UNIT-4

FINANCIAL INSTITUTIONS

In financial economics, a financial institution is an institution that provides financial

services for its clients or members. Probably the most important financial service provided
by financial institutions is acting as financial intermediaries. Most financial institutions are
highly regulated by government bodies. Broadly speaking, there are three major types of
financial institution:

1. Deposit-taking institutions that accept and manage deposits and make loans (this
category includes banks, credit unions, trust companies, and mortgage loan
companies);
2. Insurance companies and pension funds; and
3. Brokers, underwriters and investment funds.

Financial institutions provide service as intermediaries of the capital and debt markets.
They are responsible for transferring funds from investors to companies, in need of those
funds. The presence of financial institutions facilitate the flow of money through the
economy. To do so, savings are pooled to mitigate the risk brought to provide funds for
loans. Such is the primary means for depository institutions to develop revenue. Should the
yield curve become inverse, firms in this arena will offer additional fee-generating services
including securities underwriting, and prime brokerage.

FINANCIAL INSTRUMENTS:

1) DEPOSITORIES:

A depository receipt is a tradeable instrument, equivalent to a fixed number of shares,

which is floated on overseas markets. Depending on which market it is floated on, it can be
ADR or American Depository Receipt, or GDR, i.e. Global Depository Receipt. A means
of raising funds in the overseas market, several Indian companies have tried this route. A
depository house is given information on the company to provide it to foreign institutional
investors, brokers, equity analysts, and other investors. The order is placed through an
investment banker overseas, who contacts a broker in India , The local broker picks up the
shrews for the depository house, which then issues DRs against these shares at a particular
ratio. The DRs are traded on the OTC counters abroad.
Depending on the scope of the offer, there are four levels of ADRs. Level I is for OTC
trading and the company offering the DR does not have to meet the stringent listing
requirements (chiefly US accounting standards) of Wall Street. For Level II, listing is
mandatory, as is meeting its financial and listing criteria. Level III is for companies already
listed on the US exchanges, while Level IV is similar to Level III, except that the DRs are
offered only to qualified institutional investors. This last level is also called Restricted Area
DR programme, and the DRs, in this instant, are called GDRs.

2)VENTURE CAPITAL

The word Venture Capital is consists of two words i.e. Venture and Capital. A venture
refers to an undertaking involving more than normal business risk. The venture capital
thus refers to investment of capital in the relatively high enterprises. There are many
business propositions where the risk involved is more than the normal risk a firm has. In
such cases the funds are not easily available as the common investor may not be willing to
participate in a high-risk situation. Ventura capital as a source of financings has emerged as
a necessity for the potentially growth undertakings of new entrepreneurs. Venture capital
also known as high risk capital is referred to as early stage financing of new enterprises.

CONCEPT:
Venture Capital financing refers to financing and running of the start-ups and funding risky
and unproven but sophisticated technologies. It encompasses a whole gamut of activities
providing the seed capital and supplying the funds for product development and market
development and also extending the bridge financing prior to initial public offer. Venture
Capital investment is not an ordinary investment decision of a firm. The risk is very high.
There may not be good return available to the shareholders in terms of dividend etc. but the
chances of the capital gain in the long run may be more. The investor may be ready to
expose his funds to relatively high-risk enterprise to earn a relatively higher return in terms
of steady dividends or interest but through capital gains at a later stage.
The investor in such a case is known as “venture capital firm:” and where the investment
is to be made known as venture capital undertaking.
Types of venture Capital Financing

Some common method of venture capital financing are as follows:

Equity Financing: Venture Capital undertaking is a high unit involving long gestation
period and requires funds for a longer period but may not be able to provide returns to the
investors during the initial stages. Therefore the Venture Capital finance is provided by the
way of equity share capital. The equity participate contribution of Venture Capital firm
does not exceed 49% of the total equity capital of Venture Capital undertaking so that the
effective control and ownership remains with the entrepreneur.

Debt Financing: special purpose debt arrangements can be made to suit the requirement
of the Venture Capital undertakings. The ordinary debt investment may not serve the
purpose as the Venture Capital undertaking does not have income in the initial stages, as
there may be the problems to pay interest on debt financing. So the debt financing in
Venture Capital undertaking must be framed and planned in such a way, which does not
provided by the Venture Cpaital underytakings, by the interest charges. In such a case loan
may be preferred. The loan is repayable in the form of royalty after the Venture Capital
undertaking is able to generate the revenues.

STAGES IN VENTURE CAPITAL FINANCING:

Venture capital financing is undertaken with the objective of

 Support the Venture Capital undertaking in the initial stages

 Capital gains at the later stages.

The timing may be differ such as seed stage, expansion and modernization stage etc.
because the Venture Capital undertaking has to face risk at different stages.
The stages of Venture Capital may be:
 Seed money stage: at this stage, a small money may be required to prove a concept
or develop a product. Production and marketing activities are not visualized at this
stage.
Start Up: financing may also be required for a firm which has started up in the past
one year or so and now requires he fund for the development of the manufacturing
facilities
First round financing: after a Venture Capital undertaking has utilized its start up
capital, additional funds may be required to start the production and the marketing
activities.
Second Rounds financing; funds may also be required to meet the working
capital requirements of a firm, which has already started selling its product in the
market. At this stage, there is chance even of failure of the enterprise if the necessary
working capital is not immediately required.

Third round financing: the firm after attaining the break even level, may strive for
expansion program and thus requires the fund for financing the expansion of the venture
capital undertaking.
Fourth round financing: bridge financing may be required by the Venture Capital
undertaking which is planning to for public issue.

3) FACTORING

Factoring is a financial service designed to help firms to arrange their receivable better.
Under a typical factoring arrangement a factor collects the accounts on due dates, effects
payments to the firm on these dates and also assumes the credit risks associated with the
collection of the accounts.

Sometimes the factor provides an advance against the values of receivable taken over by it.
In such cases factoring serves as a source of short-term finance for the firm.

In order to provide a gamut of financial services under one roof, Corporation has also
started factoring services. Under the scheme Corporation shall be at the time being only
providing advances or prepayments against receivable and other services provided by the
factor such as debt collection and administration of sales ledger etc. shall be taken later on.
Under the scheme receivables only arising out of domestic trade shall be considered for
factoring. Supplier/Borrower shall draw bills of exchange for goods supplied and the
purchaser shall accept that. After acceptance of bills of exchange, Corporation shall make
prepayment of 80% of invoice value after deducting its discount charges @ 17% to 18%
p.a. for period of bill of exchange to supplier. Balance payment of 20% of the invoice value
shall be made after collecting the payment from purchaser. If purchaser fails to pay the due
amount on due dates, the supplier shall make the payment. Borrower/ Supplier shall submit
Bill of Exchange alongwith invoice LR/RR receipts. Suppliers to be eligible for factoring
must have minimum track record of 03 years with consistent profitability and minimum net
worth of Rs. 25.00 lacs.

4) COMMERCIAL PAPER

Commercial Paper (CP) is a short-term, fixed maturity, unsecured promissory note issued
in the open markets as an obligation of the issuing entity. Commercial Paper is usually
issued with maturities of less than 365 days, with the most common having maturities of 90
days.

Commercial Paper is sold either directly by the issuer or through a securities broker. For
entities with a sufficient credit rating, Commercial Paper is generally backed by bank lines
of credit or letters of credit. Banks are active in the Commercial Paper market as issuers,
investors, dealers, and lenders on lines of credit used to back Commercial Paper issuance.

5) CERTIFICATE OF DEPOSIT

A debt instrument issued by a bank; usually pays interest. Negotiable interest-bearing

certificates by which a bank promises to repay money deposited with it for a specific time
period at a specified interest rate. A “time deposit” in a bank, maturing on a specific date,
and traditionally evidenced by a certificate.

6) STOCK INVEST

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7) GLOBAL DEPOSITORY RECEIPTS

Global Depository Receipt means any instrument in the form of a depository receipt or
certificate created by the overseas depository bank outside India and issued to non-resident
investors against the issue of ordinary shares or foreign Currency Convertible Bonds of
issuing company. Global Depository Receipt (GDR) - certificate issued by international
bank, which can be subject of worldwide circulation on capital markets. GDR's are emitted
by banks, which purchase shares of foreign companies and deposit it on the accounts.
Global Depository Receipt facilitates trade of shares, especially those from emerging
markets. Prices of GDR's are often close to values of realted shares. Very similar to GDR's
are ADR's. GDR's are also spelled as Global Depositary Receipt.

8) CREDIT RATING

Credit Analysis & Research Ltd. (CARE Ratings) is a full service rating company that
offers a wide range of rating and grading services across sectors. CARE has an
unparallel depth of expertise. CARE Ratings methodologies are in line with the best
international practices.

CARE Ratings has completed over 6256 rating assignments having aggregate value of
about Rs.18,248 bn (as at June 30, 2009), since its inception in April 1993. CARE is
recognised by Securities and Exchange Board of India (Sebi), Government of India
(GoI) and Reserve Bank of India (RBI) etc.

An assessment of the credit worthiness of individuals and corporations. It is based upon

the history of borrowing and repayment, as well as the availability of assets and extent
of liabilities.

BOOK BUILDING:
Book Building is essentially a process used by companies raising capital through Public
Offerings-both Initial Public Offers (IPOs) or Follow-on Public Offers ( FPOs) to aid price
and demand discovery. It is a mechanism where, during the period for which the book for
the offer is open, the bids are collected from investors at various prices, which are within
the price band specified by the issuer. The process is directed towards both the institutional
as well as the retail investors. The issue price is determined after the bid closure based on
the demand generated in the process.

The Process:

• The Issuer who is planning an offer nominates lead merchant banker(s) as 'book
runners'.
• The Issuer specifies the number of securities to be issued and the price band for the
bids.
• The Issuer also appoints syndicate members with whom orders are to be placed by
the investors.
• The syndicate members input the orders into an 'electronic book'. This process is
called 'bidding' and is similar to open auction.
• The book normally remains open for a period of 5 days.
• Bids have to be entered within the specified price band.
• Bids can be revised by the bidders before the book closes.
• On the close of the book building period, the book runners evaluate the bids on the
basis of the demand at various price levels.
• The book runners and the Issuer decide the final price at which the securities shall
be issued.
• Generally, the number of shares are fixed, the issue size gets frozen based on the
final price per share.
• Allocation of securities is made to the successful bidders. The rest get refund
orders.

Sources of finance basically based on the capital required

to the company.

Sources of Finance:

Depending on the date of maturity, sources of finance can be

clubbed into the following:

Long-term sources of finance: Long-term financing can be

raised from the following sources:
# Share capital or equity share
# Preference shares
# Retained earnings
# Debentures/Bonds of different types
# Loans from financial institutions
# Loan from state financial corporation
# Loans from commercial banks
# Venture capital funding
# Asset securitisation
# International
Medium-term sources of finance: Medium-term financing can be
raised from the following sources:
# Preference shares
# Debentures/bonds
# Public deposits/fixed deposits for duration of three years
# Commercial banks
# Financial institutions
# State financial corporations
# Lease financing / hire purchase financing
# External commercial borrowings
# Euro-issues
# Foreign currency bonds

Short term sources of finance: Short-term financing can be

raised from the following sources:
# Trade credit
# Commercial banks
# Fixed deposits for a period of 1 year or less
# Advances received from customers

WORKING CAPITAL

MEANING OF Working Capital

Capital required for the business can be of two type:

 Fixed Capital
 Working Capital

Fixed capital is required to create the production facilities through purchase of fixed assets
like Land, Machinery, Building etc. Investment in these assets represents that part of
firm’s capital, which is blocked on permanent or fixed basis and is called fixed capital.
Funds are also needed for short-term purpose for the purchase of Raw material, Payment of
Wages etc. these funds are known as Working Capital.

In simple words, working capital refers to that part of firm’s capital, which is required for
financing short-term assets.
Definition:

Acc. to Shubin:-

“Working Capital is the amount of funds necessary to cover the cost of

operating the enterprises.”

Acc. to Genestenberg:-

“ Working Capital means current assets of a comp-any that are changed in the
ordinary course of business from one form to another as for e.g. Cash to
inventories, inventories to receivables and receivables to cash”.

CASH

RECEIVABLES RAW MATERIAL

CREDIT SALES WORK IN PROCESS

STOCK OF FINISHED GOODS

 KINDS OF WORKING CAPITAL

ON THE BASIS OF ON THE BASIS

CONCEPT OF TIME

GROSS . NET PERMA- TEMPORARY

WORKING WORKING NENET ORVARIABLE
CAPITAL CAPITAL OR FIXED WORKING
WORKING CAPITAL
CAPITAL

NEED FOR WORKING CAPIAL

Every business needs some amount of working capital. The need for working capital arises
due to the time gap between the production and realization of cash from sales. There is an
operating cycle involved in the sales and realization of cash. . Thus working capital is
needed for the following purposes:

1. For the purchase of raw material, components and spares parts.

2. To pay wages and salaries
3. To incur day-to-day expenses.
4. To meet the selling costs s packing, advertising.
5. To provide the credit facilities to the customers.
 FACTORS DETERMINING WORKING
CAPITAL REQUIREMENTS

NATURE OR CHARACTER OF BUSINESS

SIZE OF BUSINESS

PRODUCTION POLICY

SEASONAL VARIATIONS

WORKING CAPITAL CYCLE

RATE OF STOCK TURNOVER

CREDIT POLICY

BUSINESS CYCLE

RATE OF GROWTH OF BUSINESS

ESTIMATION OFV WORKNG CAPITAL REQUIREMENTS:

No business can successfully run without an adequate amount of working capital. To avoid
the shortage of working capital at once, an estimate of working capital requirements should
be made in advance so that the arrangements can be made to procure adequate working
capital. But estimation of working capital is not an easy task and a large number of factors
have to be considered.

Factors requiring consideration while estimating working capital

1 Total costs incurred on material, wages and overheads.

2 The length of the time for which materials are to remain in stores
before they are issued for production.
3 The length of the production cycle or work in progress.
4 The length of the sales cycle during which finished goods are to be
kept waiting for sales.
5 The average period of credit allowed to customers.
6 The amount of cash required to pay day to day expenses of the
business.
7 The average amount of cash required to make the payments.
8 The average credit period expected to be allowed by suppliers.
9 Time lag in the payment of wages and other expenses.

1.
1.
2.
1.

2.
3. 1
CASH MANAGEMENT
Cash is the most liquid asset that a business owns. Cash in the business enterprises may be
compare s to the blood in the human body, which gives life and strength to the human body
and the cash imparts life and strength, profits and solvency to the business organization.

MOTIVES FOR HOLDING CASH

The firm with the following motives holds cash:

Transaction Motive

Motives of holding cash Precautionary Motive

Speculative Motive

1. Transaction Motive: Transaction Motive requires a firm

to hold cash to conduct its business in the ordinary course.
The firm needs cash to make payments for purchases, wages,
operating expenses and other payments. The need to hold
cash arises because cash receipts and cash payments are not
perfectly synchronized. So firm should maintain cash balance
to make the required payment. If more cash is need for
payments than receipts, it may be raised through bank
overdraft. On the other hand if there are more cash receipts
than payments, it may be spent on marketable securities.
 2. Precautionary Motive: cash is also maintained by the
firm to meet the unforeseen expenses at a future date. Their
are uncontrollable factors like government policies,
competition, natural calamities, labor unrest which have
heavy impact on the business operations. In such situations,
the firm may require cash to meet additional obligations.
hence the firm should hold cash reserves to meet such
contingencies. Such cash may be invested in the short term
marketable securities which may provide the cash s and when
necessary.

3. Speculative Motive: To take the advantage of unexpected

opportunities, a firm holds cash for investment in profit
making opportunities. Such a motive is purely speculative in
nature.

For e.g. holding cash to rake advantage of an opportunity to purchase raw material at the
reduced price on the payment of immediate cash or delay that purchase of material in
anticipation of declining prices. It may like to keep some cash balance to make profits by
buying securities at the time when their prices fall on account of tight money conditions.

CASH MANAGEMNT:

Cash management deals with the following:

1. Cash Planning
2. Managing Cash flows
3. Determining optimum cash balance
Following are some facets of cash management whish are as follow:

 Cash planning: cash planning is a technique to plan and control the use of cash.
A projected cash flow statement may be prepared, based on the present business
operations and anticipated future activities.

 Cash forecasts and Budgeting: cash budget is a summary statement of the

firm’s expected cash flows and cash balances over the projected period. This
information helps the finance manager to determine the future cash needs of the
firm, plan for the financing of these needs and exercise control over the cash and to
reach liquidity of the firm. It is a forecast of expected cash intake and outlays.

The short-term forecast can be made with the help of cash floe projections. The finance,
manager will make the estimate of likely receipts in the near future and the expected
disbursement in that period.

The long-term cash forecast are also essential for proper cash planning. Long-term forecast
indicates company’s future financial needs for working capital, capital projects etc.

Both short term and long-term forecasts may be made with the help of the following
methods:

1. Receipts and disbursement methods

2. Adjusted net income methods

RECEIPTS AND DISBURSEMENT METHODS: In this method the receipts

mad payments of cash are estimated. The cash receipt may be from cash sales, collection
from debtors, sale of fixed assets. Payment may be made for cash purchases, to creditors
for goods, purchases of fixed assets etc. the receipts and disbursement are to be equaled
over a short as well as long periods. Any shortfall in receipts will have to be met from
banks or other sources. Similarly surpluses cash may be invested in the risk free marketable
securities.
ADJUSTED NET INCOME METHOID: This method also known as Sources
and Uses approach. This method helps in projecting the company’s need for cash at some
future date and to see whether the company will be able to generate sufficient cash.. If not,
then it will have to decide about borrowing.

In preparing the adjusted net income forecast, items such as net income. Depreciation, tax,
dividends can be easily determined from the company’s annual operating budget. Difficulty
is faced in estimating the working capital changes because they are influenced by factors
such as fluctuation in raw material costs, changing demand for the company’s products, for
projecting working capital ratios relating to receivables and inventories may be used.

MANAGING CASH FLOWS:

After estimating the cash flows, efforts should be made to adhere to the estimates of
receipts and payment of cash. Cash management will be successful only if cash collections
are accelerated and ash disbursement are delayed. The following method of cash
management will help:

I. Prompt payment by customers: In order to accelerate cash inflows, the

collections from the customers should be prompt. The customers should be
promptly informed about the amount payable and the time by which it should be
paid. One method is to avail cash discounts.
II. Quick conversion of payment into cash: improving the cash collection
process can accelerate Cash flows. Once the customer writes a cheque in favor of
the concern the collection can be quickened by its earlier collection. There is the
time gap between the cheque sent by the customers and the amount collected
against it. This is due to may factors:

 Mailing time
  Postal float i.e. time taken by the post office for transferring the Cheque from
customers to the firm.
 Bank float i.e. collection time within the bank.

All these are known as Deposit float

An efficient cash management will be possible only if time taken in deposit float vis
reduced which can be done only by decentralizing collections.

III. Decentralized Collections: A big firm operating over wide geographical

area can accelerate collections by using the system of decentralized
collections. A number of collection centers are opened in different area. To
reduce the mailing time.

DETERMINING OPTIMUM CASH BALANCE

There are basically two approaches to determine an optimum cash balance

 Minimizing Cost models

 Preparing cash Budget

Cash Budget
Cash budget is a summary statement of the firm’s expected cash flows and cash
balances over the projected period. This information helps the finance, manager to
determine the future cash needs of the firm, plan for the financing of these needs and
exercise control over the cash and to reach liquidity of the firm. It is a forecast of
expected cash intake and outlays.
 The cash budget should be coordinated with the other activities of the business. The
functional budgets may be adjusted according to the cash budgets. The available funds
should be fruitfully used and the concern should not suffer for the wants of funds,

RECEIVABLES MANAGEMENT

Introduction

Receivables constitute a significant portion of the current assets of a firm. But, for
investments in the receivables, a firm has to incur certain costs. there is also a risk of bad
debts also. It is therefore very necessary to have a proper control and management of
receivables.

MAEANING OF RECEIVABLES

Receivables represents amount owed to the firm as a result of sale of goods or services in
the ordinary course of business these are the claims of firm against its customers and form
a part of the current assets. Receivables are also known as accounts Receivables; trade
Receivables, customer Receivables, etc. the Receivables are carried for the customers. The
period of credit and extent of Receivables depend upon the credit policy followed by the
firm. The purpose of maintaining or investing in Receivables is to meet competition, and to
increase the sale and profits of the business.

Receivables Management

Meaning
Receivables management is the process of making decision relating to investment in trade
debtors. Certain investment in Receivables is necessary to increase the sales and profits of
a firm. But at the same time investment in this asset involves cost consideration also.
Further there is always risk of bad debts too. Thus the objective of Receivables
management is to take a sound decision as regards investment in debtors.
OBJECTIVES
In the word of Bolton, S.E.,
The objective of Receivables Management “ is to promote the sales and profits until that
point is reached where the return on investment in further funding of Receivables is less
than the cost of funds raised to finance that additional credit”.

DIMENSIONS OF RECEIVABLES MANAGEMENT

Receivables management involves the careful consideration of the following steps:

1. Forming of Credit Policy

2. Executing the Credit Policy
3. Formulating and Executing Collection policy

1. Forming of Credit Policy: A credit policy is related to decision such

as Credit standards, length of credit periods, cash discount and discount
period.

a) Credit standards: The volume of sales will be influence by the credit

policy of the concern. By liberalizing the credit policy the volume of sales can
be increased resulting into increased profits. The increased volume of sales is
associated with the certain risks also. It will result in enhanced costs and risk of
bad debts and delayed receipts. The increase in number of customers will
increase the clerical work of maintaining the additional accounts and collecting
 of information about the credit worthiness of the customers. On the other hand,
extending the credit only to credit worthy customers will save the cists like bad
debts losses, collection costs, investigation costs etc. the restriction of credit to
such customers only will certainly reduce sales volume, thus resulting n reduced
profits. The credit should be liberalized only to the level where incremental
revenue matches the additional costs. This the optimum level of investment in
receivables is achieved at a point where there is a trade off between the cists,
profitability and liquidity as depicted below:

Profitability

Cost
And
Profitability

Liquidity

Stringent Liberal

Credit Policy (Optimum Level)

b) Length of Credit period: Length of Credit period means the period

allowed to the customers for making the payment. The customers paying well in
time may also be allowed certain cash discounts. There are no bindings on fixing
the terms. The length of credit period and quantum of discount allowed determine
the magnitude of investment in receivables. A firm may allow liberal credit terms
to increase the volume of sales. The lengthening of this period will mean blocking
of more money in receivables, which could have been, invested somewhere else
to earn income. There may be an increase in debt collection costs and bad debts
losses too. If the earnings from additional sales by Length of Credit period are
more than the additional costs then the credit terms should le liberalized. A
finance manager should determine the period where additional revenues equates
the additional costs and should not extend credit beyond this period as the
increases in the cost will be more than the increase in revenue.
c) Cash discount: cash discount is allowed to expedite the collection of
receivables. The funds tied up in receivables are released. The concern will be
able to use the additional funds received from expedited collection due to cash
discount. The discount allowed involves cost. The finance manager should
compare the earnings resulting from released funds and the cist of the discount.
The discount should be allowed only if its cost is less than the earnings from
additional funds. If the funds cannot be profitably employed then discount should
not be allowed.
d) Discount period: The collection of receivables is influenced by the
period allowed for availing the discount. The additional period allowed for this
facility may prompt some more customers to avail discount and make payments.
For example, if the firm allowing cash discount for payments within 7 days now
extends it to payments within 15 days. There may be more customers availing
discount and paying early but there will be those also who were paying earlier
within 7 days will now pay in 15 days. It will increase the collection period of
the concern.

2. EXECUTING THE CDREDIT POLICY

After formulating the credit policy, its execution is necessary.

a) Collecting the Credit information: The first step in implementing

the credit policy will be to gather the information about the customers. The
 information should be adequate enough so that the proper analysis about the
financial position of the customers is possible. The type of the information can
be undertaken only up to a certain limit because it will involve cost. The cost
incurred on collecting this information and the benefit from reduced bad debts
losses will be compared. The credit information will certainly help in improving
the quality of receivables but the cost of collecting information should not
increase the reduction of bad debt losses.
The information may be available from the financial statements, credit rating
agencies, reports from the banks, firm’s records etc. a proper analysis of
financial statements will helpful in determ9ing the creditworthiness of
customers.
Credit rating agencies supply information about various concerns. These
agencies regularly collect the information about the business units from various
sources and keeps the information up to date.
Credit information may be available with the banks also. The banks have their
credit departments to analyze the financial position of customers. In case of old
customer, businesses own records may help to know their credit worthiness.
The frequency of payments, cash discount availed may help to form an opinion
about the quality of the credit.

b) Credit analysis: After gathering the required information, the

finance manager should analyze it to find out the credit worthiness of potential
customers and also to see whether they satisfy the standard of the concern or not.
The credit analysis will determine the degree if risk associated with the account,
the capacity of the customers to borrow and his ability and willingness to pay.

c) Credit Decision: The finance manager has to take the decision whether the
credit is to be extended and if yes up to which level. He will match the
creditworthiness of the customers with the credit standard of the company. If the
customer’s creditworthiness is above the credit standards then there is no problem
in taking a decision. In case the customer’s are below the company’s standards
then they should not be out rightly refused. Therefore they should be offered
some alternatives facilities. A customer may be offered to pay on delivery on
goods; invoices may be sent through bank and released after collecting dues.

d) Financing Investments in receivables and Factoring: Receivables

block a part of working capital. Efforts should be made so that the funds are nit
tied up in receivables for longer periods. The finance manager should make the
efforts to get the receivable financed so that working capital needs are met in
time.

The banks allow the raising of loans against security of receivables. Banks
supply between 60-80% of the amount of receivables of dependable parties
only. Then quality will determine the amount of loan. Beside banks, there may
be other agencies, which can buy receivables and pay cash for them known as
factoring. The factor will purchase only the accounts acceptable to him. The
factoring may be with or without recourse. If it is without recourse then any bad
debts loss taken up by the the factor but if it is with recourse then bad debts loss
will be recovered from the seller. The factor may suggest the customer for
whom he will extend this facility.

3. FORMULATING AND EXECUTING COLLECTION

POLICY:
The collection of amount due to the customers is very important. The concern
should devise the procedures to be followed when accounts become due after
the expiry of credit period. The collection policy termed as strict and lenient,. A
strict policy of collection will involve more efforts on collection. This policy
will enable the early collection of dues and will reduce bad debts losses. The
money collects will be used for other purpose and the profits of the concern will
go up. A lenient policy increases the debt collection period and more bad debts
losses. The collection policy should weigh the various aspects associated with
it, the gains and looses of such policy and its effects on the finances of the
concerns. The collection policy should also devise the steps to be followed in
collecting over due amounts. The steps should be like
  Personal request through telephone
 Personal visit to customers
 Taking help of collecting agencies
 Taking legal action etc.

INVENTORY MANAGEMENT

INTRODUCTION:

Every enterprise needs inventory for smooth running of its activities. It serves as a link
between production and distribution processes. There is generally a time lag between the
recognition of needed and its fulfillment. The greater the time, higher the requirement of
inventory. Thus it is very essential to have proper control and management of inventories.

MEANING OF INVENTORY:

The inventory means “ stock of goods, or a list of goods” in manufacturing concern, it may
include raw material, work in progress and stores etc. it includes the following things:

 Raw material
 Work in progress
 Finished goods

PURPOSE OF HOLDING INVENTORIES

There are three main purposes for holding the inventories:

  The Transaction Motive: which facilitates the continuous production and
timely execution of sales orders.

 The Precautionary Motive; which necessitates the holding of inventories for

meeting the unpredictable changes in demand and supply of material.
 The Speculative Motive: which includes keeping inventories for taking the
advantage of price fluctuations, saving in reordering costs and quantity discounts.

INVENTORY MANAGEMNT:

The investment in inventory is very high in most of the undertakings engaged in

manufacturing, wholesale and retail trade. The amount of investment is sometimes more in
inventory than on other assets. In India, a study of 29 major industries has revealed that
the average cost of the material is 64 paise and the cost of labor and overhead is 36
paise in a rupee. It is necessary for every management to give proper attention inventory
management.
A proper planning of purchasing, handling, storing, and accounting should form a proper
inventory management. An efficient system of inventory management will determine:-

 What to purchase
 How much to purchase
 From where to purchase
 Where to store

The purpose of inventory management is to keep the stocks in such a way that neither there
is over stocking nor under stocking.
The over stocking will mean a reduction of liquidity and starving for other production
processes.
On the other hand. Under stockings, will result in stoppage of work. The investment in
inventory should be left in reasonable limits.
OBJECTS OF INVENTORY MANAGEMENT:

The main objectives of inventory management are operational and financial. The
operational objectives mean that the materials and spares should be available in sufficient
quantity so that work is not disrupted for want of inventory. The financial objective mean
that investment in inventories should not remain idle and minimum working capital should
be locked in it. The followi8ng are the objectives of inventory management:

 To ensure the continuous supply of raw material, spare and finished goods so that
the production should not suffer at any time.

 To avoid both over stocking and under stocking of inventory.

 To maintain the investment in inventories at the optimum level as required the

operational and sales activities.

 To keep material cost under control so that they contribute in reducing the cist of
production and overall costs.

 To eliminate duplication in ordering stocks. This is possible with the help of

centralized purchase.

 To minimize the losses through pilferages, wastages and damages.

 To design the proper organization for inventory management.

 To ensure the perpetual inventory control so that the material shown in the stock
ledgers should be actually lying in the stores.

 To facilitate the furnishing of data for short term and long term planning and
control of inventory.
TOOLS AND TECHNIQUES OF INVENTORY MANAGEMNT

Effective inventory management requires an effective control, system for inventories. A

proper inventory control not only helps in solving the acute problem of liquidity but also
increases the profits and causes substantial reduction in the working capital of the concern.
The following are the important tools and techniques in inventory management and control:

 Determination of stock level

 Determination of safety stock
 Determination of economic order quantity
 A.B.C. analysis
 V E D analysis
 Inventory turnover ratio
 HML
 FSN
 SDE

1. Determination of stock level: Carrying too much and too little inventories is
detrimental to the firm. If the inventory level is too little, the firm will face frequent
stock outs involving heavy ordering costs and if the inventory if too high it will be
unnecessary tie up of capital. Therefore an efficient inventory management requires
that a firm should maintain an optimum level of inventory where inventory costs are
minimum. Various stick levels are as follow;

 Minimum level: This represents the quantity, which must be

maintained in hand at all, times. F stocks are less than the minimum level than
the work will stop due to shortage of material. Following factors are
undertaken while fixing minimum stock level:
  Lead time: The time taken in processing the order and then
executing is known as lead time

 Rate of consumption: It is the average consumption of material

in the factory.

Minimum stock Level =

Re order level – (Normal consumption x Normal reorder period)

 Reorder level: Re order level is fixed between minimum and maximum level.

Reorder level = Maximum Consumption x Maximum reorder period

 Maximum Level: It is the quantity of the material beyond which a firm should
not exceeds its stocks. If the quantity exceed maximum level limit then it will be
overstocking.

Maximum Level =

Reorder5 level + reorder quantity – (Minimum Consumption x Minimum

reorder period)
  Average stock level:

Average Stock level = Minimum stock level + ½ of reorder quantity

2 Determination of the safety stock:

Safety stock is a buffer to meet some unanticipated increase in usage. The usage of
inventory cannot be perfectly forecasted. It fluctuates over a period of time. Two
costs are involved in the determ8nartion of this stock.

 Opportunity cost of stock out

 Carrying costs

The stock out of Raw Material would cause production disruption. The stock out of
finished goods result into the failure of the firm in competition as the form cannot provide
proper customer service.

4. Economic order of quantity:

A decision about how much to order has a great gignifi8cance in inventory management.
The quantity to be purchased should be neither small nor big. EOQ is the size of lot to be
purchased which is economically viable. This is the quantity of the material, which can be
purchased at minimum cost. Cost of managing the inventory is made up of two parts:-
Ordering costs
Carrying costs

Ordering Costs: This cost includes:

 Cost of staff posted for ordering of goods

 Expenses incurred on transportation of goods purchased.
 Inspection costs of incoming material
 Cost of stationery, postage, telephone charges.
Carrying costs: These are the costs for holding the inventories. It includes:

 The cost of capital invested in inventories.

 Cost of storage
 Insurance cost
 Cost of spoilage on handling of materials
 The loss of material due to deterioration.

The ordering and carrying costs of material being high, an effort should be made to
minimize these costs. The quantity to be ordered should be large so that economy may be
made in transport cost and discounts may also be earned.

Assumptions of EOQ

 The supply of goods is satisfactory.

 The quantity to be purchased by the concern is certain
 The prices of the goods are stable.

EOQ = 2AS
I

Where A = Annual consumption in rupees

S = Cost of placing an order
I – Inventory carrying cost of one unit
4 A-B-C Analysis
The materials divided into a number of categories for adopting a selective approach for
material control. Under ABC analysis, the materials are divided into 3 categories viz, a B
and C. Past experience has shown that almost 10% of the items contribute to 70% of the
value of the consumption and this category is called ‘a’ category. About 20% of the items
contribute 20% of the value of the consumption and is known as category ‘B’ materials.
Category ‘C’ covers about 70% of the items of the material, which contribute only 10% of
the value of the consumption.
Class No. of items % Value of the Items %
A 10 70
B 20 20
C 70 10

100

90

80

70 B C

60 A

50

40

30

20

10
 10 20 30 40 50 60 70 80 90 100

A B C ANALYSIS helps to concentrate more efforts on category A. since greatest

monetary advantage will come by controlling these items. An attention should be paid in
estimating the requirements, purchasing, maintaining the safety stocks and properly storing
of ‘A’ Category, material. These items are kept under a constant review so that a
substantial material cost may be controlled. The control of ‘C’ items may be relaxed and
these stocks may be purchased for the year. A little more attention should be given toward
‘B’ category items and their purchase should be undertaken at quarterly or half yearly
intervals.

5. V E D Analysis

The VED analysis is generally used for spare parts. The requirement and urgency of spares
parts is different from that of the material. Spare parts are classified as Vital (V), essential
(E), and Desirable(d). The vital spares are must for running the concern smoothly and these
must be stored adequately. The non-availability of spare parts will cause havoc on the
concern. The E type of spares is also necessary but their stock may be kept at low figures.
The stocking of D type of spares may be avoided at times. If the lead time of these spares is
less, then stocking of these spares can be avoided.

The classification of spares under these three categories is an important decision. A wrong
classification of any spare will create difficulties for production department. The
classification should be left to the technical staff because they know the need urgency and
use of these spares.

6. INVENTORY TURNIVER RATIO:

This ratio is calculated to indicate whether the inventories have been used efficiently or
not. The purpose is to ensure the blocking of only required minimum funds in inventory.
This ratio is also known as Stock velocity.
 Cost of goods sold

Inventory Turnover Ratio =

Average inventory at cost

Days in Year
Inventory Conversion period =
Inventory Turnover Ratio

DIVIDEND POLICY

The term dividend refers to that part of the profits of a company which is distributed
amongst its shareholders. It may therefore be defined as the return that a shareholder gets
from the company, out of its profits on his shareholdings.

THEORY

1) WALTER MODEL: According to Prof. Walter, the choice of dividend policies

affects the value of a firm. The relationship between the internal rate of return earned by
the firm and its cost of capital is very significant in determining the dividend policy to
subserve the ultimate goal of financial management, ie, maximizing the wealth of
shareholders.
According to Walter firm can be classified into three categories:
Growth firms, normal firms, declining firms.

The firm’s internal rate of return which is greater than its cost of capital, is treated as a
growth firm . The firm, the internal rate of return which is equal to cost of capital than it is
treated as normal firm. The firm, the internal rate of return which is less than cost of
capital is treated as declining firm.

ASSUMPTIONS:

1. The investment of the firm are financed through retained earnings only.
2. Internal rate of return and the cost of capital of the firm are constant.
3. Earnings and dividend don’t change
4. The firm has long life or it has perpetual existence.

P= D+ r / Ke (E-D)
Ke

P = MARKET PRICE PER SHARE

D=DIVIDEND PER SHARE

E=EARNINGS PER SHARE

r =INTERNAL RATE OF RETURN(AVERAGE)

Ke= COST OF EQUITY CAPITAL OR CAPITALISATION RATE

2) GORDON’S MODEL:

Gordon has given this model regarding dividend policy on the lines suggested by Prof.
Walter. Under conditions of uncertainty, the shareholders discount future dividends at a
higher rate. Investors are generally risk averse. Uncertainty increases with futurnity and
therefore the discounting rate increases with uncertainty. Investors like to avoid uncertainty
and they will weigh the current dividend more than future dividend. Dividend policy does
affect the value of the share.

P= D
Ke –g

P= PRICE OF THE SHARE

D= DIVIDEND PER SHARE

Ke=COST OF EQUITY CAPITAL

g =GROWTH RATE IN RATE OF RETURN INVESTMENT

DETERMINANTS OF DIVIDEND POLICY:

1.
1. Financial
- requirements.
2. Considerations of fund availability.
3. Desire of the shareholders .
4. Stability of earnings.
5. Dilution of control .
6. Alternative opportunities to owners .
7. Tax considerations .
8. Informational content of dividend .
9. Inflation .
10. Contractual restrictions .
11. General estate of economy .