Professional Documents
Culture Documents
Chapter: One
Contents
Finance function as different from Accounts function
Objectives of Financial Management – short-term and long-term
Financial system and markets in India – Government of India, Ministry of Finance at the helm, statutes,
statutory authorities, financial intermediaries, other financial institutions, agents who operate in the
markets etc.
Brief introduction to “Financial Instruments”
Introduction
Financial Management is an integral part of Business Management. Finance is one of the key functions in an
organisation. The other key functions in an organisation are:
Production
Human Resources
Marketing
Each of the above function has got sub-divisions – for example Production has maintenance, Administration has
purchases etc.
Finance deals with financial resources. Financial management as a corollary would deal with management of
financial resources and related areas.
Management of risk in dealing with foreign exchange for imports and exports
Note: The above list is not exhaustive.
Accounts function
Core accounts have to take care of the following areas:
Maintaining accounts on a regular basis for all items of income, expenditure, assets and liabilities
Conforming to Generally Accepted Accounting Practices (GAAP – India), Accounting principles, Various
Accounting standards of the Institute of Chartered Accountants of India (ICAI), Requirements under the
Companies’ Act like following “Accrual system of accounting” (as opposed to cash system of accounting),
Requirements under The Income Tax Act while maintaining the Accounts of the limited company
Finalisation of accounts at the end of the accounting period (financial year) and preparation of final accounts
in the formats prescribed in the Companies’ Act – Schedule VI after claiming depreciation as per provisions
of Companies’ Act – Schedule XIV
Conforming to provisions relating to Advance Tax payment in four instalments – first instalment by 15/6,
second instalment by 15/9, third instalment by 15/12 and the last instalment by 15/3.
Conforming to provisions relating to statutory audit of accounts under the Companies’ Act
Preparation of revenue and capital budgets
Management Information System (MIS) relating to Accounts and Finance
Note: Further details on the above are not given here as they are outside the scope of textbook on “Financial
Management”. As the students can see, most of them are self-explanatory.
Long-term objective
The long-term objective of financial management is to increase the wealth of the shareholders. The term “wealth”
refers to various business assets of the enterprise that are free of debt. This means that this wealth belongs to the
equity shareholders. It is often reflected in the “book value” of the share as reflected in the balance sheet.
The formula for book value is:
Equity share capital + Reserves and Surplus
Number of equity shares issued
This can be explained through an example.
Example no. 3
Equity share capital = Rs. 100 lacs (paid up capital)
Reserves and surplus = Rs. 200 lacs
Number of shares = 10 lacs with the Face Value being Rs.10/-
Then the book value of the share would be = Rs. 100 lacs + Rs. 200 lacs = Rs. 30/-.
10 lacs shares
This means that at the starting point the book value was Rs.10/- and this has gone up to Rs. 30/- due to the prudent
policy of the management of retaining profits within the organisation. Thus the short-term objective also is a
contributory factor to realising the long-term objective of wealth maximisation.
Some of the measures through which we achieve the long-term objective are:
Strategic financial management decisions relating to expansion, take over of another business, financial re-
restructuring through financial re-engineering (example – swap a costly loan for a cheaper loan provided
the credibility of the firm is quite high), joint venture etc. Thus while profitability reflects the operating
efficiency wealth maximisation reflects the managerial/entrepreneurial efficiency.
To sum up, both short-term objective and long-term objective need to be put in place for sustained growth of a
business enterprise. To an extent at least, the long-term objective is dependent upon the short-term objective of profit
maximisation.
1
Carrying too much liquidity involves cost. This cost is referred to as “opportunity cost”. It simply means that by carrying too much liquidity,
the business enterprise has foregone an opportunity of getting a return on such amount that it will have got by employing the funds in business.
On the contrary, carrying too little cash is also risky as the enterprise may not be able to fulfil its obligations to creditors etc. in time.
Segments of money markets: Call money market exclusively for banks to be borrowers – inter-bank operations
for a very short period. One day to fourteen days. Fourteen day borrowing is in
the notice money market that is also a part of the Call Money Market. Only
scheduled commercial banks are permitted to be borrowers in this market. While
some banks will be borrowers, some others will be lenders. There is no specific
market place. Deals are done over the phone.
Segments of money markets Commercial paper issued by companies and Public Sector Undertakings as part
of working capital requirement. This is a promissory note issued by companies
requiring short-term funds (say from 15 days to 180 days or six months).
The Reserve Bank of India controls the money markets in India. It is known as money market regulator.
Primary market
Primary market in the money market is wherein the Institutions requiring funds issue securities like treasury bills
and get finance and there is no specific market place excepting in the case of treasury bills. RBI conducts auction of
treasury bills after due notice in national dailies and hence this can be construed as the “market place”.
Secondary market
The secondary market is provided by Discount and Finance House of India Limited (DFHI) a subsidiary of RBI. It
provides a two-way quotation, one for purchasing money market instruments and another for selling money market
instruments. For example, a holder of Treasury bill of Government of India can sell it to DFHI and anyone wants to
purchase treasury bills, he can approach DFHI who can sell it to him. There is no secondary market for call money or
notice money market.
Primary market
There is no specific market place for this. This again, like in the case of money market, facilitates issue of securities by
those who require funds in the medium to long-term. The public issue process is supervised and controlled by the
lead merchant banker/bankers in the case of all public issues. Primary market ends with the listing of securities on
stock exchanges by the Registrar to the Issue. Details of operators in the primary market have been given under
“Agents operating in financial markets”.
Secondary market
The secondary market begins with the listing of securities on the stock exchanges by the Registrar to the issue. It has
a market place in the form of stock exchanges. Its operations are through share brokers who are registered with
respective stock exchanges. The stock exchanges in turn are controlled and regulated by SEBI. Details of operators in
the secondary market have also been given under “Agents operating in the financial markets”.
Statutes governing the various segments of the financial markets and the statutory authorities
Statute means an Act passed either by the Parliament or State legislature.
Money market – No specific statute – controlled by RBI
Capital market – Securities Contracts Regulations Act and Rules as well as SEBI regulations for the various operators
in the Capital market – controlled by SEBI. Mutual Funds also come under the Regulations of SEBI.
Insurance – Insurance Regulatory and Development Act (IRDA) – controlled by the Insurance Regulatory and
Development Authority coming under GOI, Ministry of Finance
Banking – Banking Regulations Act controlled by RBI
Non-banking Financial Companies (NBFCs – example Kotak Mahindra Finance Company Limited) – Non-Banking
Financial Companies Act of RBI
Functioning of limited companies registered in India – The Companies’ Act – controlled by the Company Law Board 2
(CLB) coming under GOI, Ministry of Finance. The principal officer is known as “The Registrar of Companies”
(ROC).
Foreign Exchange market – Foreign Exchange Management Act and Exchange Control Regulations Act both coming
under the RBI
Some segments of the financial markets like the Indian companies accessing international markets come directly
under the GOI, Ministry of Finance
Special organisations
These come under one of the financial market regulators or directly under GOI – Ministry of Finance
All-India Financial Institutions – GOI – MOF
Central Board of Direct Taxes – CBDT – GOI – MOF
Stock Exchanges – SEBI
National Bank for Agriculture and Rural Development (NABARD) – RBI
Institute of Chartered Accountants of India (ICAI) – GOI – MOF
2
Company Law Board is primarily responsible for conduct of the affairs of limited companies registered in India under the Companies’ Act. The
difference in roles of CLB and SEBI is that the latter is mainly concerned with issue of securities in the capital market protecting the interests of
various kinds of investors. SEBI is not controlling The Companies’ Act while CLB is not controlling the SCRA. They play complementary roles.
3
Merchant banker controls the Primary market and is fully responsible for the issue of public securities like equity shares, debentures, bonds etc.
the capital market instruments. He is the principal operator and controls and monitors all the other operators in the capital market. He is fully
accountable to SEBI for the smooth conduct of the operations in the capital markets. He has to ensure 100% conformity with SCRA rules and
regulations as well as SEBI rules and regulations.
4
Underwriting in the capital market means giving an undertaking to invest money in securities issued to public should the issue fail to collect
the required amounts as per SEBI rules and regulations. Underwriting as such does not involve any funds and hence is referred to as “fee based
activity”. However once the issue fails to collect the required amount, the underwriter is expected to make good the deficit amount to the extent
undertaken by him.
5
At present, we have two depositories operating at the national level – National Securities Depositories Limited (NSDL – owned by the National
Stock Exchange) and Central Depository Services Limited (CDSL – owned by the Bombay Stock Exchange). As per capital market regulations,
in the secondary market, the securities can be sold only in the “demat” or electronic form and not in the physical form. Accordingly under the
national level depositories, depository participants operate at the retail level. They maintain the individual demat accounts on behalf of the
shareholders and investors of other securities. These demat accounts are often referred to as “Electronic Share Accounts”. The DPs transfer the
data from the retail level to the national level depositories who in turn collate information about ownership of securities and submit data to the
signatory companies with whom they have signed contracts.