BHARATAMATACOLLEGEOFCOMMERCEANDARTS

FI
NANCI
ALMANAGEMENT-
QUESTI
ONBANK
MODULE1
PARTA-2MARKS
1. Defi
neFinanci
alManagement ?
Fi
nancialManagementi savitalac
tivi
tyinanyorganizat
ion.I
tistheproc
essof
planni
ng,organiz
ing,cont
rol
li
ngandmoni tor
ingf
inanc
ialres
ourceswit
haview
toachi
eveor gani
zati
onalgoal
sandobj ec
tives
2.Def i
nepubli
cfinance?
Publi
cfi
nanceisthes t
udyoft her ol
eofthegovernmentintheeconomy.Iti
sthe
br
anch ofec onomi
c sthatas sessesthe gover
nmentrevenue and gover
nment
ex
pendit
ureoft hepublicaut
hor i
ti
esandt headjust
mentofoneort heotherto
achi
evedesi
rableef
fectsandavoidundesir
ableones.

3.Whati st i
meval ueofmoney?
Theval ueofmoney,t hen,i sthequant ityofgoodsi n generalt hatwi l
lbe
ex changedf oroneuni tofmoney.Theval ueofmoneyi sitspur c
has ingpower ,
i
.e.,t hequant i
tyofgoodsands ervi
cesitc anpur c
has e.Whatmoneyc anbuy
dependsont hel evel ofpr i
ces.
4.Explainc ompoundi ng?
Compoundi ngi sthepr oc esswher ebyint
eres tiscredit
edt oanex ist
ingpr i
ncipal
amountaswel last ointerestalr
eadypaid. Compoundi ngc ant husbec onstrued
asi nt erestoninter est—theef fectofwhichi stomagni fyreturnstoint erestover
time, theso-call
ed" miracleofc ompounding."
5.Whati spr i
vatefinanc e?
Private f inanceist he study of i nc ome and ex penditure,
bor rowi ngs,etc.ofi ndividuals
,hous ehol
dsandbus inessf i
rms .Publicfinancei s
conc ernedwi tht her evenue/ i
ncomesandex pendit
ure,bor rowings,et c.oft he
ec onomyorgover nment .Adjustments
Par
t-B–5mar
ks
6.Explainthescopeoffinancialmgt?
1.Fi
nanci
alManagement i s an integr
alpar
t of over
allmanagement.Fi
nanci
al
consi
derat
ionsar einvolved i
n al
lbus i
nes
sdeci
si
ons.So fi
nanc
ialmanagementis
pervasi
vethroughouttheorgani
zat
ion.

2.Thec ent
ralf
ocusoff
inanci
almanagementisval
uati
onofthef
ir
m.Thatisfi
nanc
ial
decis
ionsaredi
rect
edatinc
reasi
ng/
maximi
zati
on/opt
imizi
ngt
heval
ueofthefi
rm.

3.Fi
nanci
almanagement es s
ential
lyinvol
ves r
isk
-ret
urn tr
ade-off Deci
si
ons on
i
nvestmentinvol
vechoosi
ngoftypesofasset
swhic
hgener at
eretur
nsac c
ompaniedby
ri
sks
.Generall
yhighert
heris
kreturnsmightbehi
gherandviceversa.So,thef
inanc
ial
managerhastodecidet
hel
evelofr
iskt
hef
ir
mcanas
sumeands
ati
sf
ywi
tht
he
ac
companyingr
etur
n.

4.Financi
almanagementaff
ect
sthesurvi
val
,growthandvit
ali
tyoft
hefi
rm. Fi
nanc
eis
saidtobet heli
febl
oodofbusi
ness.I
tist
obus i
nes
s,whatbloodist
ous.Theamount,
type,sources
,condi
ti
onsandcostoffi
nancesquar
elyi
nfl
uencethefunc
tioni
ngofthe
unit.

5.Fi
nancefunc t
ions,i.
e.
,invest
ment,risi
ng ofc api
tal
,dis
tri
buti
on ofpr
ofi
t,are
perf
ormedinallfi
rms-bus i
nessornon-
business,bi
gors mal
l
,propri
etar
yorc
orpor
ate
undert
aki
ngs.
Yes ,fi
nanci
almanagementisac oncer
nofeveryconcern.

6.Fi
nancialmanagementi sa s
ub-syst
em ofthebusi
nes
ss yst
em whi
chhasot her
subsys
temsl i
ke pr
oduct
ion,market
ing,et
c.Insyst
emsarrangementfi
nanci
alsub-
syst
em istobewell-
coor
dinat
edwithother
sandothers
ub-s
ystemswel
lmatchedwith
thefi
nanc i
als
ubsys
tem.

7.Whati
spr
ofi
tmax
imi
zat
ion?Whatar
ecr
it
ici
smsagai
nstpr
ofi
tmax
imi
zat
ion?

Af
ir
m max
imi
zespr
ofi
tbyoper
ati
ngwher
emar
ginal
revenueequal
smar
ginal
c
ost
.Int
hes
hor
trun,
achangei
nfi
xedc
ost
shasnoef
fec
tont
hepr
ofi
t
max
imi
zi
ngout
putorpr
ice.
Thef
ir
m mer
elyt
reat
sshor
tter
mfi
xedc
ost
sass
unk
c
ost
sandc
ont
inuest
ooper
ateasbef
ore.

i
)Thepr ofi
tmax i
mi z
ationobject
ivei
gnoresthetimingofr et
urns.I
tequat
esar upee
receivedtodaywithar upeerecei
vedinthefutur
e.Inf ac
t,Rs100todayi
svaluedmore
thanRs1 00receivedaf t
eroneyear.Itisbecauset hemoneyr ecei
vedinanear l
i
er
periodmayber einvestabl
etoearnmore.

(i
i
)Itleadstoproperandeffi
ci
entchannel
izat
ionanduti
li
zati
onofs
urpl
usf
undsf
or
product
ivebus
inessoper
ati
onsandotherec
onomicact
ivi
ti
es.

(i
ii
)Thec r
it
icsofprof
itmaxi
mizati
onobj ecti
vear guet hatitignorestheris
kas sociat
ed
withas t
ream ofthecashfl
owofthepr oject.Forexampl e,thetotalprof
itfrom thetwo
projectsmaybet hes amebutthepr ofi
tfrom onepr ojec
tmaybef luct
uat i
ngwi del
y
thant hepr of
itf
rom t
heotherproj
ect.Thef i
rm wi t
hwi derfluctuati
oninpr ofi
tisri
ski
er.
Thisfactisignor
edbyt hepr
ofi
tmax i
mi z
at i
onobj ect
ive.

(i
v)I
t’
simposs
ibl
etoal
waysacc
urat
elyf
orec
astdemand,soyoumayendupwit
hagl ut
ofit
emst hatnobody r
eal
l
y wants,r
educi
ng the pr
ofi
tsthatyou wer
etr
ying to
maximiz
e.

(
v)Theprof
itmax
imi
zat
ionobj
ect
ivehasgr
eaterr
elevanc
etoaperf
ectl
ycompet
it
ive
f
ir
mt hantoamonopol
yf i
rm.Cr
iti
csar
guethatamonopolyfi
rm woul
dbeearning
s
uper
nor
mal
prof
itmor
eorl
essaut
omat
ical
l
y.

(
vi)Todaylarge- s
calec orporatetypeofor gani
zati
onsexist
s.Di
ff
erentstakeholders
suchasowners ,manager s,customers
,credi
tor
s,andemployeesar
edirec
tlyconnec t
ed
withtheorgani z
ation.Thei nteres
tofeac hmemberi nt hi
sorgani
zati
onalc ol
lusi
on
cannotbeachievedwi ththes ol
eobjecti
veofprofi
tmaxi
mizati
on.

(vii
)Ifyououtf
itafac
ili
tyquic
k l
yandcheapl
ytomeetanimmediat
edemand,youmay
l
os eoutont heopportuni
tytobui l
dalar
gerfac
il
it
ythatt
akesl
ongert
obuil
d,butwi
l
l
yiel
dbet t
erearni
ngsinthefuture.

8.
Whati
sweal
thmax
imi
zat
ion?Whatar
ecr
it
ici
smsagai
nstweal
thmax
imi
zat
ion

I
tsi
mpl
ymeansmax
imi
zat
ionofs
har
ehol
der
’sweal
th.I
tisac
ombi
nat
ionof
t
wowor
dsvi
z.weal
thandmax
imi
zat
ion.Aweal
thofas
har
ehol
dermax
imi
zes
whent
henetwor
thofac
ompanymax
imi
zes
.Tobeevenmor
emet
icul
ous
,a
s
har
ehol
derhol
dss
har
eint
hec
ompany/
bus
ines
sandhi
sweal
thwi
l
limpr
ovei
f
t
hes
har
epr
icei
nthemar
keti
ncr
eas
eswhi
chi
ntur
nisaf
unc
tionofnetwor
th.
Thi
sisbec
aus
eweal
thmax
imi
zat
ioni
sal
sok
nownasnetwor
thmax
imi
zat
ion.

1
.Iti
sapr
esc
ript
ivei
dea.
Theobj
ect
ivei
snotdes
cri
pti
veofwhatt
hef
ir
m ac
tual
l
ydoes
.

2.
Theobj
ect
iveofweal
thmax
imi
zat
ioni
snotnec
ess
ari
l
ysoc
ial
l
ydes
irabl
e.

3.Ther
eissomecontrovers
yast owhet hert
heobjecti
veistomaxi
miz et
hestock
holder
“wealt
horthewealthofthefi
rm, whichincl
udesotherFi
nancecl
aim hol
der
’ssuchas
debentur
eholder
s,pref
erenceshareholder

4.Theobject
iveofwealthmax i
mi z
ationmayals
of acedif
fi
cult
ieswhenownershipand
managementar eseparated,asisthecasei
nmos tofthecorporat
eform of
organi
zati
ons.Whenmanager sactastheagentsoftherealowner,t
hereist
he
possi
bil
i
tyforaconfl
ic
tofi nt
erestbetweenshar
eholdersandthemanager i
ali
nteres
ts

Par
t-C-
15mar
ks
9.
Whatar
ethef
unc
tionsofFM?

Fi
nanc eFunc
tions(ScopeofFi nanci
alManagement )
Thef i
nancefunc ti
onenc ompas sestheac t
ivi
ti
esofraisi
ngf unds,invest
ingthem in
asset
sanddi str
ibuti
ngr etur
nsear nedfr
om assetstoshareholder
s.Whi l
edoingthese
act
ivit
ies,
afi
rm at t
empt stobalancecashinf
lowandoutfl
ow.
I
tisevidentt
hatt hefinancefuncti
oninvol
vesthefourdecisi
onsviz.
,fi
nancingdeci
si
on,
i
nvestmentdec i
sion,divi
denddec is
ionandli
quidi
tydeci
sion.Thusthef i
nancefunct
ion
i
ncludes:
1.
Investmentdeci
s i
on
2.Fi
nancingdeci
sion
3.Di
videnddecis
ion

1.I
nves t
mentDec is
ion:Thei nvest
mentdec i
si
on,al
sok nownasc apit
albudgeti
ng,is
concernedwit
hthes el
ecti
onofani nvest
mentproposal
/pr opos
alsandt hei
nvestment
offundsintheselectedpropos al
.Ac apit
albudgeti
ngdec i
sioni
nvolvesthedeci
sionof
all
ocati
onoffundst olong-term assetsthatwouldyiel
dc ashfl
owsi nthefutur
e.Two
i
mpor t
antaspectsofinvestmentdec isi
onsare:

i
.Theeval
uati
onofthepros
pectiveprof
it
abi
li
tyofnewi
nves
tments
,and
i
i
.The measurementofa c ut
-offrateagai
nstthatthepros
pecti
ve r
etur
n ofnew
i
nvest
mentscouldbecompared.

Futurebenef it
sofi nves t
ment sarediffi
culttomeas ur
eandc annotbepr edictedwith
certai
nty.Ri skini nves t
mentar i
sesbec ause oft he uncertainretur ns.Investment
proposalss hould,therefore,beevaluatedi ntermsofbot hex pectedr eturnandr isk
.
Bes i
desthedec is
iont oc ommitfundsi nnew i nvestmentpr oposals,capitalbudgeting
alsoinvolvesr eplacementdec i
si
on,thati sdecisi
onofr ecommi t
ti
ngf undswhenan
assetbec omel es sproduc ti
veornon- profit
able.Thec omput ati
onoft her i
sk-adj
usted
returnandt her equiredrateofreturn,selecti
onoft heprojectont hesebas es,for
mt he
subject
-mat terofthei nvestmentdecisi
on.

Long-t
ermi nvestmentdec
isi
onsmaybebot hint
ernalandexter
nal.I
ntheformer,the
fi
nancemanagerhast odet er
mi newhi chcapi
talexpendi
tureproj
ectshavet obe
undertak
en, t
heamountoff undst obec ommit
tedandt hewaysinwhichthefundsare
tobeal locat
edamongdi ff
erenti nvest
mentoutlet
s.Inthelatt
ercase,thef i
nance
manageri sconc er
nedwiththei nvestmentoffundsoutsi
dethebus i
nessformerger
with,
orac qui
sit
ionof,
anotherfi
rm.

2.Fi nanc
ing Decisi
on: Financ i
ng dec i
sion ist he second importantfuncti
on to be
performedbyt hefinanc ialmanager .Broadly,heors hemus tdec i
dewhen,f r
om where
andhowt oacquiref undst omeett hef i
rm’sinves t
mentneeds .Thecentr
alissuebef
ore
him orherist odet erminet heappr opriatepr oport
ionofequityanddebt .Themi xof
debtandequi tyisk nownast hefi
rm’sc apit
als tr
uc t
ure.Thefinanci
almanagermus t
str
ivet oobtai
nthebes tfinanc i
ngmixort heopt i
mum c apit
als t
ruct
ureforhisorher
fi
rm.Thef i
rm’scapi tals t
ructureisc onsideredopt imum whent hemar ketvalueof
sharesismax i
mized.

3.Divi
dendDec i
sion:Di
videnddec is
ionisthethirdmajorfi
nanc i
aldeci
si
on. Thefinancial
managermus tdec i
dewhet herthef i
rms houlddist
ri
buteal lprof
it
s,orretainthem,or
dist
ri
buteapor tionandr eturnt hebal ance.Thepr oporti
onofpr ofi
tsdistr
ibutedas
divi
dendsisc al
ledt hedividend-payoutr ati
oandt her etai
nedpor t
ionofpr ofit
si s
known ast her etenti
on rati
o.Liket hedebtpol i
cy,thedi vi
dend policys hould be
determinedintermsofi tsimpac tont hes harehol
ders’value.Theopt i
mum di vidend
poli
cyisonet hatmax i
mizest hemar ketvalueoft hefirm’
ss hares.Thus, i
fshareholder
s
arenoti ndi
ff
erenttothef i
rm’sdivi dendpol i
cy,thefinancialmanagermus tdetermine
theopt i
mum di vi
dend-payoutr atio.Dividendsar egener all
ypai di nc ash.Butaf i
rm
mayi ssuebonuss hares.Bonuss haresar esharesi s
s uedt otheex i
sti
ngs hareholder
s
withoutanyc harge.Thefinanc i
almanagers houldcons i
dert heques ti
onsofdi vidend
stabi
li
ty,bonussharesandc as hdividendsinpr acti
ce.
10.Whatar etheargument sinfovourandagai nstwealt hmax i
mi s
ation
Weal t
hmax imazationi salong- term goalofac ompanyandi ti
s
concernedwi thmul tiplef
ac torss uc
hasgai ningmar ketsharein
ordertogai nindustryleaders hipandi nnovati
oninnewpr oducts
ands ervic
eswhi chdr ivesales .
Weal thisgeneratedwhent he
presentvalueofal lfuturecas hf l
owsar ehigherthant hecostof
operati
ons .I
nes sence, wealthmax i
mi zat
ionisevaluatedinterms
ofnetpr esentvalue( NPV).
 MODULE2
Par
tA–2mar
ks
1,whati sequityshare?
Equit
y s haresare l ong-
ter
m f i
nancing sour
ces for any c ompany.
Theses haresar eiss
uedt othegeneralpubli
candarenon-redeemablei
n
nature.Investorsins uchshar
esholdtherighttovot
e,sharepr of
it
sand
cl
aim as set
sofac ompany.

2.Whati sPreferenceshare?
Preference s har es
, more commonl y referr
ed t o aspr efer
redst
ock,
aresharesofa c ompany'sst
ockwi th di
vi
dendst hatare paid outto
shareholder
sbef orecommons toc
kdi vi
dendsar eissued.I
ft hecompany
entersbank ruptc y,
pref
erreds
tockhol
dersar e ent
it
led to be paidfrom
companyas setsbeforecommons t
oc k
holder
s

3.WhatisDebenture?
Debenturesareadebti nst
rumentusedbyc ompani
esandgovernmentto
i
ssuetheloan.Theloanisissuedtocorporat
ebasedonthei
rreputat
ionat
afix
edrateofinter
est.Debenturesar
ealsok nownasabondwhic hser
ves
asanIOUbet weenissuersandpurchaser.

4.Whati sRetainedEarnings ?
ret
ained earnings(RE)ist he amountofneti nc
ome leftoverf orthe
busi
nes s aft
er i t has pai d out divi
dends toitsshareholders
.Of
ten
thi
sprofiti
spai doutt os harehol
ders,butitcanals
ober e-i
nvestedback
i
ntot he company f or gr owth purposes.The money not pai d to
sharehol
dersc ountsasretainedearnings

5.WhatisSecuredpremium notes?
Sec ur
edpremium notes(SPNs)aref i
nanciali
nstr
umentswhic har ei
ssued
wit
hdet ac
hablewar r
antsandar eredeemableaf t
ercert
ainper i
od.SPNis
akindofnon-conver
tibl
edebent ure(NCD)attachedwithwarrant.Itc
anbe
i
ssuedbythec ompanieswiththelock -
in-
peri
odofs ayf
ourtos evenyears.

6.WhatisSecondmor t
gageDebentures
?
Secondmor t
gagedebent uresaret
hosedebentur
esonwhi c
ht heholder
s
havethec l
aim ont heas setchar
gedaf t
erthec l
aim offir
stmor
tgage
debent
uresissett
led.
Mor t
gagedebentureshavebeengainingpopul
arit
y
amonginvestor
sinrecentti
mes .
.
 PARTB-
5mar ks
7.
A l td issued Rs.
50,000,
8% debent
ures @par
. The t
ax r
ate i
s
50%.Comput ecostofcapi
tal
.
Kd=I
/P(1-
t)
I
=50,000*8/100
=4000
P=50,000
T=50%
Kd=4000/50,000*(
1-.
50)
=4000/50,000*.
50
=4%

8.Whataret heFeaturesofequi tyshares.

•Equitysharehol
dershavet herighttovoteonvar i
ousmat tersoft hecompany.
•Themanagementoft hec ompanyi selectedbyequi tys hareholders.
•Theequi t
ys har
ec apit
al i
shel dpermanent l
ybyt hec ompanyandr eturnedonl
y
uponwi ndi
ngup.
•Equitysharesgivetherightt otheholderstoclaim divi
dendont hes urpl
usprof
itsof
thecompany. Therateofdi videndont heequityc apit
alisdet er
mi nedbyt he
managementoft hecompany.
•Equitysharesaretransf
erabl einnature.Theyc anbet ransferr
edf rom onepersonto
anotherwithorwi t
houtcons iderati
on.
9.Li
stouttheadvant agesofEqui t
yShares

From theShareholder’sPointofView:
•Equitysharesarel i
quidinnatureandc anbes oldeas
il
yint hec apit
al
mar k
et.
•Thedi vi
dendr ateishigherfortheequit
yshareholder
swhent he
companyear nshi ghpr of
it
s.
•Theequi t
ys hareholdershavether i
ghttocontrolt
hecompany’ s
management .
•Theequi t
ys hareholdersnotonlygetthebenef i
tofdi
videndbutt hey
alsogetthebenef itofpri
ceapprec i
ati
onint
heval ueoftheirinvestment
.

From t
heCompany’ sPoi
ntofView:
•Equit
ys haresarethepermanents ourceofcapit
alf
orac ompany.
•Thereisnor equi
rementofcreati
ngac hargeovertheas s
etsoft
he
companywhenequi tyshar
esar ei
ssued.
•Theliabi
li
tyoftheequitysharesi
snotr equi
redtobepaid.
•Thec ompanydoesnothaveanyobl i
gati
ont opaydivi
dendtothe
 shar
eholders.
•Thec r
editwort
hinessofthecompanyi
nc r
easesamongt hei
nvestor
s
andcredit
orswhent hecompanyhasalargerequi
tycapit
albase.
Theabovement i
onedar etheadvant
agesofequit
ysharestoboththe
shar
eholdersandthec ompany
1
0.FI
NANCI
ALLEVERAGE
PLAN1 PLAN2

DEBT1
0% 800000 200000

Equi
tyofr
s10 200000 800000

Tot
alf
inanc
erequi
red 1
000000 1
000000

EBI
T10000.
tax50%
Ans
Pl
an1 Pl
an2

EBI
T 1
00000 1
00000

LESSI
NTEREST 80000 20000

EBT 20000 80000

LESSTAX 1
0000 1
0000

EARNING AFTER I
nter
est1
0000 40000
andtax

No.
ofequi
tys
har
e 20000 20000

EPS .
50 .
50

1
1.COMPOSI
TELEVERAGE

Acompanyhassal
eofrs100000.
V.CRs
500000,F.
CRs
200000andl
ongt
erml
oansof
Rs400000@5%r
ateofi
nter
est

Ans

OPLEVERAGE=c ontr
ibuti
on/EBI
T
CONTRIBUTION=SALES-V.C
EBIT=1
000000-500000-200000=300000
O.L=500000/
300000=1.67
F.
L=EBIT/EBIT-
I
=300000/ 300000-
40000=1.
15
COPOSITELEVERAGE=O. L*F.
L
1.
67*1.
15=1 .
92

PART–C1
5mar
ks
1
2.Whatdoyoumeanbydebent
ures
?Whatar
ethevar
ioust
ypesofdebent
ures
?

1
.Fr
om t
hePoi
ntofvi
ewofSec
uri
ty

● Sec
uredDebent
ures
:Sec
ureddebent
uresar
ethatk
indofdebent
ureswher
ea
char geisbeinges tablishedont hepropertiesoras setsoft heent erpr i
sef orthe
purpos eofanypayment .Thec hargemi ghtbeei therfloati
ngorf ixed.Thef ixed
char geises tabl
ishedagai nstt hoseas setswhi c
hc omeundert heent er pr
ise’
s
poss ess
ion fort hepur pos et ous ei n activi
tiesnotmeantf ors al ewher eas
fl
oat i
ngc hargec ompr i
sesofal lassetsexcludingt hos eac c
redi t
edt ot hes ecured
creditor
s.Af ixedc hargei ses tabli
shedonapar t
icularas setwher easaf l
oating
char geisont hegener al assetsoftheent erpr i
se.
● Un securedDebent ures:Theydonothaveapar ti
c ul
arc har geont heas setsof
the ent erpr
ise.However ,a f loating char ge may be es t abli
shed on t hese
debent uresbydef ault.Us uall
y,theset ypesofdebent uresar enotc ir
c ulated.

2.
From t
hePoi
ntofvi
ewofTenur
e

● Redeemabl
eDebent
ures
:Thes
edebent
uresar
ethos
edebent
urest
hatar
edue
ont hec essati
onofthet imef r
ameei therinal ump-sum orininstal
lmentsduri
ng
thelifet
imeoft heenterpri
se.Debenturesc anber eclai
medei theratapr emium
oratpar .
● I
rredeemabl e Debentures:These debent ures are alsoc all
ed as Per petual
Debent uresast hecompanydoes n’tgiveanyat t
emptf ort her epaymentof
moneyac quir
edorbor rowedbyc i
rculat
ings uchdebent ur
es.Thes edebentures
arer epayableont hec l
osingupofanent erpri
seoront heex pir
y( c
es s
ati
on)ofa
l
ongper i
od.

3.
From t
hePoi
ntofvi
ewofConver
ti
bil
i
ty

● Conver
ti
bleDebent
ures
:Debent
ureswhi
char
echangeabl
etoequi
tys
har
esori
n
anyothers ecurit
yeitheratt hechoi c
eoft heenterpr
iseorthedebentur
eholders
arec all
ed c onvert
ible debent ures.Thes e debentur
es are either ent
ir
ely
convert
ibleorpar tl
yc hangeable.
● Non-Conver t
ible Debent ur
es :
The debent ures whichc an’tbe changed into
shares ori n others ecur
it
ies arec al
led Non-Conver
tibl
e Debentur
es.Mos t
debenturescircul
atedbyent erpr
isesfall
inthi
sc l
ass.
4.
From CouponRat
ePoi
ntofvi
ew

● Spec
ifi
c Coupon Rat
e Debent
ures
:Suc
h debent
ures ar
eci
rcul
ated wi
tha
mentionedr ateofint
eres t
,andi tisk nownast hec ouponrate.
● Zero-Coupon Rat e Debent ures:Thes e debent ur
es don’ t normall
yc arrya
parti
cularr ate ofinterest.In or dert or est
oret he i
nvestors
,s uchtype of
debent uresarecir
cul
atedatac ons i
derabl
edi sc
ountandt hediff
erencebet
ween
thenomi nalval
ueandt hec ir
culat edpric
ei streatedast heamountofi nter
est
associatedtothedurat i
onoft hedebent ures.

5.
from t
hevi
ewPoi
ntofRegi
str
ati
on

● Regi
ster
edDebent
ures
:Thes
edebent
uresar
esuc
hdebent
ureswi
thi
nwhi
chal
l
detail
scomprisi
ngaddr ess es ,namesandpar ti
cularsofholdingofthedebent ure
holdersar
ef i
ledinar egis terk eptbyt heent erpri
se.Suchdebent uresc anbe
movedonl ybyper f
orminganor mal t
ransferdeed.
● BearerDebentures:Thes edebent uresaredebent ur
eswhi chc anbet ransfer
red
bywayofdel iveryandt hec ompanydoesnotk eepanyr ecordofthedebent ure
holdersI
nter
es tondebent uresi spaidt oaper sonwhopr oducesthei nter
est
couponattachedt osuchdebent ures
1
3.Whatarethetypesofpr eferenc es hares?
1.Cumul ativePref
erenceShar es
Apr eferenceshareisc al
ledc umulati
vewhent heouts
tandingpaymentof
adividendi scumulative.Ifac ompanydoesnothavet hefi
nanc i
al
capabi l
i
tyt opayadi videndt otheownersofitspr
efer
ences haresatany
pointoft i
me, t
henitwi ll
notpayadi vi
dendtoitscommons harehol
ders,
aslongast hepref
erenc es harehol
dersarenotpai
d.Thedividendamount
getscar ri
edont othenex tyear .

2.Non-Cumul ativePreferenceShar es
Anon- cumulativepreferenceshareholderisonlypayablefr
om eachyear’s
netprofit
. Anon-cumul ati
vepreferenceshareholderwil
lnotbepaidfrom
fut
urepr ofi
ts.
So, i
facompanyunder goesalossinthatyear,
thenthe
outst
andi ngpaymentofdi vi
dendc annotbec lai
medi nsubsequentyears
l
ikeinthec aseofc umul at
ivepreferenceshares.

3.RedeemablePr eferenceShar es
Prefer
enceshareswhi chc anber edeemedafterafi
xedper i
odoraf
ter
givi
ngac er
tai
nnot i
cear ecall
edar edeemabl
epr ef
erenceshar
eA
redeemablepreferences harei
sgoodf orthecompany. Thes
eactasa
hedgeagainstfutureinfl
ationandwhent hemonetaryratedecl
i
nesint
he
country.
4.Ir
redeemabl
ePrefer
enceShar
es
I
rredeemabl
epref
erenceshar
esareaper
pet
uall
i
abi
l
ity,
whi
chc
annotbe
redeemedduri
ngtheli
fet
imeoft
hecompany.

Accor
dingtotheCompaniesAmendmentAct
,1988,noc
ompanyc aniss
ue
anyprefer
encesharewhic
hisi
rr
edeemabl
eorredeemableaf
ter20years
fr
om t
hedat eoftheis
sue.

5.Part
icipati
ngPr eferenceShar es
Part
ici
pat i
ngpr eferenc eshareiswher
etheiss
uingc ompanyisent
itl
edt
o
payani ncreaseddi videndt otheowners
,inaddit
iontopref
erence
di
videndataf i
x edrat e,

Also,t
hehol
dersofpart
ici
pati
ngpref
erenc
eshar
esmayhavet
her
ightt
o
sharethes
urpl
usassetofthecompany,wheni
t’
swi
ndi
ngup.

6.
Non-
Par
ti
ci
pat
ingPr
efer
enc
eShar
es

Thehol
der
sofnon-par
ti
ci
pat
ingpr
efer
enc
es har
esareent
it
ledonlytoa
fi
xedr
ateofdi
vi
dendanddonothaveanysharei
nthesur
plusprofi
t.

Thes
urpl
uspr
ofi
toft
hec
ompanywi
l
lthusgot
othec
ommons
har
ehol
der
s.

Pr
efer
encesharesar
enon-par
ti
ci
pati
nginnatur
eunles
sandunt
il
ex
pressl
ypr
ovidedinthememorandum oft
hearti
cl
e.

7.Converti
blePref
erenceShares
Converti
blepref
erencesharesarethetypeofpr
efer
ences
har
eswher
ethe
holderhastheoptiontoconverti
ntothecommon/equi
tys
har
eoft
he
company.

Thi
sk i
ndofpr
eferenceshareisusef
ulfortheinvest
orswhowantt o
rec
eiveapref
erredsharedivi
dendandal soparti
ci
pateinanykindof
upwardchangeinthepriceoftheiss
uer’scommons hares
.So,
aninvest
or
hasthebenef
itandsecuri
tyofaf i
xedreturnalongwithachancetoearn
ahigherr
etur
nonhi s/
herinvest
ment.

Butthec
onvert
iblepref
erences
harehol
der
scanconver
tint
ocommon
shar
eswithi
nac ert
ainperi
odasagreedi
nthememorandum.
8.Non-Conver
tibl
ePrefer
enceShares
Non-conver
ti
blepref
erenceshar
esdonotc
arr
yther
ightofc
onver
sioni
ntot
he
company’scommons hares.
 MODULE3
PARTA-
2MARKS
1.Whati sCapi talbudget i
ng?
Capital budget i
ng, andi nves tmentappr ais al,
isthepl anningpr ocessus edt odet ermine
whet heranor ganiz ation' sl ongt ermi nves tment ss uchasnewmac hinery,replac ement
ofmac hiner y,newpl ant s ,new pr oduc ts,andr esearchdevel opmentpr ojectsarewor th
thefundi ngofc asht hr ought hefir
m' scapi tali
zationstructure
2.Whati sCapi t
alrat i
oni ng?
Capitalr ationingist heac tofpl acingr estricti
onsont heamountofnewi nvestment sor
proj
ec tsunder t
akenbyac ompany.Thi si sac complishedbyi mpos ingahi gherc ost
ofcapital fori nvestmentc ons i
derationorbys et
t i
ngac eil
ingons pec i
fi
cpor ti
onsofa
budge
3.WhatyoumeanbyARR?
Account ingr ateofr et ur n,al sok nownast heAver ager ateofr eturn,orARR i sa
fi
nanc i
alr atious edi nc api talbudget ing.Ther atiodoesnott akei ntoac countt he
conceptoft imeval ueofmoney. ARRc al culatesther eturn,gener at
edf rom neti ncome
ofthepr opos edc api tal inves tment .TheARRi saper c
ent ager et
ur n
4,Whati sOPERATI ONSRESEARCH?
Theappl i
cat i
onofs cient if
icandes peciallymat hemat icalmet hodst ot hestudyand
analysisofpr oblemsi nvol vingc ompl exs ystems
5.Whati spaybac kper iod?
Thepaybac kper iodr ef erst ot heamountoft i
mei tt akest or ecovert hec ostofan
i
nves tment .Simplyput , thepaybac kper i
odi st helengt hoft i
meani nves tmentr eaches
abr eak-
evenpoi nt.Thedes i
rabi
l
ityofaninvestmentisdi
rect
lyr
elatedtoit
spaybac k
peri
od.Shorterpaybac ksmeanmor eattr
acti
veinvest
ments.
6.
whati sNPV?
I
nf i
nanc e,t
henetpr esentvalueornetpresentworthappli
estoas eri
esofcas
hf l
ows
occurri
ngatdi f
fer
entt i
mes .
Thepresentval
ueofac ashfl
owdependsont heint
ervalof
ti
mebet weennow andt hec ashflow.Itals
odependsont hedi sc
ountrate.NPV
accountsforthetimeval ueofmoney

PARTB-
5MARKS
7.Whatarethemer i
tsanddemerit
sofpaybackmethod?
Meri
tsofPay-BackMethod:
Themerit
soradvantagesofPay-backmethods!
(1
)Thi
smet hodisEasyandSimpl
e:
Pay-
backmet hodiseasytocalc
ulateandsimpletounder
stand.I
tsqui
ckc
omput
ati
on
makesitafavorabl
eamongex ecuti
veswhoprefers
napanswers.

(2)Rank i
ngofPr oj
ec t
s:
Thismet hodispr eferredbyex ec
uti
veswholik
es napans wer sfortheselecti
onoft he
propos al
.Thepr oj
ectsarer ankedinter
msoftheirec
o( 4)Us efulinCaseofUnc ertaint
y:
Pay- backmet hodisus efulintheindus
tri
eswhichares ubjecttounc ert
ainty,i
ns t
abil
it
y
orr apidt echnologicalc hangesbec ausethe futur
e unc ertai
nty does notper mit
projecti
onofannualc ashinfl
owsbeyondal i
mitedper iod.Itreducesthepos sibi
li
tyof
l
os sthroughobs ol
es c
enc e.

(5)HandyDeviceorMet hod:
Thismethodishandydevi ceforeval
uati
ngi
nves
tmentpr
opos
alswher
epr
oces
sioni
n
esti
matesofprofi
tabi
l
ityisnoti
mportant
.

Demer i
tsorLimit
ati
onsofPay-BackMethod:
I
mpor tantde-meri
tsofPayBackMethodsareasfol
l
ows:
(a)I
tignoresannualcashfl
ow:
Pay-backmet hodtot
all
yignor
estheannualcas
hinfl
owaft
ert
hepay-
bac
kper
iod.

(b)I
tconsi
der
sonlytheper
iodofpay-
bac
k:
Pay-backmethoddoesnotconsi
dert
hepat
ter
nofc
ashi
nfl
owsort
hemagni
tudeand
ti
mingofcashinf
lows.

(c)I
toverl
ookscapi
talcost:
Pay-backmethodoverlookthecost
sofc api
tali
.e.
,i
nter
estf
act
orwhi
chi
sani
mpor
tant
consider
ati
oninmak i
ngs oundi
nvestmentdecis
ions.

(
d)Nor
ati
onal
bas
isofdec
isi
on:
Thereisnorat
ionalbas
isf
ordet
ermi
ningthemini
mum ac
c eptabl
epay-
bac
kperi
od.I
tis
generall
ysubj
ecti
vedeci
si
onofthemanagementwhi
chcreatessomanyadmi
nis
trat
ive
di
ffi
cult
ies.

(e)I
tisdelic
ateandri
gid:
As l
ightc hangeinoperati
onc
ostmayaf
fec
tthec
ashi
nfl
ow andass
uchpay-
bac
k
peri
ods hallnotbeaf
fect
ed.

(f
)Thismethod overemphas
izest
he i
mpor
tanc
e ofl
i
qui
dit
y asa goalofc
api
tal
expendi
tur
edeci
sions
:

8.Expl
ainst
epsincapi
tal
budgeti
ng?
1.
Ident
ifyandeval
uatepotent
ial
oppor
tuni
ti
es

Thepr ocessbegi nsbyex pl

ori
ngavai l
ableoppor t
uniti
es.Foranygiveni nit
iati
ve,a
companywi l
l probablyhavemul tipleoptionstocons i
der.Forexample, i
fac ompanyi s
seekingtoex pandi t
swar ehousingf aci
li
ti
es ,
itmightc hoosebetweenaddi ngontoits
curr
entbuildingorpur chasingal argerspac einanewl ocati
on.Assuc h,eachoption
mustbeeval uat edtos eewhatmak esthemos tf
inanc i
alandlogi
sti
cal sense.Oncethe
mostf easi
bleoppor tunit
yisidentifi
ed,ac ompanys houlddetermi
net her i
ghttimeto
pursueit,k
eepi nginmi ndfactorss uchasbus inessneedandupf r
ontc osts.
2.
Est
imat
eoper
ati
ngandi
mpl
ement
ati
onc
ost
s

Thenex tstepi nvol

veses t
imati
nghowmuc hitwi l
lcosttobringthepr ojecttof rui
ti
on.
Thi
spr oces smayr equirebothinternalandex ternalresearc
h. I
fac ompanyi slookingto
upgradei tsc omputerequipment, f
orinstance,itmightas kit
sITdepar tmenthowmuc h
i
twoul dc ostt obuynewmemor yforitsexis
tingmac hi
neswhi l
es i
mult aneous lypric
ing
outthec ostofnewc omput er
sf r
om anout s
ides ource.Thecompanys houl dt hen
att
emptt of urt
hernarrowdownt hec ostofimpl ementingwhi cheveropt i
oni tchoos es
.
3.Es
timatecas hf l
oworbenef i
t
Nowwedet ermi nehowmuc hcashfl
owt heprojecti
nquesti
onisex pect
edtogenerate.
Onewayt oar riveatthisfi
gurei
storevi
ewdat aons imil
arproj
ectsthathaveproved
succ
es s
fuli
nt hepas t
.Iftheproj
ectwon'
tdi r
ectl
ygeneratecashflow,suchasthe
upgradi
ngofc omputerequipmentformor eeff
ici
entoperat
ions,t
hec ompanymus tdo
i
tsbesttoassignanes t
imatedcostsavi
ngsorbenef i
ttoseeift
hei ni
ti
ati
vemak es
sens
ef i
nancially.
4.Assessri
s k
Thi
ss tepinvolvesesti
matingtheri
skass
oci
atedwiththeproject,i
ncl
udingt heamount
ofmoneyt hec ompanys tandstol
osei
ftheproj
ectfai
lsorcan'tproduceitsprevi
ousl
y
anti
ci
pat edr esul
ts.Onceadegr eeofr
iski
sdeter
mined,thec ompanyc anevaluatei
t
agai
ns titses timated cashf l
ow orbenefi
ttos ee ifitmak es senset o pur
sue
i
mpl
ement
ati
on.
5.I
mpl ement
i
fac ompanyc hoosestomovef orwardwithapr ojec
t,i
twil
lneedani mplement ati
on
pl
an.Thepl ans houl
dincl
udeameansofpayi ngfortheproj
ectathand,amet hodf or
tr
ackingc os
ts,
andapr oc
essforrecor
dingcashfl
owsorbenefit
stheprojectgenerates.
Theimpl ementati
onplans houldalsoincl
udeat imeli
newit
hk eyprojectmilestones,
i
ncludinganenddat eifappli
cabl
e.

9.Explai
nIRR?
The inter
nalrate ofreturnisa met ri
cus ed inf i
nanci
alanalysi
sto esti
matet he
prof
itabil
i
tyofpotenti
alinvest
ments.Thei nt
ernalrateofret
urnisadis
countr at
ethat
makest henetpresentvalue(NPV)ofallcashflowsequaltoz er
oinadiscountedcash
fl
owanal ysi
s.I
RRcalcul
ationsrel
yonthes amef or
mulaasNPVdoes .

KEYTAKEAWAYS

● I
RRi
stheannual
rat
eofgrowthani
nvestmenti
sexpectedtogenerat
e.
● I
RRi
scalc
ulat
edusi
ngthesameconceptasNPV,excepti
tsetstheNPVequalt
o
zero.
● IRRi sidealforanalyzingc api
t albudgetingproject
st ounder standandc ompare
potentialr
atesofannual returnovert ime.
10.Expl
ainNPV?
NPVanal ysisisusedtohel pdet erminehowmuc hani nves t
ment ,project
,oranys eri
es
ofc ashf l
owsi sworth.Iti san al l-encompas si
ng met r
ic,asi ttak esinto ac c
ount
allr
evenues ,expenses
,andc apitalc
os t
sassociat
edwi thani nvestmenti nit
sFr eeCash
Flow (
FCF) .
I
naddi ti
ontofac tor
ingal lrevenuesandc ost
s,italsotakesi nt
oac countthe
ti
mingofeac hc ashfl
ow t hatc anres ultinalargei mpactont hepr esentvalueofan
i
nves t
ment .Forexample,it’sbettertos eec ashinfl
owss oonerandc as houtf
lowsl at
er,
compar edtot heopposit
e.
WhyAr eCashFlowsDis
counted?Thec as
hflowsinnetpres
entval
ueanalysi
sare
di
scount
edfortwomainr
easons,(1
)toadj
ustf
ortheri
skofani
nves
tmentoppor
tuni
ty,
and(2)t
oaccountf
ort
hetimevalueofmoney(TVM)
.
Thefirs
tpoint(toadjustforri
sk)i
snec essarybecausenotallbusi
ness
es,proj
ect
s,or
i
nvestmentoppor t
unit
ieshavethes amel evelofri
sk.Putanot
herway,theprobabil
i
ty
ofrecei
vingc as
hf l
ow from aUSTr easurybilli
smuc hhigherthantheprobabi
li
tyof
rec
eivi
ngc ashfl
owf r
om ayoungt echnologystar
tup.

PARTC-
15MARKS
1
1.ProjectAandpr
ojec
tBr
equi
resani
nves
tmentofRs50000and80000r
espec
tivel
y
c
alculateNPV

YEARS PROJ
ECTA PROJ
ECTB
1 25000 20000

2 1
5000 22000

3 1
2500 23000

4 NI
L 25000

5 1
2000 1
8000

6 6000 8500

Di
scountr
ate1
0%
ANS

PROJ
ECTA PROJ
ECTB

Year PV CASH PV CASH PV

I
NFLOW I
NFLOW

1 .
909 25000 22725 20000 1
8180

2 .
826 1
5000 1
2390 22000 1
8172

3 .
751 1
2500 9388 23000 1
7273

4 .
683 NI
L NI
L 25000 1
7075

5 .
621 1
2000 7452 1
8000 1
1178

6 .
564 6000 3384 8500 4794

TOTALPV 55339 86672

LESSCOSTOFPROJ
ECT 50000 50000

NPV 5339 6672

NPVofprojec
tBi shi
ghert hanthatpr
ojectofA.pr
ojectBshoul
dbesel
ect
ed
12.A companyhasani nvestmentopportuni
tycosti
ngRs40000withthefol
l
owing
expec
tednetc ashfl
ow( Aftert
axandbeforedepreci
ation)
year 1 2 3 4 5 6 7 8 9 10

Cash 700 700 7000 7000 7000 8000 1

0000 1
5000 1
000 4000
fl
ow 0 0 0

Us
ing1
0%ast
hec
ostofc
api
tal
.Fi
nd
1.
payback per
iod,
2.
NPV10% dis
count
ing f
act
or,
3.
prof
it
abil
i
tyindex 1
0% di
scount
ing
fact
or,
4.
IRR10%discount
ingf
act
orand15%dis
count
ingfact
or
ANS;
YEAR NETCASHI NFLOW CUMULATIVENETCASHFLOW

1 7000 7000

2 7000 1
4000

3 7000 21
000

4 7000 28000

5 7000 35000

6 7000 43000

Paybackper
iod=5years+5ooo/
8000=5.
62years
B.NPV
YEAR NETCASHFLOW DISCOUNTFACTOR PV

1 7000 .
909 6363

2 7000 .
826 5782

3 7000 .
751 5257

4 7000 .
683 4781

5 7000 .
621 4347

6 8000 .
564 451
2

7 1
0000 .
513 51
30

8 1
5000 .
467 7005

9 1
0000 .
424 4240

1
0 4000 .
386 1
544

Tot
alpr
esentval
ueofc
ashi
nfl
ow=48961
Les
sIni
ti
ali
nvest
ment= 40000

NPV = 8961
C.
Prof
it
abil
i
tyI
ndex
Pr
esentval
ueofcas
hinf
low =48961=1
.224
Pres
entval
ueofc
as houtf
low 40000
D. IRR
YEAR NETCASHINFLOW DISCOUNT FACTOR PV
10%

1 7000 .
870 6090

2 7000 .
756 5292

3 7000 .
658 4606

4 7000 .
572 4004

5 7000 .
497 3479

6 8000 .
432 3456

7 1
0000 .
376 3760

8 1
5000 .
327 4905

9 1
0000 .
284 2840

1
0 4000 .
247 988

Totalpresentvalueofc ashinf
low 39420
Less I
nit
ial i
nves
tment
40000
NPV (-
)580
I
RR=L1 +P1-1*D
P2-P1
L1=LOWERRATE=1 0%
L2=HIGHERRATE=1 5%
P1=PVLOWERRATE=Rs 48961
I
=COSTOFI NVESTMENT=Rs40000
P2=PVATHI GHERRATE=39420
D=L2-L1=15-10=5
I
RR=1 0+48961 -40000*5
48961-39420
=10+4.696=14.696
 MODULE4
PARTA-2mar
ks
1.Defi
neworkingcapit
al?
Wor k
ingcapital
,als
ok nownasnetworki
ngcapit
al(
NWC) ,i
sthediffer
encebetweena
company'scur r
entassets
,suchascas
h,account
srecei
vable(c
us tomers
'unpaidbi
ll
s)
andinventori
esofraw mat er
ial
sandf
ini
shedgoods
,andi t
scurrentli
abi
li
ti
es,s
uchas
accountspayable

2.Whati sGrossworki
ngc apit
al?
Grosswor ki
ng c api
tali
st he sum ofa c ompany'scur
rentassets(assetsthatare
convert
ibletoc ashwit
hinayearorl ess)
.Grosswork
ingc
apital
incl
udesas s
etssuchas
cash,accountsrecei
vable,i
nventor
y,short
-ter
minvest
ments,
andmar ket
ablesecur
iti
es.

3.Whati sNetwor kingc api tal?

Networ kingc api tal (
NWC)i st hedi f
ferencebet weenac ompany' sc urrentassetsand
currentl i
abi l
i
ties .A pos iti
venetwor k
ing c apital i
ndicatesa c ompanyhass uffi
cient
fundst omeeti tsc urrentf inanc i
alobl i
gationsandi nvestinot heractiviti
es
4.Whati soper at i
ngc ycl
e?
Anoper atingc yc lereferst ot het i
mei ttak esac ompanyt obuygoods ,sel
lthem and
receivec as hf rom t hes aleofs aidgoods .I not herwor ds,it'
show l ongitt akesa
companyt otur ni t
si nvent oriesintoc ash.Thel engt hofanoper ati
ngc ycl
eisdependent
upont hei ndus try
5. Whati swor kingc apital gap?
Wor king c apit
algap= Cur rentAs sets(ex cluding c ash & bankbal ance)-Cur rent
Liabil
iti
es .So,hi ghwor kingc api t
al entail
sac ostt ot hefirmi nt hef orm ofshor tterm
l
oani nteres tpayment s.Thegr eatert hewor k i
ngc apit
al gap, thelargeristheamountt o
bebor rowedands ohigheri sthes ervici
ngc os t
6.Whati sHar dc orewor k ingc apit
al ?
Thet er m Har d-Cor eWor kingCapi t alwasf irstus edbyTandonCommi t
teeinitsrepor t
.
I
tmeanst hemi nimum amountofwor ki
ngc apital r
equiredt oi nvesti nraw mat erial
s,
storesands par es,wor ki
npr ogr esset ctok eept hef i
rmr unning

PARTB-
5MARKS

7.
Whati
soper
ati
ngc
ycl
emet
hodofes
timat
ingwor
kingc
api
tal
?

Oper
ati
ngCyc
leAppr
oac
h’or‘
Cas
hWor
kingCapi
talAppr
oac
h’t
oWor
kingCapi
tal
r
equi
rement
.

Unliket hec onvent i

onalappr oac h,c ons i
stentwi t
ht hedef i
nit
ion,thi
sappr oachvi ews
wor ki
ngc apitalasaf unc t
ionoft hevol umeofoper ati
ngex penses.Thisappr oach
sugges tst hatac t
uallevelofwor kingc apitalrequirementofaf ir
mi naper i
odc anbe
appropr iatelydet erminedwi thr eferenc etot helengt hofNetOper at
ingCyc leandt he
operatingex pens esneededf ort heper iod.
Thenetdur ationofoper atingc ycleisequalt ot henumberofdaysi nvolvedint he
diff
erents tagesofoper ationc ommenc ingf rom pur chaseofraw mat er
ialsandendi ng
upwi t
hc ollectionofs alepr oceedsf r
om Debt orsagai nstwhicht henumberofdays
creditallowedbys uppli
ersar etobeadj usted.
Thenumberofoper ati
ngc yc l
esi naper i
odi sdet erminedbydi vi
dingt henumberof
daysi nt hes amebyt hel engt hofNetOper ati
ngCyc l
e.Oncethenumberofoper ati
ng
cyclehasbeendet ermined, theac tualwor k i
ngc apitalrequi
rementisthenar ri
vedatby
divi
dingt het otaloperatingex pens esf ortheper iodbyt henumberofoper ati
ngc ycl
es
i
nt hatper i
od.

8.
Whatar
ethes
our
cesofwor
kingcapi
tal
?

1
.Loansf
rom Commer
cial
Bank
s:

Smal l
-s
caleent
erpri
sescanr aiseloansfrom thec ommercialbankswi t
horwi t
hout
securi
ty.Thi
smethodoffinancingdoesnotr equir
eanyl egalformali
tyexceptthatof
creati
ngamor t
gageontheas s
ets.Loancanbepai dinl
umps um orinpar
ts.Theshor
t-
termloanscanalsobeobtainedfrom banksont hepers
onals ec
urit
yofthedirect
orsof
ac ountr
y.

2.
Publ
i
cDepos
its
:

Oftenc ompaniesfindi teasyandc onvenienttor ai

seshort
-termfundsbyinvi
ti
ng
shareholders
,empl oyeesand t hegeneralpubli
ct o deposi
tthei
rsavi
ngswiththe
company. Iti
sas i
mpl emet hodofrai
si
ngfundsfrom publi
cforwhic
hthecompanyhas
onlytoadver t
iseandinformt hepubl
ict
hatitisauthori
sedbytheCompaniesAc
t1956,
toac c
eptpubl i
cdepos i
ts.

Publ
icdepos
itscanbei
nvit
edbyoffer
ingahi gherrateofinter
estthant heint
eres
t
al
lowedonbankdeposi
ts.However
,thec ompaniesc anrais
ef undsthroughpubli
c
deposi
tss
ubj
ec tt
oamax
imum of25%oftheirpai
dupc api
talandfreeres
erves.

But,
thes mal
l-s
caleenterpri
sesareexemptedfr
om ther
estr
ict
ionsoft
hemaxi
mum l
i
mi t
ofpubli
cdeposit
siftheys at
isf
ythefoll
owi
ngcondit
ions
:
Theamountofdepos itdoesnotex ceedRs.8lak
hsort heamountofpai
dupcapital
whicheveri
sless.
Themai nmer i
toft hi
ssourc
eofraisi
ngfundsisthati
tiss
impleaswel
lascheaper
.But
,
thebiggestdisadvantageas s
oci
atedwi t
hthissourc
eisthatiti
snotavai
labl
etothe
entr
epreneursduringdepressi
onandfinanci
alst
ri
ngency.

3.
TradeCr
edi
t:

Justast hec ompaniess el

lgoodsonc redit,t
heyal sobuyr aw materi
als
,c omponents
andot hergoodsonc reditfr
om thei
rs uppliers.Thus
,outstandingamountspayableto
thesuppliersi
.e.
,tr
adec redi
torsf
orcreditpur chasesareregardedassourcesoffi
nance.
Generall
y, s
uppli
ersgrantc r
editt
otheirc l
ientsforaperiodof3t o6months .

4.
Fac
tor
ing:

Factori
ngi safi
nancials
ervi
cedesignedtohel
pfir
msinmanagi ngthei
rbookdebt sand
rec
eivablesinabet t
ermanner .
Thebookdebtsandreceivablesar
eassignedtoabank
cal
ledt he‘fact
or’andc as
hi sr
eali
sedinadvancefr
om t hebank.Forrenderi
ngthese
ser
vices,thefeeorcommi ss
ionchargedi
susual
lyaperc
ent ageofthevalueofthebook
debts/
receivabl
esfactor
ed.

5.
Dis
count
ingBi
l
lsofEx
change:

Whengoodsar esol
donc r
edit
,bil
lsofexchangearegenerallydrawnforac
ceptanceby
thebuyersofgoods.Thebil
lsaregener al
lydrawnforaper iodof3t o6mont hs.I
n
prac
tic
e,thewrit
erofthebi
ll
,i
ns t
eadofhol di
ngthebil
lti
l
lt hedateofmaturi
ty,pr
efers
todi
scountthem wi
thcommercialbanksonpaymentofac hargeknownasdiscount.

6.
BankOver
draf
tandCas
hCr
edi
t:

Over dr
afti
saf aci
l
ityext
endedbythebank stotheircur
rentaccountholder
sf oras hor
t
-peri
odgener al
lyaweek .A cur
rentaccounthol derisall
owedt owi thdr
aw f r
om i t
s
currentdeposi
taccountupt
oac ert
ainl
imitoverthebalancewiththebank .Theinteres
t
i
sc hargedonlyont heamountact
uall
yoverdrawn. Theoverdr
aftfaci
l
ityisalsogranted
againstsecur
iti
es.

7.
Advanc
esf
rom Cus
tomer
s:

Onewayofr ais
ingf undsforshort-
ter
mrequirementistodemandf oradvancefrom
one’
sownc ust
omer s.Examplesofadvancesfrom thecust
omer sareadvanc epaidat
thetimeofbookingac ar,atelephoneconnecti
on,af l
at,etc
.Thi shasbec omean
i
ncreasi
ngl
ypopularsourceofshort-
termf
inanceamongt hes mallbusines
senterpr
ises
mainl
yduetotwor easons.

8.
Acc
rual
Acc
ount
s:
 Generall
y,ther
ei sac er
tainamountoft imegapbet weenincomesisearnedandi s
actuall
yrecei
vedorexpenditur
ebec omesdueandi sactual
lypaid.
Sal
aries,
wagesand
tax
es ,f
orexample,becomedueatt heendofthemont hbutareusual
l
ypai dinthefi
rst
weekoft henex tmonth.Thus,theout st
andi
ngs al
ari
esandwagesasex pensesfora
weekhel ptheenterpr
iseinmeet i
ngt hei
rworki
ngc api
talr
equir
ements.Thi
ss our
ceof
rai
singfundsdoesnotinvol
veanyc ost.

9.
Dif
fer
entt
ypesofwor
kingc
api
tal
?

TypesofWor
kingCapi
tal

1
. Ont
hebas
isofVal
ue

▪ Gr
ossWor
kingCapi
tal
:Itdenot
est
hec
ompany’
sover
alli
nves
tmenti
nthec
urr
ent
as
set
s.
▪ NetWor
kingCapi
tal
:I
timpl
i
est
hes
urpl
usofc
urr
entas
set
soverc
urr
entl
i
abi
l
iti
es.A
posi
ti
ve networki
ng c apit
alshowst he c
ompany’
sabil
i
tytocovershort
-ter
m
l
iabi
li
ti
es,
whereasanegat i
venetwor
kingcapit
ali
ndi
cat
est
hec
ompany’
sinabi
li
tyin
ful
fi
l
li
ngshor
t-t
erm obl
i
gations.
Ont
hebas
isofTi
me
▪ Tempor
arywor
kingCapi
tal
:Ot
her
wis
eknownasvar
iabl
ewor
kingc
api
tal
,iti
sthat
port
ionofcapi
talwhichisneededbythef i
rm al
ongwiththeper
manentwork
ing
capi
tal
,toful
fi
lshor
t-t
erm worki
ngcapi
talneedsthatemer
geoutoffl
uct
uat
ionin
thesal
esvol
ume.
▪ Per
manentWor
king Capi
tal
:The mi
nimum amountofwor
king c
api
talt
hata
company hol
dstocar
ry on t
he oper
ati
onswi
thoutany i
nter
rupt
ion,i
scal
l
ed
per
manentworki
ngc
api
tal
.
Othertypesofwor king capi
talincludeI ni
ti
alworki
ng capit
aland Regularwork
ing
capi
tal
.Thecapitalr
equir
edbyt hepr omot er
stoini
ti
atethebus i
nes
sisknownasini
tial
worki
ngc api
tal
.Ontheot herhand,regularworki
ngcapit
alisonethati
srequir
edbythe
f
irmtocarryonitsoperat
ionseff
ec t
ively.

Wor
kingCapi
tal
Cyc
le

WorkingCapit
alCyc l
eorpopul arl
yk nownasoper ati
ngc yc
le,i
st helengt
hoft i
me
betweentheout f
low andinf
low ofcashduringthebus i
nessoperati
on.I
tistheti
me
tak
enbyt hefirm,forthepaymentofmat er
ial
s,wagesandot herexpenses
,enter
ing
i
ntostockandreali
zi
ngc as
hfrom thesaleoft
hefini
shedgood.

I
nshort
,thework
ingcapi
talcyc
lei
stheaver
ageti
merequi
redt
oinves
tcas
hinas
set
s
andr
econver
ti
ngiti
ntocashbysel
l
ingt
heasset
spr
oduced.

Thewor kingcapi
talc
ycl
emayvar yfr
om enter
pri
setoenterpr
isedependingonvarious
fact
ors,
s uchasnatur
eandsizeofbusi
nes
s,product
ionpol
ici
es,manufactur
ingpr
oc ess
,
fl
uctuat
ionsintradecyc
le,c
redi
tpoli
cy,t
ermsandc ondi
ti
onsforpurchaseands ales
,
etc
10.
whati swor ki
ngc apit
almanagement ?
Ac ompany’swor kingcapi
tales
senti
all
yc onsi
stsofcurr
entassetsandc urr
entl
iabi
li
ti
es.
Currentassetsrefertothoseass
etsthatcanbec onver
tedint
oc ashwithinoneyear,
l
ikedebt or
s,ands tockandprepaidexpenses-expensesthathavealreadybeenpaidfor.
Currentli
abil
it
iesaret heday-
to-
daydebt sincur
redbyabus i
nessini
tsoperati
on.These
couldbec redi
tpur chasesmadefrom vendors(credi
tor
s)andout s
tandingexpenses
(
ex pensesthatareyett obepaid).

Thus,worki
ngcapital
managementr eferst
omonitor
ingthes
etwoc omponent
sort
he
short
-ter
ml i
qui
dit
yofyourf i
rm.
Threefundamentalparametersthathelpyoumanagewor ki
ngcapit
al
requi
rementsbett
erandi ndi
cateyourliqui
dit
yst
andingofyourf
ir
m are:

1.
Worki
ngCapit
alRat
io:
Arat
iobet
weenthecurr
entas
set
sandcurr
entli
abil
i
ties
,its
igni
fi
est
hec
urr
entabi
l
ityof
anor
ganiz
ati
ontopayoffi
tss
hor
t-t
imef
inanc
ialobl
igati
ons.

2.Coll
ecti
onPeri
odRati
o:
Alsoknownast hedebt
orsorac count
srecei
vabl
estur
noverrat
io,
thi
srat
ioi
sindic
ati
ve
ofac ompany’
sabili
tyt
oc onvertit
sdebtsi
ntocas
h.Theles
sernumberofdaysitt
akes
toreali
seit
spaymentsfr
om itsdebtor
s,thebet
ter
.

3.I
nventor
yTurnoverRati
o:
Als
ok nownasthestockturnoverr
atio,
thisr
ati
omoni t
orst
hetimeacompanytakest
o
convert
sit
sgoodsintocash.Lowerthetimetaken,
higheri
sthecompany’
sst
ock
eff
ici
ency.

St
rongworki
ngcapi
talmanagementaidsac
ompanyi
nhavi
ngahi
gheroper
ati
onal
ef
fi
cienc
yandhence,hi
gherpr
ofi
tabi
l
ity.

1
1.Whati
sthei
mpor
tanc
eofwor
kingc
api
tal
?

Workingc api
tal
isjus
twhatits ays–i
tist
hemoneyyouhavet
oworkwit
htomeetyour
shor
t-ter
m needs.Itisimport
antbecauseiti
sameasur
eofacompany’
sabi
l
ityt
opay
offs
hor t
-ter
m expensesordebts.

Butontheotherhand,
toomuchwor ki
ngcapi
tal
meanst
hats
omeas set
sar
enotbei
ng
i
nvest
ed forthelong-
ter
m,sot heyar enotbei
ngputtogood us
ei nhel
pingt
he
companygrowasmuc haspos
sible.

Themos
timpor
tantpos
iti
onsf
oref
fec
tivewor
kingc
api
talmanagementar
einvent
ory,
accountsrec
eivable,andac c
ountspayabl
e.Dependingont heindust
ryandbusi
ness,
prepaymentsreceivedfrom cus
tomersandpr epaymentspaidt osuppl
i
ersmayal s
o
pl
ayani mport
antr ol
eint hecompany’scashf l
ow.Exces
sc ashandnonoperat
ional
i
temsmaybeex cludedfr
om thecalc
ulat
ionforbett
ercomparis
on.

Wor ki
ng capi
talist he diff
erence between a busi
ness’cur
rentas s
etsand current
l
iabi
li
tiesordebts
.Wor kingc apit
alservesasamet ri
cforhow effi
ci
entl
yac ompanyi s
operatingandhow f i
nanc i
all
ys t
ableitisintheshort-
ter
m.Thewor kingcapi
talrati
o,
whichdi vi
descurrentas s
etsbyc urr
entli
abil
it
ies
,indi
cateswhetherac ompanyhas
adequat ecashflow toc overshort-
term debtsand expenses.A healt
hyc ompany
shouldhaveapos i
tiverati
o.

Currentasset
sareas set
swhi char eexpect
edt obesol
dorother
wis
eus edwithi
none
fi
scalyear.
Typic
ally,
currentassetsinc
ludecash,c
ash-
equi
val
ents
,account
srec
eivabl
e,
i
nvent or
y,andpr epaidac countswhi chwil
lbeus edwit
hinayear,ands hort
-ter
m
i
nves t
ments.

Currentl
iabi
li
ti
esarec ons
ideredtobet hedebtsoft hebusi
nessthataretobeset
tl
edin
cashwi thi
nt hefisc
alyear .Currentli
abil
it
iesincludeaccount
spayabl esforgoods
,
servi
ces,orsuppli
es,shor
tt ermloans,long-t
erml oanswithmat ur
it
ywi t
hinoneyear
,
divi
dendsandi nt
erestpayable,oraccr
uedl i
abil
i
tiessuchasaccr
uedt axes
.

Butoneoft hemeasuresshor
tcomi ngsisthatcurr
entas set
softencannotbeli
quidated
i
nt heshortter
m.Highwor ki
ngc api
talposit
ionsoftenindi
catethattherei
stoomuc h
moneyt i
edupi nac count
sreceivableorinventory,rat
herthans hor
t-t
ermli
quidit
y.In
thosecases,i
tisbesttoworktoc ol
lec
tpayment sf r
om yourcustomersandselldown
i
nventorytoincr
easeyourworkingc api
tal
.

PARTC-
15MARKS

12.Def i
ne wor king capi tal? what ar et he factors determini ng wor k
ing capital
requirement s
?
1 .
Sal es:
Among t he var i
ousf ac t
or s,si
ze oft he salesisone oft he impor tantfac t
orsi n
deter mini
ngt heamountofwor k
ingc apit
al.Inordert oincreas esalesvolume,t he
enter pr
iseneedst omai ntainitscurrentassets.I
nt hec ourseofper i
od,theent er
pri
s e
bec omesi nthepos it
iont ok eepas teadyrati
oofi t
sc urr
entas setst oannual s
ales.Asa
result,t
het ur
noverr atio,i
.e.,cur
rentassetstoturnoverincreasesr educingthelengthof
oper ati
ngc yc l
e.Thus ,lesst heoper ati
ngc ycleper i
od,lesswi llber equirementsf or
wor kingcapitalandvi cever sa.

2.LengthofOper ati
ngCycle:
Conver si
onofc ashthroughvar i
ousstagesviz.
,raw mat er
ial
,semi
-proces
sedgoods,
fi
nishedgoods ,sal
es,debtorsandbil
lsrecei
vabl
esi nt
oc ashtakesac er
tai
nperi
odof
ti
met hatisk
nownas‘ l
engthofoperatingcycl
e’.Longertheoperat
ingcycl
etime,t
he
mor eisthewor k
ingcapit
alrequi
red.
Forex ample,
heavyengi
neer
ingneedsrel
ati
vel
ymorework
ingc apit
althanar
icemil
lor
cottons pi
nni
ngmi l
loras t
eelr ol
li
ngmil
l
.Thus,i
tfol
l
owst hatdependingupont he
l
engt hofwor ki
ngcycl
e,t
her equir
ementf
orworki
ngcapi
talvariesfr
om ent
erpr
iseto
enterpri
se.

3.NatureofBusines
s:
Therequirementofwor ki
ngc api
talal
sovariesamongtheenter
pri
sesdependingupon
thenat ureoft hebus i
ness.Forinst
ance,t r
adi
ng compani
esrequir
emor ewor king
capit
alt han manufacturi
ng companies
.Thi sisbecausethatthe tr
ading bus
iness
requi
reslargequantit
iesofgoodst obeheldi nst
ockandalsocarr
ylargeamount sof
workingc api
tal
thanmanuf actur
ingconcer
ns .

I
nbot hthes etypesofbusi
ness
es,
thevalueofcurr
entassetsi
s80%to90%oftheval
ue
oftotalassets.Thei
nvest
mentincur
rentass
etsisrel
ati
vel
ys mal
l
eri
nthecas
eofhotel
s
andr estaurantsbecausetheymostlyhavec ashs al
es,andonlysmal
lamountsof
debtors
’ balances.

4.Ter msofCredit
:
Anot herimport
antfactorthatdeter
minest heamountofwor k
ingc api
talr
equir
ement s
rel
atest othetermsofc r
edital
lowedtot hecustomers
.Fori
nstance,anenterpr
isemay
all
ow onl y15daysc redit
,whileanothermayal l
ow 90daysc r
editt
oi t
sc ust
omers.
Besides,anent er
pri
semayex tendc r
editfaci
li
ti
estoitsal
lcus t
omers,whil
eanot her
enterpri
seinthes amebus i
nessmayex tendc r
editonl
ytosel
ec tandthosetooreli
able
customer sonl
y

Then,therequirementsforworki
ngc apit
alwil
lnatural
l
ybemor eifthec r
edi
tperi
odis
l
ongerandc reditfaci
li
ti
esareextendedt oallcust
omers,nomat terrel
i
ableornon-
rel
i
abletheyar e.Thisi
sbecauset
herewi l
lbelongerbal
anceofdebtorsandthatt
oofor
arelat
ivel
ylongerper i
odwhichwil
lobviousl
ydemandf ormorecapi
tal.

Onthecontr
ary,ifsuppl
i
esofraw mat
eri
alsareavailableonf avour
abl
ec ondi
ti
onsor
t
ermsofcr
editi.
e.
, t
hepaymentwil
lbemadeaf terarelat
ivel
ylongerper
iodofti
me,the
r
equi
rementforwor ki
ngcapi
tal
wil
lbecor
respondingl
ys mall
er.

5.SeasonalVariati
ons:
Thes easonalenterpri
ses,i.
e.
,theenterpr
isewhos eoperat
ionspi
ckups eas
onal
lymay
requi
remor ewor ki
ngc apit
altomeett hei
rincreasedoperati
onsduri
ngtheparti
cul
ar
season.A popul arex ampl e ofseasonalenterpri
se may be sugarfact
ory whose
operati
onsarehi ghl
ys easonal
.

6.Tur
noverofInventori
es
I
finventori
esarelargeinsi
zebutturnoverissl
ow,thesmall
-s
cal
eenterpri
sewi
llneed
morewor ki
ngc api
tal.
Onthecontr
ary,i
finvent
ori
esaresmall
butthei
rtur
noveri
squick
,
theenterpr
isewil
lneedas mal
lamountofwor ki
ngcapit
al.
7.Natur
eofPr oducti
onTechnology:
I
nc aseofl abourintensi
vetec hnol
ogy,theuni twillneedmor eamountt opayt he
wagesand,t heref
ore,wil
lrequiremor ewor ki
ngc apit
al.Ont heotherhand,ifthe
product
ion technol
ogy iscapital-int
ensive,the enter
pri
se wil
lhave to makeless
paymentforex pensesl
ik
ewages .Asaresult,
enter
prisewil
lrequi
rel
esswork
ingcapi
tal
.

8.Conti
ngencies:
I
fthedemandf orandpr iceofthepr oductsofsmall-scal
eent er
prisesaresubj
ec tto
widevariat
ionsorf luctuati
ons,thecontingencyprovisi
onswi l
lhavet obemadef or
meetingthef luctuat i
ons.Thiswi l
lobviouslyi
ncreaset herequirementsforwor king
capi
talofthes mal lenterpri
ses.Whil
eonec anaddc ert
ainotherfactorstothi
sli
st,the
sai
df act
orsappeart obet hemaj oronesi ndetermini
ngt herequirementofwor king
capi
talofas mall-
sc aleenterpr
ise

1
3.per
cent
ages
alesmet
hod

RS RS

Shar
ecapi
tal 400 Fi
xedAs
set 400

Res
erve&s
urpl
us 200 I
nvent
ori
es 300

Debent
ure 1
00 Rec
eivabl
e 200

S.
cr 200 Cas
h 1
00

Bi
l
lspayabl
e 1
00

1
000 1
000

Theturnoverofthecompanyfor2016-1
7wasRs1 000lak
hs.
itisanti
ci
pat
esas al
es
tur
noverRs1500l
akhsi
n2017-
18.
est
imatethwewor
kingc api
tal
requi
rementf
or201
7-1
8

ANS;

% cur
rentas
set& 201
6-1
7 201
7-1
8
C.
l
iabl
i
ty

SALES 1
00 1
000 1
500

Cur
rentas
st
 30 300 450

I
nvent
ori
es 20 200 300

1
0 1
00 1
50
Rec
eivabl
e

c
ash

t
otal 60 600 900

C.
l
iabi
l
ity

S.CR 20 200
300
Bil
lspayabl
e 1
0 1
00
150
Total 30 300
450

Wor
kingc
api
tal
=60-
30=30,
600-
300=300,
900-
450=450
 MODULE5
PARTA-
2MARKS
1.Whati sdivi
dend?
Adi vi
dendi sadi str
ibuti
onofpr ofi
tsbyac orporati
ontoi t
ss harehol
ders
.Whena
corporati
onear nsapr ofi
tors ur
plus
,iti
sablet opayapr oport
ionoft heprof
itas
adividendt oshareholder
s.Anyamountnotdi
s t
ributedist
akentober e-i
nvest
edinthe
business(call
edretai
nedear ni
ngs).

2.Whati sDi vi
dendpol i
cy?
Adividend pol ic
yi sthepol icya company us est os tructur
ei tsdividend payoutto
shareholders.Some r esearc her
ss uggestthedi vi
dend pol i
cyisi r
relevant,i
nt heory,
becaus einvestorscansellapor ti
onofthei
rs har
esorpor tfol
ioiftheyneedf unds.
3.Whati ss t
ockdi vi
dend?
As t
oc kdividendi sadividendpaymentt os har
ehol der
st hatismadei ns har
esr at
her
thanasc ash...
.Forexampl e,ac ompanymi ghtis s
ueas tockdi vi
dendof5%,whi chwi l
l
requir
ei ttoi s
sue0. 05shar esforeveryshar eownedbyex is
tings harehol
ders,sothe
ownerof1 00shar eswouldr ecei
ve5additionalshares

4.Whatisscri
pdi vi
dend?
Ascri
pdi vi
dendi snew sharesofani ss
uer'
sstoc
kthatarei s
suedtosharehol
ders
i
nsteadofadi vidend.Sc
ripdivi
dendsmaybeus edwheniss
uershavetooli
ttl
ec as
h
avail
abl
et oissueac as
hdividend,butst
il
lwanttopaytheirshar
ehol
der
si nsome
manner

5.Whatiss tocks
pli
t?
As t
ocks pl
itisadecisi
onbyac ompany'sboardofdirector
stoincr
easethenumber
ofsharesthatare outstanding by i
ssui
ng moresharestoc ur
rentshar
ehol
ders.For
example,ina2- f
or-
1stocks pli
t,anaddit
ionals
har
ei sgivenforeachsharehel
dbya
sharehol
der

6Whati s
.Reversespl
it
?
I
nf i
nanc e,ar ever
ses tocks pl
itorrever
ses pl
iti
s a proc
ess by whic
hs hares of
cor
poratestockareeffec
tivelymergedt of
orm asmall
ernumberofpropor
ti
onal
lymor e
val
uableshares.Arevers
es tocks
pliti
salsocal
ledastockmerge.

7.WhatisBonesi s
sue?
BonusSharesar esharesdis
tri
butedbyac ompanytoi t
scurr
entsharehol
der
sasf ul
ly
paidsharesfr
eeofc harge.tocapit
ali
seapar tofthecompany'sr
etainedear
ningsfor
convers
ionofitssharepremium account
,ordistr
ibut
ionoftr
easur
ys hares
.Aniss
ueof
bonussharesi
sr ef
err
edt oasabonuss hareis
sue?

8.
Whati
sopt
imum di
vi
dendpol
i
cy?

Theoptimaldi vidend poli

cyissimple:onl
y di
stri
butedivi
dendswhen cash holdi
ngs
exceedthreshold,whichdependsont hest
ateoftheec onomy.Thisi
sdoneex
ac t
lyasin
thedeterminis
ticinter
estratecas
e.Namely,i
ftheinit
ialcashholdi
ngsexc
eed,thenan
i
niti
aldi
videndofx−x(i )i
sdis
tri
buted.

9.
Whati
sDi
vi
dendpayoutr
ati
o?

Thedi vi
dendpayoutr at
ioisthef
ract
ionofneti
ncomeaf i
rm paystoi
tsst
ockholdersin
dividends:Thepartofearni
ngsnotpaidt
oinves
torsi
slef
tforinves
tmenttoprovidefor
futureearningsgr
owth.

PARTB-
5MARKS
10.
Whatar
etheVar
iouss
our
cesofbonusi
ssue?

Sour
ceofbonuss
har
es

Thebonuss
haresc
anbei s
suedoutofprofi
torreser
vewhic
hhavebeenearnedbyt he
companypr
ofi
torres
erveshoul
dbefreeforthepurpos
eofdivi
dendandasspeci
fi
edin
companyact.
Thereser
vescannotbeusedforiss
ueofbonuswhichar
enotearnedby
company.

Thef
oll
owi
ngi
sthel
i
stofr
eser
veswhi
chc
anbeus
edf
ori
ssui
ngbonuss
har
esby
pas
singt
hej
our
nal
ent
ri
esunderi
tsac
count
ingt
reat
ment.

● Profitandl os sac c
ount
● gener alreserve
● revenuer eserve
● freer eserves
● dividendequal izati
onf und
● capi talreserve
● sinkingf und
● debent ureredempt ionreser
veonlyaft
erredempti
on
● devel opmentr ebater eserve
● allowanc eaf t
erex piryof8years
● capi talredempt ionr eser
ve
● shar epr emi um ors ecuri
typremi
um ifr
eceivedi
ncash

11.
TypesofDivi dendPoli
cy:
Thevar i
oustypesofdi vi
dendpol
i
c i
esaredi
scuss
edasfoll
ows:
(a)RegularDividendPoli
cy:
Paymentofdi vi dendattheus
ualratei
ster
medasr egul
ardivi
dend.
Theinvest
orssuch
asreti
redpers ons ,
widowsandotherec
onomical
lyweakerpers
onspref
ertogetregul
ar
divi
dends .

Aregul
ardi
videndpol
i
cyoffer
sthefol
l
owingadvant
ages
:
(
a)Ites
tabl
i
shesaprofi
tabl
erecor
dofthecompany.

(
b)I
tcr
eat
esc
onf
idenc
eamongs
tthes
har
ehol
der
s.

(
c)I
tai
dsi
nlong-
ter
mfi
nanc
ingandr
ender
sfi
nanc
ingeas
ier
.

(
d)I
tst
abi
l
isest
hemar
ketval
ueofs
har
es.

(e)Theordi
naryshar
ehol
der
svi
ewdi
vi
dendsasas
our
ceoff
undst
omeett
hei
rday-
to-
daylivi
ngexpens
es.

(f
)Ifpr
ofi
tsar
enotdi
str
ibut
edregul
arl
yandarer
etained,
thesharehol
dersmayhavet
o
payahigherrat
eoft
axintheyearwhenacc
umulatedprofi
tsar
edistr
ibut
e

However,itmustberememberedthatregul
ardividendscanbemai nt
ainedonlyby
companiesoflong s
tandi
ng and st
abl
eearnings,A c ompanyshoul
d establ
i
shthe
r
egulardivi
dendatal
owerrat
easc omparedt
ot heaverageearni
ngsoft
hec ompany.

(
b)St
abl
eDi
vi
dendPol
i
cy:
Theterm‘stabi
li
tyofdivi
dends
’meanscons
ist
enc
yorlac
kofvari
abi
l
ityinthes
tream of
di
vidend payments.Inmor eprec
iset
erms,itmeanspaymentofc ert
ainminimum
amountofdi vi
dendregul
arl
y.

As t
abledivi
dendpolicymaybees tabl
ishedinanyofthefoll
owi
ngthreeforms:
(i
)Constantdivi
dendpers hare:
Somec ompani esfol
l
ow apol icyofpayi ngfi
xeddivi
dendpersharei
r r
espect
iveofthe
l
evelofear ni
ngsyearaf teryear.Suc hf i
rms,usual
l
y,createa‘Res
er veforDivi
dend
Equali
sati
on’toenablethem payt hefix
eddi vi
dendevenintheyearwhent heearni
ngs
arenotsuffi
ci
entorwhent herear
el os
ses .

Apol
i
cyofconst
antdivi
dendpershar
eismostsui
tabl
etoc
onc
ernswhos
eear
ningsar
e
ex
pect
edtoremains
tableoveranumberofyear
s.

(i
i
)Cons tantpayoutrati
o:
Constantpay- outratio meanspaymentofa f i
xed percent
ageofnetear ni
ngsas
divi
dendsever yyear .Theamountofdi vi
dendi nsuchapol icyfl
uct
uatesindir
ect
proport
iont otheearningsofthecompany.Thepoli
cyofconstantpay-
outispr
efer
red
bythefirmsbec aus
ei tisr
elat
edtothei
rabi
li
tytopaydivi
dends.

(i
i
i)Stablerupeedividendplusext
radivi
dend:
Somec ompaniesf oll
ow apolic
yofpayi ngconst
antl
ow di
vi
dendpershar
eplusan
extr
adi videndint heyearsofhighpr of
it
s.Suchapol
icyi
smostsui
tabl
etothefi
rm
havingfluctuat
ingear ni
ngsfr
om yeartoyear.

1
3.Ex
plai
nSEBI
gui
del
i
nesf
orbonusi
ssue?

Thes haressoreservedmaybei s
suedattheti
meofc onvers
ion(
s)ofsuchdebent
ures
ont hesametermsonwhi chthebonusis
suesweremade.
1.Thebonusissues hallbemadeoutoff r
eeres
ervesbui
ltoutofthegenuinepr
ofi
tsor
sharepremium col
lectedincashonly.
2Res
ervesc
reat
edbyr
eval
uat
ionoff
ixedas
set
sar
enotc
api
tal
i
sed.
.
3Thedec
lar
ati
onofbonusi
ssue,
inl
i
euofdi
vi
dend,
isnotmade.
.
4Thebonusiss
uei
snotmadeunl
esst
hepar
tl
y-pai
dshar
es,i
fanyex
ist
ing,ar
emade
f
ull
ypai
d-up.
5TheCompany-
(
a)hasnotdefaul
tedi
npaymentofinter
estorpri
nci
pali
nrespec
toffi
xeddepos
itsand
i
nter
estonexi
sti
ngdebent
uresorpr
inc
ipalonredempti
onther
eofand
(b)hassuf
fi
ci
entreas
ontobel
i
evethati
thasnotdefault
edinr
espectofthepayment
ofstat
utoryduesoftheempl
oyeessuc
hasc ont
ri
butiontopr
ovidentfund,gr
atui
ty,
bonusetc.
6A c ompanywhi c
hannounc esi t
sbonusi ss
ueaf tert
heapprovaloftheBoar
dof
Dir
ector
smus timpl
ementt heproposalwit
hinaperiodofsi
xmont hsf
rom t
hedateof
suchapprovalandshal
lnothavetheoptionofchangingt
hedec
isi
on.
7(i
)The Art
icl
es ofAs s
ociat
ion oft
he c
ompany s
hal
lcont
ain a pr
ovi
si
on f
or
c
api
tal
i
sat
ionofres
erves
,etc.
(i
i
)Ift
herei
snosuchpr
ovi
si
onintheArti
cl
esthec
ompanyshal
lpassaResol
uti
onatits
gener
albodymeet
ingmak
ingprovi
si
onsint
heArt
icl
esofAs
soc
iat
ionsf
orc
apital
is
ati
on.
8 Consequenttothei ssueofBonuss har
esifthes ubscr
ibed and pai
d-up c
api
tal
exceedstheauthor
isedsharecapit
al,aResol
uti
ons hal
lbepas s
edbyt hecompanyat
i
tsgeneralbodymeet i
ngfori
ncreas
ingtheauthor
isedCapi
tal
.
PARTC-
15MARKS
1
4,Det
ermi
nant
sofdi
vi
dendpol
i
cy?

Someofthemos timportantdetermi
nantsofdivi
dendpoli
cyare:(i
)TypeofIndust
ry(
ii
)
AgeofCor porat
ion( i
ii
)Extentofsharedis
tri
buti
on(i
v)Needf oradditi
onalCapi
tal(
v)
Busi
nessCycles(vi)ChangesinGovernmentPolic
ies(
vii
)Trendsofprof
it
s(vi
i)Tr
endsof
prof
it
s(vi
i
i)Taxationpoli
cy( i
x)Fut
ureRequi
rementsand(x)CashBalance.

Thedec l
arati
onofdi videndsi nvol
vess omel egalaswel
lasfi
nanci
alconsi
derat
ions.
From t
hepoi ntoflegalc onsi
derati
ons,thebas i
crul
eist
hatdi
vi
dendc anonl
ybepai d
outprofi
tswi thoutthei mpairmentofc api
talinanyway.Butthevar i
ousfi
nancial
consi
derat
ionspr es
entadi f
fi
cultsi
tuat
iontothemanagementforcomingtoadecisi
on
regar
dingdividenddist
ributi
on

Thes
econs
ider
ati
onsar
edi
scus
sedbel
ow:

(i
)TypeofI ndustr
y:
I
ndustri
est hatarec har
ac teri
sed by st
abi
li
ty ofearni
ngsmay for
mulate a more
consi
stentpol i
cyast odi videndst hanthosehavi
nganunevenf l
ow ofincome.For
example,publ i
cut i
l
iti
esc onc er
nsar einamuc hbetterpos
iti
ont
oadoptar el
ati
vel
y
fi
xeddividendratethant hei ndust
ri
al c
oncer
ns.

(i
i)AgeofCor porati
on:
Newl yestabli
shedenterpr
isesrequi
remos
toft
heirear
ningforplanti
mprovementand
ex pansi
on,whileoldcompani eswhic
hhaveat
tai
nedal ongerearni
ngexperi
enc
e,can
formulatec l
earc utdi
videndpol i
ci
esandmayevenbel i
beralinthedist
ri
but
ionof
dividends.

(i
i
i)Ext
entofshar
edist
ri
but
ion:
Ac l
osel
yheldcompanyisl
i
k el
ytogetconsentoft
hesharehol
dersforthes
uspensi
onof
divi
dendsorforfol
l
owingac ons
ervati
vedivi
dendpol
icy.Butac ompanywithalarge
numberofsharehol
derswi
delyscatt
eredwouldfaceagreatdif
fi
c ul
tyins
ecuri
ngsuch
assent.Reduct
ioni
ndi
vi
dendsc
anbeaf
fec
tedbutnotwi
thoutt
hec
o-oper
ati
onof
sharehol
ders.

(i
v)Needforadditi
onalCapital
:
The ext
entt o whicht he prof
it
sar e pl
oughed backi ntothe bus
inesshasgota
consi
der
ableinfluence on the di
vidend poli
cy.The i
ncome maybe c ons
erved f
or
meeti
ngtheincreasedrequirementsofworkingcapi
talorfut
ureex
pansion.

(
v)Busi
nessCycl
es:
Duri
ngtheboom,prudentc or
porat
emanagementc reatesgoodres
ervesf
orfac
ingt
he
cr
isi
swhic
hf ol
l
owst heinf
lati
onaryperi
od.Higherratesofdivi
dendareusedasatool
f
ormarketi
ngthesecuri
ti
esinanotherwisedepres
sedmar ket.

(vi
)Changesi nGovernmentPol i
cies:
Somet i
mesgover nmentl i
mi t
st he rate ofdi vidend declar
ed by compani
esina
parti
cularindus
tryorinallspher esofbus i
nessac tivi
ty.TheGover
nmentputtempor
ary
res
tri
ctionsonpaymentofdi videndsbyc ompani esinJ ul
y1974bymakingamendment
i
nt heIndianCompani esAct,1956. Therest
ric
tionswer eremovedi
n1975.

(vi
i
)Trendsofpr ofi
ts:
Thepas ttrendoft hec ompany’sprofi
tshoul
dbethoroughlyexaminedtofindoutthe
averageear ni
ngpos i
tionofthec ompany.Theaver
ageear ni
ngsshoul
dbes ubjec
tedto
the tr
endsofgener alec onomicc ondi
ti
ons.I
fdepr es
sion i
sappr oac
hing,onlya
conservat
ivedividendpolic
yc anber egar
dedasprudent.

(vi
ii
)Taxati
onpolicy:
Corporatetaxesaf f
ectdividendsdir
ectl
yandi ndi
rectl
y— direct
ly,i
nasmuc hast hey
reducether esi
dualpr ofi
tsaftertaxavail
ableforshareholder
sandi ndi
rec
tly,asthe
dist
ri
buti
onofdi videndsbeyondac er
tai
nlimiti
sitsel
fsubjecttotax.Atpresent
,the
amountofdi vi
denddec l
aredistaxfr
eeinthehandsofs harehol
ders.

(i
x)FutureRequirements:
Accumulation ofpr of
it
sbec omesnec ess
aryt o pr
ovide agains
tc ont
ingenc i
es(or
hazards)ofthebus i
ness,
tof
inancefut
ure-expansi
onoft hebusi
nessandt omoder ni
se
orr epl
ace equipmentsoft he ent
erpri
se.The confl
ic
ting cl
aimsofdi videndsand
accumulati
onss houl
dbeequitabl
ysett
ledbyt hemanagement .

(x
)Cas hBal
ance:
I
fthewor ki
ngc api
taloft
hecompanyissmalll
i
beralpol
i
cyofcashdi
vi
dendcannotbe
adopted.Di
videndhastotak
ethefor
m ofbonussharesi
ssuedt
othemember
sinli
euof
cashpayment .

Ther egular
it
yofdivi
dendpaymentandt hes tabi
li
tyofitsr
at earet
hetwomai n
objec
tivesaimedatbythecorpor
atemanagement.Theyareaccept
edasdes
irabl
efor
thecorporati
on’
scr
edi
tstandi
ngandfort
hewelfareofshar
ehol
ders.
Highearningsmaybeus edtopayex t
radivi
dendsbutsuchdivi
denddist
ri
but
ions
shouldbedes i
gnedas“
Extr
a”andcar
es houl
dbet ak
entoavoi
dt heimpr
essi
onthat
theregul
ardivi
dendi
sbei
nginc
reas
ed.

As t
abl
edi vi
dendpol
icyshoul
dnotbetak
entomeanani nfl
exi
bleorri
gidpol
i
cy.Ont
he
otherhand,itentai
l
st hepaymentofaf ai
rrat
eofr etur
n,takingint
oaccountt
he
normalgrowthofbusi
nessandthegr
aduali
mpactofex
ternalevents
.

Astabledi
videndr
ecordmakesfut
urefi
nanci
ngeasi
er.I
tnotonlyenhanc esthecr
edit-
st
andingofthecompanybutals
ostabi
li
sesmark
etval
uesofthes ecur
it
iesoutst
anding.
Theconfi
denceofshar
ehol
dersi
nthecorpor
atemanagementisalsost
rengthened.

Legal r
ulesgoverni
ngpaymentofdivi
dends:
I
ti sill
egalt opaya di vi
dend,i
fafteri
tspayment ;thecapitalwouldbeimpai
red
(reduced).Thisr
equirementmightbemeti fonlycapit
alsurpl
usexis
ted.Anupward
revaluati
onofas set
s,however,woul
dc r
eateac apit
alsur
plus,butatthesameti
me
mi ghtoperateasafraudonc r
edi
tor
sandforthatreas
onisi
ll
egal.

Basi
cal
l
yt hedi
vi
dendlawswereintendedtopr otec
tc r
edi
tor
sandt her
efor
eprohibi
t
paymentofadi
videndi
facor
por
ationisins
olventorift
hedi
videndpaymentwil
lcause
i
nsol
vency.

Thecorpor
atelawsmus tbet akenintocons
ider
ati
onbyt hedir
ect
orsbefor
ethey
dec
lar
eadi vi
dend.Thecompanyc anpos t
ponethedist
ributi
onofdivi
dendincash,
whi
chmaybec onser
vedforst
rengtheni
ngthefi
nanci
alcondit
ionoft
hec ompanyby
dec
lar
ingst
ockdivi
dendorbonusshares.

Tosum up,t
hedec i
si
onwi t
hr egardtodivi
dendpolic
yr es
tsont hejudgementofthe
management,si
nceitisnotac ont
ract
ualobli
gati
onlik
ei nt
eres
t.Thef or
mulati
onof
di
vi
dendpoli
cyrequir
esabal anc edfi
nanci
aljudgementbyj udi
cious
lyweighti
ngthe
di
ff
erentf
act
orsaff
ecti
ngthepolicy.

St
ockdividendorbonusshar es:
As t
ockdividendisadis
tributi
onofaddi t
ionalsharesofstoc
ktoex i
sti
ngs har
ehol
ders
onapr o-ratabasi
si.
e.s
omuc hstockforeac hshareofstockhel
d.Thus ,a10% s
toc
k
di
videndwoul dgiveaholderofI CQs hares,asadditi
onal10shar
es,wher easa250%
st
ock dividend woul
d give hi m 250 additi
onals har
es.A stoc
k dividend hasno
i
mmedi ateeffec
tuponassets .

I
tresul
tsinat r
ansf
erofanamountf r
om t
heac cumulatedearni
ngsorsurpl
usac
count
tothes har
ec api
talaccount.I
notherwords
,ther eservesarecapi
tal
is
edandt hei
r
owners
hi pi
sformal
lytr
ansfer
redtot
heshar
eholders
.

Theequit
yoftheshar
eholder
sinthecor
porati
onincr
eas
es.
Stoc
kdividendsdonotal
ter
thecashposi
ti
onofthec ompany.Theyservetocommitt
heretai
nedear ni
ngst
othe
busi
nessasapartofi
tsf
ixedcapi
tal
is
ati
on.
Reasonsfordeclar
ingastockdi
vidend:
Twopr i
ncipalreas
onswhi chusuall
yactuatethedi
rec
tor
stodecl
areas t
ockdi
vi
dend
are:
(1)Theycons i
deritadvis
abletor educ
et hemarketval
ueofthestoc
kandt her
eby
faci
li
tat
eabr oaderdis
tri
buti
onofowner s
hip.

(2)The corpor
ation may have earningsbutmay f ind i
tinadvi
sableto pay cash
divi
dends
. Thedeclar
ationofastockdivi
dendwil
lgi
vet hestoc
kholdersevi
denceofthe
i
nc r
easei
nt hei
rinvestmentwit
houti nt
erf
eri
ngwiththec ompany’
sc ashposi
ti
on.I
fthe
stockhol
dersprefercas htoaddit
ionalstoc
kinthec ompany,theyc ansellt
hestock
recei
vedasdivi
dend.

Someti
mes,as t
ockdivi
dendisdeclar
edt opr
otectthei
nter
est
sofol
ds t
ockholder
s
whenac ompanyisabouttos
ellanewi s
sueofstoc
k(sot
hatnewshar
ehol
derss
hould
nots
haretheaccumulat
edsur
plus)
.

Li
mi t
ationsofst ockdi
vi
dends:
Thebonuss haresentai
lanincreas
einthecapi
tali
sat
ionofthec orporat
ionandthi
scan
onlybej ust
ifi
edbyapr opor
ti
onateincr
easei
ntheear ni
ngc apacityofthecor
porati
on.
Youngc ompani eswithuncert
ainearni
ngsorc ompanieswithf l
uctuati
ngincomear e
l
ikel
yt otakegr eatri
skbydist
ri
buti
onstockdi
vi
dends.

Everystockdividendc arr
iesani mpli
edpromis
et hatfutur
ec ashdividendswi l
lbe
maintai
nedatas teadylevelbecauseoft hepermanentc api
tal
i
sati
onofr eser
ves.
Unles
st hecorporatemanagementhasr eas
onablegroundsofentert
ainingthishope,
thewisdom ofl
ar gestoc
kdi vi
dendisal
wayssubj
ecttogravesuspi
ci
on.

Theex i
stenc
eofl egalsanc
tionfordi
str
ibut
ingtheac cumulat
edearni
ngsorreserves
doesnotwar rantt hei
ssueofstockdi
vi
dendsfrom thepointofvi
ewofsoundfi
nanc i
al
prac
tic
e.Theres houldbeothercondi
ti
oni
ngf ac
torsals
of ort
heiss
ueofst
ockdi
vidend.