝟎 × (𝟏+𝟎.𝟎𝟒)
or
( 𝟏. 𝟎𝟕) These cash inflows will have to be discounted by the rupee

𝐒𝟏 = 𝟖𝟎 × = 𝟖𝟎 × 𝟏. 𝟎𝟐𝟖𝟖 = 𝐑𝐬. 𝟖𝟐. 𝟑𝟏𝟎 risk-adjusted discount rate to arrive at their Present Value
(𝟏. 𝟎𝟒)
(PV).
For second year:
So,
𝐒𝟐 = 𝟖𝟎 × (𝟏. 𝟎𝟐𝟖𝟖)𝟐 = 𝟖𝟎 × 𝟏. 𝟎𝟓𝟖𝟓 = 𝟖𝟒. 𝟔𝟖𝟐
𝟐𝟒𝟔𝟗 𝟑𝟑𝟖𝟕 𝟒𝟑𝟓𝟔 𝟒𝟒𝟖𝟏
𝐏𝐕 = + + +
𝟏. 𝟏𝟐 (𝟏. 𝟏𝟐)𝟐 (𝟏. 𝟏𝟐)𝟑 (𝟏. 𝟏𝟐)𝟒
𝟐𝟒𝟔𝟗 𝟑𝟑𝟖𝟕 𝟒𝟑𝟓𝟔 𝟒𝟒𝟖𝟏 Step 3. Convert initial investment in foreign currency in to
𝐏𝐕 = + + +
𝟏. 𝟏𝟐 𝟏. 𝟐𝟓𝟒𝟒 𝟏. 𝟒𝟎𝟒𝟗 𝟏. 𝟓𝟕𝟑𝟓 home currency by using actual present spot rate.
𝐏𝐕 = 𝟐𝟐𝟎𝟒 + 𝟐𝟕𝟎𝟎 + 𝟑𝟏𝟎𝟎 + 𝟐𝟖𝟒𝟖 = 𝟏𝟎, 𝟖𝟓𝟐
Step 4. Find out the period during which the cash inflows in
So, the Present Value of all the cash inflows of the project is home currency are equal to the initial investment in home
Rs. 10,852. currency.
This is the pay-back period.
EVALUATION METHODS:
We will not go into the details of the methods as these are In the example given in above, the cash flows in home
already discussed in the previous chapter. currency are calculated as under:
We will only illustrate how the Home Currency approach and Initial investment 8,000
the Foreign Currency approach are applied to these methods.
For this, we will use the same project which is mentioned in
the previous illustrations. Cash Flow Rs. in Lakh Cumulative flow
First year cash inflow 2,469 2,469
Evaluation methods using Home Currency Approach: Second year cash inflow 3,387 5,856
Pay-back period method: Third year cash inflow 4,356 10,212
Step 1. Estimate the spot rate for each year of the project's Fourth year cash inflow 4,481
𝒕
(𝟏+𝒓 )
life by using the formula, 𝑺𝒕 = 𝑺𝟎 × [(𝟏+𝒓𝒉)]
𝒇
𝟐𝟏𝟒𝟒
So, the pay-back period is 𝟐 + (𝟒𝟑𝟓𝟔)= 2.49 years or, 2 years
Step 2. Convert foreign currency cash inflows in to home
currency inflows, by using the spot rates arrived at in step 1. and 5.88 months.
Internal Rate of Return Method (IRR): So, use the following formula to calculate IRR (r) of the
project:
Step 1. Estimate the spot rate for each year of the project's
𝒕 𝟐𝟒𝟔𝟗 𝟑𝟑𝟖𝟕 𝟒𝟑𝟓𝟔 𝟒𝟒𝟖𝟏
(𝟏+𝒓 )
life by using the formula, 𝑺𝒕 = 𝑺𝟎 × [(𝟏+𝒓𝒉)] 𝟖𝟎𝟎𝟎 = + + +
𝒇 (𝟏 + 𝐫) (𝟏 + 𝐫)𝟐 (𝟏 + 𝐫)𝟑 (𝟏 + 𝐫)𝟒
Step 2. Convert foreign currency cash inflows in to home By trial and error, the rate is about 27%.
currency inflows, by using the spot rates arrived at in step 1
NPV method:
Step 3. Convert initial investment in foreign currency in to Step 1. Estimate the spot rate for each year of the project's
home currency by using actual present spot rate (𝟏+𝒓 )
𝒕
life by using the formula, 𝑺𝒕 = 𝑺𝟎 × [(𝟏+𝒓𝒉)]
𝒇
Step 4. By trial and error, find that discount rate which makes Step 2. Convert foreign currency cash inflows in to home
the PV of cash inflows equal to the initial investment. currency inflows, by using the spot rates arrived at in step 1.
ILLUSTRATION: Step 3. Convert initial investment in foreign currency in to

home currency by using actual present spot rate.
In the example given above, the cash flows in home currency
are calculated as under: Step 4. Discount the cash inflows using the domestic risk-
adjusted discount rate and find their PV.
Initial investment Rs. 8,000 lakh
Step 5. Calculate NPV by subtracting initial investment from
First year cash inflow Rs. 2469 lakh the PV.
Second year cash inflow Rs. 3387 lakh ILLUSTRATION: In the example given above, the PV of the
Third year Fourth year cash inflow Rs. 4356 lakh cash flows in home currency is calculated as Rs. 10,852 lakh.
So, NPV is 10,852 - 8000 = Rs. 2,852 lakh.
Fourth year cash inflow Rs. 4481 lakh
Profitability Index Method: ABFM MODULE - B
Step 1. Estimate the spot rate for each year of the project's Chapter 10: CAPTIAL BUDGETING FOR
𝒕
(𝟏+𝒓𝒉 )
life by using the formula, 𝑺𝒕 = 𝑺𝟎 × [(𝟏+𝒓 )] INTERNATIONAL PROJECT INVESTMENT DECISIONS (PART-IV)
𝒇
Step 2. Convert foreign currency cash inflows in to home What we will study?
currency inflows, by using the spot rates arrived at in step 1. *All about Foreign Currency Approach?
Step 3. Convert initial investment in foreign currency in to
*How to calculate Payback Period, NPV,PI, IRR using
home currency by using actual present spot rate.
foreign currency approach?
Step 4. Discount the cash inflows using the domestic risk-
adjusted discount rate and find their PV.
Step 5. Calculate PI by dividing PV by the investment.
ILLUSTRATION:
In the example given above, the PV of the cash flows in home
currency is calculated as Rs 10,852 lakh. So,
𝐏𝐕 𝟏𝟎, 𝟖𝟓𝟐
𝐏𝐈 = = = 𝟏. 𝟑𝟓𝟔
𝐈𝐧𝐢𝐭𝐢𝐚𝐥 𝐢𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭 𝟖𝟎𝟎𝟎
Foreign Currency Approach: * The risk-adjusted discount rate, required by the company, in
India, is 12%
Under this approach, the cash flows of the project remain in
the foreign currency only and are not converted in to home * Current Spot rate of 1 US$ is Rs. 80
currency (rupee).
We are required to calculate the PV of the cash inflows of the
These cash flows are then discounted, using the risk-adjusted project, which has a useful life of 4, using the Foreign Currency
discount rate of the foreign currency. approach.
The present value of the discounted cash flow, thus arrived, is Solution:
converted in to home currency by applying the present spot
We will have to first calculate the risk-adjusted discount rate
rate.
for US$, which will be acceptable to the company.
This approach will be clear from the following Illustration:
Applying the formula, given in the earlier paragraph, we
ILLUSTRATION: calculate the risk premium, required by the company, as
under:
The following data is provided:
Formula: (𝟏 + 𝒓𝒂 ) = (𝟏 + 𝒓𝒇 ) × (𝟏 + 𝒓𝒑 )
* The cash flows of the project are as under (in US$, lakh):
(𝟏 + 𝟎. 𝟏𝟐) = (𝟏 + 𝟎. 𝟎𝟕) × (𝟏 + 𝒓𝒑 ) or
* Initial investment 100
𝟏. 𝟏𝟐
* First year net cash inflow 30 (𝟏 + 𝒓𝒑 ) = = 𝟏. 𝟎𝟒𝟔𝟕
𝟏. 𝟎𝟕
* Second year net cash inflow 40 Applying the same formula and using the value of 𝒓𝒑 , as
* Third year net cash inflow 50 arrived above, we can calculate the risk adjusted discount rate
for US$, as under:
* Fourth year net cash inflow 50
(𝟏 + 𝒓𝒂 ) = (𝟏 + 𝒓𝒇 ) × (𝟏 + 𝒓𝒑 ) or,
* The risk-free discount rate in USA is 4%
(𝟏 + 𝒓𝒂 ) = (𝟏 + 𝟎. 𝟎𝟒) × 𝟏. 𝟎𝟒𝟔𝟕 = 𝟏. 𝟎𝟖𝟖𝟖
* The risk-free discount rate in India is 7%
So, the risk-adjusted discount rate, applicable for cash flows in Evaluation methods using Foreign Currency Approach:
US$, will be 8.88% or say, 8.9%.
Pay-back period method:
Now, we will discount the cash inflows in US$, using this risk-
Step 1. Find out the period during which the cash inflows in
adjusted discount rate for US$, to arrive at the present value
foreign currency are equal to the initial investment in foreign
of the cash inflows
currency.
𝟑𝟎 𝟒𝟎 𝟓𝟎 𝟓𝟎
𝐏𝐕 = + + + This is the pay-back period.
𝟏. 𝟎𝟖𝟗 (𝟏. 𝟎𝟖𝟗)𝟐 (𝟏. 𝟎𝟖𝟗)𝟑 (𝟏. 𝟎𝟖𝟗)𝟒
𝟑𝟎 𝟒𝟎 𝟓𝟎 𝟓𝟎 ILLUSTRATION:
𝐏𝐕 = + + +
𝟏. 𝟎𝟖𝟗 𝟏. 𝟏𝟖𝟓𝟗 𝟏. 𝟐𝟗𝟏𝟓 𝟏. 𝟒𝟎𝟔𝟒
In the example given above, the cash flows in foreign currency
PV = 𝟐𝟕. 𝟓𝟓 + 𝟑𝟑. 𝟕𝟑 + 𝟑𝟖. 𝟕𝟐 + 𝟑𝟓. 𝟓𝟓 = 𝟏𝟑𝟓. 𝟓𝟓 $ are calculated as under:
Initial investment 100
So, the Present Value of all the cash inflows of the project is
US$ 135.55 lakh.
Cash Flow $ in Lakh Cumulative flow
Applying the spot rate given, this is equal to
First year cash inflow 30 30
80 × 135.55$ = 10,844₹
Second year cash inflow 40 70
Third year cash inflow 50 120
Note: NPV and PI need conversion into home currency while payback Fourth year cash inflow 50
period ,IRR use foreign currency directly.
𝟑𝟎
So, the pay-back period is 𝟐 + (𝟓𝟎) = 2.6 years or
2 years and 7.2 months.

Internal Rate of Return Method (IRR): NPV method:
Step 1. First calculate the risk-adjusted discount rate for Step 1. First calculate the risk-adjusted discount rate for
foreign currency, which will be acceptable to the company, by foreign currency, which will be acceptable to the company, by
using the formula; using the formula;
(𝟏 + 𝒓𝒂 ) = (𝟏 + 𝒓𝒇 ) × (𝟏 + 𝒓𝒑 ) (𝟏 + 𝒓𝒂 ) = (𝟏 + 𝒓𝒇 ) × (𝟏 + 𝒓𝒑 )
Step 2. By trial and error, find out that rate of discount which Step 2. Discount the cash inflows in foreign currency, using
makes PV of cash inflows in foreign currency, equal to initial this risk-adjusted discount rate for foreign currency, to arrive
investment in foreign currency. This is the IRR of the project. at the present value of the cash inflows in foreign currency.
Step 3. If the rate calculated in step 2 is more than that in step Step 3. Convert the figure, arrived at Step 2 to home currency
1, the proposal is acceptable. by multiplying it by the present spot rate.
Step 4. Convert the initial investment to home currency by
multiplying it by the present spot rate
ILLUSTRATION:
Step 5. Calculate NPV by subtracting initial investment from
In the example given above, the risk-adjusted discount rate,
the PV
applicable for cash flows in US$, is calculated to be 8.88% or
say, 8.9% .
For finding IRR (r), use the formula: ILLUSTRATION:
𝟑𝟎 𝟒𝟎 𝟓𝟎 𝟓𝟎 In the example given above, the risk-adjusted discount rate,
𝟏𝟎𝟎 = + + +
(𝟏 + 𝐫) (𝟏 + 𝐫)𝟐 (𝟏 + 𝐫)𝟑 (𝟏 + 𝐫)𝟒 applicable for cash flows in US$, is calculated to be 8.88% or
say, 8.9% .
By trial and error, the value of r can be found, which will be

about 35%.
The PV, of the cash inflows, discounted by 8.9% is: Step 3. Convert the figure, arrived at Step 2 to home currency
𝟑𝟎 𝟒𝟎 𝟓𝟎 𝟓𝟎 by multiplying it by the present spot rate.
𝐏𝐕 = + + +
𝟏. 𝟎𝟖𝟗 (𝟏. 𝟎𝟖𝟗)𝟐 (𝟏. 𝟎𝟖𝟗)𝟑 (𝟏. 𝟎𝟖𝟗)𝟒 Step 4. Convert the initial investment to home currency by
multiplying it by the present spot rate
PV= 𝟐𝟕. 𝟓𝟓 + 𝟑𝟑. 𝟕𝟑 + 𝟑𝟖. 𝟕𝟐 + 𝟑𝟓. 𝟓𝟓 = 𝐔𝐒$ 𝟏𝟑𝟓. 𝟓𝟓 𝐥𝐚𝐤𝐡. Step 5. Divide the figure of step 3 by the figure of step 4 to
arrive at the PI.
Applying the spot rate given, this is equal to ILLUSTRATION:
80 × 135.55 = Rs. 10,844 lakh. In the example given above, the risk-adjusted discount rate,
applicable for cash flows in US$, is calculated to be 8.88% or
The initial investment is 100 × 80 = Rs. 8000 lakh.
say, 8.9% .
So, the NPV is 10,844 - 8000 = Rs. 2,844 lakh.
The PV, of the cash inflows, discounted by 8.9% is:
𝟑𝟎 𝟒𝟎 𝟓𝟎 𝟓𝟎
𝐏𝐕 = + + +
Profitability Index Method (PI): 𝟏. 𝟎𝟖𝟗 (𝟏. 𝟎𝟖𝟗)𝟐 (𝟏. 𝟎𝟖𝟗)𝟑 (𝟏. 𝟎𝟖𝟗)𝟒
Step 1. First calculate the risk-adjusted discount rate for

foreign currency, which will be acceptable to the company, by PV = 27.55 + 33.73 + 38.72 + 35.55 = US$ 135.55 lakh.
using the formula; Applying the spot rate given, this is equal to 80 × 135.55 = Rs.
(𝟏 + 𝒓𝒂 ) = (𝟏 + 𝒓𝒇 ) × (𝟏 + 𝒓𝒑 ) 10,844 lakh.
Step 2. Discount the cash inflows in foreign currency, using The initial investment is 100 × 80 = Rs. 8000 lakh.
this risk-adjusted discount rate for foreign currency, to arrive
at the present value of the cash inflows in foreign currency.
𝐏𝐕 𝟏𝟎, 𝟖𝟓𝟐
𝐏𝐈 = = = 𝟏. 𝟑𝟓𝟔
𝐈𝐧𝐢𝐭𝐢𝐚𝐥 𝐢𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭 𝟖𝟎𝟎𝟎
ABFM MODULE - B SENSITIVITY ANALYSIS:
Chapter 11: ADJUSTMENT OF RISK UNCERTAINTY IN The uncertainty of future movements of certain variables can
CAPITAL BUDGETING DECISION (PART-I) move either way, that puts all our present estimates and the
project or investments to jeopardy. We need to safeguard
What we will study? against this.
*What is SENSITIVITY ANALYSIS? The variables and important components of capital budget are
cost, revenue and net profits. Taking all possible variables into
account will be a difficult task, making calculations complex.
Sensitivity analysis aims to assess the impact of changes in
each of these important variables on our projections or
estimates.
To explain the sensitivity analysis due to such variations, let's
take a simple example of a project to be implemented. Table
A below gives brief but important details of a PET Tube
manufacturing project.
Table A Considering discounting rate of 12% and project term as
Rs. in Lakhs 10 years, the Net Present Value (NPV) works out to
Year 0 Year 1-10 Rs. 5,200 lakhs.
Investment (40,000) Net Present Value (NPV) calculation:
Sales 36,000 Method 1:

𝟖𝟎𝟎𝟎 𝟖𝟎𝟎𝟎 𝟖𝟎𝟎𝟎 𝟖𝟎𝟎𝟎 𝟖𝟎𝟎𝟎 𝟖𝟎𝟎𝟎 𝟖𝟎𝟎𝟎 𝟖𝟎𝟎𝟎
Variable Costs (-) 24,000 𝐏𝐕 =
𝟏.𝟏𝟐
+ (𝟏.𝟏𝟐)𝟐
+ (𝟏.𝟏𝟐)𝟑 + (𝟏.𝟏𝟐)𝟒 + (𝟏.𝟏𝟐)𝟓 + (𝟏.𝟏𝟐)𝟔 + (𝟏.𝟏𝟐)𝟕 + (𝟏.𝟏𝟐)𝟖
𝟖𝟎𝟎𝟎 𝟖𝟎𝟎𝟎
Fixed Costs (-) 2,000 + (𝟏.𝟏𝟐)𝟗 + (𝟏.𝟏𝟐)𝟏𝟎
(-) 4,000 𝟖𝟎𝟎𝟎 𝟖𝟎𝟎𝟎 𝟖𝟎𝟎𝟎 𝟖𝟎𝟎𝟎 𝟖𝟎𝟎𝟎 𝟖𝟎𝟎𝟎 𝟖𝟎𝟎𝟎 𝟖𝟎𝟎𝟎
Depreciation @10% of PV = + + + + + + +
𝟏.𝟏𝟐 𝟏.𝟐𝟓𝟒𝟒 𝟏.𝟒𝟎𝟒𝟗 𝟏.𝟓𝟕𝟑𝟓 𝟏.𝟕𝟔𝟐𝟑 𝟏.𝟗𝟕𝟑𝟖 𝟐.𝟐𝟏𝟎𝟕 𝟐.𝟒𝟕𝟓𝟗
project cost (40000) 𝟖𝟎𝟎𝟎 𝟖𝟎𝟎𝟎
+ +
𝟐.𝟕𝟕𝟑𝟏 𝟑.𝟏𝟎𝟓𝟖
Profit before Tax (PBT) 6,000
PV = 7142.86 + 6377.55 + 5694.36 + 5084.21 + 4539.52 +
Tax @ 33.33% (-) 2,000 4053.10 + 3618.76 + 3231.15 + 2884.86 + 2575.83 = 45202.20
Profit after Tax (PAT) 4,000
Depreciation (+) 4,000 NPV = PV - I = 45202 - 40000 = 5202.
Net cash flow 8,000
Method 2:
On a total investment of Rs. 40,000 lakhs, targeted sales are Given Annuity factor: 12% = 5.65
Rs. 36,000 lakhs. The PAT (Profit After Tax) is Rs. 4,000 lakhs
PV = 8000*5.65 = 45200
resulting into net cash flow from operations at Rs. 8,000 lakhs.
NPV = PV - I = 45202 - 40000 = 5202.
This is a normal scenario without getting in to risk arising out If we find such impact and identify the vulnerable aspects, we
of uncertainty. can change our plan or make amendments to contain the risk.
Now if we consider the best and the worst scenarios in the This method can thus be employed to evaluate the budget
case of investment, sales, variable cost and fixed cost; the and the project to a higher degree of risk management.
results give you surprises.
The limitation of this method is that it only shows the NPV
To calculate the impact of changes in one variable, we and only one variable is changed at a time.
presume that the other variables remain constant.
To an extent this method is also subjective because it depends
The Table B below shows that in the worst scenario, if the on the perception of the decision maker of the analyst.
investment cost goes up to Rs. 48,000 lakhs, the NPV nose
Case 1: If Investment cost goes up to 48000:
dives to -1300 (negative).
Rs. in Lakhs
Similarly, if the sales fall to Rs. 30,000 Lakhs, the NPV falls to -
Year 0 Year 1-10
2340(negative).
Investment (48,000)
Sales 36,000
Variable Costs (-) 24,000
Fixed Costs (-) 2,000
Depreciation @10% of (-) 4,800
project cost (48000)
We can, therefore, say that the sensitivity analysis is a good Profit before Tax (PBT) 5,200
method of assessing the risk, enabling us to find out how
Tax @ 33.33% (-) 1,733
robust or weak the project is.
Profit after Tax (PAT) 3,467 ABFM MODULE - B
Depreciation (+) 4,800 Chapter 11: ADJUSTMENT OF RISK UNCERTAINTY IN
Net cash flow 8,267 CAPITAL BUDGETING DECISION (PART-II)
What we will study?
Method 2: *How to Solve SENSITIVITY ANALYSIS Numerical?
Given Annuity factor: 12% = 5.65
PV = 8267*5.65 = 46708
NPV = PV - I = 46708 - 48000 = - 1292 = - 1300.
Steps involved in Sensitivity Analysis: Calculate:
The steps that need to be taken in order to perform a 1. Calculate the Net Present Value (NPV) of the project.
sensitivity analysis are as follows:
Assume that the tax rate is zero.
1. Identifying the factors that have an impact on the NPV (or
2. Compute the impact on the project's NPV considering a
IRR) of the project.
2.5% adverse variance in each variable. Which variable
2. Developing a mathematical understanding of the
connections between the different variables. shall have the maximum effect?
3. Conducting an analysis to determine how the changes in Consider Life of the project as 3 years.
each of the variables will affect the net present value (or SOLUTION:
internal rate of return) of the project.
NPV Calculation:
ILLUSTRATION 1:
Calculation of Net Cash Inflow per year
A Ltd. is considering its new project with the following details:
Particulars Amount (Rs.)
Sr. No Particulars Figure
A Selling price per unit 100
1 Initial capital cost Rs. 400 Cr.
B Variable cost per unit 50
2 Annual unit sales 5 Cr.
C Contribution per unit (A−B) 50
3 Selling price per unit Rs. 100
D Number of units sold per year 5 Cr.
4 Variable cost per unit Rs. 50
E Total Contribution (C × D) Rs. 250 Cr.
5 Fixed costs per year Rs. 50 Cr.
F Fixed cost per year Rs. 50 Cr.
6 Discount Rate 6%
G Net cash inflow per year (E−F) Rs. 200 Cr.
Calculation of Net Present Value (NPV) of the Project Sensitivity Analysis considering 2.5 % Adverse in each
variable:
Year Year Cash Flow PV factor @ 6% Present Value
(Rs. in Cr.) (PV) (Rs. in Cr) The table that follows demonstrates how to determine the
impact on the NPV of the project in terms of percentages by
0 (400.00) 1.000 (400.00)
adjusting one variable at a time by 2.5 % (in a negative
1 200.00 0.943 188.60 direction) while maintaining the other variables in their
2 200.00 0.890 178.00 original states.
3 200.00 0.840 168.00 As a result, it is clear that the change in selling price has the
greatest impact on the NPV, accounting for 24.82% of the
Net Present Value 134.60 total change.
Factors that can affect the NPV are:
Method 2: Particulars Base New
If PVIFA for 6% is 2.673: Initial capital cost increase by 2.5% Rs. 400 Cr. Rs. 410 Cr.
PV = 200 * 2.673 = 534.6 Annual unit sales decreases by 2.5% 5 Cr. 4.875 Cr.
NPV = PV - I = 534.6 - 400 = 134.60 Selling price per unit decreases by 2.5% Rs. 100 Rs. 97.50
Variable cost per unit increases by 2.5% Rs. 50 Rs. 51.25
In this case, NPV represents the outcomes that are most likely Fixed costs per year increases by 2.5% Rs. 50 Cr. Rs. 51.25 Cr.
to occur rather than the events that actually occur.
It's possible that the real conclusion will be lower than
projected, or it could end up being higher.
Case 1: Initial capital cost increase by 2.5% to 410 Cr: Particulars Base Selling Variable Fixed Units
price per cost Per sold per
Particulars Base Initial Capital cost Cost per
unit unit year
increased to Rs. 410 year
increased increased reduced
crore. increased
to to to 4.875
to
A Selling price per unit 100 100 Rs.97.5 Rs.51.25 crore
Rs.51.25
B Variable cost per unit 50 50
crore
C Contribution per unit (A−B) 50 50
(Rs.) (Rs.) (Rs.) (Rs.) (Rs.)
D Number of units sold per year 5 5 A Selling price 100 97.5 100 100 100
(units in Crores) per unit
E Total contribution (C×D) 250 250 B Variable cost 50 50 51.25 50 50
F Fixed cost per year 50 50 per unit
G Net Cash Inflow per year (E−F) 200 200 C Contribution 50 47.5 48.75 50 50
per unit
PV of Net cash inflow per year (A−B)
(G×2.673)
H 534.60 534.60
D Number of 5 5 5 5 4.875
I Initial capital cost 400 410 units sold
per year
J NPV (H−I) 134.60 124.60
(units in
K Percentage Change NPV -7.43% Crores)
E Total 250 237.5 243.75 250 243.75

contribution
(C×D)
F Fixed cost 50 50 50 51.25 50 ABFM MODULE - B
per year
Chapter 11: ADJUSTMENT OF RISK UNCERTAINTY IN
G Net Cash 200 187.5 193.75 198.75 193.75
Inflow per
CAPITAL BUDGETING DECISION (PART-III)
(E−F) What we will study?

*How to Solve SENSITIVITY ANALYSIS Numerical 2?
H PV of Net 534.6 501.19 517.89 531.26 517.89
cash inflow 0
per year
(G×2.673)
I Initial capital 400 400 400 400 400

cost
J NPV (H−I) 134.6 101.19 117.89 131.26 117.89
K Percentage -24.82% -12.41% -2.48% -12.41%

Change NPV
ILLUSTRATION 2 Three factors, the project is most sensitive to are: (if the
variable is adversely affected by 10%?)
Analyze how sensitive a project is to changes in initial project
cost, annual cash inflow, and cost of capital using the Base Amt. +10% -10%
following information regarding the project:
Initial project cost 1,20,000 1,32,000 1,08,000
Initial Project Cost (Rs.) 1,20,000
Annual cash inflow 45000 49500 40500
Annual Cash Inflow (Rs.) 45,000
Cost of capital 10% 11% 9%
Project Life (years) 4
Cost of Capital 10%
1- NPV when Initial project cost increases to 1,32,000:
(If initial project cost is varied adversely by 10%)
Identify which of the three factors, the project is most
(Rs.)
sensitive to, if the variable is adversely affected by 10%?
PV of cash on flows (Rs. 45000×3.169) 1,42,605
(Use annuity factors: 10% = 3.169 and 11% = 3.103).
Initial Project Cost (1,32,000)
Solution:
NPV 10,605 ₹
Calculation of NPV through Sensitivity Analysis:
(Rs.)
𝟏𝟎𝟔𝟎𝟓−𝟐𝟐𝟔𝟎𝟓 −𝟏𝟐𝟎𝟎𝟎
PV of cash on flows (Rs. 45000×3.169) 1,42,605 % change in NPV = *100 = *100 =-53.09%
𝟐𝟐𝟔𝟎𝟓 𝟐𝟐𝟔𝟎𝟓

NPV 22,605 ₹
2- NPV when annual cash inflow decreases to 40500: (If ABFM MODULE - B
annual cash inflow is varied adversely by 10%)
Chapter 11: ADJUSTMENT OF RISK UNCERTAINTY IN
(Rs.) CAPITAL BUDGETING DECISION (PART-IV)
What we will study?
*What is SCENARIO ANALYSIS?
NPV 8,345 ₹
𝟖𝟑𝟒𝟓−𝟐𝟐𝟔𝟎𝟓 −𝟏𝟒𝟐𝟔𝟎
% change in NPV = *100 = *100 = - 63.08%
𝟐𝟐𝟔𝟎𝟓 𝟐𝟐𝟔𝟎𝟓
3- NPV when cost of capital increases to 11%: (If cost of capital

is varied adversely by 10%)
(Rs.)
NPV 19,605 ₹
𝟏𝟗𝟔𝟎𝟓−𝟐𝟐𝟔𝟎𝟓 −𝟑𝟎𝟎𝟎
% change in NPV = 𝟐𝟐𝟔𝟎𝟓
*100 = 𝟐𝟐𝟔𝟎𝟓
*100 = - 13.14%
Conclusion: Project is most sensitive to annual cash inflow.

SCENARIO ANALYSIS: Table C
This method is an extension of or a step forward compared to (Rs. in lakhs)
the sensitivity analysis where only one variable was changed Pessimistic Expected Optimistic
at a time. In this method, one plans for say, three scenarios Scenario Scenario
Scenario
namely, normal or the expected, optimistic and the
pessimistic scenario. Investment 48,000 40,000 36,000
In the normal scenario, all the variables show expected values Sales 30,000 36,000 42,000
and the best values are taken for the optimistic scenario. Variable Costs 21,000(70%) 24,000 (66.67%) 27,300 (65%)
It is in the pessimistic scenario the worst values are placed. Fixed Costs 2,600 2,000 1,600
Thus, all the variables move in the same directions at the Depreciation 4,800 4,000 3,600
same time. Pre-Tax profit 1,600 6,000 9,500
To explain the analysis in figures, the following table is Tax 540 2,000 3,160
presented.
Profit after Tax 1,060 4,000 6,340
Annual Cash 5,860 8,000 9,940

flow from
operations
Net present (14,900) 5,200 10,080

value
Cash Flow X
PVIFA(5.65)
(12%, 10 year)
However, someone may ask, will all the variables move in the SOLUTION:
same direction at the same time?
The possible outcomes will be as follows:
The answer may not be in affirmative. Worst Case:
Year PVF @ 9 % Cash Flow PV

ILLUSTRATION 3 0 1 (1,400) (1,400)
XYZ Ltd. is considering a project "A" with an initial outlay of 1 0.917 450 412.65
Rs. 14,00,000 and the possible three cash inflow attached with 2 0.842 400 336.80
the project as follows:
3 0.772 700 540.40
(Rs.‘000)
NPV -110.15
Particulars Year 1 Year 2 Year 3
Worst case 450 400 700
Most likely:
Most likely 550 450 800 Year PVF @ 9 % Cash Flow PV
Best case 650 500 900 0 1 (1,400) (1,400)
1 0.917 550 504.35
Determine the net present value of each scenario based on 2 0.842 450 378.90
the assumption that the cost of capital is 9%. 3 0.772 800 617.60
If XYZ Ltd is sure about the most likely result in the first two NPV 100.85
years but uncertain about the cash flow in the third year, then
analyze what the NPV will be assuming the worst-case
scenario in the third year.
Best Case: Solution:
Year PVF @ 9 % Cash Flow PV 𝟏 𝟏 𝟏
𝐑𝐬. 𝟓, 𝟓𝟎, 𝟎𝟎𝟎 × + 𝐑𝐬. 𝟒, 𝟓𝟎, 𝟎𝟎𝟎 × + 𝐑𝐬. 𝟕, 𝟎𝟎, 𝟎𝟎𝟎 ×
(𝟏. 𝟎𝟗) (𝟏. 𝟎𝟗)𝟐 (𝟏. 𝟎𝟗)𝟑
0 1 (1,400) (1,400) − (𝐑𝐬. 𝟏𝟒, 𝟎𝟎, 𝟎𝟎𝟎) +
1 0.917 650 596.05 = 𝐑𝐬. 𝟓, 𝟎𝟒, 𝟓𝟖𝟕 + 𝐑𝐬. 𝟑, 𝟕𝟖, 𝟓𝟕𝟔 + 𝐑𝐬. 𝟓, 𝟒𝟎, 𝟓𝟐𝟖 − (𝐑𝐬. 𝟏𝟒, 𝟎𝟎, 𝟎𝟎𝟎) =
2 0.842 500 421.00 𝐑𝐬. 𝟐𝟑, 𝟖𝟕𝟏.
3 0.772 900 694.80
NPV 311.85
If XYZ Ltd. is certain about the most likely result in first two
years but uncertain about the third year's cash flow, then,
NPV, expecting worst case scenario in the third year, will be as
follows:
Particulars Year 1 Year 2 Year 3

Worst case 450 400 700
Most likely 550 450 800
Best case 650 500 900
ABFM MODULE - B DECISION MAKING USING COST-VOLUME-PROFIT (CVP) ANALYSIS:
Chapter 12: DECISION MAKING (PART-I) In practical terms, the cost, volume and the price are the
important ingredients of any profit analysis.
What we will study?
Cost has two main components namely, fixed and variable.
*What is COST-VOLUME-PROFIT (CVP) ANALYSIS?
The fixed cost per unit will go down if volume of production or
sales increases.
Variable cost generally varies with volume but here too the
variance will depend on the product mix and the processes
adopted.
Higher volume of productions will generally reduce the cost of
production due to economy of scale, but incremental cost due to
up scaling the facilities may again change the cost structure.
Higher volume in sales may accompany with disproportionate
increase in marketing cost, some of which will be for brand
building and the rest may commensurate with the sales volumes.
While pricing will have direct impact on profitability, it in fact
determines the breakeven point.
Higher the sales realisation, earlier the breakeven point.
Volume will also have direct impact on absolute profits, which too
will be a determining factor in calculating the breakeven point.
An investor will have many constraints and criteria while taking a We can go on giving dozens of such examples to emphasise the
decision to invest. point that cost, volume and price remain the most important and
constant factors affecting the profits, breakeven point, and
Some important points affecting investment decisions due to cost,
payback period and ultimately the decision-making process for
volume and price, which ultimately determine profits and the
any project investment.
breakeven point, are noted below.
Any change in any one or more of these factors will need
A : When we introduce a new product in the market, we cannot
reworking and reanalysis of the decision-making process.
expect high volumes and therefore the costing will be higher.
In addition to being helpful in decision making for project
B : In the aforesaid scenario, we will have to keep the price
implementation, the CVP analysis helps in answering various
affordable or practically low to attract new set of buyers, which
financial questions like:
will delay the breakeven point.
*How the profits will be affected if we reduce the selling price
C : In case of a consumer products having large market, we will
and increase the volume?
have to plan for big volumes which will require large capital
investment. *If the fixed costs undergo a change due to advertising campaign
or other sales promotion measures, what should be the additional
D: In the aforesaid scenario, to carve out a reasonable market
sales volume to meet these costs?
share, huge advertisement and brand building expenses will have
to be incurred affecting the cost and profitability. *Whether the sales staff should be paid on the basis of fixed
salary, commission or, a combination of both?
E: Moreover, building large capacity will need huge investment
delaying the payback period. *What will happen to the financial results of the organisation, if
there is fluctuation in the sales, price, output or costs?
F: A speciality product, on the other hand, can be launched with
high price and good margins but may need brand building and
huge R&D expenditure.
Example 1:
A company manufactures cycles for both adults and children. The production of these steer supports occurs in batches of 25
Given below is information about cycles made for children – units. After completing a batch intended for the children’s cycle,
Particulars Traditional Activity Based
the following batch would be intended for the adult cycles.
CVP Analysis CVP Analysis As a result, there would be a change in the set-up following the
completion of each batch. If 10,000 children’s bicycles need to be
Monthly Demand and 10,000 units 10,000 units
manufactured, the needed number of set-ups is equal to 10,000
Production
steer support divided by 25 each batch. This results in a total of
Selling Price Rs. 8,000 per unit Rs. 8,000 per unit 400 set-ups.
Variable Cost per unit Rs. 7,500 per unit Rs. 7,500 per unit
Each set-up costs Rs. 500, which includes charges for items such as
Fixed Cost p.m. Rs. 10,00,000 p.m. Rs. 8,00,000 p.m. changing the oil and purchasing jigs, among other things.
(as identified under In the past, the standard CVP analysis combined this cost with the
each cost system) fixed cost altogether.
You are required to
In the context of a traditional CVP study, fixed costs are defined (i) Determine the break-even point and profit per month using
as costs that do not change in proportion to the amount of both the classic (traditional) CVP method and the Activity Based
product or service being purchased. CVP method.
After conducting an analysis using activity-based costing, it was (ii) As the manager of the plant, it is in your best interest to limit
determined that the monthly fixed costs that do not change, the amount of times that the machine needs to be set up so that
based on factors such as volume or any other cost driver, are Rs. it can operate at full capacity.
8,00,000 per month.
Imagine for a moment that the milling machine has the capability
According to the findings of the analysis, a milling machine is of producing different types of cycles, such as adult cycles, sports
utilised to cut metal into steer support. cycles, and so on at any time.
As a result, you suggest that the batch size of the children’s steer Selling Price per unit Rs. 8,000
support be increased to 50 individual units in a single batch.
Variable Cost per unit Rs. 7,500
The current number of set-ups, 400 (10,000 units divided by 25
Contribution per unit (S - VC) Rs. 500
units), will be reduced to 200 (10,000 units divided by 50 units).
Fixed Cost per month Rs. 10,00,000
The fabrication of larger batches will necessitate the leasing of
more inventory storage space, which will result in an additional Break-even Point (per month in units) 2,000 units
expense of Rs. 50,000 per month for the business. 𝐅𝐢𝐱𝐞𝐝 𝐂𝐨𝐬𝐭 𝐩. 𝐦.
=
𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐩. 𝐮.
Analyse the impact on BEP (units per month) and PPM (earnings
per month). 𝐑𝐬. 𝟏𝟎, 𝟎𝟎, 𝟎𝟎𝟎
=
𝐑𝐬. 𝟓𝟎𝟎 𝐩𝐞𝐫 𝐮𝐧𝐢𝐭
(iii) When should the cost of labour be included in the overall
estimate of how much a set-up will cost? Explain. Monthly Demand (units) 10,000 units
(iv) How shall the number of set-ups on the milling machine and Profit per month = Rs. 40,00,000
the cost of each set-up affect the machine’s overall flexibility? {Monthly demand (units) × Contribution per unit} −
Explain. Fixed Cost per month
= (10,000 x Rs. 500 per unit) − Rs. 10,00,000
(b) Break-even point (units per month) and PPM (profit per
Solution: month) under Activity Based CVP method.
(i) (a) Break-even point (units per month) and profit per month Number of units produced per batch is 25. Therefore, number of
𝟏𝟎,𝟎𝟎𝟎 𝐮𝐧𝐢𝐭𝐬
under classical(traditional) CVP analysis: set-ups will be 𝟐𝟓 𝐮𝐧𝐢𝐭𝐬
= 400 per month.
Total expense inset up of 400 batches = 400*500 = 2,00,000. Despite the fact that the BEP units and the earnings each month
are identical when using either method, the Activity-Based
method has brought to light the fact that there are 400 set-ups
Selling Price per unit Rs. 8,000 being conducted each month.
Variable Cost per unit Rs. 7,500 This would provide management with additional data to work
Contribution per unit Rs. 500 with in order to enhance the functioning of the operations.
Fixed Cost per month (per Activity Based method) Rs. 8,00,000
Total expense in set up of 400 batches Rs. 2,00,000 (ii) Break-even point (units per month) and profit per month
under Activity Based CVP analysis: Batch size increased from
Break-even Point (per month in units) 2,000 units 25 to 50 units; monthly set-ups reduce from 400 to 200 per
=
{𝐅𝐢𝐱𝐞𝐝 𝐂𝐨𝐬𝐭 𝐩. 𝐦. +(𝐧𝐮𝐦𝐛𝐞𝐫 𝐨𝐟 𝐬𝐞𝐭𝐮𝐩𝐬 × 𝐜𝐨𝐬𝐭 𝐩𝐞𝐫 𝐬𝐞𝐭𝐮𝐩) month.
𝐑𝐬. 𝟖, 𝟎𝟎, 𝟎𝟎𝟎 + (𝟒𝟎𝟎 × 𝐑𝐬. 𝟓𝟎𝟎 𝐩𝐞𝐫𝐬𝐞𝐭𝐮𝐩)

=
𝐑𝐬. 𝟓𝟎𝟎 𝐩𝐞𝐫 𝐮𝐧𝐢𝐭 Selling Price per unit Rs. 8,000
𝐑𝐬. 𝟏𝟎, 𝟎𝟎, 𝟎𝟎𝟎
= Variable Cost per unit Rs. 7,500
Monthly Demand (units) 10,000 units Contribution per unit Rs. 500
Fixed Cost per month (per Activity Based method) Rs. 8,50,000
Profit per month = Rs. 40,00,000
Additional cost p.m. for inventory storage = Rs. 50,000
{Monthly demand (units) × Contribution per unit} –
(Fixed Cost per month +Set-up cost per month) Total expense in set up of 200 batches = 200*500 Rs. 1,00,000
= (10,000 x Rs. 500 per unit) – (Rs. 8,00,000 Break-even Point (per month in units) 1,900 units
+Rs.200,000)= Rs. 50,00,000− Rs. 10,00,00 {𝐅𝐢𝐱𝐞𝐝 𝐂𝐨𝐬𝐭 𝐩. 𝐦. +(𝐧𝐮𝐦𝐛𝐞𝐫 𝐨𝐟 𝐬𝐞𝐭𝐮𝐩𝐬 × 𝐜𝐨𝐬𝐭 𝐩𝐞𝐫 𝐬𝐞𝐭𝐮𝐩)
=
𝐑𝐬. 𝟖, 𝟓𝟎, 𝟎𝟎𝟎 + (𝟐𝟎𝟎 × 𝐑𝐬. 𝟓𝟎𝟎 𝐩𝐞𝐫 𝐬𝐞𝐭𝐮𝐩) Even after taking into account the rise in the cost of storing the
=
goods, profits have gone up by Rs. 50,000 per month (40,50,000 −
𝐑𝐬. 𝟗, 𝟓𝟎, 𝟎𝟎𝟎 40,00,000).
=
As a direct result of this, the number of units per month required
Monthly Demand (units) 10,000 units
to reach the point (BEP) where operations are profitable has come
Profit per month = Rs. 40,50,000 down from 2,000 to 1,900.
{Monthly demand (units) × Contribution per unit} – (Fixed This decrease is attributable to the savings in the overall set-up
Cost per month +Set-up cost per month) costs that were achieved as a result of there being fewer set-ups.
= (10,000 x Rs. 500 per unit) – (Rs. 8,50,000 +Rs.1,00,000) (iii) Inclusion of labour cost in the cost of set-up would depend on
their availability:
= Rs. 50,00,000− Rs. 9,50,00
(a) The cost of hiring temporary labour or the cost of outsourcing
operations necessary for set-up would be included in the total
Analysis: cost of setting up.
A conclusion can be drawn that the capacity of the machine can (b) The cost of permanent labour used for set-up who are
be enhanced if the batch size is increased. otherwise idle would not be included in set-up costs because the
salaries given to them have to be incurred even otherwise: this
The time that has been saved as a result of the reduction in set-
cost is a sunk cost. A sunk cost is money that has already been
ups from 400 per month to 200 per month is now available to be
spent and cannot be recovered.
employed in the production of parts for other cycles.
(c) The opportunity cost of labour must be taken into account, in
As a result of there being fewer set-ups, the monthly expenditures
addition to the hourly labour rate, in situations where permanent
associated with the set-ups will go down.
labour is used for setup, who are otherwise fully engaged in the
production process, additional labour supplies are unavailable in
the short term, and no further overtime work is possible.
(iv) How shall the number of set-ups on the milling machine and ABFM MODULE - B
the cost of each set-up affect the machine’s overall flexibility?
Explain. Chapter 12: DECISION MAKING (PART-II)
(iv) Setup affects a machine’s production efficiency. What we will study?

Reduced number of set-ups or reduced set-up time can help *What is Relevant Cost Concept?
increase the machine’s utilisation.
This also provides the organisation with the freedom to alter the
batches produced by the milling machine to meet the needs of
both children’s and adults’ bicycles.
Setup expenses are another issue that affects the flexibility of
production.
Reduced set-up costs result in increased adaptability to alter the
milling machine’s production batches to accommodate different
types of cycles.
DECISION MAKING USING RELEVANT COST CONCEPTS: costs are already incurred and will remain the same, irrespective
of the decision.
In decision making, one of the other ways is to classify the costs
according to whether they are relevant or not to a particular So, the costs of petrol and diesel are relevant costs, while the
decision. costs of road tax and insurance are irrelevant cost.
This concept is called Relevant Cost Concept and is valid and In this example, the costs of road tax and insurance are called
applicable for not only while planning an investment, but also “Sunk Costs” as these are made even before the decision-making
while running a business, on the premises that decision making is process starts.
a constant process and cost is an integral part of it.
Sunk cost does not mean that it is a wrongly incurred expenditure
Why we call it a Relevant Cost is because the cost is not a fixed or or has no benefit.
onetime concept but a concept relevant at a given time for a
In our above example, road tax and insurance costs have to be
given situation.
incurred and have their benefits.
It varies in total from one alternative to another.
The only point is that these are irrelevant to the decision of
In fact, every business decision has its cost whether known, making a choice of using which of the cars.
unknown, direct or indirect.
Relevant costs are also categorised as Avoidable costs, while the
Let’s now discuss in more detail various cost elements. irrelevant costs are categorised under Unavoidable costs.
Relevant costs are those future costs which will be affected by a This is because avoidable costs are incurred only if a specific
decision whereas, irrelevant costs are those which are not business decision is made while the unavoidable costs will have to
affected by the decision. be incurred irrespective of the outcome of the decision.
To give a simple example, if one owns both, a diesel and a petrol In our above example, the road tax and insurance costs are
car, and he has to undertake a long journey, the decision about unavoidable costs while the cost of petrol and diesel are the
using diesel or petrol car will take into account the costs of petrol avoidable costs.
and diesel but not the cost of road tax and insurance, as these
The relevant cost concept helps the decision-making process by However, if it is being used, say at 95% of its capacity, adding the
discarding the irrelevant cost data and thus, make the decision item to the production line will result in some sacrifice of the
making process less complicated. quantity of production of existing items, and, therefore, will
involve an opportunity cost.
While using the concept of Relevant costs, it is worthwhile to
examine the so called “Opportunity Costs”. Some of the important areas of decision making, which involve
the Relevant Cost Concept, are as under:
When you conceive a project, you had an alternative use available
or was in mind which could have given you some X return. (I) Add or drop a product line or segment.
When you use the resources for another project, you will lose that (II) Make or buy decision.
opportunity and potential income. That lost income is the
(III) Setting price of a product.
opportunity cost.
(IV) Accepting or rejecting special orders.
Opportunity cost thus does not require the payment of cash or its
equivalent. (V) Heavy discount offers from suppliers.
It is a potential benefit or income that is given up as a result of (VI) Import Substitutes.

selecting an alternative over another. (VII) Raw material mix.
It may be noted that opportunity cost, as a part of decision (VIII) Sale and Deals.
making, will arise only when use of scares resources is involved.
(IX) Outsourcing an activity or service.
For example:
To conclude, the relevant cost concept is a very wide concept and
if the forging machine in an engineering workshop is being utilised each case of management decision will need special and specific
at only 60% of its capacity for existing products, the decision to study and analysis. Relevant cost analysis plays a significant role
add another product, which uses 10% of the potential capacity of in decision-making.
the forging plant, no opportunity cost is involved as we are not
Let us check out some relevant cost examples:
sacrificing any production of existing products.
Example 1: Material A:
The ABC Company plans to launch a self-care portal, which will With zero inventories, they will buy all 50 units at Rs. 10.
result in a reduction of five positions within the company’s
Hence, relevant costs = 50 units × Rs. 10 = Rs. 500
customer support department.
Material B:
In this case, the cost that is significant and relevant is the
payment for the five personnel positions. We assume that if the order of buyer X is not accepted, the units
in inventory will have to be sold at the discounted selling price of
Example 2:
Rs. 13/unit, as there are not many buyers in the market for this
A business has received orders from buyer X for 3 materials A, B product.
and C. It already has some old inventory of products B and C, as
Our purchase price of Rs. 15/unit has no meaning.
specified in the following table.
As there are only 150 units in the inventory, we will have to
We have to arrive at the relevant cost of each material for making
purchase 50 units @ 17/unit from the market to fulfil the order.
the decision of whether to sell or not.
Hence, relevant cost of material B
Material Inventory Units Required Sale price per unit
= Rs. 13 × 150 + Rs. 17 × 50 = Rs. 1,950 + Rs. 850
A Nil 50 Rs. 10 p.u
= Rs. 2800
B 150 @ Rs. 15 p.u 200 Rs. 17 p.u
Material C:
Inventory units can
Rs. 30 per unit is not relevant since the current price is Rs. 23.
be sold at Rs. 13 Therefore,
C 90 @ Rs. 30 p.u 100 Rs. 23 Relevant cost of Material C = 100 units x Rs. 23 = Rs. 2,300
Example of Make or Buy Decision using Relevant Cost Concept: The ABC Company is in the business of producing auto parts,
some of which require very precise pieces of machinery.
A company that specialises in the production of completed items
needs to have certain components. The company needs a total of 50,000 individual units of spare
parts each year.
It must choose between manufacturing the components in-house
or obtaining them from a third party. When purchasing from a supplier, the unit price is Rs. 5 (five
rupees). Total expense = 50,000 * 5 = 2,50,000/-.
Naturally, the one with the lowest cost is the one to choose.
However, the identical component can also be manufactured by
In the case of a make or buy decision, some examples of
the company itself.
associated costs are direct materials, direct labour, and other
overhead expenses. The following costs are incurred by the company when the goods
are produced internally:
Let’s say a business needs a component for a machine.
Direct materials = Rs. 2/unit. & Direct labour = Rs. 2/unit
They have the option of procuring the part from a third party or
producing it in-house at the factory. Overhead costs = Rs. 1/unit & Special tools = Rs. 40,000
In the event that the business chooses to outsource certain
functions, it will need to free up some space that can be rented
Item Cost per Unit (Rs.) Total cost for 50,000 units
out.
Direct Materials 2 1,00,000
If the management decides to outsource work it can generate
additional cash from rented premises. Direct Labour 2 1,00,000
Thus, the company is able to reach the conclusion with the help of Overhead Costs 1 50,000
relevant cost analysis that purchasing the part is a more Special Tools 40,000
financially sound choice.
Total Cost = 2,90,000
For example:
According to the above illustration, it will cost ABC Rs. 2,50,000 ABFM MODULE - B
to buy from a supplier.
Chapter 12: DECISION MAKING (PART-III)
And it will cost Rs. 2,90,000 to make the same internally.
Therefore, ABC should continue outsourcing. What we will study?
Example of Continue Production or Close Business Unit decision, *All about decision making using Activity Based Costing
using Relevant Cost Concept: (ABC)?
The question of whether or not to continue operations or to shut
down individual business units, inevitably arises at some point in
the life of every company.
In this case, the management needs to assess whether or not the
units produced are generating the desired income and whether or
not the maintenance cost of the plant and machinery is high.
When it comes to making that decision, having the appropriate
cost analysis form is of the utmost importance
For example: The company Amol makes cheese worth Rs. 10,000
per month. Maintenance cost for machinery is Rs. 3,000, Rs. 2,000
for material, Rs. 2,500 for labour, and Rs. 2,500 for miscellaneous
costs.
Overall expenses amount to Rs. 10,000 for an income of the same
amount at Rs. 10,000. So, the company might think of
discontinuing the cheese unit. Amol might continue with cheese
production if the expenses are lower, like Rs. 7,500/-.
DECISION MAKING USING ACTIVITY BASED COSTING (ABC): Example 1:
Prior to the emergence of ABC, companies typically calculated Company SW Ltd. purchases CKD (Completely Knocked Down)
profitability using the allocation method. packs of 2 wheelers and 3 wheelers and assembles them to sell in
the market.
This allocation method involved allocating costs to a product or
customer using metrics such as the total number of units The material and labour cost of each pack, till it reaches the
produced, accounts, customers, or transactions. assembly line, is Rs. 50,000 and Rs. 80,000 respectively.
Activity Based Costing (ABC) is used for estimating the cost which Total cost incurred by assembly line, during the year, is Rs.
in turn is used for decision making. 20,00,000, utilising 20,000 labour hours.
It has been widely used to help the management in taking Assembly of a 2 wheeler takes, on an average, 20 labour hours
important decisions like pricing, outsourcing etc. while the assembly of a 3 wheeler takes 30 labour hours.
The method is used for costing of products, service or even a We have to find the cost of each 2-wheeler and 3 wheeler using
customer who is being serviced, all are termed as objects under the ABC costing method.
this method.
Solution:
The method is named after activity, which is the focus of the
Direct cost of material and labour for each pack is known, viz.
process.
Rs. 50,000 and Rs. 80,000 respectively.
ABC method of costing is based on the fact that the products and
services, provided by a company to its customers, involves various The issue is how to allocate the cost of assembly, an activity
such activities which are not exclusively related to one product or which is applied to both types of products.
service. For this, we use the term, ‘cost driver of the activity’, i.e. the most
To clarify further the concept of ABC, let us take a simple prominent constituent of the cost of the activity.
example: In the activity of assembly, the main cost constituent (cost driver)
is the labour, which is paid on hourly basis.
𝐜𝐨𝐬𝐭 𝐓𝐨𝐭𝐚𝐥 𝐜𝐨𝐬𝐭 𝐨𝐟 𝐚𝐜𝐭𝐢𝐯𝐢𝐭𝐲
In this case, the rate of the cost driver is total assembly 𝐥𝐚𝐛𝐨𝐮𝐫 𝐀𝐜𝐭𝐢𝐯𝐢𝐭𝐲 𝐜𝐨𝐬𝐭 𝐝𝐫𝐢𝐯𝐞𝐫 𝐫𝐚𝐭𝐞 =
𝐀𝐜𝐭𝐢𝐯𝐢𝐭𝐲 𝐝𝐫𝐢𝐯𝐞𝐫
𝟐𝟎,𝟎𝟎,𝟎𝟎𝟎
hours used = 𝟐𝟎,𝟎𝟎𝟎
= Rs. 100 per labour hour.
So, the assembly cost allocated to each 2-wheeler is Rs. 20×100 = Example 2:
2000 and for 3-wheeler, it is Rs. 30×100 =3000.
Let’s say that the management of a company that
So, the total cost of each 2-wheeler is Rs. 52,000 and that of each manufactures certain electronic devices has taken a decision
3 wheelers, Rs. 83,000. to install an ABC system.
What is Cost Driver? The management comes to the conclusion that there should
This is any factor that causes a change in the cost of activity. only be three cost drivers for all overhead expenses, and
those are direct labour hours, machine hours, and the
These are further classified into Resource Cost Driver and Activity
quantity of purchase orders.
Cost Driver.
The following are the company’s overhead costs, as shown in
A Resource Cost Driver measures the quantity of resources
the general ledger:
consumed by an activity and the Activity Cost Driver is a measure
of production, marketing, research etc. General Ledger Amount (Rs.)
Measuring units can be number of units produced, number of Payroll taxes 1,000
sales personnel, number of research projects, number of hours
Machine maintenance 500
spent on project etc.
Purchasing Dept, labour 4,000
Fringe benefits 2,000
In the traditional approach, we allocate the overheads based on
the volume of production unlike in ABC system where the Purchasing Dept. Supplies 250
allocation is activity based calculated on the basis of cost drivers Equipment depreciation 750
of the activities.
Electricity 1,250 Purchasing Dept, labour Rs. 4,000
Unemployment insurance 1,500 Purchasing Dept. Supplies Rs. 250
Total 11,250 Total Rs. 4,250
Differentiate which overheads are driven by direct labour Overhead rate is calculated by the formula:
hours? 𝐓𝐨𝐭𝐚𝐥 𝐜𝐨𝐬𝐭 𝐢𝐧 𝐭𝐡𝐞 𝐚𝐜𝐭𝐢𝐯𝐢𝐭𝐲 𝐩𝐨𝐨𝐥
𝐁𝐚𝐬𝐞
Payroll taxes Rs. 1,000
Base being the total number of labour hours, machine hours
Fringe benefits Rs. 2,000 and total number of purchase orders in the given case.
Unemployment insurance Rs. 1,500 Assume that the total number of labour hours be 1,000 hours,
Total Rs. 4,500 machine hours be 250 hours and total purchase orders be 100
orders.
So, Cost driver rate would be
Differentiate which overheads are driven by direct machine
hours? Cost Driver Rate (Rs.)
Machine maintenance Rs. 500 𝐑𝐬. 𝟒, 𝟓𝟎𝟎 Rs. 4.50 per labour hour
𝟏, 𝟎𝟎𝟎
Equipment depreciation Rs. 750
𝐑𝐬. 𝟐, 𝟓𝟎𝟎 Rs. 10 per machine hour
Electricity Rs. 1,250 𝟐𝟓𝟎
𝐑𝐬. 𝟒, 𝟐𝟓𝟎 Rs. 42.50 per purchase order
Total Rs. 2,500
𝟏𝟎𝟎
Differentiate which overheads are driven by no of purchase
order?
Chapter 12: DECISION MAKING (PART-IV) XYZ Ltd. is a multiproduct company, manufacturing three
products X, Y and Z.
What we will study?
The budgeted costs and production for the year ending 31st
*Activity Based Costing (ABC) Method based March are as follows:
Numerical?
X Y Z
Production quantity (Units) 4,000 3,000 16,00
Resources per Unit:
- Direct Materials (Kg.) 4 6 3
- Direct Labour (Minutes) 30 45 60
The budgeted direct labour rate was Rs. 10 per hour, and the
budgeted material cost was Rs. 2 per kg.
Production overheads were budgeted at Rs. 99,450 and were
absorbed to products using the direct labour hour rate.
XYZ Ltd. followed the Absorption Costing System.
XYZ Ltd. is now considering to adopt an Activity Based Costing
system.
The following additional information is made available for this
purpose.
1. Budgeted overheads were analysed into the following: You are requested to: Prepare a statement for management,
showing the product costs of each product using the ABC
(Rs.)
approach.
Material handling 29,100
Solution:
Storage costs 31,200
X Y Z Total
Electricity 39,150
Quantity (units) 4,000 3,000 1,600 -----
Material Weight per unit 4 6 3 -----
2. The cost drivers identified were as follows: (Kg.)
Material handling Weight of material handled Total material weight 16,000 18,000 4,800 38,800
Storage costs Number of batches of material Machine operations per 6 3 2 -----
Electricity Number of Machine operations unit
Total operations 24,000 9,000 3,200 36,200
3. Data on Cost Drivers was as follows: Total batches of Material 10 5 15 30
X Y Z
𝐑𝐬.𝟐𝟗,𝟏𝟎𝟎
For complete production: Material handling rate per kg. = Kg = Rs. 0.75 per Kg
𝟑𝟖,𝟖𝟎𝟎
Batches of material 10 5 15 Electricity rate per machine operations =

Per unit of production: =
𝐑𝐬.𝟑𝟗,𝟏𝟓𝟎
= Rs. 1.081 per machine operations
𝟑𝟔,𝟐𝟎𝟎
Number of Machine 6 3 2 𝐑𝐬.𝟑𝟏,𝟐𝟎𝟎
operations Storage rate per batch = 𝟑𝟎 𝐛𝐚𝐭𝐜𝐡𝐞𝐬 = Rs. 1,040 per batch.
Unit Cost: X Y Z
X(Rs.) Y(Rs.) Z(Rs.) Direct Labour (10₹/Hour) 30 min 45 min 60 min
Direct cost: 5 7.5 10
Direct Labour 5 7.5 10
Direct Material 8 12 6 X Y Z
Production Overhead: Direct Material (2₹/Kg) 4 Kg 6 Kg 3 Kg
Material Handling 3 4.5 2.25 8 12 6
Electricity 6.49 3.24 2.16
Storage 2.60 1.73 9.75 X Y Z
Material Handling (0.75₹/Kg) 4 Kg 6 Kg 3 Kg
Total Unit cost 25.09 28.97 30.16 3 4.5 2.25
No of units 4000 3000 1600
Total cost 1,00,360 86,910 48,256 X Y Z
Electricity (Rs. 1.081/machine operations) 6 3 2
6.49 3.24 2.16
Details:
X Y Z ABFM MODULE - C
Storage (1,040 ₹/batch) 10 5 15 Chapter 13: CORPORATE VALUATION
Storage price total 10400 5200 15600 What we will study?
No of units 4000 3000 1600 *How to calculate Weighted Average Cost of Capital
Storage price per unit = 𝟏𝟎𝟒𝟎𝟎 𝟓𝟐𝟎𝟎 𝟏𝟓𝟔𝟎𝟎 (WACC)?
𝟒𝟎𝟎𝟎 𝟑𝟎𝟎𝟎 𝟏𝟔𝟎𝟎
2.60 1.73 9.75
Weighted Average Cost of Capital (WACC): Illustration 2:
The weighted average cost of capital, or WACC, is a marginal The data in respect of ANC Limited is given:
cost, or the cost of raising more capital, that is averaged
* Additional Finance Required = Rs. 20,00,000
across the various sources of capital.
* Retained earnings = Rs. 4,00,000
Let rd, rp, and re equal the after-tax cost of debt, the cost of
preference shares, and the cost of equity shares respectively, * Debt equity ratio 25:75
and let wd, wp, and we represent the proportion of debt, * Cost of Debt Before Tax
preference shares, and equity shares capital in the capital
* 10% up to Rs. 2,00,000
structure respectively.
* 13% beyond Rs. 2,00,000
The weighted average cost of capital shall be calculated using
the following formula:
* EPS = Rs. 12.
WACC = 𝐰𝐝 𝐫𝐝 + 𝐰𝐩 𝐫𝐩 + 𝐰𝐞 𝐫𝐞
* Dividend Pay-out = 50% of earnings
This can be explained with the help of the following
illustrations: * Expected growth rate(G) in dividend 10%
Illustration 1: * Current Market Price (MP) per Share = Rs. 60

Source Weight Cost of Capital Weight * Cost * Company's Tax Rate (Tc) = 30%
Debt 45% 8% 0.036 * Shareholder's Personal Tax Rate = 20%
Preference Shares 5% 9% 0.0045 Calculate:
Equity Shares 50% 15% 0.075 A. Post-Tax Average Cost of Additional Debt?
Weighted Average Cost 0.1155
B. Cost of Equity?
of Capital
C. Cost of Retained Earnings?
D. Overall Weighted Average (After Tax) Cost of Additional 𝐏𝐚𝐲𝐨𝐮𝐭
Cost of Equity: 𝐂𝐄 = 𝐄𝐏𝐒 × +G
𝐌𝐏
Finance?
𝟏𝟐 (𝟓𝟎%)
= +10% = 10% + 10% = 20%
Solution: 𝟔𝟎
* Pattern of Raising Capital = 25(D):75(E)

* Debt = 0.25*Rs. 20,00,000 = Rs. 5,00,000 Cost of Retained Earnings: CR = CE (1 – TP)
* Equity = 0.75*Rs. 20,00,000 = Rs. 15,00,000 = 20*(1 – 0.2) = 16%
Equity Fund: Weighted Average Cost of Capital (CO):
* Retained Earnings = Rs. 4,00,000 Amount (Rs.) Cost After Tax% Cost(Rs.)
* Additional Equity = Rs. 11,00,000 Equity 11,00,000 20% 2,20,000
Debt Fund: Total 5 Lac Retained earning 4,00,000 16% 64,000
10% Debt = Rs. 2,00,000 Debt 5,00,000 8.26% 41,300
13% Debt = Rs. 3,00,000 Total 20,00,000 3,25,300
Post-Tax Average Cost of Additional Debt: 𝟑,𝟐𝟓,𝟑𝟎𝟎

CO= × 100 = 16.27%
𝟐𝟎,𝟎𝟎,𝟎𝟎𝟎
(𝟏−𝐓𝐜 )
CD = Total Interest *
𝐓𝐨𝐭𝐚𝐥 𝐃𝐞𝐛𝐭
( 𝟏−𝟎.𝟑) 𝟒𝟏,𝟑𝟎𝟎
= [20,000 + 39,000] =( ) =0.0826 * 100%
𝟓,𝟎𝟎,𝟎𝟎𝟎 𝟓,𝟎𝟎,𝟎𝟎𝟎
=8.26%
ABFM MODULE - C INTRODUCTION:
Chapter 13: CORPORATE VALUATION (PART-I) Corporate valuation is the process of determining the value of
a company entity, and it is most commonly used in the
What we will study? context of the financial industry.
*What is Book Value? We need to grasp the idea of value, before even beginning to
*What is Market Value? discuss valuation approaches.
There are two primary types of value, which are as follows:
*What are the different approaches for corporate
valuation? Book Value:
Book value can be described as the value of an asset or the
complete business entity as established by the books or the
financials of the company.
Thus, we may say that the book value can be derived from the
Balance Sheet.
Market Value:
This refers to the value that is derived through the analysis of
the market.
The market capitalization of a company, often known as the
number of outstanding shares multiplied by the share price,
defines the market worth of a company.
The market value is fundamentally an equity value because As a result of the fact that the fundamental goal of
equity investors value a company's shares apart from debt management is to maximise the value of the firm, managers
lenders and other investors. require a tool that can estimate the effects that various
strategies will have on the value of the firm.
The term "enterprise value", which is synonymous with "firm
value", refers to the value that is placed on a complete The model of the business valuation is the instrument in
company, including its debts and other commitments. question.
The significance of enterprise value lies in the fact that it The primary focus of effective financial management is to
comes close to approximating the worth of an entity's running optimise the value creation for shareholders.
assets, as we will see in the following section.
If the management cannot increase the value for
To be more specific, "Debts and other obligations" can include shareholders, they are going to hold the management
short-term debts, long-term debts, the current portion of accountable.
long-term debts, capital lease obligations, preferred
As a result, the top management and all senior managers are
securities, non-controlling interests, and other non-operating
required to have an understanding of what factors into value
liabilities.
and how to quantify it.
To summarise, the formula for determining an enterprise's
In the past, valuation was considered to be a difficult and
value is as follows:
highly technical academic subject; but, in today's business
Equity value + short-term debts + long-term debts + the world, it is of utmost relevance to managers.
current portion of long-term debts + capital lease obligations +
As a result of increasing globalisation and economic
preferred securities + non-controlling interests + other non-
liberalisation, businesses are placing a greater emphasis on
operating liabilities (e.g., unallocated pension funds) - (minus)
the capital market; and mergers, acquisitions, and other forms
Cash and cash equivalents.
of corporate reorganisation are becoming increasingly
common; strategic alliances are becoming more prevalent;
employee stock options are multiplying; and regulatory bodies This covers both equity shares and preference shares as well
are having difficulty determining appropriate tariff levels. as debentures and loans that are currently outstanding.
When carrying out these tasks, one of the most important The International Assets Valuation Standards Committee is
questions to ask is, responsible for developing the International Valuation
Standards (IVS), which are intended to be used as the primary
"How should the value of a firm, or a part thereof, be
guide for valuation professionals all over the world, in order
evaluated?"
to underpin consistency, transparency, and confidence in
The estimation of a company's true worth, in the current valuations.
market, is the primary objective of valuation.
According to the provisions of IVS 105 Valuation Approaches
It is, therefore, necessary to define "fair market value” and "a and Methods, due consideration must be given to the
company" in the beginning itself. valuation approaches that are pertinent and appropriate.
The concept of fair market value, as propounded by the
United States Internal Revenue Service (IRS), is accepted the
APPROACHES TO CORPORATE VALUATION:
world over.
As discussed in IVS 105, the primary methodologies, which are
Fair market value was defined by IRS as "the price at which
utilised in valuation, are all founded on the economic
property would change hands between a willing buyer and a
concepts of price equilibrium, anticipation of benefits, or
willing seller, when the former is not under any compulsion to
substitution.
buy and latter is not under any compulsion to sell, both
parties having reasonable knowledge of relevant facts." The principal valuation approaches, as per IVS 105, are:
When the asset being evaluated is "a corporation" the buyer (a) Market approach:
and seller are actually selling the claims that each stakeholder
The market approach is a valuation method that determines
in the firm has on the company as the property that is being
the value of a company, an intangible asset, an ownership
exchanged.
stake in a firm, or of securities, by taking into account the
price of a recent transaction or the price of assets that are This method is also known as the asset-based approach
comparable to the one being valued. (assets less its liabilities).
When determining the value of an asset, the market approach In layman's terms, this methodology has a tendency to
takes into account its size, quantity, quality, and other determine the worth of the firm on the basis of the value of
characteristics, in addition to the values of comparable assets. the assets held by the business.
This value is then applied to the item under examination. The use of this method is particularly helpful for asset-
intensive businesses, holding corporations, and troubled
This method assists in determining the worth of a business by
entities whose worth is less than their whole net tangible
making a comparison of the business (under valuation) to
value."
other businesses of a comparable nature that have been sold
in more recent times. Each of these methods of valuation contains a variety of
specific application procedures that are distinct from one
(b) Income approach:
another.
When valuing a company, the income approach is utilised to When picking ways and methodologies for the valuation of an
determine the present or current value of the company's asset, the objective is to locate the approach that is most
expected future earnings or cash flows. suitable for the specific conditions at hand.
The net operating income (NOI) of the company is determined There is no one approach that is appropriate for use in each
using this method, and then that figure is divided by the rate and every scenario.
of capitalization.
(c) Cost Approach:
The following criteria should be considered at the very least,
The cost approach, which is also known as the asset-based during the selection process:
approach, is able to extract value by combining the FMV (Fair
Market Value) of the company's net assets. (a) The relevant basis of value and premise of value, which are
established by the terms and purpose of the valuation
assignment, and the appropriate method of determining Further, the four primary methods that can be utilised for
value. determining the value of a firm are:
(b) The relative advantages and disadvantages of the various 1. Adjusted Book Value Approach.
approaches and methodologies that could be used for the
2. Stock and Debt Approach.
appraisal.
3. Direct Comparison Approach and
(c) The appropriateness of each way, having regard to the
nature of the asset, as well as the approaches or methods 4. Discounted Cash Flow Approach.
utilised by players in the relevant market, and the relative
importance of each method.
(d) The accessibility of trustworthy information that is
necessary to implement the approach.
When a valuer has a high degree of confidence in the accuracy
and reliability of a single method, given the facts and
circumstances of the valuation engagement, the valuer is not
required to use more than one method for the valuation of an
asset.
This is especially true when the valuer is valuing a property.
However, valuers should consider the use of multiple
approaches and methods, and more than one valuation
approach or method should be considered and may be used to
arrive at an indication of value.
ABFM MODULE - C ADJUSTED BOOK VALUE APPROACH:
Chapter 13: CORPORATE VALUATION (PART-II) Relying just on the data shown in a company's balance sheet,
is the least complicated method for determining the
What we will study? company's value.
*All about adjusted book value approach? When determining the value of a company, there are two
*All about stock and debt approach? methods that are functionally equal to using the information
from the balance sheet.
To begin, a direct tally of the book values of investor claims
might be performed, if desired.
Second, the total value of the company's assets can be
determined, and then from that figure, any claims made by
parties other than investors (such as accounts payable and
provisions) can be subtracted.
Let's look at an example to further understand how this
strategy works:
From the following Balance Sheet of Abstract Limited, the
value of the Company can be computed using the various
approaches relating to investor claims and the assets and
liabilities as under:
* Gross Block is the sum of the gross value of each asset as of
the beginning of the financial year.
Balance sheet of Abstract Limited as on 31/03/2022: Valuations based on the Balance Sheet:
Rs. Crore INVESTOR CLAIMS APPROACH ASSETS & LIABILITIES
APPROACH
LIABILITIES ASSETS
Share Capital 45.00 Total Assets 116.40
Share Capital 45.00 Fixed Assets (Net) 63.00
Equity 45.00 Gross Block 85.00 Reserves and Surplus 21.00 (Less) Current Liabilities 19.40
and Provision
Accumulated 22.00
Depreciation Secured Loans 24.30
Reserves and Surplus 21.00 Investments 11.50 Unsecured loans 6.50
Secured Loans 24.30 Current Assets, Loans and 41.90 TOTAL 97.00 TOTAL 97.00
Advances
Term Loans 10.00 Cash and Bank Balances 1.40

The degree of precision that may be achieved, using the book
Non-Convertible Receivables 25.00
value approach, is directly proportional to the degree to
Debentures 14.30 which the net book values of the assets accurately represent
Unsecured Loans 6.50 Inventories 15.00 their fair market values.
Bank Overdraft 3.50 Pre-paid expenses 0.50 There are three potential causes for a discrepancy between
Inter Corporate Loans 3.00
book prices and market values:
Current Liabilities and 19.40 (a) The book value of an asset might become increasingly
Provisions disconnected from its actual value as a result of inflation. The
historical cost of the asset is subtracted from the amount of
TOTAL 116.40 116.40 its depreciation to arrive at its book value. As a result, it does
not take into account inflation, which is unquestionably one STOCK AND DEBT APPROACH:
of the factors that influences market value.
When a company's securities are traded on a public exchange,
(b) Constant technological advancements render some the worth of the company can be determined by simply
essential assets obsolete and render them useless even before adding the current market value of all of its outstanding
depreciation has taken place. securities.
(c) Organizational capital, which is an extremely important This straightforward method is known as the stock and debt
form of capital, is not shown on the balance sheet. Value is approach.
added to an organization's capital when employees,
The efficiency of the market is the fundamental assumption
customers, and suppliers are brought together in a
that underpins the market-based approach.
relationship that is mutually advantageous and productive for
all parties involved. One of the most essential aspects of This indicates that the price, at which an asset is trading on
organizational capital is the fact that it cannot be readily the market, is the estimation of its intrinsic worth that is, in all
disassociated from the company, in its capacity as a likelihood, free from prejudice.
functioning entity. Let us take an example of stock and debt approach:
Organizational capital is the information/knowledge As on the 31st of March, 2022, the Seashore Limited had 15
embodied in employees. As such, business practices that lakh shares that were still outstanding.
facilitate/enhance the knowledge embodied in employees,
The market value of Seashore Limited's equity was Rs. 7.50
such as employee training, empowerment and job design will
Crore at the end of trading on that day as it was priced at Rs.
enable companies to utilize resources more efficiently, and
50 a share.
garner a competitive advantage.
Additionally, as of the 31st day of March in 2022, the
Company had an outstanding debt that totaled 15 Crore,
which had a market valuation of Rs. 14.80 Crore.
If we take the market value of the company's debt and add it There are two significant ramifications that stem from the
to the marker value of the company's equity, we get a total valuation practices involving the efficient market hypothesis:
value for the company as of the 31st of March, 2022 that
(a) The stock and debt technique will yield the most reliable
comes out to Rs. 22.30 Crore.
estimate of value in situations in which it may be applied.
Even while the stock and debt strategy are rather easy to
(b) The firm's securities have to be valued using the market
understand, there is still considerable controversy regarding
price that was obtainable on the date that the lien was
the values that should be used when valuing the instruments,
placed. It is not accurate to take an average of prices over a
notably the equity shares.
certain amount of time. The accuracy of the proposal is
Instead of utilizing the price that existed on the date of the harmed as a result.
lien, some appraisers recommend using an average of recent
stock prices, because of the volatility of stock prices (the day
on which the appraiser is attempting to value is called the lien
date).
They contend that a more accurate measure of the company's
genuine underlying value can be obtained by averaging prices
over a period of time rather than looking at the stock's price
at the current moment.
Whether or not it is rational to take the average of things is
dependent on how efficient the stock market is.
If the market is believed to be efficient, which indicates that
prices of securities reflect all of the information that is readily
available to the public, then there is no need for averaging.
ABFM MODULE - C DIRECT COMPARISON APPROACH:
Chapter 13: CORPORATE VALUATION (PART-III) The Direct Comparison Approach is founded on the Principle
of Substitution, which states that a buyer will not pay more
What we will study? for a given property than the cost of a comparable,
*All about Direct Comparison Approach? competitive property with the same utility in the open
market, provided there is no delay in making the transaction.
In this method, the analysts look for one or two businesses
that are extremely similar to the company whose value they
are attempting to determine.
Then, they base their estimate on the prices at which the
similar businesses are selling their products or services.
The most important aspect of this analysis is locating these
comparable businesses and determining their current market
prices.
The valuation method involves three steps:
1. Determining the property's highest and best use.
2. Identifying similar properties that have been sold, and
3. Adjusting the comparable sales values.
This method works best with comparable attributes. Best
comparable require minimal tweaking. When the selling price
is converted to a correct unit, the comparison is most
accurate.
The unit price is adjusted. Always do time adjustments first, In order to be regarded a comparable sale to the property in
then add all other adjustments to the time adjusted price per question, the properties that have been sold in the past must
unit to get a completely adjusted price per unit from each have had the same highest and best use, or at the very least,
comparator. one that is substantially close (as if comparing apples to
apples).
Steps involved in the Direct Comparison Approach:
It is best to make sure that they are located in the same
Direct comparison method is very often used for valuation of
geographic area, have a proven track record of sales in the
real estate.
past, and have comparable amenities.
The various steps of valuation using direct comparison
This will assure the best possible outcome.
method are as under:
The better these comparable are, the more similar they are to
The first thing that needs to be done is to figure out what the
one another.
best possible use of the property is.
In case a company is being valued, the analysts evaluate the
This is done to ensure that the property is sold at its highest
price of their own company in relation to the price of
possible price, taking into account both the inherent and the
companies in their peer group by utilising a multiple.
observable qualities of the property in question.
Therefore, if a stock is trading at 10 times earnings and the
These factors include the maximal productivity, the physical
average price-earnings ratio for the sector is 12, then the
circumstances, the legal permissibility, and the financial
stock is deemed to be inexpensive.
viability of the enterprise.
This technique is predicated on the notion that even while
In case of valuation of businesses, similar companies are
companies within a sector can differ greatly from one
identified by analysts.
another, the average for the sector is representative of the
In the second step, the valuer tries to find out the data in type of company that is most common.
respect of sales that are comparable to the one being
appraised.
The final stage is to alter the comparable sales values so that Let us take an example of using the direct comparison method
they reflect the qualities of the similar properties that are for valuation of real estate:
greater or inferior to those of the subject property.
A 4-bedroom flat was recently sold for Rs. 7 Crore.
When making changes, there are a lot of different elements
A valuer has been engaged for appraising the value of the flat
that need to be taken into consideration, such as the size,
next to it for mortgage financing.
form, topography, available facilities, and locational qualities
of the comparable transactions. The flat owner feels that, as the property next door (4-
bedroom flat) has been sold for Rs. 7 Crore, his flat, being a
In the process of valuing a company, analysts will often
corner flat with 4 bedrooms, balconies on two sides, Higher
attempt to control for differences between different
carpet area and more privacy, should be worth more.
companies.
As such, the valuer, while using the recently sold house next
This is done in recognition of the fact that there may be
door as a comparable property, must also evaluate other
significant differences between the company being valued and
properties that are similar to the flat being appraised and
other companies that are included in the comparable firm
have been recently sold.
group.
In this scenario, the valuer will first determine the
In many situations, the control is subject to interpretation.
characteristics of the comparable property, then compare
For example, if a company has a higher expected growth rate those features to the characteristics of the subject property,
than the average for its industry, it will trade at a higher and then adjust the value of the comparable property so that
multiple of earnings than the average for that industry; it is more comparable to the value of the subject property.
however, the exact amount by which it is trading higher is not
When all of this is finished, the value that has been adjusted
specified.
for inflation of the comparable property, should be roughly
equivalent to the value that has been determined for the
property in question.
The chart that follows illustrates the valuation methodology If the subject property lacks a feature that the comparable
for this flat: property possesses, the value of the subject property should
be decreased.
The attributes of the various real estate listings can be seen in
the left column. This is just a simple example between two properties for the
sake of illustration.
The comparable property and the necessary adjustments to
the valuation, that are required to make the comparable However, it is essential to note that in order to compare
property more like the subject property, are listed in the characteristics; the appraiser needs to obtain information
columns to the right of the subject property. from a variety of sources on both the subject property and
comparable properties.
When determining the value that has been changed, the
Property Being Valued Comparable Property
appraiser will first sum up all of the different changes and
Price - Rs. 7 Crore then either add them to or deduct them from the amount that
Privacy +5% - was paid for the comparable property.
Carpet Area + Pro-rate increase - In this particular illustration, the adjustments total an
increased value of more than 10% consequently and because
Balconies +5% - that amount is added to the comparable sale price of Rs. 7
Crore, this results in an adjusted value of Rs. 7.70 Crore for the
aforementioned property.
Add an amount to the value of the similar property, for each
of the subject's characteristics that is superior to that of the In conclusion, the Direct Comparison Approach can be applied
comparable. to the property in a speedy and uncomplicated manner by
using this method.
ABFM MODULE - C DISCOUNTED CASH FLOW APPROACH:
Chapter 13: CORPORATE VALUATION (PART-IV) The present value of potential future cash flows can be
calculated using a method known as discounted cash flow, or
What we will study? DCF, for short.
*What is Discounted Cash Flow Model? Obtaining an investment's value, with the use of this strategy,
is possible.
The DCF technique requires one to apply a discount rate to
each periodic cash flow of the company.
The discount rate is determined by that company's cost of
capital.
The total Present Value (PV) of all future cash flows can be
calculated by multiplying this discount by each future cash
flow to arrive at a number that represents the total present
value of all future cash flows.
One can select the alternative that results in the greatest
amount of discounted cash flows by performing the
calculation of discounted cash flows for a number of different
investment choices and then comparing the outcomes of
those calculations.
This idea is helpful for calculating the value of a prospective
acquisition, of a possible investment in an annuity, or of a
purchase of a fixed asset.
The idea that cash received today is more valuable than cash To calculate Present Value (PV) of a firm, we use the following
received at some point in the future, is the fundamental tenet formula:
upon which discounted cash flow analysis is built.
Paying someone for the privilege of delaying a payment,
which is known as interest income, is the only method to get
someone to agree to the delay in payment.
For example: If a person currently has Rs. 1,00,000 in his
possession and invests it at an interest rate of 10%, then after
one year of using the money he will have earned Rs. 10,000 in
income from the investment.
The DCF method of valuing a firm is similar to that for
If, on the other hand, he were to be prevented from accessing evaluation of a capital project.
those funds for a period of one year, then he would be
However, when valuing a company with the discounted cash
deprived of Rs. 10,000 in interest income.
flow methodology, it is necessary to make cash flow
The value of money over time is demonstrated by the interest projections over an unspecified amount of time unlike a
income in this illustration. project which is presumed to have a definite life.
The method of arriving at the Present Value (PV) of the firm, Also, the basic presumption in a capital project is that it will
by discounting future cash flows, is a helpful tool for assessing not expand during its life-cycle. But a business entity is
the value of the firm. anticipated to expand in the future.
It is also possible to use it to evaluate cash flows of other This is, without a doubt, a challenging proposition.
similar firms in order to determine which one has the greatest
In order to accomplish this objective, the value of the
present value.
company is typically segmented into two time periods,
namely:
Value of the firm = Step 2. Calculate Free Cash Flow, using the results of step 1.
Present value of cash flow during the explicit forecast period + Present Step 3. Calculate the weighted average cost of capital (WACC).
value of cash after the explicit forecast period.
Step 4. Based on calculations of Free Cash Flow (Step 2),
Since it is anticipated that significant change will take place forecast future cash flows for an explicit forecast period.
within the company over the explicit forecast term, which is
typically between 5 and 15 years, a significant amount of Calculate PV of free cash flows using WACC.
effort is put into the forecasting of its yearly cash flow. Step 5. Find the terminal value after the explicit forecast
Because it is presumed that the company will have reached a period and find its PV.
"stable level" by the time the explicit prediction period is up, Step 6. Add values in step 4 and 5 plus the value of non-
a more straightforward method is used to calculate the operating assets, to arrive at the valuation of the firm.
ongoing value of the company.
STEPS INVOLVED IN VALUATION USING DCF APPROACH:

The following steps are involved in the process of evaluating a
company using the discounted cash flow approach:
Step 1. Analyze historical performance to calculate:
A) Operating Invested Capital.
B) Net operating profit less adjusted taxes.
C) Return on Invested Capital.
D) Net Investments.
ABFM MODULE - C STEP 1: ANALYSIS OF HISTORICAL PERFORMANCE:
Chapter 13: CORPORATE VALUATION (PART-V) The first stage in valuing a firm is to conduct an analysis of the
company's past performance.
What we will study?
If you have a thorough understanding of how the company
*Steps in Discounted Cash Flow Model? has performed in the past, you have a strong basis for
estimating how well it will perform in the future.
Let us look at the following financial statements of Lala
Industries for the last four years, to understand the concept of
historical performance analysis.
Financial Statements of Lala Industries for last four years:
PROFIT AND LOSS ACCOUNT

2018- 19 2019- 20 2020- 21 2021- 22
Net Sales 400 500 600 700
Income from 20 30 35 40
investments
Non-operating Income 15 20 25 30
Total Income 435 550 660 770
Cost of goods sold 300 350 390 430
Sales and General 40 50 60 70 Total 429 514 579 671
administration
Fixed Assets 150 152 157 162
expenses
Investments 200 300 350 432
Depreciation 15 16 17 18
Net Current Assets* 69 62 72 77
Interest Expenses 22 25 26 28
Total 419 514 579 671
Total Cost and 377 441 493 546
expenses *Current Assets – Current Liabilities, which do not bear any
interest (like Accounts payable).
Profit Before Tax 58 109 167 224
Tax Provision 18 39 52 72
Extracting data useful for valuation:
Profit After Tax 40 70 115 152
All the data in the financial statements may not be useful for
Dividend 21 35 60 80
valuation of the firm.
Retained Earnings 19 35 55 72
We need the data which is useful in calculating the following:

A. Operating Invested Capital
BALANCE SHEET B. Net operating profit less adjusted taxes
Equity Capital 150 180 180 180 C. Return on Invested Capital
Reserve and Surplus 49 84 139 211 D. Net Investments
Borrowings 230 250 160 280
(a) Operating Invested Capital: (b) Net operating profit less adjusted taxes (NOPLAT):
Both operating and non-operating assets can be acquired NOPLAT = EBIT - Taxes on EBIT
using the funds provided by shareholders and lenders.
EBIT is the operating income that the company would have
This capital is referred to as invested capital. received before taxes if it did not have any debt obligations.
Operating Invested Capital refers to that portion of the During the process of computing EBIT, interest expenses,
invested capital which is used to acquire only operating interest income, and revenue or loss from non-operating
assets. activities are not taken into account.
The operating working capital is also added to it to arrive at
total Operating Invested Capital.
The calculation of NOPLAT for Lala Industries, assuming a
Operating working capital is calculated by subtracting non - marginal tax rate of 30 percent is given below:
interest bearing current liabilities from operating working
capital assets. 2018- 19 2019- 20 2020- 21 2021- 22
Operating working capital assets are total working capital Profit before tax 58 109 167 224
assets minus non-operating working capital assets like excess Add:
cash and marketable securities.
Interest expense 22 25 26 28
Operating Invested Capital:
Less:
2018-19 2019-20 2029-21 2021-22
Interest Loan -20 -30 -35 -40
Fixed Assets 150 152 157 162
Non-operating income -15 -20 -25 -30
Net Current Assets* 69 62 72 77
EBIT 45 84 133 182
219 214 229 239
Tax provision from 18 39 52 72 The following is a calculation of the ROIC for Lala Industries:
income statement
2019-20 2020-21 2021-22
Add:
NOPLAT (A) 52.5 91.2 122.6
Tax shield on interest 6.6 7.5 7.8 8.4
expense Operating Invested Capital 219 214 229
at the beginning of the year
Less:
(B)
Tax on interest income -6 -9 -10.5 -12
Return on Invested capital 23.97% 42.62% 53.54%
Tax on Non-operating -4.5 -6 -7.5 -9
(A)/(B)
income
Total Taxes on EBIT 14.1 31.5 41.8 59.4
NOPLAT 30.9 52.5 91.2 122.6 Net Investment:

The difference between the amount of gross investment and
the amount of depreciation is known as the net investment.
(c) Return on Invested Capital:
The term "gross investment" refers to the sum of "cumulative
Return on Invested Capital, ROIC, is defined as expenditure," which includes expenditure on current as well
𝐍𝐎𝐏𝐋𝐀𝐓 as non-current assets."
ROIC=
𝐎𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐢𝐧𝐯𝐞𝐬𝐭𝐞𝐝 𝐂𝐚𝐩𝐢𝐭𝐚𝐥
The term "depreciation” refers to any and all costs that are
Measurement of capital that has been invested often takes not paid in cash.
place either at the beginning of the year or as an average of
the starting and ending values for the year. Alternately, the following formula can be used to determine
the net investment made over the year:
Always use the same numerator and denominator definitions
when doing the ROIC calculation.
Net non-current fixed assets at the end of year + Net current ABFM MODULE - C
assets at the end of year Minus:
Chapter 14: Discounted Cash Flow Valuation (PART-I)
Net non-current fixed assets at the beginning of year + Net
current assets at the beginning of year What we will study?
*What is Dividend Discount Model?
Following is a calculation of the net investment for Lala

Industries using the aforementioned method:
2019-20 2020-21 2021-22
Net non-current/fixed assets at the 152 157 162

end of year
Add: Net current assets at the end of 62 72 77
the year
Sub-Total 214 229 239
Less:
Net non-current/fixed assets at the -150 -152 -157

beginning of year
Net current assets at the beginning of -69 -62 -72
the year
TOTAL -5 15 10
DIVIDEND DISCOUNT MODEL: Constant Growth Model:
The Dividend Discount Model is a quantitative method of One of the most common assumptions used by dividend
valuing a company's equity shares price based on the discount models is that the dividend paid out per share would
assumption that the fair price of share equals the present increase at a rate that is fixed (g).
value of the company's future dividends.
According to this hypothesis, the value of a share is computed
Dividend discount models are among of the oldest discounted as follows:
cash flow models still used in practice today. 𝐃𝟏 𝐃𝟏 (𝟏 + 𝐠) 𝐃𝟏 (𝟏 + 𝐠)𝐧
𝐏𝟎 = + 𝟐
+⋯ +⋯
Despite the fact that numerous analysts have moved away (𝟏 + 𝐫) (𝟏 + 𝐫) (𝟏 + 𝐫)𝐧+𝟏
from dividend discount models, on the grounds that these Where,
models produce estimates of value that are far too cautious, a
lot of the key concepts, that come through with dividend 𝐏𝟎 Is the current fair price of the share or intrinsic value of
discount models, apply when we look at alternative share.
discounted cash flow models. D₁ is the expected dividend one year from now.
The various dividend discount models used for valuation are r is the rate of return required by the investor.
as under:
n represents any particular year and can be any number
1- Constant Growth Model (Gordan Growth Model). between 0 and infinity.
2- Zero Growth Model. Following the use of the formula for the sum of a geometric
3- Two Stage Model. progression, the preceding expression can be simplified to:
4- H Model.
𝐃𝟏
5- Three Stage Model. 𝐏𝟎 =
(𝐫 − 𝐠)
Example: Illustration:
XYZ Ltd. is expected to pay a dividend of Rs. 3 per share one XYZ Ltd. is expected to pay a dividend of Rs. 3 per share one
year from now. year from now.
The dividend payments are expected to grow at 5% p.a. The dividend payments are expected to remain constant at Rs.
3 per share.
If an investor needs 12% rate of return on his investment,
what price of the share will be considered to be fair, by him? If an investor needs 12% rate of return on his investment,
what price of the share will be considered to be fair, by him?
Solution:
Solution:
Applying the formula, given above,
𝐃𝟏 = 3, g = 0 and r = 0.12
𝐃𝟏 = 3, g = 0.05 and r = 0.12
𝐃𝟏 Applying the formula for fair value,
𝐏𝟎 =
(𝐫 − 𝐠)
𝐃𝟏
𝟑 𝟑 𝐏𝟎 =
We get 𝐏𝟎 = (𝟎.𝟏𝟐−𝟎.𝟎𝟓) = 𝟎.𝟎𝟕 = Rs. 42.86 (𝐫 − 𝐠)
𝟑 𝟑
𝐏𝟎 = (𝟎.𝟏𝟐−𝟎) = 𝟎.𝟏𝟐 = Rs. 25
The vast majority of stock valuation models are founded on

the idea that dividends will increase over the course of time.
Two Stage Model:
Zero Growth Model:
The most straightforward modification of the continuous
In the event that we make the assumption that the dividend growth model postulates that the exceptional growth-
per share stays the same from year to year at a value of D, the whether positive or negative-will last for a set number of
formula will look like this: years, after which the usual growth rate will take over and
𝐃 continue indefinitely.
𝐏𝟎 =
𝐫
The market price of the equity share: Since the two-stage growth model assumes that the growth
rate after n years remains constant, 𝐏𝐧 will be equal to:
𝐃𝐧+𝟏
𝐃
𝟏 𝐃𝟏 (𝟏+𝐠 𝟏 ) 𝐃𝟏 (𝟏+𝐠 𝟏 )𝟐 𝐃𝟏 (𝟏+𝐠 𝟏 )𝐧−𝟏 𝐏
𝐧 𝐏𝐧 =
𝐏𝟎 =(𝟏+𝐫) + (𝟏+𝐫)𝟐
+ (𝟏+𝐫)𝟑
….+ (𝟏+𝐫)𝐧
+ ⋯ (𝟏+𝐫) 𝐧
𝐫−𝐠 𝟐
Where 𝐃𝐧+𝟏 the dividend is for year n+ 1 and g₂ is the growth

rate in the second period.
where 𝐏𝟎 is the present price of the equity share.
𝐃𝐧+𝟏 , The dividend for year n+1 may be expressed in terms of
𝐃𝟏 , is the dividend that is anticipated to be paid out one year
the dividend in the first stage.
from now.
g₁ is the extraordinary growth rate that is valid for n years &

𝐃𝐧+𝟏 = 𝐃𝟏 (𝟏 + 𝐠 𝟏 )𝐧−𝟏 (𝟏 + 𝐠 𝟐 )
P is the price of the equity share at the end of year n.
It is assumed that the share will be sold at the end of year n at
Substituting the above expression, we get
the price P.
𝟏 + 𝐠𝟏 𝐧
That is why its PV is included in the price 𝐏𝟎 . 𝟏−(
𝟏 + 𝐫 ) ) + (𝐃𝟏 (𝟏 + 𝐠 𝟏 ) (𝟏 + 𝐠 𝟐 )) ( 𝟏 )
𝐧−𝟏
𝐏𝟎 = 𝐃𝟏 (
𝐫 − 𝐠𝟏 𝐫 − 𝐠𝟐 (𝟏+𝐫)𝐧
The current value of a growing annuity is represented by the
first term on the Right-Hand Side of the following equation:
Illustration: The current dividend on an equity share of PML

𝟏+𝐠𝟏 𝐧
𝟏−(
𝟏+𝐫
) 𝐏𝐧 Private Limited is Rs. 5.
𝐏𝟎 = 𝐃𝟏 ( ) + (𝟏+𝐫)𝐧
𝐫−𝐠 𝟏
PML is expected to enjoy an above-normal growth rate of 25%
for a period of 6 years.
Thereafter, the growth rate will fall and stabilize at 15%. ABFM MODULE - C
Equity investors require a return of 20%.
Chapter 14: Discounted Cash Flow Valuation (PART-II)
What is the intrinsic value of the equity share of PML?
What we will study?
Solution:
*What is H Model?
The inputs required for applying the two-stage model are:
g₁ = 25% = 0.25 𝐠 𝟐 = 15% = 0.15
n = 6 years r = 20% = 0.20
𝐃𝟏 = 𝐃𝟎 (1+g₁) = Rs. 5*(1.25) = Rs. 6.25
Plugging these inputs in the two-stage model, we get the

intrinsic value estimate as follows:
𝟏 + 𝐠𝟏 𝐧
𝟏−(
𝟏 + 𝐫 ) ) + (𝐃𝟏 (𝟏 + 𝐠 𝟏 ) (𝟏 + 𝐠 𝟐 )) ( 𝟏 )
𝐧−𝟏
𝐏𝟎 = 𝐃𝟏 (
𝐫 − 𝐠𝟏 𝐫 − 𝐠𝟐 (𝟏+𝐫)𝐧
𝟏 − (𝟏. 𝟐𝟓/𝟏. 𝟐𝟎)𝟔 𝟔. 𝟐𝟓(𝟏. 𝟐𝟓)𝟓 (𝟏. 𝟏𝟓) 𝟏

𝐏𝟎 = 𝟔. 𝟐𝟓 ∗ + ∗
(𝟎. 𝟐𝟎 − 𝟎. 𝟐𝟓) (𝟎. 𝟐𝟎 − 𝟎. 𝟏𝟓) 𝟏. 𝟐𝟎𝟔
(𝟏−𝟏.𝟐𝟕𝟖) 𝟔.𝟐𝟓(𝟑.𝟎𝟓𝟐)(𝟏.𝟏𝟓)
𝐏𝟎 = 6.25∗ + (𝟎. 𝟑𝟑𝟒)
−𝟎.𝟎𝟓 𝟎.𝟎𝟓
𝐏𝟎 = 34.6918 + 146.9165 => 𝑷𝟎 = Rs. 181.6083
H Model: 𝐠 𝐧 is the expected long-term growth rate (n is normal growth
rate),
The H model is another growth model that consists of two
𝐠 𝐚 is the current growth rate ( a is abnormal growth rate), and
stages.
The H model, as opposed to the traditional two-stage model, H is the one half of duration during which 𝐠 𝐚 levels out to 𝐠 𝐧.
postulates that the exceptional growth rate in the beginning
stage does not remain constant but rather decreases linearly
The above equation can also be written as
over time until it achieves a stable rate in the steady stage.
𝐃𝟎 (𝟏+𝐠 𝒏 ) 𝐃𝟎 𝐇 (𝐠 𝒂 −𝐠 𝒏 )
This is in contrast to the conventional two-stage model. 𝑷𝟎 = +
𝐫−𝐠 𝐧 𝐫−𝐠 𝐧
The H model, which was developed by Fuller and Hsia, makes
the assumption that the earnings growth rate starts off at a
high initial rate (𝐠 𝐚 ), and then decreases at a linear rate over The H model can be understood in a straightforward manner
the course of 2H years to a stable growth rate (𝐠 𝐧 ), which is by using the equation that was just presented.
maintained forever. On the right-hand side of the equation, the first term indicates
This model also assumes that the earnings growth rate will the value based on the normal growth rate, and
remain stable forever, after the stability has been achieved. 𝐃𝟎 (𝟏 + 𝐠 𝒏 )
The equation for H model of valuation is as under: 𝐫 − 𝐠𝐧
𝐏𝟎 = 𝐃𝟎 [(𝟏 + 𝐠 𝐧 ) + 𝐇 (𝐠 𝐚 − 𝐠 𝐧 )] Whereas the second term represents the premium due to the
𝐫 − 𝐠𝐧 anomalous growth rate:
where r is the rate of return needed by investors, 𝐃𝟎 𝐇(𝐠𝒂 − 𝐠𝒏 )

𝐏𝟎 is the intrinsic value of each share, (𝐫 − 𝐠 𝐧 )
𝐃𝟎 is the current dividend per share,
ILLUSTRATION: 𝟏[(𝟏.𝟏𝟎)+(𝟎.𝟑𝟎−𝟎.𝟏𝟎)]
𝐏𝟎 = = Rs. 42
The equity shares of ABC Private Limited presently generate a 𝟎.𝟏𝟓−𝟎.𝟏𝟎
dividend payment of Rupee 1.00 every year.

The growth rate as of right now is 30%. The H model is more realistic than the two-stage model,
which predicts that the growth rate would suddenly slow
On the other hand, this will decrease in a linear fashion over
down after a given amount of time.
the course of ten years, and then it will level off at ten
percent. Instead, the H model predicts that the growth rate will
gradually slow down over time.
What is the company's intrinsic worth per share, assuming
that investors require a return of 15% on their investment?
The following information is available:
𝐃𝟎 = 1.00
𝐠 𝐚 = 30% = 0.30
H = 5 years
𝐠 𝐧 = 10% = 0.10
r = 15% = 0.15
Putting the above inputs in the H-model, we get the estimated
intrinsic value as follows:
𝐏𝟎 = 𝐃𝟎 [(𝟏 + 𝐠 𝐧 ) + 𝐇 (𝐠 𝐚 − 𝐠 𝐧 )]
𝐫 − 𝐠𝐧
ABFM MODULE - C INTRODUCTION:
Chapter 14: Discounted Cash Flow Valuation (PART-III) Even though discounted cash flow valuation is only one of
several ways to approach valuation, and even though the vast
What we will study? majority of valuations done in the real world are relative
*What is Discounted Cash Flow Valuation Model? valuations, discounted cash flow valuation serves as the basis
upon which all other valuation techniques are constructed.
In order to accurately do relative valuation, it is necessary for
us to have a fundamental understanding of discounted cash
flow valuation.
It is normal practice to start with a discounted cash flow
valuation before applying option pricing models to the
process of asset appraisal.
That is why understanding the discounted cash flow analysis is
important.
Any person who has a fundamental understanding of this
subject will be able to analyses and apply any of the other
methods.
This approach is grounded in the concept of present value,
which states that the value of any asset is equal to the sum of
the asset's predicted future cash flows, expressed as a present
value.
The cash flows will be different for each asset, such as Even though prices on the market can be different from an
dividends for stocks, coupons (interest) and the face value of asset's intrinsic value (which can be calculated based on its
bonds, and cash flows after taxes for real estate projects. fundamentals), you are keeping your fingers crossed that the
two will eventually align.
The level of risk associated with the expected cash flows will
determine how the discount rate is calculated; higher rates There are literally many different variations of discounted
will be applied to riskier assets, while lower rates will be cash flow models that can be used.
applied to safer projects.
It is widespread practice at investment banks and consulting
The discounted cash flow valuation method seeks to arrive at firms, to assert that their valuation models are superior to, or
an estimate of an asset's true worth, by basing that estimate more complex than, those utilized by their contemporaries in
on the asset's underlying characteristics. the industry.
What exactly does "intrinsic value” mean?
In the absence of a more precise definition, you can think of it ESTIMATING INPUTS:
as the value that would be attached to the company if it were
For applying the DCF method of valuing a firm or any other
evaluated by a neutral analyst who not only makes accurate
asset, we need the following inputs:
estimates of the expected cash flows for the company given
the information that is available at the time, but also uses the (a) The predicted cash flows in future.
appropriate discount rate to value these cash flows. (b) The discount rate that is suitable for the given level of risk
Even if the task of estimating intrinsic value appears to be associated with these cash flows.
impossible, particularly when valuing young companies with a (c) The estimated cash flow growth rate and
great deal of uncertainty about the future, it is still
(d) The estimated pattern of growth.
worthwhile to make the best estimates that you are capable
of and to persevere in attempting to estimate value, because
markets occasionally make errors.
These are discussed, in detail, below:
Expected Cash Flows: Estimating the cash flows prior to payments on debt and
preferred dividends is a much simpler way to reach the same
The dividend is the only source of cash flow that an equity
number.
investor receives from a publicly traded company, at least in
the most literal sense; financial models that use dividends as To do so, take the after-tax operating income and remove the
cash flows are referred to as dividend discount models. net investment that is required to maintain growth.
A broader definition of cash flows to equity would be the cash This gives us an estimate of the cash flows.
flows that are left over after the cash flow claims of nonequity
This cash flow is referred to as the free cash flow to the firm
investors in the firm have been met (interest and principal
(FCFF). The models that make use of these cash flows are
payments to debt holders and preferred dividends), as well as
referred to as FCFF models.
after enough of these cash flows have been reinvested into
the firm to sustain the projected growth in cash flows. Discount Rates:
This would be an example of how a broader definition of cash The question "how much money would have to be invested
flows to equity could be used. presently, at a particular rate of return, to yield the
anticipated cash flow, at its future date"?
This concept is known as the free cash flow to equity (FCFE),
and the types of models that make use of this concept, are Can be answered through the process of discounting future
referred to as FCFE discount models. cash flows.
The total cash flow to all claim holders in the company is what In other words, discounting determines the present value of
is referred to as the cash flow to the firm. future cash flows by using a rate that is the cost of capital that
most accurately reflects the risk and timing of the cash flows.
One technique to calculate this cash flow is to add the free
cash flows to equity to the cash flows to lenders (debt) and This rate is called the discount rate.
preferred stockholders. When doing an evaluation, we begin with the fundamental
idea that the discount rate that is applied to a cash flow
should represent the level of risk associated with that cash
flow; cash flows with a higher level of risk should have higher discussion in this chapter, which will focus on the various
discount rates. models that make attempts to do this.
There are two different perspectives on risk. The first is that risk in an investment needs to be perceived
through the perspective of the marginal investor in that
The first type of risk is known as default risk, and it refers to
investment (the investor who is most likely to be trading), and
the possibility that a person or organization may break a
it is expected that this marginal investor has a good level of
promise to fulfill some financial obligation, such as paying
diversification across a number of other assets.
interest or the principal that is owed.
Therefore, the risk of an investment, specifically the non-
When looking at debt, the rate that reflects the possibility of
diversifiable or market risk of that investment should be used
default is referred to as the cost of debt.
to estimate discount rates for that investment.
Because interest expenses are deductible from taxable
The second point is that the expected return on any
income, the cost of debt for most companies will be lower
investment may be calculated by beginning with the return
after taxes are taken into account.
that would be gained from a risk-free investment and then
The second method to look at risk is to consider how it relates adding a premium that is proportional to the degree of
to the difference between actual returns and expected market risk that is associated with the investment in question.
returns.
The cost of equity is calculated based on this anticipated
The actual returns on an investment with a high level of risk return.
may be considerably different from the predicted returns; the
The cost of capital can be determined by taking the average of
bigger the deviation, the higher the level of risk.
the cost of equity, which can be estimated using the method
When considering equity, we typically employ risk measures that was just presented, as well as the cost of borrowing
that are derived from the variation of returns. money after taxes, which is determined by the default risk,
However, there are a few fundamental areas in which these and then weighting the average by the proportions that are
models can reach a consensus, and that will be the topic of used for each type of funding.
When evaluating an existing corporation, our contention is ABFM MODULE - C
that the weights applied should be determined by the current
Chapter 15: OTHER NON-DCF VALUATION MODELS (PART-I)
market values of the company's debt and equity.
What we will study?
There are some analysts who utilize book value weights, but
doing so goes against a fundamental concept of valuation, *What are different value multiples used in Valuation?
which states that at a fair value, one ought to be indifferent
between purchasing and selling an asset. If you breach this
principle, you are in violation.
Discount rates that are applied in discounted cash flow
valuations ought to be reflective of the risk desks of the cash
flows being valued.
To be more specific, the cost of debt needs to include a
default premium or spread to account for the risk of the debt
going into default, and the cost of stock needs to include a risk
premium to account for the risk of equity.
The challenge in this case is to find out the ways in which we
quantify the risk of defaulting on a loan or losing money on an
investment, and more significantly, how do we determine the
default and equity risk premiums.
(c) Estimating future Growth:

(d) Estimating Growth Patterns: (next video)
Determining the Multiples Used in Valuation: Calculate the valuation multiples for each of the similar
companies by using the observed financial characteristics and
In reality, a variety of different value multiples are utilized.
values of the companies being compared.
They can be organized into the following two major groups:
To illustrate this point, let's imagine that there are two similar
(a) Stock valuation multiples, such as the price-earnings businesses, A and B, and their respective financial data is as
ratio(P/E ratio), the price-book value ratio(P/B ratio), and the follows:
price sales ratio (P/S ratio), and
Company A Company B
(b) Enterprise valuation multiples (EV-EBITDA ratio, EV-FCFF
Seles 6,000 9,000
ratio, EV-book value ratio, and EV-sales ratio).
EBITDA: Earnings Before Interest, Taxes, Depreciation & EBITDA 1,000 2,000
Amortization. Book value of Assets 4,000 6,000
FCFF: Free cash flow to firm. Enterprise Value (EV) 3,000 4,500
Given that none of the multiples used for valuation are ideal,
it makes the most sense to employ two or three multiples that
The valuation multiples for the companies are:
provide results that appear to be suitable for the task at hand.
Company A Company B Average
Enterprises are valued using a variety of valuation multiples,
EV-EBITDA 𝐄𝐕 𝟑𝟎𝟎𝟎 2.25 2.625
the most common of which are the EV-EBITDA ratio, the EV- 𝐄𝐁𝐈𝐓𝐃𝐀
=
𝟏𝟎𝟎𝟎
= 3
book value ratio, and the EV-sales ratio. 𝐄𝐕 𝟑𝟎𝟎𝟎
EV-BOOK value = = 0.75 0.75 0.75
𝐁𝐨𝐨𝐤 𝐕𝐚𝐥𝐮𝐞 𝟒𝟎𝟎𝟎
EV-Sales 𝐄𝐕 𝟑𝟎𝟎𝟎 0.5 0.5

= = 0.5
𝐒𝐚𝐥𝐞𝐬 𝟔𝟎𝟎𝟎
Figuring Out the Valuation Multiples for the Other

Comparable Companies:
Establishing a Value for the Concerned Business: EBITDA: Rs. 500 crore. Book value of assets: Rs. 2000 crore.
It is possible to evaluate the subject company if one considers Sales: Rs. 5500 crore.
the valuation multiples that have been observed for
The pharmaceutical businesses E, F, and G have been
comparable companies.
identified to be comparable to company M based on an
You can accomplish this in a straightforward manner by analysis of a number of other publicly traded pharmaceutical
applying the average multiples of the comparable companies companies.
to the pertinent financial attributes of the subject company.
The following information regarding the financial health of
This will allow you to obtain multiple estimates (as many as these companies is available:
the number of valuation multiples used) of the enterprise
Company E Company F Company G
value of the subject company, and you can then take the
arithmetic average of these estimates. Sales 1,000 2,000 3,000
The growth prospects, risk characteristics, and size of the EBITDA 400 500 600
subject company (the most important drivers of valuation Book value of Assets 900 1,000 2,000
multiples) should be compared with those of comparable
companies, and after that, a judgmental view of the multiples Enterprise Value 3,000 4,000 6,000
that are applicable to it should be taken.
This is a more sophisticated method of doing what needs to Company E Company F Company G Avg.
be done. EV-EBITDA 7.5 8 10 12.75
Illustration: EV-Book Value 3.33 4 3 5.165
The following financial information is available for company
EV-Sales 3 2 2 3.5
M, an unlisted pharmaceutical company, which is being
valued.
The following estimations of Company M's enterprise value ABFM MODULE - C
can be derived by applying the average multiples to the
Chapter 15: OTHER NON-DCF VALUATION MODELS (PART-II)
company's financial figures:
EBITDA Basis: EBITDA of M = 500 Cr. (given) What we will study?
Average EV-EBITDA = 12.75 *What is P/E Multiple?

𝐄𝐕
= 12.75 =>
𝐄𝐕
= 12.75 *What is P/B Multiple?
𝐄𝐁𝐈𝐓𝐃𝐀 𝟓𝟎𝟎
EV = 12.75 * 500 = 6375 Cr ₹. *What is P/S Multiple?
Book Value Basis: Book Value of M = 2,000 Cr. (given)

Average EV-Book Value = 5.165
𝐄𝐕 𝐄𝐕
= 5.165 => = 5.165
𝐁𝐨𝐨𝐤 𝐕𝐚𝐥𝐮𝐞 𝟐𝟎𝟎𝟎
EV = 5.165 * 2000 = 10330 Cr ₹.

Seles Basis:
Sales Value of M = 5,500 Cr. (given)
Average EV-Sales Value = 3.5
𝐄𝐕 𝐄𝐕
= 3.5 => = 3.5
𝐒𝐚𝐥𝐞𝐬 𝐕𝐚𝐥𝐮𝐞 𝟓𝟓𝟎𝟎
EV = 3.5 * 5500 = 19250 Cr ₹.

A simple arithmetic average of the three estimates of EV is:
𝟔,𝟑𝟕𝟓 +𝟏𝟎,𝟑𝟑𝟎 + 𝟏𝟗,𝟐𝟓𝟎
= Rs. 11,985 crore ₹
𝟑
EQUITY VALUATION MULTIPLES MODEL: (𝟏−𝐛)
𝐏𝟎 /𝐄𝟏 = 𝐫−𝐑𝐎𝐄∗𝐛
P/E Multiple:
Where (1-b) is the dividend payout ratio, r is the cost of
The price-to-earnings multiple, or P/E multiple, is a popular equity, ROE is the return on equity, and b is the plough back
valuation statistic that is typically defined as follows: ratio or retention ratio.
𝐃 𝐃
dividend payout ratio (1-b) = 𝐄 𝟎 = 𝐄 𝟏
𝟎 𝟏
𝐌𝐚𝐫𝐤𝐞𝐭 𝐩𝐫𝐢𝐜𝐞 𝐩𝐞𝐫 𝐬𝐡𝐚𝐫𝐞
P/E multiple = 𝐄𝐚𝐫𝐧𝐢𝐧𝐠𝐬 𝐩𝐞𝐫 𝐬𝐡𝐚𝐫𝐞 g= b * ROE
The denominator of this multiple is the earnings per share (𝟏−𝐛)
𝐏𝟎 /𝐄𝟏 =
𝐫−𝐠
(EPS) for the previous financial year or the EPS for the last 12
months or the expected EPS for the current year or the
expected EPS for the following year.
Example:
The numerator of this multiple is the current market price per
V & S Company's Return on Equity is 20% and its r is 15%.
share.
Company's dividend payout ratio is 0.3 and its retention ratio
One way to express the price-earnings multiple is as follows: 0.7.
𝐏𝟎 Solution:
𝐄𝟏
V & S Company's P/E multiple is:
Where Po is the current market price per share and 𝐄𝟏 , is the
ROE = 20% = 0.20 & r = 15% = 0.15 & (1-b) = 0.3 & b = 0.7
expected earnings per share a year from now.
(𝟏−𝐛)
𝐏𝟎 /𝐄𝟏 = 𝐫−𝐑𝐎𝐄∗𝐛
𝟎.𝟑
Fundamental Determinants of the P/E Multiple: 𝐏𝟎 /𝐄𝟏 = 𝟎.𝟏𝟓−𝟎.𝟐𝟎∗𝟎.𝟕 = 30
From a fundamental point of view:
P/B Multiple: Example:
Investment analysts have been using the price to book value Virtual Limited's ROE is 25% and its r is 18%. Victual’s dividend
(P/B) multiple for nearly as long as they have been using the payout ratio is 0.5 and its g is 15%.
price to earnings (P/E) multiple.
From a fundamental point of view, Vestal’s P/B multiple is:
The denominator of the P/E multiple is the earnings per share
ROE = 25% = 0.25 & r= 18% = 0.18 & (1-b) = 0.5 &
(EPS), which is a flow metric derived from the income
statement. g= 15% = 0.15
𝐏𝟎 𝐑𝐎𝐄(𝟏−𝐛)
In contrast, the denominator of the P/B multiple, which is =
𝐁𝟎 (𝐫−𝐠)
denoted by the letter B and stands for book value per share, is
a stock metric that is derived from the balance sheet. 𝐏𝟎 𝟎. 𝟐𝟓∗ 𝟎. 𝟓
= = 𝟒. 𝟏𝟕
𝐁𝟎 𝟎. 𝟏𝟖 − 𝟎. 𝟏𝟓
(𝐒𝐡𝐚𝐫𝐞𝐡𝐨𝐥𝐝𝐞𝐫𝐬 𝐟𝐮𝐧𝐝𝐬−𝐏𝐫𝐞𝐟𝐞𝐫𝐞𝐧𝐜𝐞 𝐜𝐚𝐩𝐢𝐭𝐚𝐥)
The book value per share (B) =
𝐍𝐮𝐦𝐛𝐞𝐫 𝐨𝐟 𝐨𝐮𝐭𝐬𝐭𝐚𝐧𝐝𝐢𝐧𝐠 𝐞𝐪𝐮𝐢𝐭𝐲 𝐬𝐡𝐚𝐫𝐞
P/S Multiple:
The Most Important Factors That Determine the P/B Multiple:
The price-to-sales multiple, sometimes known as the P/S
When viewed from the most fundamental angle, multiple, is a method of valuation that has garnered a lot of
𝐏𝟎 𝐑𝐎𝐄(𝟏−𝐛) attention in recent years.
= (𝐫−𝐠)
𝐁𝟎
The P/S multiple is determined by dividing the current stock
Where ROE is the return on equity, g is the growth rate, (1 - b) price of a firm by the revenue per share that the company has
is the dividend payout multiple, and r is the rate of return generated over the course of the most recent twelve months.
required by equity investors.
Alternately, it can be calculated by dividing the company's
𝐄𝟏
𝐁𝟎 = current market value of equity capital by its annual sales.
𝐑𝐎𝐄
Basic P/S Determinants: ABFM MODULE - C
𝐏𝟎 𝐍𝐏𝐌(𝟏 + 𝐠)(𝟏 − 𝐛) Chapter 15: OTHER NON-DCF VALUATION MODELS
=
𝐒𝟎 (𝐫 − 𝐠)
(PART-III)
Where NPM is the net profit margin ratio, g is the growth rate,
(1 – b) is the dividend pay-out multiple, and r is the rate of What we will study?
return required by equity investors. *What is EV/EBITDA multiple?
Example: *What is EV/EBIT multiple?
VLC Limited has a NPM of 10% and a growth rate 14%. VLC *What is EV/FCFF multiple?
dividend pay-out ratio (1 – b) is 0.4 and its r is 0.19.
*What is EV/BV multiple?
From a basic point of view, VLC P/S multiple are:
*What is EV/Sales multiple?
NPM = 10% = 0.10 & G= 14% = 0.14 & (1-b) = 0.4 &
g= 19% = 0.19
𝐏𝟎 𝐍𝐏𝐌(𝟏+𝐠)(𝟏−𝐛) 𝐏𝟎 𝟎.𝟏𝟎(𝟏.𝟏𝟒) 𝟎.𝟒
= (𝐫−𝐠)
=> = (𝟎.𝟏𝟗−𝟎.𝟏𝟒)
= 𝟎. 𝟗𝟏𝟐
𝐒𝟎 𝐒𝟎
Let us have a look at the equations for P/E multiple, P/B

multiple, and P/S multiple together.
𝐏𝟎 (𝟏−𝐛) (𝟏−𝐛) 𝐏𝟎 𝐑𝐎𝐄(𝟏−𝐛)
= = & =
𝐄𝟏 𝐫−𝐑𝐎𝐄∗ 𝐛 (𝐫−𝐠) 𝐁𝟎 (𝐫−𝐠)
𝐏𝟎 𝐍𝐏𝐌(𝟏+𝐠)(𝟏−𝐛)
= (𝐫−𝐠)
𝐒𝟎
ENTERPRISE VALUE MULTIPLES MODEL: Basic Determinants:
Enterprise value multiples put the emphasis on the value of When viewed from the most fundamental angle
the business itself, in contrast to equity multiples, which place 𝐄𝐕 (𝐑𝐎𝐈𝐂 − 𝐠) × (𝟏 − 𝐃𝐀) × (𝟏 − 𝐭)
the emphasis on the value of the equity. =
𝐄𝐁𝐈𝐓𝐃𝐀 𝐑𝐎𝐈𝐂 × (𝐖𝐀𝐂𝐂 − 𝐠)
Typically, some measure of earnings, assets, or sales Where ROIC stands for return on invested capital, g is for
contributes to the determination of the enterprise value. growth rate, DA stands for depreciation and amortization
The following are some examples of enterprise value charges as a percent of EBITDA, t stands for tax rate, and
multiples that are regularly used: WACC stands for weighted average cost of capital.
* EV/EBITDA multiple
* EV/EBIT multiple Example:
* EV/FCFF multiple JJ Company's ROIC is 20% and its g is 11%. JJ's DA is 9% and its
tax rate is 30%. JJ's WACC is 13%. Calculate JJ's EV/EBITDA?
* EV/BV multiple
Solution:
* EV/Sales multiple
𝐄𝐕 (𝐑𝐎𝐈𝐂 − 𝐠) × (𝟏 − 𝐃𝐀) × (𝟏 − 𝐭)
=
EV to EBITDA Multiple:
The Enterprise Value to Earnings before Interest, Taxes, 𝐄𝐕 (𝟎.𝟐𝟎−𝟎.𝟏𝟏)×(𝟏−𝟎.𝟎𝟗)×(𝟏−𝟎.𝟑)
= =14.33
𝐄𝐁𝐈𝐓𝐃𝐀 𝟎.𝟐𝟎 ×(𝟎.𝟏𝟑−𝟎.𝟏𝟏)
Depreciation, and Amortization (EV-EBITDA) multiple is
defined as follows:
𝐄𝐧𝐭𝐞𝐫𝐩𝐫𝐢𝐬𝐞 𝐯𝐚𝐥𝐮𝐞 (𝐄𝐕)
𝐄𝐚𝐫𝐧𝐢𝐧𝐠𝐬 𝐛𝐞𝐟𝐨𝐫𝐞 𝐈𝐧𝐭𝐞𝐫𝐞𝐬𝐭, 𝐓𝐚𝐱𝐞𝐬, 𝐃𝐞𝐩𝐫𝐞𝐜𝐢𝐚𝐭𝐢𝐨𝐧, 𝐚𝐧𝐝 𝐀𝐦𝐨𝐫𝐭𝐢𝐳𝐚𝐭𝐢𝐨𝐧
EV/EBIT Multiple: EV/FCFF Multiple:
EV/EBIT ratio is defined as: The EV/FCFF multiple can be defined as:
𝐄𝐧𝐭𝐞𝐫𝐩𝐫𝐢𝐬𝐞 𝐯𝐚𝐥𝐮𝐞 (𝐄𝐕) 𝐄𝐧𝐭𝐞𝐫𝐩𝐫𝐢𝐬𝐞 𝐯𝐚𝐥𝐮𝐞 (𝐄𝐕)
𝐄𝐚𝐫𝐧𝐢𝐧𝐠 𝐛𝐞𝐟𝐨𝐫𝐞 𝐢𝐧𝐭𝐞𝐫𝐞𝐬𝐭 𝐚𝐧𝐝 𝐭𝐚𝐱𝐞𝐬 (𝐄𝐁𝐈𝐓) 𝐅𝐫𝐞𝐞 𝐜𝐚𝐬𝐡 𝐟𝐥𝐨𝐰 𝐭𝐨 𝐟𝐢𝐫𝐦 (𝐅𝐂𝐅𝐅)
Earnings before interest and taxes are earnings from Basic Determinants:
operating assets, before taxes.
When viewed from the fundamental angle
Basic Determinants: 𝐄𝐕𝟎 𝟏
When viewed from the fundamental angle =
𝐅𝐂𝐅𝐅𝟏 (𝐖𝐀𝐂𝐂 − 𝐠)
𝐄𝐕𝟎 (𝟏 − 𝐭) × (𝟏 − 𝐫𝐞𝐢𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭 𝐫𝐚𝐭𝐞)
= Where WACC is the weighted average cost of capital and g is
𝐄𝐁𝐈𝐓𝟏 𝐖𝐀𝐂𝐂 − 𝐠
the growth rate.
Where t is the tax rate, WACC is the weighted average cost of
Example:
capital, and g is the growth rate.
XYZ Limited's WACC is 16% and its g is 11%.
Example:
Calculate EV/FCFF?
ABC Company has a tax rate of 30% and a reinvestment rate
of 70%. ABC WACC is 15% and growth rate is 12%. Calculate Solution:
EV/EBIT? 𝐄𝐕𝟎 𝟏
=
Solution:
𝐄𝐕𝟎 𝟏
𝐄𝐕𝟎 (𝟏 − 𝐭) × (𝟏 − 𝐫𝐞𝐢𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭 𝐫𝐚𝐭𝐞)
= = 20
𝐅𝐂𝐅𝐅𝟏 (𝟎.𝟏𝟔−𝟎.𝟏𝟏)
=
𝐄𝐕 (𝟏 − 𝟎. 𝟑) × (𝟏 − 𝟎. 𝟕)
= =𝟕
𝐄𝐁𝐈𝐓 𝟎. 𝟏𝟓 − 𝟎. 𝟏𝟐
EV/BV Multiple: EV/Sales Multiple:
𝐄𝐧𝐭𝐞𝐫𝐩𝐫𝐢𝐬𝐞 𝐯𝐚𝐥𝐮𝐞 (𝐄𝐕) 𝐄𝐧𝐭𝐞𝐫𝐩𝐫𝐢𝐬𝐞 𝐯𝐚𝐥𝐮𝐞 (𝐄𝐕)
EV/BV multiple is defined as: 𝐁𝐨𝐨𝐤 𝐯𝐚𝐥𝐮𝐞 𝐨𝐟 𝐚𝐬𝐬𝐞𝐭𝐬 (𝐁𝐕) The definition of EV/Sales multiple is 𝐒𝐚𝐥𝐞𝐬 (𝐒)
Basic Determinants:
Basic Determinants:
When viewed from the fundamental angle 𝐄𝐕 [𝐀𝐟𝐭𝐞𝐫 𝐭𝐚𝐱 𝐨𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐦𝐚𝐫𝐠𝐢𝐧 (𝟏+𝐠)× (𝟏−𝐫𝐞𝐢𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭 𝐫𝐚𝐭𝐞)]
=
𝐒 (𝐖𝐀𝐂𝐂−𝐠)
𝐄𝐕 𝐑𝐎𝐈𝐂 − 𝐠
=
𝐁𝐕 𝐖𝐀𝐂𝐂 − 𝐠 where g is the growth rate and WACC is the weighted average
cost of capital.
Where ROIC is the return on invested capital, g is the growth
rate, and WACC is the weighted average cost of capital. Example:
Example: Planned Limited's after-tax operating margin is 11% and
growth rate is 9%. Its reinvestment rate is 70% and the WACC
Vivek Company has an ROIC of 18% , growth rate of 11% , and
is 14%. Calculate EV/S?
WACC of 13% percent. Calculate EV/BV?
Solution:
Solution:
=
𝐁𝐕 𝐖𝐀𝐂𝐂 − 𝐠 𝐄𝐕 [𝐀𝐟𝐭𝐞𝐫 𝐭𝐚𝐱 𝐨𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐦𝐚𝐫𝐠𝐢𝐧 (𝟏+𝐠)× (𝟏−𝐫𝐞𝐢𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭 𝐫𝐚𝐭𝐞)]
=
𝐄𝐕 (𝟎.𝟏𝟖−𝟎.𝟏𝟏) 𝐄𝐕 [𝟎.𝟏𝟏×(𝟏+𝟎.𝟎𝟗)×(𝟏−𝟎.𝟕𝟎)]
= (𝟎.𝟏𝟑−𝟎.𝟏𝟏) = 3.5 = = 0.72
𝐁𝐕 𝐒 (𝟎.𝟏𝟒−𝟎.𝟎𝟗)
All formulas: ABFM MODULE - C
𝐄𝐕 (𝐑𝐎𝐈𝐂 − 𝐠) × (𝟏 − 𝐃𝐀) × (𝟏 − 𝐭)
= Chapter 16: Special Cases of Valuation
(PART-I)
𝐄𝐕𝟎 (𝟏 − 𝐭) × (𝟏 − 𝐫𝐞𝐢𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭 𝐫𝐚𝐭𝐞) What we will study?

=
*How the valuation of intangible assets is done?
𝐄𝐕𝟎 𝟏
=
=
𝐁𝐕 𝐖𝐀𝐂𝐂 − 𝐠
𝐄𝐕 [𝐀𝐟𝐭𝐞𝐫 𝐭𝐚𝐱 𝐨𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐦𝐚𝐫𝐠𝐢𝐧 (𝟏+𝐠)× (𝟏−𝐫𝐞𝐢𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭 𝐫𝐚𝐭𝐞)]

=
INTRODUCTION: We start off by taking a look at intangible assets that can
stand on their own and generate cash flows (commercially
In the last few units, we concentrated on Corporate and
developed patents, copyrights, trademarks, and licenses).
Business Valuations and also discussed the various
approaches and methodologies used by Values and Analysts These assets have monetary value and are shown in the
for the purpose of valuation. balance sheet of the company.
In this unit, we shall be discussing some special cases of As per Companies Act 2013, the fixed assets are classified as
valuation. tangible fixed assets and intangible fixed assets.
INTANGIBLES - BRAND, HUMAN VALUATION etc.: For example, the software purchased by a company for its
computer systems is an asset having monetary value but is
It is in our nature, as human beings, to make a differentiation
intangible in form.
between the assets that are visible to us and the ones that we
cannot see, and we feel somewhat safer and secure about the Also, a Spectrum, purchased by a telecom company is an
items or assets that we can see and feel. intangible asset with monetary value.
However, the latter category (not visible one) encompasses a This type of assets can be more or less accurately valued by
wide range of assets, some of which are: goodwill, a brand using the traditional discounted cash flow (DCF) models.
name, devoted employees, technological capabilities, and so
Next in line are the intangible assets like a company's brand
on.
name and reputation, which are examples of intangible assets
One of the most prominent arguments made against valuation that collectively generate cash flows for the company that
methods in general and in particular against financial analysts, owns them, but which are far more difficult to single out and
is that we give intangible assets very little consideration, value on their own.
which leads to an undervaluation of those assets.
In spite of this, we may contend that the traditional
We can address this concern by taking a comprehensive look discounted cash flow valuation techniques are able to
at intangible assets across a range of contexts. accurately capture their values, and that adding a premium
for them after using the DCF valuation can be considered as held land, buildings, and factories that were straightforward
double counting. for accountants to measure and value.
In this unit, we will also examine some of the most enigmatic In India, we have examples of companies like Tata Steel, TCS,
intangible assets i.e., those that have the potential to Infosys, Alembic, Indian Hotels, Godrej and ITC.
generate cash flows in the future but do not do so right now.
The last fifty years have given rise to a new breed of
This group will consist of assets as diverse as undeveloped companies in the world, such as Apple, Coca-Cola, PepsiCo,
patents and due to the fact that there is an option available to Amazon, Microsoft, Intel, Face book, and Pfizer, and Indian
the Company as to their use, there is a big challenge faced by companies like Bharat Biotech, Serum Institute, Wipro,
the Company about the valuation of these intangible assets. Flipkart etc.
Importance of Intangible Assets: That derive the majority of their value from intangible assets.
Over the course of the past quarter of a century, intellectual These assets include brand recognition, customer loyalty, and
capital has developed into the most important category of intellectual property.
assets.
Intangible assets might take the form of a company's brand
The traditional forms of intellectual property assets, such as name (as is the case with PepsiCo, Coca-Cola etc.), patents (as
patents, trademarks, and copyrights, are what are meant to is the case with Serum Institute, Bharat Biotech, Pfizer etc.), or
be referred to when using the term "intellectual capital". technological competence (as is the case with Infosys, Intel
and Microsoft etc.), but they all have certain things in
The majority of the value of the earliest publicly traded
common.
companies, which emerged as a result of the industrial
revolution, was derived from their physical assets. The first problem is that conventional accounting standards
either grossly underestimate their value or ignore it entirely;
These early global corporate giants, which includes companies
as a result, the balance statements of these companies
like General Motors, Con Edison, Standard Oil, and AT&T etc.
provide little indication in this regard.
The second reason is that these intangible assets contribute VALUE OF ASSETS IN SELECTED GROUP FOR S&P 500
significantly to the market valuations of these organizations; COMPANIES:
there is evidence, for instance, that brand name alone may
explain more than half of the value in many consumers'
product companies.
Last but not least, the failure to value these intangible assets
causes a distortion not just in accounting measures of
profitability like return on equity and capital, but also in
market measures of value like P/E ratios and EV/EBITDA
multiples.
*Implied market value of intangibles = Market cap + Book
Between the years 1975 and 2015, the proportion of market
value of total liabilities - Book value of intangibles.
value attributable to intangible assets rose from 17% to 84%
according to Ocean Tome, a Management Consultancy firm Given that we derive such a significant portion of the
providing advice focused on matters involving intellectual information that we use in valuation from accounting
property (IP) and other intangible assets. statements, one could argue that the valuation of intangible
assets has suffered from many of the same limitations as the
Intangible assets, according to them accounted for 90% of the
accounting measures.
market value of the S&P 500, which indicates that COVID-19
accelerated the trend of increasing IAMV share. This is because accounting statements are one of the primary
sources of information that we use in valuation.
When one looks at the chart below, which illustrates the
market capitalization of the see how the value of intangible In point of fact, the pressure that is being put on accountants
assets has increased over the years. to more accurately reflect the value of intangible assets like
brand name on financial statements has provided an impetus
for valuation analysts to take a closer look at how they have
valued or failed to value the very same assets (brand names).
ABFM MODULE - C Independent & Cash-Flow-Generating Intangible Assets:
Chapter 16: Special Cases of Valuation Those intangible assets that are attached to a particular
product or product line and create cash flows, are the ones
(PART-II)
that are the least complicated to evaluate.
What we will study? These assets typically have finite lifespan, over which the cash
*All about independent and cash flow generating Intangible flows have to be estimated, but otherwise, they are not
Assets? qualitatively distinct from the many tangible assets that
create cash flows over finite periods of time.
In this part, we will look at a few examples of assets that fit
under this category.
1. Trademarks, Copyrights, and Licenses:
The owner of a trademark, copyright, or license has the sole
authority to manufacture or sell the associated goods or
render the associated service.
As a direct result of this, their value is determined by the cash
flows that can be produced as a result of holding the exclusive
right.
To the extent that there are expenses connected with
production, the value is derived from the additional returns
that are received as a result of possessing the exclusive right.
The value of copyrights and trademarks can be determined in
one of two ways, just like the value of other assets.
A discounted cash flow valuation of the asset can be obtained In either scenario, the individual who buys the franchise,
by first estimating the expected cash flows that will result known as the franchisee, is responsible for paying the
from owning the asset, then applying a discount rate to these franchisor (McDonald's or Maruti Suzuki), either an initial
cash flows that is reflective of the uncertainty associated with charge or an ongoing annual cost in order to operate the
them, and finally taking the present value of this value. franchise.
Alternately, we have the option of attempting a relative value, In exchange, the individual receives the power of the brand
which is when we apply a multiple to the revenues or income name, as well as the support of the corporation and
that we believe can be earned by the copyright or the advertising backing.
trademark.
Approaches for valuation:
The multiple is often estimated by taking a look at the prices
It is typically challenging to isolate and put a monetary value
at which assets of a comparable nature have been sold in the
on intangible assets that both garner the most attention and
past.
are considered to have the greatest value.
2. Franchises:
They do not provide cash flows on their own, but they enable
The owner of a franchise is granted the right to promote and a firm to charge higher prices for its products, which in turn
sell a company's branded good or service under the produces a greater amount of cash flows for the company.
franchise's name.
However, there are three distinct approaches that we can
The thousands of Domino's Pizza or McDonald's fast-food take in order to arrive at an estimate of the worth of these
shops located all over the world are two examples of intangible assets, despite the fact that it is more difficult to do
franchises. so.
Other examples include the Chain of Delhi Public Schools. The 3 approaches are as under:
Dealerships for the automobile industry, and even Ola, an
app-based taxi service.
(a) Capital Investment: (b) Discounted Cash Flow Valuation:
The amount of money that a company has put into an asset We have the ability to discount the anticipated increase in
over the course of its existence can give us a good idea of how cash flows that will be brought to the company as a result of
much that asset is worth on paper. the intangible asset in question.
To do this with a brand name, for example, you would need to This will require isolating the percentage of an organization's
look at advertising expenditures throughout time, capitalize aggregate cash flows that can be attributable to its brand
these expenses, and then look at the balance of these name or its level of technological expertise and then
expenses today that has not yet been amortized. discounting back these cash flows at a rate that is appropriate
for the situation.
To capitalize is to record a cost or expense on the balance
sheet for the purposes of delaying full recognition of the (c) Relative valuation:
expense. In general, capitalizing expenses is beneficial as
Comparing the market value of a company (with the
companies acquiring new assets with long-term lifespans can
intangible asset) to the market value of companies that are
amortize or depreciate the costs. This process is known as
similar but do not have the intangible asset, is one approach
capitalization.
to isolating the effect of an intangible asset such as a brand
This method may not match or even come close to the asset's name.
market value, despite the fact that it is the least subjective of
This disparity can be traced back to the existence of the
the three approaches.
intangible asset.
However, it follows the pattern that accountants use to
determine the value of other tangible assets that are recorded
in the books.
ABFM MODULE - C FIRMS WITH NEGATIVE OR LOW EARNINGS:
Chapter 16: Special Cases of Valuation In this section, we look at a selection of companies that have
negative earnings or earnings that are abnormally low, and
(PART-III)
we investigate the most effective way to evaluate these
What we will study? companies.
*How to do the valuation of companies with low or negative We start by looking into the reasons why companies have
earnings? negative earnings in the first place, and then we investigate
the various ways in which valuation needs to be modified to
reflect these fundamental factors.
For companies that are experiencing issues that are only
temporary, such as a strike or the recall of a product, we
contend that the adjustment process can be a straightforward
one.
In this case, we remove from the company's current earnings
the portion of the expenses that is associated with the
temporary problems.
It may be argued that normalized earnings should be used in
valuation for cyclical companies, where negative earnings are
caused by deterioration in the overall economy, and for
commodity companies, where cyclical movements in
commodity prices can affect earnings.
This is because both of these types of companies are
susceptible to fluctuations in earnings.
The process of valuation is made more difficult for companies Therefore, the solutions that we come up with will be rather
that have long-term strategic or operational problems (such as straightforward, and the majority of them will consist of
obsolete plants, a workforce that is not adequately trained or replacing the present earnings, which are in the red, with the
poor investments made in the past). normalized profits (which will be positive).
This is because we have to make assumptions about whether The manner, in which we standardize earnings, will change
or not the company will be able to outlive its problems and according to the specifics of the challenge.
restructure itself.
Concerns Unique to the Company:
Finally, we examine companies that have negative earnings
It is possible for a company to have a bad year in terms of
because they have borrowed an excessive amount of money
earnings, but the problems may be unique to the company
and discuss the most effective way to cope with the possibility
and be of a sort that's just temporary.
that the company would default on its loans.
If the loss can be traced back to a particular occurrence for
Valuing Loss Making Firms:
example, a strike or a verdict in a legal case-and the financial
The reasons why a company has negative earnings in the first records disclose the cost that is linked with the occurrence,
place will dictate how we approach the problem of negative the answer is quite straightforward.
earnings in the company.
We need to make an estimate of the earnings before these
In the next section, the various options for dealing with costs, and we should not just utilize these earnings for
businesses that have a poor profit history are discussed: forecasting cash flows but also for computing basics like
return on capital.
Companies Facing Momentary Challenges:
When we are making these estimations, it is important to
When earnings are low due to issues that will only last for a
keep in mind that we should deduct not just the expense but
limited time or are just transitory, it is reasonable to
also any and all tax benefits that were achieved as a result of
anticipate that earnings will improve in the not-too-distant
the expense, presuming that the expense was tax deductible.
future.
We will have a more difficult time accomplishing our goal if Industry-Wide or Market-Driven Issues:
the source of the loss is less clear or if the cost of the event
Earnings at cyclical companies are characterized by their
that caused the loss is not broken out from the cost of any
inherent instability and sensitivity to changes in the status of
other expenses.
the economy.
First things first, we need to be sure that the loss is really
Earnings at these companies are expected to rise during times
transitory and not a sign of more serious issues with the
of economic expansion, but they will fall to lower levels when
company in the long run.
the economy is in a recession.
The following step is to make an estimate of the typical
The same is true for commodity companies that experience
earnings of the company.
price cycles, which consist of periods of high prices for the
A comparison of each spending item for the company for the commodity being frequently followed by periods of low prices
current year with the same item in prior years, scaled to sales, for the product.
is the method that is the quickest, easiest, and most
In both the circumstances, we can acquire deceptive
straightforward way to accomplish this goal.
estimations of value if we use the current year's results as our
Any metric that, in comparison to other years, appears to base year earnings.
have an abnormally high value should be normalized (by
Companies with Long-Term Issues:
taking the average of values from earlier years).
In each and every one of the values that have been discussed
Alternately, we could calculate an operating income to use in
till now, the earnings were either immediately changed to
the valuation by applying the operating margin that the
represent normal levels or very quickly changed to reflect our
company achieved in previous years to the revenues of the
expectation that the negative earnings will cease to exist in
current year. This would give us an estimate of the operating
the near future.
income.
However, in some instances, the negative earnings are a ABFM MODULE - C
symptom of larger systemic issues that have been present at
Chapter 16: Special Cases of Valuation (PART-IV)
the company for a longer period of time.
In these kinds of circumstances, we will be compelled to make What we will study?
judgments as to whether or not the problem will be solved, *How to do the valuation of companies with low or negative
and if it will, as to when this will take place. earnings (continued)?
This section offers a variety of potential options for businesses
who find themselves in this predicament:
Strategic Issues:
When it comes to the product mixes, they provide the
marketing methods they use, or even the target audiences
they decide to go for, businesses are prone to making
mistakes on occasions.
They frequently find themselves in the position of having
negative or decreased profitability, and in some cases, even
experiencing a permanent loss of market share or even
bankruptcy as a result.
Think on it in light of the following examples:
The Kodak Case: (to be continued)
The Kodak Case: Kodak didn't recognize its once-effective strategy was now
hurting it. Technology and market changes derailed the
Kodak spent over 10 years arguing with Fuji Films, its greatest
strategy.
competitor, that examining a digital camera image was a usual
procedure and people liked the feel of a printed image. Kodak spent money on modest acquisitions instead of
promoting digital camera sales.
Kodak felt Americans would always select it over Fuji Films.
When Kodak eventually figured out digital cameras, it was too
Fuji Films and other companies focused on photography and
late. Kodak couldn't compete with the big companies at the
videographer rather than arguing with Kodak.
time.
Again, Kodak promoted film cameras instead of imitating
In the year 2004, Kodak eventually declared it would end the
competition. It disregarded media and market feedback.
sales of classic film cameras. This move made 15,000 workers
Kodak squandered 10 years by promoting film over digital (one-fifth of the company's workforce) redundant.
cameras. Kodak also lost foreign finance.
Kodak fell off the S&P 500 index, which ranks the 500 largest
Digital photography surpassed traditional film photography, U.S. corporations by stock performance, before 2011.
too. Better image quality and cheaper than film.
Kodak stock hit $0.54 per share in September 2011.
A publication said Kodak was falling behind because it ignored
The shares fell over 50% that year.
emerging technology.
Kodak's marketing team tried to persuade managers to
change the company's essential ideals.
Kodak's management committee continued to rely on film
cameras, claiming the magazine reporter lacked the
competence to support his allegation.
The company has since made a comeback but the valuable
lessons learnt remain.
The Case of the Xerox Corporation:
Xerox was so successful in the photocopier market for so
many years that its brand name eventually became
synonymous with the actual product.
During the 1970s and 1980s, competition for the market came
from Asian companies such as Ricoh and Canon that had cost
structures that were less expensive.
The IBM Case:
Following an early period of losses, Xerox was successful in
The development of the personal computer industry in the recovering a portion of its market share.
1980s was a problem for IBM since it threatened the
company's dominant position in the mainframe computer Xerox's fortunes, on the other hand, has been steadily
sector as well as the unprecedented profitability of that deteriorating since the latter half of the 1990s due to the
business. impact that technology (in the form of e-mails, faxes, and low-
cost printers) has had.
Despite the fact that IBM had the capability to develop an
By the end of the year 2000, many people were beginning to
operating system for personal computers early on in the
wonder whether or not Xerox had a bright future.
process, the company instead chose to cede that business to a
newcomer named Microsoft. The failure of senior management at Xerox to notice emerging
By the year 1989, more than half of IBM's market value had technologies that would eventually emplace Xerox's copier
technology precipitated the company's downfall.
been erased, and the company's return on equity had fallen
into the single digits.
The unfortunate issue is that Xerox invented the majority of The operational margin is the variable that most accurately
the technology that changed the world, but they failed to evaluates the efficiency of the operating system, and
make use of it. companies that have problems with their operating systems
typically have margins that are substantially lower than thus
Operating Issues:
of their competitors.
Companies which are able to provide their customers with
However, the rate at which the margins will converge will be
goods and services in a more timely and cost-effective manner
determined by a number of factors, including the following:
than their rivals will experience increased profitability and
market value. The Company's Size:
But how and why can businesses gradually lose their In most cases, the amount of time required to eradicate
competitive edge? inefficiencies is proportional to the size of the company.
There are several instances in which the causes can be linked If we assume that the costs of operation are the same, then a
back to a failure to stay up with the times, replace assets, and company that has revenues of Rs. 1000 crore will need to
keep up with the most recent technologies. reduce its costs by Rs. 50 crores in order to achieve a 5%
improvement in its pre-tax operating margin.
In general, the expenses of producing one metric tons of steel
will be greater for an older steel firm that has factories that On the other hand, a company that has revenues of Rs. 100
date back several decades, and equipment that was crores will only need to reduce its costs by Rs. 5 crores in
manufactured in an earlier era, than what is currently used in orders to achieve the same goal.
the industry.
Aspects of the Inefficiency:
In other circumstances, the issue may be the price of labor.
There are some inefficiencies that can be corrected
A steel company that operates in the United Kingdom is significantly faster than others.
subject to labor expenses are significantly greater than those
of an equivalent company in Asia.
For instance, a company can swiftly replace ageing machinery ABFM MODULE - C
or an inefficient inventory management system, but retraining
Chapter 17: MERGER, ACQUISITION & RESTRUCTURING
an existing workforce will take far more time.
(PART-I)
External Limitations:
What we will study?
Contractual constraints, Government restrictions and social
pressure frequently place limitations on the scope and *What is Merger and Acquisition?
velocity of change that companies can implement in order to
address inefficiencies in their operations.
For an organization that has more workers than it needs, the
most obvious option may appear to be to lay off a significant
section of the personnel; however, union contracts and the
possibility of receiving unwanted pressure may make
businesses unwilling to take this course of action.
The Quality of Management:

A management team that is willing to embrace changes is one
of the most important ingredients for a successful turnaround.
It is possible that an organization will need to make changes
to its senior management in order to be successful in resolving
the operational issues it is facing.
INTRODUCTION: Corporate re-structuring refers to any modifications made to a
company's assets, financial structure, or ownership structure,
The reorganization of a business is an integral aspect of
as well as any expansion or contraction of the company's
modern business operations.
operations.
As a result of globalization and the loosening of constraints
Mergers, acquisitions, and takeovers; financial restructuring
and controls, new waves of competition and free trade have
and reorganization; divestitures, de-mergers, and spins;
emerged.
leveraged buyouts; and management buyouts are the most
This requires a restructuring and reorganization of the prevalent types of corporate restructuring.
corporate organization in order to produce new synergies to
However, corporate reorganization can take numerous shapes.
adapt to the altered market conditions and competitive
environment. Mergers and acquisitions (M&A) is the subject that has
garnered the greatest discussion nowadays.
Reorganizational restructuring typically involves significant
organizational changes, such as a shift in business strategies. Mergers and acquisitions are frequent occurrences in
economies that have evolved substantially.
Internal restructuring may involve additional investments in
plant and machinery, research and development of goods and Hundreds of mergers and acquisitions take happen annually in
processes, spinning off non-core enterprises, divestiture, Japan, the United States, and Europe.
selloffs, demerger, etc.
M&A activity is generally seen as typical business strategic
A form of external restructuring is the sale of non-core practice worldwide, as also in India.
businesses.
In India, the business of corporate restructuring, which
External restructuring can also occur through mergers and includes mergers, acquisitions, and other related activities,
acquisitions (M&As), joint venture formation, and strategic has exploded in the previous decade.
alliances with other companies.
The market for corporate control has expanded from 2004, Both companies were controlled by the engineering
when it was worth around $4.5 billion, hitting a record high of conglomerate Larsen & Toubro Ltd.
$13 billion in 2005 and $56.2 billion in 2016.
In everyday conversation, the phrases “mergers,”
As their home countries struggled under the weight of a “acquisitions” and “takeovers" are frequently used
recession at the time, international investors sought out an synonymously with one another. However, there are
alternate location, preferably one with a rising economy. distinctions.
This is a result of the adverse macroeconomic climate caused Acquisition is the process of one entity buying out another
by the Euro Zone crisis and other internal factors, such as and absorbing it into itself, as contrast to merger, which refers
inflation, the fiscal deficit, and currency depreciation. to the combination of two separate entities into one.
According to data collated by Bloomberg and revealed in June, In the context of Indian law, the term "merger" is more
the second quarter of the year 2022 saw the biggest amount accurately rendered as "amalgamation."
of mergers and acquisitions activity ever recorded in India,
The amalgamations can be by merger of firms within the
totaling $82.3 billion in deals that were either in the process
limits of the Companies Act, and acquisition through
of being done or had already been finalized.
takeovers.
The previous record, which was set in the third quarter of
The Securities and Exchange Board of India (SEBI) oversees
2019 at $38.1 billion, has been surpassed by more than twice
takeovers, although the Companies Act governs mergers and
that amount.
acquisitions (M&A) deals.
The HDFC Ltd. merger with the HDFC Bank for a total
In cross border transactions, international tax considerations
transaction value of $58.5 billion in April was the driving force
often arise.
behind the spike in India.
According to Halsburry’s Laws of England, an amalgamation is
The merger of two software companies, Mind tree Ltd. and
described as the combination of two or more pre-existing
Larsen & Toubro InfoTech Ltd., in an all-stock transaction
businesses, with the shareholders of each amalgamating
valued at $3.3 billion.
company becoming largely the shareholders in the Lord Swaraj Paul is credited as having initiated the practice of
amalgamating company. corporate takeovers in India when he attempted to acquire
Escorts.
As a result, the coming together of two or more businesses
into a single entity is known as a merger. The other significant takeovers include Hindujas' Shaw
Wallace's purchase of Ashok Leyland, the Chabbrie Group's
When two or more businesses combine into a single entity,
acquisition of Dunlop and Falcon Tyres, the Goenka family's
when one business merges with another, or when one
purchase of Ceat Tyres, and Tata Tea's purchase of
business is acquired by another, this process is referred to as
Consolidated Coffee.
"amalgamation."
The Board for Industrial and Financial Reconstruction (BIFR)
In the case Inland Steam Navigation Workers Union vs. R.S.
was responsible for coordinating the acquisition of smaller
Navigation Company Ltd., it was determined that in the event
businesses by industry titans such as ITC, McDowell, Lakshmi
of an amalgamation, the rights and liabilities of one company
Machine Works, and the Somali Group.
are merged into those of another company, making the
transferee company vested with all of the rights and liabilities As a result of the rapidly accelerating process of
of the transferor company. industrialization taking place in a nation whose primary
economic activity is agriculture, a great number of new
A Take-over occurs when both, the company doing the take-
businesses are being established.
over and the company being taken-over, are able to continue
operating independently following the completion of the deal. There has been a rise in the amount of interaction between
businesses and people from one country and those from other
If the acquisition results in consolidation, it means the legal
countries as a result of the new tendencies of globalization,
dissolution of both of the companies involved and the
which have been observed not only in this country but also on
creation of a new company into which the prior entities are
a global scale.
combined.
When a merger results in the legal dissolution of only one of
the corporations involved, it is called absorption.
Given the current state of affairs in the business world, it is ABFM MODULE - C
imperative that mergers and acquisitions be supported, both
Chapter 17: MERGER, ACQUISITION & RESTRUCTURING
in the interest of the general public and for the purpose of
promoting industry and trade. (PART-II)
On the other hand, the government is responsible for What we will study?
protecting the interests of its shareholders, creditors,
*What are the different types of Mergers?
investors and employees/workers.
*What is acquisition?
The provisions on "Compromises, Arrangements, and
Amalgamations" are found in Chapter XV (Section 230 to
Section 240) of the Companies Act, 2013.
These provisions cover corporate debt restructuring,
demergers, fast track mergers for small companies/holding
subsidiary companies, cross-border mergers, takeovers,
amalgamation of companies in public interest, and more.
All of these mergers and acquisitions are also governed or
controlled through relevant provisions of the Foreign
Exchange Management Act of 1999, the Income Tax Act of
1961, the Industries (Development and Regulation) Act of
1951, the Competition Act of 2002, and the restrictions
imposed by other relevant Acts including the SEBI Act of 1992,
depending on the circumstances.
TYPES OF TRANSACTIONS: Mergers between Conglomerates:
1. Merger: Mergers of this kind include companies whose lines of
business are completely unconnected to one another.
A common definition of a merger is the coming together of
two separate businesses into one. To put it another way, the acquirer and the target do not
produce the same or rival products, which means that their
The process of dissolving one or more businesses,
respective commercial endeavors are not tied to one another
corporations, or proprietorships in order to construct another
in either a horizontal or vertical sense (having relationship of
company through absorption into it is what is meant by the
buyer and supplier).
phrase "merger".
These types of mergers actually involve the consolidation of
The combined business would be significantly larger after the
several distinct types of enterprises into a single parent
transaction was completed.
organization.
The following are some of the most common types of mergers:
The utilization of financial resources, the expansion of debt
Horizontal Merger: capacity, and the integration of managerial activities will
The two businesses that have recently merged are both continue to be the primary goals of any merger.
operating in the same market sector. Congener Merger:
As a result, the newly consolidated company will likely have a The acquiring company and the company it is merging with
larger market share than its predecessors, and it is possible are connected in some way, whether it is through
that it will move closer to becoming a monopoly or a near fundamental technologies, industrial methods, or market
monopoly in order to eliminate competition. segments.
Vertical Merger: This type of merger takes place when two The acquirer will benefit from an expansion of their product
organizations that have a “buyer-seller” relationship come range, market participation, or technological capabilities as a
together to form a single entity. result of the acquired company.
These mergers represent an outward shift by the acquirer (iv) The acquisition of a portion of a company's share capital
from its existing business environment to other similar by the payment of cash and the issuing of shares.
business activities within the overall structure of the industry
(v) Making an offer to buy out the general body of
as a whole.
shareholders in the company.
Reverse Merger:
When one company acquires another, the acquiring firm has
A reverse merger occurs when a smaller, unlisted company two options:
acquires a larger, publicly listed company.
Either it can combine both businesses into a single entity and
This allows the unlisted company to avoid the lengthy and operate as a single entity, or it can continue to run the taken-
complicated process that would be necessary to be followed over company as an independent entity but with new
in the event that it desired to issue its shares to the public management and different policies.
through an Initial Public Offering.
A "merger” refers to the coming together of two separate
2. Acquisition: businesses on an equal footing.
This term refers to the purchase of a controlling interest in the When a firm is "acquired," it means that it has been bought
share capital of an existing firm by one corporation from out by another corporation, and the acquired company
another corporation. typically loses its identity.
This could happen by: This method is normally done in a cordial manner.
(i) An arrangement with the person who holds the majority of The sale is referred to as a slump sale if it is completed for a
the interest. single sum of money and no specific valuations are assigned to
any of the asset categories included in the transaction.
(ii) The acquisition of fresh shares through a confidential
agreement. As a result of a judgment made by the Supreme Court of India,
any capital gains that were realized as a result of slump sales
(iii) Acquisition of shares through the open market (open
were not subject to income tax.
offer).
3. Purchase of Division or Plant: international parent company, Alcan. INDAL, on the other
hand, was ultimately absorbed into HINDALCO after some
It is possible for one corporation to purchase a division or
time.
factory from another company.
A takeover, in contrast to a merger or the purchase of an
For instance, SRF India acquired CEAT Limited's nylon cord
existing division, does not include the transfer of assets and
division in a recent acquisition.
obligations.
In a typical business acquisition, the acquiring company
Takeover and acquisition are same, technically.
purchases the relevant division's assets, assumes
responsibility for the division's liabilities, and makes a However, the term takeover generally is used when the
monetary payment of compensation to the selling company. transaction is without the consent of the shareholders of the
target company or, in other words, it is hostile takeover.
For instance, Abbott Laboratories paid $3.72 billion to acquire
the pharmaceuticals business of Primal Health Care. Abbott Acquisition, on the other hand, refers to an amicable
Laboratories was a competitor of Primal Health Care. agreement or consent of the majority shareholders of the
target company.
It is important to keep in mind that only a fraction of the
assets and liabilities of one company are taken over by 5. Leveraged Buyout:
another firm when a transaction is carried out in this manner.
A takeover or the purchase of a division can also be referred
4. Takeover: to as a leveraged buyout, which differs in that it is mostly
accomplished with the assistance of loan financing.
A takeover often comprises the acquisition of a specified
interest in the equity capital of a company (typically between 6. Divestitures:
50 and 100 percent), which grants the acquirer the ability to
When compared to divestitures, acquisitions lead to an
exert control over the operations of the company.
increase in control and a larger asset base, while divestitures
For instance, HINDALCO was able to acquire control of INDAL result in a smaller asset base and a loss of control.
after purchasing a 54% stake in the company from its
The following is a list and brief description of the most typical For instance, the Great Eastern Shipping Business split off its
types of divestitures: offshore operations and created a new company known as
The Great Offshore Limited to house those operations.
a) Partial Selloff:
Both the firm whose business division is moved and the
A partial selloff is when one company sells a portion of its
company to which it is transferred are referred to as the
operations, like a facility or a business division, to another
demerged company and the resultant company, respectively.
company.
d) Equity Carve out:
A sale of a business division might be thought of as its inverse
in this context. When a parent firm engages in equity carve out, it is selling a
portion of its ownership stake in a wholly owned subsidiary.
b) The Transfer of Ownership:
It's possible that a strategic investor or the general investing
A sale of equity stake occurs when one investor (or a group of
public will buy the equity.
investors) sells an equity stake to another investor.
e) PSU Disinvestment:
This equity stake typically represents a controlling block in the
company. Individuals and organizations that are not affiliated with the
government, might acquire ownership stakes in previously
As an illustration, Alcan has parted ways with HINDALCO by
state-owned businesses through a process known as
selling the latter 54 percent of its stock holding in INDAL.
privatization.
A takeover is essentially what this deal is doing, just in reverse.
This can either be a partial or complete transfer of ownership.
c) Demerger:
A demerger is the process by which a corporation transfers
one or more of its business divisions to another company that
is being formed at the same time as the original firm.
ABFM MODULE - C REASONS FOR MERGER:
Chapter 17: MERGER, ACQUISITION & RESTRUCTURING The following list contains the most typical reasons for
mergers and acquisitions (M&A):
(PART-III)
1- Synergistic operating economics:
What we will study?
One possible definition of synergy is as follows: V (AB) >V (A) +
*What are the different reasons for Merger?
V (B).
To put it another way, the total value of two separate
businesses or organizations must be greater than each of their
individual values.
According to Mark L. Sorrowed of Boston Consulting Group,
who wrote "The Synergy Trap", synergy is the increase in
performance of the combined firm over what the two firms
are already expected or required to accomplish as
independent firms.
Synergy is the result of combining the resources of two or
more companies.
This could be due to complementary services, economies of
scale, or both of these factors.
One useful illustration of activities that are complementary is
the possibility that one company may have an effective
production system while another company may have an
effective networking of branches.
Therefore, the amalgamated enterprises will have a higher 3- Growth:
productivity level than their respective predecessors.
A company is able to grow at a faster rate using the mode of
Along the same lines as the previous point, one of the reasons mergers and acquisitions as opposed to the other mode,
for the benefits of synergy is the economics of huge scale. which is organic growth.
The primary reason for this is that production on a larger scale, The reduction in "Time to Market" was the driving force
results in a lower average cost of production. behind this decision.
This can be seen, for example, in a reduction in overhead costs The acquiring company avoids delays that would have been
brought about by the sharing of central services like caused by the purchase of a building and site, the
accounting and finances, office executives, top level establishment of the plant, and the hiring of people, among
management, legal, sales promotion and advertisement, and other things.
so on.
4- The Consolidation of Production Capabilities and the
2- Taxation: Enhancement of Market Power:
It is possible that the provisions of the Income Tax Act that The decrease in total number of competitors results in an
allow for losses to be offset against other income or carried increase in marketing power.
forward are yet another compelling argument for the merger
In addition, the merging of two or more plants can boost the
and acquisition.
output capacity of the overall operation.
As result, the amalgamated company will see tax savings as
5- Economies of Scale:
well as a reduction in its tax liabilities.
Due to the increased volume of business conducted by the
In a similar vein, in the event of an acquisition, the target
combined corporation, some efficiency can be realized when
business's losses will be permitted to be set against the
two or more companies merge into a single entity.
earnings of the company that is doing the acquiring.
These cost savings are the result of a more intensive
utilization of manufacturing capabilities, distribution
networks, engineering services, research and development 6- Economies of Scope:
facilities, data processing systems, and so on and so forth.
A company might broaden the range of its activities by making
In the case of horizontal mergers, where there is the potential use of a certain set of capabilities or assets that it already
for a more intensive utilization of resources, economies of owns.
scale are at their most obvious and evident.
For instance, if Proctor and Gamble (P&G) were to purchase a
Vertical mergers typically result in significant benefits, the consumer product firm that could make use of their well-
most important of which are greater activity coordination, respected consumer marketing expertise, they would be able
decreased inventory levels, and increased market power for to reap the benefits of economies of scope.
the merged firm.
7- Economies of Vertical Integration:
Horizontal merger: When companies that sell similar products
Vertical integration can lead to cost savings by combining the
merge together.
resources of multiple enterprises operating at various stages
Vertical merger: Occurs between companies where one buys of a value chain or production process.
or sells something from or to the company.
A firm that is involved in oil exploration and production, such
Last but not least, even in the case of mergers involving as ONGC, and a company that is involved in oil refining and
conglomerates, there is potential for the reduction or marketing, such as HPCL, may be able to increase coordination
elimination of some overhead expenses. and control by merging their operations.
Are there ever times when economies of scale work against 8- Complementary Resources:
you?
A merger could make sense for two companies if those
If the scope of operations and the size of the organization companies' resources are complementary to one another.
become excessively large and unmanageable, then the answer
For instance, a small company that is developing a
is yes.
revolutionary product could require the engineering
capabilities and marketing reach of a large company.
It is possible that the unique product can be successfully 10- Managerial Effectiveness:
manufactured and marketed if the two companies that
An increase in management efficiency is one of the potential
created it decide to merge into one.
benefits that could result from a merger.
As a result, the value of the two companies is increased when
It is possible for this to happen if the current management
they work together because of the complimentary resources
team, which is not doing well, is replaced with a new
that the two possess.
management team that is more effective.
9- Utilization of Surplus Funds:
A company that has been plagued by managerial
Although a company operating in an established market might shortcomings can frequently benefit enormously from the
make a lot of cash, it might not have many options for making superior management that is expected to emerge as a sequel
lucrative investments. to the merger of the two companies.
A company of this nature ought to pay out significant 11- Industry Consolidation:
dividends and even purchase back some of its own shares,
The necessity of consolidation has been a key factor in the
assuming such actions are viable options.
formation of mergers across a wide variety of business sectors
However, the majority of management teams have a all over the world.
propensity to make more investments, despite the fact that
Consolidation is required for boosting efficiency whenever
these expenditures might not be lucrative.
there are an excessive number of players and surplus
In circumstances like these, a merger with another company capacities.
that involves cash compensation is frequently the case that
This has happened (and is continuing to happen) in several
reflects a more effective utilization of surplus capital.
industries all over the world, including but not limited to
banking, telecommunications, pharmaceuticals, cement, steel,
autos, and so on.
12- Dubious Reasons for Mergers: It is not anticipated that the merger will result in the creation
of any new value.
There are instances when the desire to diversify, achieve a
cheaper cost of financing, and achieve a greater rate of The exchange ratio is set at 1:2, which indicates that one
earnings growth will lead a company to pursue a merger. share of A Limited will be transferred in exchange for two
shares of B Limited.
At first glance, these goals appear to be worthy; nonetheless,
it is highly unlikely that they will increase value. This ratio was determined based on the market prices that
existed prior to the merger.
13- Growth in Earnings:
After the merger, the financial position of A Limited, assuming
It is indeed pass that a merger will provide the impression
the market is "smart," will be as illustrated in column 3 of the
that earnings are growing.
table that is presented below.
If investors are misled, a price increase could result from this.
Even when earnings per share go up, the price-earnings ratio
An illustration of these phenomena might be provided in the goes down because the market realizes that the growth
form of an example. prospects of the combined company will not be as bright as
Imagine that A Limited has purchased B Limited. those of A Limited alone.
The column headings 1 and 2 of the table that follows present This causes the price-earnings ratio to reflect a lower value.
an overview of A Limited and B Limited's respective financial Therefore, the price of one share on the market has remained
situations prior to the merger. stable at sixty yen.
The price-earnings ratio for A Limited is set at 20, reflecting Therefore, the market value of the combined firm can be
the company's exceptional growth prospects. calculated by adding the market values of the two companies
On the other hand, B Limited has subpar growth prospects that merged to form the combined company.
and is trading at a price-earnings ratio of 10 times its current If the market continues to behave in an "inefficient or foolish"
price. manner, it may consider the 33% increase in earnings per
share to be reflective of genuine growth. As a result, the price- Therefore, if the market is "inefficient," it may be susceptible
earnings ratio will not experience a decline. to being hypnotized by the allure of earnings growth.
The market price per share of A Limited will increase to Rs. 80 In a market that is inefficient, such an illusion might be
as a result of increased earnings per share and a price- successful for a while.
earnings ratio that has remained steady.
The false profits are sure to vanish once the market reaches
As a consequence of this, the overall market worth will rise its optimal level of efficiency.
from Rs. 9 crores to Rs. 12 crores.
Financial Position of A Limited & B Limited
Particulars A Ltd B Ltd before A Ltd after Merger
before Merger
Merger
Market is Market is
Smart Inefficient
Earnings per 3 3 4 4
share
Price per 60 30 60 80
share
PE Ratio 20 10 15 20
No. of shares 10 lakhs 10 lakhs 15 lakhs 15 lakhs
Total Rs. 30 Lakhs Rs. 30 Lakhs Rs. 60 Lakhs Rs. 60 Lakhs

Earnings
Total Value Rs. 6 crores Rs. 3 crores Rs. 9 crores Rs. 12 crores
ABFM MODULE - C Acquisition vehicle: Legal structure created to acquire the
target firm (e.g., corporation, limited liability company, or
Chapter 18: DEAL STRUCTURING AND FINANCIAL STRATEGIES
partnership).
(PART-I)
Post-closing organization: Organization or legal framework
What we will study?
used to manage the combined businesses following the
*What is Deal Structuring? consummation of the transaction (e.g., corporation, holding
company, or partnership).
*What is Negotiation?
Holding Company: holding company is a parent company —
*What is Payment and legal consideration?
usually a corporation or LLC — that is created to buy and
control the ownership interests of other companies. The
companies that are owned or controlled by a corporation
holding company or an LLC holding company are called its
subsidiaries.
Earn-out is a contractual provision stating that the seller of a
business is to obtain future compensation if the business
achieves certain financial goals.
INTRODUCTION:
As a deal outlines how it will generate value for all the parties
involved in Mergers and acquisitions (M&A) transaction, it is
very important to structure the deal with extreme care.
The process through which it happens is called 'deal
structuring'.
A well-structured M&A deal takes into account issues which Specific strategies for bridging significant price disparities will
may arise several years into the future, as also the unforeseen also be presented.
risks impacting the deal.
Tax issues, such as different forms of taxable and non-taxable
Deal structure and financing are closely interwoven, as structures and how they affect agreement-making, as well as
establishing a consensus throughout the deal-structuring and new legislation affecting corporate tax inversions, are
negotiation process is crucial for closing the deals. extremely crucial.
This procedure results in an agreement or deal structure Equally relevant are the means through which M&A
between two parties (the acquirer and the target firms) that transactions are financed, the effect of near-zero/negative
defines their respective rights and responsibilities. interest rates on M&As, and the role played by private equity
firms and hedge funds in financing highly leveraged
The process includes conversations regarding the implications
agreements.
of various components of deal structuring for risk
management, the consequences of risk on how agreements NEGOTIATIONs:
are executed, and the difficulties of financing transactions,
After it has been decided by management that an acquisition
particularly highly leveraged transactions.
is the most effective way for the company to put its business
A highly leveraged transaction is a bank loan to a company strategy into action, after a target has been chosen, and after
that has a large amount of debt. an initial financial analysis has been performed and found to
be satisfactory, it is time to start thinking about how to
The major aspects of the deal-structuring procedure include
properly structure the deal.
the acquisition vehicle and post-closing organization, the form
of acquisition, the form of payment, and the legal form of the An agreement between two parties (the acquirer and the
selling entity, as well as how changes in one area of the deal target firms) specifying their rights and obligations is known
frequently have substantial effects on other parts of the as a deal structure.
contract.
The procedure that leads to the formation of this agreement is
referred to as the deal-structuring process.
The process of deal structuring entails establishing how risk PAYMENT AND LEGAL CONSIDERATIONS:
will be distributed and achieving as many of the major
The overall consideration, which can come in the form of cash,
objectives of both the acquirer and the target as possible.
common stock, or debt, or even a combination of all three of
The extent to which the acquiring company takes on the these things, can be considered the method of payment.
liabilities of the target organization is referred to as risk
The pay-out might be a one-time lump sum, it could be tied to
sharing.
how well the target does in the future, or it could be paid out
The optimal structure for the business transaction is one that over an extended period of time.
not only achieves the basic goals of all parties involved while
Both the nature of the thing being bought (whether it be stock
also laying out each party's rights and responsibilities in a
or assets) and the manner in which ownership is transferred
clear and concise manner.
are reflected in the form of acquisition.
This structure must also take into account an acceptable
amount of risk.
Form of Acquisition Vehicle and Post closing Organization:
It is possible that the process may be exceptionally difficult, as
it will include a number of different parties, approvals, types When deciding on an acquisition vehicle or post-closing
of payment, and sources of financing. organization it is necessary to take into consideration the
elements listed below:
Choices made in one part of the transaction frequently have
repercussions in other parts. (a) The cost and level of formality involved in the organization.
The process of containing the risk involved with a complicated (b) The ease with which ownership can be transferred.
transaction is comparable to squeezing one end of a water (c) The continuous existence of the organization.
balloon, which just causes the contents to migrate to another
(d) Management control.
location.
(e) The convenience of obtaining financial support.
(f) Ease of assimilation into the system. Selecting Suitable Post-closing Organization:
(g) The manner in which earnings shall be distributed. It is possible for the post-closing organization to be identical
to the one selected for the acquisition vehicle.
(h) The scope of individual responsibility.
Structures such as divisional and holding company
(i) Taxation.
arrangements are frequently used after a closing.
The buyer must consider a variety of factors, including risk,
Although holding companies are usually corporations, they
financing, taxation, and control, depending on the form of the
are also characterized by a distinctive organizational and
legal entity being used.
management style within the company.
If we choose the right organisation, we may be able to lessen
The goals that the acquirer hopes to accomplish should guide
the impact of potential risks, increase the scope of available
the selection of the post-closing organization.
financing options, and reduce the total amount that will be
spent on the acquisition. The acquiring company may opt for a structure that makes
post-closing integration easier, reduces the risk of the target's
Selecting the Appropriate Acquisition Vehicle:
known and unknown liabilities, minimizes taxes, passes
The corporate structure that is most frequently utilized is the through losses to shelter the owners' tax liabilities, maintains
acquisition vehicle, because it provides the majority of the target independence throughout the duration of an earn-out,
attributes that buyers want, such as limited liability, flexible preserves unique target characteristics, or maintains the tax-
financing, continuity of ownership, and transaction flexibility free status of the deal.
(e.g., option to engage in a tax-free deal).
Because it allows for the greatest amount of control, the
An Employee Stock Ownership Plan (ESOP) structure may be corporate or divisional structure is frequently chosen when
an easy way for small privately held businesses to transfer the the acquirer plans to immediately integrate the target after
owner's equity in the company to the employees while the transaction has been finalized.
providing significant tax benefits.
Because of the distributed ownership in joint ventures and ABFM MODULE - C
partnerships, decision making may be slowed down or made
more controversial.
(PART-II)
It is more likely that implementation will depend on tight
What we will study?
cooperation and creating consensus, both of which may slow
down efforts at speedy integration of the company that was *What are the different types of payment consideration for
bought. merger and acquisition?
It is possible that realizing synergies will take longer than it
would if managerial control were centered more within the
parent company.
When the target company has large liabilities, an earn-out is
required, if the target company is a foreign corporation, or the
acquirer is a financial investor, a holding company structure
may be preferable as the acquisition vehicle.
It is possible that the parent will be able to isolate specific
obligations that exist within the subsidiary, and then the
parent will be able to push the subsidiary into bankruptcy
without putting the parent in jeopardy.
It may be possible to reduce the amount of disruption caused
by cultural differences by running the target company in a
manner that is distinct from the rest of the acquirer's
operations when the target company is an international
business.
Different Types of Payment Consideration: When a company has a high credit rating and relatively low
borrowing costs, it is more likely that a cash transaction will
The following is a list of the various types of payment that are
be financed by borrowing rather than being paid for in cash.
accepted, as well as the situations under which one form may
be favored over another: Highly leveraged acquirers are less likely to offer agreements
that consist entirely of cash and are more likely to pay less
(a) Cash:
cash in mixed payment offers that include both cash and stock.
Cash may be used by acquirers if the target company has a
It's possible that undervalued shares will lead to a significant
considerable borrowing capacity, a high credit rating, cheap
reduction in the acquirer's existing shareholder base.
shares, and the desire to preserve control of the company
after the acquisition. If the issuance of voting stock to acquire the target poses a
threat to the bidder's dominant shareholder's ability to
Surprisingly, there is very little of a correlation between the
exercise voting control, the bidder may choose to pay for the
magnitude of an acquirer's cash balances and the possibility
target with cash rather than shares.
that it would make a cash offer in a takeover situation.
(b) Non-cash:
In point of fact, acquirers who have larger cash holdings are
typically more inclined to make stock offers rather than cash Because of the necessity to comply with the rules that are
offers as compared to acquirers who have smaller cash now in place regarding securities, the use of stock is a more
holdings. involved process than the usage of cash.
This seeming oddity may be the result of the target's It is possible that the acquirer will prefer to pay for the
preference for the acquirer's stock due to the target's acquisition with its own shares if it is deemed that the target
perception of the acquirer's company's prospects for growth company is overvalued, the acquirer has limited borrowing
or for a tax-free transaction. capacity, and surplus cash balances.
When it is anticipated that the integration of the target
company will take a significant period of time, acquirer's stock
may be utilized as the principal form of payment instead of (c) Mix of Cash and Stock:
cash in order to reduce the total amount of debt that will be
It is possible that providing target shareholders with a number
necessary to finish the takeover.
of different payment choices will motivate more of them to
The acquirer is in a position to finance unplanned cash outlays participate in tender offers.
throughout the integration period and to explore investment
If a target company's shareholders are unsure about the
possibilities that may present themselves if they are able to
prospective appreciation of the acquirer's shares, they may
maintain their ability to borrow money.
prefer a transaction that includes a combination of cash and
Companies whose actual leverage is higher than their desired acquirer stock.
leverage are more likely to make acquisitions using a form of
Some people might prefer a combination of cash and stock,
payment other than cash.
particularly if they need the cash to pay taxes that are owed
This is because actual leverage is higher than desired leverage. on the sale of their shares of the company.
In addition, acquirer's stock may be a beneficial type of In addition, acquirers who are either unable to borrow money
payment in situations where it is difficult to value the target to finance an all-cash offer or hesitant to take on the dilution
company, such as when the target has intangible assets that that comes with an all-stock offer may opt to make an offer to
are difficult to value, new product entrants, or high R&D the target company that is a combination of cash and shares.
expenditures.
Because acquirers have the ability to issue fewer shares, they
If a seller desires to take part in any appreciation of the stock may feel more compelled to sell their shares if they consider
it receives from an acquirer and accepts acquirer's stock in the price they paid for them was excessive.
exchange for those shares, the seller may have less motivation
The term "overvaluation" refers to the situation in which the
to negotiate an overpriced acquisition price.
current share price of the acquirer is higher than the
Real estate, rights to intellectual property, royalties, earn outs, company's intrinsic value.
and contingent payments are some more examples of non-
cash sources of payment.
(d) Convertible Securities: People who are interested in bidding but think their shares
are worth less than they should be hesitant to use stock so
Even after conducting all of the necessary due diligence, an
they don't dilute the ownership of their existing shareholders.
acquirer and a target frequently have insufficient information
about one another. It is possible for such bidders to offer convertible debt as a
kind of payment in order to indicate their belief.
Both the acquirer and the shareholders of the target company
are concerned about whether or not the offer price accurately Target shareholders may find such offers appealing because
reflects the value of their shares. they provide a floor equal to the value of the debt at maturity
plus accumulated interest payments and the potential for
The acquirer is anxious about paying too much for the target
participating in future share appreciation.
company.
Additionally, such offers floor equal to the value of the debt at
Because target shareholders wishing to participate in any
maturity plus accumulated interest.
future appreciation are less likely to withhold vital
information when using acquirer's stock as the major source On the other hand, potential buyers, who think the price of
of payment, this problem may be partially mitigated by using their shares is too high, are more likely to make an offer of
acquirer's stock as the primary form of payment. stock rather than cash or convertible instruments.
However, this does not solve the problem of whether or not If it is doubtful that the convertible securities will be
the purchase price is fair to the shareholders of the target converted into equity because of the limited share price
company. appreciation of the bidder's stock, then the instruments will
continue to function as debt and the company will be subject
When both the buyer and the target lack vital knowledge
to a significant amount of leverage.
about one another, convertible securities have the potential
to alleviate the concerns of both parties. There is evidence from real-world situations to suggest that
making use of convertible securities, when both the buyer and
the seller are lacking information, can be beneficial to both
parties.
ABFM MODULE - C TAX AND ACCOUNTING CONSIDERATIONS:
Chapter 18: DEAL STRUCTURING AND FINANCIAL STRATEGIES Accounting concerns address the influence on future earnings
(PART-III) of the combined firms that will be caused by the requirements
for financial reporting.
What we will study?
Tax considerations involve the establishment of tax structures
*All about tax and accounting consideration in Merger and
to ascertain whether or not a transaction will result in taxable
Acquisition?
income for the shareholders of the selling company.
The tax ramifications of the selling entity's legal structure
should not be ignored.
The core economics of the sale should always be the decisive
factor, with any tax benefits serving to reinforce a purchasing
decision.
Although taxes are a significant consideration, this aspect
should never override the core economic aspects.
The influence of accounting concerns on the structure of a
deal can be more subtle at times, but it nonetheless poses a
threat to the profitability of the acquirer both now and in the
future.
Alternative Tax Structures:
In case of acquisition, tax implications are typically less crucial
for the buyer than they are for the seller.
Buyers are primarily concerned with assessing the basis of the A forward triangular merger is the acquisition of a company
assets they are acquiring and avoiding accountability for any by a subsidiary of the purchasing company. The target
tax issues that may exist with the target organization. company is then merged into the shell company completely.
The tax basis is the level at which an asset can be depreciated A reverse triangular merger is when the shell company is
and also determines the future taxable gains that will be merged into the target company.
realized by the buyer in the event that such assets are sold in
Taxable Mergers:
the future.
In a direct statutory cash merger (i.e., the form of payment is
On the other hand, the seller is typically worried about how
cash), the acquirer and target boards come to a negotiated
the transaction might be structured to postpone the payment
settlement, and both firms, with certain exceptions, are
of any taxes that are owed.
required to receive approval from their respective
Taxable Transactions: shareholders.
A transaction is considered taxable to the shareholders of the In a direct statutory stock merger (i.e., the form of payment is
target company if it involves the majority of the consideration stock), the acquirer and target boards reach a negotiated
being in the form of cash, debt, or something other than settlement, and either the target is merged into the acquirer
equity. or the acquirer is merged into the target, and at that point,
only one of them is left standing.
A cash purchase of target assets, a cash purchase of target
shares, or a statutory cash merger or consolidation, are all All assets and liabilities, both on and off the balance sheet, are
examples of transactions that are subject to taxation. immediately transferred to the company that is left standing.
Statutory cash mergers and consolidations most typically The use of so-called triangular mergers is a common tactic
include direct cash mergers as well as triangular forward and adopted by acquirers who wish to shield themselves from the
reverse cash mergers. liabilities of their targets.
In these types of transactions, the target company is either company recognizes as an immediate gain or loss on assets
merged into the acquirer's operating or shell acquisition that are sold (i.e., book value less accumulated depreciation).
subsidiary, with the subsidiary continuing to exist (this type of
There is a possibility that the shareholders of the target will
transaction is known as a forward triangular cash merger), or
be subject to double taxation: first, when the firm pays taxes
the acquirer's subsidiary is merged into the target company,
on any gains, and then again when the proceeds from the sale
with the target company continuing to exist (called a reverse
are paid to the shareholders either in the form of a dividend
triangular cash merger).
or a distribution following the liquidation of the corporation.
The following topic of discussion will be the repercussions of
If a buyer purchases a significant enough portions of the
these deals on taxes:
target company's assets to force it to discontinue operations,
Taxable Cash Purchase of Target Assets: then the target company may be forced into liquidation.
The target company's tax cost or basis in the acquired assets is In most cases, the buyer will be required to jack up the
increased, or "stepped up" to its fair market value (FMV), purchase price in order to compensate the owners of the
which is equal to the purchase price (less any assumed target firm for any potential tax obligation they may suffer.
liabilities) paid by the acquirer.
Taxable Cash Purchase of Target Stock:
This occurs when a transaction involves the cash purchase of
In order to prevent the target company's shareholders from
target assets and the buyer assumes none, some, or all of the
being subject to double taxation on gains, taxable
target company's liabilities.
transactions - that is, transactions that include something
The combined companies will have a lower tax liability in the other than acquirer stock- require the purchase of the target
current year as a result of the additional depreciation that will company's voting stock.
be taken in subsequent years.
When a company buys an asset, they are required to pay tax
The difference between the asset's fair market value (FMV) on any gain that the company made from selling the asset, as
and its net book value (NBV) is the amount that the target well as another tax if the company pays any of the after-tax
earnings to shareholders.
Due to the fact that the transaction takes place between the Target shareholders are required to own a significant portion
acquirer and the shareholders of the target company, taxable of the value of the combined firms in order to provide
stock purchases do not result in a double taxation. evidence of the continuity of ownership interests.
On the other hand, shareholders of the target company can This necessitates the majority of the purchase price being
make a profit or a loss through the sale of their stock. comprised of acquirer stock.
Tax-Free Transactions: To demonstrate a long-term commitment to the target, the
acquirer must show that they will continue to operate a large
When the primary form of payment for an acquisition is
amount of the target's "historic business assets" in a business
acquirer stock, the transaction is exempt from taxation.
in order to meet the requirements of "continuity of
Transactions may be subject to partial taxation if the commercial enterprise."
shareholders of the target company receive something other
In most cases, this indicates that an acquirer is required to
than the acquirer's stock in exchange for their shares.
purchase "substantially all" of the target company's assets.
This non-equity consideration, often known as boot, is
In addition, the transaction must serve a legitimate
typically subject to the same taxation as regular income.
commercial goal, such as increasing the acquiring
There is no automatic increase in the value of newly acquired corporation's profits to their full potential, rather than serving
assets to their Fair Market Value, if the transaction does not the sole aim of evading taxes.
trigger any taxes.
Last but not least, according to the step-transaction concept,
To be exempt from paying taxes, a transaction needs to fulfill the transaction in question is not allowed to be a component
the requirements of the step-transaction theory, which of a wider scheme that would have otherwise constituted a
requires that it maintain continuity of ownership interests, taxable agreement.
continuity of business enterprise, and a legitimate business
objective.
ABFM MODULE - C TAX RELIEFS & BENEFITS IN CASE OF AMALGAMATION IN
INDIA:
(PART-IV) If an amalgamation takes place within the meaning of section
2(1B) of the Income Tax Act, 1961, the following tax reliefs
What we will study?
and benefits shall be available:
*What are the tax relief and benefits in case of amalgamation
(a) Tax Relief to the Amalgamating Company:
in India?
(i) Exemption from Capital Gains Tax [Sec. 47(Vi)]:
Under section 47(vi) of the Income-tax Act, capital gain arising
from the transfer of assets by the amalgamating companies to
the Indian Amalgamated Company is exempt from tax as such
transfer will not be regarded as a transfer for the purpose of
Capital Gain.
The two conditions that must be satisfied, are:
a) The scheme of amalgamation satisfies the conditions of
Section 2(1B) and
b) The amalgamated company is an Indian Company.
(ii) Allotment of Shares In Amalgamated Company To The
Shareholders Of Amalgamating Company [Section 47(Vii)&
49(2)]:
Any transfer by a shareholder in a scheme of amalgamation of
shares held by him in the amalgamating company shall not be
regarded as transfer if
a) Transfer is made in consideration of allotment to him of (c) Tax Relief to the Amalgamated Company:
shares in the amalgamated company; and
A) Carry Forward and Set Off of Accumulated loss and
b) Amalgamated company is an Indian company. unabsorbed depreciation of the amalgamating company [Sec.
72A]:
Section 49(2)-provides that in above case the Cost of Shares of
the amalgamating company shall be the Cost of Shares to the Section 72A of the Income Tax Act, 1961 deals with the
amalgamated company. mergers of the sick companies with healthy companies and to
take advantage of the carry forward of accumulated losses
(b) Tax Relief to the Shareholders of The Amalgamating
and unabsorbed depreciation of the amalgamating company.
Company:
But the benefits under this section with respect to
Exemption from Capital Gains Tax [Sec 47(vii)]:
unabsorbed depreciation and carry forward losses are
Under section 47(vii) of the Income-tax Act, capital gains available only if the followings conditions are fulfilled:
arising from the transfer of shares by a shareholder of the
There should be an amalgamation of:
amalgamating companies are exempt from tax as such
transactions will not be regarded as a transfer for capital gain (a) A company owning an industrial undertaking (Note 1) or
purpose, if: ship or a hotel with another company.
a) The transfer is made in consideration of the allotment to (b) A banking company referred in section 5(c) of the Banking
him of shares in the amalgamated company; and Regulation Act, 1949 with a specified bank (Note 2), or
b) Amalgamated company is an Indian company. (c) One or more Public Sector Company or companies engaged
in the business of operation of aircraft with one or more
Note: 'Transferor company' means the company which is
public sector company or companies engaged in similar
merging also known as amalgamating company in case of
business.
amalgamation and 'transferee company' is the company
which is formed after merger or amalgamation also known as Note 1. The term 'Industrial Undertaking' shall mean any
amalgamated company in case of amalgamation. undertaking engaged in:
(i) The manufacture or processing of goods, or C) The amalgamating company should be engaged in the
business, in which the accumulated loss occurred or
(ii) The manufacture of computer software, or
depreciation remains unabsorbed, for 3 years or more.
(iii) The business of generation or distribution of electricity or
D) The amalgamating company should hold continuously as on
any other form of power, or
the date of amalgamation at least three-fourth of the book
(iv) Mining, or value of the fixed assets held by it two years prior to the date
(v) The construction of ships, aircrafts or rail systems, or of amalgamation.
(vi) The business of providing telecommunication services, E) The amalgamated company holds continuously for a
whether basic or cellular, including radio paging, domestic minimum period of five years from the date of amalgamation
satellite service, and network of trucking, broadband network at least three-fourths in the book value of fixed assets of the
and internet services. amalgamating company acquired in a scheme of
amalgamation.
Note 2.
F) The amalgamated company continues the business of the
(i) Specified bank means the State Bank of India constituted
amalgamating company for a minimum period of five years
under the State Bank of India Act, 1955 or
from the date of amalgamation.
(ii) A subsidiary bank as defined in the State Bank of India
G) The amalgamated company fulfils such other conditions as
(Subsidiary Bank) Act, 1959 or
may be prescribed to ensure the revival of the business of the
(iii) A corresponding new bank constituted under section 3 of amalgamating company or to ensure that the amalgamation is
the Banking Companies (Acquisition and Transfer of for genuine business purpose.
Undertaking) Act, 1980.
H) The amalgamated company, which has acquired an
industrial undertaking of the amalgamating company by way
of amalgamation, shall achieve the level of production of at
B) The amalgamated company should be an Indian Company.
least 50% of the installed capacity of the said undertaking
before end of four years from the date of amalgamation and Consequences When Above Mentioned Conditions Are Not
continue to maintain the said minimum level of production till Satisfied:
the end of five years from the date of amalgamation.
After Adjusting Business Loss/ Depreciation - In case the
The Central Government may relax above condition in desired above specified conditions are not fulfilled then that part of
situations. brought forward loss and unabsorbed depreciation which has
been set off by amalgamated company shall be treated as
I) The amalgamated company shall electronically furnish to
income of the amalgamated company for the year in which
the Assessing Officer (AO), a certificate in Form 62 duly
failure to fulfill above conditions occurred.
verified by an accountant, with reference to the books of
account and other documents showing particulars of
production along with the return of income for the AY
Availability of MAT credit:
relevant to FY falling within a period of five years from the
date of amalgamation. Section 115JB of the ITA levies MAT (Minimum Alternate Tax)
on a company if the amount of income-tax payable under
The requirements of furnishing Form 62 will arise for the first
general provisions of the ITA is less than 15% of the
time only when amalgamated company fulfils conditions of
company's 'book profits'.
achieving level of production of 50% of installed capacity of
undertaking of amalgamating company within four years In such case, the ‘book profits' computed are deemed to be
period. the total income of the company and income-tax is levied
thereon at 15%.
However, the excess of MAT paid over normal tax liability for
Consequences When Above Conditions Are Satisfied:
the year is permitted to be carried forward under Section
If the above conditions are satisfied then accumulated 115JAA of the ITA for set-off in future years in which normal
business loss and unabsorbed depreciation of the tax liability exceeds MAT liability ("MAT Credit").
amalgamating company shall be deemed to be business loss.
There is no express provision in Section 115JAA which allows These issues typically cover the following cases:
an amalgamated/ resulting company to carry forward and
(a) Allotment of securities or payment of cash consideration
claim MAT Credit which was available to the amalgamating /
to shareholders of amalgamating company.
demerged company.
(b) Part consideration paid directly to shareholders of
Capital Gains Taxes:
demerged company.
If the shares qualify as capital assets under Section 2(14) of
(c) Availability of MAT credit.
the ITA, the gains arising upon transfer of the shares would
attract capital gains tax liability. (d) Merger of Limited Liability Partnership into a company.
As per Section 45, capital gains tax must be assessed at the

time of transfer of the capital asset, and not necessarily at the Tax Issues in Cross Border M&A:
time when consideration is received by the transferor or on
In cross-border transactions, tax concerns emerge when two
the date of the agreement to transfer.
countries seek to tax the same income or the same legal entity,
In other words, a taxpayer is required to pay capital gains tax resulting in double taxation of the money.
with respect to the year his right to receive payment accrues,
Most countries recognize that double taxation acts as a
even if such payment is deferred in whole or in part.
disincentive for cross-border trade and activity; consequently,
Tax issues in Domestic M&A: in order to promote cooperation, trade, and investment,
Tax issues arise in domestic M&A transactions when the countries enter bilateral Double Taxation Avoidance
conditions stipulated under the ITA are not fulfilled or the tax Agreements (DTAAs) to limit their taxing rights voluntarily
authorities allege that such conditions are not fulfilled. through self-restraint, thereby avoiding overlapping tax claims.
Courts have interpreted the exemptions provided under The availability of DTAA benefits and the ultimate tax liability
section 47 of the ITA in relation to amalgamation and frequently drive or impede cross-border transactions.
demerger in such cases.
Particularly in the Indian setting, where the tax administration ABFM MODULE - C
is viewed as aggressive and the laws are ambiguous, any
protection granted by a country with which India has a DTAA
(PART-V)
is crucial.
What we will study?
For a buyer, it is essential to determine whether a tax
withholding duty exists when making a payment to a seller. *All about financial reporting of Business Combination?
India is undergoing a transformation of its current investment *All about Deal Financing?
climate.
Foreign Direct Investments ("FDI") from Mauritius, Singapore,
and Cyprus accounted for more than fifty percent of all FDI in
India.
India appears to be altering the status quo and limiting
investors' access to tax benefits by amending its DTAAS with
each of these countries.
Moreover, worldwide concern over treaty violations is
growing.
FINANCIAL REPORTING OF BUSINESS COMBINATIONS: In a share acquisition, no intangible assets are recognized in
the standalone books of the target company.
An entity shall account for each business combination by
applying the acquisition method. However, if the share acquisition results in acquisition of
control over the target company, the assets and liabilities of
Applying the acquisition method requires:
the target company may be recorded at their acquisition-date
(a) Identifying the acquirer. fair values in the consolidated financial statements and the
(b) Determining the acquisition date. excess of asset over liabilities may be recorded as Goodwill in
the consolidated financial statements.
(c) Recognizing and measuring the identifiable assets acquired,
the liabilities assumed and any non-controlling interest in the The purchase method must be used to account for business
acquiree and combinations by a company that maintains its financial
statements in accordance with International Financial
(d) Recognizing and measuring goodwill or a gain from a
Reporting Standards (IFRS) or Generally Accepted Accounting
bargain purchase.
Principles (GAAP) (also called the acquisition method).
Each of the above steps is explained in detail in IND AS 103
According to the purchase method of accounting, the
Business Combination.
purchase price or acquisition cost is calculated, assigned first
Under Generally Accepted Accounting Principles (I-GAAP), to tangible net assets and then to intangible net assets using a
shares acquired by the buyer would be recorded at cost and cost-allocation strategy, and then recorded on the books of
continued to be done so in subsequent years as well. the purchasing business.
However, under Indian Accounting Standard (Ind-AS) method Acquired assets less assumed liabilities are referred to as net
of accounting, investments will be recorded at fair value, assets (or net acquired assets).
unless the buyer opts to record its investments in its
Any difference between the purchase price and the acquired
subsidiaries and associates at cost.
net assets' fair market value is recorded as goodwill.
Goodwill is an asset that represents potential future financial Non-controlling/minority interest is shown separately from
gains from acquired assets that were not specifically the parent's equity in the equity account of the consolidated
recognized. balance sheet.
Acquirer must record assets, liabilities, and any non- Additionally, the consolidated income statement should
controlling interest in the target at their fair value as of the include the revenues, expenses, gains, losses, net income or
acquisition date in accordance with current accounting rules. loss, and other income related to the non-controlling interest.
Instead of the announcement or signing date, the purchase The value of the 49.9% non-controlling, or minority, interest in
date typically coincides with the closing date. shareholders' equity must be recorded if, for instance, Firm A
purchases 50.1% of Firm B, indicating its effective control over
the latter.
Recognizing Acquired Net Assets and Goodwill at Fair Value:
In this case, Firm A must also add 100% of the assets and
Current accounting standards mandate recording 100% of the liabilities of Firm B that it has acquired and assumed to its
assets bought and liabilities assumed, even if the acquirer own assets and liabilities.
buys less than 100% of the target, in order to facilitate
This recognizes that Firm A is in charge of managing all the
comparisons across various transactions.
acquired assets and assumed liabilities and sees the non-
As a result, regardless of whether 51%, 100%, or any other controlling stake as merely another type of stock.
proportion of the target is bought, the target's business is
Similar to Firm A, Firm B's income statement is added to the
recognized in its entirety.
consolidated firms' retained earnings and contains 100% of
As a result, the buyer must account for the goodwill Firm B's earnings less the portion attributed to the 49.9%
attributable to both it and the non-controlling interest. minority owner.
This is because the component of the target that was not
bought (i.e., the non-controlling, or minority stake) is also
recognised.
DEAL FINANCING: The company is able to draw investors by clearly indicating
that the issue's goal is to finance future acquisitions.
M&A deals are frequently financed using cash, stock, debt, or
a combination of all three. These investors think that acquisitions are a better use of the
proceeds than operating capital, creating liquidity, or
For instance, the $17.7 billion (including assumed debt)
reinvested back into the company.
acquisition of US cable operator Cablevision by French
telecommunications giant Altice, in late 2015, was financed by As a result, the acquirer returns on the acquisition's
a combination of bank financing, cash on hand, and new announcement date can be larger than they would be if the
equity offerings. acquirer's investor composition were less favourable to the
firm making acquisitions.
The choice of financing source or sources is influenced by a
number of variables, such as the state of the capital markets, Further, if the acquirer can time the issuance of shares to
the liquidity and creditworthiness of the target and acquiring periods when they are highly valued by investors and use the
companies, the combined borrowing capacity of the target proceeds to buy another company in the same industry when
and acquiring companies, the size of the transaction, and the firms in the industry are seen as being undervalued, the value
target shareholders' preference for cash or acquirer shares. of the deal to the acquirer could be enhanced, at least in the
short run.
The choice to buy might be made independently of the
financing structure of the deal. The particulars of the contract will ultimately determine what
source of cash, or combination of sources, are used and when
An acquirer can draw different kinds of investors by
they are used.
decoupling these choices (or clientele).
The various financing options, available to an acquirer are:
In the case of mergers and acquisitions, a company may issue
shares prior to a bid in order to acquire money to finance a 1. Issue of equity and/or preference shares.
cash purchase of a target.
2. Internal accruals.
3. Long Term loans from banks or other lenders.
4. Issue of convertible/non-convertible debentures or other It would appear that companies place a higher value on the
types of domestic or foreign debt instruments. flexibility that low leverage provides in terms of funding
desirable but unexpected investment possibilities than they
The potential for debt to boost earnings per share and returns
do on the tax benefits that are associated with debt.
on equity are two factors that contribute to the desirability of
long-term debt. Despite this, merging companies, the cash flows of which are
relatively uncorrelated with one another, have a tendency to
The cost of the debt after taxes is also relatively modest.
increase their leverage after the completion of the deal.
But, an excessive amount of debt can make the possibility of
This is because more stable total cash flows make it easier for
default more likely.
the combined firms to pay interest and principal on the
The capacity of a company to finance unanticipated incremental debt.
investment opportunities, as they come up, can be hindered
In the event of liquidation, long-term debt issues might be
when it has an excessive amount of leverage.
categorized as either senior or junior.
Since the late 1970s, there has been a significant rise in the
When it comes to a company's earnings and assets, senior
proportion of businesses operating with little to no leverage
debt has a greater priority claim than junior debt does.
in the United States.
Another way to categorise unsecured debt is according to
This trend can be traced back to the beginning of the 1980s.
whether or not it is subordinated to other forms of debt.
The percentage of businesses that have no debt has climbed
Because they are not secured by anything other than the
from about 7% in 1977 to approximately 20% in 2010.
overall creditworthiness of the borrower, subordinated
The percentage of businesses that have debt that is less than debentures are typically ranked lower than other forms of
5% of their total capital has increased from approximately debt, such as bank loans.
14% in 1977 to approximately 35% in 2010.
This is due to the fact that subordinated debentures are
Why? unsecured.
Convertible bonds are a type of debt that can be converted Credit-rating agencies assign a numerical value to each debt
into shares of stock in the issuing firm at a predefined ratio issue based on how high of a risk it poses in comparison to
(i.e. a particular number of shares for each bond). other debt issues.
They often have a coupon rate that is not particularly high. The rating agencies take into account a variety of factors,
including the consistency of a company's earnings, interest
The ability to convert the bond into common stock at a
coverage ratios, debt as a percentage of total capital, the
significant discount from the company's market value is the
degree of subordination, and the company's historical
primary form of compensation that is provided to the buyer of
performance in meeting the requirements of its debt service
the bond.
obligations.
When bondholders convert their bonds into new shares, it will
have the effect of diluting the earnings of current
shareholders as well as their ownership of the company.
The degree to which one debt issue is subordinate to another
relies on the constraints that are placed on the company by an
agreement known as an indenture.
An indenture is a contract that is made between the
corporation that issues the long-term debt instruments and
the lenders.
The indenture provides specifics regarding the form of the
offering, the manner in which the main obligation must be
repaid, as well as the affirmative and negative covenants that
are relevant to the long-term debt offering.
ABFM MODULE - D INTRODUCTION:
Chapter 19: HYBRID FINANCE (PART-I) The characteristics of debt and equity which are combined
into a single instrument is known as a hybrid security.
What we will study?
They allow for greater flexibility to postpone the payment of
*What is Hybrid Finance?
debt service compared to traditional forms of debt, and they
*What are the advantages and disadvantages of Hybrid can be beneficial to all parties involved, including investors,
Finance? shareholders, and issuers.
*What are the features of Warrants? For many years, Indian companies have been actively
participating in the hybrid securities market by issuing
*What are the features of convertible debentures?
preference shares, optionally or compulsorily convertible
securities/debentures, and foreign currency convertible bonds
(FCCB), among other types of hybrid securities.
The issuance of hybrid securities, which give companies the
ability to optimise the proportion of debt to equity in their
overall capital structure, has become the preferred method
for companies.
The maturity terms of hybrid issuances can vary, several call
options can be exercised, and there is some leeway to
increase the coupon rate.
The equity share capital of a company is the type of capital
that represents the investment by promotors and investors
who will always have a residual claim on the cash flows and
assets of the company and shall also have the managerial It is possible that the conversion won't be required at all.
control and authority over the company.
A convertible bond that is denominated in a foreign currency
On the other hand, debt is often not related with managerial is a subtype of a convertible debenture, called Foreign
control but does reflect a fixed claim on the cash flow and Currency Convertible Bond (FCCB).
assets of the company.
This is an instrument issued outside India and denominated in
The two extremes of the finance spectrum are known as a different currency.
equity and debt, respectively.
US Dollar is one of the most common currencies used for the
In the middle are hybrid forms of finance, which can be Foreign Currency Convertible Bonds.
thought of as a combination of equity and debt in their make-
Although quite popular some time back and remaining as one
up.
of the most crucial vehicles for the purpose of corporate
Preference capital, warrants, convertible debentures, and India's capital raising efforts, of late the proportion of Foreign
inventive hybrids are some of the key forms of hybrid Currency Convertible Bonds to External Commercial
financing. Borrowings (ECB) and Rupee Denominated Bonds (RDB) has
been quite low as is evident from the following table:
In most cases, preference capital will come with a
predetermined rate of dividend, which will be paid out at the DATA ON ECB/FCCB/RDB FOR THE PERIOD
directors' discretion whenever the firm has surplus funds JANUARY, 2021 TO SEPTEMBER, 2022
available for distribution. NATURE NO. OF CASES AMOUNT IN USD % SHARE
MILLION
The owner of a warrant has the ability, for a limited time and
at a predetermined cost, to purchase an agreed-upon number ECB 1516 63848.70 95.02
of equity shares in a company. FCCB 3 425.00 0.63
A debenture that can be converted into equity shares, either RDB 33 1920.64 4.35
in whole or in part, is referred to as a convertible debenture. TOTAL 67194.34 100.00
A hybrid security is considered to be innovative if the reward TYPES OF HYBRID SECURITIES:
of the security is connected to some general economic
While there are many types of hybrid securities, the most
variable such as the interest rate, exchange rate, or
common are:
commodities index.
1. Preference Shares.
ADVANTAGES AND DISADVANTAGES OF HYBRID SECURITIES:
2. Warrants.
Advantages:
3. Convertible Debentures/Bonds.
Higher yield:
4. Foreign Currency Convertible Bonds (FCCB).
Hybrid securities generally offer a higher rate of return than
debt. 5. Mezzanine Financing.
Less volatile market price:

Hybrid securities show less volatility in their market price as FEATURES OF WARRANTS:
there is a regular, pre-determined, return. The holder of a warrant has the right but not the
Risk diversification: responsibility to purchase a predetermined number of equity
shares at a predetermined price during a predetermined time
Hybrid securities can diversify the overall risk for the issuer as
period.
these do not have any strict definition either equitable
securities or debt security. This right is granted by the warrant.
Disadvantages: In some cases, warrants are attached to the debt instruments

in order to "sweeten" the terms of debt issues.
Assessment is difficult:
In many cases, the warrants are issued to the promoters, on a
Calculation of return on hybrid securities is not as simple as on
preferential basis, to provide them an option to increase their
equity or bond securities and, therefore, investing through
stake in the company within a specified future period.
these is more complicated.
For example, pursuant to the receipt of "In-principal In case the warrants are not exercised, the entire upfront
Approval" from both the NSE and the BSE, the Allotment payment is forfeited.
Committee of the Board of Directors of Man Industries (India)
To protect the interest of the minority shareholders, the pre-
Ltd. allotted Rs. 30 lakhs worth of warrants that are eligible
determined price of warrant conversion in cases of
for conversion into equity shares to M/s Man Finance Private
preferential allotment cannot be less than either:
Limited, a Promoter Group Entity in November 2020, at an
issue price of 65 rupees per warrant along with a premium of 1) The average of the weekly high and low of the closing prices
60 rupees per warrant on a preferential basis in accordance of the related shares quoted on the stock exchange during the
with the SEBI (Issue of Capital and Disclosure Requirements) 6 months preceding the relevant date or,
Regulations, 2018 [last amended on April 27, 2022]. 2) The average of the weekly highs and lows of the closing
The Company also received from M/s Man Finance Private prices of the related shares quoted on a stock exchange during
Limited 25% of the consideration amount equalling Rs. the 2 weeks preceding the relevant date.
4,87,50,000/- that constituted the statutory minimum. The warrants do not carry any dividend or voting rights.
Warrants are also issued to institutional investors and other Only after warrants are converted into equity shares, the
strategic investors, by the way of preferential allotment, to investor gets these rights.
allow such entities to increase their stake if the company
performs well.
FEATURES OF CONVERTIBLE DEBENTURES:
As per regulation in India, in the case of preferential
allotments, the buyer of the warrants has to pay 25% of the In India, convertible debentures have only been around for a
price, upfront. short period of time.
This amount is adjusted against the final payment that is However, throughout this relatively short time span, major
made in case the warrants are exercised. alterations have been made to the characteristics of these
debentures.
When they emerged into the scene for the first time in the (c) Unless the conversion duration is made optional with "put"
early 1980s, they were normally required to be compulsorily and "call" options, a conversion term, that is longer than 36
convertible (either partially or completely) at a given months, will not be approved.
conversion price on a predetermined date.
(d) If the fully convertible debentures have a conversion time
The Controller of Capital Issues was the Authority which that is longer than 18 months, there will be a mandatory
decided about the terms that would apply to such debentures. requirement for a credit rating.
The Capital Issues Control Act was struck down in 1992, and in As per SEBI guidelines there are now three different forms of
the same year, the Securities and Exchange Board of India Act convertible debentures that can be issued in India:
(SEBI Act 1992) was passed.
(i) Debentures that are automatically convertible and have a
This brought about a shift in the regulations that govern conversion provision that takes effect after 18 months.
convertible debentures.
(ii) Debentures with an optional conversion feature that allow
The following are the provisions that apply to Fully or Partially for the conversion to take place within 36 months.
Convertible Debentures, also known as FCDs and PCDs, in
(iii) Debentures that allow for conversion after 36 months but
accordance with SEBI guidelines:
have "call" and "put" features in addition to that provision.
(a) It is required that the conversion premium as well as the
DIFFERENCES BETWEEN WARRANTS AND CONVERTIBLE
timing of the conversion be determined and reported in the
DEBENTURES:
prospectus.
Both warrants and convertible debentures share the same
(b) If the conversion takes place at or after 18 months but
core property in their structure.
before 36 months from the date of allotment, the holder of
the debenture will have the option to convert either partially They confer a call option on the equity stock of the
or fully if the conversion takes place during this time period. corporation upon the holder of the security.
However, there are several key distinctions between the two, ABFM MODULE - D
which are as follows:
Chapter 19: HYBRID FINANCE (PART-II)
(a) The debenture and the option in a convertible debenture
What we will study?
cannot be separated from one another.
However, a warrant, if issued as an attachment to debenture, *What are the features of FCCB?
can be removed at any time. *What is Mezzanine financing?
(b) Warrants have the ability to be issued on their own. They *What is Innovative Hybrid?
do not have to be associated with any other instrument.
(c) The conversion of convertible securities results in just an
accounting transfer, but the exercise of warrants leads to the
injection of additional capital into the company.
(d) The vast majority of convertibles have a call provision,
which provides the issuer with the option to either refund the
debt or force conversion.
This decision is based on whether the conversion value is
more than or lower than the call price.
Warrants, on the other hand, in usually cannot be cancelled.
(e) In case of warrants issued on preferential basis, 25%
amount is paid upfront and this is forfeited if the holder
decides not to convert these into equity shares.
In case of optionally convertible debentures, no forfeiture is
involved.
FEATURES OF FOREIGN CURRENCY CONVERTIBLE BOND (FCCB): attraction of conversion option. This reduces the cost for the
issuing company.
Foreign currency convertible bond (FCCB) is a bond issued in a
currency other than the issuer's domestic currency, i.e., However, these bonds carry the risk of moves in the exchange
foreign currency. rates.
A convertible bond is a hybrid of debt and equity instruments. As the principal and the interest have to be paid in foreign
currency, an adverse movement in exchange rates can cause
The holder gets a regular coupon and principal payment, but
cash outflows to be higher than the savings in interest rates.
they also get the option to convert the bond into equity
shares. In addition, issuing bonds in a foreign currency exposes the
issuer to any political, economic, and legal risks prevalent in
The conversion rate at which the bonds will be converted to
the country.
equity is specified in the terms of issue of the bonds.
Also, if the bondholders do not convert their bonds to equity,
As the holder has the option, if the stock price is below the
the issuer will have to make the principal repayments on
conversion price on the relevant date, he will not convert the
maturity.
bond into equity shares.
The term of foreign currency convertible bonds, generally, is
FCCB investors are usually hedge funds and foreign investors.
around five years.
These bonds may also have a call option, whereby, the right of
Holders of Foreign Currency Convertible Bonds are exposed to
early redemption lies with the bond issuer, or put option
exchange rate risk and credit risk.
whereby, the right of early redemption lies with bondholder.
If the issuing company goes bankrupt, the repayment of the
FCCBS are generally issued by corporates in those currencies
principal at maturity, will not be there.
which are stable and for which, the interest rates are lower.
The coupon payments on such bonds are lower than that on a
straight coupon-bearing plain vanilla bond, because of the
MEZZANINE FINANCING: INNOVATIVE HYBRIDS:
This is another hybrid type of debt and equity financing. There can be a number of innovative hybrids.
It gives the lender the right to convert the debt in to equity of In these cases, the formation of a hybrid security involves
the company in case of default. different combinations of two distinct forms of securities: a
conventional debt or equity security and an over-the-counter
Mezzanine financing is normally for raising funds for specific
derivative (a forward contract, or swap, or option).
projects or to finance an acquisition.
The following are some illustrations of distinct categories of
Mezzanine financing can provide higher returns to investors
hybrids:
compared to normal debt instruments.
Hybrids as Convertible Bearer Form Bond:
However, for the issuing company, its cost is lower than the
cost of equity capital therefore, it can be considered as very A bearer forms convertible Eurobond amounting to of £64.25
expensive debt or cheaper equity. million was issued by the British firm Carlton in the year 1992.
Mezzanine debt is often an unsecured debt. The subordinated issuance had a term of 15 years and paid a
coupon of 7.5%, which was at least two percentage points less
It may be structured with partially fixed and partially variable
than comparable straight Eurobonds issued at the time.
interest rates.
Hybrids as a risk management strategy for commodities:
It typically matures in more than 5 years. Depending on the
scheduled maturities of existing debt in the books of the Standard Oil of Ohio Company was the issuer of the oil-linked
issuing company. bond at the end of June in the year 1986.
The bond had a face value of $3,75,00,000 and comprised of
zero-coupon notes that would mature on March 15, 1992.
The bearer of each $1,000 note was guaranteed to receive
face value at maturity, in addition to an amount equal to the
excess, if any, of the price of crude oil (West Texas Hybrids to mitigate Interest rate Risk:
Intermediate) over $25 multiplied by 200 barrels.
Collared Floating Rate Notes (FRNs):
This promise was made to the holder of each note.
The United Kingdom severed its ties to the European
The upper bound for the price of WTI was set at $40, which Exchange Rate Mechanism in the fall of 1992, so liberating its
meant that the highest amount an investor could receive at domestic monetary policy from the limitations imposed by its
maturity was ($40-$25) x 200, which equalled $3000, in previous connection to the Deutschemark.
addition to the $1,000 par value of the security.
The base rate, which is the most important short-term rate in
In addition, commencing on April 1, 1991, each note holder Britain, was decreased by the Bank of England from 7% to 6%
had the opportunity to redeem their respective note prior to on Tuesday, January 26, 1993.
its maturity on the first and fifteenth of each month, subject
The first issue of collared floating-rate notes denominated in
to the terms outlined above.
sterling was spearheaded by Salomon Brothers in London on
To manage foreign exchange risks: the Thursday of that same week for 'The Leeds Permanent
Building Society' which issued the bond with a face value of
Bonds denominated in two different currencies:
£100 million and a maturity of 10 years.
Sperry Corporation, through a Delaware financing subsidiary,
Investors were provided a flat LIBOR rate, with a minimum
issued a US $56 million dual currency bond in February, 1985.
interest rate of 7% and a maximum interest rate of 11% which
The interest rate, payable annually in dollars, was 6 3/4% was seven and a half percentage points higher than the
(6.75%). prevailing London interbank offered rate for 6 months.
The principal, however, was equal to 100 million Swiss francs. This is typical of the collared FRN structure, which at the time
The final maturity was February, 1995. had seen transactions totaling more than $8 billion done in
dollar-denominated form.
ABFM MODULE - D PREFERENCE SHARE CAPITAL:
Chapter 19: HYBRID FINANCE (PART-III) Preference shareholders have a higher priority claim on both
the company's income and assets than the equity
What we will study?
shareholders have.
*What is Preference Share? A dividend is guaranteed to preference shareholders, and this
*What are the types of Preference Share? dividend must be paid out before any dividends are
distributed to regular shareholders.
There may be cumulative or non-cumulative type of
preference shares.
The repercussions of failing to pay the dividend on preference
shares are not nearly as severe as those of failing to pay, for
example, the interest on a debt obligation.
Preference shareholders, in contrast to creditors, do not have
a legal claim to receive the dividend, which means that they
are unable to push the company into bankruptcy if they are
not paid.
However, in the event that the company is put into liquidation,
which involves the sale of all of its assets and the use of the
proceeds to settle all of its debts and pay off its owners, the
preference shareholders will receive everything that is
rightfully theirs before the equity shareholders receive
anything.
This prior claim gives preference shareholders an edge in the The term "perpetual or irredeemable preference shares"
restructuring of companies that are either struggling refers to preference shares that do not have a maturity date.
financially or have filed for bankruptcy, despite the fact that
Salient Provisions of the Companies Act, 2013:
few enterprises actually end up being liquidated.
In terms of provisions of Section 47 of company's act, where
The same organisations that assign ratings to corporate bond
the dividend in respect of a class of preference shares has not
offerings also assign ratings to issues of preference shares.
been paid for a period of 2 years or more, such class of
In India, we have several Credit Rating Agencies like CRISIL, preference shareholders shall have a right to vote on all the
ICRA, CARE, Fitch etc., which are nationally recognized. resolutions placed before the company.
It is possible for there to be multiple classes of equity shares, Section 55 of company's act is related to the issue and
just as it is possible for there to be multiple classes of redemption of preference shares.
preference shares, each having its own unique dividend rate
1. No company limited by shares shall issue any preference
and set of rights.
share which is irredeemable.
Some classes of preference shares are considered junior to
2. A company limited by shares may, if so authorized by it's
other classes of preference shares.
article of association, issue preference shares which are liable
When it comes to dividends and liquidation, owners of junior to be redeemed within a period not exceeding 20 years from
classes of preference shares have to wait in line behind the date of their issue.
owners of senior classes of preference shares.
3. A company may issue preference shares for a period
Despite this, all preference shareholders have priority over exceeding 20 years for infrastructure projects, subject to the
equity shareholders in terms of voting rights. redemption of such % of shares as may be prescribed on an
annual basis at the option of such preferential shareholders.
Preference shares, on the other hand, can be issued either
with or without a maturity date, in contrast to equity shares,
which is never issued with one.
Types of Preference Shares: If for some reason a dividend is not declared throughout the
course of a given year, the right to receive that dividend for
The various kinds of preference shares that can be issued are
that year will be forfeited.
as follows:
As a consequence of this, the owner of such a share will never
Cumulative Preference Shares:
be eligible to receive dividends in arrears in the future.
A cumulative preference share is one that holds the right to a
Participating Preference Shares:
definite sum of dividend or dividend at a predetermined rate.
In addition to the right to a fixed dividend, these shares give
These shares are more valuable than regular preference
the holder the right to participate in any surplus profits that
shares.
remain after equity shareholders have been paid dividends at
The name "Cumulative Preference Shares" comes from the a predetermined rate.
fact that the dividend on these shares will continue to
This right is granted regardless of whether or not the fixed
accumulate unless they are completely paid out.
dividend is paid out.
Till payment is done, the unpaid dividends are recorded as a
Additionally, in the event that the company is wound up, the
contingent liability in the company's balance sheet.
holder of this type of share is entitled to receive a
As mentioned above, in the event that the dividend is delayed predetermined amount of the surplus as well, but only after
for a period of at least two years, the holders of such shares the equity shareholders have been compensated in full.
shall be granted the right to participate in and vote on every
Non-Participating Preference Shares:
resolution and every item brought before the general body
meeting of the shareholders. A non-participating preference share is a share that only
receives a predetermined rate of dividend payment each year
Non-Cumulative Preference Shares:
and does not get any additional rights in profits or in the
A non-cumulative preference share grants the holder the right surplus when the company is wound up.
to receive a dividend payment that is predetermined in
advance.
Redeemable Preference Shares: Non-Convertible Preference Shares:
These shares are issued on the condition that the company A non-convertible preference share is one in which the owner
will redeem them after the specified period or even earlier at of the preference share does not have the right to have his
the company's option. holdings converted into equity shares.
A call option may also be incorporated in this type of shares, Adjustable-rate Preference Shares:
giving the company the right to redeem at a specified time
Adjustable-rate preference shares do not qualify for a fixed
and rate.
dividend rate.
Non-Redeemable Preference Shares:
The dividend pay-outs depend on the interest rates prevalent
The preference shares that do not come with an arrangement in the market.
regarding redemption, are referred to as Non-Redeemable
Preference Shares.
Irredeemable preference shares can be redeemed by a
company only on liquidation or shutting down of operations.
However, Indian companies are not permitted to issue
irredeemable preference shares.
Convertible Preference Shares:
The holders of these shares have the right to have them
converted into equity shares, at their discretion, in accordance
with the terms and circumstances of the issue of which they
are a part.
ABFM MODULE - D Purpose of issuing Preference Shares:
Chapter 19: HYBRID FINANCE (PART-IV) The following are some of the reasons why preference shares
may be issued:
What we will study?
a) It is an improved method for acquiring capital in primary
*What is the purpose of issuing preference share? market.
*What are Perpetual Non-Cumulative Preference Share b) If a firm's shares can't be bought and sold, it might have
(PNCPS)? trouble obtaining funds, but the possibility of getting one's
money back at some point in the future could entice investors
to invest in the company.
c) In most cases, the preference shares are redeemed when
there is a surplus of cash and there are no other successful
ventures in which to invest the money.
d) If there is a loss or a reduction in profit, there will be no
dividend paid out, which is not the case with debentures or
loans.
There was a time when preference capital was not a popular
method of capitalisation because it neither offered much
gains associated with capital markets to investors nor did it
provide the tax advantage to the companies which were
available in case of interest paid on debentures.
The investor interest in preference capital keeps fluctuating
with the change in taxation laws.
Preference dividend, which was exempt from taxation in the It is a contract that gives the holder the right to redeem
hands of investors is once again taxable in the hands of the preference shares at an agreed upon price either at the
investor. conclusion of a specific time period or before the end of that
time period.
Therefore, investors' willingness to accept a lower rate of
dividend on preference capital, which was resulting in a lower The redemption date, also known as the maturity date, is
cost of preference capital for the companies that were issuing typically printed on the share certificate, and it indicates the
it, is again at a low ebb. day on which the repayment of the debt is planned to take
place.
However, for a company that has more or less reached its
limit on the amount of debt it can take on, and is hesitant to These shares are issued on the terms and conditions that the
release equity capital, this strategy seemed to make an shareholders will be refunded the money invested by them in
incredible amount of sense and may still yield results for addition to the dividend that they get over the tenure of
companies with good track record and which are willing to preference shares.
offer preference dividend at a rate higher than the fixed
Methods of Redemption of Fully Paid-Up Preference Shares:
deposit.
Section 55 of the Companies Act 2013, deals with provisions
A charge, such as a mortgage or hypothecation, is not
relating to redemption of preference shares.
necessary in order to issue preference shares.
It ensures that there is no reduction in shareholder's funds
It is possible to immediately issue preference shares for the
due to redemption.
purpose of obtaining cash for the medium term, with flexible
maturity periods. Therefore, it either issues fresh shares or distributable profits
are retained and transferred to Capital Redemption Reserve
Redemption of Preference Shares:
Account.
Redemption (maturity) refers to the process of repaying an
In case of redemption through fresh issue, the shareholder
obligation at predetermined times and amounts over the
fund is kept intact directly while in case of distributable
course of its existence.
profits being retained and transferred to Capital Redemption 3. Perpetual Non-Cumulative Preference Shares (PNCPS) in
Reserve Account, the same is kept intact indirectly. Additional Tier 1 Capital cannot exceed 1.5% of risk-weighted
assets (RWA).
If distributable profits being retained then in this case, the
amount which would have gone to shareholders in the form Once this minimum total Tier 1 capital is met, any additional
of dividend is retained in the business and is used for settling PNCPS issued by the bank can be added.
the claim of preference shareholders.
Excess PNCPS can be considered Tier 2 capital if less than 2%
The transfer of divisible profits to Capital redemption Reserve of RWAs, while meeting minimum Total Capital of 9% of RWAs.
account makes them non-divisible profits.
4. The PNCPS have no maturity date, step-ups, or other
As balance in Capital redemption reserve account can only be redemption incentives.
used for issue of bonus shares and hence the shareholder
5. Investor dividends may be fixed or floating, based on a
funds come back to same amount as before redemption.
market-determined rupee interest benchmark rate.
6. PNCPS shouldn't have a "put option". However, banks may
Perpetual Non-Cumulative Preference Shares (PNCPS): issue instruments with a call option at a specific date.
This type of Preference Shares is issued by Indian banks as a) The call option on the instrument is acceptable after it has
part of Additional Tier 1 Capital, subject to extant legal run for at least five years.
provisions, only in Indian rupees and should meet the
b) To exercise a call option, a bank must have RBI
following terms and conditions to qualify for inclusion in
(Department of Regulation) clearance.
Additional Tier 1 Capital for capital adequacy purposes:
c) A bank must not do anything that generates an expectation
1. The instruments should be issued by the bank (not a bank-
that the call option will be exercised. The dividend/coupon
created SPV) and fully paid up.
reset date need not be co-terminus with the call date to avoid
2. Bank boards may decide how much PNCPS to raise. such expectations. Banks may, at their discretion, consider a
gap between dividend/coupon reset date and call date.
d) Banks must not exercise a call unless: 11. FIls and NRIs may invest up to 49% and 24% of the issue,
respectively, with each investor limited to 10% and 5%.
i) They replace the called instrument with capital of the same
or better quality at conditions sustainable for the bank's FIIs: Total 49% (each investor limit 10%)
income capacity or
NRIs: Total 24% (each investor limit 5%)
ii) The bank demonstrates that its capital position is well
Redemption of Preference Shares by Fresh Issue of Shares:
above the minimum capital requirements after the call.
Exercise of calls due to tax event and regulatory event may be A company can use the proceeds from fresh issue of shares to
permitted. redeem preference shares.
7. Principal of the instruments may be repaid (e.g., through A problem arises when a fresh issue of shares is made at a
purchase or redemption) only with prior approval of RBI. premium and premium amount goes to securities premium
account.
8. The bank must have full discretion at all times to cancel
distributions/payments. Dividends can neither be cumulative For securities premium account, Section 52 of the companies
nor have a credit sensitive coupon feature. Act, 2013 provides that the securities premium account may
be applied by the company:
9. Neither the bank nor a related party should purchase
PNCPS, nor should the bank directly or indirectly fund the 1. Towards issue of un-issued shares of the company to be
purchase. Banks should also not grant advances against their issued to members of the company as fully paid bonus
PNCPS. securities.
10. The claims of investors in instruments shall be: 2. To write off preliminary expenses of the company.
(a) Superior to the claims of equity investors. 3. To write off the expenses of, or commission paid, or
discount allowed on any of the securities or debentures of the
(b) Subordinated to the claims of Perpetual Debt Instruments
company.
(PDIs), all Tier 2 regulatory capital instruments, depositors,
and general creditors of the bank and
4. To provide for premium on redemption of preference ABFM MODULE - D
shares or debentures of the company.
Chapter 19: HYBRID FINANCE (PART-V)
5. For the purchase of its own shares or securities.
What we will study?
*All about Black Scholes Model?
VALUATION OF WARRANTS: Applying the Black Scholes Model:
The methods that are used to value options can be used to If one is willing to disregard the complexities brought about
warrants because a warrant is comparable to a call option on by dividends and dilution, it is possible to assess the value of a
the equity stock of the corporation that is issuing the warrant. warrant by following this (Black Scholes) approach.
The maximum value that a warrant can have is determined by Black Scholes model is used for valuation of options.
taking the current stock price and subtracting the exercise
As warrant is like a call option, this model can be used for its
price from it.
valuation also.
The stock price itself determines the maximum value that a
This model takes into consideration five variables viz.,
warrant can have.
volatility, underlying stock price, time, strike price, and risk-
The warrant price lies within the parameters established by free interest rate.
the lower limit and the upper limit.
Consider the following information regarding Company X to
The following variables have an effect on the gap that exists help show how the calculation works:
between the current market price of the warrant and its
Current stock price = 𝐒𝐨 = Rs. 125
minimum acceptable level:
Total Number of warrants issued = 1.6 lakh.
1. The fluctuation in the prices of the stocks.
Exercise Price = E = Rs. 100
2.Remaining time before expiration.
Time to expiration of warrants (t)= 6 months (0.5 year),
3. Risk Free interest rate.
represented by t.
4. The Value of the Stock.
Annual Standard Deviation of Stock Price Changes (σ) = 0.4,
5. Exercise Price. represented by σ.
Risk free Interest Rate = 8%, represented by r = 0.08.
N is Cumulative Distribution Function of the standard normal These values can be obtained from the Probability Tables,
distribution. It represents a standard normal distribution with readily available on internet.
mean = 0 and standard deviation = 1
N(d₁) = N (1.0718) = 0.8582
Applying the Black Scholes model involves four steps:
N(d₂) = N (0.7890) = 0.7849
𝐄
Current price (𝐂𝐨 ) = 𝐒𝐨 N(d₁) — N(d₂)
𝐞𝐫𝐭
Third Step: Estimating the present value of the exercise price,
using the continuous discounting principal:
First Step: Calculate 𝐝𝟏 and 𝐝𝟐
𝐄 𝟏𝟎𝟎 𝟏𝟎𝟎 𝟏𝟎𝟎
= 𝒆𝟎.𝟎𝟖∗𝟎.𝟓 = 𝒆𝟎.𝟎𝟒 =𝟏.𝟎𝟒𝟎𝟖 = Rs. 96.08
𝐒 𝛔𝟐 𝒆𝒓𝒕
𝐥𝐨𝐠 𝐧 ( 𝟎 ) +(𝐫+ )𝐭
𝐄 𝟐
d1 = Fourth Step:
𝛔√𝐭
𝟏𝟐𝟓 𝟎.𝟏𝟔 Plug the numbers, obtained above, in the Black Scholes
𝐥𝐨𝐠 𝐧 ( )+ (𝟎.𝟎𝟖+ 𝟐 )∗𝟎.𝟓 𝟎.𝟐𝟐𝟑𝟏+𝟎.𝟎𝟖
𝟏𝟎𝟎 Formula:
d1 = = = 1.0718
𝟎.𝟒√𝟎.𝟓 𝟎.𝟐𝟖𝟐𝟖
𝐄
Current price (𝐂𝐨 ) = 𝐒𝐨 N(d₁) — N (d₂)
𝐞𝐫𝐭
𝒅𝟐 = 𝒅𝟏 - 𝝈√𝒕 = 1.0718 - 0.2828 = 0.7890 = 125 * 0.8582 – 96.08 * 0.7849 = 107.27 -75.41
= Rs. 31.86
Second Step: *Excel makes it relatively simple to apply each of these
Find N(d₁) and N(d₂): formulas for calculating option prices.
N(d₁) and N(d₂) represent the probabilities that a random *The functions NORM.DIST, EXP and LN have been used for
variable, that has a standardised normal distribution, will computing the values in the above illustration and the dilution
assume values d₁ and d₂. effect has not been considered.
ABFM MODULE - D
Chapter 20: STARTUP FINANCE (PART-I)
What we will study?
*What is Startup Finance?
*What are the benefits to startups under startup India plan?
*What is Startup?
INTRODUCTION: The idea is to entice investments as well as to create an
ecosystem that helps businesses develop.
Startup refers to a business that is just getting started.
The Startup India Hub, an online portal, that offers a variety of
Startups are created by one or more business owners who
services under Startup India, and connects aspirants to other
desire to provide a good or service, they feel there is a market
significant ecosystem builders, launched the project in April
for.
2016.
These businesses typically have large startup expenses and
Additionally, the scope of the term was expanded to
little income, which is why they seek funding from a number
encompass scalable businesses with a high potential for
of sources including venture capitalists.
creating money or jobs.
Wikipedia defines 'a startup or start-up as a company or
Additionally, the need for a letter of recommendation from an
project undertaken by an entrepreneur to seek, develop, and
incubator or industry group was dropped in order to profit
validate a scalable business model.
from the projects.
While entrepreneurship refers to all new businesses including
Stakeholders were given a totally online forum with the start
self-employment and businesses that never intend to go
of the recognition project under Startup India.
public, startups are new businesses that intend to grow large
beyond the solo founder. All applications are gathered, reviewed, and granted
certificates of recognition for complete and qualified
At the beginning, startups face high uncertainty and have high
applications within 48-72 working hours on this platform.
rates of failure, but a minority of them do go on to be
successful and influential. The DPIIT recognition procedure enhanced the ecosystem as a
whole and permitted entrepreneurs to participate in
Under the Department for Promotion of Industry and Internal
numerous support programmes offered by Startup India.
Trade (DPIIT), Startup India was established to effectively
handle the incentive disbursement process for new businesses. The Indian government wanted to tap into and develop its
citizens' entrepreneurial potential.
The goal was to inspire India's creative genius to conjure up According to the Economic Survey 2021-22, at least 14000
ideas, act on them, and turn them into profitable ventures. startups were recognised during the fiscal year 2022.
In order to achieve this goal, the government introduced the The report also noted that 555 districts in India have at least
"Startup India" initiative in January 2016. one new company, drawing attention to the fact that over the
previous 6 years, startup activity in India has expanded
The program's goal is to create a strong environment for
significantly, with the majority of them being in the IT and
fostering innovation and startups in the nation which will
knowledge-based sectors.
promote long-term economic growth and provide countless
job possibilities. In India, startups have increased significantly during the past 6
years.
On January 16, 2016, a “Startup India Action Plan" was
unveiled in order to include all these goals under a single The survey found that from just 733 in 2016-17, there will be
overarching policy framework for the entire country while almost 14,000 new recognised companies in 2021-22. After
taking into account all facets of the startup ecosystem. the United States and China, India now has the third-largest
startup ecosystem globally.
It included 19 recommendations for actions that fell into three
categories: According to the data, 44 firms in India achieved unicorn
status in 2021, bringing the total number of unicorn startups
financial assistance and incentives, industry-academia
to 83, with the service sector accounting for the majority.
collaboration, and simplification and coercion.
The report shed light on new-age company IPOs as well.
Each of the States and UTS currently has at least one
recognised startup. In comparison to previous years, Rs. 89,066 crore was raised
through 75 IPOs issuance between April and November 2021.
The Department for Promotion of Industry and Internal Trade
(DPIIT) has recognised 69636 businesses nationwide as part of According to the poll, there will be 47 companies in India's
the Startup India Program through April 2022, with Delhi and startup sector in 2021, up from 11 in 2019.
Karnataka having the highest totals.
Through January 2022, 130 agreements totaling up to $3.5 On a written, verifiable allegation of a breach, accepted by at
billion were invested in by India Startups. least one level above the inspecting officer, startups may be
inspected.
The total contract value in January 2022 is 6 times greater
than it was in the same month the previous year, which Other significant provisions of the action plan were access to
included 75 deals at $600 million. an 80% fee discount for patent registration and a 50% fee
rebate for trademark filing.
Among the main industries, where start-ups are registered,
are those in the food processing, application development, Additionally, it offers the option of faster exit regulations and
product development, and IT consulting sectors. no-cost support from facilitators of patent and trademark
applications.
There are more than 1000 recognised startups in each of the
12 States and UTs (Maharashtra, Delhi, Karnataka, Uttar To encourage an innovative and entrepreneurial culture, it has
Pradesh, Telangana, Gujarat, Haryana, Tamil Nadu, Kerala, also developed the Atal Innovation Mission with Self-
Rajasthan, Madhya Pradesh, and West Bengal). employment and Talent Utilization (SETU) programme.
Its purpose is to act as a platform for the promotion of startup
companies, world-class innovation hubs, and other self-
BENEFITS TO STARTUP UNDER THE STARTUP PLAN:
employment endeavours in technologically advanced fields.
Startups are eligible for a range of benefits under this strategy,
Incubator setup expertise from the private sector is another
including tax incentives, government funding support, capital
goal of this initiative.
gain tax exemptions, priority treatment for startups in public
procurement, etc. Institutions called, business incubators, help entrepreneurs
build their businesses, particularly in the beginning.
The ability to self-certify in relation to nine labour regulations
and three environmental laws is another benefit, as is a 3-5 These businesses are targeted toward accelerating the
years exclusion from any business inspections. development and success of startup and early-stage
businesses.
Atal Tinkering Labs will be constructed in a number of schools Expanded Startup Definition:
across the country, and these schools have been chosen.
Under the Startup India Action Plan, An entity shall be
The Atal Innovation Mission has chosen incubators all considered a startup:
throughout the country to which it will provide financial
If it is incorporated as a private limited company (as defined in
support in the form of grants-in-aid.
the Companies Act 2013) or registered as a partnership firm
(registered under Section 59 of the Partnership Act 1932) or a
limited Liability partnership (under the Limited Liability
STARTUP DEFINITION IN INDIA:
Partnership Act, 2008) in India, and Up to 10 years from the
Initial Definition: date of its incorporation/registration.
An entity shall be considered a startup: If its turnover for any of the Financial Year since
Up to 5 years from the date of its incorporation/registration Incorporation/registration has not exceeded 100 crore and
If its turnover for any of the financial year has not exceeded It is working towards innovation, improvement or
Rs. 25 crores. development of products or processes of services or if it is a
scalable business with a high potential of employment
If it is working towards innovation, development, deployment
generation or wealth creation.
or commercialization of new products, processes or services
driven by technology or intellectual property. Provided that any such entity formed by splitting up or
reconstruction of a business already in existence shall not be
Provided that any such entity formed by splitting up or
considered as a startup.
reconstruction of a business, already in existence, shall not be
considered a "Startup".
ABFM MODULE - D CHALLENGES FACED BY STARTUPS:
Chapter 20: STARTUP FINANCE (PART-II) The main challenges, faced by startups, may be listed as under:
What we will study? ➢ Failure to plan appropriately.
*What are the challenges faced by startups? ➢ Unrealistic Expectations.
*All about State Startup Policy? ➢ Knowledge and skills gaps.
*What is Pitch Presentation? ➢ Time management and productivity.
*What are the programs for startups? ➢ Lack of Leadership.

➢ Fierce Competition, lack of demand, and Ineffective
marketing.
➢ Winning Trust of Customers.
➢ Hiring Suitable Candidates.
➢ Partnership Decision Making.
➢ Financial Management.
➢ Securing funding.
➢ Cyber Security.
STATE STARTUP POLICY:
It is important for a state to have a startup policy because it
provides crucial funding, mentorship, and market access
support that is required by startups in order for them to grow
into significant contributors to the economy of the state in the reasons for which an investor should invest into the
terms of revenue and job creation. business.
It also includes provisions to provide incentives to key startup The pitch presentation came into picture in the late 1990s,
stakeholders such as incubators and institutions of higher during the dotcom boom.
education, amongst others, in order to encourage the
The entrepreneur should focus on the following, while
accumulated development of India's startup ecosystem.
preparing slides for pitch presentation:
The Startup India Team is committed to actively assisting
➢ The Problem Statement i.e. The issues faced by
individual states in the formulation and implementation of
business/society.
their respective startup policies.
➢ Solutions to solve the issue.
Currently, 31 states (including UTs) out of a total of 36 have
their own startup policy. ➢ Business Model.
Following the introduction of the Startup India Initiative in the ➢ The Technology used.
year 2016, a total of 26 of these startup policies were drafted. ➢ Business and Commercial Activity.
There is at least one startup that has been recognised by the ➢ The Competitive Environment.
DPIIT operating in each of the 36 states and Union Territories.
➢ The Team Composition.
Each of the 623 districts has acknowledged at least one
➢ Predictions and Significant Events.
startup that has been recognised by the DPIIT.
➢ Present Status and Timelines for Execution.
PITCH PRESENTATION:
➢ Executive Summary and call for action.
The pitch presentation is a slide presentation usually using
either Power point or Keynote Slides in the background, that The presentation of the pitch should be clear and concise, and
helps the entrepreneur to showcase its business and provide it should emphasise the most significant aspects of the
enterprise, rather than all of the intricacies.
It should answer the maximum questions that an investor These Incubators will each receive a financial support of Rs. 10
might have while investing in the venture and should be crores, which can be used to improve the overall quality of the
flexible depending on the type of venture for which the services that are given.
entrepreneur is looking for investment.
Startup India Yatra:
In addition, it should address any concerns that the investor
The Startup India Yatra programme was started with the
might have regarding the venture.
intention of travelling across Tier 2 and Tier 3 cities in India in
PitchDeck is an all-in-all presentation building platform search of entrepreneurial talent and with the intention of
exclusively for start-ups, offered by Startup India. assisting in the expansion of the startup ecosystem.
The platform focusses primarily on helping users build their Its primary objective is to identify prospective business
first pitchdeck from scratch with next to zero design effort. owners living in non-metropolitan areas and provide them
with a venue in which they can pursue their dreams of
running their won companies.
PROGRAMMES AND COMPETITIONS FOR STARTUPS:
This will be accomplished by providing them with business
Incubator Grand Challenge: incubation and mentoring from well-known institutions in
As part of the Atal Innovation Mission's Established order to assist them in overcoming the constraints posed by
Incubation Centres (EIC) programme, the Incubator Grand the dearth resources in their region.
Challenge has been introduced as a means of recognising The objective of the Startup India Yatra is to visit every single
incubators. district in country.
To date, Rs. 54.65 crore has been distributed to 9 different The following is a list of the important elements that are
incubators through AIM's Grants-in-Aid programme. included in Startup India Yatra:
As of May 2021, AIM had selected 16 incubators from around ➢ The mobile van for the Startup India travels across the
the country for the purpose of providing financial support. states and records ideas.
➢ The Startup Yatra has been carried out in 23 states and The Insolvency and Bankruptcy Code 2016 (IBC 2016):
220 districts, having an effect on about 7,80,000 people
The Insolvency and Bankruptcy legislation of 2016 provides a
interested in starting their own businesses.
framework for the expeditious resolution of insolvency cases
➢ A total of approximately 1,450 opportunities for involving corporate persons, partnership firms, and individual
entrepreneurs to participate in an incubator programme debtors.
have been made available.
The Ministry of Corporate Affairs has notified startups that
➢ Throughout the course of the day, a boot camp will be they are "Fast Track Firms," which will allow them to wind up
held, which will include idea validation, awareness their activities within 90 days rather than the 180 days that
workshops, and pitching sessions. are required for regular enterprises.
According to the terms of the IBC, start-up companies that
have simple debt structures or that meet such conditions as
Rule 170(1) of GFR 2017:
may be specified, must have their operations wound down
There is an exemption from the requirement to submit an within 90 days after making an application for winding down
earnest money deposit or bid security in public procurement on a fast track basis.
bids, as stated in Rule 170(1) of GFR 2017, which was updated
In the event that this occurs, an insolvency professional will
in 2017. (GFR: General Financial Rules)
be arranged for the startup.
Rule 173 was notified vide GFR 2017 in order to relieve the
This individual will be in charge of the company (the
condition of past turnover and prior experience for DPIIT
promoters and the management will not be permitted to run
recognized startups in all proposals for government tenders.
the business) for the purpose of liquidating its assets and
paying its creditors within 6 months of the appointment of the
insolvency professional.
After being appointed, the insolvency professional is
responsible for the prompt closure of the company, the sale of
assets, and the reimbursement of creditors in line with the National Startup Award:
distribution rules established by the IBC.
National Startup Award was initiated in 2021.
INSPIRE:
The purpose of this award is to recognise and reward
INSPIRE or INSPIRE Manak is "Innovation in Science Pursuit for excellent startups and ecosystem enablers that are
Inspired Research", which is being run by the Department of contributing to the economic ecosystem by stimulating
Science and Technology (DST) in collaboration with the innovation and injecting competition.
National Innovation Foundation-India (NIF), an autonomous
This award is in the quest to recognise and reward excellent
body of the DST.
startups and ecosystem enablers.
The objective of the Awards is to encourage and inspire young
Startups that are developing ground-breaking technologies or
people between the who are currently enrolled in classes 6
solutions, businesses that are scalable and have a good
to 10.
chance of creating jobs or riches, and ventures that are having
The program’s objective is to foster an environment that a measurable positive effect on society are examples of good
encourages youngsters to think creatively and innovatively by candidates.
celebrating the planting of one million unique ideas and
The award show is broken up into different categories, some
innovations in the fields of science and societal applications.
of which are as follows: providing India with innovative
From the approximately 3.2 million nominations that were solutions to real problems and challenges; developing
received from schools, around 50,000 of the best ideas were innovative technologies, solutions and products from India to
chosen to earn a grant of Rs. 10,000/- each to be used toward the rest of the world; building businesses that are scalable,
the production of a project model and participation in a sustainable, and responsible; and delivering measurable
district-level exhibition and project competition. development gains.
The winning startups in the competition received monetary
prizes in addition to support from the government.
ABFM MODULE - D Women Capacity Development Programme (WING):
Chapter 20: STARTUP FINANCE (PART-III) The Women Capacity Development programme, often known
as WING, offers training and a platform for women-led
What we will study?
businesses as part of its capacity development efforts.
This is done with the goal of increasing awareness of the
*What are the programs for startups (continued)? project.
As of May 2021, a total of 21 capacity development
workshops had been carried out in 9 different states, with
more than 1150 female business owners receiving benefits.
Communications for Female Entrepreneurs, backed by
Lending and Venture Funding from SIDBI Institutions are
arranged by accepting applications on the "Startup India
Hub," and shortlisted women entrepreneurs are asked, after a
process of screening by experts, to meet with these
institutions for both equity and debt finance.
On the website known as Startup India Hub, one may now
find a page specifically devoted to female business owners.
GEM Startup Runway:
GEM entrepreneurial runway has introduced a designated
area for startups to set up shop and sell their wares.
Swayatt, which stands for "Startups, women and Youth
Advantage through e-transactions" is the name of a startup
runway that was recently introduced on the government E improving the quality of life of citizens; this will be done
market (GeM) place by the Ministry of Commerce and with the intention of improving the overall quality of life.
Industry in an effort to entice more startups to participate in
➢ Investigate novel approaches to resolving these kinds of
the Government E Market place.
problems through the use of grand challenges,
Through the Starting Runway Corner, participants in the hackathons, problem-specific pitching sessions, reverse
programme will have the opportunity to engage with pitching sessions, and any other method you can think of.
government purchasers and market their products and
States Startup Ranking:
services as part of their startup businesses.
The States Startup Ranking was established in April 2017 with
On the other hand, the listing will only be open to companies
the intention of harnessing the force of competitive unionism
who have been certified by the Department of promotion for
and fostering the growth of a thriving startup ecosystem
Industry and Internal Trade (DPIIT).
across the nation.
Innovation Zones:
The primary purpose of this study is to assess the states and
The government is establishing Innovation Zones at the level territories with regard to certain intervention areas that are
of Urban Local Bodies (ULBs) in order to enhance the basic crucial to the development of a healthy ecosystem.
level of public service delivery and governance.
Additionally, a States Ranking Framework has been
This is done in order to improve the overall quality of life for established as part of the strategy.
citizens and to handle local problems in the areas of sanitation,
This framework raises awareness regarding the volume and
cleanliness, health, trash, water, taxation, traffic, enforcement,
scope of state-driven initiatives and encourages reciprocal
and any other facets of citizen services supplied by ULBs.
learning among ecosystem players.
The following functions will be assigned to innovation zones:
The ranking framework is based on seven reform areas that
➢ Recognize significant challenges and research needs are essential to the expansion of startup ecosystems.
linked to all elements of citizen services with the goal of
These are access to markets, support for incubation, support Support for Ayushman Bharat Jan Arogya Yojana's efficient
from institutions, support for fostering innovation and Implementation.
entrepreneurship, support for funding, support for capacity
The challenge consists of inviting startups that are primarily
building of enablers, and support for mentoring.
working in the fields of medical devices, digital health,
Digital Demo Day: hospital services, hospital management, health
communication, medical workforce training and capacity
The Digital Demo Day is a conference and display for new
building and reducing the cost of operations, amongst other
technology companies who are just getting started in
fields.
Germany.
It provides a platform for industrial tech startups, primarily in
the fields of virtual reality (VR), augmented reality (AR), Textile Grand Challenge:
internet of things (IoT), cyber security, smart devices, drones,
The initiative resulted in the beginning of the Textile Grand
and robotics, to showcase their digital technologies for people
Challenge.
to test out and get in touch with.
India is a significant participant in the global textile and
It honors inventiveness by bringing together colleges,
clothing manufacturing industry.
corporations, small and medium-sized businesses, and
startups, all of which are searching for chances in digital It is anticipated that by the year 2025, the global market for
transformation. garments made from textiles will reach $ 1.3 trillion.
Ayushman PMJAY Startup Grand Challenge: In a similar vein, it is anticipated that the domestic market for
garments will reach 59.3 billion dollars by the year 2022.
In cooperation with Startup India, the Ayushman PMJAY
(Pradhan Mantri Jan Arogya Yojana) Startup Grand Challenge The primary objective is to introduce innovation into the
is extending an invitation to India's newest businesses to sector of concern, which will, in the long run, contribute to the
develop innovative solutions for the National Health Authority industry's expansion.
Innovation Challenge: ABFM MODULE - D
An Innovation Challenge was launched with the goal of Chapter 20: STARTUP FINANCE (PART-IV)
developing a Portable Device for Water Quality Testing.
What we will study?
This innovation challenge was launched by the Department of
*What are the programs for startups (continued...)?
Drinking Water and Sanitation's National Jal Jeevan Mission
(NJJM) in collaboration with the Department of Drinking
Water and Information Technology.
Both surface water and groundwater are used as sources of
potable water in rural regions, with ground water accounting
for 80% of the total.
However, because there is a limited amount of groundwater
available, particularly in dry and semi-arid regions, there has
been an increase in the consumption of surface water.
People who have their water supplied to them through pipes
at their homes are unable to verify the potability of the water
that comes out of their taps, which is why many people are
reluctant to drink water directly from the faucet.
People living in urban areas typically install household water
treatment units, which results in additional costs.
There is a need for "Portable Water quality testing Devices"
that can test the water quality for critical factors.
MNRE Startup Grand Challenge: Grants will be provided to the selected startups so that they
can pilot their solutions with Food & Beverage (F&B) Partner
An Ministry of New and Renewable Energy (MNRE) startup
in Goa.
grand challenge has been kicked off to achieve the goal of
lowering carbon emissions while also ensuring energy security There was a total of eight Entrepreneur Support Organizations
and access. (ESOS) that were considered for the role of running the SUP
Challenge with the F&B Partner in the five nations of India,
The possibilities that are now available aim to investigate the
the Philippines, Thailand, Vietnam, and Indonesia.
potential for bigger contributions from renewable resources in
the fields of livelihood, health, water, and innovation in The following areas will receive particular attention as a result
products, services, and business models. of this challenge:
The MNRE offers a one-of-a-kind opportunity for innovative *Reverse Logistics.
businesses and entrepreneurs to solve some of the most
*Circular Reuse/Refill models.
pressing problems that the Renewable Energy Sector in India
is now facing. *Alternatives to Plastics Intended for Single-Use Only.
Startup India Single Use Plastic International Challenge: The following benefits will be made available through the
programme:
Because single-use plastics, also known as disposable plastics,
are only used a single time before being thrown away or *Individualized guidance from seasoned professionals in the
recycled, government of India has created the Startup India sector.
Single use plastic International Challenge in order to *Grant funding for 10 pilots.
encourage inventors and startups to develop design solutions.
*An exhibition of the impact of successful pilot projects.
To help reduce the amount of single-use plastic used in the
*Occasions to Establish Professional Contacts.
food and beverage industry, The SUP Challenge-Goa is calling
for the participation of innovative startup companies. *Seminars and online presentations.
Research Park: The Micro and Small Enterprises who wish to participate in
Government Purchases must first become registered with
As of May,2021, the following eight new research parks had
NSIC under the Single Point Registration Scheme (SPRS).
been established:
Under the Single Point Registration Scheme, the National
*IIT Delhi
Small Industries Corporation (NSIC) is willing to register any
*IIT Kanpur micro and small businesses that have an Udyog Aadhar
*IIT Gandhinagar Memorandum (UAM) or an EM Part - II (Optional).
*IIT Mumbai EM Part - II: Entrepreneurs Memorandum Part - II
*IIT Guwahati Those micro and small businesses who have begun
commercial production but have not yet reached their one-
*IIT Kharagpur
year anniversary of operation are the ones that are qualified
*IIT Hyderabad to be registered under this programme.
*IIsc Banglore The registration certificate that is awarded to Micro and Small
Enterprises as part of the Single Point Registration Scheme is
Single Point Registration Scheme:
valid for a period of 2 years, after which it will be subject to
The Ministry of Micro, Small, and Medium Enterprises (MSME) review and must be renewed.
has initiated a scheme known as Single point Registration.
This review and renewal will be determined by an evaluation
The Indian Government is the single biggest buyer of a wide of the Registered Micro and Small Enterprise's continuous
variety of products. Commercial and Technical Competence in manufacturing or
The Government Stores Purchase Programme was initiated in producing.
1955-1956 with the purpose of increasing the proportion of
purchases made from the micro- and small-scale business
sectors.
Micro and small enterprises that fall under the Single Point ABFM MODULE - D
Registration umbrella and have a maximum annual revenue of
Chapter 20: STARTUP FINANCE (PART-V)
Rs. 5 lacs are eligible to receive a Provisional Registration
certificate. What we will study?
This certificate is valid for 1 year and can be used by *What are the different types of Startup finance?
businesses that have already begun commercial production
*What are the different Stages of Startup and source of
but have not yet reached their first anniversary in business.
finance?
Types of Startup Financing: It is possible to acquire it through angel investors, venture
capitalists, crowd funding incubators and accelerators, as well
Debt Financing:
as from one's own family and friends through self-financing.
It entails borrowing money from a lender, paying that money
Grant:
back with interest within a predetermined amount of time,
and adhering to the deadlines that have been established for A grant is an incentive, typically financial, that is granted by
the payback of the loan. one organisation to another organisation in order to promote
the achievement of a goal or to encourage superior
The lender does not have any influence over the company,
performance.
and in order to secure financing, the fledgling company can be
required to submit some form of collateral. A grant does not call for any sort of payback of the monies.
It is possible to get it through banking institutions, non- The disbursement of grants occurs in stages, with each one
banking financial institutions, government loan programmes, contingent on the previous one having been successfully
and other similar avenues. completed.
Equity Financing: In the case of a grant, the investor will not receive any return
on their investment.
It comprises selling equity shares of the company in exchange
for the capital that was provided. In most cases, grants can be obtained from the Central
Government, the State Government, Corporate Challenges, or
In the case of equity financing, there is no requirement to
grant programmes run by private entities.
make any payments toward the principal.
However, startups are required to share ownership in the
company, even though they are not required to offer
collateral for the same.
In most cases, equity investors are given the authority to
make decisions within the organisation.
Stages of Startups and Sources of Funding: It involves basing both the operation of the firm and its
growth on the profits and savings generated by it.
There are many different funding options available for new
businesses. Because there is no obligation to pay back the cash or to
dilute control of the firm, this is the first choice that the vast
Nevertheless, the origin of the funding ought to normally
majority of entrepreneurs choose.
correlate with the stage of operation that the startup is now
in. Due to the inherent level of trust that exists between
investors and business owners, many entrepreneurs also turn
The following is an outline of the various stages:
to their friends and family for financial assistance.
Idea Phase:
Even the financial backing can be acquired in the form of a
At this point, the entrepreneur has the business concept in prize or reward at a pitching event, which are offered by
their head and is working to turn it become a reality. institutes or organisations that oversee business plan
At this point in the process, the quantity of money that is competitions and challenges.
required is relatively low. Even though the amount of money is not very large, it is
In addition, when a business is in its early stages of operation, typically enough to go through the phase of idea development.
there are very few avenues and sources via which cash can be Seed Stage:
raised and financed.
A company is required to carry out field trials, test the product
At this point in time, most of the money that is needed to be on a selected number of clients, bring on board mentors, and
raised can come from unofficial sources. build a formal team before it is eligible to investigate the
Growing a company using only one's own resources and following funding sources.
refusing any outside investment is an example of Incubators are organisations that have been established with
"bootstrapping". the specific purpose of assisting entrepreneurs in the process
of constructing and launching their enterprises.
They are also able to assist with a wide variety of value-added Series A Stage:
services, such as providing office space, utilities,
At this point in the process, monies are being raised so that
administrative aid, legal advice, and so on.
the company can develop its user base, product offerings,
They offer financial assistance in the form of grants, debt extend to other geographies, and so on.
investments, and equity investments in businesses.
The following categories of funding sources are common:
The government has also initiated a few loan programmes to
Venture capital funds are pools of money that are managed
offer entrepreneurs collateral-free financing and to assist
by professionals and are dedicated to making investments in
them in gaining access to low-cost finance.
companies with rapid development.
Some examples of these programmes include the Startup
Every venture has its own philosophy, which should
India Seed Fund Scheme and the SIDBI Fund of funds.
correspond to the necessities of the business in terms of
Angel Investors are private individuals that put their money favoured industries, stage of start-up, and funding quantity.
into high-potential enterprises in exchange for a share of the
Venture capitalists want start-up companies to give them
company's ownership.
ownership in exchange for their investment, and they often
There are a number of different angel networks, some provide active mentoring to the startups in which they have
examples of which are the Indian Angel Network, Mumbai invested.
Angels, Lead Angels, Chennai Angels, and others.
At this point, the startup is in a position to present the market
At this point, it is possible to raise funds through a method response and income to NBFCs and banks to establish its
known as "crowdfunding", in which a big number of people credibility, which allows for the raising of loans and debt from
give a modest amount of money apiece. these institutions.
Platforms that facilitate online crowd fundraising are Because loans from banks, NBFCs, and other financial
frequently utilised for this purpose. institutions do not do the dilution in the equity, the majority
of business owners choose this method of funding.
Scaling: If the company's founders want to recover control of their
business but lack the liquid assets necessary to execute the
Funding for these late-stage firms comes from venture capital
acquisition, they can buy the shares back from the fund of
funds that have larger ticket sizes.
investors who initially invested in the business.
When the market response has already been validated, it is
best to approach venture capital firms, as this is often the best
time to do so. Process to Startup Fund Raising:
Exit Options: The process of soliciting financial support can be broken down
into the following stages:
It's possible that the investors will come to the conclusion that
they want to sell the portfolio firm to another company ➢ Determining whether or not money is required.
currently operating in the market.
➢ Assessing the need for funding.
When one firm merges with another, either purchasing the
➢ Assessing Investment Readiness.
entire target company or only a portion of it, both businesses
benefit. ➢ Preparation of PitchDeck presentation.
A startup may a launch an initial public offering (IPO) by listing ➢ Investor Targeting.
its shares for the first time on a stock exchange. ➢ Due diligence by Interested Investor.
Considering that an initial public offering (IPO) is a laborious ➢ Term Sheet.
process, generally speaking, it is only undertaken by
The new company needs to design a plan that is based on
corporations that have a commendable history of earnings
milestones and includes specific timetables for the things it
and are consistently expanding.
wants to accomplish in the future years.
In addition, the investor has the option of selling their shares
to other venture capitalists or private equity companies in
order to make their exit.
It is important to make financial estimates over a specific ABFM MODULE - D
amount of time, taking into account predicted sales data in
Chapter 20: STARTUP FINANCE (PART-VI)
addition to market and economic variables.
What we will study?
It is important to plan not only the cost of production but also
the cost of developing prototypes conducting research, and *What are the different tax exemptions available to startup?
manufacturing.
TAX EXEMPTIONS: This perquisite is subject to a TDS deduction from the
employer.
Section 56(2) (viib):
This sum is reflected as Income from Salary on the Employees
It was implemented by means of the Finance Act 2012 with
Form 16.
the intention of discouraging the generation and use of
unaccounted money through the subscription of shares of a Second, when the ESOP is finally put up for sale.
closely held company at a value that is higher than the Fair
On the other hand, the tax burden at the time of Exercise was
Market Value of the shares of such Company.
reduced in the Budget for 2020.
This was done with the intention of preventing tax evasion.
By delaying the payment of taxes (on ESOPs) for a period of
According to the part that is being referred to, the total value five years, or until the employee leaves the company, or until
that is greater than the fair market value is considered to the person sells their shares, whichever comes first.
constitute revenue for the company under the heading
Section 80-IAC:
Income from Other Sources for the applicable fiscal year.
The turnover criteria for eligible startups has been increased
On the basis of a self-declaration, startups have been granted
to Rs.100 crores from the limit of Rs.25 crores as a result of
an exemption from income tax under section 56(2)(viib) for
the amendment that was provided by the Finance Act in
the issuance of shares at a price higher than their fair market
Section 80-IAC of the Income Tax Act.
value.
Eligible startups can claim deductions under this section for
ESOPs (Employee stock ownership plan):
any three consecutive years out of 10 years beginning from
ESOPs are subject to double taxation. the year in which such eligible startups are incorporated.
Once, during the time of the exercise, the whole amount of This modification went into effect from April 2021.
the Fair market value that is greater than the Exercise Price is
subject to taxation as a perquisite.
Section 54 GB: Condition 1:
Under the provisions of Section 54 of the Act, a person or a Continued 51% Shareholding At least 51% of voting power is
Hindu Undivided Family (HUF) may be excused from paying beneficially held by the same individuals in the year of set off
tax on capital gains that result from the sale of residential of losses who held them as on the last day of the year in
property (a house or a piece of land) as long as certain which loss was incurred.
conditions are met.
This is referred to as the "continued 51% shareholding"
These conditions include the following: condition.
(A) The net consideration that results from such a transfer or
must be utilised for subscription in the equity shares of an
Condition 2:
eligible startup company that satisfies prescribed conditions.
On the final day of the preceding fiscal year in which the loss
(B) Additionally, such an eligible startup must utilise the afore
was incurred, one hundred percent of the company's
mentioned amount for the purchase of new property within 1
shareholders had to continue to hold the same number of
year of the date that the assessee subscribes in equity shares.
shares on the final day of the preceding fiscal year in which
(C) In the event of closely held companies in which there has the loss is to be set off.
been a significant shift in the voting power of the company,
In addition, these losses need to have been incurred during
there are limitations placed on the ability to deduct business
the period of seven years commencing with the year in which
losses.
the company was incorporated.
On the other hand, in the event of a qualifying startup, such
losses may be carried forward if any of the two conditions
outlined below are met: Relaxation by MCA:
The Companies (Acceptance of Deposits) Rules, 2014 have
been modified by the Ministry of Corporate Affairs (MCA) on
September 7, 2020.
In accordance with the notification issued by MCA, in case of a ABFM MODULE - D
private company which is a startup,
Chapter 20: STARTUP FINANCE (PART-VII)
(i) A deposit does not include an amount of Rs. 25 lacs or more
What we will study?
received by a startup business in a single tranche from a
person, by way of a convertible note which is convertible into *What are the different Funding Schemes and Programs
equity shares or repayable within 10 years from the date of available for Startups?
issue, and
(b) The maximum limit in respect of deposits to be taken from
members set forth in Rule3(3) of the deposit Rules (i.e. 35% of
the aggregate of the paid up share capital, free reserves, and
securities premium account) is not applicable.
FUNDING SCHEMES AND PROGRAMMES: Throughout the many stages of a startup's lifespan, the fund
of funds is utilised to supply the necessary funding.
SIDBI Funds of Funds Scheme (FFS):
As of 31st March 2022, SIDBI had committed Rs. 7,225.45
The government of India established a fund with a total value
crore to 86 AIFs and further 1541.79 crore has been
of Rs. 10,000 crores with the goals of increasing the amount of
distributed to 51 AIFs. (AIF: alternative investment funds)
available capital, stimulating private investment, and
ultimately fostering the expansion of the Indian startup A total of Rs. 9,408 crores have been invested in startups by
ecosystem. AIFs under FFS to boost 582 startups.
The money was originally intended to be used as a fund of The indicative process is as below for considering applications
capital for new businesses. under FFS:
In June 2016, it was proposed by the cabinet, and shortly
thereafter, it was founded by the Department for the
Promotion of Industry and Internal Trade (DPIIT).
Capital is provided by FFS to SEBI-registered alternative
investment funds, often known as daughter funds, so that
these funds can make further investments in startup
companies.
Because of this, the fund of funds does not make direct
investments in the new businesses.
The selection of daughter funds and the monitoring of the
distribution of committed money are both tasks that fall
under the purview of SIDBI as it carries out its duties to
manage the FFS.
Credit Guarantee: The scheme will provide handholding to approx. 3600
entrepreneurs through 300 incubators in the coming 4 years
A credit guarantee programme with a corpus of Rs. 500 crore
from 2021.
per year for the next 4 years has been launched with the
intention of making it simpler for early-stage entrepreneurs to The scheme was announced by the Prime Minister in January
secure funding. 2021 in his Address of Prarambh: Start-up India International
Summit.
The total amount of money available through the Credit
Guarantee Scheme for new businesses is Rs. 2,000 crores. DPIIT has constituted Expert Advisory Committee (EAC) to
assess and select the incubators.
Its goal is to provide coverage of guarantee for about 15,000
crores for 3,000 startups, with the average loan amount to These Incubators will then constitute Incubator Seed
eligible borrowers being 5 crores. Management Committee to assess, select and observe
startups.
Startup India Seed Fund Scheme (SISFS):
As on 16th March 2022, the Startup India Seed Fund Scheme
Startup India Seed Fund scheme was launched by the
(SISFS) has received more than 140 incubator applications, out
Department for Promotion of Industry and Internal Trade
of which 76 incubators have been selected by the EAC, and
(DPIIT) on 19th April 2021 with an estimate of Rs. 945 crores
more than Rs. 290 crores have been approved to them.
to provide funding to startups for proof of concept, product
trials, prototype development, commercialization and market Further, as of 16th March 2022, more than 2550 applications
entry. have been received from startups and more than 265 startups
have been further selected for funding via various instruments
These would allow the startups to reach the maturity level to
such as grants, debts, and convertible debentures.
raise investments from angel investors or venture capitalist or
seek loans from financial institutions or commercialized banks.
Startup India Global Venture: Farmers, producer groups, partnership or proprietary firms,
self-help organizations, companies , units in Agri export zones,
Startup India Global Venture is held every year by the
and agriculture graduates can submit the application on their
Department for Promotion of Industry and Internal Trade in
own or in groups for the purpose of setting up agribusiness
order to mobilise Global Capital for Innovation in India.
ventures.
It will assemble many representatives of leading Global
Support for International Patent Protection in Electronics and
Venture Capital Firms, Limited Partners, Family Offices, High
Information Technology (SIP-EIT):
Network Individuals, Government of India Officials and Top
Corporates. Encourage innovation, recognise the value and capabilities of
global intellectual property, and encapsulate opportunities for
The 2022 Global Venture Capital session was conducted on
growth in the Information Communication Technology &
16th January, 2022 with the aim to mobilize domestic and
Electronics (ICTE) sector, are the goals of the Support for
global capital for Indian startups.
International Patent Protection in Electronics and Information
Venture Capital Assistance Scheme: Technology (SIP-EIT) programme, which is run by the Ministry
The purpose of the Venture Capital Assistance Scheme, which of Electronics and Information Technology.
is administered by the Ministry of Agriculture and Farmers This programme is designed to provide financial support to
Welfare, is to provide eligible projects with monetary micro, small, and medium enterprises (MSME) and technology
assistance in the form of an interest-free loan from Small startups so that they can file international patents.
Farmers' Agribusiness Consortium (SFAC) in order to make up
The applicant must fulfil the investment restrictions in plant
for any shortfall in the capital requirements for the successful
and machinery or equipment that are specified in the MSME
execution of the project.
Development Act 2006 of the Government of India.
Through financial participation, it is possible to facilitate
Additionally, the applicant must be registered as a company
agricultural entrepreneurs' investments in the establishment
under the Companies Act of the Government of India.
of agribusinesses.
MSME 2006 NEW LIMITS: stake need to be owned by either a person from a historically
oppressed group or a woman.
There is a minimum age requirement of 18 years old for the
SC/ST or female entrepreneur.
Only projects that are considered greenfield can qualify for a
loan through this programme.
Greenfield refers to an enterprise that is the beneficiary's first
foray into the manufacturing, commercial, or service
industries.
IREDA NCEF Refinance Scheme:
Start-up India for Financing SC/ST and/or Women
Indian Renewable Energy Development Agency (IREDA) has
Entrepreneurs or Stand-Up India Scheme:
prepared and issued a revised refinance scheme assisted by
Small Industries Development Bank of India (SIDBI) makes the National Clean Energy Fund (NCEF) narrating about the
arrangements for bank loans ranging from 10 lakhs to 1 crore revival of the operations of existing biomass power and small
to be given to at least one borrower belonging to a scheduled hydro power projects that have been affected due to
caste or scheduled tribe, as well as at least one woman, for unanticipated circumstances.
the purpose of establishing a greenfield business in India.
IREDA NCEF Refinance Scheme was prepared and issued by
A manufacturing firm, a trading concern, or a service concern IREDA.
could make up the enterprise.
Under the terms of this programme, IREDA would be willing to
In the case of businesses that are not run by individuals, at provide refinancing to commercial banks and other financial
least 51% of the company's shareholdings and the controlling institutions that are on the timetable.
The decision to refinance will be made solely by the IREDA, Technology Development Fund:
which will also determine whether or not refinancing is
As part of the "Make in India” plan, a fund for the
available and the amount that can be refinanced.
development of technology has been established so that India
For the scheduled commercial banks and financial institutions can become more self-sufficient in its defence technologies.
to be eligible to receive refinancing under the plan, they will
It is a programme that is being carried out by DRDO on behalf
need to demonstrate that they satisfy the following
of the Ministry of Defence to meet the requirements of the
parameters:
Tri-services, Defence production, and DRDO.
(A) Scheduled commercial banks and financial institutions
The purpose of the scheme is to encourage the participation
should have made a profit over the course of the previous 3
of public and private industries, particularly micro, small, and
years and should not have any accumulated losses.
medium-sized enterprises (MSMEs), in order to establish an
(B) The total portfolio of the lending institution shouldn't have atmosphere conducive to the development of cutting-edge
a ratio of gross non-performing assets (GNPA) to gross technological capabilities for use in defence applications
advances that is higher than 5%, as this is considered an through the incorporation of a research and development
unsafe level for the lending institution. culture in industry.
This stipulation does not apply to State or Central PSU Banks, The following are the criteria that must be met to be eligible:
Government NBFCs, or Government Financial Institutions.
(A) Public limited companies, private limited companies,
(C) The Capital Adequacy Ratio ought to be in accordance with partnership firms, limited liability partnerships, one-person
the rules that have been imposed by the regulatory companies, and sole proprietorships that are registered in
authorities. accordance with applicable Indian laws.
(B) An Indian citizen who resides in India and who owns at
least 51% of the company's shares in order to exercise
ownership and control over the business.
(C) Micro, Small, and Medium-Sized Businesses (MSMEs) and ABFM MODULE - D
Startups Registered in India.
Chapter 20: STARTUP FINANCE (PART-VIII)
The funding will be considered for projects with costs of up to
What we will study?
Rs. 10 crores.
*What are the different programs running for startups in India
The industry will be awarded grants in order to assist it in
in 2022?
meeting its financial obligations.
PROGRAMS RUNNING IN 2022: The following categories are outlined in the statement of the
problem:
India Croatia Startup Challenge 2022:
Clean Water and Sanitation:
It was first introduced in 2022, and applicants were invited to
submit their materials beginning in April of the same year. As early as 2025, it is anticipated that over half of the world's
population will be living in regions that are affected by water
In order to work together to solve some of the world's most
scarcity.
pressing innovative problems. India and Croatia have formed
a partnership. This prediction is based on current trends.
Innovations and new businesses that are aiming to improve It is possible that 700 million people would move because of a
areas such as sustainability, education, livelihoods, and skill lack of water in the year 2030.
development are the focus of Startup India and HAMAG-
If this occurs, it will be the most expensive migration in the
BICRO (Croatian Agency for SMEs, Innovations and
history of the human race.
Investments) and they want to recognise and support such
endeavours. The solution that is being sought ought to be environmentally
friendly, hygienic, self-sufficient, and independent of the grid.
This massive competition will not only help innovative
startups and technologies in India and Croatia to co-develop Reduced Inequality:
solutions, but it will also encourage inventive startups in their Investigation of the ways in which refugee lives can be
efforts to grow these solutions beyond international borders. reconstructed and improved, as well as ways in which their
The competition is open to any and all registered businesses future can be made more promising than it is at the moment,
(from an early stage all the way up to a late stage) from India as well as ways in which it can be integrated into regional and
and Croatia that are working in the fields that are outlined in international economies.
the problem statement. The proposed solutions and products ought not to rely on
outside funding and ought to a significant part, to be capable
of supporting themselves financially.
Decent work and Economic Growth: Under this programme, high school students up to Class 12 as
well as undergraduate and graduate students with a science,
Even if the global economy is doing well and jobs are plentiful
engineering, or medical background can apply.
for those with degrees in STEM fields (science, technology,
engineering and mathematics), some people still find that The answer needs to have anything to do with translational
becoming a driver or an on-demand delivery professional is healthcare devices, artificial intelligence-driven medical
the most lucrative alternative. technology, smart medical assistance and portable diagnostic
systems, or any other relevant medical technology innovation.
The majority of these professions are at an extremely high risk
of becoming automated within the next 10 years because
there are neither retirements nor safety nets in place.
NCL-IIT BHU Cleantech Innovation Challenge 2022:
Therefore, there is a need for solutions that can improve the
NCL: Northern Coalfields Limited.
skills of workers in the on-demand economy so that they may
easily transition into other industries within the next 5 to 6 It is a nation-wide effort that aims to instill a culture of
years. product innovation and an attitude of problem solving by
providing students and startups with a forum to address real-
I-DAPT Health Tech Hackathon (H2):
world issues that are experienced by the mining industry.
I-DAPT: Interdisciplinary Data Analytics and Predictive
The problem statements call for contributions from a wide
Technology.
range of fields in order to produce solutions of the highest
An all-India I-DAPT Health-tech Hackathon (H2) is being quality.
organized by the I-DAPT HUB FOUNDATION BHU, and it is
The global culture of entrepreneurship may be promoted with
looking for student innovators who are developing cutting-
its help, and it can help hackathons at the institute level
edge innovative ideas in the Health-Tech or Med-Tech field.
sparkle.
Applications for this event can be submitted beginning in May
a) Draw on the ingenuity and knowledge of the students.
2022.
b) Solicit suggestions from the general public for possible d) An application focusing on sitting and operating a dragline.
solutions to issues facing the industry.
e) Methods and applications for the most efficient use of
c) Make chances for investments available to individuals as water in mining operations during the summer months.
well as businesses who are already operating in this sector.
f) Utilization in its entirety of overburden for big open-pit coal
The following types of individuals are eligible to submit an mines.
application for this competition:
f) The development of a cage drone or a drone ball for use in
a) Students already enrolled at any university or institute in inspecting the various structural components of draglines and
India solo founders, entrepreneurs, and other individuals. other types of mining infrastructure.
b) New businesses and businesses that focus on innovation, as g) The development of an autonomous or wirelessly piloted
well as professionals and employed individuals. underwater drone that can be used for inspecting, mapping,
or exploring flooded mines.
The following items are included in problem statement that
pertains to this competition: INTERNATIONAL CHALLENGES AND BRIDGES:
a) In a large open cast mine, the design of traffic system at a The India - Brazil Startup Bridge is an initiative that has been
road crossing that can accommodate both large and small launched with the goal of encouraging profound collaboration
dumpers will need to take into account the respective between the startup ecosystems of the 2 nations.
segments’ level of production.
Startups, investors, incubators, corporates, and aspiring
b) Various groups of workers are going to be given access to a entrepreneurs from both nations will be able to connect with
mobile application so that they can finish their task in one another thanks to the bridge, which will also make it
accordance with the maintenance checklist. possible to provide them with the resources they need to
expand and become globalised startups.
c) Various groups of workers will receive a mobile application
that will serve to remind them of the correct safe operating
practice to follow when performing their tasks.
Even more, it developed the Indo-Sweden Mentor link ABFM MODULE - D
initiative to boost cross-border collaboration and to inspire
Chapter 21: PRIVATE EQUITY AND VENTURE CAPTIAL
Indian startups to grow their operations in Sweden.
In addition to this, it also launched the UK-India Startup (PART-I)
Launchpad, the India-Korea Startup Hub, and the Indo-Russian What we will study?
Innovation Bridge.
*All about Venture Capital?
In addition to this, it made it possible for the finalists of the
National Startup Award to participate in a pitching session *What is Private Equity?
with Japanese stakeholders.
INTRODUCTION: Venture capital fund anticipate a high rate of return on their
investments.
Investors contribute venture capital, which is a form of private
equity as well as a type of finance, to new enterprises and The industry of venture capital has only recently reached a
start-up organisations that they believe have the ability to certain level of maturity and sophistication, particularly in the
expand their operations over the long term. United States, during the course of the past half century or
more.
The majority of funding for new businesses comes from
wealthy individuals, investment banks, and various other Private equity is a word that is frequently encountered in
types of financial institutions. business contexts.
Nevertheless, it does not always take the form of monetary Despite the fact that there are certain Key distinctions
compensation; rather, it may also be supplied in the form of between the two there is a substantial degree of overlap
specialised knowledge or managerial experience. between the two.
Small businesses with outstanding growth potential, or The industry of venture capital in India didn't really get
businesses that have expanded rapidly in the recent past and started until very recently.
appear to be in a position to continue their expansion, are the
Before the establishment of venture capital funds, the various
traditional recipients of venture capital.
Indian development financial institutions supplied risk capital
It is possible for a young private firm that is not yet ready or to industry in the form of subscriptions to equity, seed capital
willing to access the public financial market, to look into to first generation entrepreneurs, and other forms of risk
obtaining venture capital. capital that were analogous to those provided by these
venture capital institutions.
When a budding company is in the early phases of its
development, venture capital funds look for ways to assist the Although, they did not adhere to the strict method that a
company in making a public offering of stocks. modern-day venture capital fund would adhere to, they were,
in a sense, acting in the role of venture capital funds.
ICICI ventures, formerly known as Technology Development biotechnology and pharmaceuticals, banking and
and Information Company of India Limited (TDICI), was finance/insurance, public sector disinvestment, media and
launched as a joint venture between ICICI limited and the Unit entertainment, and education.
trust of India in 1988 and was re-named to ICICI Venture after
When foreign investors arrived, they carried with them the
becoming wholly owned subsidiary of ICICI Limited (now ICICI
knowledge and experience they had gained in a variety of
Bank).
different markets, both mature and emerging.
At the outset, venture capital, often known as VC, was
They have incorporated the investment philosophies and
confined to the subsidiaries that had been established by IDBI,
procedures common in the West into their dealings with
ICICI, and the IFCI.
Indian businesses.
The primary focus of these companies was on large industrial
Among their essential contributions are things like rigorous
concerns.
due diligence, stringent contracting, active post-financing
In 1990s, multinational investors began to emerge as more involvement, and a focused attention on exiting the market in
prominent players in the Indian VC sector as a result of the a timely and lucrative manner.
liberalisation of foreign investment into enterprises based in
As a result of the fact that the investible funds represent a
India.
component of a worldwide pool of capital, the investment
Companies in the consumer services and consumer retail feelings of foreign venture capital investors in India have
space have emerged as leading competitors for venture become closely related to investment sentiments on a global
capital funding, and they have attracted approximately half of scale.
the total venture capital investments.
During its formative years, the Indian industry was defined
This is due to shifting patterns and growing liberalisation. more by venture capital-style investments in small enterprises
that were still in early stages of development.
Other important industries included information technology
and services related to information technology, software
development, telecommunications, electronic manufacturing,
Increasingly recently, roughly in the last ten years, It is often argued that large private equity companies have the
investments of the type known as private equity have become experience, organisation, protocols, and risk appetite to move
more widespread. swiftly to analyse and close Investment and they are the only
class of investors who have the capability, track record, and
One of the reasons for the move away from investments in
willingness to add value without any wants to exercise
small and early stage companies could be the difficulties in
ultimate control.
selling such investments.
Why does VC Exist:
Another factor could be that fund managers are unable to
manage greater pools of capital without increasing the It is a result of the existing deficiencies in bank lending.
number of companies in their portfolios due to the impact the
Visiting a bank is the typical first step for someone who is
larger investments have on their operations.
interested in beginning a new enterprise.
Because of this reason, the fund management organisations
However, banks will only provide financing to newly
are able to enjoy economies of scale, which results in more
established companies if those companies already possess
fee income despite not having to increase the number of their
tangible assets to use as collateral for the loan (e.g., a factory).
employees.
However, in today's information economy, many new
It is also possible that the absence of high-quality early stage
businesses have little tangible assets, making it difficult for
opportunities that one can find in the United States and the
them to obtain a bank loan.
lack of experience among investment managers to deal with
the risks in those investments, are some of the other reasons Additionally, the risk involved in starting a new business is
for the shift to larger investments, as has been the experience rather significant.
in Europe. The risk level is so high that even if financial institutions were
Both of these factors are equally likely to be contributing willing to lend, they would have to apply interest rates that
factors. were so prohibitively expensive that no one would take out
the loan.
Venture capitalists flourish in the high-risk environment that 1. Investors in venture capital are typically willing to take on a
traditional financial institutions avoid. high level of risk in the hope of achieving a high rate of return
on their investment.
They are willing to provide financial backing to very new
businesses that have no assets and likely to do business with 2. The venture capitalist not only provides the aided company
people with little or no prior expertise as well. with funding, but also takes an active interest in leading the
company.
Instead of providing financial assistance in the form of a loan,
the investors demand a share of the company as 3. The venture capitalist will often make a subscription to
compensation for the risk they are taking, so that they can stock or quasi-equity financing instruments, which gives it the
take a greater percentage of the upside, which means they opportunity to partake in both the risk and the profit of the
can get a portion of the profits that will be made in the future. company in which it invests.
Another distinction is that the word "bank" simply refers to 4. The financial burden that is placed on the aided company is
money. often minimal in the early years of the partnership.
However, venture capital consists of financial backing in 5. The venture capitalist typically has an exit strategy in place
addition to strategic guidance on how to create enterprises, for his or her investment in the business being aided after
making it more beneficial to business owners. three to seven years.
In most cases, the promoter of the company, that is receiving
assistance, has the first option to purchase the equity
CHARACTERISTICS OF VENTURE CAPITAL INVESTMENTS:
investment that is being held by the VC.
The following is a list of the most important aspects of a
venture capital arrangement, although there are no standard
terms and conditions that apply to venture capital companies.
CHARACTERISTICS SHARED BY PRIVATE EQUITY AND VENTURE Some distinctions that can be made between private equity
CAPITAL, AS WELL AS THEIR KEY DISTINCTIONS: and venture capital are as follows:
The following is a list of characteristics that are shared by 1. A private equity investment might be used by the investee
private equity and venture capital: company to restructure either its finances or its operations.
1. They are established as autonomous pools of capital, to 2. In contrast to venture capitalists, private equity investors
which contributions may be made by institutions or high-net- typically put their money into established businesses in their
worth individuals, and they are managed by managers who later stages of development that have a proven track record.
have significant financial incentives directly connected to the
3. Private equity investors place a greater premium on good
funds' levels of success.
corporate governance, whereas various venture capital
2. They make investments in businesses that are either unable investors devote more of their attention on management
or not yet prepared to raise funds from members of the capability.
general public.
4. A private equity investment deal may incorporate debt,
3. There are not many restrictions placed on the activities they which is unusual for a venture capital investment deal.
engage in.
FINANCING OPTIONS AVAILABLE THROUGH VENTURE CAPITAL:
4. Equipped with carefully drafted investment agreements,
The various forms of venture capital can be categorised
they engage in active oversight of the enterprises in which
according to the stages of a company's development in which
they have invested.
they are most useful. The following are the three primary
forms of venture capital financing:
1. Financing for the Initial Stages of Development.
2. Financing for Expansion.
3. Acquisition Financing.
The following is a list of the many forms of financing based on ABFM MODULE - D
the stages of business development:
Chapter 21: PRIVATE EQUITY AND VENTURE CAPTIAL
1. Finance at a low level for the purpose of validating and
developing a new idea. (PART-II)
2. Financing for new businesses in their formative stages, What we will study?
when those businesses have financial needs related to *What is the procedure involved in getting venture
product development and marketing.
capital fund?
3. Initial investment, which may include funding for
manufacturing and early sales.
4. A second round of financing, often known as an operational
capital injection, given to early stage enterprises that are
selling items but are not yet generating a profit.
5. The third round of financing, also known as a mezzanine
financing, is when a company receives the funding necessary
to expand after experiencing recent financial success.
6. The fourth round of funding is sometimes referred to as
bridge financing, and it comprises financing for the process of
becoming public.
THE PROCEDURES INVOLVED IN OBTAINING VENTURE Deals are brought to the attention of venture capitalists
CAPITAL FUNDING: through a referral system by the entrepreneurs' business
partners, parent organisations, friends, and other contacts.
In most cases, the financing of venture capital is accomplished
through the following six primary steps: 2. Screening and Shortlisting:
1. The Beginning of a Transaction. Screening is the process by which a venture capitalist
investigates and evaluates all of the potential ventures in
2. Screening and shortlisting.
which he may invest his money.
3. Detailed Evaluation and rating of proposals.
The projects are sorted into different categories according to a
4. The Final Deal Negotiations. variety of criteria, including market scope, technology or
5. Post-Investment-Related Activities. product, size of investment, geographical location, stage of
financing, and so on.
6. Exit Plan.
For the purpose of conducting the screening process, business
owner are given the option of either provide a concise profile
1. The Beginning of a Transaction: of their company or being called for a owners are given the
option of either providing face-to-face conversation in order
The first step in venture capital financing is the establishment
to seek specific clarifications.
of a business relationship.
3. Detailed Evaluation & Rating of Proposals:
Because it is impossible to make an investment without first
having a deal, it is vital to have a steady stream of Following the screening and the completion of the in-depth
transactions; nevertheless, the genesis of such deals might analysis, the proposal is given a rating.
come from a variety of different places.
The predicted profile, the track record of the entrepreneur,
The referral system is one of the most typical places where and the future turnover, among other things, are some of the
such genesis can be found. documents that are analysed in great detail.
The review process is a comprehensive procedure that not The amount of the investment, the percentage of the profit
only examines the capacity of the project, but also the that will be held by each party, the rights of the venture
capacity of the entrepreneurs to meet such claims. capitalist and the entrepreneur, and other issues are among
those that are up for negotiation.
During the evaluation process, several characteristics of the
entrepreneur are taken into consideration. 5. Post-Investment Related Activities:
These characteristics include the individual's experience, When the transaction is finalised, the venture capitalist joins
technical competence, manufacturing and marketing abilities, the venture as an investor and assumes certain rights and
and entrepreneurial talents. responsibilities in connection with the investment.
Following the completion of exhaustive risk management and The venture capitalist, on the other hand, is not involved in
the conclusion of all the relevant considerations, the next step the day-to-day operations of the company; rather, it is only
is to negotiate the terms of the contract. concerned when there is a potential for a loss of financial
resources.
4. The Final Deal Negotiations:
The venture capitalists have a representation on the
After determining that the project will be profitable, the
company's board of directors, which enables them to
venture investor will begin negotiations on the agreement.
participate in the operation of the business and check that it is
The negotiation of a contract is a process in which the terms carrying out its strategy.
and circumstances of the deal are formed in such a way as to
6. Exit Plan:
make it beneficial to both parties involved.
The final step in investing in venture capital is to create an exit
Both the parties present their needs, and then an attempt is
strategy that takes into account the type of investment, the
made to find a compromise that will satisfy both sets of
size and nature of the financial stake, and other factors.
demands.
The exit strategy is designed to generate the greatest possible
It has to be a win-win situation for both the parties.
gains with the fewest possible losses.
Exits for venture capitalists might take the form of initial 2. The founder loses his or her independence and control of
public offerings (IPOs), acquisitions by other businesses, or the the business after an investor becomes a part owner.
promoter or an outsider purchasing the venture capitalist's
3. Since the investments are made with a long-term objective,
portion of the company.
the return of the earnings is often delayed.
ADVANTAGES AND DISADVANTAGES OF VENTURE CAPITAL
4. Both the potential for the investment's purpose and the
FUNDING:
return on investment are undetermined and uncertain.
The following are some of the benefits that come along with
financing through venture capital:
EXAMPLES OF VENTURE CAPITAL FINANCING:
1. The investor will receive a significant amount of wealth and
expertise from the investment, despite the fact that the One of the top-tier alternative investment asset managers in
investment is time consuming and fraught with risk. the world, Kohlberg Kravis & Roberts (KKR), has entered into a
definitive agreement to invest USD 150 million (roughly
2. The amount of funding that can be delivered through equity
equivalent to Rs. 962 crore) in Mumbai-based listed polyester
is enormous.
maker JBF Industries Ltd.
3. The business owner is in a less precarious situation because
The company intends to purchase a 20% ownership in JBF
there is no responsibility for the company to repay the
Industries and will also make an investment in zero-coupon
investor's money.
compulsorily convertible preference shares with fourteen and
This is because the investor is well aware of the risks a half percent of voting rights in its wholly owned subsidiary
associated with the project. JBF Global Pte Ltd, which is situated in Singapore.
The following is a list of the drawbacks of financing through The financing that is being provided by KKR will assist JBF in
venture capital: finishing the projects that are currently underway.
1. The procedure is drawn out (takes longer time) and difficult
because there is a significant amount of risk involved.
Pepperfry.com before a company can launch an initial public offer or become
a listed company.
The most recent funding round for India's largest furniture e-
marketplace was led by Goldman Sachs and Zodius On the other side, entrepreneurs would also prefer venture
Technology Fund, and it brought in a total of one hundred capital investments over loan financing because the latter
million dollars. places on them a significant amount of responsibility to pay
interest, which is especially problematic for young businesses
Pepperfry plans to utilise the cash to increase the size of its
that are not yet profitable.
fleet of delivery vehicles, which will allow the company to
increase its presence in Tier III and Tier IV cities. But why is it considered a short-term investment to engage in
venture capital?
In addition to that, it plans to extend its network of carpentry
and assembly service providers as well as build new Typically, venture capitalists invest for a period of five years;
distribution centres. after that, when the company has reached a substantial size
or stature, the venture capitalists sell their ownership and
This represents the highest amount of capital ever raised by a
make returns that are multiples of their initial investment.
company in India that is solely focused on the e-commerce
sector. In most cases, this takes place during a time in the
development of the business when the company is in need of
THE IMPORTANCE OF PRIVATE EQUITY AND VENTURE CAPITAL
additional funds and is eager to raise more capital.
FOR NEW BUSINESSES:
This may occur if the startup decides to sell its shares to
Due to the fact that their options are limited, entrepreneurs
additional investors or if it goes public in the market by way of
and small businesses that are just getting started often choose
an initial public offering (IPO).
to work with venture capitalists.
At this point, investment bankers are brought in, which paves
They are not in a position to raise funds through the stock
the way for the owners to execute their exit plan.
market due to the numerous conditions that must be satisfied
INDIAN VENTURE CAPITAL FIRMS: Nexus Venture Partners:
The companies listed below are among the successful venture Founded in 2006, Nexus was one of the first India-US venture
capital firms in the country: funds started by successful entrepreneurs in enterprise
technology and consumer internet.
Blume Ventures:
Nexus has been a pioneer of investing in global technology
Blume Ventures is a venture capital firm that was established
products and technology-led businesses for India.
in 2010 by Karthik Reddy and Sanjay Nath. They presently
have $280 million invested in over 150 startup businesses as Nexus Venture Partner has offices in both the United States
part of their portfolio and have 24 exits. and India. The present portfolio managed by the organisation
is worth more than US$1.5 billion.
These include popular platforms such as Dunzo, Unacademy,
Instamojo, and Milbasket, among others. Zomato, Snapdeal, Delhivery, WhiteHat Jr., Delhivery, Rapido,
Unacademy, and Olx are some of the significant companies in
Kalaari Capital:
which they have invested.
Kalaari Capital is an early-stage, technology-focused venture
capital firm. Kalaari Capital was created in 2006 in Bengaluru
by Vani Kola. This venture capitalist is responsible for
managing a portfolio that is currently worth $650 million.
Among these are companies such as Cure.fit, Milkbasket,
CashKaro, and Zivame, among others. They have already left
some well-known organisations, like Myntra and Snapdeal,
among others.
Chapter 22: ARTIFICIAL INTELLIGENCE (PART-I) The term "artificial intelligence" (AI) refers to the replication
of human intelligence in computers that have been trained to
What we will study? think like people and emulate the activities that humans
*What is Artificial Intelligence? engage in.
The phrase "artificial intelligence" can also be used to refer to
any type of computer that simulates mental processes
common to humans, such as learning and problem-solving.
The concept of artificial intelligence can be conceptualised as
a computer-controlled robot designed to look and behave just
like a human person.
The most exciting aspect of artificial intelligence is the
prospect of new research leading to the creation of computer
programmes that think with minds that are as fully functional
as those of humans.
Neural Networks
Artificial Intelligence Machine Learning
Deep Learning
The creation of an artificial brain and its subsequent transfer In what would eventually be known as the Turing Test, a
to a computer in order for it to carry out tasks in a manner machine plays an imitation game in which it attempts to pass
analogous to those carried out by a human, constitutes the itself off as a human being by responding to a series of
entirety of artificial intelligence. questions in a manner that is consistent with how a person
would respond.
In its most basic form, artificial intelligence is a process in
which computer vision is used to conceptualize objects and Turing held the belief that a machine could be judged to have
the ROBOTICS process is used to control the objects and move the same level of intelligence as a human being provided it
them around. could convince a person that they were having a conversation
with another human being when in reality they were not.
As a result, we can draw the conclusion that the study of ideas
to create computers that respond to stimulus in a manner John McCarthy, a professor at the Massachusetts Institute of
compatible with traditional responses from people, given the Technology (MIT), is credited with being the one who first
human ability for reflection, judgement, and intention, is what coined the term "artificial intelligence" in 1956.
artificial intelligence research entails.
McCarthy came up with the term in that year in preparation
HISTORY OF ARTIFICIAL INTELLIGENCE: for a conference that he was arranging.
The study of artificial intelligence is still in its development as The symposium, which AI researchers later came to refer to as
a discipline. the Dartmouth Conference, was essential in establishing AI as
a separate field of study.
In the 1950s, when scientists and researchers began to
investigate the prospect of computers processing intellectual The conference also identified the primary objectives of
powers equivalent to those of human beings, the academic artificial intelligence, which are to comprehend and simulate
discipline of Artificial Intelligence was born as a field of study. the cognitive processes of people and to create robots that
behave in a manner that is analogous to this.
Alan Turing, a mathematician from the United Kingdom, is
credited with being the first person to suggest a test to assess Between the years 1956 and 1966, the majority of AI research
whether or not a machine is intelligent. focused mostly on theoretical aspects of the field.
APPLICABILITY OF ARTIFICIAL INTELLIGENCE: Research in artificial intelligence has the potential to make an
important and useful contribution to the education of people.
There are many different industries that have found
applications for artificial intelligence, such as medical At the very least in many instances, an intellectual difficulty
diagnosis, stock trading, robot control, law, remote sensing, can be handled by first breaking it down into pieces and then
scientific discoveries, and even toy manufacturing. coming up with a solution for each of those individual
components.
Nevertheless, many uses of AI are not viewed as utilising AI.
Whether it is a person or a computer trying to solve the
According to Nick Bostrom's research, a significant amount of
problem, the underlying issues are the same and cannot be
artificial intelligence has made its way into general
avoided.
applications, without being classified as AI.
It may be beneficial for a human problem solver to be aware
This is because once something becomes valuable enough and
of the strategies used by the computer, particularly in the
ubiquitous enough, it is no longer considered to be AI.
event that a particular strategy proves beneficial for the
Many thousands of AI applications are deeply embedded in machine.
the infrastructure of every industry.
Educators and cognitive scientists have come up with the
During the late 1990s and early 21st century, artificial concept of intelligent computer assisted instruction (CAI), in
intelligence technology became widely used as components of which a computer would be programmed to act as a "tutor"
larger systems. that would observe a student's efforts as they worked to solve
Despite this widespread adoption, the field of Al is rarely a problem.
given credit for the successes it has produced. This idea has been floated by a number of researchers in the
The algorithms of the artificial intelligence are designed to fields of cognitive science and education.
make the decision by using the real time data, combining all The tutor would be aware of some of the incorrect
the information by using the sensors, remote inputs, digital assumptions that people can have about a specific class of
data, and from different sources.
problem, and they would be able to recognise when a student It assists Google in processing search results and providing
was slipping into one of those traps. users with search results that are more relevant to their
queries.
It would then be able to provide guidance that was specifically
catered to meet the requirements of that particular pupil. RankBrain was mentioned by Google in an interview in 2015,
and the company stated that it was the third most significant
A second advantage of education is one that is less direct but
factor in the ranking algorithm, after links and content.
is ultimately more significant.
"RankBrain was used for less than 15% of queries as of 2015,"
The learner will be able to describe what mechanical thinking
according to the report.
is and what it is not once they have actively learned to
emulate mechanical thinking and have done so successfully. According to the findings, the results produced by RankBrain
are within 10% of those produced by the human search engine
The activity may result in increased self-assurance regarding
engineers working for Google.
one's capacity to select a cognitive strategy that is ideally
suited to the challenge at hand. If RankBrain encounters a word or phrase it is not familiar
with, the machine is able to speculate as to what other words
CONTRIBUTION OF GOOGLE:
or phrases might have a similar meaning and filter the result
Google has made immense contributions to the field of accordingly.
Artificial Intelligence over a period of time.
This makes it more effective at dealing with search queries or
Some of the important contributions of Google to Artificial keywords that have never been seen before.
Intelligence are as under:
Search queries are organised into word vectors, which are also
Search Engine Algorithm -Google RankBrain: referred to as "distributed representations."
The adoption of Google's RankBrain, a search engine These word vectors are situated in close proximity to one
algorithm that is based on machine learning and its use was another in terms of their linguistic similarity.
officially confirmed on October 26, 2015.
RankBrain makes an effort to map the query into words The first step is to make available to all companies in the
(entities) or word clusters that have the highest probability of world high-quality machine learning resources that have been
matching it. built by Google Cloud AI, Google Research, and other teams
located within Google.
As a result, RankBrain makes an effort to predict what people
mean and records the findings. The second benefit is that it gives businesses access to a
private and protected portal where they may upload and
It then changes the results to deliver a higher level of pleasure
share machine learning resources within their own companies.
for its users.
Because of this, it is simple for companies to reuse pipelines
Al Hub:
and deploy them to production in Google Cloud Platform (GCP)
AI Hub provides developers and data scientists working on or on hybrid infrastructures by utilising the Kubeflow Pipeline
artificial intelligence (AI) systems with access to a collection of system in just a few simple steps.
components to use in their work.
Making artificial intelligence more accessible to more
companies requires making it simpler for them to find,
exchange, and reuse the tools and work they already have.
However, until very recently, there was a lack of machine
learning expertise among workers, which made it difficult to
construct a comprehensive resource.
The AI Hub is a one-stop shop for plug-and-play machine
learning (ML) content.
This content includes pipelines, Jupyter notebooks,
TensorFlow modules, and more.
It possesses two important advantages to provide.
ABFM MODULE - D CONTRIBUTION OF GOOGLE:
Chapter 22: ARTIFICIAL INTELLIGENCE (PART-II) Kubeflow Pipeline System:
What we will study? Container-centric end-to-end machine learning (ML) processes

are what Kubeflow pipelines all about.
*What is Kubeflow Pipeline System?
Components, which are self-contained collections of code that
*What is Google Duplex and Hold for Me? are packaged as container images, are what used to construct
pipelines.
In the machine learning (ML) workflow, each component of
the pipeline is responsible for a specific stage, such as pre-
processing, data transformation, or training a model.
The Kubeflow Pipelines system is responsible for orchestrating
the execution of pipelines, which includes the creation and
running of component containers in the sequence specified by
the workflow graph so as to
(a) Build and distribute repeatable machine learning
workflows with the Kubeflow Pipelines system.
(b) Create machine learning experiments and deploy them
into production using the Kubeflow Pipelines system.
Kubeflow Pipelines is a new component of Kubeflow, which is
a well-known open-source project initiated by Google.
It packages machine learning code in a manner analogous to Google Duplex and Hold for Me:
the construction of an application in order to make it RNN: Recurrent Neural Network
accessible to other users within an organisation.
Kubeflow Pipelines offers a workbench for the composition,
deployment, and management of reusable end-to-end
machine learning workflows.
Automatic Speech RNN Text to
This makes it a hybrid solution without lock-in that can be Recognition Speech
used from the prototyping stage all the way through
production.
In addition to that, it makes it possible for users to conduct
Conversation
experiments in a quick and dependable manner, allowing Parameters
them to explore a variety of ML techniques and determine

which ones perform best for the application they are
developing. An innovative artificial intelligence technology, known as
With the Al Hub and Kubeflow pipelines, Google is following Google Duplex, is currently being used in the United States
up on its previous release of Cloud AutoML and continues its and in a restricted number of other nations across the world.
strategy to simplify and accelerate its customers' ability to At first, its use was limited to reservations at restaurants but,
adapt to Google's AI technologies and services. since then, it has been broadened to include various kinds of
activities.
In May 2018, during the Google I/O developer conference,
Google CEO Sundar Pichai made the initial announcement of
Google Duplex.
He demonstrated how the service could schedule phone Expanding its total capabilities, Google began rolling out a
appointments using a voice that was controlled by AI without range of Duplex features on the web in 2019.
requiring the user to take any action.
At the moment, some of the capabilities offered by Duplex
The artificial intelligence was not only able to comprehend include helped retail checkout, assisted airline check-in,
what was being said on the other end of the line, but it could restaurant reservations, purchasing food or movie tickets
also provide appropriate responses to the questions that were online, setting up haircut appointments, holding in a phone
asked of it and add "ums" and pauses in its speech so that it queue, or assistance with hacked passwords.
appeared to be more human-like.
Due to the fact that Google is actually constrained by the
After some time, Google shared a video that walked viewers capabilities of its AI, the service has the potential to
through the process of instructing Google Assistant to make a accomplish much more in the future.
reservation at a restaurant.
The ability to check business hours is a somewhat
Following the completion of the call shown in the video, unimportant function, nonetheless, given that normal times
Assistant will send a notification to the user informing them are frequently included in the results of Google Search or
that a reservation has been booked. Maps, this option is only truly helpful in the case of holidays
or urgent situations.
The business revealed in November 2018 that Google Duplex
would soon be made available to a limited number of public You might be able to acquire the inventory status for products
consumers in a few cities throughout the United States. that are in high demand in some instances.
However, in order to address the controversy, changes were Hold For Me, which is supported by Google Duplex, will
made, the most notable of which was the requirement that maintain your position in a phone wait while you attend to
Assistant must now identify itself and warn call recipients that other business.
their conversations are being recorded.
When it is ultimately someone else's turn to speak, the
Businesses have the option to not participate in Duplex at all. function will signal to you that it is now your turn to speak
once more.
ABFM MODULE - D ARTIFICIAL INTELLIGENCE IN BANKING AND FINANCE:
Chapter 22: ARTIFICIAL INTELLIGENCE (PART-III) Utilising Al-based systems allows for increased productivity,
which in turn leads to cost savings, as well as the ability to
What we will study? make decisions, utilising information that is unavailable to
*Use of AI in Banking and Finance? human decision-makers.
*Future Scope of AI? The employment of an AI algorithm system allows for the
detection of fraudulent activity, as well as the easy
identification of anomalies.
A few examples of how artificial intelligence is being used in
the banking industry are given below:
(a) Customer service/engagement (Chatbot):
Chatbots offer a very high return on investment (ROI) in terms
of cost savings, which is one of the reasons why they are one
of the most widely employed applications of AI across all
sectors.
Chatbots are able to efficiently handle the majority of the
tasks that are frequently accessible, such as checking account
balances, viewing micro statements, making fund transfers,
and so on.
This serves to relieve some of the strain placed on other
channels, such as customer service call centres, internet
banking, and so on.
(b) Robo Advice: experienced threats and learning the patterns and signs that
might initially appear to be unconnected in order to forecast
Within the realm of financial services, one of the most
and thwart assaults.
contentious debates is the use of automated guidance.
Al may monitor internal risks or breaches and advise remedial
The goal of a robo-advisor is to gain an understanding of a
steps, which can result in the prevention of data theft or
client's financial health by evaluating the data that the client
abuse.
provides, in addition to the client's financial history.
(e) Scoring Credit and Direct Lending for Customers:
The robo-advisor will be able to make appropriate investment
recommendations in a certain product class, even getting as Analysing data from a wide variety of traditional and non-
detailed as recommending a particular product or equity, traditional data sources is one of the most important roles
based on the results of this study and the goals that the client that Al plays in the process of assisting alternative lenders
has set for themselves. estimate the creditworthiness of clients.
(c) Predictive Analytics with a General Purpose Focus: Even for those people or companies with a low credit history,
this makes it easier for lenders to design new systems for
Artificial intelligence has the ability to recognise specific
lending that are supported by a comprehensive credit rating
patterns and correlations hidden within the data that older
model.
technologies were unable to recognise.
Companies such as Affirm and GiniMachine are examples of
These patterns could imply unmet sales prospects, potential
notable businesses.
to cross-sell products, or even measures based on operational
data, all of which could have a direct impact on the company's Hybrid Information System (HIS):
income.
A software system known as a hybrid information system is
(d) Cybersecurity: created by combining various artificial intelligence
methodologies and techniques, such as a fuzzy expert system,
Al has the potential to dramatically increase the efficiency of
a neuro-fuzzy system, and a genetic-fuzzy system.
cybersecurity systems by utilising data from previously
This results in the construction of the hybrid information
system.
An efficient learning system, also known as an HIS system, is
one that not only combines the beneficial aspects of various
learning paradigms and representations, but also overcomes
the limitations of processing capabilities.
These systems are also utilised for the purpose of finding
solutions to issues that arise in a variety of contexts.
The following examples highlight the importance of HIS in the
field of finance:
Portfolio Management: Stock Market Prediction:
The management of a portfolio is an involved and complicated AI can help in stock market prediction using a wide range of
task that contributes significantly to the decision-making computer methods, which are necessary due to the highly
process. unpredictable nature of the stock market.
HIS has seen widespread use in portfolio selection, and it has Because hybrid systems are able to combine the skills of many
been playing a vital role in the operations of a great number systems with the special traits that each system possesses,
of organisations and financial institutes. they are utilised to a far greater extent in the field of financial
prediction than they are in any of the other AI disciplines.
The term "artificial intelligence" describes one of the most
fundamental aspects of the modern world, and financial
institutions have started incorporating related technology into THE FUTURE SCOPE OF ARTIFICIAL INTELLIGENCE:
their services and products in order to maintain their
In Artificial Intelligence, the computer performs the following
relevance.
functions:
a. The processing of the natural language in order to make it
possible for it to communicate effectively in English, natural
language.
b. For the purpose of storing the auditory inputs, it requires
the Knowledge Representation.
C. Once the inputs have been saved, the next step in
automated reasoning is to use the knowledge that has been
saved to answer the question or draw any graphics.
d. Machine Learning is required in order to adopt all of the
functions in order to take advantage of newly processed and
stimulated ideas and patterns. As artificial intelligence is one
of the most important technological advancement in the field
To ensure the success of artificial intelligence, we require two
of science and engineering.
things, namely intelligence and an artefact.
At the moment, artificial intelligence encompasses a vast
The computer has been the most prominent type of artefact
number of subfields, ranging from the broad (learning and
in recent history.
perception) to the narrow (playing chess, proving
mathematical theorems, writing poetry, driving a car through While the current digital electronic computer was
a crowded street, and diagnosing any disease). independently developed and almost immediately invented,
the electromechanical Health Robinson was the first computer
These subfields range from the general to the specific.
that was successfully put into service.
Artificial intelligence can be applied to any intellectual
endeavor and as such, it has truly become a universal realm. To grasp the fundamental idea behind understanding a
language, one must first have a firm grasp on the subject
matter, the surrounding environment, and the structural c) Education: The early-stage virtual tutors would assist
components of individual sentences. human instructors & facial analysis gauges the emotions of
the students to help to determine who's bored & struggling
Al forms the very foundation of the computer learning, so the
and for better tailor the experience to their individual needs
Artificial Intelligence is vastly important to our future.
after the textbooks are digitized with the help of the AI.
The computers have already started to have the ability to
d) Customer Services: The system would understand the
harness massive amount of data and use their intelligence to
context and the nuance, in addition to words, as Al assistant
make flawless decisions and discoveries in a fraction of the
that can placed human works like to attend your call, book
time presently taken by us with the help of Artificial
your appointments, etc.
Intelligence.
Artificial Intelligence is making breakthroughs in medical
research and other fields and is resulting in introduction of
cutting-edge technologies every other day.
A Look at the Future:

a) Transportation: An autonomous car will one day ferry us
from one place to another place, although it could take a
decade or more to perfect.
b) Manufacturing: To perform a limited range of tasks easily
like assembly & stacking and predictive analysis sensors keep
equipment running smoothly, Al powered ROBOTS work
alongside humans.
ABFM MODULE - D NEURAL NETWORKS:
Chapter 22: ARTIFICIAL INTELLIGENCE (PART-IV) The term "artificial neural networks” refers to a category of
exceptionally effective methods that have seen a surge in
What we will study? popularity over the past few years.
*What is Neural Network? The reason for this is that when utilised in supervised data
*What is Control Theory and Cybernetics? mining applications, they are capable of producing extremely
accurate predictions.
These networks are examples of highly adaptable algorithms
that can be used to solve a wide variety of modelling
challenges, including supervised and unsupervised issues.
When there is a categorical dependent variable, neural
networks can be used instead of logistic regression and
decision trees, or they can be used in conjunction with both of
those methods.
Because of their high degree of adaptability and the fact that
they are capable of working with continuous dependent
variables, neural networks are suitable for use in situations
that include regression.
Neural networks have the potential to evolve into models that
are significantly more sophisticated, more flexible, and
potentially more accurate when utilised in applications where
other methods such as regression, logit, and decision trees
may be used.
One of the models' flaws is that it might be challenging to As a result, no assumptions are made regarding linearity,
understand what they are trying to convey. normalcy, or anything else of the sort. Because of this, there is
now a notion known as "machine learning".
When there are numerous input variables and those variables
have non-linear correlations with the target variable, neural When there are a large number of observations from which
nets are especially successful. training, validation, and test subsets may be created, neural
networks function most effectively.
Neural nets are especially effective when there are many
input variables. Putting neural networks into practice and making use of them
may be made quite simple with today's software.
The model structure of a neural net simply needs to be stated
in terms of the number of nodes and hidden layers, which is There is a wide variety of software available to download.
one of the many exciting aspects of neural networks.
Even though in one sense they are essentially a mixture of
There is no need for the analyst to be worried about non- non-linear regression models, the models that can come from
linearities or interactions between the predictors. employing neural networks can be rather intricate.
When using neural nets, the computer is able to "learn" from The complexity of artificial neural networks comes from the
the inputted data in a sense. fact that many different simple models are combined into a
single system.
In contrast to regression models, there is no specific model
that is defined. CONTROL THEORY AND CYBERNETICS:
In its place, the procedure is carried out as follows: Ktesibios or Ctesibius of Alexandria is credited with building
the earliest self-controlling machine, which was a water clock
"Here are my numbers, this is how complicated the internet
that had a regulator that kept a steady flow rate. This was
can be. Create a model that can accurately forecast".
about the year 250 B.C.
Not statistical models, but rather very advanced computer
The definition of what an artefact is capable of doing was
programmes are being discussed here.
shifted as a result of this creation.
In the past, only living organisms had the ability to adjust their Wiener, along with Warren McCulloch, Walter Pitts, and John
actions in reaction to shifts in their surrounding environment. von Neumann, arranged a series of major seminars in the late
1940s that examined the new mathematical and
Other types of self-regulating feedback control systems
computational theories of cognition.
include the steam engine governor, which was developed by
James Watt, and the thermostat, which was developed by These conferences were held in Wiener's honour.
Cornelis Drebbel, who also developed the submarine.
The public's awareness that artificially intelligent machines
Both of these examples date back to the 18th and 17th might be possible was sparked by Wiener's best-selling book
centuries, respectively. Cybernetics (1948).
The nineteenth century saw the development of the In the meantime, W. Ross Ashby was a pioneer in comparable
mathematical theory behind reliable feedback systems. concepts in the United Kingdom.
Norbert Wiener is widely regarded as the seminal figure in the "Those who had Wiener's ideas before Wiener's book
development of what is now known as control theory. appeared" are the members of the Ratio Club, which was
established by Ashby, Alan Turing, Grey Walter, and others.
Before becoming interested in biological and mechanical
control systems as well as the connection between those In his books published in 1948 and 1952 under the title Design
systems and cognition, Wiener was a great mathematician for a Brain, John Ashby focused on his theory that it would be
who collaborated with a number of notable figures, including possible to manufacture intelligence through the utilisation of
Bertrand Russell. homeostatic devices that have adequate feedback loops to
produce stable adaptive behaviour.
They believed that purposeful behaviour originated from a
regulatory system that was attempting to reduce "error," The purpose of contemporary control theory, in particular the
which they defined as the gap that existed between the subfield of the field known as stochastic optimum control, is
existing state and the desired state. to design systems with the intention of maximising an
objective function over time.
This is generally in line with how we view AI, which is the The Connection Between Thought and Language:
process of creating systems to act in the best possible way.
Verbal Behaviour book was first released by B. F. Skinner in
Why, then, are artificial intelligence (AI) and control theory the year 1957.
two separate sciences, despite the close relationships that
Written by the foremost authority in the field, this description
exist between the people who founded them?
of the behaviourist method of language acquisition was
The solution can be found in the intimate connection that exhaustive and specific in its coverage of its subject matter.
exists between the mathematical approaches that were
However, in a strange turn of events, a review of the book
already understood by the participants and the related sets of
became just as widely known as the book itself, and it nearly
issues that were included into each perspective on the world.
entirely extinguished people's interest in behaviourism.
Calculus and matrix algebra, which are the instruments of
Linguist Noam Chomsky, who had recently released a book on
control theory, are best suited for describing systems that can
his own theory and was the author of the review, had written
be characterised by predetermined sets of continuous
the article. The book was titled Syntactic Structures.
variables.
Chomsky pointed out that the behaviourist theory did not
On the other hand, artificial intelligence was developed in
handle the concept of creativity in language, it did not explain
part as a means to break out of these perceived confines.
how a child could understand and make up words that he or
Researchers in artificial intelligence were able to consider she had never heard before.
problems like as language, vision, and planning that were
Chomsky argued that this was a major flaw in the theory.
wholly outside the scope of control theorists because they
had access to the tools of logical inference and computing. This was something that Chomsky's theory, which was based
on syntactic models that date back to the Indian linguist
Panini (about 350 B.C.), was able to explain.
In contrast to other theories, Chomsky's theory was formal
enough that it could in principle be programmed.
Therefore, modern linguistics and artificial intelligence were The most emphasis has been paid to the characteristics that
"born" at roughly the same time, and they developed are detailed below:
together throughout their childhoods, eventually combining
Reasoning, problem-solving:
to form a new subject known as computational linguistics or
natural language processing. Researchers in the early days of computer science devised
algorithms that mirrored the step-by-step reasoning that
The issue of language comprehension quickly revealed itself to
humans employ when they solve problems or make logical
be a great deal more difficult than it had initially appeared in
deductions.
1957.
Research in artificial intelligence had by the late 1980s and
Not only is an awareness of sentence form necessary for
early 1990s established strategies for dealing with uncertain
language comprehension, but also an understanding of the
or partial information.
topic at hand and the setting in which it is being used.
These methods utilised notions from probability and
This may appear to be self-evident, but it did not gain
economics.
widespread recognition until the 1960s.
The majority of these algorithms suffered from what is known
Knowledge representation is the study of how to put
as a "combinatorial explosion," which caused them to become
knowledge into a form that a computer can reason with.
exponentially slower as the size of the issues increased.
As a result, they were not effective at solving huge reasoning
Goals: problems.
The overarching challenge of emulating (or fabricating) Even among humans, the method of step-by-step deduction
intelligence has been subdivided into a number of specific that early studies in artificial intelligence could replicate is
challenges. uncommon.
These are specific characteristics or skills that researchers They are able to address the majority of their issues by
anticipate an intelligent system to possess. making snap decisions based on their intuition.
Knowledge representation: ABFM MODULE - D
Information engineering and the representation of that Chapter 23: BUSINESS ANALYTICS AS MANAGEMENT TOOL
knowledge are what enable artificial intelligence programmes (PART-I)
to intelligently respond to questions and draw conclusions
about real-world events. What we will study?
An ontology is a set of objects, relations, concepts, and *What is Business Analytics?

attributes that are formally characterised in order to ensure
*What are different types of Analytics?
that software agents are able to interpret them.
An ontology is a description of "what exists".
Upper ontologies are ontologies that seek to provide a basis
for all other information and operate as mediators between
domain ontologies, which cover specific knowledge about a
particular knowledge domain.
Upper ontologies are the most broad ontologies, and they are
also termed ontologies (field of interest or area of concern).
A programme that is truly intelligent would also need access
to common sense knowledge, which is the collection of facts
that the typical person is aware of.
In most cases, the description logic of an ontology, such as the
Web Ontology Language, is used to represent the semantics of
an ontology.
INTRODUCTION: By the year 1995, when the First International Conference on
Knowledge Discovery and Data Mining was held in Montreal,
Business analytics (BA) refers to the combination of skills,
the phrase "data mining" was already in common usage.
technologies, and practices that are used to analyse the data
and performance of an organisation in order to gain insights The Association for the Advancement of Artificial Intelligence
and make decisions in the future, that are driven by data. (AARI), which also hosted the conference on an annual basis
for the subsequent three years, was the organisation that was
Statistical analysis is one of the most common methods used
responsible for sponsoring the event.
in business analytics.
The conference, which has been held annually since 1999 and
The objective of business analysis is to determine which
is commonly referred to as KDD 2021 and so on, is primarily
datasets are valuable and which have the potential to boost
coordinated by Special Interest Group on Knowledge
revenue, productivity, and efficiency.
Discovery in Data (SIGKDD), which is part of the Association
When applied appropriately, BA may be used to make for Computing Machinery that focuses on knowledge
accurate predictions of future events that are related to the discovery and data mining.
activities of consumers, and trends in the market.
In 1997, the first issue of a specialised journal called Data
It can also help create more efficient operations, which could Mining and Knowledge Discovery was released to the public.
contribute to an increase in revenue, if it is used to its full
It was once published on a quarterly basis, but it is now
potential.
published on a biweekly basis and has articles on data mining
Data Mining History and Origins: and knowledge discovery that have been vetted by experts in
During late 1980s and early 1990s, data warehousing, business the field.
intelligence, and analytics technologies began to develop. In 2016, a second publication known as the American Journal
These innovations provided an enhanced capability to of Data Mining and Knowledge Discovery was made available
evaluate the ever-increasing amounts of data that to readers.
organisations were creating and gathering.
ESSENTIALS OF BUSINESS ANALYTICS: When it comes to applying BA, there is no single strategy that
is more significant than the others, it all depends on what our
There are numerous different applications for Business
final aim is.
Analytics (BA), however, when it comes to commercial
enterprises, BA is most commonly used to: TYPES OF ANALYTICS:
a) Analyse data coming from a range of different sources. There are four primary approaches to business analysis, and
Anything from cloud applications to marketing automation each one is put into practice in succession, beginning with the
tools and customer relationship management software could least complicated.
fall under this category.
When you apply these four different types of analytics, your
b) Find patterns within the data sets by employing more data can be cleaned, examined, and digested in such a way
complex analytics and statistical methods. These patterns can that makes it feasible to produce answers for any difficulties
assist you in predicting future trends and providing you with that your organisation may be facing.
new information regarding consumers and the behaviours
Descriptive analytics: (What happened in the past)
they engage in.
This method involves the interpretation of historical data and
c) Keep an eye on key performance indicators (KPIs) and
key performance indicators to discover patterns and trends.
trends as they evolve in real time. Because of this, it is much
simpler for companies to not only store all of their data in a Using methods such as data aggregation and data mining, this
single location but also draw correct and speedy conclusions makes it possible to get a comprehensive view of events that
from those data. have occurred in the past as well as those that are occurring at
the present time.
Despite the fact that these are the most typical applications,
there are actually four basic approaches to business analysis. Numerous businesses today make use of descriptive analytics
to gain a more in-depth understanding of the actions taken by
They are put into effect in phases, beginning with the most
their customers and the ways in which they may better direct
elementary ones.
their marketing efforts toward those customers.
Diagnostic analytics: (Which factor contributed for particular Prescriptive analytics: (What action to be taken to achieve the
trend) predicted results)
This type of analysis focuses on previous performance to This approach makes use of data on previous performance to
understand which factors drive particular trends. make recommendations for how similar situations should be
managed in the future.
This can be accomplished through the use of drill-down, data
discovery, data mining, and correlation to uncover the reasons This particular kind of business analytics not only forecasts
behind particular occurrences. results, but it also has the ability to make suggestions
regarding the particular activities that need to take place in
After arriving at a knowledge of the likelihood of an event and
order to get the greatest potential conclusion.
the reasons why an event may occur, algorithms are utilised
for classification and regression. Deep learning and sophisticated neural networks are
frequently used to accomplish this goal.
Predictive analytics: (What will happen in future, forecasting)
The purpose of this type of business analytics is often to
This is the practice of applying statistics to estimate and
match different solutions to the requirements of a customer.
evaluate future outcomes by employing statistical models and
techniques derived from machine learning. The current state of the company's operations will play a
significant role in determining which approach to pursue.
In many cases, the conclusions of descriptive analytics are
used in this manner to construct models that determine the
likelihood of particular outcomes.
ELEMENTS OF BUSINESS ANALYTICS:
It is common for sales and marketing teams to employ this
When one takes a more in-depth look at business analytics,
type in order to forecast the opinions of specific clients based
the method of business analytics that we choose to use is
on data collected from social media.
going to be depend on the end-goal that we establish for
ourselves before beginning the process.
No matter the approach a person decides to take, they will ABFM MODULE - D
undoubtedly be rewarded at the end with insights that can be
Chapter 23: BUSINESS ANALYTICS AS MANAGEMENT TOOL
put into practice.
(PART-II)
The various elements of business analytics are as follows:
What we will study?
1. Data Mining
*What is Data Mining?
2. Text Mining
3. Data Aggregation
*What are the steps involved in Data Mining?
4. Forecasting *What are types of Data Mining techniques?
5. Data Visualisation
Data Mining: The information that it generates can be put to use in
applications for business intelligence (BI) and advanced
Data mining is the process of searching through big data sets
analytics, both of which involve the examination of historical
in order to find patterns and relationships that, when
data.
analysed, can assist in the resolution of issues that arise in
commercial enterprises. Additionally, the information can be put to use in applications
for real-time analytics, which look at streaming data as it is
Enterprises now have the ability to forecast future trends and
being created or collected.
make better informed business decisions thanks to the
methodologies and tools of data mining. Data mining if done well can be of assistance in the planning
and management of numerous elements of corporate
The process of extracting meaningful information from data
operations and strategies.
sets is known as "data mining," and it is one of the
fundamental disciplines that make up "data science". This covers services such as marketing, advertising, sales, and
customer support that directly interact with customers.
Both of these terms refer to the application of advanced
analytics methods. It also includes functions like production, supply chain
management, finance, and human resources.
At a more granular level, data mining is a step in the KDD
process, which is a data science approach for obtaining, The prevention of fraud, management of risks, and planning
processing, and analysing data. for cybersecurity are only few of the many important business
uses that data mining serves.
KDD is an acronym for knowledge discovery in databases.
Knowledge discovery and data mining are two different
concepts, despite the fact that they are sometimes used Data Mining Process: How does it Work:
interchangeably.
Data mining is often carried out by data scientists in addition
to other qualified experts in the business intelligence and
analytics fields.
However, it is also possible for it to be carried out by data- comprised of a combination of structured and unstructured
savvy business analysts, executives, and employees who work data.
within an organisation and operate as citizen data scientists.
There is also the possibility of utilising data from external
Machine learning and statistical analysis are two of its sources.
fundamental components, coupled with data management
In order to continue with the process after the data has been
operations that are carried out in order to get the data ready
collected from its original location, a data scientist will
for analysis.
frequently relocate it to a data lake.
Mining massive data sets, such as customer databases,
2. Data preparation:
transaction records, and log files from web servers, mobile
apps, and sensors, has become significantly simpler thanks to During this stage, a series of actions are carried out to get the
the implementation of machine learning algorithms and other data prepared for the mining stage.
artificial intelligence (AI) tools. It begins with the exploration, profiling, and pre-processing of
This has resulted in a greater degree of process automation. data, and then moves on to the job of data cleansing to
correct errors and other issues related to the data's quality.
The process of data mining can be split down into four basic
steps, which are as follows: It is also necessary to convert data in order to keep data sets
consistent.
1. Data collection:
This is the case unless a data scientist intends to do an
It is determined which data are pertinent for an analytics
analysis on raw, unfiltered data for a specific application.
application, and then they are compiled.
3. The Data Mining Process:
The data could be stored in a variety of source systems, a data
warehouse, or a data lake, the latter of which is becoming an After the data has been prepared, a data scientist will select
increasingly typical repository in big data contexts and is the proper data mining technique, at which point they will
apply one or more algorithms in order to mine the data.
Before being applied to the whole set of data, the algorithms Anomaly detection, which seeks to identify outlier values in
that are used in machine learning applications often need to data sets, is another data mining use case that is enabled by
be trained on smaller sample data sets to search for the multiple techniques.
information that is being sought after.
The following categories of data mining methods are among
4. The interpretation and analysis of the data: the most common:
The findings from data mining are incorporated into analytical a) Data mining using association rules:
models, which are then utilised to guide decision-making and
When mining data, if-then statements known as association
other aspects of business operations.
rules are used to determine the connections between
It is the responsibility of the data scientist or another member different data elements.
of the data science team to explain the findings to business
Support and confidence are two of the criteria that are
executives and users.
utilised in the process of evaluating the relationships.
This is typically accomplished through the use of data
Support is a measurement of the frequency with which the
visualisation and methodologies that are based on data
related elements appear in a data set, and confidence is a
storytelling.
reflection of the number of times an if-then statement is
accurate.
Types of Data Mining Techniques: b) Classification:
Various techniques can be used to mine data for different Using this strategy, the components of the data sets are
data science applications. partitioned into the various categories that have been
established as part of the data mining process.
A common data mining, use case that is enabled by multiple
techniques is pattern recognition. Among the many classification methods available, some
examples include decision trees, Naive Bayes classifiers, k-
nearest neighbour, and logistic regression.
c) Clustering: f) Neural networks:
As part of the data mining applications, the data elements The functioning of the human brain can be modelled using a
that have certain characteristics in common are grouped system of computer programmes known as a neural network.
together into clusters.
Deep learning is a subfield of machine learning that is
Some examples of clustering methods are k-means clustering, considered to be a more advanced form of the field overall.
hierarchical clustering, and Gaussian mixture models.
Neural networks are particularly helpful in pattern recognition
d) Regression: applications that involve deep learning.
Calculating predicted data values based on a set of variables is
another method that can be utilised in the process of
discovering relationships hidden within data sets.
Some examples of regression include linear regression and
multivariate regression.
Regressions can be done with decision trees and other
classification methods too, such as some of those
classification methods.
e) Sequence and path analysis:
Data can also be mined to look for patterns in which one set
of events or values leads to later ones.
This type of pattern can be used to predict future events.
ABFM MODULE - D Data Mining Software and Tools:
Chapter 23: BUSINESS ANALYTICS AS MANAGEMENT TOOL There are a large number of companies that offer data mining
(PART-III) tools, and these products are generally packaged as part of
larger software platforms that contain a variety of other types
What we will study? of data science and advanced analytics tools.
*What are the Data Mining softwares available in Data preparation capabilities, built-in algorithms, support for
market? predictive modelling, a graphical user interface (GUI) based
development environment, and tools for deploying models
*What are the benefits of Data Mining?
and scoring how well they perform are among the most
*What are the examples of uses of Data Mining? important aspects offered by software designed for data
mining.
Alteryx, AWS, Databricks, Dataiku, DataRobot, Google, H2O.ai,
IBM, Knime, Microsoft, Oracle, RapidMiner, SAP, SAS Institute,
and Tibco Software are among the many vendors that offer
solutions for data mining.
Data mining can also be accomplished with the assistance of a
number of other free and open-source technologies, such as
Data Melt, Elke, Orange, Rattle, scikit-learn, and Weka.
There are some software manufacturers that also offer open
source option(s).
For instance, Knime is able to manage data science
applications by combining an open source analytics platform
with commercial software.
Other businesses, such as Dataiku and H2O.ai, provide free that can be used during phone calls and online chats with
versions of their respective technologies. customers.
Benefits of Data Mining: c) Improvements in the management of the supply chain:
The improved capability of data mining to discover previously Companies are able to recognise patterns in the market and
hidden patterns, trends, correlations, and anomalies in data make more accurate projections about the demand for their
sets is the primary source of the benefits that data mining products, which enables them to better manage their
provides to businesses as a whole. stockpiles of goods and supplies.
Combining traditional data analysis with predictive analytics is d) Increased production uptime:
one way that this knowledge can be put to use to enhance the
The mining of operational data from sensors installed on
processes of decision-making and strategy planning in
manufacturing machines and other industrial equipment
commercial enterprises.
supports predictive maintenance applications.
The following is a list of specific benefits that come with data
e) Stronger risk management:
mining:
Business executives and risk managers are in a better position
a) Increased productivity in terms of marketing and sales:
to evaluate the financial, legal, and cybersecurity threats that
Mining consumer behaviour and preferences for patterns can a firm faces and to devise strategies for mitigating those risks.
help marketers better understand client preferences, which in
g) Reduction in cost:
turn enables them to develop more targeted marketing and
advertising campaigns. Efficiencies in business processes and Mining data helps drive
down costs by improving operating cost cutting down on
b) Improved quality of service to customers:
unnecessary spending and redundancy in corporate spending.
Because of data mining, businesses are able to detect possible
problems with customer service in a more timely manner and
provide contact centre personnel with up-to-date information
Industry Examples of Data Mining: c) Insurance:
Listed below are some of the ways in which businesses Data mining is utilised by insurance companies to assist with
operating in certain sectors make use of data mining: the pricing of insurance policies as well as the determination
of whether or not to approve policy applications.
a) Retail:
d) Manufacturing:
Online merchants can better focus their marketing efforts,
advertisements, and promotional offers to individual Applications of data mining for manufacturers include work to
customers by mining consumer data and tracking shoppers' enhance uptime and operational efficiency in production
clickstreams on the internet. plants, as well as product safety and the performance of
supply chains.
Data mining and predictive modelling are the driving forces
behind recommendation engines, which make suggestions e) Entertainment:
about potential purchases to website users.
Streaming services mine user data to determine what people
These technologies are also used in the management of are watching or listening to on their platforms, and then
inventory and supply chains. utilise this information to provide personalised suggestions
based on users' viewing and listening preferences.
b) Financial services:
f) Healthcare:
Data mining technologies are utilised by financial institutions
such as banks and credit card firms in order to construct The ability to diagnose medical diseases, treat patients, and
financial risk models, identify fraudulent transactions, and analyse X-rays and other medical imaging results is made
validate loan and credit card applications. possible with the use of data mining.
Data mining is also an essential component of marketing and
is essential for determining whether or not existing clients
have prospects for upselling.
ABFM MODULE - D Text Mining:
Chapter 23: BUSINESS ANALYTICS AS MANAGEMENT Text mining, also known as text data mining, is the process of
TOOL (PART-IV) converting unstructured text into a structured format in order
to find relevant patterns and fresh insights.
What we will study?
Companies are able to investigate and identify hidden links
*What is Text Mining? within their unstructured data when they employ advanced
analytical approaches such as Naive Bayes, Support Vector
Machines (SVM), and other deep learning algorithms.
Within databases, text is one of the types of data that is used
the most frequently.
This information might be arranged in the following ways,
depending on the database:
a) Structured data:
This data has been standardized into a tabular format, which
consists of several rows and columns.
This makes it much simpler to store and handle for the
purposes of analysis and machine learning algorithms.
Inputs like names, addresses, and phone numbers are all
examples of the kinds of things that can be included in
structured data.
b) Unstructured data: This, in turn, leads to improved decision-making within
organisations, which in turn leads to improved outcomes for
This data does not adhere to any particular data format that
businesses.
has been standardised.
Text Mining Techniques:
Text from various sources, such as social media or product
reviews, as well as rich media formats, such as video and Text mining is a process that involves deducing information
audio files, may be included in this section. from unstructured text data by using a series of activities that
are included in the process.
c) Semi-structured data:
Text pre-processing is the practice of cleaning and
This information is a combination of structured and
transforming text data into a format that can be used.
unstructured data forms, as the name of the data set suggests.
Before you can apply various text mining techniques, you
Although it is organised to some degree, it does not possess
must first begin with text pre-processing, which is the practice.
the necessary level of structure to fulfil the prerequisites of a
relational database. This methodology is an essential part of natural language
processing (NLP), and it typically entails the application of
Files written in XML, JSON, and HTML are all examples of
processes such as language identification, tokenization, part-
types of data that are considered semi-structured.
of-speech tagging, chunking, and syntax parsing in order to
Text mining is an immensely helpful activity for organisations appropriately format data for analysis.
to implement due to the fact that the majority of data in the
After the text has been pre-processed to your satisfaction, you
world is stored in an unstructured manner.
will be able to apply text mining algorithms to the data in
Text mining tools and natural language processing (NLP) order to gain insights.
approaches, such as information extraction, enable us to
The following is a list of some of the more common text
transform unstructured materials into a structured format,
mining techniques:
which in turn enables analysis and the development of high-
quality insights.
a) The retrieval of information: b) Natural Language Processing:
Information retrieval, also known as IR, is the process of Natural language processing (NLP) is an offshoot of
locating and delivering pertinent data or documents based on computational linguistics that draws on techniques from a
a predetermined list of queries or phrases. variety of fields, including computer science, artificial
intelligence, linguistics, and data science, to give computers
IR systems make use of algorithms to monitor user activities
the ability to comprehend spoken and written forms of
and identify data that is pertinent to those activities.
human language.
The process of information retrieval is utilised frequently in
NLP subtasks allow computers to "read" by analysing
library catalogue management systems as well as in popular
sentence structure and grammar, which gives them the ability
search engines such as Google.
to do so.
The following are some examples of typical IR side jobs:
Typical examples of subtasks are as follows:
(i) Tokenization: refers to the process of separating a lengthy
(i) Summarization: is a method that condenses lengthy
piece of text into individual sentences and words that are
passages of text into a concise and logical overview of the
referred to as "tokens."
most important aspects of a document.
After that, these are incorporated into models, such as bag-of-
This method provides a synopsis of the text.
words, that are used for text clustering and document
matching activities. (ii) Part-of-speech (PoS) tagging: is a method in which a tag is
assigned to each token in a document based on the part of
(ii) Stemming: is the process of removing prefixes and suffixes
speech that the token denotes, such as nouns, verbs,
from words in order to determine the form and meaning of
adjectives, and so on.
the root word.
Following this step, semantic analysis can be performed on
This is referred to as "stemming".
unstructured text.
This method decreases the amount of space required for
indexing files, which results in improved information retrieval.
(iii) Text categorization: This task, which is also known as text information regarding entities, attributes, and relationships in
classification, is responsible for analysing text documents and a database.
classifying them based on predefined topics or categories.
The following are examples of common information
In other words, this task is responsible for text classification. extraction sub-tasks:
When it comes to classifying synonyms and abbreviations, this (i) Feature Selection:
subsidiary task is especially useful.
The process of selecting the important features (dimensions)
(iv) Sentiment analysis: is a task that identifies positive or that will contribute the most to the output of a predictive
negative sentiment from internal or external data sources. analytics model is referred to as feature selection, which is
also known as attribute selection.
This gives you the ability to monitor changes in customer
attitudes over the course of time. (ii) Feature Extraction:
It is frequently utilised to provide information about people's The process of selecting a subset of features in order to
opinions regarding various brands, products, and services. improve the accuracy of a classification task is referred to as
feature extraction.
These insights have the potential to propel businesses toward
connecting with customers and improving processes as well as This is of utmost significance when attempting to reduce the
the user experiences they provide. number of dimensions.
c): The Extraction of Information: (iii) Named-entity recognition (NER): also known as entity
identification or entity extraction, seeks to locate and classify
When searching through a variety of documents, information
particular entities in text, such as names or locations.
extraction (IE) brings to the surface the pertinent pieces of
data. This can be accomplished by searching for and analysing the
text.
In addition to this, the emphasis is placed on the extraction of
structured information from free text and the storage of For instance, NER recognises "Mary" as a female name and
"California" as the name of a place in the world.
ABFM MODULE - D Data Aggregation:
Chapter 23: BUSINESS ANALYTICS AS MANAGEMENT TOOL The process of collecting raw data and presenting it in a
(PART-V) summary format for the purposes of statistical analysis is
referred to as data aggregation.
What we will study?
For instance, raw data can be aggregated over a specified
*What is Data Aggregation? amount of time to provide statistics like the average, the
lowest, the maximum, the sum, and the count.
*What is Forecasting?
Following the aggregation of the data and its subsequent
writing to a view or report, you will be able to perform an
analysis on the aggregated data in order to get insights on
specific resources or resource groupings.
There are two different approaches to accumulating data:
Time aggregation: Every single data point that pertains to a
single resource over a particular time period. For Example,
counting all leads from a single marketing channel per month
or per year.
Spatial aggregation: Every single data point for a collection of
resources over a predetermined amount of time. For example,
calculating the total number of leads across all marketing
channels is considered spatial aggregation.
Time Intervals for Data Collection and Aggregation: Granularity can range anywhere from one minute to one
month, depending on the view or report type, as well as the
Within the context of a number of different time intervals,
time period being analyzed.
data is compiled and shown in a view or report as follows:
DataView is capable of dynamically aggregating data down to
a) Time frame for reports:
a granularity of less than one day.
This refers to the time frame that encompasses the collection
DataChannel aggregates data for larger granularity values.
of data prior to its dissemination.
c) Voting time period:
For instance, a resource summary table can include data that
was gathered for a specific network device over the course of The length of time over which the frequency with which
a single day. resources are sampled for data is established is referred to as
the voting time or polling period.
A reporting period could contain raw data points (data that
has not been aggregated) as well as aggregated data points. For illustration's sake, a set of resources may be surveyed
once every five minutes, which would imply that a data point
The time intervals supported for reports are: daily, weekly,
was produced for each resource once every five minutes.
monthly, quarterly, and yearly.
The output of a spatial aggregate can be affected by a number
of factors, including polling period and granularity.
b) Granularity:
For illustration's sake, let's say you want to determine the
Granularity is defined as the time frame during which average of a collection of data points that were gathered for a
individual data points for a specific resource or collection of group of devices over the course of 10 minutes (the
resources are gathered for the purposes of aggregation. granularity).
For instance, the granularity would be five minutes if you The result is the average of the single data points acquired
wanted to get the average of the data points for a particular from each device, and if the polling period is also 10 minutes,
resource that were gathered over the course of five minutes. this is what is calculated.
If, on the other hand, the polling time is only 5 minutes, then 1. Qualitative Research Approach:
each device is only sampled once over the 10-minute
The qualitative approach of forecasting, which is sometimes
granularity period.
referred to as the judging method, generates subjective
findings because it is based on the personal judgements of
experts or forecasters.
Forecasting:
Because the process of creating forecasts is not based on
The process of making predictions about what will occur in the
mathematics but rather on the knowledge, intuition, and
future by taking into account what has happened in the past
experience of the experts making them, there is a high
and what is happening in the present is referred to as
likelihood that the forecasts will contain errors.
forecasting.
One illustration of this would be if a person were to predict
In its most fundamental form, it is a decision-making tool that
the outcome of a finals game in the NBA, which, of course,
examines previous data and patterns with the goal of assisting
would be influenced more by their own personal drive and
organisations in dealing with the impact of the
interest.
unpredictability of the future.
The possibility of error is one of the shortcomings of using
It is a tool for planning that gives companies the ability to map
such a strategy.
out their next steps and set budgets that will ideally cover any
unpredictability the future may bring. 2. Quantitative Technique:
The quantitative technique of predicting is based on a
mathematical procedure, which gives it the qualities of being
Forecasting Methods:
consistent and objective.
When companies wish to make educated guesses about what
It avoids based the results on opinion and intuition, opting
might take place in the future, they have the option of
instead to use enormous volumes of data and statistics that
choosing between two fundamental approaches: qualitative
and quantitative approaches.
are then interpreted, as opposed to basing the results on The Process of Forecasting:
opinion and intuition.
In order to get reliable results, forecasters need to follow a
methodology that is both detailed and methodical.
Features of Forecasting: The following are some of the stages that make up the process:
The following is a list of some of the characteristics of creating 1. Establishing a foundation for future projections:
a forecast:
Developing the foundation for the study of the company's
1. Involves future events: state and determining where the company is now positioned
in the market is the first stage in the process.
Because they are used to make predictions about the future,
forecasts are an essential part of the planning process. This step also marks the beginning of the process.
2. Covers recent and historical occurrences: 2. Formulating projections for the company's ongoing
business activities:
Opinions, intuition, and educated estimates, in addition to
facts, numbers, and other pertinent data are the foundations The first part of the forecasting process involves conducting
around which forecasts are constructed. an investigation.
All of the components that go into the formation of a The second part of the forecasting process involves estimating
prediction are, to some extent, a reflection of what has the future conditions of the industry in which the company
occurred with the company in the past as well as what is operates, projecting and analysing how well the company will
anticipated to take place in the foreseeable future. do, and making projections based on those analyses.
3. Uses various techniques of forecasting: 3. Making adjustments to the forecast:
The quantitative methods are utilised by the majority of firms, This entails going back through the many forecasts that have
notably in the processes of planning and budgeting. been made in the past and contrasting them with the actual
events that have transpired with the company.
The disparities between historical data and the most recent ABFM MODULE - D
projections are broken down and analysed, and the factors
Chapter 23: BUSINESS ANALYTICS AS MANAGEMENT
that led to the differences are taken into consideration.
TOOL (PART-VI)
4. Taking a look back at the steps:
What we will study?
At each stage, there is a check, after which tweaks and
improvements are done. *What is Data Visualisation?
*What are the different types of Data Visualisation?
Data Visualisation: The expanded coverage of these topics is as under:
The process of representing data through the use of popular The practice of using data visualisation to stimulate new idea
graphics, such as charts, plots, infographics, and even development across teams is becoming increasingly popular.
animations, is referred to as data visualisation.
They are usually put to use during the brainstorming or design
These visually appealing representations of information thinking sessions that take place at the beginning of a project.
simplify the communication of complicated data relationships
These sessions support the collection of various points of view
and insights that are generated by data in a way that is easy
and bring attention to the concerns that are shared by the
to grasp.
group as a whole.
It is crucial to highlight that the usage of data visualisation is
Even though initial visualisations are typically not polished or
not limited to data teams alone; it can serve a number of
improved in any way, they assist build the foundation within
functions, and its use is not limited to that.
the project to ensure that the team is on the same page
It is also utilised by management in order to communicate the regarding the problem that they are trying to address for
organisational structure and hierarchy, whilst data analysts important stakeholders.
and data scientists utilise it in order to uncover and explain
The practice of using data visualisation to illustrate a concept
patterns and trends.
is helpful in communicating an idea, such as a strategy or
According to Harvard Business Review, the primary functions method.
of data visualisation may be broken down into the following
It is most commonly used in educational environments such as
four categories:
tutorials, certification courses, and centres of excellence.
idea creation, idea illustration, visual discovery, and everyday
However, it can also be used to represent the structures or
dataviz or data visualisation.
processes of organisations, thereby facilitating
communication between the appropriate individuals for a
given set of duties.
Gantt charts and waterfall charts are two types of charts that Dashboards are useful data visualisation tools for tracking and
are widely used by project managers to describe workflows. visualising data from many data sources.
Visual discovery and day-to-day data visualisation are They provide visibility into the consequences of certain
increasingly integrated with the work of data teams. behaviours on performance, whether such behaviours are
carried out by a team or by a team that is next to it.
Visual discovery assists data analysts, data scientists, and
other data professionals in locating patterns and trends within The following are examples of common visualisation
a dataset. approaches included in dashboards:
Every day data visualisation, on the other hand, is beneficial a) Ables:
to the subsequent storytelling that takes place after a new
This is a grid with rows and columns that can be used to
insight has been discovered.
compare different variables.
The process of data science includes a crucial stage called data
Tables have the ability to display a large amount of
visualisation, which assists teams and individuals in more
information in an organised manner.
effectively communicating data to their co-workers and
decision makers.
Types of Data Visualisation: b) Pie charts and stacked bar charts:
The Egyptians, who lived before to the 17th century, are Both of these types of graphs are broken up into portions that
credited with developing the first kind of data visualisation, each reflect a different component of the total.
which was primarily utilised to aid with navigation. They offer a straightforward method for arranging data and
As time went on, people began to use data visualisations for a contrasting the proportions of the various constituent parts.
wider variety of applications, including those in the fields of
economics, social sciences, and health.
c) Line graphs and area charts:

These are graphical representations that depict how one or
more quantities have changed over time by plotting a set of
data points in a certain order.
Area charts connect data points with line segments, stacking d) Histograms:
variables on top of one another, and utilising colour to This graph depicts a distribution of numbers using a bar chart
differentiate between variables. (with no spaces between the bars), reflecting the quantity of
Line graphs use lines to depict these changes, whereas area data that falls within a given range.
charts connect data points with line segments. Histograms do not have any spaces in between the bars.
An end user can easily spot anomalies within a dataset with
the assistance of this graphical representation.
e) Scatter plots:
These graphics are helpful in reveling the link between two
variables, and they are widely employed within the analysis of
regression data.
Scatter plots can be found in regression data.
However, these are sometimes confused with bubble charts,
which are used to represent three variables via the x-axis, the
y-axis, and the size of the bubble.
In this case, however, the bubble charts are used to display
three variables.
f) Heat maps:
These are handy graphical representations that allow for the
visualisation of behavioural data according to location.
This can be a spot on a map, or it could even be a webpage.
EXCEL PROFICIENCY:
The ability to edit text documents, develop templates, and
automate the generation of tables of content in Microsoft
Word is often required to be considered proficient in
Microsoft Office.
Being proficient with Excel requires being able to execute and
create functions, pivot tables, and charts.
g) Tree maps: The following is a list of the numerous Excel skills that need to
be kept up to date:
Tree maps present hierarchical data as a set of nested forms,
most often rectangles; these maps are becoming increasingly 1. Spreadsheets. 2. Workbooks.
popular. 3. Formulas. 4. Data Linking.
Tree maps are an excellent tool for comparing the proportions 5. Pivot Tables. 6. Charts.
of different categories based on the size of their respective
areas. 7. Data Analytics. 8. Macros and Automatization.
9. IF Statements. 10. Data Validation.
ABFM MODULE - D BIG DATA ANALYTICS:
Chapter 23: BUSINESS ANALYTICS AS MANAGEMENT TOOL Big data analytics is the application of more advanced
(PART-VII) analytical methods to very large, diverse data sets.
These data sets might be organised, semi-structured, or
What we will study?
unstructured, come from a variety of sources, and range in
*What is Big Data Analytics? size from terabytes to zettabytes.
*What are different uses of Big Data Analytics? Big data is a term that refers to data sets that are so large or
complex that typical relational databases are unable to
*All about uses of Big Data Analytics in different
effectively record, manage, or process the data in a timely
Industries? manner.
This form of data is known as unstructured data.
Big data can be characterised by high volume, high velocity, or
high diversity, or all three of these properties simultaneously.
The rise of artificial intelligence (AI), mobile, and social
platforms, as well as the Internet of Things (IoT), are all
contributing to an increase in the complexity of data through
the introduction of new forms and sources of data.
For instance, big data can be derived from sensors, devices,
video/audio, network, log files, transactional applications, the
web, and social media, with a significant portion of it being in
real time and on a very large scale.
Big data analysis enable analysts, academics, and business Companies are able to deflect and prevent fraud by utilising
user to make better judgments, more quickly, using data that the power of big data conjunction with predictive and
was previously either inaccessible or unsuitable. prescriptive analytics, as well as the comparison of historical
and transactional data.
Businesses have the ability to gain new insights from
previously untapped data sources by using advanced analytics c) Improving the efficiency of the supply chain:
techniques such as text analytics.
Collecting and examining large amounts of data to figure out
Uses of Big Data Analytics: how items get to their final destination highlighting areas of
inefficiency as well as opportunities to cut costs and save both
Big Data Analytics can be used for the following purposes:
time and money.
a) Enhancing the integration of the customers:
Tracking vital information from the warehouse to its final
Gathering data that is structured, semi-structured, and destination with the use of sensors, logs, and transactional
unstructured from the various touch points that customers data is possible.
have with the firm in order to obtain a comprehensive
The use of big data analytics in the following six industries has
understanding of the client’s action and the factors that
been explained below:
motivate them so that we may better our personalised
marketing. 1. Manufacturing.
Data sources can include social media, sensors, mobile devices, 2. Retail.
sentiment and call log data.
3. Health Care.
b) Detecting and minimising frauds:
4. Oil & Gas.
Monitoring transactions in real time and staying on the
5. Telecommunication.
lookout for strange patterns and behaviours that could
indicate fraudulent activity. 6. Financial Services.
Manufacturing: b. The effectiveness of operations:
The manufacturing industry has been completely disrupted by One of the areas in which big data can have the largest impact
the digital revolution. on a company's profitability is the operational efficiency of
the business.
Manufacturers are now finding new methods to harness all of
the data that they generate in order to enhance the efficiency Big data gives you the ability to study and evaluate production
of their operational processes, streamline their business processes, provide a proactive response to feedback from
procedures, and uncover important insights that will drive customers, and anticipate future demand.
both profits and growth.
c. Production optimisation:
a. The practice of predictive maintenance:
Increasing revenue while lowering costs is possible if
Big data can assist in the prediction of equipment failure. production lines are optimised.
Analysis of structured data (including the year, make, and Using big data, manufacturers may better analyse the
model of the equipment) as well as analysis of multi- movement of things through their manufacturing processes
structured data might lead to the discovery of potential and determine which sectors could stand to gain from the
problems (log entries, sensor data, error messages, engine change.
temperature, and other factors).
The examination of the data will show which processes
With this information, manufacturers are able to maximise contribute to an increase in production time as well as which
the amount of time that their components and equipment are regions are creating delays.
operational and reduce the amount of money spent on
Retail:
maintenance.
Retail is an industry with a lot of strong competition.
More than simply the breakdown of equipment can be
forecast with the help of this data. Companies constantly work to find new ways to set
themselves apart from competitors.
The usage of big data is prevalent throughout the entirety of Big data gives merchants a more accurate picture of the
the retail process, from product projections and demand customer experience, which they can utilise to hone their
forecasting to in-store optimization and inventory business practices.
management.
Companies are able to optimise customer interactions and
Retailers are discovering new avenues of innovation by maximise the value offered to them if they collect data from
utilising big data. social media platforms, website visits, phone records, and
other company interactions, as well as from other data
a. Product development:
sources.
The use of big data helps us to anticipate the demand from
The analysis of large amounts of data can be utilised to make
customers.
customised offers, decrease customer turnover, and improve
We can create predictive models for new products and proactive problem resolution.
services by first identifying important characteristics of
C. Customer lifetime value:
completed and ongoing product offers, and then modelling
the relationship between those characteristics and the degree All customers are valuable. However, there are some that are
to which the offerings were successful commercially. more precious than others.
We can dig deeper for planning, producing, and introducing Big data gives you insights on consumer behaviour and
brand-new products with the help of the data and analytics spending habits, allowing you to determine which customers
gleaned from focus groups, social media, test markets, and are the most valuable to your business.
early store rollouts.
When you have a better understanding of who they are, you
b. Customer experience: will be able to better target marketing efforts at them.
The competition for consumers has been becoming more and They are able to receive more attention from sales staff.
more intense day by day.
d. The in-store shopping experience: including the capture of new market opportunities and the
reduction of fraud.
The in-store experience may be enhanced by the utilisation of
big data. a. Fraud and compliance:
A growing number of retailers are beginning to evaluate When it comes to safety, the problem isn't just a few of
customer data obtained through mobile apps, in-store unscrupulous hackers.
purchases, and geolocations in order to improve
The industry that provides financial services is competing
merchandising and persuade customers to make full
against full teams of experts.
purchases.
Despite the fact that both the threat landscape and the
e. Pricing analytics and optimization:
compliance standards are always changing.
Retailers have a responsibility to understand the true
With the use of big data, businesses are able to recognise
profitability of their client base, the various ways in which
patterns that point to fraudulent activity and to combine vast
markets might be divided up, and the scope of any
volumes of information in order to simplify regulatory
prospective future opportunities.
reporting.
A review of profits and margins throughout the entire
b. Drive innovation:
business process can be of assistance in locating chances to
increase pricing as well as places in which profits may be being Big data may provide enterprises with insightful information
lost. that can help them develop.
Financial Services: The interdependencies that exist between persons,

institutions, entities, and processes become increasingly
Big data is being utilised to the fullest potential by banks and
obvious when big data analytics are performed.
other businesses in the financial services industry.
Organizations are able to improve their decision-making
Big data has enabled businesses in the financial services
about new products and services if they have a better
industry to gain a competitive advantage in a variety of areas,
awareness of the trends in the market and the needs of their ABFM MODULE - D
customers.
Chapter 23: BUSINESS ANALYTICS AS MANAGEMENT TOOL
c. Anti-money laundering: (PART-VIII)
As a result of governments enacting anti-money laundering
What we will study?
rules, businesses that provide financial services are under
more pressure than they have ever been before. *What is the Importance of Big Data Analytics?
Because of these restrictions, financial institutions are *How does Big Data Analytics work?
required to provide evidence of adequate care and file reports
*What are the different Big Data Analytics Tools
of suspicious conduct.
available in the market?
Big data analytics may be able to assist businesses in
recognising possible instances of fraud in a highly complex *What are the challenges faced by Big Data Analytics?
industry.
d. Financial regulatory and compliance analytics:
Companies that provide financial services are required to
adhere to a wide number of regulations pertaining to risk,
behaviour, and transparency.
At the same time, financial institutions are obligated to
comply with the Basel III, and any other rules that call for
extensive reporting.
Importance of Big Data Analytics: 3. Developing and marketing new products and services:
Big data analytics enables businesses to get control of their Through the use of analytics, companies can gain the ability to
data and make better use of it to discover new opportunities. provide customers with exactly what they want, when they
want it by understanding their demands and how satisfied
Because of this, subsequent corporate decisions are wiser,
they are with their experiences.
operations are more efficient, profits are higher, and
consumers are more satisfied. With the use of big data analytics, more businesses now have
the opportunity to create innovative new products to satisfy
Companies that combine their use of big data with more
the ever-evolving requirements of their customers.
advanced analytics can increase their value in a number of
different ways, including the following: How does Big Data Analytics Work:
1. Reducing cost: The term “big data analytics" refers to the process of
collecting, processing, cleaning, and analysing massive data
When it comes to the expense of keeping vast amounts of
sets with the goal of assisting businesses in operationalizing
data, big data technologies such as cloud-based analytics can
their big data.
drastically lower such costs (for example, a data lake).
1. Collection of Data:
In addition to this, big data analytics assists businesses in
discovering new and more effective ways to conduct their The collecting of data takes on a variety of forms across
operations. organisations.
2. Speedier and quality decisions: With the technology available today, businesses are able to
collect both structured and unstructured data from a wide
Businesses are able to rapidly evaluate information and make
range of sources, including cloud storage, mobile applications,
quick decisions based on that analysis thanks to the speed of
in-store Internet of Things sensors, and more.
in-memory analytics, which, when paired with the capacity to
study new sources of data, such as streaming data from the
internet of things (IoT), is extremely helpful.
A portion of the data will be kept in data warehouses, which Stream processing examines relatively small batches of data
are locations that are conveniently accessible by business all at once, cutting the amount of time that passes between
intelligence tools and solutions. data collection and analysis so that decisions can be made
more quickly.
Raw data or data that has not been structured can be stored
in a data lake. Processing data in streams is more difficult and typically more
expensive.
If the data is too diverse or complicated for a warehouse, it
can be allocated metadata and stored in a data lake instead. 3. Data Cleaning:
2. Processing of Data: In order to strengthen the results and increase the quality of
the data, it is necessary to clean the data.
In order to achieve reliable results from analytical queries, the
data must first be properly organised after they have been This means that the data must be correctly formatted, and
collected and stored. any redundant or irrelevant information must be removed or
accounted for.
This is especially important when the data is both vast and
unstructured. Incorrect data can obscure and mislead, which ultimately
results in inaccurate insights.
The amount of data that is now available is expanding at an
exponential rate, which presents a difficulty for companies 4. Analysis of Data:
that need to process that data.
Getting huge data into a useful form takes time.
Batch processing, which looks at huge data blocks over a
When it is ready, sophisticated analysis procedures can
period of time, is one of the processing options available.
transform large amounts of data into meaningful insights.
When there is a longer turnaround time between gathering
The following are examples of these strategies for analysing
data and analysing it, batch processing is a valuable technique
huge data:
to utilise.
(a) Data Mining: The following is a list of some of the most important actors in
big data ecosystems:
The process of data mining involves sorting through massive
datasets to find patterns and linkages. a) Hadoop:
This is accomplished by locating data outliers and forming Hadoop is an open-source system that stores and analyses
data clusters. large datasets on clusters of commodity hardware in an
efficient manner.
(b) Predictive analytics:
This framework can manage massive amounts of structured
This is a method that analyses the past data of an organisation
and unstructured data, and it is free to use.
in order to create forecasts about the future and to spot
potential threats and opportunities Because of these features, it is an invaluable component for
any big data activity.
(c) Deep learning:
This imitates human learning patterns by employing artificial
intelligence and machine learning to layer algorithms and b) NoSQL databases:
uncover patterns in the most complicated and abstract data.
NoSQL databases are non-relational data management
This is accomplished through the use of the "deep learning" systems that do not require a fixed scheme.
technique.
Because of this, they are an excellent choice for large amounts
Big Data Analytics Tools and Technology: of raw data that are not structured.
The analysis of large amounts of data cannot be reduced to a These databases, whose name comes from the phrase "not
single instrument or piece of technology. simply SQL," are able to deal with a wide variety of data
models.
Instead, you'll need a combination of different kinds of
technologies to help you collect, process, clean, and analyse
large amounts of data.
c) MapReduce: f) Tableau:
MapReduce is a key component Hadoop's framework, and this Tableau is a platform for end-to-end data analytics that
framework serves two different purposes. enables you to prepare, analyse, collaborate, and share your
insights derived from large amounts of data.
The first step is called mapping, and it distributes data to
different nodes within the cluster using various filters. Tableau is a leader in the field of self-service visual analysis,
which enables individuals to pose novel inquiries using
The second step is called "reducing," and it involves organising
managed big data and to simply communicate their findings
and condensing the results obtained from each node in order
throughout an organisation.
to respond to a query.
Challenges of Big Data:

d) "Yet Another Resource Negotiator": is what "YARN" stands
for. It is yet another component of the Hadoop system of the Enormous data delivers big benefits, but it also introduces big
second generation. issues, such as new privacy and security concerns, accessibility
for business users, and the need to choose the correct
The job scheduling and resource management in the cluster
solutions for your company's requirements.
can be improved with the assistance of the cluster
management technology. In order for enterprises to make the most of incoming data,
they will need to handle the following issues:
e) Spark:
Making big data accessible:
Spark is an open-source cluster computing framework that
provides an interface for programming complete clusters by When there is a greater volume of data, it is significantly more
utilising implicit data parallelism and fault tolerance. challenging to collect and process the data.
Spark is capable of handling both batch and stream processing, It is imperative that organisations make the usage of data
which enables it to do computations quickly. simple and accessible to individuals with varying degrees of
expertise.
Maintaining data quality: ABFM MODULE - D
Due to the large amount of data that needs to be maintained, Chapter 24: GREEN AND SUSTAINABLE FINANCING (PART-I)
businesses are devoting more time than they ever have before
What we will study?
to the process of checking for mistakes, inconsistencies,
conflicts, and duplication. *What is Green Finance?
Data Security: *What is Sustainable Finance?
Privacy and safety are becoming ever more of a worry as more *What are the ISO standards for Green Finance?
and more data is collected.
*All about ISO 32210?
Before organisations can begin to reap the benefits of big data,
they will need to first work toward compliance and establish
data processes that are particularly stringent. *All about ISO 14008?
Identifying appropriate tools and platforms:

Continuous innovation takes place in the field of developing
technologies that can process and analyse large amounts of
data.
In order to meet their specific requirements, organisations
have to locate suitable technological solutions that are
compatible with the ecosystems they have already developed.
The optimal solution is frequently one that is also flexible and
able to adapt to alterations in the underlying infrastructure at
a later point.
INTRODUCTION: The 27th Conference of the Parties to the United Nations
Framework Convention on Climate Change - COP27 - builds on
Around the world, regulators, national authorities, and
the outcomes of COP26 to deliver action on an array of issues
supranational organizations have begun to pay attention to
critical to tackling the climate emergency - from urgently
climate risk and sustainable finance.
reducing greenhouse gas emissions, building resilience, and
The report, that was put out by the Intergovernmental Panel adapting to the inevitable impacts of climate change, to
on Climate Change (IPCC) in August 2021, underlined the delivering on the commitments to finance climate action in
changes that have been noticed in the climate of the Earth in developing countries.
every region and throughout the whole climate system.
Faced with a growing energy crisis, record greenhouse gas
According to the findings of the report, emissions of concentrations, and increasing extreme weather events,
greenhouse gases from human activities are responsible for COP27 seeks renewed solidarity between countries, to deliver
approximately 1.1 degrees Celsius worth of warming that has on the landmark Paris Agreement, for people and the planet.
occurred between the years 1850 and 1900.
One of the many phrases, that are used to represent activities
The report also finds that the global temperature is expected that are connected to the two-way interaction between the
to reach or exceed 1.5 degrees Celsius warming, over the next environment and finance and investment, is "green finance".
20 years, on average.
Over the course of the past decade, it has developed into a
Consequently, during the Conference of the Parties (COP26) common phrase, in part as a result of the proliferation of
Summit, which took place in Glasgow, United Kingdom, in national green investment banks and the fast-expanding
November 2021, a number of governments pledged to take green bond market.
extensive climate action.
However, green finance is strongly connected to other
Therefore, the focus that has been placed on climate change concepts, such as climate finance and sustainable finance,
has increased as a result of the recent IPCC Report and the which are related in some way.
COP26 Summit.
The United Nations Environment Programme provides the or green investments, which is an increase of 34% from the
following helpful explanations of what each term refers to in year 2016.
the following order:
The International Energy Agency estimates that a total of 53
1. A sustainable financial system takes into account the trillion US dollars ought to be invested in the global energy
environment, society, and government in addition to the industry by the year 2035 in order to avoid climate change
economy. from becoming a hazard to human life.
2. Green finance does not take into account social or This is an example of supporting green initiatives.
economic factors, but it does incorporate climate finance.
On the other hand, greening the finance can be demonstrated
3. The term "climate finance" refers to a subset of "green" or by the research conducted by the New Climate Economy,
"environmental" financing. which reveals that the implementation of this systemic shift
will require money equal to ninety trillion dollars.
Therefore, the most inclusive phrase is sustainable finance,
which encompasses all forms of financing activity that aid in In a nutshell, there is a significant need for environmentally
the achievement of sustainable development. friendly and sustainable forms of money.
Both "financing the green," or investing in environmentally
friendly solutions, and "greening the finance," or reorienting
ISO STANDARDS FOR GREEN FINANCE:
the financial system, are necessary components of the
investment that must be made in order to address the Investors have been drawn to growing industrial areas, such
sustainability concerns that exist in the modern world. as renewable energy, energy efficiency, green building, and
recycling, not only due to the prospect of healthy financial
According to a report published by the Global Sustainable
returns in a developing part of the economy, but also by the
Investment Alliance, which is a group of organisations tracking
ethos of ethical and environmental investments.
these movements in five regions from the United States to
Australia, at least $30.7 trillion of funds are held in sustainable
The International Organization for Standardization (ISO) is ISO 32210:
working on a set of standards to underlie and catalyze green
It is of the utmost importance to move at a faster pace toward
and sustainable finance.
a global economy that is more sustainable in order to achieve
Investments in environmental initiatives and programmes will the targets set for climate change and to bring activities into
benefit from having more organisation, openness, and alignment with sustainable development goals.
credibility, as a result of this.
Without making significant adjustments in the financial
The International Organization for Standardization (ISO) has industry, it will not be possible to meet these objectives.
already begun publishing standards to meet these needs
within the confines of three ISO technical committees (TCs):
ISO 32210 "Sustainable finance":
ISO/TC 207: Environmental Management.
Principles and guidance outline a set of guiding principles and
ISO/TC 322: Sustainable Finance and
practices that are intended to assist financial institutions in
ISO/TC 309, Governance of Organisations. enabling positive environmental and social outcomes,
mitigating risk, and delivering sustainable value.
These committees fall under the umbrella of ISO.
The objective of the standard is to provide assistance to
The various ISOs are:
organizations in:
1. ISO 32210: Framework for Sustainable Finance.
A) Activities geared toward contributing to long-term
2. ISO 14007: Environmental costs and Benefits. sustainability goals are being transitioned.
3. ISO 14008: Monetary valuation of environmental impacts. B) Creating value by seizing the new investment opportunities
4. ISO 14097: Assessing and reporting investments related to afforded by the ongoing transition in the global economy.
climate change. C) Improving investment portfolios' ability to generate long-
term financial returns while also minimizing their impact on
the environment.
D) Identifying and mitigating risk. In order to comprehend and then manage the risks and
opportunities connected with them in a cost-effective manner,
E) Aligning the interests being pursued with the expectations
it is crucial to establish the monetary value.
of the stakeholders.
The first globally accepted reference for determining the
Examples of ESG criteria include:
economic value of an organization's environmental impacts
Environmental (E): Climate change, Natural resource depletion and aspects is ISO 14008, Monetary valuation of
and environmental degradation (including land use change, environmental impacts and related environmental aspects.
habitat loss and species loss).
It utilises a coordinated collection of technologies to combine
Social (S): Working conditions (including slavery and child economic studies with environmental management in a
labour), local communities, conflict, health and safety, standardised manner.
employee relations and diversity.
To make its information more accessible to users rapidly, the
Governance (G): Executive pay, bribery and corruption, standard, created by ISO TC 207, employs the vocabulary of
political lobbying and donations, board diversity and structure, ISO 14001 on environmental management systems. Why then
and tax strategy. do we require ISO 14008? Simply said, in order to evaluate
ISO 14008: risks and possibilities, firms must be aware of all costs and
externalities.
An organization's interactions with the environment are
referred to as its environmental aspects, while these The standard also aids in the formulation of policies like green
interactions' effects are referred to as its environmental taxes, compensation schemes, and subsidies that take into
impacts. A favourable or negative influence is possible. account the present or potential cost of environmental harm.
The projects backed by green finance and the businesses Additionally, it offers a crucial tool for the expanding fields of
involved in these processes each have aspects and disclosure and reporting today.
repercussions that are present across the whole finance cycle.
ISO 14007: ISO 14097: Risks and opportunities brought about by climate
change can have an impact on the performance of financial
Additional guidance for calculating environmental costs and
institutions and the businesses they invest in.
benefits is provided by ISO 14007, Environmental
management. In light of this, a fresh framework for assessing how climate
change may affect funding and investment has just been
ISO 14007 offers instructions on how to use those values for
created.
cost and benefit analyses after organisations have determined
monetary values for environmental consequences. Organizations reporting in accordance with the suggestions of
the Task Force for Climate-related Financial Disclosures will
The concept of dependencies, or how organisations depend
benefit greatly from ISO 14097, Greenhouse gas management
on the environment, is also explained in this standard.
and related activities - Framework including principles and
The commercial case for evaluating an organization's reliance requirements for assessing and reporting investments and
on "natural capital" is becoming more compelling due to financing activities related to climate change.
increasing resource scarcity and deteriorating ecosystem
The standard accomplishes three goals:
services.
1. Aid finance managers and investors in identifying
Natural Capital can be defined as the world's stocks of natural
opportunities and dangers associated to climate change.
assets which include geology, soil, air, water and all living
things. 2. Provide the information and data required to make
defensible decisions to reduce or eliminate climate-related
Companies will choose greener investments and build more
risks and to seize opportunities.
sustainable enterprises when they recognise the obvious
environmental advantages of the natural capital they rely on. 3. Facilitate the shift to a low-carbon economy with fewer
risks to the climate and spur more investment in the prospects.
ABFM MODULE - D BUILDING GREEN FINANCE:
Chapter 24: GREEN AND SUSTAINABLE FINANCING (PART-II) ISO 14000, released in August, 2022, provides guidance on
identifying and assessing environmental aspects and impacts,
What we will study?
and performance criteria for projects, assets and activities.
*All about building Green Finance?
The intent is to support the development of green finance by
*What are the different Instruments to fund Green Financial assisting borrowers and financiers to take into account the
Project? environmental aspect and impacts or environmental
performance of the project,
The guidance is applicable to individual, corporate or public
entities providing or seeking green finance, regardless of size.
A framework to determine relevant environmental criteria
supported by credible information is presented.
The objective of applying these criteria is to avoid, minimize,
reduce and mitigate adverse environmental impacts and risks,
as well as to identify opportunities to optimize environmental
performance.
Key concepts involved in identifying and assessing relevant
environmental criteria, including significance, context and
materiality as well as "do no significant harm", are examined.
Instruments to fund Green Financial Project: Green loans and green bonds are the two main categories of
debt securities.
Governments, charities, banks, and private investors can
finance "green" initiatives using a variety of methods. Only banks offer green loans, but a wider range of investors
can purchase green bonds, commonly referred to as climate
They can be divided into four categories: loan, equity, and
bonds.
risk-mitigation products.
In a bond, the issuer serves as the borrower, while the holder
Global foundations and NGOs typically provide project-
serves as the lender.
specific grants, such as for decentralised solar mini-grids for
rural electrification. The lenders receive a return in the form of fixed interest
payments.
Credit enhancement guarantees and insurance products are
risk-mitigation tools. Green bonds are the green financing product that has gained
the most interest.
In guarantees, government agencies, development financial
institutions (DFIs), or financial services firms can assure A global non-profit group called the Climate Bonds Initiative
lenders that payment will be made in full or in part in the (CBI) reports that the issuance of green bonds and loans
event that the borrowers default. worldwide surged 51% year over year to reach $257 billion in
2019.
Environmental risk liability coverage and environmental loss
insurance are features of green insurance products. According to the Economic Survey 2019-20, the first half of
2019 saw $10.3 billion in green bond transactions in India, one
The DFIs may offer early-stage seed money to launch a project
of the Asian markets with the quickest rate of growth for
under equity.
green bonds.
Additionally, for an ownership stake in such ventures or assets,
As previously mentioned, green bonds are similar to ordinary
venture capitalists and private equity funds may invest, or the
bonds, except that the revenues are designated towards
general public may do so through initial public offerings (IPOs).
particular "green," or climate-friendly, projects or assets.
Organization-guaranteed bonds, asset-backed bonds, and The funds that are raised via the sale of green bonds are then
hybrid-bonds are the three main categories of green bonds, utilised for the purpose of financing 'green' projects.
according to the source of repayment for the lenders and the
Green bonds are an efficient means of raising financing for
available remedies in the event of a default.
renewable energy projects while simultaneously achieving the
Going above and beyond the innovative sustainability-themed environmental goals of investors and the climate goals of the
capital market products such as Green Bonds or Social Impact Government of India.
Bonds, India is moving in the direction of creating a Social
Green bonds are a global phenomenon that was first
Stock Exchange (SSE), which will fall under the regulatory
introduced in the United States.
ambit of SEBI and will be used for the raising of capital by
Social Enterprises working toward the realisation of a social In 2017, the Securities and Exchange Board of India (SEBI)
welfare objective. issued guidelines on green bonds.
The Securities and Exchange Board of India (SEBI) established These guidelines included the requirement that green bonds
a Working Group (WG) on Social Stock Exchanges in be listed on Indian stock exchanges.
September 2019. This was done to encourage the issuing of green bonds in
On the first of June in 2020, the Working Group handed the India.
Report, provided an overview of its vision and made a number Passive and retail investors are now able to invest in "green"
of recommendations. companies thanks to the creation of green indexes such as
One of these recommendations calls for the participation of S&P BSE CARBONEX (2012), MSCI ESG India (2013), and S&P
non-profit organisations (NPOs) and for-profit enterprises BSE 100 ESG Index (2017).
(FPEs) on SSE, with both types of organisations agreeing to All of these indices were introduced in their respective years.
abide by a set of minimum reporting requirements.
In India, as of the 24th of December in the year 2020, eight
Green bonds are a type of financial instrument that are issued ESG mutual funds have been established.
by a company in order to raise money from investors.
In the year 2020, the total amount of green bonds that have ABFM MODULE - D
ever been issued worldwide surpassed the one trillion dollar
Chapter 24: GREEN AND SUSTAINABLE FINANCING (PART-III)
mark.
What we will study?
Following China in terms of size, the green bond market in
India is the second largest among emerging markets. *All about Green Bond?
*Types of Green Bond?
*All about Green Masala Bond?
About Green Bonds: However, to this day, they have been issued most commonly
in the form of "use-of-proceeds" bonds, which are designed to
Green bonds are a type of unsecured debt instrument that is
raise capital that will be distributed across a portfolio of green
used to finance green projects that provide benefits to the
projects.
environment.
The momentum of continued issuance and market demand
The commitment of an issuer of a green bond to use the
has led to a growing consensus on what constitutes a green
proceeds from the sale of the bond to finance or re-finance
bond, and progress has been made on standards and criteria
"green" projects, assets, or business activities distinguishes a
for what constitutes a green project or activity. Both of these
bond from a standard bond.
factors have contributed to the growth of the green bond
Green bonds can be issued up front by either public or private market.
actors in order to raise capital for projects or for the purposes
In order to develop a credible green bond market and prevent
of re-financing.
"green washing" , green bond project definitions and
This results in increased lending and frees up capital for other requirements for disclosure of the use of proceeds are the
uses. foundational elements.
In the same manner as traditional bonds, green bonds involve
the issuing entity providing a guarantee that the amount
borrowed will be repaid over a predetermined amount of
time and compensating the creditors through the issuance of
a coupon that bears either a fixed or variable interest rate.
It is possible to structure them as asset-backed securities that
are linked to particular green infrastructure projects.
The various types of bonds are explained below: The asset of the solar farm is moved into a distinct entity,
which is subsequently referred to as a special purpose entity
a) Organization-guaranteed Bonds:
(SPE) or a special purpose vehicle (SPV).
Not only the financed asset, in this case the solar farm, but
Only this asset is held by this particular entity.
also the issuing organisation itself is taken into consideration
when determining the credit-worthiness of an organization- Only the revenue that is made from this farm will be used to
guaranteed bond, which is also referred to as a general make the payments that are owed to the lenders.
obligation bond.
c) Hybrid Bonds:
The farm is recorded as an asset on the issuer's books, and
There are two different ways that a hybrid bond, which is a
repayment to the lenders is made from all of the issuer's
dual-recourse bond and is also known as a covered bond,
sources of cash flow, not only those that are directly
might be formed.
attributable to the farm.
In the first approach, the farm is listed as an asset owned by
Bonds like these could be issued by the government, public
the issuer; however, in the event of a payment default, the
institutions, or even private corporations.
lender will take ownership of the farm.
One or more of these bonds may also be convertible, which
furthermore, if the value of the farm is insufficient to cover
means that the lenders may, at a later time, exercise their
the default, the lender will also have a claim on the issuer's
option to transform the bond into stock.
other assets.
b) Asset-Backed Bonds:
In the second approach, the farm is held by a special purpose
When it comes to asset-backed bonds, the issuer's entity (SPE), and in the event of a default, the lender receives
creditworthiness is not dependent on any of the issuer's other ownership of the SPE's assets.
cash flows; rather, it is only related to the predicted revenue
In a manner analogous to the first approach, the lender has
from the solar farm.
the option of staking a claim on the issuer's additional assets
in the event that the value of the assets is insufficient.
Framework for Green Bond Issuance: Last but not least, the GBP discusses different techniques for
providing transparent reports to the lenders, including the
The Green Bond Principles (GBP) are a collection of optional
impact that the project will have.
process principles that were established by the International
Capital Market Association. The Climate Bonds Initiative has released a set of voluntary
guidelines and a certification scheme in order to promote
Their purpose is to increase the transparency and integrity of
investments that are truly linked with the goal of tackling
the green bond market around the world.
climate change.
They advise the issuers to construct a framework for the
The goals of these initiatives are to increase investor
process of issuing green bonds, which should include four
confidence and scale the green bonds market.
essential components.
At the moment, certificates can be obtained for bonds in the
The first of these is the usage of profits in situations when the
building, energy, and transport and water utility sectors.
GBP has established criteria for determining which types of
initiatives are qualified to be labelled as "green." Beginning in 2015 with Yes Bank, a number of public
institutions, banks, and private firms in India have issued
The second approach is a technique of evaluating and
green bonds.
selecting projects, in which the issuers are required to
describe the environmental objectives of the project as well as The vast majority of the bonds have some sort of connection
the risks that are expected to be incurred and the strategies to the energy industry.
that will be used to mitigate those risks.
Bonds that are issued outside of India but are denominated in
The third component is the management of the proceeds, Indian Rupees rather than the local currency have been issued
which requires the issuers to store the money in a sub- by Indian corporations.
account or a separately managed account and to keep the
These bonds are known as Green Masala Bonds.
lenders updated on the movement of the money.
In this scenario, the investors are the ones who are ABFM MODULE - D
responsible for bearing the risk of the fluctuating currency
Chapter 24: GREEN AND SUSTAINABLE FINANCING (PART-IV)
exchange rate.
What we will study?
The pandemic in 2020 had a negative effect on the issuance of
green bonds, which are fixed-income financial instruments *What are the benefits of Green Investment or Green Bonds?
used to finance projects that have positive environmental and
*What are the advantages and disadvantages of Green
or climate benefits.
Investments or Green Bonds?
Green bonds are used to finance projects that have positive
environmental and or climate benefits.
However, it was able to recover in 2021, reaching levels higher
than those recorded prior to the pandemic and recording an
increase of 116.9% from the $3.1 billion that was raised in
2019.
India is now the sixth largest country in the Asia-Pacific region
in terms of the total amount of green bonds issued in 2021.
According to statistics provided by the Climate Bonds
Initiative (CBI), the Asia-Pacific region issued a total of $126
billion worth of green bonds in 2021.
The largest amount was issued by China, which was $68 billion,
greater than the total value issued by the other APAC nations
combined.
Benefits of Green Investment or Green Bonds: b) Making it possible to finance more environmentally friendly
projects over the long term by reducing the maturity
The green bond market may provide a number of significant
mismatch:
advantages for environmentally responsible investment,
including the following: Due to the short maturity of their liabilities and the absence
of instruments for hedging duration risks, banks in many
a) Providing an additional source of financing for
countries are unable to provide long-term green loans to
environmentally friendly projects:
customers.
Given the massive amount of money that needs to be
This poses a problem for the financial sector as a whole.
invested in environmentally friendly projects, bonds are one
form of financing that is suitable for doing so. Businesses that can only get access to short-term bank credit
face additional risks when it comes to refinancing long-term
In light of the immense green investment needs, traditional
environmentally friendly projects.
sources of debt financing will not be sufficient.
These limitations on long-term green financing may be
As a result, there is a need to introduce new means of
alleviated if banks and corporations were allowed to issue
financing that can leverage a wider investor base, including
green bonds with medium- and long-term maturities
institutional investors (such as pension funds, insurance
specifically for environmental projects.
companies, and sovereign wealth funds) that manage more
than USD 100 trillion in assets worldwide.
In addition to green lending done by banks and green equity c) Improving the issuers' reputations and providing more
financing done by investors, the growth of the green bond transparency regarding environmental strategy:
market may be able to provide an additional source of funding
The issuance of a green bond is an efficient method for
in the future.
developing and putting into action a credible sustainability
strategy to present to investors and the general public.
This is accomplished by elaborating on the manner in which In some countries the reduction of tax rates, interest rate
the proceeds raised will contribute to a pipeline of concrete subsidies, and credit guarantee programmes are being
environmental projects. discussed as potential options for further lowering the funding
costs for green bonds.
Because green bonds are an efficient way for an issuer to
demonstrate its dedication to enhancing environmental The United States has already conducted experiments in this
sustainability, they have the potential to assist in the field with green property bonds and municipal bonds.
enhancement of an issuer's reputation in conjunction with
internal policies for the promotion of sustainable
development. e) Facilitating the "greening" of traditionally "brown" sectors:
d) Offering potential cost advantages: The benefits of the green bond market can function as a
transition mechanism that encourages issuers in less
It is possible that, once the market attracts a wider investor
environmentally-friendly sectors to take part in the green
base both domestically and internationally, a better pricing
bond market (provided that they ring-fence proceeds for
structure for green bonds as compared to regular bonds may
green projects) and also to reduce their environmental
emerge provided that demand is sustained.
footprint by engaging in green investment activities that can
However, the cost advantage is not yet evident in the current be funded via a green bond.
nascent green bond market because the market has not yet
This can be accomplished through the benefits of the green
had enough time to develop.
bond market that were discussed above.
According to the Climate Bonds Initiative (CBI), a number of
This is in addition to mandatory policies pertaining to the
issuers report an additional benefit in the increased speed of
"real economy," which lead to changes in business models
"book building," which refers to the process of generating,
(such as carbon pricing, waste reduction and recycling targets,
capturing, and recording investor demand for a bond issue.
policies to promote the circular economy, etc.)
This, in turn, translates into reduced costs for marketing and
road shows.
f) Making newly developed environmentally friendly financial Advantages and Disadvantages of investing and issuing Green
products accessible to investors who are committed to the Bonds:
long term:
The advantages of investing in green bonds are as under:
Institutional investors such as pension funds, insurance
a) Investors can balance financial and environmental returns.
companies, sovereign wealth funds, and other institutional
investors with a special preference for sustainable b) Meets Environmental, social, and corporate governance
(responsible) investment and long-term investment are (ESG) /green investing requirements.
looking for new financial instruments to help them achieve c) Improved risk assessment in an opaque fixed income
their investment goals. market through proceeds reporting.
These investors are looking to invest responsibly and for the d) Recognized by UNFCCC as non-state actor "climate action".
long term.
e) Private interaction with issuers on ESG topics relevant to
Green bonds give these investors access to such products and green bond issuance results in more thorough credit profiles
offer many other investors a way to diversify the holdings in of borrowers.
their portfolios.
f) Added openness of proceeds use and reporting
Green bonds also help the environment. requirements gives green bond investors an informational
Investors who are looking for green opportunities in a vast edge (on spending efficiency, project specifics and updates,
ocean of bonds can cut down on their "search costs" with the impact performance).
help of the green label, which is a discovery mechanism. g) Tracking and reporting proceeds utilisation improves
internal governance and the issuer's credit quality.
The disadvantages of investments in green bonds are: d) Advantages to one's reputation (for example, marketing
can promote the issuer's support for green investment and
a) A market that is still in its infancy and is quite small, with
the issuer's green credentials).
bond amounts that are relatively low.
e) Clarification of the sustainability plan and increased
b) The absence of universal criteria can increase the potential
confidence in its validity.
for confusion, as well as the damage to one's reputation if the
green integrity of a bond is called into question. g) The ability to take advantage of "economies of scale," given
that the majority of issuance expenses are associated with the
c) There is a restricted amount of room for the legal
process of setting up the system.
enforcement of green integrity.
The disadvantages of issuing green bonds are:
d) A lack of uniformity can result in research that is more
difficult to understand and a requirement for further due a) The one-time and continuing transaction costs associated
diligence that is not always met. with labelling and the accompanying administrative,
certification, reporting, verification, and monitoring
requirements.
The advantages of issuing green bonds are as under:
b) The risk to a bond's reputation if its "green credentials" are
a) Presenting and carrying out the issuer's approach to called into question.
environmental, social, and governance concerns.
c) Investors have the right to claim for damages in the event
b) Strong demand from investors might result in of a "green default," which occurs when an issuer violates the
oversubscription, which opens up the possibility of increasing terms of an agreement even though the bond was paid in full.
the amount issued.
c) There is evidence of an increase in investors who "buy and
hold" green bonds, which may result in decreased bond
volatility on the secondary market.
Chapter 25: SPECIAL PURPOSE ACQUISITION COMPANIES A company that does not carry any commercial operations
(SPAC) (PART-I) and is incorporated purely for the purpose of raising capital
through an Initial Public Offering (IPO) or is incorporated for
What we will study?
the goal of acquiring or merging with an existing company, is
*What is SPAC? known as a special purpose acquisition company (SPAC).
*What are the advantages of SPAC? A company, structured in this way, enables investors to
contribute money to a fund, which is subsequently used for
*What are the disadvantages of SPAC?
the acquisition of one or more unnamed enterprises, which
are only revealed after the IPO.
They first came into existence in the 1980s, during a time
when they were poorly regulated and, as a consequence,
investors lost money due to fraud.
Blank Cheque Companies is another name for these
businesses.
They have seen a rise in popularity just recently.
According to reports, in the year 2020, about 250 SPACs were
established, most of which were in the United States, and $80
billion was invested.
Approximately 600 SPACs initial public offerings(IPOs) took
place in 2021.
The Indian regulatory framework does not allow the creation In 2019, there were just 59 new SPACs introduced to the
of blank cheque companies. market with an investment of $13 Billion.
The Companies Act, 2013 stipulates that the Registrar of SPAC investors can be private equity funds or even well-
Companies can strike off a company if it does not commence known figures in the public eye.
operations within a year of incorporation.
They have a deadline of two years to successfully complete a
Recently, ReNew Power, an Indian company, had a business purchase, if they miss it, they will be required to repay the
transaction for combining with a company situated in the money to the investors.
United States, called RMG Acquisition Corporation II, which is
SPACs are organisations that are formed by investors or
a SPAC or a blank cheque company.
sponsors who have experience in a specific industry or
After the transaction, the combined company was named business sector with the purpose of pursuing business
ReNew Energy Global PLC and was publicly listed on NASDAQ. opportunities in that field.
This is the first major overseas listing of an Indian company via In most cases, the investors have at least one acquisition
the SPAC. target in mind at the time of the company's establishment.
Videocon d2h and online travel agency Yatra earlier had SPAC However, this information is not disclosed at the time of the
deals. IPO in order to streamline the disclosure process.
Because of the flexibility of SPACs to attract industries based Investors in an IPO do not have any information about the
on changing market fundamentals and also because SPAC IPO company in which they will ultimately be investing.
investors have the downside protection of redemption
Before issuing their shares to the general public, SPACs must
decisions, SPACs have recently become very popular as a
first get underwriters and institutional investors.
result of the market disruption caused by the Covid-19
pandemic. Underwriting is the process through which an individual or
institution takes on financial risk for a fee.
The money that are collected by SPAC are placed in a trust The vast majority of these businesses are extremely
account that earns interest on the funds. speculative, have massive capital requirements, and are able
to provide very little assurance on their revenue and
These funds can only be used for acquisitions or, in the event
profitability in the near term.
that the SPAC is dissolved, for the purpose of returning money
to investors. It's possible that India will launch its own "blank cheque firm"
in the near future.
In a select few instances, the interest that is accrued from the
trust account may be applied toward the aim of providing the The market regulator SEBI is likely to permit the listing of
SPAC with working capital. Special Purpose Acquisition Companies, much as they do in
the United States.
After an acquisition has been completed, a SPAC will typically
apply to be listed on one of the stock exchanges. The Securities and Exchange Board of India (SEBI) is reported
to have informed the Parliamentary standing committee,
Not every SPAC will be successful and accomplish their
according to news reports published in May 2022, that “The
milestone goals, in fact, some of them will fail entirely,
sub group of the principal market advisory committee (PMAC)
causing investors to lose their investment capital.
is in the process of finalising the report on SPACs."
Despite this, they plan to continue operating in the sector
After that, a consultation document on the topic that invites
since they provide investors and targets new alternatives for
feedback from the general public might be distributed.
funding that are in direct competition with later stage venture
capital, private equity, direct listing, and the traditional IPO Consultation with the PMAC is required before any actions
process. can be taken respecting the SPACs framework.
Today, the majority of SPACs place an emphasis on companies The company law committee report of the Ministry of
that are causing disruption in consumer, technology, or Corporate Affairs (MCA) for February 2022 advocated the
biotech areas. introduction of an enabling provision to recognise SPAC under
the Companies Act and allowing a SPAC formed in India to
trade on domestic and global markets.
ADVANTAGES OF SPAC: Even in the event that certain SPAC investors decide to cash
out their shares, it is still expected that the transaction would
When compared to an initial public offering (IPO), going public
be successfully concluded thanks to the backstop debt and
through a SPAC merger has the following primary advantages:
equity.
a) Speedier Execution:
What is back stop?
A SPAC merger typically takes place within three to six months
A back stop is the act of providing last-resort support or
on average, but an initial public offering (IPO) often takes
security in a securities offering for the unsubscribed portion of
between twelve and eighteen months to complete.
shares. When a company is trying to raise capital through an
b) Discovery of the price up front: issuance, it may get a back stop from an underwriter or a
While the price of your IPO will be determined by the state of major shareholder, such as an investment bank, to buy any of
the market at the time of listing, you will negotiate the price its unsubscribed shares.
with the SPAC before the transaction is finalised. d) Reduced Marketing Cost:
This is a far more favourable strategy in an unstable market. Decreased costs associated with marketing as a result of the
c) The possibility of raising additional capital: fact that a SPAC merger is not required to attract interest
from investors in public exchanges by means of a
SPAC sponsors will raise debt or PIPE funding in addition to
comprehensive roadshow (although raising PIPE involves
their initial capital in order to not only finance the transaction
targeted roadshows).
but also to fuel growth for the combined company.
e) Ease of access to specialised operational knowledge:
PIPE stands for "private investment in public equity".
The individuals that sponsor SPACs are typically seasoned
Private investment in public equity (PIPE) is when an
business and financial experts. They can provide their
institutional or an accredited investor buys stock directly from
managerial knowledge by drawing on their extensive network
a public company below market price.
of contacts, or they can volunteer to serve on the board
themselves.
The following is a list of the additional benefits: b) Poor Returns:
1. It shortens the time it takes for a company to become Returns may be below the expectations from the SPACs when
publicly traded. the initial hype has worn off.
2. There is less regulatory oversight of SPACs. Goldman Sachs strategists noted in September 2021, that out
of the 172 SPACs that had closed the deal since the start of
3. When compared to an IPO, the process of going public with
2020, the median SPAC had outperformed the Russel 3000
a high-leverage company is made much simpler by the
index from its IPO to deal announcement, but in the six
availability of SPACs.
months after the deal closure, the Median SPAC had
underperformed the Russel 3000 index by 42% points.
DISADVANTAGES OF SPACs: c) Low Market Cap:
When compared to an initial public offering (IPO), going public According to Renaissance Capital Strategist, nearly 70% of
via merger of SPACs suffers from the following disadvantages: SPACs that had their IPO in 2021 were trading below their $10
a) Inability to Track Use: offer price as of Sept 15, 2021.
An investor in a SPAC IPO has no idea about where his funds This desolate performance could mean that the SPAC Bubble
will be invested and may lose his investments because there is might be in the process of bursting.
doubt on whether its promoter will be successful in acquiring d) Increasing Regulatory Oversight:
or merging with a suitable target company in the future.
It is evident, that SPACs have lost some of their dazzle in late
The narrow degree of oversight from the regulators, coupled 2021 and early 2022 due to increased regulatory oversight and
with an absence of disclosure from the SPAC, means that the less than exceptional performance.
retail investors have the risk of hampering with an investment
e) Increased Disclosure Norms:
that could be overhyped or occasionally even fraudulent.
New accounting regulation issued by the Securities and
Exchange Commission (SEC) in April 2021 has led to a drop in
the new SPAC filings in the second quarter as compared to the SPACs to seek PIPE financing in order to fill the resulting
first quarter. shortfall.
f) Shareholding dilution: h) Compact Timeframe for Compliances:
SPAC sponsors typically own a 20% stake in the SPAC through Although the SPAC sponsor may offer assistance during the
founder shares or "promote" as well as warrants to purchase merger process, target company is typically responsible for
additional shares. the bulk of the preparation for required financials in the SEC
filings as well as the establishment of public company
This is in addition to the warrants that allow them to purchase
functions such as investor relations and internal controls
additional shares.
within a much shorter timeframe than in an IPO.
SPAC sponsors also benefit from an earnout component,
i) Narrow Scope for Financial diligence:
which enables them to receive more shares when the stock
price achieves a specified target over a certain time frame. The SPAC process does not require the stringent due diligence
of a traditional IPO, which could lead to potential
However, this could result in further dilution for the investors
restatements, incorrectly valued businesses, or even lawsuits.
who initially invested in the SPAC.
This is because the scope of the financial diligence performed
Earn-out: A provision written into some financial transactions
is narrower.
whereby the seller of a business will receive additional
payments based on the future performance of the business j) Absence of underwriting and comfort letter:
sold.
In a traditional initial public offering (IPO), the underwriter is
g) Deficiency in available capital: responsible for ensuring that all of the regulatory
requirements are met, however, because the target company
This can happen due to the possibility of redemption, Initial
in a SPAC is already public, it does not have an underwriter.
SPAC investors may choose to redeem their shares.
In the event that redemptions are higher than anticipated, the
availability of cash will become uncertain, which will force
ABFM MODULE - D SPAC FORMATION & TIMELINES:
Chapter 25: SPECIAL PURPOSE ACQUISITION COMPANIES The initial public offering (IPO) of a special purpose acquisition
(PART-II) company (SPAC) is typically predicated on an investment
thesis that is concentrated on a particular industry and
What we will study?
geographical region, such as the intention to acquire a
*All about SPAC formation and timeline? technology company in North America, or the experience and
history of a sponsor.
*All about SPAC merger?
After the initial public offering (IPO), the proceeds are
*Who are stakeholders of SPAC?
deposited into a trust account, and the SPAC normally has
*What are characteristics of SPAC? between 18 and 24 months to find and finalise a merger with
a target firm.
This process is frequently referred to as de-SPACing.
In the event that the SPAC is unable to accomplish a merger
within the specified amount of time, the SPAC will be
liquidated, and the profits from the IPO will be distributed
back to the public shareholders.
The public shareholders of the SPAC have the option to vote
against the deal once a target firm has been found and an
announcement of a merger has been made.
Alternatively, they may choose to redeem their shares.
If the SPAC needs additional finances to complete a merger, it
may choose to issue debt or additional shares through a
transaction known as a private investment in public equity Additionally, it will include a plethora of financial information
(PIPE) agreement. about the company that is the target of the merger, such as
proforma financial statements demonstrating the effects of
Alternatively, the SPAC may sell additional assets.
the merger, historical financial statements, and
management's discussion and analysis (MD&A).
The merger will be finalised and the target business will
transition into a publicly traded firm as soon as shareholders
provide their consent to the SPAC merger and all regulatory
issues are resolved.
Within four business days of the closing, a Form 8-K must be
filed with the United States Securities and Exchange
Commission (SEC).
This Form 8-K, which is commonly referred to as the Super 8-K,
THE SPAC MERGER: must contain information that is equivalent to what would be
required in a Form 10 filing of the target company.
After its formation, the SPAC will normally be required to seek
the permission of shareholders for a merger, and it will also STAKEHOLDERS:
prepare and file a proxy statement (or a joint registration and Typically, special purpose acquisition companies (SPACs) have
proxy statement on Form S-4 if it intends to register new three different stakeholder groups: sponsors, investors, and
securities as part of the merger). targets.
This document will contain a description of the proposed Every one of them is unique in the demands, worries, and
merger as well as aspects pertaining to governance, all of viewpoints that they have.
which will be seeking approval from the shareholders.
Sponsors: At a price of $10 per share, the SPAC sells investors a total of
50 million shares.
The process of creating a SPAC is started by sponsors.
Additionally, the sponsor purchases certain shares of the
Their contributions to SPAC, which take the form of non-
company at a nominal price.
refundable fees to bankers, attorneys, and accountants, are
intended to cover the costs of running the organisation. This purchase accounts for approximately 20% of the total
outstanding shares, or 12.5 million shares.
In the event that the Sponsor is unable to form a combination
within a period of two years, the SPAC will have to be If the sponsor is successful in meeting the goal of completing
dissolved, and the investors will be entitled to a full refund of the merger within two years, then the founder's share will be
their money. vested at the price of ten dollars per share, giving the stake a
value of one hundred twenty-five million dollars.
Therefore, sponsors run the risk of losing their risk capital in
the event that the transaction is unsuccessful. The only way for sponsors to be eligible for these awards is if
they have a powerful concept and are able to effectively
However, if the transaction is successful, sponsors receive the
attract investors, locate a suitable target, and convince him of
sponsor's shares in the combined corporation, which
the financial and strategic benefits of the business
frequently amount to as much as 20% of the equity raised
combination.
from investors.
In order to avoid losing the investors along the way, they will
Example:
need to discuss the parameters of the deal during the entire
A sponsor establishes a SPAC with the intention of raising a process.
total of $500 million in capital and makes an initial investment
However, competition among sponsors for targets and
of approximately $7 million to $8 million to fund the
investors has heated up, which has led to an increase in the
administrative costs of the enterprise.
possibility that a sponsor will lose both the risk capital it has
These costs include underwriting, attorney, and due diligence invested and the time it has invested.
fees.
CHARACTERISTICS OF SPACS: In most cases, the management team of the SPAC is entitled
to receive 20% of the equity of the vehicle, excluding the
Once the public offering is complete, SPACs are often traded
value of any warrants that may be issued.
on stock exchanges as units, or as distinct common shares and
warrants, depending on the structure of the offering. Prior to the business merger, the management team did not
receive any cash compensation in the form of wages, finder's
Because of the liquidity in the trading market, investors have
fees, or other types of cash compensation.
the option of easily exiting their positions.
In the event that the management team is unable to
The corporation is obligated to provide the stockholders of
successfully complete a business combination, they will not be
the target business with full disclosure, which must include
included in the distribution of assets that results from the
comprehensive audited financial statements and the terms of
liquidation.
the proposed business combination.
This is done to enable the stakeholders to make an informed
decision regarding whether or not they wish to approve the
business combination.
All of the stakeholders of the SPAC are given voting rights at a
shareholder meeting so that they can either agree to or
disagree with the proposed combination of the two
companies.
The SPAC is often led by an experienced management team
that includes at least three people who have previous
expertise in private equity, mergers and acquisitions, and
operating roles.
ABFM MODULE - D PROCESS:
Chapter 25: SPECIAL PURPOSE ACQUISITION COMPANIES

(PART-III)
What we will study?

*All about SPAC Process?
*All about Capital Structure of SPAC?
When the SPAC obtains the funds through the IPO, the money
is placed in a trust and kept there for a predetermined
amount of time or until the acquisition is completed,
whichever comes first.
The Special Purpose Acquisition Company (SPAC) is obligated
to repay the funds to investors after deducting bank and
broker costs in the event that the planned acquisition is not
completed or the legal requirements are not yet complete.
A Special Purpose acquisition company is made up of
seasoned business leaders who are self-assured about their
reputation in the industry and the fact that they have the
knowledge necessary to assist them in locating a lucrative
company to purchase.
When seeking financial backing from investors, the founders After successfully raising cash through an initial public offering,
of a company are the primary selling point. the SPAC's management team has between 18 and 24 months
to find an acquisition target and successfully close on it.
The company's founders are the ones that contribute the
startup funding, and they stand to benefit financially from the The time period could be different depending on the company
large interest in the purchased business. and its history.
After the company's founders have provided the initial money The target company's enterprise value at the time of
and paid a minimal price for a portion of the company's stock, acquisition should represent at least 80% or more of the
the management team will approach an investment bank to trust's total assets.
execute the initial public offering (IPO).
Following the completion of the acquisition of the target
Both the investment bank and the management team will company, the founders of the new company will reap the
collect a fee equivalent to around 10% of the IPO's total value. benefits of their ownership in the business, and the other
investors will receive equity interests proportional to the
If the business requires additional funding, the sponsors have
amount of capital they contributed.
the option of lending the necessary money to the SPAC in the
form of a loan. In the event that the acquisition of the target firm cannot be
completed within the allotted amount of time, the funds that
Due to the fact that the company has a shorter history and
have been deposited into the trust account will be distributed
lower revenues, the prospectus of the SPAC places more
back to the investors.
emphasis on the investors.
Before the transaction is finalised, it is against the rules for
The money obtained from an initial public offering (IPO) is
the management team to collect their salary.
placed in a trust account until a private firm is selected as a
possible acquisition target. In order to fund a portion of the purchase price for the
business combination, the SPAC will first organise committed
debt or equity financing, such as a Private Investment in
Public Equity (PIPE) commitment, prior to signing the The funds are often gathered from institutional and retail
acquisition agreement. investors and are kept in a trust account.
Afterwards, it will declare publicly both the acquisition In exchange for their investment, investors get units of SPAC,
agreement and the committed finance. each of which contains a share of common stock and a
warrant to buy more shares at a later time.
After the acquisition has been announced, the SPAC is
required to either conduct a tender offer process or hold a After the IPO, the units can be split up into warrants and
mandatory vote of the shareholders. shares of common stock that can be sold on the open market.
In either case, the investors will be given the right to return
their public shares to the SPAC in exchange for cash that is
approximately equivalent to the IPO price paid for those
shares.
The business combination will be carried out if the
shareholders provide their consent to the transaction, the
financial requirements are met, and all other conditions
outlined in the purchase agreement are satisfied.
This will result in the formation of a publicly traded operating
company as a result of the combination of SPAC and the
target firm.
SPAC CAPITAL STRUCTURE:

To raise the necessary funds to finish the acquisition of a
private company, a SPAC typically conducts an IPO.
TRUST ACCOUNT: In most cases, the share price at the time of the first public
offering will serve as the basis for determining the strike price
In connection with the closure of the IPO, a sum equal to or
of the warrant.
greater than 100% of the gross proceeds of the IPO is used to
finance the trust account, with roughly 95% of the funds The public warrants are typically settled in cash, with the
coming from the general public and 5% from the sponsors. investor being required to pay an amount equal to the
warrant's strike price in exchange for a share of the company's
The money in the trust account is invested in government
stock.
securities, or it is kept as cash, to pay for the business
combination, the redemption of common stock under a On the other hand, the founder warrants are net settled,
compulsory redemption offer, the payment of the deferred meaning that the founder is not required to make a payment
underwriting discount, any transaction costs, and the in cash but rather receives a number of shares of stock with a
company's working capital following the De-SPAC transaction. fair market value equal to the difference between the trading
price of the stock and the warrant's strike price.
WARRANTS:
The warrants are purchased in their whole (or in a bunch) by
the sponsor, whereas the units offered for sale to the general
public often include only a portion of a single warrant.
In larger initial public offerings (IPOs) these days, the issuance
of one-third of the warrant is more prevalent, nonetheless,
the standard practise is to issue - half of the warrant.
In every circumstance, the entirety of the warrants can be put
to use.
ABFM MODULE - D DE-SPAC PROCESS:
Chapter 25: SPECIAL PURPOSE ACQUISITION COMPANIES The following procedures make up each stage of the De-SPAC
(PART-IV) process:
What we will study? ● Requirements for Shareholder Approval.
*All about DE-SPAC Process? ● Founder Approbation Votes.

● Disclosure of Material on a Super 8-k Form.
● Redemption Offer.
Shareholder Approval:
The procedure of de-SPACing is quite similar to that of
merging two public companies, with the exception that the
buyer, in this case the SPAC, needs to get approval from the
shareholders.
On the other hand, voting by shareholders is not necessary for
stock exchanges.
Founder Vote Requirements:

At the time of the initial public offering (IPO), the founder
shareholders, also known as the sponsor or any other holders,
will make a commitment to vote in favour of the De-SPAC
transaction for any founder shares owned by them as well as
any public shares purchased during or after the IPO.
Therefore, at least 20% of the outstanding shares of the SPAC If the De-SPAC deal does not go through, however, the money
will be committed to voting in support of the De-SPAC will be returned to the public shareholders, but the public
Transaction, and as a result, just 37.5% of the public shares warrants, founder shares, and founder warrants will all lose
are necessary to accomplish the goal of the majority vote and their value and expire.
approve the transaction.
Redemption Offer:
SPACs are desirable because they give owners of public shares
the option to exchange those shares for a proportional share
of the profits stored in a trust account.
This is one of the reasons why public share ownership is
desirable.
The redemption offer will not be valid for public warrants
until such time as those warrants are either exercised,
exchanged, or otherwise voided in accordance with the terms
of a vote.
If the time limit to finish the SPAC transaction passes, and the
company wants to change its charter documents to allow for a
longer period of time to carry out the De-SPAC transaction,
then it will be required to redeem the public shares for their
proportional share of the amount that is held in the trust
account.
ABFM MODULE - D IPO AGREEMENTS:
Chapter 25: SPECIAL PURPOSE ACQUISITION COMPANIES The establishment of the SPAC as well as the initial public
(PART-V) offering (IPO) of the SPAC both involve the customary signing
of a series of contracts and other documents.
What we will study?
There are a few documents that are universal to all SPACs,
*All about IPO Agreement for SPAC?
such as the registration rights agreement and the certificate of
incorporation.
The remaining documents are specific to SPACs and cannot be
found elsewhere.
Charter:
The SPAC Charter is the document that establishes the public
shares as well as the founder shares and includes an anti-
dilution modification to the conversion ratio for the founder
shares.
Additionally, it places limitations on the use of the money in
the trust account, limiting its applications to only the
repurchase of public shares and the determination of a
minimum size requirement for the business that would be
acquired in a De-SPAC transaction.
Securities Purchase Agreement: Promissory Note:
The Sponsor and the SPAC enter into a Securities purchase With the funds raised through the initial public offering (IPO)
Agreement, which provides for the issue of founder shares to as well as the sale of founder shares and founder warrants,
the Sponsor of the SPAC. SPAC is able to cover all of the costs associated with putting
on the offering as well as organising the offering.
The number of founder shares is typically set at 25% of the
total amount of publicly traded shares that are initially The legal fees, travel and road show fees, accounting fees,
registered on the registration statement. insurance premium, and other incidental charges are included
in these costs.
However, the number of founder shares may be decreased or
increased through a stock split, dividend, or forfeiture in order Because the SPAC does not have adequate cash to pay off
to size the founder shares to the initially agreed upon such expenses prior to the completion of the IPO, the sponsor
percentage of 25%. agrees to engage into a promissory note with the SPAC in
order to lend funds to the SPAC in the form of a loan until the
completion of the SPAC's first public offering.
Warrant Agreement:
Sponsor Constituent Document:
The SPAC and the transfer agent both sign the warrant
Often, a new limited liability company is established for the
agreement, which outlines the parameters of the warrant and
sole purpose of acting as the sponsor for the special purpose
must be done so before the warrant may be issued.
acquisition company (SPAC).
The warrant specifies that the SPAC will be required to comply
In the constituent documents, the owners of the sponsors put
with an obligation to register the issuing of public shares in
their relationship with one another and their relative
the event that the public warrants are exercised.
participation in the SPAC in writing.
To change the conditions of the warrant agreement, approval
For example, they specify the proportionate amount of the
is required from 50% of the warrant holders.
founder warrant purchase price that each will fund as well as
their economic ownership of the founder warrants and Registration Rights Agreement:
founder shares.
For the benefit of the sponsor and any other holders of
Letter Agreement: founder shares and founder warrants, the SPAC enters into a
registration rights agreement granting the sponsor and such
The SPAC reaches a letter agreement with its officers,
other holders broad registration rights with respect to the
directors, and sponsor before moving forward with the
founder shares, founder warrants, and any other equity held
process.
by the sponsor and such other holders in the SPAC.
The letter agreement may include a lock up agreement, an
indemnification from the sponsor towards SPAC for certain
claims that may be made against the trust account, a voting Private Placement Warrants Purchase Agreement:
agreement obligating the officer, directors, and sponsor to
In accordance with the terms of the Private placement
vote their founder shares and public shares, if any, in favour
warrants purchase agreement that it has signed with the SPAC,
of the De-SPAC transaction.
the sponsor has agreed to purchase founder warrants.
An obligation to forfeit founder shares to the extent that
The financing of the purchase price occurs one business day
green shoe is not exercised in full, and an agreement to not
before the conclusion of the initial public offering (IPO), as
sponsor other SPACs until the De-SPAC transaction has been
well as one business day before the closing of any exercise of
completed.
the green shoe option.
Green Shoe option: A green shoe option is a provision in an
Securities Assignment Agreement:
IPO underwriting agreement that grants the underwriter the
right to sell more shares than originally planned. The compensation for independent directors is provided by
the SPAC in the form of the cost-plus sale of founder shares.
Since the directors are not paid any fees in any other way, this
is the only method that they can receive their remuneration.
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Administrative Service Agreement:
A monthly charge is paid by the SPAC to the sponsor in
exchange for the sponsor providing utilities, office space,
secretarial support, and other administrative services in
accordance with an administrative service agreement
between the sponsor and the SPAC.
After the initial public offering (IPO), it will also sign into an
investment management trust agreement with the trustee.
This agreement will control the investment and release of the
funds that will be held in the trust account.

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ABFM MODULE - A INTRODUCTION:

Active participation by managers, in all the above functions, is

*All about Maslow’s hierarchy of needs?

*All about Motivation-Hygiene Theory? Classical or Traditional School:

According to this theory, an organisation, comprises of both

The theory can be summarized as follows: Theory X Assumptions:

Total Quality Management:

The Contemporary School of Management: 2- Customer focus:

Further, continuous research is giving rise to new approaches

Deming, Juran and Crosby were three main contributors to

4- Team learning: c) A learning organisation has higher productivity and output.

Chapter 1: Basics of Management (PART-VII) Introduction:

c) Functional strategy refers to the approach adopted by

What we will study?

1. The Context (Environmental Scanning):

• Who will execute?

What we will study? The key components of Planning include:

b) Trigger. *Since forecasting makes use of a wide variety of methods,

Principles of Decision Making:

Organising Capabilities Management is the capacity to 3- Assignment of duties.

Chapter 3: ORGANISING (PART-IV) In the context of management, the term "line-staff

Functional Organisation: Illustratively, the functional heads and marketing directors in

Efficient Control: Disadvantages of Functional Organisation:

Alterations to an organisation can take on a variety of forms. Developmental Change:

The process of utilising change to bring about a successful

The formal organisational structure describes in detail the

What we will study? Recruitment, Selection, Training.

Therefore, if you want to be successful in recruiting, you need *What is Selection?

Hire the person already excelling in similar jobs:

It is necessary for an organization to develop its own selection

Chapter 5: DIRECTING (PART-I) The management functions in an organisation broadly involve,

Chapter 5: DIRECTING (PART-II) Direction at all levels:

Humanist: *What is Authoritarian leadership?

Herzberg's Theory of Motivation:

(a) Controlling is beneficial to the accomplishment of 1. Assists in accomplishing Organisational Goals.

Selection of the Techniques of Controlling:

First-stage: Management Buyout (MBO):

The simplest example of a lever is the see-saw which has a

𝐄𝐀𝐓 PAT 40,000 65,000

Chapter 8: Financial and Operating Leverages (PART-II) 1-Operating Leverage

What we will study? 2-Finanacial Leverage

In other words, we are measuring the impact of Fixed Cost.

Particulars Product X (Rs.)

Sales (50 x 1000 units) 50,000

Less: Variable Cost (30 x 1000 units) (30,000)

Less: Fixed Cost (15,000)

Profit (EBIT) 5,000

Solution: A Ltd (Rs.) B Ltd (Rs.) C Ltd (Rs.) D Ltd (Rs.)

Variable cost per unit 6 16 20 50

𝑪𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏 Less: Variable cost (Unit x (30,000) (80,000) (1,00,000) (2,50,000)

EBIT 10,000 40,000 50,000 1,00,000

𝑪𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏 𝟖𝟎,𝟎𝟎𝟎 Particulars Product A Product B

Break-Even Analysis: Total Variable Cost 20*1000= (20,000) 12*1000=(12,000)

Particulars Product A Product B Contribution 20,000 8,000

(Rs.) (Rs.) Fixed Cost (15,000) (5,000)

Selling Price p.u. 40 20 Profit (EBIT) 5000 3000

Variable Cost p.u. 20 12 DOL 20000/5000 = 4 8000/3000 = 2.67

Break-Even Analysis: Total Variable Cost 201000= (20,000) 121000=(12,000)