MICRO FINANCE

II SEM MCOM
 Introduction
• The term finance is derived from the latin word “Finis” which means
end /finish.
• Finance is the life blood of business.
• Finance is provision of money at the time when it is required.
• Finance is an art and science of managing money.
• Finance is the set of activities dealing with the management of funds.
• Finance refers to the science that describes the management,
creation and study of money, banking, credit, investments, assets and
liabilities.

Definition
 According to Paul G Hasings, “ Finance is the management of the
monetary affairs of a company”
 According to Bodie and Merton, “ Finance is the study of how scarce
resources are allocated over time”.
 According to Oxford Dictionary ,” Finance connotes management of
money”.
 According to Henry Ford, “ Finance or money is an arm or leg which
one can either use it or lose it”
 Business Finance

• Business finance refers to the funds and monetary support

required by an entrepreneur for carrying out the various
activities relating his/her business organization.

Definition

 Business finance may be defined as the allocation of a

concerns liquid assets to assure their most productive use-
Steven S. Anreder
 Business finance is concerned is concerned with how the
finance of a business enterprise should be managed- Christy
& Foster Roden
 Business finance can broadly be defined as the activity
concerned with planning, raising, controlling, administering of
the funds used in the business- Guthumann and Dougall
 Finance Function
 The term finance function can be defined as “Procurement of
funds and their effective utilization in the business”.
 It is been classified into two types 1.Managerial finance
function 2.Routine finance functions.
1. Managerial Finance Function
 Investment Decision involves the type and volume of assets
to be acquired.
 Financial Decision involves the decision about the various
sources and the extent of funds to be obtained.
 Dividend Decision involves the extent of profit to be allocated
and the extent of profit to be retained.
2. Routine finance function
 Supervision of cash receipts and payments and safeguarding
of cash balances.
 Custody and safeguarding of securities, policies and other
valuable documents.
 Record keeping of financial transactions and reporting
 Aims of Finance Function
 Aim is to acquire sufficient from the right sources
 The funds raised should be utilized to gain maximum benefit and funds should not remain
idle at any point of time in the business.
 To increase the profitability of a firm.
 Aims at maximizing the value of a firm.

o Financial Management
It is primarily concerned with maximizing shareholder value through long
term & short term financial planning and implementation of various
strategies.

 It is concerned with 6 A’s

a) Anticipation of financial requirements

b) Acquisition of funds
c) Allocation of funds
d) Administering
e) Analyzing
f) Accounting
 Definitions of Financial Management
According to S.C Kuchal “Financial management deals with
procurement of funds their effective utilization in the
business”.
According to Soloman, “Financial management is concerned
with the efficient use of an important economic resource viz
Capital Funds”.
According to Joseph & Massie “ Financial Management is the
operational activity of a business that is responsible for
obtaining and effectively utilizing the funds necessary for
efficient operations.
Objectives/Goals of Financial Management
1. To ensure regular and adequate supply of funds to the
concern
2. To ensure optimum utilization of funds.
3. To ensure safety of investment
4. To plan a sound capital structure
5. To ensure profit maximization
6. To ensure adequate returns to the shareholders
 Scope of Financial Management
1. Evaluation of Financial requirement
2. Formation of capital structure
3. Sources of finance
4. Choice of investment Plans
5. Cash Management
6. Implementation of Financial Controls
7. Usage of Surpluses
Profit Maximization
It refers to the process where in companies focus on
maximizing their profit or getting the best possible profit in
the particular kind of business.
Profit is the yardstick for measuring the efficiency of a
business which is associated with economic activity.
Features of Profit Maximization
 It leads to maximization of the business operation of the for Profit
maximization.
 It considers all the possible ways to increase the profitability of the concern.
 It shows entire position of the business.
 Profit maximization objectives help to reduce the risk of the business.
 It leads to exploitation of workers and consumers
 Profit maximization reduces risk of the business
 Profitability meets the social concern

Advantages of Profit Maximization

1. Leads to maximizing the business operation.
2. It considers all the possible ways to increase the profitability .
3. It shows the status of the business.
4. It is a technique which is mainly focused on efficient utilization of capital
resources to maximize profit.
5. Reduces the risk of business.
6. It attracts investors to invest their savings in securities
7. Profit maximization can be achieved in a short period.
8. It gives way to the business for expansion and diversification.

Disadvantages of Profit Maximization

1. Profit is not defined precisely or correctly under profit maximization
objective
2. It creates unnecessary opinion regarding earning habits of the business.
3. It ignores time value of money.
4. It leads to certain differences between actual cash inflow and net present
cash flow during a particular period.
5. It ignores risk
6. Leads to exploitation of workers & consumers
7. It leads to management anxiety and frustration.
8. Profit maximization is a good thing for a company but can be bad thing for
if the company starts to using cheaper products or decides to increase
prices.
Arguments in favour of Profit Maximization
1. Profit is the test of economic efficiency
2. Efficient allocation of fund
3. Social welfare
4. Internal resources for Expansion
5. Reduction in risk and uncertainty
6. More Competitive
7. Desire for controls
Arguments against Profit Maximization
8. Ambiguity
9. Timings of benefits
10. Quality of benefits
11. Effect of dividend
12. Exploitation
13. Immoral Practices
14. Inequalities
Wealth Maximization
It is a process that increases the current net value of business or shareholder
capital gains , with the objective of bringing in the highest possible return.

Features of Wealth maximization

1. Protection of interest of shareholders
2. Security to financial lenders
3. Protection of interest of the employees.
4. Survival of Management
5. Interest of society
Advantages of Wealth Maximization
1. Wealth maximization is a clear term
2. It considers the concept of time of value of money
3. The concept of wealth maximization is universally accepted.
4. Guides the management in framing consistent strong dividend policy , in
order to earn maximum returns to the equity
holders.
5. It considers the impact of risk factor.

Favorable Arguments for Wealth Maximization

6. It is superior to the Profit Maximization because the main aim of the
business is to improve the value of the shareholders.
7. It is total value deducted from the total cost incurred for the business
operation.
8. It considers both time and risk of the business
9. It ensures the economic interest of the society.
Unfavorable arguments for wealth Maximization
1. It is the indirect name of the profit maximization.
2. It creates ownership-management controversy
3. Management alone enjoys certain benefits
4. It can be activated only with the help of profitable position of the business.

Functions of Financial Management/ Role of Finance Managers

5. Estimation of capital Requirements
6. Determination of capital composition
7. Choice of sources of funds
8. Investment of funds
9. Disposal of surplus
10. Dividend declaration
11. Retained earnings
12. Management of cash
13. Financial controls
14. Ensuring Liquidity
15. Capital Budgeting
Financial Decisions refer to the decisions concerning financial matters of a
business.
Types of Financial Decisions

Investment Decisions

Financing Decisions

Dividend Decisions
1. Investment Decision- is referred to the activity of deciding the pattern of
investment.
It covers both short term as well as long term investment.
Long term investment decision is about allocation of capital to investment
projects.
Short term investment decision is about allocation of funds are among cash
receivables and inventory.
Investment decisions can be classified into two categories
I. Long term investment decisions- It referred to as the capital budgeting
decisions and is the process of making investment decisions in capital
expenditure.
II. Short term investment-they are also called as working capital decisions. It
is related to allocation funds.
2. Financing Decision- business concern has to take maximum care in
financing different proposals.
Profitability of business depends upon the appropriate blend of finance
with debt and equity
 Dividend decision
It refers to quantum of profits to be distributed among shareholders and the
quantum of profits to be retained earnings.
The higher rate of dividend may increase the market price of the shares and
thus maximize the wealth of the shareholders.
The finance manager must decide whether the firm should distribute all
profits or retain them or distribute a portion and retain the balance.
 Board of Directors

President

VP:Sales VP:Finance VP:Operations

Treasurer Controller

Credit Manager Cost Accounting

Financial Accounting
Inventory Manager

Capital Budgeting Tax Department

Director
Functions of Controller
1. Formulation of accounting and costing policies, standards and procedures.
2. Preparation of Financial Statements
3. Preparation and interpretation of financial reports
4. Maintenance of books of accounts
5. Internal audit
6. Preparation of Budgets
7. Inventory control
8. Safeguarding company’s assets
9. Controlling cash receipts and cash payments
10. Preparation of payrolls

Functions of a Treasurer
11. Cash Management Functions
a. Opening accounts and depositing fund in banks
b. Payment of company obligations through proper disbursements
c. Maintaining records of cash transactions
d. Management of petty cash and cash balance
2. Credit Management Functions
a. Determination of customers credit standards
b. Orderly handling of collections from debtors
c. Cash discounts to encourage prompt from debtors
d. Determination customers credit risks
3. Financial Planning Functions
e. Reporting financial results to the top level management
f. Forecasting future financial requirements
g. Forecasting cash receipts and payments
h. Planning the various avenues for investment of company's surplus funds
i. Advice on dividend payments
4. Security Floatation Functions
j. Taking decisions on the type of securities a company has to float to raise the funds
from the public
k. Compliance with government regulations
l. Maintaining good relationships with the stock holders
m. Disbursements of dividends
n. Redemption of bonds
Approaches of Financial management
A. Traditional Approach
B. Modern Approach

C. Traditional Approach- It covers the following areas:

1. Management of Funds from Financial Institutions.
2. Arrangement of funds through financial instruments such as shares, bonds,
debentures etc.
3. Administering of funds

Criticized on following reasons

a) It ignored balancing of funds for routine problems in an enterprise.
b) It ignored non corporate enterprises.
c) No emphasis made on allocation of funds
d) It emphasized on the problems faced by long term financing but ignored
short term finance(Working Capital)
Modern Approach
 It is concerned with acquisitions and allocation of funds.
 It relates to broad areas of financial management like funds
requirement decision, financing decision, investment decision &
investment decision.
 It is concerned with profitability and the volume of capital used.
 The modern approach relates to various facets of financial planning &
control

Interface of Financial Management with other functional area

Relationship to HR
HR activities include recruitment, training & Development , Promotion.
HR manager need to consult Finance manager and he has to take
decision after studying the impact. Hence there is a relation of HR
relation.
Relationship of Production
Production department is another functional area that involves huge
investment on fixed assets(Machines & Tools)
Production manager & finance manager need to work closely for effective
investment on plant & machinery.
Relationship of Marketing

It involves selection of distribution channel and promotion policies.

Both need to work with coordination for maximize value of the firm.

Relationship to R & D

Innovation of products and process is the only way to survive in the

competitive market.
No guarantee of development, but should be given importance & try to
balance.
Relationship with accounting

Finance manager requires accurate and scientifically arranged financial

records of the enterprise to guide inflow & outflow of funds.
Relationship with Purchasing Department

Materials required for production of commodities should be

procured on economic terms and should be utilized in efficient
manner to achieve maximum productivity.

Financial Planning

Financial Planning is deciding in advance the course of actions

for the future in respect of the financial management.

It involves following activities

1. Estimating the requirements of funds
2. Deciding about the securities to be issued for raising funds
3. Setting the firm’s financial objectives.
 Sources of Finance

Short term Sources Long term Sources

Indigenous Bankers Shares

Trade credit Debenture

Commercial Banks Public Deposists

Installment Credit Ploughing back of Profits

Advances Loans from financial
institutions
Factoring

Commercial Paper

Accrued Incomes

Deferred Expenses
1.Indigenous bankers
Private Money lenders were the source of finance prior to the commercial banks.
They charge high rate of interest
But many business have to depend upon indigenous bankers for loan to meet working
capital requirements.
2. Trade Credit
Refers to the credit extended by the suppliers of goods in the normal course of
business.

Advantages
1. It is easy, automatically available.
2. It is flexible and spontaneous source of financing
3. It does not require negotiations & formal agreement.

3. Bank Credit( Commercial Banks)

Important source of short term capital
Working capital loans are provided by commercial banks.
Different forms of credit provided by Commercial banks:
1. Loans
2. Cash Credits
3. Overdrafts
1. Loans: When a bank makes an advance in lump sum against some security it is called
a loan.
The loan amount is sanctioned and amount is paid to the borrower either in cash or
by credit to his account.
The borrower is required to pay interest on the entire amount of loan from the date of
amount sanctioned.
2. Cash credits: A cash credit is an arrangement by which a bank allows the customer to
borrow money up to a certain limit against some tangible securities or guarantees.
Customer can withdraw from his cash credit limit according to his needs and he can
also deposit surplus amount with him.
The interest is charged on daily balance and not on the entire amount.
3. Overdrafts: Current account holder is allowed to withdraw more than the balance to
his credit up to certain limit.
Interest is charged on daily withdrawn balances.
OD is allowed for a short period and is a temporary arrangement
4. Purchasing & discounting of Bills
Bank lends money without collateral security.
The seller draws a bill of exchange on the buyer of goods on credit.
The bill is accompanied by documents of title to goods purchases the bills payable on
demand and credits the customers account with the amount of bill less discount.

5. Installment: Assets are purchased and the possession is taken immediately but the
payment is made in installments over a predetermined period of time.

6. advances: Business get advances from their customers against orders and this source is
a short term source of finance for them.

7. Factoring:
8 Commercial Paper: it is an unsecured promissory notes issued by firms to raise short
term funds
9. Accrued Expenses: Expenses which have accrued but not yet due and hence not yet
paid.
10. Deferred Incomes: are the incomes received in advance before supplying goods or
services.
II. Long Term sources of Finance
1. Issue of Shares
2. Issue of Debentures
3. Public deposits
4. Ploughing of back of profits
5. Loans from Financial Institutions

Types of Debentures
1.Non Convertible Debentures
2. Partly Convertible Debentures
3. Fully Convertible Debentures
4. Optionally Convertible Debentures
On the basis of security

5. Secured Debentures: They are secured by a charge on the fixed assets of the
issuer company.

6.Unsecured Debentures: If the issuer defaults on payment of the interest or

principal amount, the investor has to be along with other unsecured creditors of
the company.

7. Registered Debentures: They are registered in the register of the company.

They are also called debentures payable to registered holders.

8. Bearer Debentures: Debentures which are not registered in the register of the
company. They are payable to the bearer and are deemed to be negotiable
instrument.

9. Redeemable Debentures: Debentures are issued by the company for the

specific period only. On the expiry of period, debenture capital is redeemed or
paid back.
Irredeemable debentures: are issued foe an indefinite period which is
also known as perpetual debentures. It is repaid either at the option of
the company by giving prior notice to that effect or at the winding up of
the company.

Mortgage Debentures: which is secured by the mortgage on the real

property of the company.

Naked Debentures:

Agency Debentures:

Advantages of Debentures:
1. Provides long term funds to a company.
2. Rate of interest is lower than the dividend paid on shares.
3. The interest on debentures is a tax deductible expense.
4. Does not result in dilution of control
5. Prefer issue of debentures because of the fixed rate of interest.
6. Debentures provide flexibility in the capital structure of company.

Advantages to Investors
1. Debentures provide a fixed, regular and stable source of income to
its investors.
2. It is comparatively a safer investment .
DIFFERENCE BETWEEN SHARES AND DEBENTURES
Capital
A share is a part of equity It is a part of loan capital of the
Return company

Return on share is known as Dividend. Return on a debenture is known as

interest.
Appropriation

Dividend is an appropriation of profit

and it is debited in Profit & Loss It is charged against profits and
Appropriation Account. therefore debited in profit/Loss Account

Redemption
Not returned during lifetime of the It has to be returned after a stipulated
Company. period of time
Purchase
Company cannot purchase its own Company can purchase own
shares. debentures.
Convertibility
Shares cannot be converted into Debentures can be converted into
debentures shares
Public Deposits

Public deposits are the fixed unsecured deposits accepted by the

companies directly from the public.
The rate of interest on public deposits offered by the companies is
more as compared to banks and post offices.
companies are able to obtain funds directly from public without
financial intermediaries.

Features of Public Deposits

1. They are unsecured.
2. Loan period varies from 6 months to 3 yrs.
3. Rate of Interest is fixed.
4. Rate of Interest Varies from 11% to 15%
5. Company issues a deposit receipt under terms & conditions.
6. It does not require complicated legal Formalities
Advantages of Public Deposits

Interest paid on deposits is a deductible expense for income tax purpose

Administrative cost of deposits is lower.
Lesser formalities in accepting public deposits
Rate of interest on public deposits is fixed.
Depositors have no interference in the management and control of the affairs of

the company.
Capital structure of the company is flexible as the company can repay the
deposits when they are not required by the company.

Disadvantages of Public Deposits

It is an Uncertain & Unrealistic form of Financing
It is available for short period
The management may misuse the deposits as it is unsecured
Public deposits are generally not available to new companies.
Raising finance is valid only for short term .
Retained Earnings/ Ploughing back of Profits

Retained earnings is one of the source of internal finance. It is a

technique of financial Management under which all profits of a
company are not distributed amongst the shareholders as dividend,
but part of the profits are retained or re invested in the company. This
process of retaining profits year and year and their utilization
in the business is known as ploughing back of profits.

It can be used by the company for the following purposes:

I. For expansion and growth of the business.

II. For strengthening the financial position of the company.
III. For meeting various working capital requirements of the company.
IV. For redemption of old debts.
V. For replacement of obsolete assets and modernization
Factors influencing Retained Earnings

1. Profit level
Higher the net profit earned by a company, the greater is its capacity
to plough back profits.
2. Dividend policy
Determines the extent to which the profits can be retained for
reinvestment in the business
3. Corporate Tax
If the rate of tax is higher then it may have lesser amount of internal
savings
4. Age of the company
Can retain larger amount of internal savings.
5. Future Plans
Modernization and expansion affects the amount of retained
earnings
Advantages of retained Earnings
A. Advantages to the Company
1. Ready Availability
2. Cheaper than External Equity
3. No dilution of ownership
4. Interest free
5. Positive Connotation(atmosphere)
6. Uncertainties
7. Stable dividend policy
8. Creditworthiness
9. Growth & Expansion

B. Advantages to the shareholders

10. Increases the value of shares
11. Enhances earning capacity
12. No dilution of control
13. Reduces tax burden
C. Advantages to the Society/Nation

1. Increases the rate of capital formation

2. Encourages industrial Development
3. Standard of living
4. Decreases the rate of industrial failure
5. Provides employment

Disadvantages of Retained Earnings

6. Limited Finance
7. High opportunity Cost
3. Dissatisfaction among shareholders
4. Over capitalization
5. Misuse
6. Manipulation
7. Start up firm
Financial Planning
According to Solomon & pringle, Financial planning may refer
to the process of determining the financial requirements and
financial structure necessary to support a given set of plans I
other areas