The Finance Function Long Answer Type Questions

The Finance Function Long Answer Type Questions

Question 1.
Explain the scope of financial management.
Answer:
The primary objective of a finance Manager is to arrange sufficient finances in order to meet the short term long, term needs. The funds are procured at minimum costs so that the profitability of the business is maximised.

The finance manager should basically concentrate on the following areas:
(1) Financial Estimation: As stated earlier, the prime task of a finance executive is to estimate the short term and long term financial requirement of the business. The estimation of finance should be such that there should neither be inadequate nor excess funds with the concern because both the situations would be uangerous for the concern. If there is inadequacy of funds, the day-to-day functioning of the organisation gets affected whereas excess funds results in misuse of funds are unprofitable investment.

(2) Planning of the capital structure: The process of planning of the capital structure includes selection of right proportion of securities for raising funds. The process involves deciding about the quantum of funds and also the type of securities to raise the funds. The organisation should choose long term debts for financing fixed assets and overdrafts and cash credits should be selected for financing working capital requirements.

(3) Selecting right source of funds: In market, finance is available in different forms like shares, debentures, financial institutions, commercial banks public deposits etc. Selecting a right source at the right time at right cost is the challenge for the finance executive. Before making any commitment about the funds, the finance executor should decide and be clear about the period for which funds are required. It funds are needed for short period then he should choose banks, financial institutions etc. If funds are needed for long periods then equity or debentures should be selected.

(4) Investment of funds: After the mobilisation of funds, it is the responsibility of the finance manager to allocate or invest the funds towards capital expenditure and revenue expenditure. Before making a final decision the profitability of each project has to be evaluated by the finance manager. The proposal is selected based on the fair returns it promises.

(5) Analysing the financial performance: After the investment of funds in different investment proposals, the performance of each proposal has to be measured. In other words the profit generating capacity of each proposal has to be analyzed.

(6) Planning of profit: Profit earning capacity of an organisation speaks about the efficiency level Of the organisation. Profit earning capacity enables future expansion and diversification programs of the company. It is the prime responsibility of the finance manager to plan the profits before hand as he has to protect the interest of the stakeholders and shareholders.

(7) Ensuring liquidity: Another responsibility of a finance manager is to ensure the liquidity of the organisation as it is directly by related to the borrowing capacity of the company.

Question 2.
Give a brief note on sources of business finance.
Answer:
There are two major sources of finance for meeting the financial requirements of any business enterprises, which are as under

Owners Fund:
Owners fund is also called as Owners Capital or owned capital. It consists of the funds contributed by the owners of business as well as profits reinvested in business. A company cans raise owner’s funds in the following ways:

• Issue of equity shares,
• Ploughed back profits

Borrow Fund:
The second source of funding to a business is the borrowed fund. Borrowed fund consists of the amount raised by way of loans or credit. It is also known as borrowed capital.
The borrowed fund is procured from the following sources:

• Debentures
• Bank Loans
• Loans from specialized financial institutions.
• Other long term financial institutions

All businesses require an adequate finance. They need money for investment in fixed asset such as land, building, machinery etc. Once business is in operation, money is needed for Working Capital, such as purchase of raw material, payment of wages, utility bills etc. A going concern also requires extra capital to cover a temporary cash flow crisis, or purchase new improved machinery or simply to expand the business. The financial requirements of a business, on the basis of time duration, are usually classified under three heads which are as follow

1. Short Term Finance:
Short term Sources of finance is defined as money raises for investment in business for a period of less than one year, it is also named as working capital or circulating capital or revolving capital.

The purpose and amount of obtaining short term capital varies with the nature and size of the business. Generally the short term capital is required for meeting the day to day expenses of business such as payment of utility bills, wages to the workers, unforeseen expenses, seasonal upswings in business, increasing inventories raw material, work in progress and finished goods etc.

The various sources of short term finance are as under –

• Trade creditor open book account
• Advance from customers
• Installment credit
• Bank Overdraft
• Gash credit
• Discounting bills
• Against bill of lading

2. Medium Term Finance:
Medium term sources of finance are required for investment in business for a medium period which normally ranges from one to five years. The medium term funds are required generally for the repair and modernization of machinery, renovation of the building, adoption of new methods of production, carrying advertisement campaign on large scale, in newspapers, television etc. The various sources of medium term finance are as under:

• Commercial Banks
• Debentures
• Loans from Specialized Credit Institutions

3. Long Term Finance:
Long term sources of finance refer to the funds, which are required for investment in business for a period exceeding up’ to five years. It is also named as long term capital or fixed capital. Long term sources’of finance are mostly required for the purchased of fixed assets, such as land, building, machinery etc. modernization and expansion of business. The amount of long term finance varies with the nature of business, size of business, nature of the product manufactured, the number of goods produced, and the method of production etc. The various sources of long term finance are as under

• Equity shares
• Issue of right shares
• Debentures
• Loans from industrial and financial institutions –
• Leasing
• Ploughing back of profits

Question 3.
What are the aims/goals/objectives of financial management?
Answer:
Financial Management of any business firm has to set goals for and to interpret them in relation to the objectives of the firm. Broadly there are only two alternative goals/objectives of financial management.
1. Specific Objectives:
(a) Profit Maximisation: It is considered as an important goal in financial decision making in an organisation. Maximisation is the condition of achieving the maximum target profit with available resources .in an economic and efficient manner. Profit ensures maximum welfare to the share holders, employees and creditors and increases confidence of the management of the company.

(b) Wealth Maximisation: It refers to the maximisation of wealth through maximisation in the market value of shares of a company. The efficient management of an organisation maximises the present value not only for shareholders but for all including employees, customers, suppliers and community at large. It Is the ultimate objective of every organisation.

2. General Objectives:
(a) Balanced asset structure: A proper balance between the fixed and current assets is an important factor for efficient management of funds. This is one of the objectives of financial management that the size of current asset must permit the company, to exploit the investments on fixed assets.

(b) Liquidity: Liquidity refers to available cash and it is an indication of positive growth of a company. It is an important factor for meeting the short and long term obligations of a firm.

(c) Proper planning of funds: Proper planning of funds include acquisition and allocation of funds in the best possible manner i.e. minimum cost of acquisition of funds but maximum returns through wise decisions.

(d) Efficiency: Efficiency and effectiveness are very much necessary in controlling the flow of funds. The efficiency level should continuously increase for betterment of
the organisation.

(e) Financial discipline: There shouldn’t be any bulk handling of funds, mis-use etc. Proper discipline should be practiced in matters relating to finance, its flow and control. This can be done through various techniques like budgeting, fund flow statements etc.

Question 4.
Evaluate Wealth Maxmisation and Profit Maximisation as primary objectives of a concern?
Answer:
Profit maximisation: It is the primary motive of any business concern to earn profit. Profit is the means through which the efficiency level of an organisation can be measured. Profits reduce the risk of companies. The ultimate survival of the firm depends upon the profit generating capacity.

Wealth Maximisation: Wealth Maxmisation refers to creation of wealth of the concern. In other words, it refers to the increase in the market value of shares. By taking care of the interest of shareholders and stakeholders, the company in the long run can ensure the increase in the value of its shares.

Profit maximisation:
Advantages:

• The efficiency level of an organisation can be ensured only through profits.
• The interest of shareholders, creditors, employees, banks, financial institutions etc., can be protected and
• their welfare can be ensured only through profits.
• The profits enable a concern to take up expansion and diversification programs.
• Profits increase the demand for the shares of the company.
• Profits ensure the survival of the concern

Disadvantages:

• Profit maximisation objective does not consider the element of risk.
• Profit maximisation unnecessarily invites competition for the concern
• There is unnecessary government intervention because of profit maximisation
• Huge profits invite problems from workers.
• Huge profits unnecessarily create doubts in the minds of customers that they are cheated

Wealth Maximisation:
Advantages:
1. Wealth maximisation is a clear term. The present values of cash flows are taken into consideration. The effect of investment and benefits can be measured clearly.

2. Wealth Maximisation includes the concept of time value of money. This concept includes the usage of present value of cash inflows and cash outflows which helps in achieving the overall objectives of the company.

3. Wealth Maximisation guides the management in framing consistent strong dividend policy to give maximum returns to the equity shareholders.

Disadvantages:
The objective of wealth maximisation is not descriptive. The wealth maximisation concept differs from one entity to another entity.

Question 5.
Write short note economic environment for business.
Answer:
Economic environment influences the business to a great extent. It refers to all those economic factors which affect the functioning of a business unit. Dependence of business on economic environment is total i.e. for input and also to sell the finished goods. Trained economists supplying the Macro economic forecast and. research are found in major companies in manufacturing, commerce and finance which prove the importance of economic environment in business.

The following factors constitute economic environment of business:

• Economic system
• Economic planning
• Industry
• Agriculture
• Infrastructure
• Financial & fiscal sectors
• Removal of regional imbalances
• Price and distribution controls
• Economic reforms
• Human resource and
• Per capita income and national income

Question 6.
Explain various functions of financial markets.
Answer:
The various functions of financial markets are:
Functions of a financial market can be classified into two categories: Economic Functions, and Financial Functions. The various functions of financial markets are as follows:
(a) Economic Functions:

• It facilitates the transfer of real economic resources from lenders to ultimate borrowers in financial system
• Lenders earn interest/dividend on their surplus invisible funds, thereby increasing their earnings, and as a result, enhancing national income of the country.
• Borrowers will have’ to use borrowed funds productively if invested in new assets, hence increasing their income, spending and standard of living.
• By facilitating transfer of real resources, it serves the economy and finally the welfare of the general public in the country.
• It provides a channel through which new savings flow into capital market which facilitates smooth capital formation in the economy.
• Interaction of buyers and sellers in the financial market helps in price discovery of financial assets.
• Financial markets provide a mechanism for an investor to sell a financial asset and liquidate the funds invested. In the absence of liquidity, the owner will be forced to hold a debt instrument till its maturity.
• Financial market reduces the search and information costs of transacting financial instrument. Search costs include money spent to advertise the desire to sell purchase a financial asset.

(b) Financial Functions:

• It provides the borrowers with funds which they will invest in some productive purpose.
• It provides the lenders with productive assets so that they can invest it in productive usage without the necessity of direct ownership of assets.
• It provides liquidity in the market through which the claims against money can be resold by investors at any time and there by assets can be converted in to cash.

Question 7.
Give the classification of financial markets. OR Discuss the types o of financial markets.
Answer:
Financial markets can be classified into:
a. Money market and capital market: Money market is a market for short term financial assets, which are near substitutes for money. Money market instruments are highly liquid in nature and can be easily converted into cash without major losses. The instruments of money market are for shortest duration usually for a period less than one year. The dealings of money market can. be conducted with the involvement of brokers and middlemen.

Money market consists of a number of sub markets such as treasury bills market, call money market, inter bank transactions market, commercial paper market and commercial bill market etc. Capital market is the market for developmental finance. This market deals with instruments such as shares, debentures etc. Capital market instruments are for long term duration. It is a market for long term finance.

b. Primary market and secondary market: Primary (or new issue) market basically consists of all people, institutions, services and practices involved in raising fresh capital for both new and existing companies. Primary markets is a market for new securities, which acquire capital for the first time.

Secondary market basically consists of securities which are already issued. Secondary market also known as stock market which deals with purchases and sales of securities issued by government, semi government or public sector undertakings and shares and debentures by Joint stock companies.

c. Organised, and Unorganised market: The operators of organised market are non-bank financial institutions such as LIC, and GIC, State Co-operative Banks etc. At the top, there are state co-operative banks, at the district level there are central co-operative banks and at local level, there are primary credit societies and urban co-operative banks. This is called as organised market because they are governed by RBI.

The Unorganised market structure comprises of Money lenders, indigenous bankers etc. It is said as unorganised market because the activities of these market are not governed by RBI or any other authority. The principal operators of unorganised market are money lenders, indigenous banks, nidhis and chit funds etc.

d. Foreign Exchange market: It is a market where foreign currency are bought and sold. The major operators of this market are central bank and its authorised dealers. The foreign exchange market plays the part of a clearing house through which purchases and sales of foreign exchange whether originating outside the market or within the market itself are offset against each other.

e. Broad, deep and shallow market: Broad market is a market that basically attracts funds from national and international investors in greater volume. Deep market is a market where there are good opportunities for swap dealings. Shallow market is an under developed financial market. This underdevelopment exists due to unnecessary regulations and control imposed by government.

Question 8.
What are functions of financial intermediaries?
Answer:
The various functions performed by these intermediaries are broadly classified into two:
(а) Traditional functions:

• Underwriting of investments in shares/debentures etc
• Dealing in secondary market activities
• Participating in money market instruments
• Involving in leasing, hire purchase, venture capital, seed capital etc.
• Dealing in foreign exchange market activities
• Managing the capital issues
• Making arrangements for the placement of capital and debt instruments with investing institutions
• Arrangement of funds from financial institutions for the clients project
• Assisting in the process of getting all Government and other clearances.

b. Modern Functions:

• Rendering project advisory services
• Planning for mergers and acquisitions and assisting for their smooth carry out
• Guiding corporate customers in capital restructuring
• Acting as trustees’to the debenture holders .
• Structuring the financial collaboration joint venture by identifying suitable partner and preparing joint venture agreement
• Rehabilitating and reconstructing sick companies
• Hedging of risks by using swaps and derivatives –
• Managing portfolio of large public sector corporations .
• Undertaking risk management services like insurance service, buy back options etc
• Advising the clients on best source of funding overall
• Guiding the clients in the minimisation of the cost of debt
• Capital market .services such as clearing, registration and transfers, safe custody of securities, collection of income on securities
• Promoting credit rating agencies.
• Recommending suitable changes in the management structure and management style with a view of achieving better result.

Question 9.
Explain the different instruments traded in money market.
Answer:
The instruments traded in Money market are:

• Treasury bills
• Commercial bills
• Certificates of deposits
• Inter-bank participation certificates
• Commercial papers
• Money at call or call money

(a) Treasury bills: Treasury bills are purely finance bills, which are for short term not exceeding one year, issued by RBI on behalf of the government. The primary objectives behind the issue of treasury bills is to meeting temporary financial deficits of government.

(b) Commercial bills: There are situations of credit sale, the seller draws a bill on behalf of the buyer, the buyer accepts the bill by promising him to pay the bill amount later Usually bills are drawn for 3 months and 6 months.

(c) Certificates of deposits: These are short term instruments issued by banks, financial institutions to raise large sums of money. The Certificates of deposits are issued for period ranging from 3 months to one year. These are issued to individuals, corporation, companies, trust, funds, associations etc. r in the form of promissory notes payable on a particular fixed date without days of grace.

(d) Inter bank participation: With the permission of RBI, the banks are authorised to raise short term finance by issuing Inter bank participation certificate. This scheme of inter banks participation is restricted to scheduled commercial banks only and the participation is for a minimum period ranging from 91 days to 180 days. Participation is permitted in two types a. With risk participation b. Without risk participation.

(e) Commercial papers: These refers to promissory notes issued by i companies, basically approved by RBI. These are negotiable by endorsement and delivery. These are usually issued with a fixed maturity and at a discount usually determined by the company issuing it.

(f) Money at call: This is basically a market for short term loans say one day to fourteen days. These are payable on demand at the option of the lender or borrower.

Question 11.
Briefly explain the components of money market.
Answer:
The Indian Money Market is divided into two parts, namely, the unorganised sector and the organised sector. This has been depicted below:

I. Unorganized Sector:
The unorganized sector is more predominant in small towns and villages where modern banking facilities are not available. Farmers, labourers, craftsman, artisans and other small scale producers and traders who do not have access to modern band, rely on the unorganized sector.

A. Unregulated Non banking financial intermediaries:
These include – i) Finance companies, ii) Chit fund, and iii) Nidhis Finance companies are found all over the country and generally give loans to retailers, wholesalers, traders, artisans and other self-employed persons. They charge high rates of interest from 36% to 48% Chit funds have no standardised form. It has regular members who make fixed periodic subscriptions to it.

The total fund collected from this periodic subscription is given to some member of the chit fund selected on the basis of previously agreed criterion. The RBI has absolutely no control over the lending activities of the chit funds. The nidhis are predominant in South India they are like some kind of mutual benefit funds as their dealings are restricted only to members. Since the nidhis operate in the unregulated credit market, there is hardly any information available about the amount of lending business done by them.

B. Indigenous bankers: are individuals or private firms which receive deposits and give loans and thereby operate as bands. Indigenous bankers do not constitute a homogenous groups. They can be classified under four subgroups. Namely equjarati shroffs, Muitane shroffs, Chettiars and Marwari kayas Amongst these four, the Gujarati indigenous bankers are the most important in terms of volume of business. Indigenous bankers are facing stiff competition from the commercial and co-operative banks.

C. Moneylenders : are of three types:

• professional money enders whose main activity is money lending;
• itinerant money lenders like pathans and Kabouli’s and
• non professional money lenders whose main source of income is not money lendings, the activities of money lenders are generally lacalised.

II. Organized Sector:
Mumbai, Delhi, Chennai, Kolkatta, Ahmedabad and Bangalore are the principal centres of the organized money market in India, Mumbai being the most prominent, the organized sector of the Indian money market comprises the RBI, commercial banks, foreign banks, cooperative banks, finance corporations, Mutual Funds and Discount and Finance House of India limited (DFHI) the principal constituents of the Indian money market are:

• The call money market
• The treasury Billmarket
• The Repo market
• the commercial Bill market
• The certificate of Deposits Market
• The commercial paper market and
• Money Market Mutual Funds.

A. The Call Money Market: The call money market refers to the market for extremely short period loans, say one day to fourteen days. These loans are repayable on demand at the option of either the lender or the borrower.

B. Treasury Bill Market: Treasury bills are short term promissory notes issued by RBI on behalf of Central Government for raising fund to meet revenue expenditure. These are issued at discount to face value.

C. The Repo Market: Repo is a money market instrument which helps in collateralised short term borrowing and lending through sale purchase operations in debt instruments.. Under a repo transaction, securities are sold by their holder to an investor with an agreement to repurchase them at a predetermined rate and date. Under reverse repo transactions, securities are purchased with a simultaneous commitment to resll as a predetermined rate and date.

D. The Commercial Bill Market: The Commercial Bill Market is the Submarket in which the trade bills or commercial bills are handled. The Commercial bill is a bill drawn by one merchant firm on the other. The legitimate purpose of a commercial bill is to reimburse the seller while the buyer delays payment. In India, the commercial bill market is highly undeveloped Commercial bills as instruments of credit are useful to both business firms and banks

E. The Certificate of Deposit Market: Certificate of deposits are short term deposit instruments issued by banks and financial institutions to raise large sums of money.

F. Commercial Paper: A Commercial Paper is an unsecured promissory note issued with a fixed maturity, short-term debt instrument issued by a corporation approved by RBI, typically for the financing of accounts receivable, inventories and meeting short-term liabilities. Maturities on commercial paper rarely range any longer than 270 days. The debt is usually issued at a discount, reflecting prevailing market interest rates. Commercial paper is not usually backed by any form of collateral, so only firms with high-quality debt ratings will easily find buyers without having to offer a substantial discount (higher cost) for the debt issue.

G. Money Market Mutual funds: A Scheme of money market mutual funds was introduced by the RBI in April 1992. The objective of the scheme was to provide an additional short term avenue to the individual investors. As the initial guidelines were not attractive, the scheme did not receive a favourable response. The new guidelines allow banks, public financial institutions and also the institutions in the private sector to set up MMMFs. MMMFS have been brought under the purview of-the SEBI regulations since March 2000.