National Institute of Business Management

Chennai - 020

FIRST SEMESTER EMBA/ MBA

Subject : Financial Management

Attend any 4 questions. Each question carries 25 marks

(Each answer should be of minimum 2 pages / of 300 words)

1. Explain the objectives of financial management, interphase between

finance and other functions.

2. Explain the Indian Financial Systems.

3. Explain debentures as instruments for raising long-term debt capital.

4. What are Inventories? Explain.

5. Explain the different sources of cash.

6. What is cash budget and proforma balance sheet? Explain.

25 x 4=100 marks

SOLUTIONS:-
 Question Number:- 3

Explain debentures as instruments for raising long-term debt capital .

Answer :-

Debenture means a document issued by the company as an acknowledgment

of indebtedness to its debenture-holders and giving an undertaking to repay
the debt at a specified date or at the option of the company. These are the
instruments for raising long term debt capital. Debenture holders are the
creditors of the company to which company pays the interest at a fixed rate
and at the intervals stated in the debenture. No voting rights are given to the
debenture holders. Usually debentures are secured by charge on the assets of
the company. Following are the features of debentures:

1) Debenture holders of the company are the creditors of the company and
not the owners of the company.

2) Capital raised by way of debentures is required to be repaid during the life

time of the company at the time stipulated by the company. Thus, it is not a
source of permanent capital.

3) Debentures are generally secured.

4) Return paid by the company is in the form of interest which is

predetermined.
5) Debentures are very risky from company’s point of view for raising long
term funds.

6) Risk on the part of debenture holders is very less.

7) Debenture holders do not carry any voting rights.

8) Debentures are a cheap source of funds from the company’s point of view.

Benefits to Company : Controlling position of the existing equity

shareholders does not get affected as debentures do not carry any voting
rights. The post tax cost associated with debentures is less. Debentures
provide funds for a specific period. During the period of inflation the
company may be compelled to issue debentures as a source of raising long
term capital.

Benefits to Investors : Investment in debentures is a good option for

conservative investors as well as institutional investors as fixed rate of
interest is payable by the company and security available for the investment.

Question Number :-4

 What are Inventories? Explain.
Answer:-

Definition: Inventory, often called merchandise, refers to goods and

materials that a business holds for sale to customers in the near future.

In other words, these goods and materials serve no other purpose in the
business except to be sold to customers for a profit. They are not used in the
produce things or promote the business. The sole purpose of these current
assets is to sell them to customers for a profit, but just because an asset is for
sale doesn’t mean that it’s considered inventory. We need to look at three
main characteristics of inventory to determine whether an asset should be
accounted for as merchandise.

3 Basic types of inventories are raw materials, work-in-progress, finished

goods,

Inventories are also classified as merchandise and manufacturing inventory.

Other such classifications on various bases are goods in transit, buffer stock,
anticipatory stock, decoupling inventory, and cycle inventory. We will
understand all these inventories in details in the further article.

There are three types of businesses such as trading or merchandising,

manufacturing, and service. Out of these, services are not inventorial. Here,
the first classification of inventory is based on nature of business –
Merchandise Inventory and Manufacturing Inventory.

o Raw Materials: These are the materials or goods purchased by the

manufacturer. Manufacturing process is applied on the raw material to
produce desired finished goods. For example, aluminum scrap is used to
 produce aluminum ingots. Flour is used to produce bread. Finished goods
for someone can be raw material for someone. For example, the aluminum
ingot can be used as raw material by utensils manufacturer.
The business importance of raw material as an inventory is mainly to
protect any interruption in production planning. Other reasons can be
availing price discount on bulk purchases, guard against market shortage
situation, etc.
o

o Work-In-Progress (WIP): These are the partly processed raw

materials lying on the production floor. They may or may not be saleable.
These are also called semi-finished goods. It is unavoidable inventory
which will be created in almost any manufacturing business.
This level of this inventory should be kept as low as possible. Since a lot
of money is blocked over here which otherwise can be used to achieve
better returns. Speeding up the manufacturing process, proper production
planning, customer and supplier system integration etc can diminish the
levels of work in progress. Lean management considers it as waste.
o

o Finished Goods: These are the final products after manufacturing

process on raw materials. They are sold in the market.
There are two kinds of manufacturing industries. One, where the product
is first manufactured and then sold. Second, where the order is received
first and then it is manufactured as per specifications. In the first one, it
is inevitable to keep finished goods inventory whereas it can be avoided
in the second one.
Question Number:-2

Explain the Indian Financial Systems.

Answer:-

Economic growth and development of any country depends upon a well-knit

financial system. Financial system comprises, a set of sub-systems of
financial institutions financial markets, financial instruments and services
which help in the formation of capital. Thus a financial system provides a
mechanism by which savings are transformed into investments and it can be
said that financial system play an significant role in economic growth of the
country by mobilizing surplus funds and utilizing them effectively for
productive purpose.

The financial system is characterized by the presence of integrated,

organized and regulated financial markets, and institutions that meet the
short term and long term financial needs of both the household and corporate
sector. Both financial markets and financial institutions play an important
role in the financial system by rendering various financial services to the
community. They operate in close combination with each other.

Financial System;
The word "system", in the term "financial system", implies a set of complex
and closely connected or interlined institutions, agents, practices, markets,
transactions, claims, and liabilities in the economy. The financial system is
concerned about money, credit and finance-the three terms are intimately
related yet are somewhat different from each other. Indian financial system
consists of financial market, financial instruments and financial
intermediation

Role/ Functions of Financial System:

A financial system performs the following functions:

* It serves as a link between savers and investors. It helps in utilizing the

mobilized savings of scattered savers in more efficient and effective manner.
It channelizes flow of saving into productive investment.
* It assists in the selection of the projects to be financed and also reviews the
performance of such projects periodically.
* It provides payment mechanism for exchange of goods and services.
* It provides a mechanism for the transfer of resources across geographic
boundaries.
* It provides a mechanism for managing and controlling the risk involved in
mobilizing savings and allocating credit.
* It promotes the process of capital formation by bringing together the
supply of saving and the demand for investible funds.
* It helps in lowering the cost of transaction and increase returns. Reduce
cost motives people to save more.
* It provides you detailed information to the operators/ players in the market
such as individuals, business houses, Governments etc.

Components/ Constituents of Indian Financial system:

The following are the four main components of Indian Financial system

1. Financial institutions.
2. Financial Markets.
3. Financial Instruments/Assets/Securities.
4. Financial Services.

Financial institutions:

Financial institutions are the intermediaries who facilitates smooth

functioning of the financial system by making investors and borrowers meet.
They mobilize savings of the surplus units and allocate them in productive
activities promising a better rate of return. Financial institutions also provide
a service to entities seeking advises on various issues ranging from
restructuring to diversification plans. They provide whole range of services
to the entities who want to raise funds from the markets elsewhere. Financial
institutions act as financial intermediaries because they act as middlemen
between savers and borrowers. Were these financial institutions may be of
Banking or Non-Banking institutions.
Financial Markets:

Finance is a prerequisite for modern business and financial institutions play

a vital role in economic system. It's through financial markets the financial
system of an economy works. The main functions of financial markets are:

1. to facilitate creation and allocation of credit and liquidity;

2. to serve as intermediaries for mobilization of savings;
3. to assist process of balanced economic growth;
4. to provide financial convenience

Financial Instruments

Another important constituent of financial system is financial instruments.

They represent a claim against the future income and wealth of others. It will
be a claim against a person or an institutions, for the payment of the some of
the money at a specified future date.

Financial Services:

Efficiency of emerging financial system largely depends upon the quality

and variety of financial services provided by financial intermediaries. The
term financial services can be defined as "activites, benefits and satisfaction
connected with sale of money that offers to users and customers, financial
related value".

Pre-reforms Phase

Until the early 1990s, the role of the financial system in India was primarily
restricted to the function of channeling resources from the surplus to deficit
sectors. Whereas the financial system performed this role reasonably well,
its operations came to be marked by some serious deficiencies over the
years. The banking sector suffered from lack of competition, low capital
base, low Productivity and high intermediation cost. After the
nationalization of large banks in 1969 and 1980, the Government-owned
banks dominated the banking sector. The role of technology was minimal
and the quality of service was not given adequate importance. Banks also did
not follow proper risk management systems and the prudential standards
were weak. All these resulted in poor asset quality and low profitability.
Among non-banking financial intermediaries, development finance
institutions (DFIs) operated in an over-protected environment with most of
the funding coming from assured sources at concessional terms. In the
insurance sector, there was little competition. The mutual fund industry also
suffered from lack of competition and was dominated for long by one
institution, viz., the Unit Trust of India. Non-banking financial companies
(NBFCs) grew rapidly, but there was no regulation of their asset side.
Financial markets were characterized by control over pricing of financial
assets, barriers to entry, high transaction costs and restrictions on movement
of funds/participants between the market segments. This apart from
inhibiting the development of the markets also affected their efficiency.

Financial Sector Reforms in India

It was in this backdrop that wide-ranging financial sector reforms in India

were introduced as an integral part of the economic reforms initiated in the
early 1990s with a view to improving the macroeconomic performance of
the economy. The reforms in the financial sector focused on creating
efficient and stable financial institutions and markets. The approach to
financial sector reforms in India was one of gradual and non-disruptive
progress through a consultative process. The Reserve Bank has been
consistently working towards setting an enabling regulatory framework with
prompt and effective supervision, development of technological and
institutional infrastructure, as well as changing the interface with the market
participants through a consultative process. Persistent efforts have been
made towards adoption of international benchmarks as appropriate to Indian
conditions. While certain changes in the legal infrastructure are yet to be
effected, the developments so far have brought the Indian financial system
closer to global standards.

The reform of the interest regime constitutes an integral part of the financial
sector reform. With the onset of financial sector reforms, the interest rate
regime has been largely deregulated with a view towards better price
discovery and efficient resource allocation. Initially, steps were taken to
develop the domestic money market and freeing of the money market rates.
The interest rates offered on Government securities were progressively
raised so that the Government borrowing could be carried out at market-
related rates. In respect of banks, a major effort was undertaken to simplify
the administered structure of interest rates. Banks now have sufficient
flexibility to decide their deposit and lending rate structures and manage
their assets and liabilities accordingly. At present, apart from savings
account and NRE deposit on the deposit side and export credit and small
loans on the lending side, all other interest rates are deregulated. Indian
banking system operated for a long time with high reserve requirements both
in the form of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio
(SLR). The efforts in the recent period have been to lower both the CRR and
SLR. The statutory minimum of 25 per cent for SLR has already been
reached, and while the Reserve Bank continues to pursue its medium-term
objective of reducing the CRR to the statutory minimum level of 3.0 per
cent, the CRR of SCBs is currently placed at 5.0 per cent of NDTL.

As part of the reforms program, due attention has been given to

diversification of ownership leading to greater market accountability and
improved efficiency. Initially, there was infusion of capital by the
Government in public sector banks, which was followed by expanding the
capital base with equity participation by the private investors. This was
followed by a reduction in the Government shareholding in public sector
banks to 51 per cent. Consequently, the share of the public sector banks in
the aggregate assets of the banking sector has come down from 90 per cent
in 1991 to around 75 per cent in2004. With a view to enhancing efficiency
and productivity through competition, guidelines were laid down for
establishment of new banks in the private sector and the foreign banks have
been allowed more liberal entry. Since 1993, twelve new private sector
banks have been set up. As a major step towards enhancing competition in
the banking sector, foreign direct investment in the private sector banks is
now allowed up to 74 per cent, subject to conformity with the guidelines
issued from time to time.

Conclusion: The Indian financial system has undergone structural

transformation over the past decade. The financial sector has acquired
strength, efficiency and stability by the combined effect of competition,
regulatory measures, and policy environment. While competition,
consolidation and convergence have been recognized as the key drivers of
the banking sector in the coming years.

Question Number:- 1
Explain the objectives of financial management, interphase between finance and
other functions.

Answer:-

Finance is the study of money management, the acquiring of funds (cash)

and the directing of these funds to meet particular objectives. Good financial
management helps businesses to maximize returns while simultaneously
minimizing risks.

Financial management is an integral part of overall management and not

merely a staff function. It is not only confined to fund raising operations but
extends beyond it to cover utilization of funds and monitoring its uses. These
functions influence the operations of other crucial functional areas of the
firm such as production, marketing and human resources. Hence, decisions
in regard to financial matters must be taken after giving thoughtful
consideration to interests of various business activities. Finance manager has
to see things as a part of a whole and make financial decisions within the
framework of overall corporate objectives and policies.

Let us discuss in greater detail the reasons why knowledge of the financial
implications of their decisions is important for the non-finance managers.
One common factor among all managers is that they use resources and since
resources are obtained in exchange for money, they are in effect making the
investment decision and in the process of ensuring that the investment is
effectively utilized they are also performing the control function.

Marketing-Finance Interface
There are many decisions, which the Marketing Manager takes which have a
significant location, etc. In all these matters assessment of financial
implications is inescapable impact on the profitability of the firm. For
example, he should have a clear understanding of the impact the credit
extended to the customers is going to have on the profits of the company.
Otherwise in his eagerness to meet the sales targets he is liable to extend
liberal terms of credit, which is likely to put the profit plans out of gear.
Similarly, he should weigh the benefits of keeping a large inventory of
finished goods in anticipation of sales against the costs of maintaining that
inventory. Other key decisions of the Marketing Manager, which have
financial implications, are:

 Pricing
 Product promotion and advertisement
 Choice of product mix
 Distribution policy.

Production-Finance Interface

As we all know in any manufacturing firm, the Production Manager controls

a major part of the investment in the form of equipment, materials and men.
He should so organize his department that the equipment under his control
are used most productively, the inventory of work-in-process or unfinished
goods and stores and spares is optimized and the idle time and work
stoppages are minimized. If the production manager can achieve this, he
would be holding the cost of the output under control and thereby help in
maximizing profits. He has to appreciate the fact that whereas the price at
which the output can be sold is largely determined by factors external to the
firm like competition, government regulations, etc. the cost of production is
more amenable to his control. Similarly, he would have to make decisions
regarding make or buy, buy or lease etc. for which he has to evaluate the
financial implications before arriving at a decision.

Top Management-Finance Interface

The top management, which is interested in ensuring that the firm’s long-
term goals are met, finds it convenient to use the financial statements as a
means for keeping itself informed of the overall effectiveness of the
organization. We have so far briefly reviewed the interface of finance with
the non-finance functional disciplines like production, marketing etc.
Besides these, the finance function also has a strong linkage with the
functions of the top management. Strategic planning and management
control are two important functions of the top management. Finance function
provides the basic inputs needed for undertaking these activities.

Economics – Finance Interface

The field of finance is closely related to economics. Financial managers

must understand the economic framework and be alert to the consequences
of varying levels of economic activity and changes in economic policy. They
must also be able to use economic theories as guidelines for efficient
business operation. The primary economic principle used in managerial
finance is marginal analysis, the principle that financial decisions should be
made and actions taken only when the added benefits exceed the added
costs. Nearly all-financial decisions ultimately come down to an assessment
of their marginal benefits and marginal costs.

Accounting – Finance Interface

The firm’s finance (treasurer) and accounting (controller) activities are

typically within the control of the financial vice president (CFO). These
functions are closely related and generally overlap; indeed, managerial
finance and accounting are often not easily distinguishable. In small firms
the controller often carries out the finance function, and in large firms many
accountants are closely involved in various finance activities. However,
there are two basic differences between finance and accounting; one relates
to the emphasis on cash flows and the other to decision making.