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Chapter: One
At the end of the chapter the student will be able to Map the differences between Finance and Accounts functions in an organisation and explain the integration of these functions Link the short-term and long-term objectives of Financial Management to profitability and wealth maximization respectively Draw the Financial system in India and Differentiate one financial instrument from another
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.
Chapter: One
Ensuring that the funds are available in adequate quantity at appropriate time and at an affordable cost Management of cash in the organisation through cash flow statement Management of investment outside the business enterprise in other organisations Management of risk in dealing with foreign exchange for imports and exports Note: The above list is not exhaustive. Let us examine briefly the above functions with some examples.
Chapter: One
Preparing the cash flow statement for a given period, taking all the cash inflows and cash outflows during the period to determine whether there is a surplus or deficit at the end of the period Arranging for funds from outside especially through a bank with whom the enterprise has loan facilities in case of deficit in the cash flow statement; if on the contrary, the cash flow statement reveals a surplus, dealing with this surplus in a suitable manner (For further details, please refer to chapter no. 7 on working capital management)
Accounts function
Core accounts have to take care of the following areas:
Chapter: One
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 selfexplanatory.
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
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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. 4
Chapter: One
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 longterm 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.
Chapter: One
The statutes governing the various segments of the financial markets The statutory authorities responsible for regulating, supervising, monitoring and controlling the markets and its components The financial intermediaries Special organisations Agents operating in different segments of the financial markets and Financial instruments/securities issued in the markets to raise resources
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. Commercial paper issued by companies and Public Sector Undertakings as part of working capital requirement. This is a promissory note issued by companies requiring shortterm funds (say from 15 days to 180 days or six months). Maximum period is twelve months. The six-month commercial paper can be extended for a further period of six months, making a total of 12 months. Commercial bills discounted by banks and Non-banking Financial Institutions. These are short-term bills usually not exceeding 90-120 days covering commercial transactions in the private sector.
Treasury bills issued by Government of India through the RBI for meeting budgetary deficits. These are for fixed maturity periods of 91 days and 364 days.
Chapter: One
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.
GOI bonds
Various state government bonds Bonds issued by Public Sector undertakings like BHEL etc. institutions Bonds issued by private sector companies, banks and financial Debentures issued by private sector companies Equity share capital issued by private sector companies Preference share capital issued by private sector companies In the case of public issues by private sector companies, banks, financial institutions and mutual funds, Securities Exchange Board of India (SEBI) is the controlling authority. It is referred to as the capital market regulator. However SEBI does not control Government bonds or securities issued by Public Sector Undertakings. GOI bonds and state government bonds are handled and controlled by RBI. Public sector undertaking like Bharat Heavy Electricals Limited (BHEL) come directly under GOI MOF.
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
Chapter: One
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 Board2 (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
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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. 8
Chapter: One
National Bank for Agriculture and Rural Development (NABARD) RBI Institute of Chartered Accountants of India (ICAI) GOI MOF Institute of Cost and Works Accountants of India (ICWA) GOI MOF Institute of Company Secretaries of India (ICSI) GOI MOF Institute of Chartered Financial Analysts of India (ICFAI) GOI MOF Foreign Investment Promotion Board (FIPB) GOI - MOF
Agents operating in different segments of the financial markets The agents operating in the capital market are more. Hence we examine them briefly here. In respect of other segments of the financial markets from a study of the above it will be clear to the students as to who the operators are in the respective segments. Primary market: Merchant banker3 (the principal operator) Share brokers who underwrite4 besides marketing the issue Bankers to the issue who collect the share application money along with the share application forms Advertisement companies and publicity companies Printers for printing the stationery required for the issue Registrars to the Issue who take the responsibility of issuing the securities to successful investors (in case the issue collects more money than the issue size), refund excess money together with interest and getting the securities listed on a Stock Exchange Secondary market: Stock Exchanges controlled and regulated by SEBI Share brokers controlled by respective stock exchanges Depositories National level special organisations coming under the national stock exchanges and assume responsibility
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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.
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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.
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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. 9
Chapter: One
for collating details of ownership of shares issued by a limited company. Depository participants Retail level operators who maintain Electronic Share Accounts of various owners of securities Financial instruments
Already referred to under financial markets above. For further details, please refer to chapter on financial sources
With the help of details given under Indian Financial System, draw the map of Indian Financial system, starting from Government of India Ministry of Finance. Also visit website www.nic.in to know more about the functioning of Government of India Ministry of Finance, its different departments and their functions etc.
2. What is the difference between a share broker and a depository participant? 3. Is there a statute controlling the money markets in India? Who provides the secondary market in the money markets segment? 4. What are the instruments in the money market and capital market? 5. What do you understand by the term underwriting in the capital market? 6. Can you name some NBFCs operating in India? 7. Try to bifurcate the banking sector in India into different segments like private sector, public, co-operative and commercial banks. Further bifurcate the private sector banks into banks of Indian origin and foreign banks. 8. Does ICICI still exist as a Financial Institution? If not, why?
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