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
 1. Explain the objectives of financial management, interphase between
finance and other functions.

Finance is regarded as the life blood of a business enterprise. Finance is one of the
basic foundations of all kinds of economic activities, particularly in the present
modern money-oriented economy. The field of finance is closely related to accounting
and economics

As a management function, finance may be defined as the procurement of funds and

their effective utilisation.

Financial management is mainly concerned with the proper management of funds. The
finance manager must see that the funds are procured in such a manner that the risk,
cost and control considerations are properly balanced in a given situation and there is
optimum utilisation of funds.

Traditionally the basic objectives of financial management are ;

1.maintenance of liquid assets and
2.maximisation of profitability of the firm.

Maintenance of liquid assets:

Maintenance of liquid assets is to ensure that the firm has adequate cash in hand to
meet its obligations at all times.

Profit Maximisation

Suppose the Finance Manager manages to make available the required funds at an
acceptable cost and that the funds are suitably invested and that everything goes
according to plan because of the effective control measures used. A business firm is a
profit-seeking organisation. Hence, profit maximisation is also well considered to be
an important objective of financial management. The results of good performance are
reflected as profits of the firm. However, profit maximisation cannot be the sole
objective of a firm as there is a direct relationship between risk and profit. If profit
maximisation is the only goal, then risk factor is ignored. Sometimes, higher the risk,
higher is the possibility of profits.
Maximisation of wealth:

Profit maximisation is not considered to be an ideal criterion for making investment

and financing decisions The objective of a firm or company must be to create value
for its shareholders. Value is represented by the market price of the company’s
common stock, which, in turn is a function of the firm’s investment, financing and
dividend decisions. The idea is to acquire assets and invest in new products and
services where expected return exceeds their cost, to finance with those instruments
where there is particular advantage, tax or otherwise, and to undertake a meaningful
dividend policy for stockholders.

Thus, wealth maximisation or value creation is considered to be the main objective of

modern financial management. Achievement of the non-financial objectives may
indirectly help the company in increasing its value. A corporate advertising campaign
highlighting the above achievements may boost the share prices in the market

INTERFACE BETWEEN FINANCE AND OTHER FUNCTIONS

The finance manager depends upon the inputs provided by other operating managers:

 the production manager or engineer, who is accountable for optimum use of

equipment and facilities and of the funds invested therein;
  the marketing manager, answerable for the forecast of demand for the product,
customer satisfaction, credit policy etc;

 the top management, which is interested in ensuring that the firm’s long-term
goals are met.

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 utilisation 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.

Summery of interfaces of finance;

1. Marketing-finance interface:

 A finance manager 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 are pricing, product, promotion and advertisement,
choice of product mix and distribution policy.

2. Production-finance interface:

 The production manager should so organize his department that the

equipment’s, 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.
3. Top management-finance interface:

 Strategic planning and management control are two important functions of

the top management. Finance function provides the basic inputs needed to
undertake these activities.

4. Other Challenges in Financial Management:

 Treasury Operations
 Foreign Exchange
 Maintaining Share Prices
 Ensuring Management Control
3. Explain debentures as instruments for raising long-term debt capital.

Debenture means a document issued by the company as an acknowledgement 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

Debentures are instruments for raising long-term debt capital and it is the most
popular form of debt capital. Debt capital is funds supplied by lender that is part of a
company’s capital structure. Debt capital usually refers to long-term capital,
specifically bonds, rather than short-term loans to be paid off within one year.
Apart from term loan and credit facilities, the various instruments of debt are ;
(i) Bonds (ii) Debenture (iii) Equipment Financing (iv) Deposit (including Public
Deposit) (v) Commercial Paper (vi) Inter-corporate Debt.

A debenture represents a superior and refined form of the promissory note. Debenture-
holders are the creditors of the company. The obligation of the company towards its
debenture-holders is similar to that of a borrower who promises to pay interest and
capital at specified times.

Debentures are raised for long-term capital needs. Like any other form of debt, they
have the two fundamental features of periodic payment of interest and repayment at a
specific point of time. The debenture-holders receive an interest and not a dividend.
Therefore, the amount paid to the investor is a charge against the profits and not
appropriation of profits.

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.

Debentures are important;

a) A company can have funds without giving any control to the debenture-holders.

b) There is certainty of finance for a specific period.

c) Interest on debentures is a charge on profit and hence payment of income tax

will be less.

d) Considering the tax savings, the cost of debt is cheaper compared to any other

form of financing. It is an opportunity to the company to trade on equity and

thus EPS will increase.

e) From the investors’ point of view, it is an ideal combination of high yield, low

risk and potential capital appreciation.

LIMITATIONS OF DEBENTURES

a) The debenture interest and capital repayment are obligatory payments. Payment of
interest is obligatory even if the company incurs losses.
b) There may be protective covenants associated with issue of debentures.
c) Debenture issues raise the cost of equity capital as debenture financing increases
the financial risk associated with the firm.
d) From the investors’ point of view, debenture interest is taxable.
e) The debenture-holders do not have voting rights. According to the characteristics,
debentures are classified as under:
 4.What are Inventories? Explain.

Inventory is an important and valuable asset. Inventories, like receivables, represent a

very large portion of a firm’s current assets. Inventory covers a wide variety of items,
which are meant to be procured, used up and sold in the ordinary course of business.

The items forming inventories can be grouped into three categories:

(i) Raw materials
(ii) Work-in-process
(iii) Finished goods.

Raw material inventory represents the items of basic input for processing. The
quantity of raw materials required for production and the average time taken in
obtaining fresh delivery - the combination of the above two factors decide the quantity
of raw materials required to be kept in stock

Work-in-process covers all items, which are at various stages of production process.
This is an intermediary item between raw materials and finished goods. i.e., these
items have ceased to be raw material but have not developed into final products and
are at various stages of semi-finished levels. For calculation of the amount of work-in-
process, the time period for which the goods are in the production process is to be
found out. The cost of WIP includes raw materials, wages and overheads.

Finished goods are completed products awaiting sale. They are final output of the
production process in a manufacturing firm. The period for which the finished
products have to remain in the warehouse before sale determines the amount locked
up in finished goods.

The levels of raw materials, work-in-process and finished goods differ depending
upon the nature of the business. Inventories form a link between production and sale
of a product. The money blocked in inventories is substantial, and monitoring the
movement of this asset requires considerable attention from the finance manager.
Good inventory management is good finance management.

A company should maintain adequate stock of materials of right quality at minimum

cost so that they are issued to production when needed in order to have uninterrupted
flow of production. Inadequate inventories will disturb the production line and result
in loss of sales.

The main objectives of inventory management are:

a) to ensure that the materials are available for use in production as and when
required, facilitating uninterrupted production,
b) to maintain sufficient stock of raw materials in periods of short supply,
c) to ensure that inventory of finished goods is adequate to fulfil the customers’
orders as per committed delivery schedules,
d) to optimise the investment in inventories and
e) to protect the inventory from deterioration and obsolescence by providing for
proper warehousing and insurance.

The specific benefits of holding inventories are:

1. Avoiding losses of sales :

2. Quantity discounts Reducing Ordering cost
3. Achieving efficient production runs
4. Reducing risk of production shortages :

The following are the risks associated with holding inventories:

i. Reduction/decline in market price

ii. ii. Deterioration of product
iii. iii. Obsolescence of product

The costs associated with holding of inventories can be broadly classified into two.
Direct costs and indirect costs

(a) Materials cost:

(b) Ordering cost:
(c) (c) Carrying cost:

The indirect costs of holding inventory are:

(a) Cost of funds tied up in with inventory
(b) Cost of running out of stocks:
The following are the various techniques of inventory control
(a) Determination of Economic Ordering Quantity (EOQ)
(b) Determination of Re-order level
(c) ABC Analysis
(d) Inventory Turnover Ratios
6.What is cash budget and proforma balance sheet? Explain

As every transaction of the business is affected eventually by cash, the cash budget is
often the last and the most difficult subsidiary budget to be prepared. The principal
tool of cash management is cash budgeting or short-term cash forecasting. The cash
budget is a forecast of expected cash receipts and payments for a future period.

Cash forecast preceded a Cash Budget. Cash forecasting is the estimating of cash
receipts and payments for a future period before any necessary adjustments have been
made. Cash budgeting is the estimating of cash receipts and payments for a future
period after due consideration has been given to expected conditions and the overall
budget plan.

Cash budget becomes a part of the total budgeting exercise under which other budgets
and statements are prepared. Cash budget consists of three parts :
a) estimates of cash receipts
b) estimates of cash disbursement and
c) cash balances each month of budget period.

Cash budget is also called cash flow statement, which indicates the expected cash
inflow and cash outflow. Depreciation and other non-cash expenses are not taken into
account for the preparation of cash budget. Usually the period for making short-term
forecast for preparing cash budget is one year. Then it is divided into monthly cash
budgets.

FUNCTIONS OF CASH BUDGET

The main functions of cash budget are:
1. To ensure that sufficient cash is available when required.
2. To reveal any expected shortage/surplus of short-term cash or long-term cash.
3. To preserve liquidity.
4. To indicate the availability of funds for replacement of assets, addition to assets,
expansion schemes, new schemes and modification of existing plant and equipment
etc. Cash budget or the short-term cash forecast is the principal tool of cash
management. They are absolutely essential and help the finance manager in the
following functions.

a) Estimating cash requirement.

b) Planning short term financing.
c) Scheduling payments for capital expenditure projects and authorising release of
purchase orders based on this schedule.
d) Scheduling payments for purchase.
e) Formulating policies for extending credit to customers.
f) Monitoring the operations vis-à-vis the long term forecasts.

Cash Budget
The generation of sales and profits does not necessarily indicate that there will be
adequate cash on hand to meet financial obligations as they come due. A profitable
sale may generate accounts receivables in the short run, but no immediate cash to
meet maturing obligations. Therefore, we must translate the pro forma income
statement into cash flows. The longer-term pro forma income statement is divided into
smaller and more precise time frames in order to appreciate the seasonal and monthly
patterns of cash inflows and outflows. Cash budgets or cash flow estimates are very
specific planning tools that are prepared every month or even every week. Cash
budgets show the cash needs or excesses

Pro forma Balance Sheet

Preparation of Pro forma Balance Sheet involves integration of pro forma income
statement and cash budget. This is relatively a simple job. As the balance sheet
represents cumulative changes in the business over time, the prior period’s balance
sheet is first examined and then these items are translated through time to represent
the latest balance sheet.
COMPUTERISED FINANCIAL PLANNING SYSTEM

The present day is marked by mechanisation and automation in almost all spheres of
life. The invasion of automation in finance area is no exception. There are
computerised planning models and also the more popular computer-generated
spreadsheets. Most of the available financial software packages also offer financial
simulation and projection capabilities. The financial analyst has got the widest choice
and area which could be probed with different assumptions, conditions and plans.
When the business is computerised, it becomes easy for the financial analysts to study
various assumptions and their outcomes with the given set of accounting, tax and
other policy constraints. Also, budget projections and sensitivity analysis becomes
easier with the aid of computers.